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Technical Assistance to the Modernisation of

Agriculture Programme in Sri Lanka

EuropeAid/138-539/DH/SER/LK Technical Assistance to the Modernisation of Agricultural Programme in Sri Lanka (TAMAP)

TAMAP Value Chain Analysis Study on Essential Oils in Sri Lanka March 2020

Submitted to: Delegation of the European Union to Sri Lanka and the Maldives 389, Bauddhaloka Mawatha, Colombo 7, Sri Lanka Ministry of National Policies & Economic Affairs Department of National Planning, The Secretariat, 1st floor Colombo 01, Sri Lanka This project is implemented by a Consortium led by Ecorys Nederland , B.V



Technical Report: TAMAP Value Chain Analysis on Essential Oils in Sri Lanka

Project title: Technical Assistance to the Modernisation of Agriculture Programme in Sri Lanka

Project number: ACA/2017/389-911

Country: Sri Lanka

Address: Ecorys Nederland B.V Watermanweg 44 3067 GG Rotterdam The Netherlands

Tel. number: T: +31 10 453 86 76

Fax number: F : +31 10 453 87 55

Contact person: Bart Provost [email protected]

Date of report: 29 March 2020

Assignment period: November – December

Disclaimer. The content of this report does not reflect the official opinion of the European Union. Responsibility for the information and views expressed lies entirely with the author(s) and the consortium led by Ecorys Nederland BV for the implementation of TAMAP



PROJECT SYNOPSIS

Project Title: Technical Assistance to the Modernisation of Agriculture Programme in Sri Lanka

Project Details: Project Ref. No:

EuropeAid/138-539/DH/SER/LK Programme Manager

Dr Olaf Heidelbach

Date of project start:

8 January 2018 Contracting Authority

Delegation of the European Union to Sri Lanka and the Maldives 389 Bauddhaloka Mawatha, Colombo 7, Sri Lanka

Contract Duration:

36 months Name of contact person (Contractor):

Project Manager: Bart Probost Project Director: Nick Smart

Contract No:

ACA/2017/389-911

Contractor’s name, address, telephone numbers and e-mail address:

Ecorys Nederland B.V Watermanweg 44 3067 GG Rotterdam The Netherlands T +31 (0)10 453 88 00

[email protected] [email protected]

Total contracted amount:

EUR 4, 167, 000 Team Leader

Dr. Christof Batzlen Postal Address: Ministry of National Policies and Economic Affairs, Treasury Building, Lotus Road, Colombo 01, Sri Lanka.

[email protected]

mailto:[email protected]

Technical Assistance to the Modernisation of Agriculture Programme in Sri Lanka

TAMAP Essential Oils Value Chain Study March 2020 Page i

TAMAP Value Chain Analysis Study on Essential Oils in Sri Lanka

1 EXECUTIVE SUMMARY........................................................................... 10

2 INTRODUCTION AND CONTEXT ............................................................ 16

2.1 Introduction to the project .......................................................................... 16

2.2 Challenges of the agriculture sector in Sri Lanka and its reorientation ....... 16

2.3 Value chain and VCA4D methodology....................................................... 17 2.3.1 What are value chains? ............................................................................. 17 2.3.2 VCA4D methodology ................................................................................. 18

2.4 Data collection........................................................................................... 19 2.4.1 Secondary data ......................................................................................... 19 2.4.2 Primary data .............................................................................................. 19 2.4.3 Why essential oils were selected for the study .......................................... 19

3 ESSENTIAL OILS SECTOR ..................................................................... 20

3.1 Sector Overview in Sri Lanka .................................................................... 20 3.1.1 Natural Essential Oils ................................................................................ 20 3.1.2 Oleoresin ................................................................................................... 21 3.1.3 Major raw materials for Sri Lankan essential oil production ....................... 22 3.1.4 Exports and imports of essential oils from and to Sri Lanka ....................... 23 3.1.5 Production of essential oil in Sri Lanka ...................................................... 24 3.1.5.1. Spice based essential oil ........................................................................... 24 3.1.5.2. Oleoresin and other essential oils.............................................................. 25

3.2 Governance and Institutional framework ................................................... 25 3.2.1 Essential oils policies and strategies ......................................................... 25 3.2.2 Institutions responsible for and supporting the sector ................................ 26 3.2.2.1. The Ministry of Agriculture ......................................................................... 26 3.2.2.2. Industrial Technology Institute ................................................................... 26 3.2.2.3. Spice Council ............................................................................................ 27 3.2.2.4. The Ministry of Primary Industries and Social Empowerment .................... 27 3.2.2.5. Spices and Allied Products Producers’ & Traders’ Association (SAPPTA) 27 3.2.2.6. Various private sector and governmental institutes and initiatives ............. 27 3.2.3 Legal framework and acts ......................................................................... 28 3.2.4 Export and market requirements and licenses ........................................... 28

3.3 Problems encountered in the essential oil sector ....................................... 29 3.3.1 High cost of production .............................................................................. 29 3.3.2 Violent market and price structure ............................................................. 30 3.3.3 Pest and disease and Good Agriculture Practice ....................................... 30 3.3.4 Low level of technology in extraction ......................................................... 30 3.3.5 Adulteration (mixing of oils) and substitutes .............................................. 31 3.3.6 Ineffective government support ................................................................. 31 3.3.7 Copying strategies of essential oil producers............................................. 32 3.3.7.1 Lobby for ban on import of spices.............................................................. 32 3.3.7.2 Lobby for fair competition and establishment of a Spice Board ................. 32 3.3.7.3 Access to improved technology, GAP and GMP ........................................ 32 3.3.7.4 Own growing and out growing ................................................................... 33

3.4 Demand related aspects on essential oils in Sri Lanka .............................. 33


TAMAP Essential Oils Value Chain Study March 2020 Page ii

3.4.1 Size of local and export market ................................................................. 33 3.4.1.1 Local market.............................................................................................. 33 3.4.1.2 Export markets .......................................................................................... 34 3.4.2 Sri Lanka’s import and export of essential oils ........................................... 34 3.4.3 Cost of production of major competitors compared to Sri Lanka ................ 36 3.4.4 Growth of the essential oils sector in Sri Lanka ......................................... 37

4 FUNCTIONS ............................................................................................. 39

4.1 Function description .................................................................................. 39 4.1.1 Introduction ............................................................................................... 39 4.1.2 Organisational functions along the chain ................................................... 42 4.1.3 Marketing networks and distribution channels ........................................... 43 4.1.4 Stakeholder Strategies .............................................................................. 43 4.1.5 Horizontal and vertical coordination ........................................................... 44

4.2 Flows of Product ....................................................................................... 49 4.2.1 Value Chain network map ......................................................................... 49

4.3 Location of activities .................................................................................. 53

4.4 Quantification ............................................................................................ 54

4.5 Contribution Analysis (distribution of margins along the value chain) ........ 54

4.6 Gross Margin Analysis .............................................................................. 61

4.7 Contribution of VC to public sector finance and balance of trade ............... 70

4.8 Viability of the VC in international economy ............................................... 70

4.9 Competitiveness analysis .......................................................................... 71

5 SOCIAL ANALYSIS.................................................................................. 74

5.1 Working Conditions in the VC acceptable .................................................. 74

5.2 Land and water rights in VC acceptable .................................................... 74

5.3 Gender equality in VC ............................................................................... 75

5.4 Distribution of social capital over the VC ................................................... 75

5.5 Social infrastructure and services acceptable ............................................ 76

6 T E C H N O L O G I C A L I N N O V A T I O N ..................................... 77

6.1 Overview and quality control system ......................................................... 77

6.2 Essential oil processing in Sri Lanka ......................................................... 77

6.3 Technologies used in essential oil processing ........................................... 78

6.4 Distillation .................................................................................................. 78

6.5 Liquid-liquid extraction ............................................................................... 79

6.6 Requirements for quality management systems in aquaculture value chain .................................................................................................................. 81

6.7 Legal framework and regulations............................................................... 81

6.8 Laboratories and quality control system .................................................... 82

6.9 Hazards in the essential oils industry ........................................................ 82

7 ENVIRONMENTAL ANALYSIS ................................................................ 87


TAMAP Essential Oils Value Chain Study March 2020 Page iii

7.1 Impact of essential oil production on the environment ............................... 87

7.2 Impact of climate change on essential oil production ................................. 88

8 OPPORTUNITIES, OUTLOOK AND RECOMMENDATIONS ................... 90

8.1 Opportunities ............................................................................................. 90 8.1.1 Essential oils high potential sector ............................................................. 90 8.1.2 Opportunities to develop the export and local market ................................ 90 8.1.3 Opportunities to develop vertical organised production and trade system . 90 8.1.4 Potential to modernise processing ............................................................. 91 8.1.5 Potential to develop quality farming of raw materials ................................. 91 8.1.6 Opportunity to increase co-operation with foreign buyers and service

providers ................................................................................................... 91

8.2 Outlook...................................................................................................... 91

8.3 Recommendations .................................................................................... 92 8.3.1 Improve the export regime for essential oils .............................................. 92 8.3.2 Improve the transparency of the essential oils sector ................................ 92 8.3.3 Establish good access to new equipment and knowledge for oil extraction,

storage and packaging (including GMP) .................................................... 92 8.3.4 Promote use of more efficient farm technologies (including GAP) ............. 92 8.3.5 Promote horizontal and vertical integration ................................................ 93


TAMAP Essential Oils Value Chain Study March 2020 Page iv

List of Tables

Table 1 Dominant utilisation of Sri Lankan essential oils ........................................ 21

Table 2 Major export markets for essential oils from Sri Lanka in 2017 .................. 35

Table 3 Product Cinnamon quills (Grade C4) - Grower > Collector > Processor > Local market.............................................................................................. 55

Table 4 Product Cinnamon quills (Grade C4) - Grower > Collector > Processor/exporter > International market ................................................. 56

Table 5 Product Cinnamon leaf oil - Grower > Collector > Processor > Local market .................................................................................................................. 57

Table 6 Product Cinnamon leaf oil - Grower > Collector > Processor/exporter > International market................................................................................... 58

Table 7 Product Cinnamon bark oil - Grower > Collector > Processor/exporter > International market................................................................................... 59

Table 8 Product: Citronella oil - Grower > Collector > Processor > Local market ... 60

Table 9 Product: Citronella oil - Grower > Collector > Processor/exporter > International market................................................................................... 61

Table 10 Gross margin analysis for an average cinnamon farmer who produces quills and leaves ................................................................................................. 63

Table 11 Gross margin analysis for an average cinnamon farmer who produces quills and leaves and operates a boiler with a group of 25 farmers ..................... 64

Table 12 Gross margin analysis for an average cinnamon farmer who produce quills, leaf and bark oil and operates a boiler with a group of 25 farmers ............. 66

Table 13 Gross margin analysis for an average citronella farmer with 1 acre of land and no distillation facility ............................................................................ 68

Table 14 Gross margin analysis for an average citronella farmer with 1 acre of land and own distillation facility receiving leaves from 25 other farmers ............ 69

Table 15 Hazards in essential oils ............................................................................ 83


TAMAP Essential Oils Value Chain Study March 2020 Page v

List of Figures

Figure 1 Imports and exports of essential oils to and from Sri Lanka ....................... 23

Figure 2 Export of natural essential oils and oleoresin from Sri Lanka ..................... 24

Figure 3 Trend in export of natural essential oils in Sri Lanka .................................. 25

Figure 4 Trend in imports of essential oils in Sri Lanka............................................ 34

Figure 5 Prices for essential oils in 2017 ................................................................. 36

Figure 6 Unit import value essential oils: Sri Lanka and main competitors in 2017 .. 36

Figure 7 Sri Lankan trend in trade in essential oils .................................................. 37

Figure 8 Year-over-year trend in trade of essential oils from Sri Lanka ................... 37

Figure 9 Essential oils sector value chain function map........................................... 47

Figure 10 Essential oils sector value chain stakeholder map ..................................... 48

Figure 11 Value Chain map: Cinnamon leaf and bark oil ........................................... 51

Figure 12 Value Chain map: Citronella oil ................................................................. 52

Figure 13 Position of main exporting countries in global essential oil exports ............ 71

Figure 14 Position of Sri Lanka in USA essential oil imports ..................................... 72

Figure 15 Position of Sri Lanka in German essential oil imports ................................ 72

Figure 16 Dry steam distillation ................................................................................. 79

Figure 17 Solvent extraction unit ............................................................................... 80


TAMAP Essential Oils Value Chain Study March 2020 Page vi

List of Photos

Photo 1 Typical distillation facility ........................................................................... 40

Photo 2 Cinnamon tree, leaf and bark .................................................................... 41

Photo 3 Citronella grass harvesting and drying in the field ..................................... 42

Photo 4 Women working in essential oil production ................................................ 75

Photo 5 Sieving and collection of essential oil ........................................................ 78

Photo 6 Small collection container for essential oil ................................................. 81

Units and measurements

Old system of measurements Modern, commonly understood measurements

1 acre 0.4048 ha = 4,048 m2

1 mile 1.6093 km

1 foot or feet 30.48 cm

1 acre feet (volume) 1,233.5 m3

1 cusec (1 cubic foot per second) 0.2832 m3

1 bushel of paddy rice 22.5 kg paddy rice

1 square mile 2.59 km2

1 US$ 180 LKR


TAMAP Essential Oils Value Chain Study March 2020 Page vii

ACRONYMS

€ Euro

AEO Agricultural Extension Officers

ASC Agricultural Service Centre

BOI Board of Investment

CARP Council for Agricultural Research Policy

CBC Ceylon Business Council

CBO Community Based Organisation

CFA Core functional analysis

CIF Cost Insurance Freight

CRIDF Climate Resilience

CSA Climate Smart Agriculture

CSEF Civil Society Environmental Fund

CSO Civil Society Organisation

DEA Department of Export Agriculture

DoA Department of Agriculture

EC European Commission

EDB Export Development Board

EDF/BUDGET European Development Fund

EEP Economic Empowerment of Poorest

EU European Union

EUD European Delegation

FAO Food and Agriculture Organisation

FDI Foreign Direct Investment

FIRST Food and Nutrition Security Impact, Resilience, Sustainability and Transformation

FOB Free on Board

GAMP Good Agricultural Manufacturing Practices

GAP Good Agricultural Practices

GDP Gross Domestic Product

GMPs Good Manufacturing Practices

GoSL Government of Sri Lanka

GSP General System of Prefernces

HACCP Hazzard Analysis Critical Control Points

HRARTI Hector Kobbekaduwa Agrarian Research and Training Institute


TAMAP Essential Oils Value Chain Study March 2020 Page viii

HRM Human Resource Management

ICRISAT International Crops for Research in Semi Arid Tropics

ICT Information Communication Technology

IFPRI International Food Policy Research Institute

ILRAD International Livestock Research Institute

ISO International Standards Institute

ITI Industrial Technology Institute

JICA Japanese International Cooperation Agency

JPAs Job Performance Aids

KE Key Expert

KPI Key Performance Indicator

M&E Monitoring & Evaluation

MEDA Microenterprise Development Association

MEDC More Economically Developed Countries

MOA Ministry of Agriculture

MOF Ministry of Finance and Mass Media

MONPEA Ministry of National Policies and Economic Affairs

MoPISE Ministry of Primary Industries and Social Empowerment

MTEF Medium Term Expenditure Framework

NAO National Authorising Officer

NAP National Agriculture Policy

NAP New Agriculture Policy

NCFRU National Committee on Floriculture Research & Development

NGO Non-Government Organisation

NKE Non Key Expert

NLDB National Livestock Development Board

NPF National Program for Floriculture Sector

NRM Natural Resource Management

NSS National Statistics Service

OECD Overseas Economic Council for Development

OFCs Other field crops

PAF Performance Assessment Framework

PEP Performance Enhancement Programme

PET Public Expenditure Tracking

PFM Public Finance Management

PIP Public Investment Programme


TAMAP Essential Oils Value Chain Study March 2020 Page ix

PMU Project Management Units

PPP Public Private Partnerships

PSC Project Steering Committee

R&D Research & Development

RDD Rubber Research Department

RMS Resource Management System

RWASH Rural Water Sanitation and Hygiene

SACCOs Savings And Credit Cooperative Organisations

SRC Sector Reform Contract

SDDP Support to District Development Programme

SL Sri Lanka

SLBDC Sri Lanka National Chamber of Commerce

SLSI Sri Lanka Standards Institute

SAPPTA Spices & Allied Products Producers & Traders Association

SWOT Strengths, Weaknesses, Opportunities, Threats

T&V Training and Visit

TAT Technical Assistance Team

TACIS Technical Assistance to the Commonwealth of Independent States

TAIEX Technical Assistance and Information Exchange of the EU

TAMAP Technical Assistance to the Modernisation of Agriculture Programme in Sri Lanka

TNA Training Needs Analysis

ToRs Terms of Reference

TOT Training of Trainers

TRI Tea Research Institute

VCA4D Value Chain Analysis for Development

WB World Bank

WTO World Trade Organisation


TAMAP Essential Oils Value Chain Study March 2020 Page 10

1 E X E C U T I V E S U M M A R Y

Introduction and context

This value chain study of the essential oil sector in Sri Lanka is part of a series of value chain studies carried out by the Technical Assistance to the Modernisation of Agriculture Programme in Sri Lanka (TAMAP) team in order to assist the GoSL and the EUD SL in developing an overarching agriculture policy and implementation strategy. This policy and strategy is aiming at higher productivity and efficiency of the agriculture sector through specific interventions.

Though the importance of the Sri Lankan agriculture sector has decreased over the last years, there are still opportunities for diversified and commercially oriented farming. To fully understand the development potential of the essential oil sector TAMAP commissioned this value chain study. The methodology applied in this study follows to a large extent the EU facilitated value chain analysis for development (VCA4D), apart from conducting a detailed economic effects analysis.

For this study, information of secondary sources as well as interviews with stakeholders was used. Interviews were conducted with stakeholders (exporters, traders and farmers) in Western, Central and Southern Province.

Essential oil sector in Sri Lanka

The Sri Lanka essential oils industry can be divided into two subsectors i.e. natural essential oils and oleoresins. Natural essential oils are concentrated hydrophobic liquid containing easily evaporated chemical compounds from plants. Oleoresins contain both easily and less easily evaporated chemical compounds than natural essential oils. The short-term opportunities on major global markets for essential oils and oleoresins depend largely on the availability of raw materials. Crop failures in major producing countries can overnight change the global market situation. Sri Lanka’s essential oil sector is small with estimated 346 metric tons of natural essential oils exports and 654 metric tons of oleoresins exports in 2017. The local market is about 80 to 85 metric tons and the import about 130 metric tons import in 2017. The dominant products in the subsector of natural essential oils are cinnamon leaf and cinnamon bark oil, pepper oil, nutmeg oil and citronella oil. The Sri Lankan oleoresins production is nearly exclusively pepper oleoresin. Sri Lanka started only in the ninety seventies with commercial production and exports of essential oils. The global essential oils market had a value of about 7 billion US $ in 2018 and is expected to grow to 14.6 billion US $ in 2026. Sri Lankan essential oils exports in 2017 are valued at 46 million US $. For 2017, we estimate the production value of the Sri Lankan commercial essential oils sector at 50 million US $ or LKR 7,450 million.

Governance and entities supporting the sector

Sri Lanka is implementing the National Export Strategy (NES) for Spices and Concentrates 2018-2022. The NES observed that: “the spices and essential oils sector has significant potential to make socio-economic contributions to Sri Lanka through export-led growth”. The key institutions related to the development and regulation of the essential oils sector are the Department of Export Agriculture, Sri Lanka Standard Institute, Industrial Technology Institute, the National Chamber of Commerce, Spices & Allied Products Producers’ & Traders Association and the Spice Council. In addition, the National Chamber of Commerce supports competitiveness in the sector and promotes trade and investment while also the Board of Investment (BoI) encourages foreign and local investment in the sector. The Export Development Board (EDB) has sector extension staff and provides information on the spice and essential oil sector in Sri Lanka. Through the One Window Portal established by the



Ministry of Finance, the trading community is provided with access to online systems developed for Regulatory Agencies involved in Import & Exports.

Problems encountered in the sector and coping mechanisms

It is difficult and costly to obtain labourers for the extraction facilities and many extractors provide service extraction only. In this system, the farmers use the facility of the extractor and pays with percentage of the extracted oil. The farmer then generally sells the rest of the oil also to the same contractor. Various extractors explained that although this is the most common operational structure, it has a danger/cost. Farmers can add unwanted substances to the oil leading to lower quality. All major manufacturers and exporters and more and more extractors are considering to use only supplies from their own fields and a few trusted farmers. They conduct the processing operations with their own staff. Exporters also indicated that obtaining all certificates and permits for export is a major challenge and raising the cost of their business.

The majority of production units are traditional oil extraction units in the rural areas. Sri Lanka has only about 10 manufacturers and exporters with modern equipment. Only few companies dominate the world market for essential oils and in Sri Lanka only a small group of companies dominate the exports and manufacturing of final consumer market products. In addition to the established oil manufacturers and exporters, some general trading companies handle irregular Sri Lankan essential oil exports. These companies have no permanent connection to the essential oils manufacturing and trade. Over time essential oil prices swing in all directions. In the current situation of low prices many smallholder farmers are in debt and remaining with high stocks.

Sri Lanka’s production areas for essential oils are experiencing prolonged wet periods leading to more pests and diseases and more problems in drying of raw materials. Raw materials need to be dried before oil extraction to avoid a long extraction time. With more wet conditions, field drying of the raw materials or drying at the extraction site takes more time leading to more fungi and pest in the raw material. Higher fungi and pest in the raw material leads to a lower quality of oil. There is a general lack of knowledge regarding advanced technology in the main production areas. The distillation technology used in the traditional installations is very basic and outdated with many units having broken equipment. The handling, clearing and storage of the final product is also deteriorating the quality of the oil. In addition, Sri Lankan equipment is not able to extract all water out of the oils and oils are send to India for further refinery.

Extractors are mixing cheap oil (locally produced lower quality or imported) with good quality locally produced oil. The adulteration has severely damaged Sri Lanka’s reputation as a high-quality producer. A structural thread for the essential oils sector is the increased uses of substitutes. Synthetic substitutes for essential oils are available in the local and global market.

The National Export Strategy for Spice and Concentrate is the first concise governmental sector-wide development approach. Until recently, government supported the essential oils sector only through case-by-case incidental activities. In its international trade promotion, the government wasn’t really successful for the sector. The current ban on import of raw materials (cinnamon, black pepper and citronella) may give only some short relief to local producers and farmers as it may eventually lead to further deterioration of competitiveness on international markets.

TAMAP team observed the following coping strategies of businesses participating in the sector:

• Stakeholders in the sector are lobbying with government for ban on import of spices and fair competition;



• Stakeholders are advocating the establishment of a Spice Board;

• Many in the sector are forcing increased access to improved technology, GAP and GMP;

• Stakeholders are co-operating to Increase the vertical integration of the sector.

Market for Sri Lankan essential oils

The local market in Sri Lanka for essential oils originates from demand by middle- and high-income groups concentrate in the cities. A special category of consumers on the local market are tourists visiting Sri Lanka. The products are sold by specialised retailers and shops & spa saloons as well as the spice gardens and ayurveda treatment centres in major towns and cities. The local market absorbs annually about 83 metric tons of essential oil products. Sri Lanka’s imports of essential oils are around 100 metric tons annually. The imports are dominantly from Vietnam, India and China. These are mainly natural essential oils which are mixed with Sri Lankan oils, used in Sri Lankan processing industries and in final consumer market items.

The size of the export market is estimated at 1,000 metric tons annually. Of the total Sri Lankan essential oil production, oleoresins are exclusively produced for exports while essential oils are estimated to be 80% for exports. The 10 largest manufacturers and exporters are directly linked to buyers and foreign markets. The small extractors supply the market via the activities of these manufacturers and exporters as well as the irregular exporters. Sri Lanka is with its essential oil exports of about 46 million US $ in 2017 only a tiny player in the overall essential oil world market. The most important product from Sri Lanka is cinnamon essential oil. Sri Lanka supplies about 25 to 30% of the world trade in cinnamon essential oil. For all other essential oils, the Sri Lankan share of the export market is very small. Apart from the North American and European markets, India is important for Sri Lankan essential oils exports. India has more capacity of advanced technology to add value to the Sri Lankan oil (reduce the amount of water remaining in the Sri Lankan oil). Sri Lankan stocks are sent to India for refinery and subsequently partly re-exported from India.

Competition, competitors and outlook

The main competitors for Sri Lankan essential oils exports are India, China and Indonesia as these countries have similar spice based essential oil exports. When comparing the FOB export prices of Sri Lanka with the CIF import prices of major markets, Sri Lanka essential oils are high priced on all major markets except India.

The USA is the largest importer and exporter of essential oils. The USA also acts as a re-distributor to other countries and re-exporter of oil supplies by other countries. The USA and the EU have been traditionally the main essential oils traders but lately high industrialization and urbanisation in India, China, Mexico and Brazil fostered demand for aromatics and flavours. Rising consumer disposable income and awareness regarding health benefits of essential oils will further stimulate demand. These emerging markets have the highest growth rates in the global essential oils market but also the traditional markets show growth.

India and China together have a share of about 20% of the USA imports of essential oils while Sri Lanka has a share of about 1%. However, Sri Lanka exports higher value oils to the USA. Sri Lanka receives a much higher average import price for its essential oil products on the USA market than its main competitors. On the German market, India and China together have a share of about 14% of the imports of essential oils in volume terms but only about 5% in value terms. Indonesia and Sri Lanka are much smaller suppliers to the German market. Sri Lanka having a share less than 0.5% of German imports. However, Indonesian and Sri Lankan average prices for their supplies are substantially higher than those of India and China.



Average prices are just a rough indicator of the competitive position but generally it is accepted to evaluate the competitive position of a country using prices of nearest competitors. China, India and Indonesia are the nearest competitors for Sri Lanka essential oils supplies in terms of scale (volume and value) as well as quality. The global trade in essential oils is booming and exports of Sri Lanka are growing but the Sri Lankan market share is still limited. It can be concluded that Sri Lanka has sound opportunity to expand its essential oils production and exports.

Margin and gross margin analysis

Farmers receive a higher contribution margin for their cinnamon quills and oils and citronella oil on the local market than on the international market. The dominant product i.e. cinnamon leaf oil, has a low contribution margin for farmers. The processor/ exporter receives the highest contribution margin in value chains producing for the international market. It should be considered that the production of cinnamon leaf oil is less costly for farmers than the production of cinnamon bark oil. Hence the contribution margin for farmers in cinnamon leaf oil is higher than in cinnamon bark oil. Citronella is the least risky product for farmers as its production costs are considerably lower than for cinnamon oil.

Cinnamon farmers with 1 acre of land and no distillation facility obtain an annual gross margin of 713,400 LKR (3,941 US $) per year from oil production. Their breakeven quantity of cinnamon quills is 185 Kg and the breakeven price is 556 LKR/Kg (3.07US $). For them the income from leaves is low compared to the income from quills. Cinnamon farmers with 1 acre of land and own distillation facility and receiving leaves from 25 other farmers obtain an annual gross margin of 1,755,600 LKR (9,699US $) from oil production. Their breakeven price of leaf oil is 1,075 LKR/L (5.94US $) and the breakeven quantity of leaf oil is 336L/year. Cinnamon farmers with 1 acre of land and own distillation facility producing quills and leaves and also processes leaves from 25 other farmers producing both bark and leaf oil obtain an annual gross margin of 4,215,600 LKR (23,291US $) from oil production. Their breakeven quantity of cinnamon bark oil is 5 L and the breakeven price is 36,923LKR/L (204US $).

Citronella farmers with a 1 acre of land and no distillation facility obtain an annual gross margin of100,320 LKR (862US $). Their breakeven quantity of citronella oil production is 28 L while the breakeven price is 714 LKR/L (3.94US $). Citronella farmers with 1 acre of land and own distillation facility receiving leaves from 25 other farmers obtain an annual gross margin of 3,285,120 LKR (18,150US $) per year. Their breakeven price of citronella oil is 1,180 LKR/L (6.52US $) and the breakeven quantity of oil is 1,197 L per year.

Margin farmer as %

end user product value

LKR per

kg

LKR per

liter

LKR per

kg

LKR per

liter

Cinnamon Quill production local market 3,500 1,249 35.7%

Cinnamon Quill production international market 9,200 1,248 13.6%

Cinnamon Leaf oil local market 3,800 1,023 26.9%

Cinnamon Leaf oil international market 6,500 1,023 15.7%

Cinnamon Bark oil international market 90,000 10,998 12.2%

Citronella oil local market 3,900 1,498 38.4%

Citronella oil international market 7,500 1,498 20.0%

End user product

value Margin farmer

Farmer's share in value created in various essential oil value chains



Social Analysis

The smallholder farmers peel their limited amount of cinnamon harvest (on average 600 Kg from 1 acre) themselves. Working conditions are at a very low standard. The large plantations are more organized and workers use protective gear and are employed full time. These companies also have the necessary certifications (ISO, GMP and HACCP certifications). The situation is similar with extractors having boilers in the citronella value chain. Exporters in the cinnamon leaf and bark oil and citronella oil value chain have very large cultivation areas. They work with a limited number of farmers with their own distillation facilities. As the export product has to meet all the quality standards, it is mandatory that their distillation facilities properly follow processing standards.

Environmental Analysis and impact of climate change

Large amounts of raw materials are required to produce oil. For example, 500 kg of cinnamon leaves gives 10 litres of oil and 500 kg of citronella leaves gives 7 litres of oil. The use of pesticides in farming is common to achieve good yields of raw material. Currently Sri Lanka does not have organic certifications specifically for the essential oils value chain. Companies like Hettigoda Industries Pvt Ltd emphasized the importance of having citronella leaves from farms where no chemicals are used. However, it is difficult for the company to control the utilisation of chemicals by the farmers.

Each essential oil should have a Material Safety Data Sheet (MSDS) that provides toxicity information, flammability warnings, and disposal directions. Most essential oils are extremely flammable requiring extra precautions when disposing produce or cleaning up a spill. Many oils are toxic to aquatic life, and can have long-lasting impacts on marine/riverine ecosystems. Oils should not come in contact with river or groundwater, meaning oils should never be dumped in drain or toilet. Individual distillation facilities owned by Sri Lanka farmers provide little or no evidence to support proper disposal methods. If an oil is contaminated or rancid and cannot be used, it must be disposed of through a hazardous-waste collection service. Container recycling can also pose challenges. All quality essential-oils products come in glass containers. Pure essential oils degrade plastic containers. Surprisingly most oil in Sri Lanka’s rural areas is stored in plastic barrels.

Opportunities, outlook and recommendations

Sri Lanka produces high quality raw material for various types of high value oils. Both Sri Lankan essential oils exports and global essential oils demand and trade are growing rapidly. However, Sri Lanka is internationally still a small player with huge scope to further develop the business. Essential oils are high value items with good return on investment. Health and healthy food awareness push the sales of essential oils up. Essential oils are considered to contribute to a modern healthy live-style. The upper class in urban Sri Lanka and internationally will continue to demand more and more supply of high-quality essential oils. Sri Lanka is already market leader in cinnamon oil and can further strengthen its position in this product. Sri Lanka has good opportunity to further strengthen its position in pepper essential oil as it produces high quality black pepper. To achieve high quality produce, complete control and management of farming, processing and trade is required using the best equipment and trained staff. Sri Lankan companies need to invest substantially in equipment and staff and implement efficient control over farming. Companies are developing exclusive raw material supply lines using the services of selected farmers and production on their own fields. The traditional low efficient processing units spread all over the rural areas seem to lose business and medium-scale and large-scale units with modern equipment seem to take over. Farmers will most likely more and more be pushed to their core business i.e. farming of high-quality raw



materials while processing will be done in companies using up-to-date equipment and highly trained staff. The goal is to establish a technological well-equipped sector supplying high quality produce in larger volumes. Some traditional oil production will continue for specific local target groups (such as Ayurveda and tourists) but the mainstream production will move one to modernised installations. Parallel, the business support services should be strengthened and the government compliance control and administrative regulations and institutions should be streamlined. The TAMAP study team recommends for the development of the essential oils sector:

• Improve the export laws and regulations and institutions for essential oils;

• Improve the transparency of the essential oils sector;

• Establish good access to new equipment and knowledge for oil extraction, storage and packaging (including GMP);

• Promote use of more efficient farm technologies (including GAP);

• Promote further horizontal and vertical integration of the sector.



2 I N T R O D U C T I O N A N D C O N T E X T

2 . 1 I n t r o d u c t i o n t o t h e p r o j e c t

The Technical Assistance to the Modernisation of Agriculture Programme in Sri Lanka (TAMAP) service contract, implemented by a consortium led by ECORYS, started with the mobilisation of the Technical Assistance Team (TAT) on 8 th January 2018. The project will have an operational phase of 36 months and will end on 7 th January 2021.

The objective of the service contract is to contribute to a more productive, sustainable, diversified, climate-resilient, market-oriented and inclusive agriculture in Sri Lanka. The following four (4) results have to be accomplished within this service contract. They are:

Result 1: An overall (overarching) Agricultural Policy in line with the Government Development Goals is developed.

Result 2: An enabling environment is created and relevant policies for the modernisation and diversification of agricultural production, as well as the promotion of agricultural exports, are implemented.

Result 3: Existing systems and practices used by central and provincial agricultural ministries for planning, budgeting and policy implementation are improved.

Result 4: The statistical and analysis systems to monitor and assess the impact of implementing the overall agricultural policy are improved.

The threads running through these five critical elements are the coordination, facilitation, training, mentoring and mainstreaming of cross-cutting issues such as climate change, gender, youth and smart nutrition.

One of the main activities of the TAMAP is to develop in close consultation with the stakeholders an Overarching Agriculture Policy (OAP) and based on that an Implementation Strategy specifying detailed action plans and costs for all relevant subsectors with the main objective to make the entire agriculture sector more productive, effective and efficient. Several assignments are being carried out to support the development of the overarching policy and its implementation strategy as well as to assist the EUD Sri Lanka in the programming of future interventions. As such 8 value chain studies on commodities with future potential for development and a cold chain pre-feasibility study are carried out to assess and recommend future interventions in the agriculture sector.

2 . 2 C h a l l e n g e s o f t h e a g r i c u l t u r e s e c t o r i n S r i

L a n k a a n d i t s r e o r i e n t a t i o n

Agriculture has been an important driver of poverty reduction through income and employment

generation in Sri Lanka. Although Sri Lanka has a history of exporting agricultural products a

large part of the agricultural population remained highly traditional with archaic relations to

markets and commercial networks. Also, the share of GDP generated by agriculture sector

decreased as other sectors gained more prominence. With the departure of labour force from

the rural areas to urban areas and other economic activities it becomes increasingly urgent to

modernize the farming sector.

Promoting farming as a business has the potential to uplift rural areas further and increase the

contribution of agriculture to the national economy. Improved connectivity to potential demand



and markets, investment in agriculture to increase labour productivity and diversify production,

reduction of wasteful use of resources and adding value to agricultural processes via

processing and improved handling are all components of the modernization process.

Over the last decades it has become increasingly clear that farming for a market cannot be

promoted by stimulating the supply side only. Modern commercial farming is part of a total

system which gets its information from the demand side of the economy and leads this to the

supply side where it sets the rules and regulations for participation of the farmers. This system

operates in a regulatory environment set by policies and strategies of local and international

governments and is supported by financial and non-financial services. Over the last decades

in more and more countries (and also in Sri Lanka) systems are evolving in which all

stakeholders co-operate closely together to generate the highest possible value in the chain.

Such chains are identified as value chains.

This report provides an analysis of the essential oils value chain in Sri Lanka, using to some

extent the evidence-based, largely quantitative, toolkit developed/ compiled by the Directorate-

General for International Cooperation and Development (DG DEVCO) within the project “Value

Chain Analysis for Development” (VCA4D).

This diagnosis of the essential oils value chain is intended to support the European

Commission and the Government of Sri Lanka in structuring their policy dialogue around the

strategic issues related to this sector. This to assist in developing a resilient, competitive,

commercially viable and environmentally sustainable essential oils sector in Sri Lanka. The

goal is to increase the value added in the chain and secure social inclusion of smallholders.

This study was conducted over a period of four weeks, from 1 to 30 November 2019 by 2

agriculture economists from the TAMAP project.

2 . 3 V a l u e c h a i n a n d V C A 4 D m e t h o d o l o g y

2 . 3 . 1 W h a t a r e v a l u e c h a i n s ?

Value Chains are interactive systems with products, money and information flowing through

them, all reliant on relationships. The success of a value chain depends on effective flow and

use of information along the entire chain from the market via traders and retailers and

processors to farmers and agro-input suppliers. The flow depends on trust and commitment

between trading partners. The success of the chain depends on understanding market

opportunities and the whole chain rather than looking at its own part of the chain in isolation.

In a successful value chain, each stakeholder knows the whole chain and understands benefits

from chain-wide interdependence in the flow of products and money. Every stakeholder in the

chain cooperates and works together to supply the same market opportunity and avoid

competing only on price. The value created in the chain increases through gains in efficiency

and quality. Relations between stakeholders in a chain are stable and strong. Conducting such

a collaborative action to avoid price competition and focus on efficiency gains and produce

quality only makes commercial sense in case market information shows that reference

products in local and export markets generate considerable higher value than the standard

products of the supply chain of a sub-sector. This is exclusively the case for demand/markets

catering for the middle- and high-income groups (tourist hotels and restaurants, supermarkets

and specialty shops) and export production. These markets are the target for value chain

development approaches.



A large amount of knowledge and methodologies have been developed related to value chain

development since Michael Porter introduced the concept in his book Competitive Advantage

in 1985.

2 . 3 . 2 V C A 4 D m e t h o d o l o g y

The VCA4D project is part of the European Union’s “Inclusive and Sustainable Value Chains

and Food Fortification” Programme.

The VCA4D methodology aims to provide evidence, supported by a list of indicators measured

quantitatively or based on expert assessments that together provide an answer to four framing

questions:

1. What is the contribution of the VC to economic growth?

2. Is this economic growth inclusive?

3. Is the VC socially sustainable?

4. Is the VC environmentally sustainable?

The analytical process has four components:

Functional analysis: provides a general mapping and description of the main actors,

activities, and operations in the chain, an overview of the products and product flows, the major

production systems, a description of the main governance mechanisms in the chain, and a

short description of (known) constraints. The functional analysis forms the basis for the

analyses in the other three components. The analysis is mainly based on secondary data, and

key informant interviews with both value chain actors and key experts.

Economic analysis: Firstly, consists of a financial analysis of each actor type (financial

accounts, return on investment), as well as an assessment of the consolidated value chain

(total value of production, global operating accounts). Secondly, it assesses the economic

performance (contribution to economic growth in terms of direct and indirect value added

generated, and the sustainability/viability for the national economy (domestic cost ratio, Policy

analysis matrix Data is derived from secondary data, key informant interviews, and structured

questionnaires.1

The social analysis explores whether the value chain is socially sustainable. It also

contributes to discussion on whether potential economic growth in the value chain can be

socially inclusive. The social analysis draws on multiple information sources, including

secondary data and field data from floriculture producers at different scales, farmers, traders,

exporters etc., and other government and non-government stakeholders.

The environmental analysis evaluates the environmental sustainability of the value chain.

1 The economic analysis in the VCA4D methodology applies to a large extent the economic effects analysis which is a tool often used in financial and economic analysis. Given the limited time available for the essential oils value chain study, an economic effects analysis was not conducted.



2 . 4 D a t a c o l l e c t i o n

2 . 4 . 1 S e c o n d a r y d a t a

The study team obtained relatively latest information from projects and GoSL sources (reports

and statistics) and from trade related websites such as IndexMundi or UNcomtrade.

2 . 4 . 2 P r i m a r y d a t a

Primary data was collected through key informant interviews and focus group discussions with farmers (small, medium and large), traders, exporters in the main production areas of Matara, Galle, Embilipitiya and Ratnapura. The study team is aware that the data collected are not a complete survey. Also given the oligopolist situation in the sector, some stakeholders were reluctant to expose information which could have a negative impact on their position in the business.

2 . 4 . 3 W h y e s s e n t i a l o i l s w e r e s e l e c t e d f o r t h e s t u d y

In the course of this report more details on the justification why essential oils were selected for a detailed value chain assessment. However, in order to understand the report, a brief summary is presented on the justification.

Essential oils are oils derived from plants and trees is a farming activity as plants are grown for commercial purposes by farming communities. Production of essential oils has a very long tradition in Sri Lanka but the large-scale commercial production for export purposes is relatively new. Sri Lanka has wide variety and good growing conditions for several plants and trees which can provide high value essential oil.

Under the influence of global trends of healthy food and live style among middle- and high-income groups worldwide, the use of essential oils has grown tremendously over the last decades. At present, essential oils are one of the booming businesses with high growth rates in international trade. Sri Lankan essential oil exports have grown rapidly over the last decade and the potential for further growth is substantial. Essential oils provide income and rural employment to small, medium-scale and large farmers and foreign currency earnings to countries participating in the business. Given the large potential Sri Lanka has to further develop the sector, essential oils sector has been selected for the value chain analysis.



3 E S S E N T I A L O I L S S E C T O R

3 . 1 S e c t o r O v e r v i e w i n S r i L a n k a

Sri Lanka’s essential oils industry can be divided into two subsectors i.e. natural essential oils and oleoresins. Natural essential oils are concentrated hydrophobic liquid containing easily evaporated chemical compounds from plants. Essential oils are known as the oil of the plant from which they were extracted. An essential oil is called “essential” because it contains the “essence of” the plant’s fragrance. Oleoresins are the concentrated form of spices and herbs. Oleoresins contain both easily and less easily evaporated chemical compounds than natural essential oils. This makes them more interesting for the flavour and food industry as food and flavouring manufacturers are increasingly looking for ways to produce foods and flavourings from natural ingredients. The wide variety of oleoresins gives the manufacturers numerous possibilities to formulate new or improved natural foods and flavourings. Compared to synthetic ingredients, oleoresins can vary in the quality and manufacturers use very strict specifications for oleoresins. The chemical compounds in oleoresins do not vaporise as easily as in natural essential oils and are not lost when exposed to open air. Oleoresins yield a more complete flavour profile for example pepper oleoresin contains the non-easily evaporated piperine whereas essential oil of pepper does not contain this compound. Piperine is the spicy hot part of pepper. Another difference between essential oils and oleoresins is that oleoresins dissolve in fats, oils and lipids whereas essential oils do not. This characteristic of oleoresin provides manufacturers with different options for food formulation compared to essential oils.

The short-term opportunities on major global markets for essential oils and oleoresins depend largely on the availability of raw material to produce them. Crop failures in major producing countries can overnight change the global market situation. Sri Lanka’s essential oil sector is small with estimated 346 metric tons of natural essential oils exports and 654 metric tons of oleoresins exports in 2017. The local market is about 80 to 85 metric tons and the import about 130 metric tons import in 2017. The dominant products in the subsector of natural essential oils are cinnamon leaf and cinnamon bark oil, pepper oil, nutmeg oil and citronella oil. The Sri Lankan oleoresins production is nearly exclusively pepper oleoresin.

Sri Lanka started only in the ninety seventies with commercial production and exports of essential oils. Even presently, Sri Lanka has only a tiny share of the world market of essential oils. The global essential oils market had a value of about 7 billion US $ in 2018 and is expected

to grow to 14.6 billion US $ in 20262. Sri Lankan essential oils exports in 2017 are valued at 46 million US $. We estimate the production value of the Sri Lankan commercial essential oils sector in 2017 at 50 million US $ or LKR 7,450 million.

3 . 1 . 1 N a t u r a l E s s e n t i a l O i l s

A wide variety of plants are used to prepare natural essential oils. The oils can be made from the leaves, the stems, the bark, the fruits or flowers and the roots. The Sri Lanka natural essential oils subsector focus is on cinnamon leaf and bark oil, pepper oil, nutmeg oil and citronella oil. Other minor natural essential oils produced in Sri Lanka are cardamom. mace and cloves oil as well as ginger, citronella and lemon grass oil. Over 60% of the volume export of Sri Lankan natural essential oils is cinnamon leaf oil with nutmeg oil second most important

2 Fortune Business Insights, Essential Oils Market- Global Market Analysis, Insights and Forecast 2015 - 2026



export in volume terms. Pepper oil is third most important export3. Natural essential oils made from cinnamon are largely dominating the commercial production in Sri Lanka. In fact, Sri

Lanka is dominating the international essential oils market for cinnamon. Global cinnamon exports totalled 691.1 million $ in 20184. The share of Sri Lanka in global cinnamon exports in 2018 was 28.2% Global exports of cinnamon increased with 4.9% from 2017 to 2018. Natural essential oils industry of Sri Lanka produces both semi-finished intermediate products as well as finished consumer products for utilisation in food and beverages industry, pharmaceutical and cosmetics industry and flavours industry.

3 . 1 . 2 O l e o r e s i n

Sri Lankan oleoresin production originates from mainly pepper farming. Sri Lanka oleoresin production is dominated by pepper products. In some segments of the food industry,

manufacturers prefer oleoresins above fresh or dried spices as they are easier to apply5. The use of oleoresins enables manufacturers to standardise the flavour profile of their products and improve quality consistency also because oleoresins are natural and a substitute for chemical ingredients. Oleoresin is mainly produced through solvent extraction whereas natural essential oils are produced through distillation. The processing technology for oleoresin is more complex and more expensive than for natural essential oils. Consequently, the Sri Lankan companies involved in oleoresin production are only few (less than 5). Oleoresin processing in Sri Lanka produces semi-finished intermediate products for utilisation in food and beverages industries. Table 1 gives an overview of the utilisation of Sri Lanka essential oils

Table 1 Dominant utilisation of Sri Lankan essential oils

Key product category Varieties

Food & Beverages especially in meat products but also for instance in coca cola

Spices oleoresins & natural essential oils

Pharmaceuticals & Cosmetics Cinnamon oil

Pepper oil

Nutmeg oil

Cardamom oil

Cloves oil

Ginger oil

Citronella oil

Flavourings for sauces, marinades, bakery products and many other products

Spices oleoresins

Source: Own description based on various secondary sources

3 A.P.P. Disna - Export Potential for Export Agriculture Crops, Dept of Export Agriculture, Kandy 2017

4 D Workman, Cinnamon Exports by Country, May 26, 2019

5 CBI, Exporting oleoresins for food to Europe, Rotterdam, April 2018



3 . 1 . 3 M a j o r r a w m a t e r i a l s f o r S r i L a n k a n e s s e n t i a l o i l p r o d u c t i o n

Cinnamon is obtained from the inner bark of several tree species from the genus Cinnamomum. True cinnamon is native to Sri Lanka. Cinnamon is originally grown wild in central hill country of Sri Lanka. There are eight cinnamon species in Sri Lanka. Among them only Cinnamomum zeylanicum Blume is grown commercially. These are ever-green trees with oval-shaped leaves, thick bark and berry fruit. The spice, the bark and the leaves are the primary parts of the tree. Only 0.5 mm of the inner bark of the stems is used giving metre-long cinnamon strips that curl into rolls (called quills) on drying. The processed bark dries completely in 4 to 6 hours in a well-ventilated and warm environment. Once dry, the bark is cut into 5 to 10 cm pieces for sale. Cinnamon is used mainly as an aroma and flavouring additive in food and beverages but also in cosmetics. The bark is mainly used for spice pieces with parts which are not so suitable for spice production also used for essential oil production. The main source of cinnamon oil are the leaves. Tthere were several types of cinnamon categorized based on the taste of the bark. “Pani-Miris Kurundu” with sweet-pungent taste and “Miris Kurundu”, “Sevel Kurundu” and “Thiththa Kurundu”. Currently ten cinnamon accessions have been identified based on yield and quality performances. The best two lines, named as “Sri Vijaya” and “Sri Gamunu”, were released. Other selections are under evaluation in different agro climatic zones. The soils of Negombo (white sandy) and South Western region (red yellow podzolic) produce the best quality cinnamon.

Black pepper (piper nigrum) is a flowering vine from the genus Piperaceae cultivated for its fruit called peppercorn. The plant grows up to 4 m in height on supporting trees, poles or trellises. The plants bear fruit from the 4th or 5th year and then typically for seven years. When fresh and fully mature, the fruits are about 5 mm in diameter and dark red containing a single seed. Peppercorns or called black pepper (cooked and dried unripe fruit), green pepper (dried unripe fruit) or white pepper (ripe fruit seeds). Black pepper is the world’s most traded spice and its spiciness originates form the chemical compound piperine. Once the peppercorns are dried, pepper oil and pepper oleoresin can be extracted from the berries. Sri Lankan piperine is very sharp/ spicy hot making it a much looked after component by global traders.

Nutmeg is obtained from the seed of several species of the genus Myristica. The most used species is Myristica fragrans which is an ever-green tree cultivated for its fruit. Nutmeg is obtained from the seed and mace is obtained from the seed covering. The first harvest of nutmeg trees takes place seven to nine years after planting, and the trees reach full production after twenty years. Nutmeg and mace oil and oleoresin can be extracted from the seed and preferred by food and beverage industry compared to nutmeg as it leaves no particles in the final product

Cardamom is obtained from the seeds from species in the genera of Elettaria and Amomum of the family Zingiberaceae. The plants have small seed pods, triangular in diameter and spindle shaped with a papery outer shell and small black seeds. Elettaria pods are smaller and light green (giving true or green cardamom) while Amomum pods are larger and dark brown (giving black cardamom). Cardamom oil and oleoresin can be extracted from the seed. The content of oil in the seed is strongly dependent on storage conditions. Cardamom is the world’s third most expensive spice, surpassed in price per weight only by vanilla and saffron and cardamom oil is the most expensive essential oil from Sri Lanka.

Cloves are obtained from an ever-green tree of the genus Syzygium aromaticum. The tree is growing up to 8 to 12 m height. The tree has large leaves and crimson flowers grouped in terminal clusters. The flower buds initially are pale, then turn green and transition to a bright red when ready for harvest. The aromatic flower buds are harvested at 1.5 to 2 cm long. Cloves oil and oleoresin can be extracted from the buds.



Ginger is obtained from the root of Zingiber officinale. The plant grows annual pseudo stems about 1 m tall bearing narrow leaf blades. Ginger is in the family Zingiberaceae to which also belong turmeric, cardamom and galangal. Ginger oil and oleoresin can be extracted from the root tubers.

Lemon grass or Cymbopogon is a genius in the grass family. The genius has a large number of grasses. Citronella grass (Cymbopogon nardus) grows to about 2 m height and is used for the production of citronella oil. The oil is obtained from the leaves and stems through distillation or chemical treatment (for example with alcohol). Cymbopogon nadus (“Heen pangiri”) and Cymbopogon winterianus (“Maha pangiri”)) are the two important species grown in Sri Lanka. The “heen pangiri” plant has narrow, long shiny leaves. Leaf sheaths are reddish purple in colour and dried leaves curled down at the base of the bush. Plants are erect and height of the bush is about one meter. Roots penetrate into deep soil and this plant is native to Sri

Lanka6.

3 . 1 . 4 E x p o r t s a n d i m p o r t s o f e s s e n t i a l o i l s f r o m a n d t o S r i L a n k a

Figure 1 presents an overview of imports and exports of natural essential oils and oleoresins to and from Sri Lanka. It is clear that the Sri Lanka trade balance in essential oils is strongly positive. Exports both in terms of quantity and value are much higher than imports. The imports are about 3 million US $ in 2017. The exports are rapidly growing both in value and volume terms over the last decade. In 2016, the export had a value of 47.7 million US $ and in 2017 a value of 46 million US $ with a volume of about 1000 metric tons.

Figure 1 Imports and exports of essential oils to and from Sri Lanka

Source:UNComtrade

Figure 2 shows the trend in exports of natural essential oils and oleoresin from Sri Lanka. The export of natural essential oils and oleoresin is growing but the Sri Lanka growth pattern in oleoresin exports seems more erratic than in natural essential oils. Oleoresin caters nearly

6http://www.exportagridept.gov.lk/web/index.php?option=com_content&view=article&id=129&Itemid=159&lang=en

http://www.exportagridept.gov.lk/web/index.php?option=com_content&view=article&id=129&Itemid=159&lang=en




exclusively to the global food and beverages industry while natural essential oils are catering to the global food and beverages industry, the pharmaceutical and cosmetics industry and the flavours industry. Natural essential oils exports are hence less vulnerable for global dynamics in the food and beverages industry.

Figure 2 Export of natural essential oils and oleoresin from Sri Lanka

Source: Own calculation on basis of UNComtrade and A.P.P. Disna - Export Potential for Export Agriculture Crops, Dept of Export Agriculture, Kandy 2017

3 . 1 . 5 P r o d u c t i o n o f e s s e n t i a l o i l i n S r i L a n k a

Spices are the main raw material for the essential oils industry in Sri Lanka. Sri Lanka is the 9th most important exporter of spices in the world with total spice export value of about 2 billion US $ excluding re-exports. Sri Lanka is the largest producer and exporter of cinnamon in the world. Sri Lanka exports about 55,000 to 60,000 metric tons of spices annually of which 17,000

metric tons of cinnamon and 35,000 metric tons of pepper7.

3 . 1 . 5 . 1 . S p i c e b a s e d e s s e n t i a l o i l

About 30% of the Sri Lankan essential oil export in volume terms is cinnamon oil (see Figure 3). Cinnamon leaf and bark oil have approximately the same production value but cinnamon leaf oil is about 87% of the production volume of the two products. Cinnamon bark oil has a much higher unit value (price per kg) than cinnamon leaf oil. Nutmeg oil is in volume terms the second most important product of the natural essential oil industry in Sri Lanka. The product has a relatively low unit value comparable with the unit value of cinnamon leaf oil. Pepper oil is the third most important natural essential oil product in Sri Lanka with a relatively high unit value.

7 Daily Financial Times, Spice Industry Eyes $ 500 m in Exports in 2019, 19-2-2019



Figure 3 Trend in export of natural essential oils in Sri Lanka

Source: A.P.P. Disna – Export Potential for Export Agriculture Crops, Dept of Export Agriculture. Kandy 2017 and Ultra International – Sri Lanka the Spice Island, Colombo May 26, 2018

3 . 1 . 5 . 2 . O l e o r e s i n a n d o t h e r e s s e n t i a l o i l s

Over a decade ago, Sri Lanka started oleoresin production for export, initially for western markets where food industry processing was centred. The main oleoresin product is pepper, partly because of Sri Lankan pepper’s high piperine level. Export of oleoresins and other essential oils (mainly non-spice of which about 40 metric tons of ginger and citronella oil) is about 50 to 60% of the total volume exports of essential oils in Sri Lanka. Citronella exports have grown sharply lately from 8 to 10 metric tons annually (2014 to 2016) to 38 metric tons in

20178. The dominant oleoresin product is pepper oleoresin which is a high-priced item with an estimated FOB export value in 2017 of about LKR 17,650 per kg.

3 . 2 G o v e r n a n c e a n d I n s t i t u t i o n a l f r a m e w o r k

3 . 2 . 1 E s s e n t i a l o i l s p o l i c i e s a n d s t r a t e g i e s

Sri Lanka is implementing the National Export Strategy (NES) for Spices and Concentrates

2018-20229. The NES observed that: “the spices and essential oils sector has significant potential to make socio-economic contributions to Sri Lanka through export-led growth”. The NES describes as the main constraints for the development of the sector:

• Limited availability of high yielding planting stock and planting techniques causing slow productivity growth and low adaptation of improved varieties;

• Limited availability of good quality packaging and labeling services;

8 Ultra International – Sri Lanka the Spice Island, Colombo May 26, 2018

9 Govt of Sri Lanka, National Export Strategy of Sri Lanka 2018-2022, Spices & Concentrates Strategy, Colombo 2018

0

100

200

300

400

500

600

700

800

CinnamonLeaf oil

CinnamonBark oil

Pepper oil Nutmeg oil Cardamomoil

Clove oil Oleoresin &essentialoils nes

Export of essentail oils of Sri Lanka in metric tons

2013 2014 2015 2016 2017



• Insufficient skilled and unskilled labour, coupled with limited training opportunities;

• Limited promotion of spices in destination markets and inadequate brand promotion.

The NES has identified the following strategic objectives for the sector:

1. Led by industry stakeholders, strengthen, integrate and simplify the policies and governance framework related to spices;

2. Improve production and productivity of Sri Lanka’s spice sector by ensuring quality control and safety compliance in accordance with global standards;

3. Become globally recognized as an innovative player in the value-added spice market segment

The NES acknowledges that coordinating activities, monitoring progress and mobilizing resources for implementation will be critical to successful achievement of these targets. As such, a public-private advisory committee for the sector was established, operationalized and empowered for overall coordination, provision of policy guidance and the monitoring of industry development against the strategic objectives. High-level support for the government and strong championship by the private sector is considered crucial for a successful transformation of the sector.

3 . 2 . 2 I n s t i t u t i o n s r e s p o n s i b l e f o r a n d s u p p o r t i n g t h e s e c t o r

The key institutions related to the development and regulation of the essential oils sector are the Department of Export Agriculture of the Ministry of Primary Industries, Sri Lanka Standard Institute, Industrial Technology Institute, Spices & Allied Products Producers’ & Traders Association and the Spice Council.

3 . 2 . 2 . 1 . T h e M i n i s t r y o f A g r i c u l t u r e

Ministry provides fertiliser subsidies and planting materials to growers. The Ministry of Agriculture supported the dissemination of extraction technologies and extension and training of smallholder farmers among others in citronella production.

3 . 2 . 2 . 2 . I n d u s t r i a l T e c h n o l o g y I n s t i t u t e

Sri Lanka Standards Institute developed methods of testing of essential oils. ITI is providing tests according to these specifications. ITI’s goal is to support industry through testing, investigation and research; improving product quality, technical processes and methods used in industry. ITI is under the Ministry of Science, Technology & Research and is based in Colombo and Malabe. ITI has conducted a broad testing program for spices and essential oils quality standards and specifications. Also developed new technologies to increase productivity in processing and handling of spices and essential oils.



3 . 2 . 2 . 3 . S p i c e C o u n c i l

The Spice Council is a joint initiative of the public and private sector in the spice industry. The Spice Council was founded in December 2003 as a non-profit organization, registered under the Registrar of Companies Act No 17, 1982. The Spice Council acts as an apex body for the spice industry and a unifying front to meet the stakeholders’ activities to develop the industry. The Spice Council works towards to ensure the Sri Lankan spices and allied products compete effectively in the local and global market. It promotes high standards of business conduct and scientific research as well as training and development programs for the industry. Also, it advocates industry interests with the government and in policy making. The Spice Council works with the SLSI to develop standards and quality management systems for the country. They developed GMPs for various spices.

3 . 2 . 2 . 4 . T h e M i n i s t r y o f P r i m a r y I n d u s t r i e s a n d S o c i a l E m p o w e r m e n t

The Ministry of Primary Industries and Social Empowerment has introduced new crop varieties and new management techniques for spice industry and assisted in branding of products to ensure their viability and profitability, The Department of Export Agriculture of the MoPISE provides extension services to growers. The Department of Export Agriculture also runs research centre in Matale and the National Cinnamon Research and Training Centre in Thihagoda, Matara. The latter aims to develop and deliver research and training for all stakeholders in the cinnamon industry. It worked on introduction of new production techniques and their adaptation in farming, crop management, harvesting, processing and grading. Through the ASMP, vary smallholder activities in essential oils are supported with grants and technical assistance to innovate the extraction installations (mainly spreading the use of stainless steel in such installations)

3 . 2 . 2 . 5 . S p i c e s a n d A l l i e d P r o d u c t s P r o d u c e r s ’ & T r a d e r s ’ A s s o c i a t i o n ( S A P P T A )

SAPPTA is the official body representing the spice trade in Sri Lanka. The Association contains representatives from the exporter, producer, processor, dealer and service sectors. The Association promotes regular dialogue with the government and other policy bodies. SAPPTA identifies problems in spice commodities, difficulties in exporting and benefits of government regulations. SAPPTA coordinates participation of members in marketing/international trade fairs, organizes trade fairs and seminars. Also, SAPPTA assists its members in legal issues and publishes weekly prices for all spices and sets the auction prices. SAPPTA successfully intervened in several taxation disputes and managed to remove several taxes. SAPPTA also encouraged the plantation sector to diversify in large scale spice cultivation.

3 . 2 . 2 . 6 . V a r i o u s p r i v a t e s e c t o r a n d g o v e r n m e n t a l i n s t i t u t e s a n d i n i t i a t i v e s

The National Chamber of Commerce has as its members major private sector companies and has strong linkage with Chambers of Commerce in many countries. The NCCSL supports competitiveness in the sector and promotes trade and investment. The Board of Investment encourages Foreign Direct Investments (FDI) as well as local investments in the sector. Registered exporters receive high levels of support. The spice sector is a special target sector of the National Export Strategy. The Export Development Board has sector extension staff and



provides information on the spice and essential oil sector in Sri Lanka at its website to facilitate foreign buyers in understanding the capabilities of Sri Lanka. Also, EVD collects and spreads information to Sri Lankan farmers and companies interested in exports of essential oils products and provides assistance for export. Through the One Window Portal established by the Ministry of Finance, the trading community is provided with access to online systems developed for Regulatory Agencies involved in Import & Exports.

3 . 2 . 3 L e g a l f r a m e w o r k a n d a c t s

The Food Act No 26 of 1980 regulates the spice sector by defining what are spices, their level of accepted mould and insect infestation as well as their colour profile and accepted levels of purity. It provides for a specific description of the standards of each spice and its products.

The Plant Protection Act No 35 of 1999, confirms the institutional structure of plant protection under the responsibility of the Ministry of Agriculture and core components of the Ordinance No 2, of 1937. Also indicates special license and conditions to the importation of plants, for inspection of plants, at, before or after the time of landing in Sri Lanka. Also, the cleaning, destroy, fumigation and disinfection at the expense of the consignee at, before or after landing without compensation of all plants, or packages and pots which are suspected of pest or disease. The Act specifies quarantine of imported plants in special areas and the feed to be charged therefor as well as identifying and declaring any area to be an infested area and its proper quarantine. The Act describes methods for the destruction and proper disposal as well as the spraying or treatment of any weed or of any plants within Sri Lanka affected with any pest or disease. It also covers regulation for the transfer of plants from one locality to another and the officers who are to carry out regulations under this Act and their powers and duties. Finally, the Act allows for the constitution of committees to advise the Director and officers for the purpose of the Act. The Fauna and Flora Protection Ordinance No 2 of 1937 has been several times amended with the latest amendment in 2009.

Other regulations for the spice sector are provided by:

Control of Pesticides Act 1994 provides for the licencing of pesticides, to regulate the import and packaging, labelling, storage and formulation, transport, sales and use thereof, the appointment of a licensing authority for pesticides and for the establishment of a pesticides technical and advisory committee.

The Enactment of New Plant Variety Protection Act is an enactment under the Intellectual Property Act No 36 of 2003 and focus on protection of plant varieties by patents or by an effective sui generis system or some combination of the two.

Custom Act 2019 regulates the ban on imports of cinnamon, black pepper, nutmeg and citronella

3 . 2 . 4 E x p o r t a n d m a r k e t r e q u i r e m e n t s a n d l i c e n s e s

Any exporter of essential oils requires an export license which has to be annually renewed. All exporters in Sri Lanka have to be registered with the Board of Investment and have to pay an annual fee. This is the so-called Return of Economic Service Charges which amount to 1 % of the revenues irrespective whether profits or losses have occurred. The exporter also has to be registered with the Export Development Board and has to pay a-once-and-off fee.

Import requirements for essential oils of EU and other countries deal with food safety, contamination, adulteration (mixing of different qualities or different types of oil), labelling and packaging, allowed substances, food extracts for the coloring of additive-free foods and conditions for the use of extraction solvents, documentation, samples, payment and delivery



terms and organic certification. The International Standards Organization (ISO) provides standards for major essential oils but many buyers also have their own specifications which can differ from ISO standards. Sustainable production is rapidly becoming a crucial element for access to mainstream market in Europe and USA. Until recently only Fairtrade buyers had requirements for sustainability but now all leading food manufacturers are turning to sustainability. European and American importers value the quality of essential oils on the basis of chemical and physical analysis (color, flavor, density, optical rotation, refraction, solubility). Essential oils must be 100% pure and diluted essential oils with solvents must be called a flavor or stated as diluted.

Sri Lanka applies both Tariff and Non-Tariff Measures to regulate import and exports. Sri Lanka is a member of the World Trade Organisation since 1 January 1995 and applies General System of Preferences (GSP) and the Trade Facilitation Agreement. Sri Lanka has special GSP+ conditions in trade with EU and negotiated a number of free trade agreements with countries in Asia. Under GSP+ Sri Lanka has duty free essential oils imports in the EU and also in USA Sri Lanka doesn’t face import duties on its essential oils. Consequently, especially the non-tariff import restrictions mentioned before are more important in the essential oil trade of Sri Lanka. Generally, importers/buyers in EU and USA work closely together with the exporting Sri Lankan companies and have obtained experience in compliance with export and import regulations. Their main issues are the capability of compliance with the quality standards as well as guaranteeing a sustainable supply of the products meeting the standards.

3 . 3 P r o b l e m s e n c o u n t e r e d i n t h e e s s e n t i a l o i l

s e c t o r

3 . 3 . 1 H i g h c o s t o f p r o d u c t i o n

Oil extraction suffers from a shortage of skilled and unskilled labour leading to high cost for labour. Especially the high turn-over of workers is a problem for oil extractors. As the work is quite specialistic it is difficult and costly to obtain labourers for the extraction facilities. This is a major reason why many extractors provide service extraction only. They let the farmers process their own harvest and take an agreed amount of the oil produced in the extraction process as compensation for the use of the equipment. Then, generally they purchase the remainder of the processed oil against the prevailing market price form the farmer. However, as various extractors explained, this can come as a cost too as the farmers can add unwanted substances to the oil leading to lower quality. All major manufacturers and exporters and more and more extractors are therefore considering to use only supplies from their own fields and a few trusted farmers and conduct the processing operations with their own staff. Exporters also indicated that obtaining all certificates and permits for export is a major challenge and raising the cost of their business. Different governmental institutions are involved in the processing of an export order and the co-operation between these institutions is problematic. The government has initiated several initiatives in the past to reduce this burden (latest initiative is the Export Market Portal of the Ministry of Finance) but up-to-now these initiatives have not substantially reduced this part of the handling costs.



3 . 3 . 2 V i o l e n t m a r k e t a n d p r i c e s t r u c t u r e

The majority of production units are traditional oil extraction units in the rural areas. Sri Lanka

has only about 10 manufacturers and exporters with modern equipment10. The local and world market for essential oils is quite unstable with peaks and lows of volume and prices. This is typical for a niche market with limited number of players. In essential oils only few companies dominate the world market and in Sri Lanka only a small group of companies dominate the exports and manufacturing of final consumer market products. Moreover, irregular exports from Sri Lanka are handled by general trading companies with no permanent linkage to essential oils trade. This situation causes prices to swing in all kinds of directions. For example, few years ago the market price of 1 liter of citronella in Sri Lanka was about LKR 10,000 while at the moment the price is just LKR 2,000 to 3,000. The previous high prices encouraged many farmers to engage into citronella production and extraction. Now, many of them are not harvesting the grass and have stopped extraction as it is considered too little profitable.

3 . 3 . 3 P e s t a n d d i s e a s e a n d G o o d A g r i c u l t u r e P r a c t i c e

Under climate change the Sri Lanka’s production areas for essential oils are experiencing prolonged wet periods. This leads to a higher prevalence of pests and diseases in the plants and more problems in drying the raw materials. Raw materials need to be dried before oil extraction in order to avoid long extraction time. However, at the moment drying the raw materials on the field or at the extraction site takes considerably more time leading to more fungi and pest in the raw material. This has an impact on the quality of the raw material. Good Agriculture Practice would be to store the raw materials after harvesting for drying in a covered place. Good Agriculture Practice is also related to the farming of the raw materials. For example, there are more than 15 varieties of citronella grass with each different yields and best agriculture management practice. Also extensive use of chemicals (fertilizer or pesticides) in agriculture production leaves residues in the oil and reduces the quality of the oil.

3 . 3 . 4 L o w l e v e l o f t e c h n o l o g y i n e x t r a c t i o n

There is a general lack of knowledge regarding advanced technology in the main production areas. Sri Lanka has about 10 companies using advanced technologies but the majority of production units are traditional installations in the rural areas. The distillation technology used in these traditional installations is very basic and outdated. Most installations are over 20 years old and comprise of galvanised steel or copper pipes. Only few installations are newer and use stainless steel pipes and vats. TAMAP noted that for many people engaged in this industry the business is too low profitable and they stopped producing. Improved technology is needed to save the industry. Technology that gives higher oil yields with good quality can be achieved by adopting an efficient distillation procedure and selecting suitable raw materials for distillation. The materials of the older installations interfere with the product (for example citronella turns green in these installations) and lead to lower quality and price. Moreover, the equipment used in Sri Lanka is not capable to extract all water out of the oils and therefor many oils are exported to India for further refinery. Also, the TAMAP team encountered many extraction units which had broken parts which the owners had tried to repair but in vain.

10 Ceyshine has a very modern installation, Verger Naturals has a new factory with advanced technology, PTC Agro and CCS BioExtracts are smaller companies but with good facilities, Citro Essential Oils and HDDES are established major companies with modern equipment, Plant Lipids Lanka, EOAS Organics, Link Natural Products and Vita Essential Oils are also major manufacturers and exporters.



Also handling, clearing and storage of the oil is bad for quality. No HACCP or GMP implemented, raw material placed on the floor were everyone enters with street shoes or even outside for drying. Most sieving is done with a piece of cloth and in open air which harms the quality. Essential oils are volatile products and the aromas tend to disappear in the air. Frequently, the product is stored after sieving in old bottles or plastic containers which may also affect the quality of the product. Also, longer storage has an impact on the product quality as the product loses its aroma and can change in characteristics (for example citronella turns green after one-year storage and red after 2 years of storage).

3 . 3 . 5 A d u l t e r a t i o n ( m i x i n g o f o i l s ) a n d s u b s t i t u t e s

Extractors are mixing cheap oil (locally produced lower quality or imported) with good quality locally produced oil. The adulteration has severely damaged Sri Lanka’s reputation as a high-quality producer. At the moment, the import of spices (cinnamon, black pepper) and oil (citronella) is banned in Sri Lanka but there is no proper mechanism to prevent illegal imports. Moreover, it has no impact on the local adulteration. For example, expensive cinnamon bark oil can be mixed with cheaper cinnamon leave oil. This will be detected by the importers/ buyers and also local manufacturers and harmed the reputation of the oil producers.

A structural thread for the essential oils sector is the increased uses of substitutes. Pharmaceutical and cosmetic industries in Sri Lanka and worldwide are increasingly using substitutes. Synthetic substitutes for essential oils are available in the local and global market. For example, fragrance oils represent the most cost-effective alternative to essential oils. Fragrance oils are made from synthetic ingredients or synthetics mixed with small amounts of

essential oils11

3 . 3 . 6 I n e f f e c t i v e g o v e r n m e n t s u p p o r t

The National Export Strategy for Spice and Concentrate is the first concise governmental sector-wide development approach. Until recently, the governmental support to the essential oils sector was not comprehensive with only case-by-case incidental activities. For example, government promoted the growing of citronella grass few years ago based on exceptional market conditions. These market conditions do not longer exist and many smallholder farmers have left the extraction business and farming. Many have remained with a stock of oil they can’t sell at a good price.

In its international trade promotion, the government wasn’t really successful for the sector. For example, at the moment India has imposed a minimum import price for black pepper that makes exports for Sri Lanka difficult. The government didn’t take action against this minimum price and also delays in the certification of free trade agreements (ISFTA and SFTA) to spices

such as nutmeg and pepper12. Moreover, the ban on import of raw materials (cinnamon, black pepper and citronella) may give only some short relief to local producers and farmers. It will eventually lead to non-competitiveness on international markets due to the impact of the measure on Sri Lankan prices for raw material. At the moment, spices are one of the few agricultural products that have higher international prices than local market prices. The ban if maintained longer time may totally destroy the competitive position of Sri Lankan supply.

11 E Douglas, Substitutes for Essential Oils, www.livestrong.com

12 Q Perera, Spices Industry Effected by Falling Prices, Sunday Times 1 September 2019



3 . 3 . 7 C o p y i n g s t r a t e g i e s o f e s s e n t i a l o i l p r o d u c e r s

3 . 3 . 7 . 1 L o b b y f o r b a n o n i m p o r t o f s p i c e s

The private sector successfully lobbied for a ban on imports of raw materials. Sri Lanka has

banned the import of cinnamon, pepper, citronella and nutmeg13. Sri Lanka wants to crack down on spice re-exporting under free trade arrangements and the Cabinet has approved a proposal to implement new policies aimed at ensuring that spices re-exported from Colombo port are not labelled indicating Sri Lanka as country of origin. The ban on imports was taken after the Customs identified that imported cinnamon was re-exported to several countries under entrepot trade facilities. Also mixing of low-quality pepper from Vietnam with local Sri Lankan pepper was detected and could have been exported to India at zero tariffs. Sri Lanka enjoys export duty concessions of 8 per cent when exporting pepper to India under South Asian Preferential Trading.

3 . 3 . 7 . 2 L o b b y f o r f a i r c o m p e t i t i o n a n d e s t a b l i s h m e n t o f a S p i c e B o a r d

The private sector is also lobbying for the establishment of a mechanism to control competition and establish a Spice Board. Many suppliers in the production areas are complaining about oligopolistic behaviour of major manufacturers and exporters leading to unfair competition practices. It was indicated by stakeholders in these production areas that the establishment of a Spice Board. The Board would be the administrative and regulatory body for the spice industry with representatives from both private and government bodies involved in the industry, including farmers and manufacturers, traders and exporters. It could assure branding of Sri Lankan spices, monitoring and controlling the quality of Sri Lankan spices, promoting sales and consumption of spices locally and abroad, collecting information related to the sector and foster fair competition between players inside Sri Lanka and between Sri Lankan stakeholders and stakeholders in other countries.

3 . 3 . 7 . 3 A c c e s s t o i m p r o v e d t e c h n o l o g y , G A P a n d G M P

Major manufacturers and exporters have invested substantially in modern equipment and new investments are taking place. For example, Ceyshine Corporation (Pvt) Ltd in Homagama is presently installing a completely new factory for essential oils and oleoresins. Several entrepreneurs with traditional facilities in the production areas are presently modernising their equipment. TAMAP saw entrepreneurs using the facilities provided under the ASMP to innovate their business. Main innovation is to shift to stainless steel equipment for the distillation boilers which would have a significant positive impact on the quality of the oils. The product would be free from solvents originating from the material of the boiler. By using also stainless-steel containers for storage of the product and introduction of higher standards of hygiene in processing and handling, the improve technology will lead to substantially better prices for these entrepreneurs.

13 B. Sirimanna, Government cracks down on spice re-export racket, In Sunday Times 10-2-2019



3 . 3 . 7 . 4 O w n g r o w i n g a n d o u t g r o w i n g

Confronted with the low and declining quality of product delivered by the traditional extraction units, major manufacturers have decided to produce more raw materials on their own fields. In this way they control the whole process of harvesting, drying and handling at the extraction unit themselves. The vertical integration in the value chain assures high control over the quality of the oils. Such manufacturers will only use additional supply from a selected group of out-growers which they trust and can control completely. Even major manufacturers use only a small number of larger out-growers to make sure the management of the farming and handling is completely according to their requirements.

3 . 4 D e m a n d r e l a t e d a s p e c t s o n e s s e n t i a l o i l s i n S r i L a n k a

3 . 4 . 1 S i z e o f l o c a l a n d e x p o r t m a r k e t

The demand for essential oils in Sri Lanka originates from regional markets and export market. Essential oils are basically luxury products catering to middle- and high-income groups in Sri Lanka and globally. To estimate the quantitative size of the demand we attempt to estimate this type of demand for essential oils in the local and the export market.

3 . 4 . 1 . 1 L o c a l m a r k e t

The middle- and high-income groups concentrate in the cities. The characteristics of this market are:

1. Specialised retail activities cater for consumers with more purchasing power 2. Quality health and cosmetic products are in demand 3. Consumers have a high awareness about benefits of natural products 4. Consumers are more aware of fashion trends and quality brands 5. Higher absorption capacity for quality products

A special category of consumers on the local market are tourists visiting Sri Lanka. These consumers provide a market for original local product preferably of a natural high quality. Tourists visit the spice gardens with shops offering essential oils and frequently also attend the specialised retailers and shops as well as spa saloons in the major cities.

These specialised retailers and shops & spa saloons as well as the spice gardens and Ayurveda treatment in major towns and cities are the core of the local market for essential oils. These outlets cater for local consumers and tourists demand. Our informants estimate the share of the specialised retailers and shops & spa saloons in the total sales in the regional market at about 80% and the spice gardens and Ayurveda at about 20%.

Specialised retailers and shops & spa saloons

Colombo has upmarket retailers and shops and spa saloons for health care and natural cosmetics selling among others natural essential oils and products made out of such oils (medicines, soaps, creams, lotions, balsams etc). Other major cities such as Galle and Kandy also have few of these specialised shops. The specialised retailers and shops sell annually about 66 metric tons of essential oil products.

Spice gardens and Ayurveda

Spice gardens and Ayurveda treatment are mainly found in the west, centre and south of Sri Lanka both inside and outside major towns and cities. Spice gardens can be found along major



tourist routes while Ayurveda treatment is widely spread. These markets sell annually about 17 metric tons of essential oil products.

3 . 4 . 1 . 2 E x p o r t m a r k e t s

The export market is far larger than the local market. The size of the export market is estimated at 1,000 metric tons annually. Of the total Sri Lankan essential oil production, oleoresins are totally produced for exports while essential oils are estimated to be 80% for exports. The 10 largest manufacturers and exporters are directly linked to buyers and foreign markets. The small extractors supply the market via the activities of these manufacturers and exporters as well as the irregular exporters.

3 . 4 . 2 S r i L a n k a ’ s i m p o r t a n d e x p o r t o f e s s e n t i a l o i l s

Sri Lanka’s imports of essential oils are quite stable in volume (around 100 metric tons annually) and in value (at around 2.5 million US $ until 2013 with the exception of 2008). In 2014 imports in value terms declined sharply but more recently they are increasing again (see figure 4). The imports are dominantly from Vietnam, India and China. These are mainly natural essential oils which are mixed with Sri Lankan oils, used in Sri Lankan processing industries and in final consumer market items.

Figure 4 Trend in imports of essential oils in Sri Lanka

Source: UNComtrade

The global essential oil market had a value of 7 billion US $ in 2018 (see section 3.1). Sri Lanka is with its essential oil exports of about 46 million US $ in 2017 only a tiny player in the overall essential oil world market. The most important product for Sri Lanka is cinnamon essential oil. The world market for this product is estimated at 95 to 100 million US $ annually (2018 and

2019) and estimated to grow to 120 million US $ by 202414. In 2017, we estimated the value of the Sri Lanka exports of cinnamon leaves and bark oil at about 14 to 15 million US $ or

14 Cinnamon oil market 2019, MarketWatch, Oct 21, 2019

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Import of essential oils in Sri Lanka

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about 22 to 25 million US $ import value in global markets. Consequently, Sri Lanka supplies about 25 to 30% of the world trade in cinnamon essential oil.

The USA and European countries are the major markets for essential oils (see table 2). Sri Lanka exports of essential oils hold only a tiny share of all major essential oil markets but roughly its distribution of exports over the international markets is in line with the position of those countries in the global imports. Apart from the North American and European markets, India is an important market for Sri Lankan essential oils exports. India has more capacity of advanced technology to add value to the Sri Lankan oil (reduce the amount of water remaining in the Sri Lankan oil). The Sri Lankan FOB unit export value of essential oils (34.6 US $ per kg in 2017) is lower than the average the average CIF unit import value of essential oils (36.7 US $ per kg in 2017) from India. This is partly related to the lower quality of Sri Lankan oil that is further processed in India but it makes Sri Lanka a highly competitive supplier to the Indian market.

Table 2 Major export markets for essential oils from Sri Lanka in 2017

Source: UNComtrade

Figure 5 shows the competitive position of Sri Lanka on the international market for essential oils. The main competitors for Sri Lankan essential oils exports are India, China and Indonesia. When comparing the FOB export prices of Sri Lanka with the CIF import prices of major markets, Sri Lanka essential oils are high priced on all major markets except India. Compared to China, India and Indonesia (countries with compete with Sri Lanka in a supply structure in essential oils), Sri Lanka is also a high-priced supplier.

1000 US $ metric tons 1000 US $ metric tons

World 46034 1001

USA 17974 358 1296446 51470

Canada 2591 24 170672 8954

France 2328 29 442192 9690

Germany 7321 147 418333 21726

India 5396 156 272052 7405

Spain 1510 46 147426 6391

Sri Lanka exports Total import



Figure 5 Prices for essential oils in 2017

Source: UNComtrade

3 . 4 . 3 C o s t o f p r o d u c t i o n o f m a j o r c o m p e t i t o r s c o m p a r e d t o S r i L a n k a

Sri Lanka is considered as a high cost country regarding agriculture production due to labour shortages, high investment costs and high handling and transport costs. As it is very difficult to get reliable comparable production costs in the essential oils sector of different countries, we use average CIF unit import prices in US $ per kg for a comparison. These prices are generally considered a good indicator of the global competitive strength of countries. We analysed in figure 6 the average CIF unit import prices of essential oils of Sri Lanka and its main competitors (India, China and Indonesia) on the three for Sri Lanka most important importing countries (USA, Germany and India) . On the dominant USA market and the German market, Sri Lankan essential oils are on average higher than the import prices of major competitors. For Sri Lanka and Indonesia, especially the German market is a high-priced market but also on the USA market, these two countries benefit from higher import prices than India and China. In absolute volume and value terms India and China are much larger exporters to the USA and Germany than Sri Lanka and Indonesia but Sri Lanka and Indonesia benefit from relatively high import prices. India is a major market for Sri Lankan essential oils and the country is a low-cost supplier to the world market of essential oils. Sri Lanka is a lower cost supplier to the Indian market than China.

Figure 6 Unit import value essential oils: Sri Lanka and main competitors in 2017

Source: UNComtrade



3 . 4 . 4 G r o w t h o f t h e e s s e n t i a l o i l s s e c t o r i n S r i L a n k a

The growth of the essential oils sector in Sri Lanka is mainly determined by the trend in export and imports of essential oils (see Figure 7). The value of Sri Lankan essential oils exports has increases substantially and gradually over the last decade. The value of the imports remained low and imports don’t show a strong growing trend.

Figure 7 Sri Lankan trend in trade in essential oils

Source: UNComtrade

However, if we analyse the year-over-year growth trend in the Sri Lankan essential oils trade (see Figure 8) it is clear that the growth pattern is quite erratic with the period 2008 to 2010 showing a major decline in growth in trade and also in 2017 the trade declined as compared to the previous year. The trend in the trade in essential oils is typical for a niche market product with years of high demand and low stocks and years with lower demand and high stocks.

Figure 8 Year-over-year trend in trade of essential oils from Sri Lanka

Source: UNComtrade



We estimate that with unchanged conditions (macro-economic and/or business environment) this trend will continue over the next 5 years. Essential oils imports are expected to figure around 130 to 140 metric tons annually and the exports around 1,000 to 1,100 metric tons. The value of exports is expected to be the coming years between 45 and 50 million US $ annually.



4 F U N C T I O N S

4 . 1 F u n c t i o n d e s c r i p t i o n

4 . 1 . 1 I n t r o d u c t i o n

Sri Lanka produces a variety of essential oils. TAMAP selected two types for a closer look and a good understanding of the value chains. Cinnamon oil was selected because of its dominance in the essential oils business in Sri Lanka and the importance of Sri Lanka in the global trade in cinnamon oil. Citronella oil was selected because it is the major non spice related oil in Sri Lanka and it was promoted strongly as a source of income and employment for smallholder farmers.

Cinnamon is propagated by seeds or through stem cuttings. Planting is done with the onset of monsoon rains. First harvest of cinnamon is after three years of planting and after that two more harvests can be taken from the plant. When the bark colour of the stem turns into brown and stick diameter is about 3-5cm diameter the plant is ready for harvesting. Branches and leaves are removed from harvested sticks before peeling and harvested stems should be peeled on the same day. During peeling the outer skin is scraped and the bark is rubbed with a brass rod to loosen bark from the hard wood. Then the bark is peeled with a special knife and peeled bark is dried in the sun for few hours. After drying the rolling of the bark starts where pieces of bark are connected together to make a pipe like structure (called as a quill). The quills have a standard length of the tube of 42 inches. The hollow of the tube is filled with

small pieces of stem and the tubes are left for in-door drying about 4-7 days15.

The oil is distilled from the leaves or from the bark. Euginol is the main chemical ingredient in cinnamon leaf oil and Cinnamaldihide is present in cinnamon bark oil. However, there are hundreds of minor chemical ingredients which give characteristic flavour and aroma in true cinnamon. Leaf oil is a product of the leaves and twigs left in the field after sticks were collected for the quills production. Therefore, the cost of raw material is low reflecting only the labour costs for collecting, transport and processing. Leaves are dried for three days before distillation in order to economize on fuel. The yield and quality of the product depend on the botanical variety, geographical origin of the raw material and the farming and distillation practices used. Formerly, two types of oil were produced with the Negombo area producing oil lighter in colour and Eugenol as compared to the oil produced in the Ambalangoda and Matara districts. This was mainly caused by the shorter distillation time in Negombo area.

The traditional technology used by many distillers consists of large metal or wooden vessels capable of holding a charge of about 200 Kg of raw materials. The copper or metal still head is rendered steam-tight by sealing with metal clamps or soft clay. Steam is generated in a separate wood-fired boiler and distillation takes about 8 to 9 hours. The distillate is condensed in a copper coil submersed in a tank of water. Metal still bodies are also used in certain areas, and here heating water in the still body itself generates the steam. The raw material is placed

on a grid above the surface of the water where the same type of condensing system is used16. Cinnamon bark oil is obtained from the bark. Cinnamon bark oil has a delicate aroma and a sweet, pungent taste. Cinnamon bark oil is made of broken and small sized quills and has 90 identified compounds and over 50 unidentified compounds. Sri Lankan cinnamon bark oil contains more than 60% Cinnamaldehyde. In Ayurvedic medicine, cinnamon bark is used as


16 http://www.ruh.ac.lk/research/academic_sessions/2007_mergepdf/33-40.PDF



http://www.ruh.ac.lk/research/academic_sessions/2007_mergepdf/33-40.PDF



an antiemetic, antidiarrheal, anti-flatulence, and a general stimulant. Cinnamon bark oil has been proven to naturally; lower cholesterol, kill bacteria, heal wounds, control blood sugar levels and relieve stomach flu. Cinnamon bark oil is perfect for aroma therapy and food

flavouring and an ingredient of famous French perfumes17.

Photo 1 Typical distillation facility

The citronella plant is a perennial grass with a 1-2 m tall bush of green to yellowish green leaves. The oldest known records of using citronella oil and leaves as perfumes in religious ceremonies were found in India about 2000 years ago. First evidence of the use of citronella oil in Sri Lanka has been reported by Dr. Nicolas Grim in 17th century. By 18th Century Sri Lanka was a reputed exporter of citronella oil and samples of Sri Lankan citronella oil were on display at world trade auctions in London and Lisbon. However, with the entering of Indonesia and a few other countries in to market the demand for Sri Lankan citronella declined. The oil is extracted from the leaves using traditional and more modern distillation technologies similar to the ones used for cinnamon oil. Citronella oil is used as a fragrant in cosmetic industry, soap and detergent manufacturing, polish, paint and in insecticide industry. It is a common mosquito repellent and also used in indigenous medicine as well as in flavouring food and alcoholic drinks in some countries. It is used in aromatherapy and as massage oil. Harvesting of the grass starts 6-8 months after field planting and will be repeated with three months intervals. Aerial part of the plant is harvested 12-20 cm above the ground level and allowed to wither in the field for 1-2 days prior to processing. Up to 20,000 kg/ha of fresh leaves can be harvested but the yield highly varies with the agronomic practices and the age of the plantation. The oil yield can be 60 – 80 kg per hectare and 100 kg per hectare for “Heen pangiri” and “Maha pangiri” respectively.

17 https://www.lankacinnamon.com/cinnamon-bark-oil/

https://www.lankacinnamon.com/cinnamon-bark-oil/



Photo 2 Cinnamon tree, leaf and bark



Photo 3 Citronella grass harvesting and drying in the field

4 . 1 . 2 O r g a n i s a t i o n a l f u n c t i o n s a l o n g t h e c h a i n

The scale of cinnamon farming varies considerably. Many households in the cinnamon producing areas have a couple of cinnamon trees sufficient for their own consumption. However, farmers with more than half acre land cultivate cinnamon commercially. The medium-scale farmers have more than 5 acres of cinnamon and the largest farmers more than 50 acres. Cinnamon peeling or coil production is a high skilled job. Subsistence cinnamon growers peel their cinnamon themselves but larger growers need the service of professional cinnamon peelers. Cinnamon quills produced by small holders usually end up in collection centres before being traded to other parts of the country. Small holders sell their produce directly to traders who come to their households. Larger growers with their own cinnamon processing centres operate with their own collection centres. They buy from small holders and other larger growers without processing capacities. The cinnamon quills are then further processed with sulphur treatments. Majority of this cinnamon would be exported and some would come to the local market as well. Cinnamon leaf oil is made by larger farmers with distillation facilities. Several such larger farmers are also exporters. Exporters rarely buy extracted cinnamon leaf oil from farmers since it is hard to maintain the homogeneity of the oil. Rather they have their own distillation facilities and buy only around 10% of the leaf oil requirements from other producers. The majority of owners of distillation facilities who are not exporters sell their oil for domestic use. The requirements of homogeneity of the extracted oil are not maintained at the domestic market. Demand for cinnamon bark oil is a low at the local market and the product is nearly completely produced for export purposes. This extraction is done by only handful of entrepreneurs who are reputed exporters of cinnamon bark oil. Exporters use their own distillation facilities to extract cinnamon bark oil and never mix it with another extraction from another producer.



Many government institutes are stakeholders in the essential oil value chain (see alsosection 3.2) providing advisory service, training programs and extension and services and some finance to smallholders to procure new equipment. Manufacturers and exporters have to constantly deal with EDB, ITI, Department of Commerce and Sri Lanka Customs for compliance both with export and import regulations.

4 . 1 . 3 M a r k e t i n g n e t w o r k s a n d d i s t r i b u t i o n c h a n n e l s

Cinnamon leave and bark oil are produced by larger farmers and manufacturer and exporters. Manufacturers and exporters increasingly use raw materials produced in their own fields or from trusted preferred suppliers (larger farmers with whom they have a standing relationship).Oil for exports need to meet high quality standards and can only be profitable produced in case the manufacturer and exporter control and manage the raw material supply. For use in the local market, less high-quality standards are required and more lower quality oil enters this market.

Currently, local demand for citronella oil is larger than what is exported. The main local user of citronella is Hettigoda Industries (Pvt) Ltd. This company produces over 150 Ayurveda medicines, health care, beauty, skin, oral care, wellness and spa products. The group was founded in 1934 by kidney specialist and astrologer Dr. Hendrick de Silva Hettigoda. Citronella

oil is one of their main ingredients next to more than 40 other products18. The company initially started with a farmer out-grower model to obtain citronella oil. They had limited own production of raw material initially and were depend on the farmers as well as larger farmer/collectors with distillation facilities. Around 2015-2016, the price of citronella oil went drastically up. Initially it was LKR 2,500 per 750 ml and went up to 12,000 LKR per 750ml. A main reason for the price hike was artificial scarcity created by oligopolistic behaviour of large owners of distillation facilities who maintained larger stocks to drive the price up. Hettigoda Industries (Pvt) Ltd understood that it had no option but to have their own plantations and distillation facilities of citronella. At the moment, the company has several plantations and distillation centres in Rathnapura district and the company is planning to build another one in Puttalam district for a production of more than 200 acres of citronella. They work with a handful of trusted preferred farmers who are allowed to use company’s distillation facilities. In this case, 1/7 of the extracted oil is charged as the distillation fee and the rest of the oil is bought back by the company. In addition, the company works with three large owners/farmers of distillation facilities to be supplied with oil. The latter work with a group of small-scale farmers and supply oil exclusively to the company.

The manufacturers of cosmetics buy oil from distillation facilities directly. Only handful or exporters deal with citronella oil at the moment. They have their own distillation facilities. Some use exclusively raw material form their own citronella plantations while others work with small scale farmers. Any distillation facility will charge 1/7 of the extraction as the distillation fee and buy the rest at the prevailing market rate. Currently the market price for citronella is about 2000 LKR/ per 750 ml. For many smallholder farmers and traditional distillation facilities this price doesn’t recover their production costs and they have stopped operating. Many owners of traditional distillation facilities have stocks of citronella oil in storage waiting for better prices.

4 . 1 . 4 S t a k e h o l d e r S t r a t e g i e s

Only few exporters are dealing with cinnamon bark oil while the majority is exporting cinnamon leaf oil. Cinnamon leaf oil extraction happens in all most all cinnamon producing areas

18 https://siddhalepa.com/index.php/about-us/

https://siddhalepa.com/index.php/about-us/



alongside cinnamon coil production. Small scale farmers do not own distillation facilities and supply all their leaves to larger farmers with facilities. Owners of distillation facilities do not buy leaves but the oils. When a farmer brings his leaves, he has two options. Farmer can use the facility himself and extract the oil or he can use the labour of the facility owner. If the farmer uses the labour of the facility owner, a labour fee is charged based on the number of times he/she uses the facility. In addition, a distillation fee is charged of 1/8 th of the oil production for each time the facility is used. On average a boiler is staked with 450-500Kg of leaves and the yield varies due to many factors such as leaf quality, dryness and weather. Facility owners allow their boilers to be used on a first come first serve basis. Therefore, during the harvesting seasons of cinnamon there is competition to use boilers and boilers hardly run out of supply. However, this changes during the off season when cinnamon sticks are not harvested. During off season leaf supply to boilers is limited hence most small-scale distillation facilities close. Yet larger distillation facilities operated with supply from own fields, extract oils at a slower pace. Almost all the facilities operate at high capacity during the harvesting season and store as much oils as they can. As mentioned before, only a handful of entrepreneurs are in cinnamon bark oil extraction. While the oil extraction process is similar, cinnamon bark oil is expensive due to higher value of the raw material hence production of bark oil is largely demand driven. Cinnamon bark oil is produced in accordance with a particular order, for exports or for local hotels and upscale restaurants. Because cinnamon dark oil is expensive, larger stocks are not maintained. There are producers and exporters of cinnamon quills that have enough raw materials to produce a significant amounts of cinnamon bark oil. However, they restrain from cinnamon bark oil extractions since they do not have a market and do not wish to keep stocks. Exporters of cinnamon bark oil use their own cinnamon to extract oils and do not lend their boilers to other farmers. Homogeneity and the quality of cinnamon oil is very important and cinnamon oil extractors therefore work with their own raw materials.

Hettigoda Industries (Pvt) Ltd created the main local demand for citronella oil. The company shifted from purchased oil to own production of oil and own citronella plantations. They have significantly cut down purchases from farmers and now work with a handful of trusted farmers and large owners of distillation facilities. These farmers come to the company distillation facility with citronella leaves, use the company boiler and sell the oil back to the company. Large scale distillation facilities work with a group of small-scale farmers as well as their own cultivation and supply extracted oil to the company directly. Exporters predominantly use their own cultivations. The distillation facility is always owned and managed by the exporters to guarantee the quality parameters of the exports. Some exporters have products aimed at the local market thus they buy extracted oils from other boiler owners. Except for Hettigoda Industries (Pvt) Ltd, other companies that produce citronella associated products purely for the local market buy citronella oils from distillation facilities not owned by them. However, they are

increasingly using citronella substitutes and imported oils for their manufacturing purposes19.

4 . 1 . 5 H o r i z o n t a l a n d v e r t i c a l c o o r d i n a t i o n

For both cinnamon and citronella oil, raw materials come from small holder farmers as well as

large plantations20. Large plantations are owned by companies that engage in local as well as export trading. Large plantations are equipped with distillation facilities. Oils from these

19 http://www.dailynews.lk/2018/01/17/local/140126/citronella-oil-industry-crisis

20 According to the General Report of the Census of Agriculture 2002, the cultivation of cinnamon was dominated by the smallholder sector. Most of the smallholdings (70 percent) were less than 2 ac. 15 percent of land was 2-5 ac, 7 percent ranged 5-10 ac and the balance was 10-50 ac. More than 90 percent of cinnamon was cultivated as a mono crop. Some of the cinnamon trees are more than 100 years old. Most of the growers are involved mainly in producing cinnamon, which is highly labour intensive.



distillation facilities of larger scale companies could come to the market as a finished product. Or as an input to a manufacturing company that supply final products to local and international markets. This is evident mainly in the cinnamon value chain. For citronella, Hettigoda Industries (Pvt) Ltd owns the largest extent of citronella cultivation (More than 200 acres) followed by

Citro Essential Oils (Pvt) Ltd (More than 50 acres)21. Both entities are engaged in producing products for the local markets as well as for the export market. However, Hettigoda Industries (Pvt) Ltd does not export citronella in the form of oil rather it is an ingredient for many cosmetics. In addition, there are several other export companies that grow citronella on their own lands and extract oil using their own distillation facilities however their cultivations are

below 20 acres22.

Small scale cinnamon farmers are organized around large scale farmers who have their own distillation facilities. They bring in their leaves to the facility regularly and have informal cooperation and coordination with the facility owners. In some areas, farmers are organized as a group. For example: ‘Siriparakum Cinnamon Association’ at Gonnapinuwala, Galle District Growers Association. These associations help producers to get access to subsidised fertilizer, organize workshops and disseminate knowledge amongst their members on new varieties; new programmes conduct by the department and pest and diseases affecting cinnamon

cultivation23. Some farmers and farmer associations are using exclusive one distillation facility but majority move among facilities depending on the prevailing price. At the same time, the owners of facilities also operate individually and are not organized as a group. Competition among the exporters of cinnamon leaf and bark oil is low and some of them work with their own plantations and distillation facilities. Some exporters buy oils from other facilities but only to mitigate a scarcity in their production. They will buy only from preferred trusted owners of distillation facilities of whom the exporters fully trust the production process (without adulterations) and quality. A close coordination can be seen among government institutes and export/processing companies. For example, cinnamon exporters are closely linked with DEA, EDB, ITI, SLSI, SAPPTA and spice council. Cinnamon collection centres are a common entity in cinnamon growing areas. These collection centres buy cinnamon quills from farmers and sell to the local traders as well as to the exporters. Some exporters have their own collection centres to by-pass middlemen.

A similar type of collectiveness can be seen among small growers of citronella. Farmer associations were performing well several years ago when the price was very high. At the moment with low prices, the farmer organizations do not operate well. Many farmers have uprooted their citronella plantations and moved to other crops such as pepper and cinnamon. There are some small holder farmers who are still waiting for a better price however they have not harvested plants for about 2 years. All this has resulted in closure of operations of many distillation facilities. Some facility owners are upgrading their boilers with stainless steel equipment under matching grant program of the government. They hope that the prices will increase when they are ready to use their boilers again. But many boiler owners who have totally given up their boilers and moved on to other livelihoods. Their expectations of a better price are very low therefore they are not interested in investing to upgrade their equipment. Several years ago, distillation facilities’ owners also got together and formed associations to service farmer groups in the surrounding areas. This to facilitate the fast-growing number of

21 https://www.citroessentialoils.com/abo.htm

22 https://www.rathnacinnamon.com/wholesale/oil-products/all

23 http://www.ips.lk/wpcontent/uploads/2018/10/ANALYSIS%20OF%20CINNAMON%20PEPPER%20AND%20CARDAMOM%20VALUE%20CHAINS%20IN%20SRI%20LANKA_.pdf

https://www.citroessentialoils.com/abo.htm

https://www.rathnacinnamon.com/wholesale/oil-products/all

http://www.ips.lk/wpcontent/uploads/2018/10/ANALYSIS%20OF%20CINNAMON%20PEPPER%20AND%20CARDAMOM%20VALUE%20CHAINS%20IN%20SRI%20LANKA_.pdf

http://www.ips.lk/wpcontent/uploads/2018/10/ANALYSIS%20OF%20CINNAMON%20PEPPER%20AND%20CARDAMOM%20VALUE%20CHAINS%20IN%20SRI%20LANKA_.pdf



farmers entering citronella farming. However, they do not function as a group any more. Many of these owners have stocks ranging from 500-5,000 Kg of citronella oil. Just like in cinnamon, exporters of citronella oil keep close coordination with DEA, EDB, ITI, SLSI, SAPPTA and spice council. However, the coordination activities are limited compared to cinnamon since citronella related exports are limited. Only entity that deals with a regular supply of citronella oil is the Hettigoda Industries (Pvt) Ltd, but almost 75% of their oils come from their own plantations. With new plantations in Puttalam district, their engagement with farmer will become even less. Substitutes and imported oils reduce competition for locally produce oil and facility owners are left with stocks and a reduced market price. For cinnamon oil and citronella oil, usually, exporters do not share or communicate market information with other manufacturers or exporters. There is a high competition amongst them for buyers and markets. Foreign buyers change their local suppliers if they are not satisfied with quality, price, volume and delivery.



Figure 9 Essential oils sector value chain function map



Figure 10 Essential oils sector value chain stakeholder map



4 . 2 F l o w s o f P r o d u c t

Cinnamon leaf and bark are the raw materials for cinnamon leaf and bark oil. When cinnamon sticks are harvested for bale production, leaves are left on the ground for several days to dry. They are collected after about a week time and taken to boilers for distillation. A standard boiler can usually take about 500 Kg of leaves at one time and produce oils. Oil harvest would vary on many factors but on average 500 Kg of leaves would produce 10 bottles, where one bottle is 750 ml. This oil is then collected in to plastic barrels and transported to a manufacturer or exporter where it is further filtered, bottled and branded. The same applies to cinnamon bark oil production. While cinnamon quills are produced in different grades, a particular grade is not required to produce cinnamon bark oil. Rather broken cinnamon and cinnamon chips are used for cinnamon bark oil production. Distillation technology for cinnamon bark oil is similar to cinnamon leaf oil with temperature differences. Only handful of manufacturers and exporters have gone in to cinnamon bark oil production and are aiming at niche markets overseas. Most distillation facilities in Sri Lanka are using steam extraction technology for both cinnamon bark and leaf oil extractions. Cinnamon oil is exported as a bulk produce in metal or plastic barrels and the buyer will use, re-pack and brand the products according to their markets. But also, some exporters have their own brands. In such cases packed and branded bottles get exported from Sri Lanka.

Citronella oil is extracted from leaves. Once cut, these leaves get dry in the field within 2-3 days and transported to the distillation facility. Citronella oil is used as an ingredient for many value-added products and extracted oils are transported to processing facilities in metal or plastic barrels. Some exporters send citronella oil as unbranded intermediate product to the export destination in metal or plastic containers. However, exporters who have their own brands would pack citronella oil locally under their branded packaging and export.

4 . 2 . 1 V a l u e C h a i n n e t w o r k m a p

Figure 9 and 10 show the value chain function and stakeholder maps. Several major trading channels can be seen in both cinnamon and citronella oil value chain. Basically, cinnamon leaf is produced by small scale grower (< 2 acres of land), large scale growers (2-10 acres of land) and large plantations (> 10 acres of land). Cinnamon bark is produced by exporters themselves from their own plantations. Large scale growers and large plantations have distillation facilities. Small scale growers do not have distillation facilities. Exporters also have distillation facilities since all of them have their own plantations as well.

Citronella leaf is also produced by small scale growers (>2 acres of land), large scale growers (2-10 acres of land) and large plantations (> 10 acres of land). However, in citronella value chain, exporters as well as larger plantations would work directly with small scale growers in extracting oil from their leaves. Exporters have their own lands as well as own distillation facilities.

For cinnamon leaf and bark oil value chain:

1. Leaves from small-scale grower (<2 acres) ……> large scale grower with a

distiller…… > exporter……> export destination

2. Leaves from small-scale grower ….> large scale grower with a distiller ……… > local

market-oriented manufacturer …… >local market

3. Leaves from large-scale growers (2-10 acres) ….> large scale grower with own

distiller ……> exporter……> export destination



4. Leaves from a large-scale grower …. > large scale grower with own distiller….>

processor for the local market …. > local market

5. Leaves from large plantation (> 10 acres) ….> large plantation with own distiller….>

processor for the local market ….> local market

6. Leaves from large plantation….> large plantation with own distiller ….> exporter ….>

export market

7. Leaves from exporter with plantation (size of the land is usually > 10 acres) …. >

export’s distiller ……. > export destination

8. Bark from exporter with plantation …… > exporter’s distiller……> export destination

9. Import destination …. > Export companies ……. > Re-export

10. Import destination …. > processors for the local market ….> local market

For citronella value chain:

1. Leaves from small-scale grower (<2 acres) ….> large scale grower with a distiller

……> processor for local market ……> local market

2. Leaves from small-scale grower …. > large scale grower with a distiller …. > exporter

……> export destination

3. Leaves from small-scale grower …… > exporter’s distiller…… > export market

4. Leaves from small-scale grower …… > large plantation with a distiller …… > local

market

5. Leaves from large-scale grower (2-10 acres) ……. > large-scale grower with a

distiller…. > exporter……> export destination

6. Leaves from large-scale grower (2-10 acres) ……. > large scale grower with a distiller

…. > processor for the local market……> local market

7. Leaves from large plantation (>10 acres) ……. > own distiller….> own processing

….>. local market

8. Leaves from large plantation….> large plantation with own distiller ….> exporter ….>

export market

9. Leaves from exporter with plantation ……> exporter’ distiller …. > export market

10. Import destination …. > Export companies ……. > Re-export

11. Import destinations …. > processors for the local market ….> local market

Figure 11 and 12 show the value chain network map for cinnamon oil and citronella in detail.



Figure 11 Value Chain map: Cinnamon leaf and bark oil



Figure 12 Value Chain map: Citronella oil



4 . 3 L o c a t i o n o f a c t i v i t i e s

Cinnamon is commercially grown in Sri Lanka’s coastal belts and in some interior parts of the country below 250 meter above sea level. Naturally cinnamon has been found in central hilly area of Sri Lanka and Sinharaja and Knuckles forest reserve up to about 500 m above sea level. The wet zone is ideal for the successful growth of cinnamon. It can be grown

commercially in zones where annual rainfall is more than 1750 mm24.Citronella grass grows well under tropical and sub-tropical conditions from sea level up to an elevation of about 600m. Hot humid conditions with bright sun light are required. An average rainfall of 1500 – 1800mm per annum is adequate for citronella grass. Total area of citronella is 1,065 ha. and cultivations

have largely been confined to Hambantota and Rathnapura districts25. Exports of cinnamon and citronella oil products are via air (Katunayake Bandaranayake International Airport) and sea freight (Colombo port). Use of air or sea freight will depend on the type of product, quantity and the destination. Sea freight is much cheaper when exporting larger quantities of materials. Large scale exporters usually have their trading office in Colombo district.

Map 1 provides a country wide overview of the essential oil production areas in Sri Lanka.

Map 1 Essential oil production districts









4 . 4 Q u a n t i f i c a t i o n

There are 254 registered private sector companies in Sri Lanka exporting cinnamon to commodity or bulk markets. Further, there are another 34 private sector companies exporting value added products such as cinnamon oils and cinnamon flavoured tea bags. These companies range from small and medium to large. There are 3 companies that manufacture cinnamon based value-added products, mainly essential oils, for the export market. Cinnamon is mainly exported as quills (98 percent). Cinnamon is also exported as quislings, featherings and chips in primary form and also as powder, cut cinnamon, cinnamon oil in value added form (2 percent) according to Sri Lanka Customs. Nearly, 50 percent of Sri Lankan cinnamon is exported to Mexico mainly in primary form. Usually, Mexican buyers do not request any international product or process standards, whereas, European buyers are more concerned about both product and process standards. Thus, SLS 81:2010, ISO 6535:1997, GAP, GMP, Fair trade, microbiological safety requirements, are important standards when exporting to EU but not to Mexico. Processors/ exporters carefully cut and pack cinnamon according to buyer requirements and send them through a stringent quality control process to ensure high quality. Exporters divide the cinnamon into different grades of products (Alba, C5 Special, C5, C4, C3,

M5, M4, H1, H2, H3 7). These grades are sold either in quills or cut form26. As highlighted by the National Chamber of Exporters (NCE) and the EDB, Sri Lanka has 24 companies that engage on a regular basis in exports of essential oils including cinnamon (leaf and bark) and

citronella oil27.

4 . 5 C o n t r i b u t i o n A n a l y s i s ( d i s t r i b u t i o n o f m a r g i n s a l o n g t h e v a l u e c h a i n )

The tables in this section explain how margins are distributed among different actors in the value chain. In order to do this, different products and prominent distribution channels are identified first. Then margins are calculated for each and every stakeholder and activity along that particular distribution channel. From the starting point of cost of production to the final sale price, margins distributed are summed up to 100%. Analysis starts from the cost of production. Price as based on a kilogram for cinnamon quills and litre for cinnamon and citronella oils. This analysis focuses on cinnamon quills, cinnamon leaf oil, cinnamon bark oil and citronella oil. The flow of these products in the various distribution channels differs, some are long and some are short. Shortest one is where the producer/exporter is selling to the final local consumer or the exporter to the overseas consumer. Longest one is where products flow from the producer/grower to the collector and then to the processor/exporter for local or international market. The tables describe contributions for the longest trading channel for each product.

26 http://www.ips.lk/wp-content/uploads/2018/10/ANALYSIS%20OF%20CINNAMON%20PEPPER%20AND%20CARDAMOM%20VALUE%20CHAINS%20IN%20SRI%20LANKA_.pdf

27 https://www.nce.lk/spices-2/

http://www.ips.lk/wp-content/uploads/2018/10/ANALYSIS%20OF%20CINNAMON%20PEPPER%20AND%20CARDAMOM%20VALUE%20CHAINS%20IN%20SRI%20LANKA_.pdf



https://www.nce.lk/spices-2/



Table 3 Product Cinnamon quills (Grade C4) - Grower > Collector > Processor > Local market

Cinnamon quill production (C4)

ITEM Farmer- Collector-Processor-Local

market

LKR US $

Cost of production (per kg) 550.00 3.04

Percentage 15.71

Producer grading and transport 1.00 0.006

Percentage 0.03

Producer margin 1249 6.90

Percentage 35.69

Producer price 1800.00 9.94

Collector transport and handling 1.00 0.006

Percentage 0.03

Collector margin 719 3.97

Percentage 20.54

Collector price 2520.00 13.92

Processor transport and handling 1 0.006

Percentage 0.03

Processor margin 979 5.409

Percentage 27.97

Selling price at the processor's shop 3500 19.34

In this distribution channel cost of production price is 550 LKR/Kg (3.04 US $). Producer receives a price of 1,800 LKR/Kg (9.94US $) when selling to the collector. Processor offers a price of Rs 2,520 LKR/Kg (13.92US $) to the collector. Final price at the processor’s shop is 3,500 LKR/Kg (19.34 US $). The farmer’s margin is 35.7% and the collector keeps a margin of 20.5% when delivering to the processor’s factory. At the end, processor would keep a margin of 27.9% when selling to the final consumer.



Table 4 Product Cinnamon quills (Grade C4) - Grower > Collector > Processor/exporter > International market

Cinnamon quill production (C4)

ITEM Farmer-Collector-Processor/ Exporter

LKR US $

Cost of production (per kg) 550.00 3.04

Percentage 5.98


Percentage 0.02

Producer margin 1248.00 6.90

Percentage 13.57



Percentage 0.02

Collector margin 718.00 3.97

percentage 7.80


Exporter transport and handling 5 0.028

Percentage 0.05

Storage, handling and freight 450 2.49

Percentage 4.9

Exporter margin 6225 34.39

percentage 67.66

FOB price for exporter 9200 50.8

Cost of production in this trading channel is Rs 550 LKR/Kg (3,04US $). The producer receives a price of 1,800 LKR/Kg (9.94US $). Processor/ exporter offers a price of LKR 2,520LKR/Kg (13.92US $) to the collector if product export quality. Final FOB price for the exporter is 9,200 LKR/kg (50.80 US $). The collector receives 2,520 LKR/kg (13.92 US $). The farmer’s margin is 13.6% and the collector keeps a margin of 7.8%. At the end, processor/ exporter keeps the highest margin of 67.7%.



Table 5 Product Cinnamon leaf oil - Grower > Collector > Processor > Local market

Cinnamon leaf oil

ITEM Farmer-Collector-Processor-Local

market

LKR US $

Cost of production (per L) 1075.00 5.94

Percentage 28.29


Percentage 0.05


Percentage 26.92



Percentage 0.05


Percentage 18.37



Percentage 0.13


Percentage 26.18


In this distribution channel cost of production price is 1,075 LKR/L (5.94 US $). Producer receives a price of 2,100 LKR/L (11.6US $) when selling to the collector. Processor offers a price of 2,800 LKR/L (15.47US $) to the collector. Final price at the processor’s shop is 3,800 LKR/L (20.99 US $). The farmer receives a margin of 26.9% and the collector keep a margin of 18.4% when delivering to the processor’s factory. At the end, processor would keep a margin of 26.2% when selling to the final consumer.



Table 6 Product Cinnamon leaf oil - Grower > Collector > Processor/exporter > International market

Cinnamon leaf oil

ITEM Farmer-Collector- Processor/Exporter

LKR US $


Percentage 16.54


Percentage 0.03

Producer margin 1023.00 5.65

Percentage 15.74



Percentage 0.03

Collector margin 698.00 3.86

Percentage 10.74



Percentage 0.08


Percentage 10.00


Percentage 46.85


Cost of production in this trading channel is 1,075 LKR/L (5.94US $). This is bought by a collector (producer receive price) for 2,100 LKR/L (11.6US $). Collector receives 2,800 LKR/L (15.47US $) from the exporter if product is export quality. Final FOB export price for the exporter is 6,500 LKR/L (35.9US $). The farmer receives a margin of 15.7% and the collector keep a margin of 10.7%. At the end, processor/ exporter keeps a margin of 46.9% when selling to the international market.



Table 7 Product Cinnamon bark oil - Grower > Collector > Processor/exporter > International market

Cinnamon bark oil

ITEM Farmer-Collector-Processor/Exporter

LKR US $

Cost of production (per L) 37000 204.42

Percentage 41.11


Percentage 0.00


Percentage 12.22

Producer price 48000 265.19


Percentage 0.00


Percentage 13.33

Collector price 60000 331.49


Percentage 0.01


Percentage 0.72


Percentage 32.61


Cost of production in this trading channel is LKR 37,000 LKR/L (204.42US $). This is bought by a collector (producer receive price) for 48,000 LKR/L (265.19US $). Collector receives 60,000 LKR/L (331.49US $) from the exporter if it is export quality. Final FOB export price for the exporter is 90,000 LKR/L (497.2US $). The farmer receives a margin of 12.2% and the collector keeps a margin of 13.3%. At the end, processor/ exporter keeps a margin of 32.6% when selling to the international market.



Table 8 Product: Citronella oil - Grower > Collector > Processor > Local market

Citronella oil

ITEM Farmer-Collector- Processor-Local

market

LKR US $


Percentage 19.23


Percentage 0.05


Percentage 38.41



Percentage 0.05


Percentage 19.18



Percentage 0.13


Percentage 22.95


In this distribution channel cost of production price point is 750 LKR/L (4.14 US $). The producer receives a price of 2,250 LKR/L (12.43US $) when selling to the collector. Processor offers a price of LKR 3,000 LKR/L (16.57US $) to the collector. Final price at the processor’s shop is 3,900 LKR/L (21.55 US $). The farmer receives a margin of 38.4% and the collector keeps a margin of 19.2% when delivering to the processor’s factory. At the end, the processor keeps a margin of 23.0% when selling to the final consumer.



Table 9 Product: Citronella oil - Grower > Collector > Processor/exporter > International market

Citronella oil

ITEM Farmer-Collector- Processor/Exporter

LKR US $

Cost of production (per L) 750 4.14

Percentage 10.00


Percentage 0.03


Percentage 19.97

Producer price 2250 12.43


Percentage 0.03


Percentage 9.97

Collector price 3000 16.57


Percentage 0.07


Percentage 8.67


Percentage 51.27


Cost of production in this trading channel is Rs 750 LKR/L (4.14US $). The producer receives a price of 2,250 LKR/L (12.43US $) from the collector. The processor/exporter offers a price of 3,000 LKR (16.57US $) to the collector. Final FOB price for the exporter is 7,500 LKR/L (41.4US $). The farmer receives a margin of 20.0% and the collector keeps a margin of 10.0% when delivering to the processor’s factory. At the end, the processor keeps a margin of 51.3% when selling to the international market.

4 . 6 G r o s s M a r g i n A n a l y s i s

Gross margin analysis is based on the cost and revenue information collected from the growers of the selected products. The gross margins are calculated for the same products as in section 4.5. Conventional farming of cinnamon and citronella is an open fields monocrop farming system. As explained earlier cinnamon and citronella are grown by small scale farmers (< 2 acres of land), large scale farmers (2-10 acres of land) and large plantations (> 10 acres of land). Large plantations are sometime producing raw material for export purposes while others produce for the local market. Large farmers and large plantations have distillation facilities and buy also raw materials from outgrowing/contracted farmers to add to their own supplies.



Therefore, the gross margin analysis is conducted both for the small-scale farmer production system as well as for the larger farmer/processor system with distillation facility. For cinnamon production, TAMAP team analysed three different scenarios:

Scenario 1: Cinnamon farmer with 1 acre of land and no distillation facility

Scenario 2: Cinnamon farmer with 1 acre of land and own distillation facility receiving leaves from 25 other farmers

Scenario 3: Cinnamon farmer with 1 acre of land and own distillation facility producing quills and leaves and also processes leaves from 25 other farmers producing both bark and leaf oil

Scenario 1: Cinnamon farmer with a 1 acre of land and no distillation facility. This farmer processes leaves using the distillation facilities of someone else. This farmer has as his major income the sales of cinnamon quills and additionally obtains income from the distilled oils. Distilled oils are bought by the owner of the distillation facility after deducting the boiler fee an labour costs (see Table 10). The gross margin for a cinnamon farmer in Scenario 1 is 713,400 LKR (3,941 US $) per year. The breakeven quantity of cinnamon quills is 185 Kg and the breakeven price is 556 LKR/Kg (3.07US $). Income from leave is low compared to the income from quills.



Table 10 Gross margin analysis for an average cinnamon farmer who produces quills and leaves

Note: Calculations are done for 1 acre

Harvesting is considered for year

First harvest is obtained 3 years after planting

Fixed costs

Unit cost No of units Total LKR US $

Land clearance 25000 1 25000 138

Land harrowing 50000 1 50000 276

Fencing 50000 1 50000 276

Planting holes 70000 1 70000 387

Other materials 25000 1 25000 138

Land rent for 1 ac 30,000 1 30000 166

Planting materials 20 3600 72000 398

Planting cost 30000 1 30000 166

Total fixed cost 352000 1945

Variable costs

Fertilizer (2 times per year) 3500 16 56000 309

Organic fertilizer ( 2 times per year) 700 20 14000 77

Pesticide applications (2 times per year) 14000 2 28000 155

Labour (Man days) 2000 90 180000 994

Fixed component of variable cost (20%) 55600 307

Total variable cost 333600 1843

Revenue

Total harvest of Alba (5%) 30 2300 69000 381

Total harvest of C5 special (10%) 60 2100 126000 696

Total harvest of C5 Normal (10%) 60 2000 120000 663

Total harvest of C45 (10%) 60 1750 105000 580

Total harness of H2 (60%) 360 1450 522000 2884

Total harvest of Other (5%) 30 1200 36000 199

Average price 1800

Total Kg of quills 600

Total Kg of leaves 1500

Total revenue from quills 978000 5403



Total revenue from leaf oils (dry matter 1500 Kg per year. 500Kg leaves produce 10 l of oil after boiler's portion) 30 2300 69000

Total revenue 1047000 5785

Gross margin (Per ac/year) 713400 3941

Breakeven price (per Kg) 556 3.07

Break even quantity (Kg) 185

Scenario 2: Cinnamon farmer with 1 acre of land and own distillation facility receiving leaves from 25 farmers. The farmer obtains leaves from average of 25 farmers for the year. Therefore, the boiler owners’ income comes from: (a) Quills production from his 1 acre of land, (b) Leaf oil production from his 1 acre of land and (c) leaf oil from production from supply of other 25 farmers (see Table 11). The annual gross margin for a farmer in scenario 2 is 1,755,600 LKR (9,699US $). The breakeven price of leaf oil is 1,075 LKR/L (5.94US $) and the breakeven quantity of leaf oil is 336 L/year.

Table 11 Gross margin analysis for an average cinnamon farmer who produces quills and leaves and operates a boiler with a group of 25 farmers




Farmer has a boiler where he uses leaves from others

Boiler owner works with 25 farmers where each has average 1 ac land

Fixed costs




Fencing 50000 1 50000 276



Land rent for 1 ac 30,000 1 30000 166


Planting cost 30000 1 30000 166

Boiler establishment with building and other materials 2500000 1 2500000 13812


Variable costs






Labour (Man days) 2000 90 180000 994

Electricity for building (per month) 2000 12 24000 133

Labour for boiler from boiler owner 25000 12 300000 1657

Leaf buying cost (from 25 farmers each with 1 ac): 1500 kg from a farmer per year 15,000 25 375000 2072


Total variable cost (quills + leaf oil) 1172400 6477

Total variable cost (quills only) 333600 1843

Total variable cost (leaf oil only) 838800 4634

Revenue





Total harvest of H2 (60%) 360 1450 522000 2884


Ave price 1800




Revenue from leaf oils from own 1 ac (500 Kg dry leaves give 10 l of oil) 30 2500 75000

Leaf oil from other farmers 750 2500 1875000



Breakeven price for quills (per Kg) 556 3.07

Break even quantity (quills) 651

Breakeven price for leaf oils (Per L) 1075 5.94

Break even quantity (leaf oil L ) 336

Scenario 3: Cinnamon farmer with 1 acre of land and own distillation facility producing quills and leaves and also processes leaves from 25 other farmers producing both bark and leaf oil. The farmer produces cinnamon bark oil using broken cinnamon and cinnamon bark from his own cultivation (or by-product of cinnamon quill production) and raw materials form 25 other farmers. In Scenario 3 (see table 12), the gross margin for a year is 4,215,600 LKR (23,291US $). Breakeven quantity of cinnamon bark oil is 5 L and the breakeven price is 36,923 LKR/L (204US $).



Table 12 Gross margin analysis for an average cinnamon farmer who produce quills, leaf and bark oil and operates a boiler with a group of 25 farmers




Farmer has a boiler where he uses leaves and broken and cinnamon bark from others


Fixed costs




Fencing 50000 1 50000 276



Land rent for 1 ac 30,000 1 30000 166


Planting cost 30000 1 30000 166



Variable costs




Labour (Man days) 2000 90 180000 994



Leaf buying cost (from 25 farmers each with 1 ac): 1500 kg from a farmer per year 15,000 25 375000 2072

Bark+broken cinnamon buying cost (from 25 farmers each with1 ac): 50Kg from a farmer per year 160 1250 200000 1105


Total variable cost (quills + leaf + bark ) 1412400 7803

Total variable cost (quills only) 333600 1843

Total variable cost (leaf oil only) 838800 4634

Total variable cost (bark oil only) 240000 1326

Revenue







Total harvest of H2 (60%) 360 1450 522000 2884


Ave price 1800



Total Kg of bark 1250


Revenue from leaf oils from own 1 ac (500 Kg dry leaves give 10 l of oil) 30 2500 75000 414

Leaf oil from other farmers 750 2500 1875000 10359

Revenue form bark oil from own 1 ac (200 Kg of bark will give 1 l of oil) 250 9600 2400000 13260

Bark oil from other farmers 6.25 48000 300000 1657



Breakeven price for quills (per Kg) 556 3.07

Break even quantity (quills) 785

Breakeven price for leaf oils (Per L) 1075 5.94

Break even quantity (leaf oil) 336

Breakeven price for bark oils (Per L) 36923 204

Break even quantity (bark oil) 5

For citronella production, TAMAP team analysed two different scenarios:

Scenario 1: Citronella farmer with 1 acre of land and no distillation facility

Scenario 2: Citronella farmer with 1 acre of land and own distillation facility receiving leaves from 25 other farmers

Scenario 1: Citronella farmer with a 1 acre of land and no distillation facility. The farmer is supplying leaves to an owner of a distillation facility. Hence his income comes citronella oil. Distilled oils are bought by the owner of the distillation facility after deducting the boiler fee and labour costs (see Table 13). In this scenario, the gross margin from an acre of citronella for a year is 100,320 LKR (862US $). Breakeven quantity of citronella oil production is 28 L while the breakeven price is 714 LKR/L (3.94US $).



Table 13 Gross margin analysis for an average citronella farmer with 1 acre of land and no distillation facility


Harvesting is considered for an year

First harvest is obtained 3 months after planting

Fixed costs




Fencing 50000 1 50000 276



Land rent for 1 ac 15,000 1 15000 83

Planting materials 50,000 1 50000 276

Planting cost 12000 1 12000 66


Variable costs




Labour (Man days) 1200 30 36000 199



Revenue

Total Kg of leaves from 1 ac/year (20,000 kg fresh leaves per Ha then 30% weight loss with drying) 5600

Total Kg of oil from leaves (500 kg leaves produce 7L of oil) 78 2000 156000 862

Total revenue from oil 156000 862


Breakeven price (per L) 714 3.94

Break even quantity (L) 28

Scenario 2: Citronella farmer with 1 acre of land and own distillation facility receiving leaves from 25 other farmers. This farmer gets his income from distilling citronella leaves from his own plantation as well as plantations from other 25 farmers (see Table 14). This farmer will earn a



gross margin of 3,285,120 LKR (18,150US $) per year. The breakeven price of citronella oil is 1,180 LKR/L (6.52US $) and the breakeven quantity of oil is 1,197 L per year.

Table 14 Gross margin analysis for an average citronella farmer with 1 acre of land and own distillation facility receiving leaves from 25 other farmers



First harvest is obtained 3 months after planting

Farmer has a boiler where he uses leaves from others


Fixed costs

Unit cost No of units Total LKR US$



Fencing 50000 1 50000 276



Land rent for 1 ac 15,000 1 15000 83

Planting materials 50,000 1 50000 276

Planting cost 12000 1 12000 66



Variable costs




Labour (Man days) 1200 30 36000 199



Leaf buying cost from 25 farmers of 1 ac each 70000 25 1750000 9669



Revenue

Total Kg of leaves from 1 ac/year (20,000 kg fresh leaves per Ha then 30% weight loss with drying) 5600



Total Kg of oil from leaves (500 kg leaves produce 7 L of oil) 78 2800 218400 1207

Total Kg of oil from other 25 farmers 1950 2800 5460000 30166

Total revenue from oil 5678400 31372


Breakeven price (per L) 1180 6.52

Break even quantity (L) 1197

4 . 7 C o n t r i b u t i o n o f V C t o p u b l i c s e c t o r f i n a n c e a n d b a l a n c e o f t r a d e

As illustrated in par 3.4.4, the value of exports of essential oils is about 45 to 50 million US $. The exports are growing but the annual growth is quite erratic. With a Sri Lanka Agriculture GDP in constant (2010) prices of LKR 639.3 billion in 2017, the contribution of the essential

oils export sector to the country’s Agriculture GDP was about 1.1%28. Consequently, the present contribution of the essential oils export sector in Sri Lanka is still meagre but worldwide essential oils is one of the most potential sectors.

4 . 8 V i a b i l i t y o f t h e V C i n i n t e r n a t i o n a l e c o n o m y

The total world exports of essential oils in 2017 amounted to about 5.4 billion US $ with a volume of about 282.500 metric tons. In 2018, the global essential oils market had a value of

about 7 billion US $ and is expected to grow to 14.6 billion US $ in 202629. This makes this sector one of the fastest growth sectors in the world!

The top five essential oil exporters to the international market in 2017 were USA, India, France, Brazil and China. The share of the top 5 exporters in this business was about 51% in value terms and about 53% in volume terms.

28 Agriculture GDP according to Central Bank of Sri Lanka

29 Fortune Business Insights, Essential Oils Market- Global Market Analysis, Insights and Forecast 2015 - 2026



Figure 13 Position of main exporting countries in global essential oil exports

Source: UNComtrade

India is in value terms, the world largest exporter of essential oils. India dominates the global market for spice oleoresin. India controls 60% of the 13,500 metric tons global spice oleoresins market. Kochi in Kerala is the Indian hub for spice oleoresin manufacturing. India is also a major importer of spices and essential oils for the local market and re-export after value addition. Brazil is in terms of volume the world largest exporter.

France essential oils products have the highest prices in export markets but also India products are relatively high priced. The USA and Chinese essential oil exports obtain prices more or less at the level of the world average export price.

4 . 9 C o m p e t i t i v e n e s s a n a l y s i s

Sri Lanka is the world leader and main exporter of real cinnamon with a share of 28% in global

exports and an export value of about 194.5 million US$ (2018)30. Sri Lanka, India, China, Indonesia and Taiwan are the major citronella oil producing countries.

The USA is the largest importer and exporter of essential oils. The USA acts also as a re-distributor to other countries and re-exporter of essential oil supplies from other countries. The USA and the EU have been traditionally the main importers and exporters of essential oils but lately high industrialization and urbanisation in India, China, Mexico and Brazil has shown

greater demand for aromatics and flavours31. Rising consumer disposable income and awareness regarding health benefits associated with essential oils is likely to work in favour of the market. The highest growth rates in the global essential oils demand are expected in these emerging markets but also the traditional market show growth.

In the global essential oil business Sri Lanka is only a small player. However, Sri Lanka’s essential oil exports increased hugely in value from about 10 million US $ in 2010 to 46 million US $ of essential oil products in 2017 and in cinnamon oil Sri Lanka is the major exporter in the world with a share of about one-fourth of the business globally. Sri Lanka is not a low-priced exporter but is known for reliability of supply and quality of its product.

30 Visited Online on 26th November 2019. http://www.worldstopexports.com/cinnamon-exporters/

31 https://www.grandviewresearch.com/industry-analysis/essential-oils-market

http://www.worldstopexports.com/cinnamon-exporters/

https://www.grandviewresearch.com/industry-analysis/essential-oils-market



Figure 14 Position of Sri Lanka in USA essential oil imports

Source: UNComtrade

Figure 15 shows the Sri Lankan competitive position on the USA market. India and China together have a share of about 20% of the USA imports of essential oils while Sri Lanka has a share of about 1%. However, clearly Sri Lanka exports higher value oils to the USA and has a much higher average import price for its essential oil products on the USA market than its main competitors.

Figure 15 Position of Sri Lanka in German essential oil imports

Source: UNComtrade

Figure 16 shows the Sri Lankan competitive position on the German market. India and China together have a share of about 14% of the German imports of essential oils in volume terms but only about 5% in value terms. Indonesia and Sri Lanka are much smaller suppliers to the German market with Sri Lanka having a share less than 0.5% of imports. However, Indonesian and Sri Lankan average prices for their supplies a much higher than those of India and China.

In oleoresin exports, Sri Lanka finds it hard to compete with neighbouring India. Kochi in Kerala, some 500 km north of Colombo, dominates world oleoresin production. India had substantial economies of scale relating to bulk extraction facilities, alongside the ability to extract several volume spice crops, including pepper, capsicums, turmeric and ginger. India



has substantial domestic spice production and imports sizeable volumes for further processing including Sri Lankan pepper. India also has a strong technical base capable of creating new

more specialist products32

Of course, it needs to be remembered that these are average prices for essential oils supplied to these countries and the basket of different oils in terms of type and quality varies. So, average prices are just a rough indicator of the competitive position but generally it is accepted to evaluate the competitive position of a country using prices of nearest competitors. China, India and Indonesia are the nearest competitors for Sri Lanka essential oils supplies in terms of scale (volume and value) as well as quality. As the global trade in essential oils is booming and exports of Sri Lanka are growing rapidly but the market share is still limited, it can be concluded that Sri Lanka has good potential for growth of its essential oils production and exports.

32 Ultra International, Sri Lanka the Spice Island, Colombo 28 may 2018



5 S O C I A L A N A L Y S I S

5 . 1 W o r k i n g C o n d i t i o n s i n t h e V C a c c e p t a b l e

Essential oil value chain comprised of smallholder farmers (usually < 2 acres of land), larger farmers with distillation facilities (usually with 2-10 acres implementing distillation with around 25 farmers) and large plantations (>10 acres of land). The plantations are owned by exporters or a company producing for the local market or a mix of both. The smallholder farmers peel their limited amount of cinnamon harvest (on average 600 Kg from 1 acre) themselves. In these situations, working conditions are at a very low standard. They usually sit on the ground when peeling and do not wear protective gear. Sometimes smallholder farmers hire an experienced peeler on the basis of giving him 1/3 of the harvest (or it could be the value of 1/3 of the harvest quills) as a fee. The large plantations are more organized and workers use protective gear and are employed full time. Large farmers with distillation facilities have their own workers operating the equipment. However sometimes farmers help in distillation operations to prevent paying labour charges. Most distillation facilities owned by larger farmers are old and need repair. Efficiency of the equipment is low and operations at the boiler are not well organized. However, boilers operated by larger plantations and exporters are well organized. They have the necessary certifications (ISO, GMP and HACCP certifications) as well. The situation is similar with boilers in the citronella value chain. Here too, the plantations and exporters are better organized with acceptable working conditions. Exporters in the cinnamon leaf and bark oil and citronella oil value chain have very large cultivation areas. Their distillation facilities are larger as well. These organizations work with a limited number of farmers who have their own distillation facilities. As the export product has to meet all the quality standards, it is mandatory that their distillation facilities are well managed following processing standards. However, the same cannot be said for other distillation facilities and their operations are lower in product hygiene and quality standards.

5 . 2 L a n d a n d w a t e r r i g h t s i n V C a c c e p t a b l e

Water is an essential for the distillation operations. Boilers are usually located close to a clean water source. Water from rivers and lakes is not used in the distillation process. The facilities use dug wells or deep tube wells. Hence water used in the distillation processes is private water and does not create any negative impact on water sources available for the community. However, most distillation facilities discharge their waste water into the open environment. Smallholder’ farmers private lands are used for cinnamon and citronella cultivation. Both crops are cultivated within the home garden. Some households would have several cinnamon trees for cinnamon quills. However cinnamon leaf oil and bark oil extraction needs larger amounts of leaves and barks therefore usually comes from larger cultivations. Distillation process needs at least 500 Kg of leaves or bark at once hence boiler owners are not interested in smaller quantities. Similar applies to distillation of citronella leaves. Citronella is grown in hilly lands. It has the ability to protect hilly lands from soil erosion and also helps nitrogen fixation in soil. Citronella cultivation is mostly on private lands but many are giving up the citronella grass cultivation. Citronella oil price is low as compared to several years ago and smallholder farmers can produce profitable at the moment.



5 . 3 G e n d e r e q u a l i t y i n V C

Land preparation for the cultivation of cinnamon (harrowing and making planting holes) is usually done with machines while planting is done manually. Citronella requires less land preparation than cinnamon. Therefore, use of machinery in citronella land preparation and planting is relatively low. Involvement of heavy machinery demands more male labour. Cutting of cinnamon sticks and citronella leaves are done mainly by men. Knives are used to cut cinnamon sticks while grass cutting machines are used for cutting citronella leaves. Female engagement can be seen in collecting cinnamon sticks, leaves and citronella grass. In small holder cultivations cinnamon stick harvesting and collection is done by women as well. However, in larger cultivations harvesting and collection of sticks, loading them to tractors and bring them to the peeling centres is done predominantly by men. In citronella cultivations, leaf cutting is done by machinery and cut grass is collected and bundled by women. Cinnamon peeling and quills production is done by men and women. Some plantations are using only female workers for cinnamon peeling. Here it has been a conscious decision to engage women in employment activities. In cinnamon value chain, quality checking of cinnamon quills and packing is predominantly done by women. In both value chains, distillation equipment operations are done by men.

Photo 4 Women working in essential oil production

5 . 4 D i s t r i b u t i o n o f s o c i a l c a p i t a l o v e r t h e V C

Farmer organizations are active in both the cinnamon and citronella oil value chains however most of these organizations are not for business development purpose. For example, Sumitha Boiler Association” in Ambilipitiya has 17 distillation facility owners. Only 3 boilers operate at the moment while other have shut down operations due to the current low prices. The association is not registered as a producers’ association rather as a welfare society providing donations for funerals and weddings and scholarships for students of their respective member families.

These farmer organizations are established and work in collaboration with government institutions (DEA, MoPISE and DOA). DEA provided access of research findings to farmers and assisted in enhancing their production including distillation operations as well. MOPISE’s engagement with the farmers is mainly to provide cultivation subsidies (planting material and



land preparations) and improving the distillation facilities. As mentioned before, most distillation facilities are quite old and are being built using steel and copper materials. These distillation facilities are now outdated and needed to be replaces and MOPISE is proving matching grants to upgrade the facilities with stainless steel materials. For facility owners, it is important to co-operate with a wider farmer base in order to attract these subsidies.

DoA and the Spice Council of Sri Lanka indicate the area under cinnamon but do not provide an estimation of the number of farmers/entrepreneurs engaged in the oil extraction business. The TAMAP team encountered various organisational models of engaging with farmers and workers. For example, G. P DE Silva and Sons International Pvt Ltd in Galle district operates with their own distillation facility for cinnamon bark oil. However, for cinnamon leaf oil production, they engage with 30 distillation facility owners to supply cinnamon leaf oil. Yet, complete information regarding the number of distillation facility owners in Galle is not available as only the area under cinnamon cultivation is recorded. Also, in the citronella value chain, distillation facilities are not recorded and again only the area under citronella is available. TAMAP was therefore not in a position to estimate the number of entrepreneurs engaged with essential oil production.

Exporters in the essential oil value chain work in isolation although they are members of the Spice Council and SAPPTA. Information related to their value chains and distillation technologies is not shared among them. The cinnamon leaf oil and citronella oil value chains are more open than the cinnamon bark oil value chain.

5 . 5 S o c i a l i n f r a s t r u c t u r e a n d s e r v i c e s a c c e p t a b l e

The cinnamon oil value chain operates in Galle and Matara districts and the citronella oil value chain is limited to Rathnapura and Hambantota districts. Exporters have their processing facilities in these districts with only marketing divisions in Colombo. The Southern express road and the other good roads connecting south with Colombo have benefited export operations and Colombo can be reached in several hours. Oil transportation using the highway is much safer than taking the usual road to Colombo from these districts. Electricity is available in all these districts with 100 % penetration rate to all distillation and processing operations (main fuel source for distillation are the raw materials distilled once). Water scarcity is not an issue for these operation for the moment. In fact, these areas have seen increased rainfall over time which obstruct distillation operations. Rains will delay raw materials harvest and the oil quality also goes down with heavy rains. As mentioned earlier boilers are out dated and need to be refurbished with stainless steel materials. One of the major issues is finding material suppliers to renovate the boilers. While some companies offer to construct the stainless-steel boiler, many boiler owners consider the investment too risky given the low prices at the moment. Frequently, they buy materials from Colombo and work with local technicians to renovate their facilities.



6 T E C H N O L O G I C A L I N N O V A T I O N

6 . 1 O v e r v i e w a n d q u a l i t y c o n t r o l s y s t e m

The essential oils sector has to follow the quality standards required by buyers in export markets. General standards for products exist such as for example for cinnamon leaf oil which is graded on its eugenol content (must be 65 to 95%) and its compounds valuable to industries. ISO standards exist for the oil or cinnamon bark oil which is graded on its origin (superior from the inner bark and lower from broken quills) and on its percentage of cinnamaldehyde (must be 65 to 76 %)

However, buyers use a large variety of physical and chemical standards to select the products. Before making a full order, buyers normally ask for a sample. The sample shipment should show the producer name, date, sample contents, batch number and quantity represented. Samples should be packed in glass bottles and sent in plastic bags to avoid or isolate leakages. Frequently buyers request additional information related to technical aspects, pesticides residue analysis. Genetically Modified free declaration and declaration of non-animal product derivates. Of course, for organic products exporters need an organic certificate. Then before purchase, the buyer will again check that the oil has not been adulterated, stretched or otherwise “adjusted”. This through physical parameters test such as viscosity, color, clarity and odors profiling and specific gravity, optical rotation and refraction. This confirms or rejects the authenticity of an oil’s declared botanical species and country of origin. Finally, the essential oil has to pass the Gas Chromatography/ Mass Spectrometry test to determine exactly the vaporized constituents of the oil. Every component can be identified and then be compared to an established profile or fingerprint of that particular essential oil to finally determine the purity of the oil.

Such comprehensive analysis of the quality of the oils in mostly available with the buyers. Sri Lanka has basic general testing facilities available at ITI. ITI can identify the key chemical components of the essential oil and produce certificates related to those components. The major manufacturers and exporters of spices and essential oils follow HACCP and ISO 22000 but the large amount of traditional production units have little knowledge about such standards and Good Manufacturing Practise.

6 . 2 E s s e n t i a l o i l p r o c e s s i n g i n S r i L a n k a

Apart from the growing, harvesting and handling of the raw material, the technologies used to process the raw materials into oil are crucial for a good quality oil. It is important not to harm the available amount of oil in the raw material. Fresh raw material contains the highest amount of oil but demands for prolonged extraction time costing more energy. So, use of dried material is acceptable but material shouldn’t be too brown or old as the oil content will be very low. Wilting or drying on the field for 1 to 3 days is okay but not longer.

Oil extraction technologies have a long history and technologies such as squeezing, steam distillation, solvent extraction have been used since decades. All these technologies have evolved over time and improvements were made related to materials and energy sources used for the equipment. The newest boilers are of stainless steel and steam is produced with gas or oil. Filtering the oil moved on from simple open sieves to modern closed systems in the new factories. Apart from the processing equipment also the storage equipment has improved. The traditional storage of essential oils was in old glass bottles. Then it moved to plastic containers (which is a more practical storage container but actually worse for the quality of the oils than glass). Now the modernised processing units are using metal or stainless steel containers.



Photo 5 Sieving and collection of essential oil

6 . 3 T e c h n o l o g i e s u s e d i n e s s e n t i a l o i l p r o c e s s i n g

6 . 4 D i s t i l l a t i o n

The essential oil of a plant consists of many compounds which generally boil between 150° 300° C. If attempts are made to remove these compounds by dry distillation many will decompose and the oil will be ruined. However, the compounds are steam volatile and can be distilled out of the vegetal materials at around 100° C. Leaves can be distilled after some wilting for one or two days while bark needs to be soaked before distillation. There are basically three types of essential oil distillation:

1. Hydro distillation

In this method the raw material is immersed totally in water which is boiled. The stills are mostly heated over an open fire. The heat is difficult to control in this system and hence the rate of distillation varies. The possibility exists for local overheating and burning of the raw material which can lead to a poorer quality oil. Improved systems use steam from a separate boiler, which is passed into a jacket around the still or through a closed coil in the bottom of the still, to heat the contents of the still. This method also has the disadvantage that it requires the heating of a large quantity of water adding to cost and time needed for distillation. However, for woody materials such as cinnamon bark is remains the best method.

2. Wet steam distillation

This is an improvement of the hydro distillation and the still contains a grid which keeps the raw material above the water level. The water is boiled below the raw material and wet steam passes through the raw material. The raw material is protected from direct



heat. The still is mostly heated by a steam jacket and needs to be packed evenly and not too tightly so that steam can pass through the complete raw material effectively.

3. Dry steam distillation

The most advanced type of distillation is by direct steam provided from a separate boiler (see figure 17). The still contains a grid plate under which an open steam pipe is fitted. This system gives a relatively rapid distillation. Charging and emptying the still is much faster and energy consumption is lower.

After distillation, the steam containing the essential oil vapour leaves the still and passes through a condenser. Here the vapours are cooled and condense. The most used condensers are tubes contained in a water bath and condense is obtained at the bottom of the condenser tube. It is important to make sure that condensation is complete or oil may be lost by evaporation. The more advanced technology in condensers is the multi-tubular type in which a series of parallel tubes are mounted inside a cylindrical jacket through which the cooling water passes.

After the condenser the mixture of water and essential oil flows into a separator. Most essential oils are lighter than water and the oil floats to the surface and is drained there. Some oils such as cinnamon oils are heavy than water and flow to the bottom of the separator and drained from there. The simplest separators are buckets with a drain on top or on bottom leading to a collection vessel. More advanced separators are metal or stainless-steel closed vessels connected to a metal or stainless-steel closed collection tank.

Figure 16 Dry steam distillation

S o u r c e : https://www.newdirectionsaromatics.com/blog/articles/how-essential-oils-are-made.html

6 . 5 L i q u i d - l i q u i d e x t r a c t i o n

For the production of oleoresins, it is important that the solvents stay in the final product. With distillation, the solvents remain in the raw material. Therefore, distillation is not a suitable

https://www.newdirectionsaromatics.com/blog/articles/how-essential-oils-are-made.html

https://www.nascentnaturals.com/blog/2015/04/07/plants-and-distillation-forever-entwined/



technology for oleoresin production. Liquid-liquid extraction is a method to separate compounds based on their relative solubility into two different liquids, usually water and organic solvent. The transfer is driven by chemical reaction and once the transfer is complete, the chemical components that make up the solutes and the solvents are more stable. The solvent that is enriched in solute is called an extract. The basic technology for liquid-liquid extraction is partitioning of the compounds between two immiscible liquid phases in a separating funnel. This is a cone with a hemispherical end with a stopper at the top and a tap at the bottom. Industries use large stainless-steel vessels sometimes with centrifuges. The sloping sides of the vessel are designed to facilitate the identification of the layers. The tap drains the liquid out of the funnel (figure 18 shows modern solvent extraction unit).

The steps in using the separating funnel are: 1) introduction of the compound mixture in the funnel; 2) shaking of the funnel to mix the two layers and allow for mass transfer of the compounds in and out of the phases; 3) allow the contents of the funnel to settle back into two distinct phases and 4) drain out the bottom phase. Frequently, a series of funnels have to be employed to separate the compounds that have different solubility

Figure 17 Solvent extraction unit

Source:https://www.google.com/url?sa=i&source=images&cd=&cad=rja&uact=8&ved=2ahUKEwior-7hq_jlAhUP7nMBHU65DPUQjhx6BAgBEAI&url=http%3A%2F%2Fwww.bestextractionmachine.com%2Fproducts%2Fpilot-solvent-extraction-unit.html&psig=AOvVaw0UgiDWHVCKGQBciDQzks6U&ust=1574323835229949

Most essential oils and oleoresins can be stored for long periods under suitable conditions. They should be in a dry place, not in contact with the air or direct sunlight and kept cool. It is important that the products do not come into contact with materials with which they might react such as rubber of plastic. Glass containers are often used for smaller quantities but larger quantities should be stored in metal vessels (see photo 6). Mild 200 litre steel drums lined with epoxy resin are popular for essential oils storage and transport. Plastic containers should be avoided as the oil maybe absorbed by the plastic and contamination may occur. To ensure the oil is not wet it should be left to stand for some time before filtered into its container.



Photo 6 Small collection container for essential oil

6 . 6 R e q u i r e m e n t s f o r q u a l i t y m a n a g e m e n t

s y s t e m s i n a q u a c u l t u r e v a l u e c h a i n

6 . 7 L e g a l f r a m e w o r k a n d r e g u l a t i o n s

Sri Lanka has a legal structure for quality control but many Acts are out dated and not in compliance with international best practices. Sri Lanka has no Central Body that coordinates or monitors market surveillance. Various bodies are incorporated in the system such as for example CAA and Sri Lanka Standards Institute (SLSI). Regulators do not use product certification bodies accredited by Sri Lanka Accreditation Board (SLAB) or another international accreditation organisation. SLSI aligns as much as possible with international standards and is member of ISO and IEC. Metrology is important for agriculture standards and in Sri Lanka under Department of Measurement Units (MUSSD). This body also contains the National Measurement Laboratory which executes the calibration function in Sri Lanka. Conformity in Sri Lanka is mostly through the SLSI mark and not through international accreditation. Finally, none of the market surveillance bodies perform accredited inspections with many bodies understaffed and underfunded. Quality of service has also been lacking in some particular areas of the National Quality Infrastructure (NQI), such as metrology and conformity assessment.

A manufacturer and exporter of essential oils has to both comply with the standards of the buyers/ importers and navigate between all the Sri Lankan institutions to ensure compliance with regulations. The complex structures make it virtually impossible for small or medium size companies to export and even for the established manufacturer and exporter cause loss of efficiency in a competitive international market. Further, a start-up facility will find this situation a legal impediment to function and survive. There is an obvious lack of coordination body or function among these institutions. In addition, not all key NQI bodies report to the same ministries, which misalign planning and resourcing.



6 . 8 L a b o r a t o r i e s a n d q u a l i t y c o n t r o l s y s t e m

The determination of critical control point is to know the critical point between safety and insecurity; food quality would be safe only when all the critical control points are controlled in the safe range. To determine critical control points is the core of HACCP, therefore in the early planning stage, the selection of CCP should follow scientific methods, CCP should start from farm level. Quality Control means compliance with specification. It includes sampling, inspection and testing to ensure that the materials comply with specifications (and also control of product which does not conform to specifications). This includes inspection of raw materials, temperature controls, weight controls, organoleptic testing, etc.

Quality assurance is to ensure effectiveness of the various control systems. An internal system of audit would check that the control on incoming material is in place and effective. An audit of this type would form an integral part of formal quality management system such as ISO 22000. Good Manufacturing Practices-This may be considered as two complimentary functions such as effective manufacturing operations and effective quality control. It includes elements of equipment design, cleaning and sanitation, product specifications, HACCP and Auditing techniques.

Food quality and safe use of cosmetics are major concerns of consumers and health authorities globally and hence of manufacturers and importers. Importing countries and their business will make sure that products used are of high quality and safety and uncompliant product will not be able to enter the market. High quality essential oils have a premium on western markets as several overall health benefits offered by these products are fuelling their demand. Growing inclination of consumers towards natural and organic products is leading to increased use of essential oils. Surveys show that consumer awareness of the quality of food and cosmetics is growing day by day not only in western countries but also in emerging markets. Essential oils are a perfect answer on concerns related to chemical products but only if the pre-harvest and post-harvest systems are optimised to control and maintain the quality of the product.

6 . 9 H a z a r d s i n t h e e s s e n t i a l o i l s i n d u s t r y

With the hazards identified it is possible to determine critical control points in the value chain (see table 15). To determine critical control points is the core of HACCP. The selection of CCP should follow scientific methods and CCP should start from farming level. Quality Control means compliance with specifications. It includes sampling, inspection and testing to ensure that the materials comply with specifications (and also control of product which does not conform with specifications). This include inspection of raw materials, temperature controls, weight controls, organoleptic testing. Quality assurance is to ensure effectiveness of the various control systems. An internal system of audit would check that the control on incoming material are in place and effective. An audit of this type would form an integral part of formal quality management system such as ISO 22000.



Table 15 Hazards in essential oils

Chain operations Potential hazard

Crop production No crop records or site information on pesticide use, heavy metal contamination of soil and pesticides residues, poor soil nutrient status, use of wrong species or cultivars, poor germination, pollution through misuse of fertilisers

Primary Processing Deterioration and loss of volatiles, over-drying, storage contamination

Extraction & Formulation

Over or under heating, inadequate cooling, contamination from water and/or oil, incorrect storage conditions, contamination of water course with pollution or odour, incorrect blending

Packaging, labelling and sales

Incorrect quantity, contamination in distribution channel, incorrect labelling

Critical Control Points in HACCP for essential oils33.

CCP1 pesticide residues or historic pesticide use.

a) Hazards-, no crop records/ side information on pesticide residues or historic pesticide use.,

b) Preventive measures- do not plant if no side history.

c) Limits- All fields conform no tolerance.

d) Corrective action- Reject site if no records

CCP2 heavy metal contamination of soil

a) Hazards, site records show heavy metal contamination of soil,

b) Preventive measures- obtain site records and follow safe sludge matrix guidelines.

c) Limits-All historic applications have followed safe sludge matrix no tolerance

d) Corrective action- Reject site if no evidence of use of safe sludge matirx

CCP3 pesticide residues

a) Hazards, site records indicate pesticide residues from previous cropping

b) Preventive measures-obtain pesticides application records

c) Limits- All applications of pesticides conform GAP no tolerance

d) Corrective action- Reject site if no records

CCP4- poor soil nutrient status

a) Hazards, low yield or crop failure

b) Preventive measures- test soil and nutrients, correct deficiencies

c) Limits- Maintain nutrient and pH within optimum from crop growth tolerance: pH species specific, P and K aim for optimum for crop

d) Corrective action- Apply appropriate amount of nutrients

33 R Weghtman, A Lyne a.o, HACCP Based Crop Assurance Scheme for medical herbs, Boxworth UK, March 2005



CCP5- wrong species or cultivar, risk of legal action by mis-selling

a) Hazards, loss of crop

b) Preventive measures-purchase planting material from reputable supplier

c) Limits- Specific species and cultivar, no tolerance

d) Corrective action – Reject if out of specification

CCP6- Poor germination or growing of planting material

a) Hazard – Poor quality and yield

b) Preventive measures- purchase planting material of guaranteed quality

c) Limits- germination and growing as specified by supplier, tolerance some deviation (crop dependent)

d) Corrective action- Reject if out of specification

CCP7- Pesticides residues

a) Hazard – contamination of products and environment by pesticide residues

b) Preventive measures- correct rate and timing of pesticides, matched to weather conditions and train staff properly

c) Limits- each pesticide application justified and follow pesticide manual, no tolerance

d) Corrective action- destroy contaminated crop, retrain operator

CCP8- Misuse of fertiliser

a) Hazard- poor quality and environmental pollution

b) Preventive measures- follow nutrient management plan

c) Limits- apply sufficient nutrients to balance crop offtake, no tolerance

d) Corrective action- retrain operator

CCP9- Volatiles

a) Hazard- deterioration and loss of volatiles

b) Preventive measures- work in shade and early morning or late afternoon and process in shortest time possible

c) Limits- apply lowest temperature environment, some tolerance allowed

d) Corrective action- make sure staff works in coolest environment

CCP 10- Over drying or mould due to inadequate drying

a) Hazard- destruction of quality

b) Preventive measures- use correct drying practices

c) Limits- apply target time and temperature for specific crop and equipment, tolerance is crop and equipment specific

d) Corrective action- destroy crop if quality impaired, repair equipment and/or retrain operators

CCP 11- Storage

a) Hazard- contamination during storage

b) Preventive measures- keep storage dry and clean and free of insects, rodents etc



c) Limits- maintain crop dry and free of pests. No tolerance

d) Corrective action- destroy crop if contaminated, repair buildings and containers

CCP 12- Over or under-heating in extraction

a) Hazard- poor quality or loss of crop

b) Preventive measures- ensure equipment properly maintained and procedures correct followed

c) Limits- follow written procedure -crop and equipment specific. No tolerance

d) Corrective action- test quality and re-blend if necessary

CCP 13- Inadequate cooling in extraction

a) Hazard- loss of volatiles and/or distillate

b) Preventive measures- Follow correct procedures

c) Limits- Coolant running. No tolerance

d) Corrective action- increase flow or decrease temperature of coolant. Stop process of necessary

CCP 14- Contamination from water or oil in extraction

a) Hazard- loss of product

b) Preventive measures- use correct separation procedures

c) Limits- Dry oil and water free oil. No tolerance

d) Corrective action- re-dry, separate water from oil

CCP 15- In correct storage in extraction

a) Hazard- loss of quality of product

b) Preventive measures- store in coloured bottles or in metal or stainless steal containers and keep in dark cool place

c) Limits- Coolest ambient. Tolerance product specific

d) Corrective action- blend inferior batches or discard

CCP 16- Contamination of water source in extraction


b) Preventive measures- Use correct disposal of waste

c) Limits- No pollution No tolerance

d) Corrective action- inform environment agency in case of heavy pollution

CCP 17- Incorrect blending of product


b) Preventive measures- Follow ingredients recipes and use approved ingredients

c) Limits- According to recipes No tolerance

d) Corrective action- destroy inferior batches

CCP 18- Incorrect quantity in packing

a) Hazard- loss of product, risk of legal action buyers



b) Preventive measures- Correct practices

c) Limits- Minimum quantity of product in each unit packed No tolerance

d) Corrective action- recalibrate filler, weighing equipment, retrain staff

CCP 19- ingestion of water in packing

a) Hazard- loss of product and quality

b) Preventive measures- Use tamperproof packing, correct labelling and code of practice

c) Limits- Tamperproof packing applied and information on packaging 100% correct No tolerance

d) Corrective action- re-pack, correct printing equipment, retrain staff

The HACCP is complete with a quality manual (covering all quality issues and making references where necessary including procedures that are critical to safety, legality and quality) containing an outline of working methods and practices and a production manual (covering all aspects of raw material receipts, selection, grading, storage, production and packing in the entire value chain). These documents should be available to the senior staff and production manager at all times. Any licensing authority should have access to quality and production manuals. Good manufacturing practices are recommended with the goal of safeguarding the health of consumers well as producing quality products

GMP guidelines are not prescriptive instructions on how to manufacture products. They are a series of general principles that must be observed during manufacturing. When a company is setting up its quality program and manufacturing process, there may be many ways it can fulfil GMP requirements. It is the company's responsibility to determine the most effective and efficient quality process that both meets business and regulatory needs.



7 E N V I R O N M E N T A L A N A L Y S I S

7 . 1 I m p a c t o f e s s e n t i a l o i l p r o d u c t i o n o n t h e e n v i r o n m e n t

In order to produce a single pound of essential oil, enormous quantities of plants are required. It’s important to understand how plants for these resource-intensive products are farmed. The majority of popular essential-oils companies source their raw materials from corporate farms (mostly owned by them) that turn out large quantities of plants. As with the cultivation of

products on many large farms, the use of pesticide is common34. And there are currently no organic certifications specifically for essential oils value chain in Sri Lanka. Companies like Hettigoda Industries Pvt Ltd emphasized the importance of having citronella leaves from farms where they do not use chemicals. However, they have no control over the chemical usage of farmers and are not in a position to push farmers to cultivate organic citronella (certification is too costly).

Each pure oil comes with its own set of potential ecological and disposal issues. Each essential oil should have a Material Safety Data Sheet (MSDS) that provides toxicity information, flammability warnings, and disposal directions. While this information is required of all essential oils in the United States, many essential-oils companies, such as Young Living, DoTerra, and Mountain Rose Oils, require consumers to contact the company directly to request MSDS information. By comparison, in the UK most MSDS information is posted directly on the

company’s website35.

Most essential oils are extremely flammable requiring extra precautions when disposing or cleaning up a spill. Flammable oils are considered household hazardous waste in small quantities, and the containers holding those items cannot be recycled unless the oil is washed from the container. Removing essential oils from a previously used container must be done carefully. Many oils are toxic to aquatic life, and can have long-lasting impacts on marine/riverine ecosystems. Oils themselves should not come in contact with water supply or groundwater, meaning they should never be dumped down the drain or toilet. If a bottle of oil has expired and is no longer good for therapeutic use, the best options for disposing of the remaining oil is to use it with a passive diffuser (a porous, non-flammable material that can soak up the oil and allow the scent to linger over a period of time), or to add it to homemade cleaning products for the scent alone. However individual distillation facilities owned by farmers in Sri Lanka provide little or no evidence to support these proper disposal methods. If an oil is contaminated or rancid and cannot be used, it must be disposed of through a hazardous-waste collection service. Container recycling can also pose challenges. All quality essential-oils products come in glass containers, since pure essential oils can degrade plastic. Surprisingly oil is stored in plastic barrels at many distillation facilities in Sri Lanka.

34 Visited Online on 26th November 2019. http://www.earthisland.org/journal/index.php/articles/entry/the_environmental_impact_of_essential_oils/

35 Visited Online on 26th November 2019. http://www.earthisland.org/journal/index.php/articles/entry/the_environmental_impact_of_essential_oils/

http://www.earthisland.org/journal/index.php/articles/entry/the_environmental_impact_of_essential_oils/

http://www.earthisland.org/journal/index.php/articles/entry/the_environmental_impact_of_essential_oils/



7 . 2 I m p a c t o f c l i m a t e c h a n g e o n e s s e n t i a l o i l

p r o d u c t i o n

Agriculture is always vulnerable to unfavourable weather events and climate conditions. Despite technological advances such as improved crop varieties and irrigation systems, weather and climate are important factors, which play a significant role to agricultural

productivity36. Poor crops of raw materials for essential oils, due to adverse weather or environmental calamities, can result in significant price spikes; while excess supplies can

depress prices to uneconomic levels for producers37. Most spice plants get their distinct flavour characteristics from essential oils that also show antioxidant and pesticidal activities. Spice essential oils contain a complex mixture of volatile monoterpenes, sesquiterpenes, and

phenols, which play important defensive roles against insect herbivory38. Some of these essential oil constituents were found to exhibit contact or fumigant toxicity, while others had only insect repellent, and antifeedant effects. Among the major drawbacks of plant essential

oils are their quick evaporation and rapid degradation under sunlight39. Hence adverse temperatures from climate change can impact the quality of distilled oil.

Cinnamon is the hardiest among the tree spices, tolerating a wide range of soil and climatic conditions. The optimum climate has an average temperature between 27-30°C and 2000- 2500mm of rainfall. Cinnamon is an evergreen tree that is kept to a height of 2-3m. The soil

conditions are very important; as waterlogged soil will produce a bitter cinnamon bark40. Like most grasses, citronella prefers a moist loamy soil that drains well without drying out completely. This type of soil ensures a steady stream of nutrition gets to the plant and that the roots of the grass do not dry out or become disentangled from the ground. The citronella can tolerate full sunlight if necessary but prefers a slightly shaded area that receives six to eight hours of sunlight per day. Like many species of grass, the citronella plant requires a great deal of water, especially if exposed to direct sunlight for most of the day. Overall, a healthy citronella grass plant will consume up to 30 inches of water per year. While citronella is a resilient and

adaptable plant, it does not handle long periods of cold very well41. Climate change brings changes to temperatures, rainfall patterns (rain fall amounts and intensities), changes to soil macro and microorganisms thus affecting the overall production of cinnamon and citronella plants. This will directly impact the oil yields and qualities. Plant metabolism is also vastly

influenced by climatic factors in terms of quantity and quality42. Climate change has drastically changed rainfall patterns of Sri Lanka as well. Galle. Matara, Rathnapura and Hambantota where cinnamon and citronella is being grown at a large scale is experiencing rainfall for the past few months continuously. This has resulted in closedown of some citronella and cinnamon

36 Visited Online on 27th November 2019. https://pdfs.semanticscholar.org/7bdb/68db6931422acfaf257c7bb491f9047e548d.pdf

37 Visited Online on 27th November 2019. http://www.intracen.org/itc/market-insider/essential-oils/

38 Isman, M.B. 2006. Botanical insecticides, deterrents and repellents in modern agriculture and an increasingly regulated world. Annual Review of Entomology 51:45-66.

39 Isman, M.B. 2000. Essential oils for pest and disease management. Crop Protection 19:603-608

40 Visited Online on 27th November 2019. http://www.fao.org/3/a-ad420e.pdf

41 Visited Online on 27th November 2019. https://homeguides.sfgate.com/citronella-plant-care-39793.html

42 Visited Online on 27th November 2019. https://www.researchgate.net/publication/328080989_Effect_of_Climatic_Factors_on_Essential_Oil_Accumulation_in_Two_Lamiaceae_Species_from_Algerian_Semiarid_Lands

https://pdfs.semanticscholar.org/7bdb/68db6931422acfaf257c7bb491f9047e548d.pdf

http://www.intracen.org/itc/market-insider/essential-oils/

http://www.fao.org/3/a-ad420e.pdf

https://homeguides.sfgate.com/citronella-plant-care-39793.html

https://www.researchgate.net/publication/328080989_Effect_of_Climatic_Factors_on_Essential_Oil_Accumulation_in_Two_Lamiaceae_Species_from_Algerian_Semiarid_Lands

https://www.researchgate.net/publication/328080989_Effect_of_Climatic_Factors_on_Essential_Oil_Accumulation_in_Two_Lamiaceae_Species_from_Algerian_Semiarid_Lands



distillation operations in these districts. Usually rainfall is low in these areas during months of November and December (usually South West Monsoons are from June to September).



8 O P P O R T U N I T I E S , O U T L O O K A N D R E C O M M E N D A T I O N S

8 . 1 O p p o r t u n i t i e s

8 . 1 . 1 E s s e n t i a l o i l s h i g h p o t e n t i a l s e c t o r

Sri Lanka produces high quality raw material for various types of high value oils. Both Sri Lankan essential oils exports and the global demand and exports are growing sharply. However, Sri Lanka is still only a small player on the global market and there is huge scope to further develop the business. Essential oils are high value items and the return on investment and profit is high.

8 . 1 . 2 O p p o r t u n i t i e s t o d e v e l o p t h e e x p o r t a n d l o c a l m a r k e t

The middle- and high-income groups in emerging markets are the main driver of growth in the sector. Health and healthy food awareness push the sales of essential oils as it is considered contributing to a modern healthy live-style. Both the upper class in urban Sri Lanka and internationally will continue to demand more and more supply of high-quality essential oils. Sri Lanka is already market leader in cinnamon oil and can further strengthen its position in this product. Pepper essential oil is internationally a much bigger market than cinnamon essential oil. Sri Lanka has good opportunity to further strengthen its position in pepper essential oil as well as the country produces high quality black pepper. Prices of essential oils on the international market are higher than on the local market which will further push export-oriented production.

8 . 1 . 3 O p p o r t u n i t i e s t o d e v e l o p v e r t i c a l o r g a n i s e d p r o d u c t i o n a n d t r a d e s y s t e m

Quality is the magic word in essential oil production. The country that produces and supplies at the highest quality standards, manages to certify and register itself as a premium supplier and the branding of its products can be assured of sustainable growing high profitable business. To achieve high quality complete control and management of the farming, the processing and the trade is required with the best equipment and trained staff. More and more companies in Sri Lanka understand that this requires substantial investments in equipment and staff and efficient control over the farming. Companies are setting up exclusive raw material supply lines using the services of selected farmers and supply of their own fields. Trusted preferred farmers are contracted as long-term suppliers of high-quality raw material. Out-growers schemes using the services of these trusted preferred farmers are getting more and more popular in the essential oil business in Sri Lanka. It seems that a process of scaling up of farming for essential oils is evolving both at processing level as well as at farm level. The benefit for trusted preferred farmers is that out-growing and contract farming gives a assured market for their production reducing the risk of their business.



8 . 1 . 4 P o t e n t i a l t o m o d e r n i s e p r o c e s s i n g

The Sri Lanka essential oils sector is going through a transition. The traditional low efficient processing units spread all over the rural areas seem to lose business and medium-scale and large-scale units with modern equipment seem to take over. Farmers will most likely more and more be pushed to their core business i.e. farming of high-quality raw materials while processing will be done in companies using up-to-date equipment and highly trained staff. Some traditional processing units will be able to connect and modernise their facilities but many will be closed as the out-dated equipment cannot supply the quantities and qualities the market demands.

8 . 1 . 5 P o t e n t i a l t o d e v e l o p q u a l i t y f a r m i n g o f r a w m a t e r i a l s

Most farmers have little knowledge about the planting materials they are using and the GAP needed to obtain good farming results. A good quality essential oil starts with a good quality raw material. This relates to the proper variety (for example oil content of plant varieties providing the oil varies considerably) and knowledge of producing the best raw material from the selected variety. This refers both to pre-harvest as well as post-harvest handling of the crop. Investing in some smart affordable mechanisation can have a high impact on efficiency in farming.

8 . 1 . 6 O p p o r t u n i t y t o i n c r e a s e c o - o p e r a t i o n w i t h f o r e i g n b u y e r s a n d s e r v i c e p r o v i d e r s

Essential oils are high priced luxury items and sales are highly dependent on trends in markets. Close co-operation with foreign buyers provides the required information to timely adjust to new trends and access to new markets. The major Sri Lankan manufacturers and exporters are already co-operating closely with their buyers but many stakeholders are still only supplying orders without much knowledge of the buyers and the markets. Currently, not much foreign investment in the essential oils sector occurs in Sri Lanka and also service providers such as accreditation and certification institutes are not co-operating closely with foreign institutions. The sector would benefit from a higher involvement of foreign capital and knowledge.

8 . 2 O u t l o o k

Essential oils are high priced luxury items following fashion and live-style trends in markets. The sector needs the flexibility to follow trends in markets and fashion and designing. Constant improvement of the quality and assortment is essential for the survival of the sector. The current process of transformation from a traditional low-quality low volume sector to a modern equipped sector supplying high quality at larger volumes are crucial for the long-term sustainability of the sector. Some traditional oil production will continue for specific local target groups such as Ayurveda and tourist but the mainstream production should move one to modernised installations. Parallel, the business support services should be strengthened and the government compliance control and administrative institutions should be streamlined. Current efforts of the Ministry of Finance to establish a one-window approach for exporters should be speeded up.



8 . 3 R e c o m m e n d a t i o n s

8 . 3 . 1 I m p r o v e t h e e x p o r t r e g i m e f o r e s s e n t i a l o i l s

Streamline the procedures and document requirements from different institutions via the one-window of the Ministry of Finance. The list of documents, registrations and certificates required for exports should be reviewed and the system should be electronic on the internet. Accreditation and certification companies and institutions should be encouraged to establish in Sri Lanka and supply an efficient service to the sector.

Export promotion for the essential oils sector by the Export Development Board should focus on the manufacturers and exporters and not on irregular traders. The image to be build through export promotion should focus on Sri Lankan product produced with modern technology giving highly reliable volumes of high-quality product which is traceable and branded as originally Sri Lankan.

8 . 3 . 2 I m p r o v e t h e t r a n s p a r e n c y o f t h e e s s e n t i a l o i l s s e c t o r

It is recommended that instruments will be put in place that promote the fair competition in the business. Oligopolistic production and sales structures will harm the long-term development of the essential oil sector. A good development would be to establish a Spice Board comprising of stakeholders from private and public sector which would promote sector interests and advocate and lobby for fair competition. The spice sector and concentrate sector committee monitoring and guiding the implementation of the National Export Strategy for the sector consisting of members from private and public sector could be a starting point for establishing a Spice Board.

8 . 3 . 3 E s t a b l i s h g o o d a c c e s s t o n e w e q u i p m e n t a n d k n o w l e d g e f o r o i l e x t r a c t i o n , s t o r a g e a n d p a c k a g i n g ( i n c l u d i n g G M P )

Modernisation of the essential oils sector has started and should continue with maximum force. Financial services should be encouraged to support investing in equipment and import restrictions and taxes on imported equipment should be slashed. Staff of essential oils manufacturers should be trained in all aspects relevant to their jobs. Operators in the processing units should understand GMP and HACCP procedures and management should co-operate with operators to establish GMP and HACCP for each production facility. As also observed in other value chains, Sri Lanka should consider developing certified vocational training for the sector which would make it more attractive for the youth to enter this business.

8 . 3 . 4 P r o m o t e u s e o f m o r e e f f i c i e n t f a r m t e c h n o l o g i e s ( i n c l u d i n g G A P )

Modernisation on the level of processing is currently moving in Sri Lanka, but technology development at farm level is still backward. Farming is still a manual activity while many activities can be done with equipment and machines. It is recommended to support the introduction of low-cost farming equipment and machines to reduce the cost of labour as well as the high turnover of labour in the sector and farming. The government may decide to reduce the import duties on equipment for the farms as well as the VAT on locally produced equipment. Also, farmers should understand GAP and its impact on the quality of the oils produced.



Farmers should be encouraged by all stakeholders to apply GAP on their field operations in both pre- and post-harvest as well as during harvest.

8 . 3 . 5 P r o m o t e h o r i z o n t a l a n d v e r t i c a l i n t e g r a t i o n

The scaling-up and modernisation of mainstream essential oil production demands for trusted preferred farmers to achieve production targets and arrange orders. For farmers, contract and out-grower schemes supply stability to their business and a secure source of income and employment. Farmers should be encouraged to become trusted preferred suppliers to manufacturers and exporters. For farmers this will be the only feasible way to participate in the mainstream sector and benefit from its growth over the coming years.

The farmer organisations that currently exist in the sector are lose structures mainly established for social welfare goals. These organisations have contributed little to farming as a business for the members. It is recommended to study if it is feasible to establish committed trusted preferred farmers groups which negotiate as a group with manufacturers and exporters for their individual members. The members of the group could all be suppliers to the same manufacturer or also to different manufacturers based on individual contracts or outgrowing schemes.

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