Exchange Benefits in Farmers' Supply Chain

“Essential oils quickly becoming nature’s liquid gold for Australian farmers” – the headline of an article of the Australian Broadcasting Service.[1] Ninety per cent of these oils are exported, mostly for use in the food, personal care, health and beauty industries. Global demand is booming.

But where are the headlines about Indonesian farmers entering this fast-growing and high-value industry? Indonesian soils are perfectly suited for many of the plants and trees that are used to produce essential oils. The value produced per acre is high, which is perfect for a country where most farmers only have little land. Many oils are produced from trees, so these trees can be planted both because of the income they will generate and the environmental benefits they provide.

Essential Oils Export and Production in Indonesia

Some regions in Indonesia have traditionally produced essential oils. In 2010, Indonesia exported USD 469 million of essential oils; by 2019, exports had increased to USD 773 million, accounting for 4.5 per cent of the world market.[2] Indonesia exports around 40 types of essential oils, and is the world’s major exporter of clove, patchouli, turpentine and nutmeg oil.[3]

But the country’s essential oil imports in 2019 were as high as USD 1.3 billion, a balance of trade gap of USD 527 million. Many of the oils that can be produced locally are instead imported. A huge wasted opportunity for Indonesian farmers and SMEs! Furthermore, on international markets essential oil prices are generally set in USD, exposing Indonesian farmers, exporters and importers to exchange rate risk – a risk that could be avoided if the supply chain is local.

A weak marketing infrastructure is one the major constraints for the industry. Farmers are not offered access to organized markets. Instead, they rely on traders who give them advances in return for their product, meaning they are locked into selling at a low price. The traders unilaterally decide on quality, which in practice means that farmers are not paid any quality premiums.

After the traders there is a long marketing chain to reach the exporters or domestic end-users, and all the links in the chain have incentives to adulterate good oil with bad one, because quality is not rewarded. This, in turn, leads to low prices for Indonesian exports, and to a preference of the Indonesian industry for imported oils.

A key problem for developing the essential oils sector, therefore, is the enormous trust gap in the supply chain. Putting a commodity exchange in the middle, between farmers and buyers, can fill this gap. The mechanism is simple. Buyers inform the exchange of the quality specifications of the product they want. The exchange sets up a number of delivery centers, where farmers and others can deposit their produce – the operator of the center will check whether the produce quality meets specifications.

On successful delivery, the depositor is assigned warehouse receipts, which he can sell in different ways – offer for sale on a dedicated trading platform, or offer to pre-approved buyers, with either immediate or forward delivery. Competition among buyers will ensure he gets the best price. The buyer pays into the exchange clearing house, which in turn pays the depositor. And the buyer then receives the essential oils, with full quality guarantee by the exchange. There is full traceability, something of key importance in today’s commodity markets.

Looking at The Global Essential Oils Market

In India, the introduction of such a mechanism led to the production of mentha oil increasing three-fold in two years’ time, and to farmers’ part of export prices almost doubling. For other products like spices there were similar effects. There is no reason why in Indonesia, an exchange would not succeed in linking quality-conscious buyers with farmers in such a way that the latter receive a fair value for their work.

The global market for essential oils continues growing, driven by the demand from industries that incorporate essential oils into their products, ranging from personal care to pest control. The global market is expected to reach 12.58 billion USD in 2023. [4] With excellent growing conditions in most of the country’s regions, Indonesian essential oil farmers have plenty of room to grow. But, being small businesses that lack capital and technology, they do not have the capacity by themselves to fuel accelerated growth, so a coordinated effort is necessary to relieve the core constraint of distrust in the supply chain.

As farmers’ representatives and Indonesia’s regional leaders are looking for new earning opportunities for farming communities, it would be a good idea to consider what a commodity exchange can bring to the table – to ensure that suppliers will be able to realize the value of their produce, and that buyers will indeed receive the quality and quantity of goods for which they pay.

[1] ABC news, 2 April 2018.

[2] https://trendeconomy.com/data/h2/Indonesia/33

[3] D. Alighiri et al., Potential Development of Essential Oil Production of Central Java, Indonesia, Journal of Physics, Conf. Series 824 (2017).

[4] Indesso, Perspective of the Essentials and Aroma Industry - INDONESIA on the World Map (2018)