Sustainability  Risk  Analysis  |  Fires  Burn  SE  Asian  Assets  |  December  2015  

Disclaimer:  This   report   and   the   information   therein   is   derived   from  selected   public   sources.   Chain   Reaction   Research   is   an  unincorporated   project   of   Climate   Advisers,   Profundo,   and  Aidenvironment   (individually   and   together,   the   "Sponsors").  The   Sponsors   believe   the   information   in   this   report   comes  from  reliable  sources,  but  they  do  not  guarantee  the  accuracy  or   completeness   of   this   information,   which   is   subject   to  change  without  notice,  and  nothing   in  this  document  shall  be  construed   as   such   a   guarantee.   The   statements   reflect   the  current   judgment   of   the   authors   of   the   relevant   articles   or  features,   and   do   not   necessarily   reflect   the   opinion   of   the  Sponsors.   The   Sponsors   disclaim   any   liability,   joint   or  severable,  arising  from  use  of  this  document  and  its  contents.  Nothing  herein  shall  constitute  or  be  construed  as  an  offering  of   financial   instruments   or   as   investment   advice   or  recommendations  by  the  Sponsors  of  an   investment  or  other  strategy   (e.g.,   whether   or   not   to   “buy”,   “sell”,   or   “hold”   an  investment).  Employees  of  the  Sponsors  may  hold  positions  in  the  companies,  projects  or  investments  covered  by  this  report.  No   aspect   of   this   report   is   based   on   the   consideration   of   an  investor   or   potential   investor's   individual   circumstances.   You  should   determine   on   your   own   whether   you   agree   with   the  content   of   this   document   and   any   information   or   data  provided  by  the  Sponsors.  

Chain  Reaction  Research  1320  19th  Street  NW,  Suite  400  Washington,  DC  20036  United  States    Website:  www.chainreactionresearch.com  Email:  cushing@climateadvisers.com    Authors:  Eric  Wakker  Jan  Willem  van  Gelder  Joel  Finkelstein  Ben  Cushing  

Financial  Risks  Discussed  In  This  Report:    Golden  Agri-­‐Resources  Ltd.  ..............  GR:SP  IOI  Corporation  Bhd  .........................  IOI:MK  PT  Garuda  Indonesia  Tbk  .................  GIAA:IJ  PT  Austindo  Nusantara  Jaya  Tbk…..  ANJT:IJ  Genting  Bhd  .................................  GENP:MK  JM  Corporation  Bhd  ......................  IJMP:MK  First  Resources  Ltd.  ............................  FR:SP  PT  Eagle  High  Plantations  Tbk…....  .  BWPT:IJ  Wilmar  International  Ltd  .................  WIL:SP  POSCO  ........................................  005490:KS  

   

FIRES  BURN  SE  ASIAN  ASSETS    

Indonesian  Government  Growth  Down,  Corporates’  Earnings  Uncertain    

 Key  Findings    

• Ineffective  governance  drives  fires  resulting  in  industry  anxiety  • Analysis  projects  Indonesian  government  could  lose  USD  35  billion  in  revenue  • Investors  sell  shares  • Supply  chain  contracts  now  in  question  • Government  agencies  question  license  to  operate  • Casualties  cause  potential  future  health  risk  liability  

 Financial  Consequences  Result  from  Burning  Through  Assets  

Across  Indonesia,  an  area  half  the  size  of  Switzerland  burned  in  less  than  four  months  this  year,  with  investors’  capital  going  up  in  smoke.  From  July  1st  to  October  20th,  2015,  97,000  fires  were  detected  in  Indonesia,  and  over  two  million  hectares  of  forest  caught  fire,  one-­‐third  of  which  were  High  Carbon  Stock  peat  forests.1  Sumatra  and  Kalimantan  were  hardest  hit  with  over  800,000  ha  burnt  each.  Papua  has  over  350,000  ha  of  land  burnt.2   Investors   may   lose   money   as   ineffective   oversight   and   enforcement   by  plantation  companies,  as  well  as   local  and  national  government,  has  allowed   fires   to  burn  without  proper  control  measures  in  place.  The  resulting  haze  in  SE  Asia  is  now  a  material   financial   issue   for   investors   as   governments,   individuals,   and   investors  consider  legal  and  financial  action.    Figure  1:    Thousands  of  hectares  on  fire  in  Muara  Kendawangan,  West  Kalimantan,  October  16-­‐24,  2015.      

 

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Lack   of   SE   Asian   Governance   Causes   Fires,   Results   in   Deadly   Haze:   Singapore   has  been  suffering   from  the  health  consequences   from  Indonesian  haze  since   the  1970s.  Recently,   Indonesia   recently   ratified   the   ASEAN   Agreement   on   Transboundary   Haze  Pollution,  opening  doors  for  liability.3  While  the  annual  haze  is  predictable,  the  public  conversation  and  both  public  and  private  institutions  focus  on  “who  lit  the  match,”  not  on  “what  drives  the  fires.”    Poor   Governance   and   Weak   Law   Enforcement:   Fires   emerge   at   the   edges   of  cultivated   land.  Newly   cleared  plantation   land   commonly   catches   fire.  Over   the  past  decades,  Indonesia  has  made  numerous  announcements  to  take  responsible  parties  to  court  and  hold  them  financially  responsible.  This  rarely  occurs  at  a  scale  matching  the  problem.  In  fact,  the  Indonesian  government  enables  the  haze  by  letting  corporations  off  the  hook  and  allowing  smallholders  to  burn  up  to  two  hectares  of  land  (Indonesia’s  Environmental  Management  Act  Nr.  32/2009,  Art.  69(2)).  Currently,  while  Indonesia’s  Ministry   of   Environment   and   Forestry   reportedly   is   investigating   276   cases   involving  companies   causing   fires,   they   have   so   far   withheld   the   names.4   This   can   pose  reputational  risks  even  for  responsible  palm  oil  companies  as  investor  concerns  about  the  sector  grows.    New  Policy  Shows  Promise,  Implementation  Needed:  Through  a  series  of  presidential  and  ministerial-­‐level   instructions,   the  Ministry   of   Environment   and   Forestry   recently  issued   instruction   to   plantation   companies  banning  the   clearance   and   conversion   of  peatlands  across  the  country.  The  move  notably  extends  to  existing  concession  areas.  The  government  is  also  issuing  a  ban  on  the  use  of  fire  for  new  land  clearing,  as  well  as  a   ban   on   planting   in   recently   burned   areas   in   order   protect   them   for   future  restoration.   Prominent   civil   society   groups   hailed   the  move   as   a  major   step   forward  but   warned   “the   policy   must   be   made   practical   with   a   clear   timeline   for  implementation,  and  given  teeth  through  sanctions  for  non-­‐compliance”  and  called  for  a   binding   presidential   decree   (perppu)   to   strengthen   the   non-­‐binding   government  instructions.5    Material   Costs   to  Private  and  Public   Sectors:  The   Indonesian   government  estimates  the   fires   and   haze  will   cost   Indonesia   USD   35   billion.   These   costs   would   amount   to  about   four   percent   of   Indonesia’s   gross   national   product,   wiping   out   all   economic  growth   for   2015.   With   many   direct   and   indirect   socio-­‐economic   impacts,   the   total  costs  to  Indonesia’s  economy  could  exceed  USD  50  billion.6    Fires’  Health   Impacts  Make  Children   Sick   and  People  Die:  Approximately   40  million  people  are  breathing   in  noxious  smoke  each  day.7  At   least  19  people   in  Sumatra  and  Kalimantan   have   died,   and   thousands,   mostly   children,   have   been   hospitalized  because   of   severe   respiratory   illnesses.   The   National   Disaster   Mitigation   Agency  (BNPB)  states  that  the  fires  have  put  more  than  500,000  people  in  six  provinces  –  Riau,  Jambi,  South  Sumatra,  West  Kalimantan,  Central  Kalimantan  and  South  Kalimantan  —  at  severe  health  risk  resulting  from  acute  respiratory  infections.  Studies  estimate  that  fires  cause   life-­‐threatening   illnesses   that  kill  an  estimated  110,000  people  every  year  across  SE  Asia,  especially  new  born  babies.8    Contagion   Financial   Impacts:   For   example,   Indonesian   airline   company   PT   Garuda  Indonesia   (GIAA:IJ)   reports   to   have   lost   at   least   USD   8   million   in   September   and  October  2015  because  fires  delayed  and  canceled  over  1,600  flights.9      

 

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 Singapore’s   Trans-­‐boundary  Haze   Pollution  Act   2014:  Several   Indonesian   plantation  companies,   including   Asia   Pulp   and   Paper,   have   faced  legal   action  from   Singapore’s  Trans-­‐boundary   Haze   Pollution   Act,   which   allows   fines   up   to   $1.4   million   for   air  pollution.  Confidential   interviews   confirm   further   possible   Singaporean   government  legal  action  against  company  directors  who  are  responsible  for  the  fires.      Palm  Oil  Production  May  Fall  10%  to  20%:  The  persistent  haze  contributes  to  stunted  fruit   growth   and   disruptions   in   harvesting   during   peak   production   season,   an   IJM  Plantations  representative  was  quoted  saying.10  The  smog  may  also  choke  weevils,  or  beetles,  which  aid  in  pollinating  palm  fruits.    Fires   Cause   Loss  of   Landbanks   and  Estate  Assets:  For   some   smallholders   and   larger  companies,  their  physical  assets  literally  are  burnt  to  ashes.  Most  losses  are  caused  by  mismanagement  of  operational  risks,  exacerbated  by  weak  government  oversight  and  enforcement,  resulting  in  increased  operational  costs  and  greater  revenue  uncertainty.  The  Riau  branch  of   the   Indonesian  Palm  Oil  Association   (GAPKI)  estimates  significant  losses   for   palm   oil   plantation   owners   as   a   result   of   the   fires   between   August   and  September  2015.11      Fires   Smolder   Underground   for   Years:   Peat   fires   are   the   main   source   of   the   haze,  which  is  also  more  toxic  than  particles  released  from  above  ground  burning.12  Planters  report  “tinderbox”  dry  conditions  in  the  field.  Fires  may  cover  hundreds  of  hectares  at  once   and   reach   up   to   60   meters   tall.   Eerily,   as   fires   smolder   in   the   peat   bed  underground,  fires  may  also  spontaneously  appear  from  5  meters  underground.      Indonesia   Burns   Because   of   Poor   Management   and   Governance:   Newly   cleared  plantation   land  commonly  catches   fire,   typically  a   few  months  after   companies  have  deforested  and  drained  their   land.  Fires  often  appear  at   the  edges  of  cultivated   land  from  where  they  can  spread  in  all  directions  directly  impacting  planted  plantations.    

Figure  2:    With  reported  scores  of  2,000  to  3,000,  the  Pollution  Standards  Index  (PSI)  in  Palangkaraya,  Central  Kalimantan,  went  off  every  official  chart.  In  Singapore,  a  PSI  of  300  is  considered  hazardous.      (Un-­‐manipulated  photo,  credit:  Bjorn  Vaughn)i  

 

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Palm  Oil  Companies  use  Fire  for  Deforestation:  Fire  is  the  cheapest  and  fastest  way  of  clearing  land  for  plantation  expansion.  The  extreme  dry  season  caused  by  the  global  El  Niño   phenomenon   in   2015,   which   all   asset   owners   expected   and   many   properly  governed   plantation   companies   planned   for,   has   made   fires   historically   destructive.  The  result  is  good  governance  pays  as  poor  governance  may  degrade  assets.      Poor   Governance   Causes   Fires:   Plantation   companies   are   required   to   have   fire  prevention   and   mitigation   measures   in   place   as   a   precondition   to   various   permits,  particularly   the   Environmental   Permit   (Izin   Lingkungan),   which   grants   the   right   to  commence  land  development.  But  there  are  strong  incentives  to  evade  this  regulation  as   financial   analysis   has   shown   that   land   prices   go   up   by   IDR   3  million   per   ha   after  clearance.    Fires   Burn   Orangutan   Habitat:   Fires   have   destroyed   orangutan   habitat   in   High  Conservation  Value  and  High  Carbon  Stock  forests  on  the  plantations  of  Golden  Agri-­‐Resources  Ltd.  (GGR:SP),   IOI  Corporation  Bhd.  (IOI:MK),  and  PT  Austindo  Nusantara  Jaya  Tbk.  (ANJT:IJ).  These  fires  and  the  destruction  of  HCV  and  HCS  areas  undermine  these   companies’   No   Deforestation,   No   Peat,   No   Exploitation   (NDPE)   commitments.  The   Indonesian   National   Disaster  Management   Agency   (BNPB)   recorded   the   loss   of  2,398  ha  of   land  biosphere  and  21,214  ha  of   forestland  caused  by   fires   in  2015.13   In  Riau,  Sumatra,  30%  of  the  fire  hotspots  were  identified  in  conservation  areas.14        Reputational  Risks:  Regional   and   international  media   are   investigating   companies   in  connection  with  the  fires  and  deforestation.  The   Indonesian  Ministry  of  Environment  and  Forestry  reportedly  is  investigating  276  cases  involving  companies  causing  fires,15  though  it  has  so  far  withheld  the  names.  In  October  2015,  it  was  announced  that  five  tree   plantation   companies,   two   logging   companies,   and   three   palm   oil   companies  

PT  Austindo  Nusantara  Jaya  Tbk.  subsidiary  PT  Kayong  Agro  Lestari:  494  ha  burnt  in  newly  planted  areas  at  the  edges  of  the  concession  area.  

Golden  Agri-­‐Resources  Ltd.  subsidiary  PT  Agro  Lestari  Mandiri:  1,300  ha  burnt  of  which  a  majority  in  High  Conservation  Value  orangutan  habitat.  

Figure  3:    Fires  on  palm  oil  concessions  of  Golden  Agri-­‐Resources’  (GR:SP)  and  PT  Austindo  Nusantara  Jaya’s  (ANJT:IJ)  in  West  Kalimantan,  September  7-­‐14,  2015.  

 

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were   facing   administrative   sanctions.16   One   of   the   companies   being   investigated  includes  IOI  Corporation  Bhd.  (IOI:MK)  subsidiary  PT  Bumi  Sawit  Sejahtera.      

 Institutional   Investors   Seeking   Opportunities   That   Avoid   Burning:   The   Norwegian  Government   Pension   Fund   Global   (GPFG),   like   many   investors,   is   exiting   from  investments   in   palm   oil   companies   because   of   the   industry’s   track   record   of   poor  governance   and   fires   that   increase   operational   costs,   increase   possible   health   care  liabilities,  and  increase  market  risks  as  future  revenue  streams  are  degraded.  In  August  2015,   GPFG   announced   that   it   was   exiting   its   investments   in   Genting   Berhad  (GENP:MK),   IJM   Corporation   Bhd   (IJM:MK),   and   POSCO   (005490:KS).17   The   GPFG  concluded   that   POSCO   subsidiary   PT   Bio   Inti   Agro’s   activities   represented  unacceptable  financial  risk  as  recent  satellite   imagery  showed  a  significant  portion  of  its  newly  cleared  concession  area  in  Papua  New  Guinea  was  on  fire.      Figure  5:  Fires  in  PT  Bio  Inti  Agro’s  new  clearings  in  Papua  (22-­‐30  September  2015)  

Figure  4:    Fires  threatening  High  Conservation  Value  orangutan  habitat  area  and  High  Carbon  Stock  peat  swamp  forests  near  the  palm  oil  plantations  of  First  Resources  Ltd.  (FR:SP)  and  PT  Eagle  High  Plantations  Tbk.  (BWPT:IJ)  in  West  Kalimantan,  September  2015.  

 

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Financial  Risks  from  Losing  License  to  Operate:  Palm  oil  companies  face  risks  to  their  license   to   operate.   The  Deputy  Governor   of   Papua   recently   called   for   the   closure  of  palm  oil  companies  found  guilty  of  forest  burning.18    

             CSPO   Contract   Suspension   and   Cancellation:   Given   overwhelming   evidence   that  Korindo   Group   is   involved   in   large-­‐scale   deforestation   and   burning   in   Papua,   its  subsidiary  PT  Tunas  Sawa  Erma  is  at  risk  of  being  suspended  from  certified  sustainable  palm   oil   (CSPO)   supply   to  Wilmar   International   Ltd.   (WIL:SP)   and  Musim  Mas,   two  customers  of  the  Korindo  Group.      Investor  Demands  Driving  Change  

Investors   Need   Effective   Governance   to   Enable   Plantations   to   Commit   to   No  Deforestation,   No   Peat,   No   Exploitation   (NDPE)   to   Decrease   Financial   Risks:  NDPE  policies  contribute  to  effective  governance  while  enabling  operative  fire  risk  mitigation  and   improved   land   management.   Without   transparent   and   verified   NDPE  commitments,   plantation   companies   risk   suffering   from   poor   governance   that   often  leads  to  greater  risk  of  fires  that  hurt  a  company’s  ability  to  meet  achieve  its  revenue  expectations.  Without  company  action,  investors  may  be  left  with  stranded  assets.    Investors   Demand   Good   Governance:   It   is   no   longer   viable   for   local   and   national  governments  to  excessively  lease  out  land  to  plantation  companies  regardless  of  their  ability   to   ensure   strong   environmental,   social   and   governance   (ESG)   standards.   The  recent   wave   of   NDPE   commitments   by   major   palm   oil   traders   has   created   much  greater  demand  to  support  good  ESG  practices   that  ultimately   reduce   financial   risks.  Governments  should  support  this  development.        

Figure  6:    Open  fires  in  an  Industrial  Tree  Plantation  concession  in  West  Kalimantan,  September  14-­‐22,  2015.  

 

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References    

1     Mongabay.  “Carbon  emissions  from  Indonesia’s  peat  fires  exceed  emissions  from  entire  U.S.  economy”.  15  October  2015.  

2     Dr.  Sutopo  Purwo  Nugroho,  Msi,  APU  Kepala  Pusat  Data  Informasi  dan  Humas  BNPB  Jakarta,  30  Oktober  2015.  

3     ASEAN  Haze  Action  Online.  “Status  of  Ratification”,  online:  http://haze.asean.org/status-­‐of-­‐ratification/,  viewed  on  6  November  2015.  

4     CNN  Asia.  “Pemerintah  Cabut  Dua  Izin  Perusahaan  terkait  Kebakaran  Hutan”.  19  October  2015.    

5     Greenpeace.  “President  Joko  Widodo’s  peatland  ban  ‘sets  the  bar’  for  action  on  climate  change.”  10  November  2015.  

6     The  Jakarta  Globe.  “Erik  Meijaard:  Indonesia's  Fire  Crisis  —  The  Biggest  Environmental  Crime  of  the  21st  Century”.  23  October  2015.  

7     The  Jakarta  Globe.  “Erik  Meijaard:  Indonesia's  Fire  Crisis  —  The  Biggest  Environmental  Crime  of  the  21st  Century”.  23  October  2015.  

8     The  Jakarta  Post.  “The  week  in  review:  The  worst  forest  fires.”  1  November  2015.    

9       BBC  Indonesia  Online.  “Dampak  kabut  asap  diperkirakan  capai  Rp  200  trilliun.”  27  October  2015.  

10     Bloomberg.  “Palm  Oil  Crop  at  Risk  as  Haze  Envelops  World's  Biggest  Growers”.  17  September  2015.  

11     Kompas  Online.  “Kebakaran  Hutan  Rugikan  Perkebunan  Kelapa  Sawit  hingga  Rp  7,2  Triliun.”  18  September  2015.  

12     The  Jakarta  Post.  “The  week  in  review:  The  worst  forest  fires.”  1  November  2015.  

13     Harian  Nasional.  “Puluhan  Triliun  Rupiah  Melayang  Akibat  Kebakaran  Hutan”  19  September  2015.    

14     Kompas  Online.  “Kebarkaran  Hutan  di  Riau,  30  Persen  di  Wilayah  Konservasi”  1  November  2015  

15     Republika  Online.  “276  Perusahan  Diduga  Penyebab  Kebakaran  Hutan”.  20  September  2015.  

16     CNN  Asia.  “Pemerintah  Cabut  Dua  Izin  Perusahaan  terkait  Kebakaran  Hutan”.  19  October  2015.    

17     NBIM  website:  [nbim.no/en/responsibility/exclusion-­‐of-­‐companies].  

18     Antara.  “Wagub  Papua  minta  perusahaan  penyebab  kebakaran  hutan  ditutup”.  20  Oktober  2015.