How Are Global Supply Chains Responding?
The European Union aims to raise the global bar with new Deforestation Regulations. Effective since June of 2023, the regulations ban imported goods that stand to profit off of deforestation practices. By devaluing and even penalizing these practices, the EU hopes to create a commodity trade standard that will reverse the effects of deforestation. They predict 177,920 acres of forests, or one quarter of Rhode Island, will be saved in 2025, and are optimistic that these steps will reduce air pollution.
Soy, palm oil, beef, coffee, and cocoa trades are expected to experience a significant impact due to these new requirements. Brazil, Argentina, Malaysia, Indonesia, Canada and parts of Africa are on edge as they consider trading options. Some argue this is the beginning of a new era, while others see it as a reorganization of supply chains.
Complexities of EU Regulations
For companies working to meet regulations, the process is complex. While individual companies must produce data to receive deforestation- free certification, entire supply chains must be vetted. Each industry faces unique obstacles. Soy, for example, goes from farm production, and is then transported to processing facilities, then moved onto crushers, then to product manufacturers, and finally to retailers. If at any point in the process operations have made use of deforested land, the trading company could be banned from exporting goods to EU countries. Palm oil batches typically mix fruit from many sources at once. Many of these companies can only trace a product after it has been processed and would need to develop brand new traceability methods to meet requirements.
Meeting the new regulations requires an investment in technology and manpower. In order to make products fully traceable many companies are purchasing GPS technology that allows them to accurately map and consistently monitor their farms. Similarly, if products must be tracked and segregated from planting all the way to a grocery store shelf, digital tracking technology will also be needed. Guaranteeing deforestation-free methods must include in person inspections done by real people traveling from farm to farm to see operations up close.
It’s a time consuming process to build out this framework, but one that many companies deem both valuable to the global environment and financially lucrative in the long run. Decisions involve farmers, transportation companies, processing plants and manufacturers, but they also must include government policy, technology and in some cases legal crossroads. There is no overnight shift, but rather a development of practices.
A Supply Chain Split
Already many companies are rerouting supplies to other buyers and avoiding EU regulations altogether. The trend prompts speculation that the new requirements will not raise the bar, but simply split or change the flow of supply chains. Brazil could turn to China as a new soy buyer and Indonesia could potentially trade palm oil to Africa. We’ve seen substitute shifts like these in the past with the U.S.-China trade war and sanctions on Russian energy. It may prove simpler and more cost effective to change buyers rather than invest in meeting new EU regulations. Many of these companies have little ability to enforce downline or upline adherence to regulation and they fear penalties.
Interestingly, in 2020 Brazil produced ⅓ of the world’s soy, but only 13% of crops account for 95% of the deforestation that occurred that year. The other 87% appear to have been produced on grassland and savannah areas. The scenario is true elsewhere and begs the question; will this create a new environmental imbalance that puts stress on other ecosystems? Companies looking to meet regulations could potentially exploit approved farming areas by over farming them.
Demand For a Different Type of Supply
Will it be harder to secure buyers or much used commodities? For the EU, value is placed not just on the product, but how it is sourced. The decision will impact both consumers and European agriculture.
European countries are braced to experience a decreased supply of things like chocolate and coffee. But, exactly how increased operating costs will be absorbed remains uncertain. Typically consumer prices reflect production cost increases, but in this situation one or more points along a supply chain may need to take ownership of costs to ensure tradability. The result, at least in the initial stages, would be lower profit margins for most of these companies and possibly higher purchase prices for consumers.
Several European countries are seeking reduced regulations and maintain that the current requirements are virtually impossible for small and medium sized farms to accommodate. They also argue that these regulations negatively impact many of the current sustainability processes farmers are working to implement for the sake of biodiversity, crop and grazing rotations. Farmers worry that they will not be able to produce the soy meal needed to feed their own livestock and that the EU will become too reliant on exports which would negatively affect the European ag sector.
Good News For U.S. Producers
The EU is not alone. Other countries have similar environmentally focused goals and policy in the works to support these goals. The United States has seen a growing consumer demand for traceability, prompting many businesses to begin the process of leveraging technology and better communication up and down supply chains to help customers make informed decisions.
The Forest Act of 2023 was birthed out of the same desire to stabilize regions of the world that have suffered from illegal deforestation and offer opportunities for many industries and individual businesses to clean up their processes. If it goes into effect, the Forest Act would be very similar to the EU’s Deforestation Regulation; banning products that have been produced on illegally deforested land and penalizing unmet requirements.
Many American operations are positioned to receive deforestation-free certification. Several top soy producers are predicted to meet regulations and be granted access to the EU markets. A welcome relief to farmers who have faced narrowing markets in recent years.
Exactly how competitive this “new” market will be, only time will tell. Traceability efforts take time. Unless trade lines were already working toward deforestation-free goals, it will take years for many of these supply chains to implement methods that meet EU regulations. In the meantime, it’s highly likely that global trade negotiations will be impacted and supply chains will shift in response to the environmental standard.