(Corrects paragraph 3 in story from Nov. 21 to make clear Friends of the Earth's role in the roundtable)

By Niluksi Koswanage

KUALA LUMPUR, Nov 21 (Reuters) - An environmental group has threatened to withdraw its support for a plan to certify "eco-friendly" palm oil, accusing the world's two biggest producers of cynically exploiting the initiative.

Friends of the Earth said the Malaysian and Indonesian governments appeared to be using the programme, a voluntary industry-led initiative, as an excuse not to legislate to protect rainforests from the rapid expansion of palm-oil estates.

The certification system is set to be unveiled in Kuala Lumpur this week at a meeting of the Roundtable on Sustainable Palm Oil, which groups producers, consumers and environmentalists such as WWF. Friends of the Earth, though not a member, is participating in the event and, according to its Web site, has encouraged UK firms to join the roundtable.

If green groups walk away from the roundtable, it could deal a blow to the industry, which is trying to promote palm oil as a sustainable alternative to petroleum. Demand for palm-based biofuel has sent demand and prices for the commodity soaring.

"The governments in Malaysia and Indonesia use the roundtable as an excuse not to undertake strong legislation to protect their environments and the rights of indigenous people," said Ed Matthews, head of new economics for Friends of the Earth.

"That is beginning to happen now and if that continues to happen over the next year or two, then I think we would be deeply concerned about that and at that point we will have to walk away," he told Reuters last Friday.

Malaysia and Indonesia, home to more than 4 percent of the world's rainforests, produce nearly 85 percent of total palm oil.

Both nations have laws to protect tracts of rainforests against illegal logging, but green groups say penalties should be stiffened and that more rainforest should be locked away. They also say existing laws are not properly enforced.

The Malaysian Timber Council agreed that enforcement needed to be stepped up but rejected the call for stronger legislation.

"Current laws have been more than adequate...," a council spokeswoman said.

ALARM OVER EXPANSION PLANS

Malaysia has 19.3 million hectares of rainforests, peat and mangrove forests, with 78 percent of the area available for production, Forestry Department data showed.

Many of these concessions are on the island of Borneo, in which Malaysia and Indonesia have territories. It is a treasure trove of plant and animal species, including the orangutan.

Malaysian states, such as Sarawak, on Borneo, are allowing palm oil firms to take up these concessions.

"Unfortunately, there are no very strong government standards and enforcement is poor," Friends of the Earth's Matthews said.

"Sarawak is the place where companies are looking to achieve the greatest expansion of oil palm over the next five to 10 years and it is reeling in the money from these concessions."

With palm oil prices hitting record highs, Malaysian planters are looking to expand beyond the 4 million hectares covered by palm-oil estates across Malaysia.

Malaysian palm-oil firms already have nearly 1 million hectares of palm-oil estate in Indonesian Borneo.

Overall, there are around 6 million hectares of estate in Indonesia, and the country's agriculture minister expects this area to expand by about 300,000 hectares per annum.

Malaysia is setting up an institute to probe allegations that palm-oil firms are also destroying peatlands which, with rainforests, are important in countering global warming.

"If by converting peat soil into palm plantations it will cause enormous emissions of carbon dioxide, then we will be taking proactive steps to limit peatlands usage but we have to be certain," Malaysian Commodities Minister Peter Chin said on Friday. (Additional reporting by Naveen Thukral) (Editing by Mark Bendeich and Ben Tan)

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