The Case of Segregated versus Mass Balance

Abstract

An explanation of the different RSPO supply chains is important in order for different companies to identify which model they will implement within their business model. This case study aims to clarify the differences between a segregated supply chain model and the mass balance supply chain model. This information can, in turn, assist other companies in ensuring that sufficient feasibility studies are carried out to help them decide on which business model is more feasible and appropriate for their company. This could very well be one of the more important decisions a company makes regarding its choice for sustainability.

Key words: Supply chain, mass balance, segregated, RSPO sustainable oil, business models, and premiums

Background situation

Segregated versus mass balance?
A segregated supply chain model is one where all sustainable products, from the source to the end product, remain separate from non-sustainable products throughout the entire supply chain; for example, the fresh fruit bunches (FFBs) from the plantation of a certified grower are not mixed in with the fruits from a non-sustainable grower. The fruits are kept separate at the mill level, so the non-sustainable fruits are processed at a different milling site. This ensures that segregated crude palm oil produced at the mill is not contaminated by fruit from uncertified plantations so remains 100% certified sustainable. Segregated palm oil is then transported and refined separately from uncertified palm oil, ensuring that all segregated certified sustainable palm oil (CSPO) that is eventually sold to the end user remains segregated along the whole supply chain.

The mass balance supply chain model is one where certified and non-certified materials are mixed together at any section of the supply chain, often due to low volumes of CSPO and for efficiency. This differs from the segregated model because it requires no clear change in the business model of a company which purchases non-sustainable materials from a third party. To ensure that a company is selling the projected amount of certified materials, a mass balance accounting sheet is created wherein the percentages of certified materials and non-certified materials are measured for each estate through a clear and transparent process. This provides assurance that the CSPO that is being sold will never be more than what a miller can actually produce. With these percentages calculated, a company is able to sell the same amount of certified material as produced or purchased at the CSPO price even though the downstream user might only be able to purchase a mixed non-segregated palm oil for use in their products.

Options and action

Challenges
The RSPO offers a few options along the supply chains to companies that want to comply with its standards but do not produce a sufficient volume of CSPO or have the capacity to only process segregated CPSO; these include the Mass balance, Segregated, and GreenPalm Book and Claim mechanisms. At this early stage of sustainable palm oil development, where there are few segregated mills, transportation facilities and refineries,  there remains the need for these various supply chain options to accommodate different markets and to meet different customer requirements and end-use applications. As with any process, each of these supply chain options has advantages and disadvantages, and the choice of different supply chains is often dependent on the costs of implementation and the benefits and feasibility of implementation due to company constraints.

In the four years since the inception of the RSPO Principles and Criteria in November 2007, physical CSPO has remained inaccessible to many markets at competitive prices due to the lack of infrastructure along the supply chain. One of the major challenges the industry faces in stimulating change in practices is that demand does not meet supply of CSPO, resulting in a surplus. Currently only approximately 50% of CSPO in the market is bought, leaving a 50% surplus of CSPO; therefore companies making the investment in sustainable practices are not seeing a return on their investment. As a result of this, for most players in the industry it is not economically or administratively feasible to set up a fully segregated supply chain.

Often the biggest variable that a company needs to assess when moving towards producing and or using CSPO, is whether or not their business model allows for segregation. Just because a company has the capital to implement a segregated business model does not necessarily mean that their operations will actually be able to handle it and the dual production required when a company purchases a portion of their FFBs from uncertified sources. The company will face difficulties when attempting to segregate this oil from the CSPO at the milling and refinery stages. If a company owns all their plantations, then the business case for segregation becomes much more viable and the model becomes more realistic as the costs become smaller.

In countries such as Indonesia and Malaysia, where it is a requirement by law for mills to accept a certain percentage of oil palm crops grown by smallholders, the issue of segregation from the harvest point becomes more complex. Smaller holders are currently unlikely to be RSPO certified, making the possibility of segregation extremely challenging. This issue has proven to be the biggest barrier to companies who wish to move towards segregation but currently receive a large amount of their fruit from an outside, uncertified supply base.

If a company is not bound by legal or other requirements to receive outside crops, then it can decide if it wants to continue its sourcing relationship with those non-certified outsiders. If the company does wish to continue the relationship then it must either set up a duplicate operation or divert the crop to another mill. The mill may, in turn, run at a lower capacity due to the diversion of FFBs and the transport distance; this will raise the costs significantly, making the profit from the premium almost non-existent. If the company only sources FFBs from sustainable sources, an intangible asset will be lost—that is, the relationship built up with a supplier—and the local communities can lose an important revenue source. The premiums may also be diminished through the changing of business models if not planned correctly.

Benefits and business model choices
There are of course monetary incentives and benefits associated with both supply chain models. Segregated oil will offer a higher premium over mass balance oil as well as being much more streamlined. Another less tangible benefit to the buyers is that the supply chain is ‘green’, simple and transparent. They can trace the CSPO from source to their products and can therefore claim that they source wholly certified sustainable palm oil. This is the goal of many large downstream players, to allow them to meet their commitments to source 100% CSPO by 2015.

To achieve this, companies must evaluate which supply chain they can actually implement within the constraints of the capital available, because currently the premiums they receive will not offset their total costs, particularly in the short term.  Decision making models can be tailored to better analyse which of the supply chain options is currently more favourable for each individual site.

Outcomes and conclusion

Driving forces
The main driving forces pushing an upstream producer company to choose between the different supply chain options are its business model and the type of sustainable palm oil that the downstream market demands. It would be foolish to choose only segregation if the company’s business model could not accommodate it. Likewise, supplying segregated CSPO would be very costly if there was no market demand for it.

  • Running a mass balance model does not impact operations as heavily as if the company were to implement a segregated model. This is because adopting the mass balance model does not require a business to change its operations drastically. Each estate that was certified sustainable would have to integrate sustainability practices into its operations, but the mills and refineries could still be used to maximum efficiency.
  • Segregation on the other hand would likely require a company to sever ties with old suppliers that are not certified and incur significant costs in segregating their mill and refinery lines. Alternatively, if the site and location were suitable, a company could partner with another company with better capability for a segregated business model from the plantations to the mill line, assuming their combined volume of produce would be enough to run a mill processing purely CSPO. It could also commit to providing or cooperating in the segregation of shipping transport options and downstream certified refinery sites.

Impact of moving towards segregation on upstream and downstream stakeholders

  • Upstream: Many smallholders do not have the capital or manpower to implement RSPO certification costs and thus can potentially be cut out of companies’ supply base. Companies need to work in tandem with the smallholders that supply a mill or refinery to build up their capacity and assist them in reaching sustainability requirements.
  • Downstream: Being certified at the refinery level allows sellers the option of supplying many different sustainable materials to the market. In turn, this minimises the excuse of a non-existent or minimal supply of downstream materials.

Performance indicators

  • Performance indicators are vital indicators of success and are necessary to highlight the profits of sustainability. Premiums should offset the costs of implementation, and benefit-cost analysis studies should be done through feasibility reports.
  • When these premiums are realised, they should not only be kept at the corporate level but must also be redistributed to the operators of the work on the ground. This is their incentive to continue the work at hand. Many times, premiums are only distributed to the commercial arms of companies and plantations, and mills and refineries are forgotten. The operations are the reason the commercial teams have a sustainable product to sell and they must be rewarded accordingly.

High capital and market manipulation

  • Companies need high capital to implement segregated supply chains, so this may lead to market manipulation by the big players.
  • The big players in the industry tend to have an advantage over the smaller players, especially in terms of market reach and capability. If sustainability is to be reached by all, large players need to begin to include smallholders in their sustainability schemes by helping them to achieve certification. Not only will this help the small farmer or the single miller, but it will bring rewards to the large company as well. Most likely, those single millers or smallholders will sell their certified materials to the company that has assisted them in obtaining certification. This increases the company’s volume of material and it moves the industry towards greater sustainability.

Lessons learned
The choice between mass balance and segregation is highly dependent upon the business model of the company; therefore companies must take time and assess which model is most suitable. This choice must be made as a unified decision within a company.

The major hindrances are the uncertified supply bases upstream, which will require companies to invest in getting smallholders certified or risk cutting off their supply base. Ultimately this could result in their mills functioning under capacity or their business model becoming unfeasible due to a higher cost-benefit ratio. Also, smallholders always ask what they can gain from being certified. They cannot afford the costs of certification, which must be borne by the companies, and most smallholders do not wish to be bound to one mill or one company.

Prepared by: Joshua Chang Parulian and Calley Beamish
Positions: Supply Chain Executive and Senior Sustainability Manager
Organisation: Wilmar International Ltd
Date:  29th August 2012