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Malaysia Pits Palm Oil Against Fighter Jets in EU Trade Spat

A palm oil farmer displays palm oil seeds in Kampar, Riau province, Aug. 20, 2018. Indonesian palm oil farmer Kawal Surbakti says his livelihood is under attack: The EU Parliament is moving to ban the use of palm oil in biofuels.
A palm oil farmer displays palm oil seeds in Kampar, Riau province, Aug. 20, 2018. Indonesian palm oil farmer Kawal Surbakti says his livelihood is under attack: The EU Parliament is moving to ban the use of palm oil in biofuels.

As the United States and China tussle over tit-for-tat tariffs, another trade spat between West and East is quietly playing out, one pitting Malaysian palm oil against European fighter jets.

When the European Union announced in March that it would phase out the use of palm oil as a transport biofuel by 2030 over environmental concerns, the world's two largest palm oil exporters — Indonesia and Malaysia — were quick to react, threatening to lodge complaints with the World Trade Organization.

Malaysian Prime Minister Mahathir Mohamad told Reuters that the EU risked starting a trade war over "grossly unfair" policies that smacked of protectionism, then named the first potential casualty. He said that if the EU went through with the phase-out, Malaysia would turn away from European defense contractors and look to China to fill its order for new fighter jets, a deal likely worth upwards of $1 billion.

It remains to be seen how Malaysia's brinkmanship will play out.

The Malaysia Palm Oil Council warns that the new EU rules could deliver a "significant" blow to the industry, which it says contributed 6% to the country's GDP in 2017. Upwards of 12% of the palm oil it exports goes to the EU, its second largest market after India. China comes in a close third.

The EU rules mean member states will not be able to count biofuels derived from palm oil toward their renewable energy targets because of the deforestation the crop is driving. Malaysia says the forest-loss reports are overblown.

Either way, Malaysia's gambit was not likely to change EU policy, said Peter Mumford, head of Southeast Asia coverage for the Eurasia Group, a political risk consultancy.

"First, European countries will not want to be seen to be arguing against a policy which, in Europe at least, is seen as positive in terms of promoting environmental sustainability," he said.

"Second, even if one or two of the countries which might wish to sell jets to Malaysia decided to argue for a change in EU policy, it is not clear how much impact they could have as the issue is being promoted by the European Commission and European Parliament."

And barring some exceptions, Mumford said, Indonesia's and Malaysia's threats to shun EU products — fighter jets and otherwise — will carry only modest weight with the many bloc members who sell relatively little to the Asian neighbors.

Fight for palm oil

Shankaran Nambiar, a senior research fellow at the Malaysian Institute of Economic Research, said Mahathir might still want to play hardball as a matter of principle.

He said Malaysia's palm oil exports to the European Union "are not trifling figures. But I think beyond the quanta that is at stake, it is the perception that the EU is biased against palm oil."

Nambiar said Malaysia could also count on China, Russia and others to pick up some of the slack from the EU and that they were more likely to agree to offsets — to barter their products for Malaysia's.

Malaysian Defense Minister Mohamad Sabu has told reporters that China, Russia and others might be willing to trade defense equipment for Malaysia's palm oil. A faltering economy and heavy public debt make a swap all the more attractive for Malaysia.

With that in mind, Nambiar said, "the prime minister probably thinks that a tit-for-tat strategy is not out of place.”

"If the EU won't buy Malaysian palm oil, then Malaysia will not buy European jets unless they are financed by palm oil offsets. This implies payment through palm oil. The logic runs as follows — If the EU wants to do business with Malaysia, it will, one way or the other, have to buy palm oil from Malaysia. If the EU won't, it doesn't matter because there are other countries that will."

Offsets have been part of Malaysia's trade playbook for decades, but no so much with the European Union.

Jon Grevatt, an Asia-Pacific defense industry analyst at Jane's, said Malaysia may find it hard to get its hands of European fighter jets if it insists on swapping palm oil but added that the country has proven willing to barter with a wide variety of products and commodities in the past.

Trade with other countries

China and Russia have also proved willing to barter, and their jets would come far cheaper than Europe's. But Grevatt said there was little talk of buying from China in March at the latest Langkawi International Maritime and Aerospace exhibition, one of the premier events of its kind in the region. And he said the catch with Russia was the Countering America's Adversaries Through Sanctions Act (CAATSA), a U.S. law that imposes penalties on countries that make major defense purchases from Russia.

But Grevatt said Malaysia was probably five to 10 years away from actually buying the light fighter aircraft it was looking for, about the same time the EU's phase-out of palm oil will truly start to bite. And if Malaysia still insisted on trading with palm oil, he added, there would likely be ways around the new EU rules.

Palm oil is used in a broad range of products, from instant noodles to soap. And the EU rules do not bar its import per se, only its use in biofuel to meet renewable energy targets, and even then with caveats.

"If you were to go to countries like Sweden — and also SAAB, which is obviously from Sweden — as I have done, and ask SAAB, 'So obviously, that would rule you out, then, wouldn't it, SAAB? You cannot trade with Malaysia on palm oil.' They will tell you that they will find a way. They will tell you that there are ways and means of ... agreeing to requirements in terms of palm oil without it stopping major defense deals," he said.

"There is so many ways of getting these things done that no one is going to die in a ditch over palm oil if it means that Malaysia could go ahead and buy a major defense system such as a light fighter aircraft from Europe. There will be ways around it, there is no doubt about that."