Rising food prices and a government drive to develop Indonesia’s commodity processing sector will lure more firms to invest in palm oil products in the world’s top maker of the oil, despite erratic power, bad roads and aging ports that complicate the task of processing and moving goods.
Record food prices may have hurt many emerging market nations, but Indonesian producers of the edible oil have seen margins rise and are giving the green light to more investments.
Government plans to spend nearly one-third more funds this year to refurbish power and transport facilities are also a potent draw, analysts say.
Firms such as the world’s biggest food group, Nestle, and top listed palm producer Wilmar are also eyeing growing domestic demand in the region’s biggest economy and government tax incentives to attract manufacturing.
The new investments, which amount to around $1.2 billion so far, will slowly cut Indonesia’s exports of crude palm oil to a market already at three-year highs and boost profits at Indonesian firms as they snatch a greater share of processing from main player Malaysia.
“It’s a trend we’re seeing,” said Andreas Bokkenheuser, an analyst at UBS. “It follows high crude palm oil prices, which have increased the profitability of the plantation companies significantly, and a lot of that money is being reinvested.”
The benchmark May crude palm oil contract on the Malaysia Derivatives Exchange hit a near three-year high at 3,967 ringgit ($1,307) last week on worries about the impact of rains on output.
Prices have gained about 50 percent over the last six months and analysts see further gains in the short term.
Indonesia plans to offer fiscal incentives and restructure its export tax policy on crude palm oil, after it steadily hiked the tax to 25 percent in February from just 3 percent a year ago, to do more to spur downstream processing in the country.
The government said this month that Wilmar would invest $900 million to build factories in Indonesia to produce palm products such as soap and margarine. Wilmar has a total area of more than 235,000 hectares in the country and also plans to develop a 200,000-hectare sugar plantation in Papua. Nestle will put $100 million into a new factory to make Milo beverages and infant cereals to tap an emerging middle class, while Germany’s Ferrostaal will invest $100 million to $150 million in downstream palm oil.
“These plans have likely been in the works for quite some time, but a combination of factors could have triggered the investment decision, including the recent spike in prices,” said Chen Xin Yi, an analyst at Barclays Capital.
Analysts said other candidates for downstream investments in Indonesia were palm producers Indofood Agri Resources and Sinar Mas, as well as food firms such as Unilever.
Such moves reflect increasing confidence by investors in Indonesia, where the economy grew an annual 6.9 percent in the fourth quarter of 2010, the strongest pace in six years. Total investment grew by 54 percent last year, with foreign direct investment rising 52 percent as firms put money into plants to make goods or to extract resources.
The country is still reliant on exports of raw materials and aims to move up the value chain. Rival palm producer Malaysia sells mostly higher-value refined products.
Indonesia exported 15.6 million tons of palm oil products in 2010, with byproduct exports at 6.8 million tons and crude palm oil at 8.7 million tons, according to the Association of Indonesian Palm Oil. Global palm output is 45 million tons.
Indonesia outpaced Malaysia to become the top palm oil producer in 2007, though the move toward the downstream comes as firms may now face slower upstream expansion as a planned two-year moratorium on forest clearance aims to curb greenhouse gas emissions from rampant deforestation.
Buyers are already increasingly relying on Indonesia for processed palm oil whenever Malaysia has a shortage.
China, the biggest buyer of palm oil, also used as cooking oil, took up twice as many Indonesian cargoes as Malaysian ones in December, extending a trend that began in November.
However, manufacturers aiming to expand in the archipelago have to grapple with power shortages, a lack of roads and aging ports that make it hard to process and transport goods.
Investors hope a new land bill will be implemented this year to speed land acquisition for infrastructure projects.
“It is an issue, especially the road network,” said Tristan Price, group finance director at Indonesian plantation company M.P. Evans Group. “Over the last four or five years, the average journey time has increased. It doesn’t encourage you to go and visit plantations and makes it harder to attract good staff.”
The Dumai region on northern Sumatra island is one area earmarked by the government for downstream palm oil development, but investors are hoping for better railways and ports.
The government plans to increase infrastructure spending by 28 percent this year to $13.6 billion, though it is still relying on private investment for two-thirds of its needs. It has already drawn billions in commitments from Japan and India.
“Now there is a strong, aggressive move within the government to change land reform,” Bokkenheuser said. “That would be very, very positive for both the plantations and mining industry.”