Cocoa: Food of the Gods Faces 21st Century Challenges

Call it the thin, sweet line. And it’s all that stands between us and our growing need for a chocolate fix. The line is manned by the world’s besieged cocoa farmers, who toil along the Earth’s equatorial middle, battling the elements and unpredictable markets to ensure the flow of a crop needed to create one of the world’s most popular guilty pleasures. But with the prediction cocoa demand will outstrip supply within five years, the industry is in dire need of better management and more sophisticated trading tools to help farmers and consumers cope. Not everyone is optimistic.

“Cocoa is by nature a smallholder’s crop,” said Liock Kieng Peter Ng, Commercial Director of Trading & Sustainability for ADM Cocoa in Singapore. He warns the industry will be “challenged” to ensure a steady supply of cocoa in such volatile conditions.

Volatility has been a recurring nightmare for market players, due to the often uncertain growing conditions in West Africa, which supplies some 70 percent of cocoa to the world’s $150 billion a year chocolate industry.

Cocoa prices have been on a razor’s edge again this year, which is characteristic of the market recently. Cocoa prices opened at €2782 a tonne in late March, before yo-yoing down.  But with concerns over the prospects of a poor crop in Ghana, the prices rose above €2,800 again by late May, according to CME Group data.

 

Like China for Chocolate

The longer term outlook is just as uncertain. Last November, the Swiss chocolate giant, the Barry Callebaut Group,  expressed concern about “a potential cocoa shortage by 2020.” The musing was an echo of a warning the previous year by Mars  and other industry players of a shortfall that could top 1 million tonnes in five years.

The world’s sweet tooth could be left with unrequited cravings because of a range of woes, including a rising demand in Asia and climate change, which could jilt once reliable rain and wind patterns in the producing countries.

“The key challenge facing cocoa producers and chocolate makers is to increase global production by at least one million tonnes over the next decade, in order to meet rising demand from emerging markets, such as China and India,” according to Edward George, Head of Group Research at Ecobank.

The producing countries are keen to boost yields and for that they need a fair price.

Some farmers have been fleeing the business in favor of more profitable crops such as rubber and palm, which only exacerbates the problems in the supply chain. “The ultimate challenge is to knit together the entire cocoa chain, from farmer through trader and processer to chocolate maker,” George said.

The heavy labor and number of workers needed to harvest cocoa trees is another challenge for the sector, according to Professor David Guest at the University of Sydney’s Department of Plant and Food Services.

“It takes you about three years after you plant a tree to start harvesting and once the tree is mature you should be able to harvest it for about 15-20 years if you look after it properly,” he recently told ABC News Australia.

 

Future(s) Tense for Prices

Cocoa has been around for eons. The crop, used like a cash machine for modern day farmers in the developing world, played a central role in the rise of ancient civilizations in Latin America. The Mayans mixed cocoa to make a sacred drink and the Aztecs, despite a vast supply of gold, used cocoa beans as a form of money. Fittingly, the Latin name of cocoa is Theobroma, or “food of the gods.”

Today, you can hardly blame market players turning to the heavens to pray for better weather and, perhaps, new tools to deal with all the market volatility. On the latter, the market gods seem ready to comply.

Prior to this year cocoa was traded on two futures markets. ICE operated the New York contract and in 2013 assumed the NYSE Liffe contract, owner of the London cocoa futures. But users of the London sterling contract bemoaned the lack of competition and were frustrated by the slowness of getting the product out of warehouses when needed.

In 2015 the CME Group decided to weigh in, introducing the physically delivered euro cocoa contract and another contract in dollars, settled in cash. Not to be left behind, ICE also introduced a euro-based contract. “Let the cocoa wars begin,” the Financial Times intoned as the contracts began competing head to head in Europe in March.

CME was crowned the early winner as the new contracts went head to head. More than 200 lots traded hands on the new CME contract on the first trading day, which marked the venerable exchange’s entry into deliverable soft commodities.

CME’s cocoa product offerings are comprised of a Euro-denominated deliverable futures contract and a U.S. dollar denominated cash settled contract, which together provide much needed risk management tools for the global cocoa industry.

Chris Tubby, Head of Market Making and Training for LDN Capital and a veteran who cut his commodity teeth trading cocoa, said CME’s new contracts were well received by the market. He noted LDN Capital traded more than they initially expected in the first month.

“Cocoa is quite a niche market with a select number of participants and I believe the CME addressing warehousing, delivery and grading issues is a great attraction,” Tubby said. “However, it is important for the industry to get involved soon to ensure the attention and success of the new contract.”

The physically-delivered cocoa futures contract will, according to the CME, track the underlying cash market more closely than any other futures product out there. Through mid-May the contract had over 2,500 contracts traded and nearly 900 in open interest.

The CME believes they are answering a need in a market seeking more stability and price convergence.  “We wanted to launch a contract that reflects the physical trade, and judging by market response, we’ve done that. In the first month of trading, we had more than triple the volume of the competition,” says Jeffry Kuijpers, CME’s Executive Director of Agricultural Commodities.

With the cocoa industry prone to everything from bad weather to galloping demand, it is clear everyone — farmer, trader and chocolate maker — need all the help they can get to ensure chocolate does not become a product only the gods can afford.

Russell Blinch has extensive experience writing about commodities, energy and the environment. His work has appeared in numerous outlets such as the Guardian, DeSmogBlog, Huffington Post, Reuters and at his own site, copycarbon.com. Russell was previously a senior editor with Thomson Reuters where he wore many hats—correspondent, bureau chief, and specialist editor – while being stationed in Ottawa, San Francisco, Singapore, Washington, DC, and Toronto.

Additional Recent Articles in Commodities