Although oil palm trees need plenty of water, too much water can trigger an overdose (especially in case of floods) while denying the trees the necessary sunlight. As a result the trees will become less productive. If the La Nina weather phenomenon will become increasingly strong toward the end of the year, then Indonesia's total crude palm oil (CPO) production can drop by 5 percent (y/y) in 2016.

According to the latest data from the Indonesian Palm Oil Producers Association (Gapki), Indonesia produced 15.3 million tons of CPO in the first half of 2016, while exports stood at 12.5 million tons.

One of the problems related to Indonesia's palm oil industry is that farmers tend to use weak cultivation techniques that result in non-optimal production practices. For example, the distance between trees is often not ideal, while the seeds and fertilizers that are used are of low quality. Apart from the lack of expertise, the smallholder farmers also lack the financial resources to invest in the optimization of production.

The Indonesian government is still busy drafting a moratorium on new palm oil concessions. In April 2016 Indonesian President Joko Widodo ordered Environment and Forestry Minister Siti Nurbaya to issue this moratorium to safeguard the environment. Since the devastating forest fires (and toxic haze) in June-October 2015 Indonesia is more and more criticized for its environmental and forestry policies as well as weak law enforcement and monitoring. Widodo said he does not want to curtail domestic production of CPO (a key foreign exchange earner and provider of millions of jobs in Indonesia) but wants further output growth to be achieved by increasing productivity of existing palm oil plantations, not by adding new plantations.

Earlier this month palm oil planter National Sago Prima, unit of Sampoerna Agro, was given the largest ever fine by a Jakarta court for its negligence related to fires on 3,000 hectares of its concessions in Riau (Sumatra) in 2014. According to the court ruling the company needs to pay IDR 1.07 trillion (approx. USD $82 million) in fines. It was the largest fine that has been handed to a company related to forest fires. It remains unknown whether National Sago Prima will appeal the decision.

Meanwhile, Singapore recently passed a law that allows authorities to prosecute Indonesian citizens involved in the annual toxic haze (usually around August) that is caused by the slash-and-burn practices of peatlands and forests on the islands of Sumatra (and Kalimantan).

Looming tightening CPO supply implies that palm oil prices should get a lift. However, a significant price hike may only be felt next year as prices are expected to remain at the current range of USD $600-$700 per metric ton in the remainder of 2016. But if Indonesia remains committed to its biodiesel program, it could boost palm oil prices further. Southeast Asia's largest economy is eager to boost biodiesel usage within the country in order to reduce oil imports, cut greenhouse gas emissions and create more demand for the oil by requiring a minimum 20 percent of bio content in diesel fuel in 2016.

Indonesian Palm Oil Production and Export Statistics:

  2008 2009 2010 2011 2012 2013 2014 2015  2016
(million tons)
 19.2  19.4  21.8  23.5 26.5  30.0  31.5  32.5  30.0¹
(million tons)
 15.1  17.1  17.1  17.6 18.2  22.4  21.7  26.4  24.0¹
(in USD billion)
 15.6  10.0  16.4  20.2 21.6  20.6  21.1  18.6  16.0¹

¹ indicates forecast
Sources: Indonesian Palm Oil Producers Association (Gapki) & Indonesian Ministry of Agriculture