Cocoa

We're currently in peak chocolate season. As holiday baking kicks into high gear, and chocolate makers pack up chocolate Santas bound for Christmas stockings, the price of chocolate, be it for home baking, cookies, or the finest chocolate delicacies, all goes back to cocoa commodity markets. And commodities, whether it be oil or gold, corn or cocoa, work on a couple of levels. There's the spot market, the price to buy a ton of cocoa today, and then there's the futures market, speculation on what the price of that commodity might be at some future date based on supply, demand, weather, wars, shipping, and because of the unique nature of the raw cocoa industry, the futures market has been on a ride the last several years. So this week we're diving into cocoa, specifically the cocoa markets. It's what we do here on Reuters Econ World. Every week we pick a phrase or buzzword and go deep on the economic principles and ideas driving the biggest news around the world. I'm your host Christopher Walgesper in Chicago. Now to walk us through what's happening in the world of cocoa production and markets, I'm joined by three of my Reuters colleagues who've been covering cocoa for years. Jobavye is our Africa business correspondent based in Johannesburg, South Africa. May Angel covers financial markets out of London, and Marcello Tegera tracks cocoa out of New York as a part of our coverage of the soft commodities. So Joe, May, Marcello, thanks for joining me here today. Happy to be here. Hello, Jechris. Good to chat. Yeah. Thank you. Okay. So first and foremost, I want to set the stage. What's been going on in the cocoa market the last couple of years? Well, on the physical side, we've just had two or three successive seasons of terrible harvests. I'm talking about Ivory Coast and Ghana, which produce like two-thirds of the world's cocoa. It's a lot of small scale farming, impoverished farmers. So they quite at the mercy of the whims of nature, which are increasingly erratic. And then in Ghana, we had a few more specific problems with illegal gold mining, smuggling, sector mismanagement, and it all culminated in a kind of a perfect storm that sends stocks to their lowest since the 1960s. Yeah. I mean, I think if you look at cocoa, you have, as May said, around 65% of global supply is concentrated in just two countries. And I mean, if you think about it, that's a bigger share of global supply than OPEC has over oil. Whatever decision is made by an OPEC country or by OPEC immediately has an impact on global prices. Ivory Coast and Ghana had seen a steady increase in production until just a few years ago. Ivory Coast hit 2 million tons of production, Ghana hit slightly over a million tons of production in 2021. So there is a sense that we may have hit peak cocoa. So we've had declining production for the last several years. Climate change has made seasons more erratic. Cocoa growing regions are getting too much rain when they need dry weather. They're getting drier weather when they need rains. Temperatures are off. You also have had swollen shoot disease, which once it gets into a tree, production will decline steadily until the trees not only have to be cut down, the roots have to be ripped up. The soil has to be treated, has to be left fallow for a season or two, and then you can plant more cocoa. And it takes several years before those cocoa trees can come up. So these factors have come together to create kind of like a gradual decline in production in West Africa that last season led to an acute problem that was particularly bad in number two producer Ghana. And then the knock-on effect to the cocoa market of last season is also being felt this season just because of the way traders operate and hedge. And that's kind of led to basically now what's looking like two successive seasons of near record high cocoa prices. Another strong aspect is the demand side, right? We've seen chocolate production and chocolate consumption. It's been up by five to six or seven percent in some regions like Asia. There's a strong growth on demand as well. So prices may not, I don't know, may you can help me here, but around 200 percent in two years, right? Well, by from January to April this year, they almost tripled at one point. But right now they are, they're probably about double. Yeah. They're probably up by 100 percent. Now out of all the fundamental issues impacting the cocoa markets, one issue stands out on the ground in Ghana. To really understand what some of these cocoa farmers are facing, I called up Maxwell Akelare Audombila. He's in Ghana, the capital, Accra. He spent more than a decade covering cocoa in the region. Ghana's cocoa farmers are facing a range of challenges, key among them being illegal mining. Illegal mining happens across the country. Interestingly, where cocoa grows is also where gold, diamond, manganese and other minerals are also mined. So we have a situation where Ghana's farmers have to compete with these illegal miners who are first armed with weapons, armed with money, supported by politicians, supported by big business people, supported by the land owners. So the cocoa farmer is less empowered, even going into the fight. In the course of our reporting, we met a lot of farmers who have suffered various degrees of devastation from these illegal miners. And one of the victims is Janet Genfi, a widower who initially had these people coming to tell her that please release your land for mining because we found gold in it. We've had approval from the government to come and mine. Janet refused because she and her family have been farming cocoa on that piece of land for over 30 years. But she woke up one day after she refused to willingly release the land, only to see that it had been kind of ring fence and then a signboard put on it that it is a mining site. And when I spoke to Genfi in tears, he told me that her livelihood, what she had fought for for decades, was gone. And it was replaced when we visited there by trenches, pools of cyanide water, destroyed cocoa trees, or you could literally feel the sweat of 30 years gone down the drain. And the interesting thing is that these guys used less than a month to extract whatever that they needed and left behind a lot of poverty for this woman. The cocoa farm was what she was using to take care of her family, to sponsor her children in school. At the time we visited her, those children were there unable to go to school. She told us she owed a lot of people. She couldn't pay and she was wondering how she was going to live. We went to the cocoa regulator, Ghana Cocoa Board, and we met the public affairs director, Sisi Boafu. If we have all these farms being lost, productivity affected as a result of illegal mining, then its impact on the industry is one we are really struggling to deal with. Sisi Boafu acknowledged the extent of damage that Cocoa is suffering from illegal mining. But interestingly, Sisi Boafu told us that Cocoa Board is overwhelmed. The illegal miners are empowered more than Cocoa Board is, so they end up destroying these lands with impunity. And so Sisi Boafu did tell us that they will follow up with Gene Genfi, but as I speak now, nothing has been done. Now, you mentioned hedging earlier. Tell me about the maybe unique way that hedging is used in the cocoa market and how that might differ from other commodities. Okay. I think we should start with how the two major cocoa producers market their cocoa. So they will estimate the size of their upcoming crop and they will do agreements with exporters, traders, processors to fix a price that they're going to sell their cocoa at, at a specific period of time. So you might do a deal with a Nestle or a Berry Cabo to deliver, say, 10,000 tons of Ghanaian cocoa or Ivorian cocoa for during the month of March and then use an average of the sale price to fix a price that farmers must be paid. So in forward selling their crops, Ivory Coast and Ghana can ensure that stability, can ensure they, they keep their farmers happy. The problem that can occur and what did occur last year is if you estimate the size of your crop, sell your cocoa forward and then have a disaster and end up not having enough cocoa to fill the contracts that you've agreed with these companies. It really puts the whole ecosystem around the chocolate industry in a lot of doubt because they are also hedging, particularly with trading houses who are selling on to the chocolate industry. They also want to lock in their prices. Can you kind of explain how that, that supply shock then affected this structure? Well, so Ghana sold twice as much as they ended up being able to deliver. Traders had hedged those, those contracts on the futures market. So they, they were long physical. So to offset the long physical, they take a short futures position, which is essentially a bet on price falls. When the market started to realize that prices were not at all falling, Ghana didn't have this supply to deliver. Ivory was also struggling to meet its delivery obligations. Hedging doesn't work if you don't get the physical at the price and the time that you expected to get it. What you have to do is you have to lift your hedge by going long, which, because that offsets the short or gets you out of that position, but of course it lifts up prices because you've gone long and that's how prices tripled in four months. And then what they did was Ghana said, no, no, we're not defaulting, we'll give it to you next season at the price we promised it. And now they're in again in the same position waiting to get this cocoa from Ghana. And if they don't get it, they're facing losses. And the biggest loss is by rolling because when a physical commodity market is short supplied, that's reflected in the shape of a curve. The curve is inverted, which means nearby prices are higher than far out prices. And that difference is what traders lose when they roll their position. And in the case of cocoa, the reason they lost an estimated billion is because the difference between the contract they were getting out of and the one they were buying was like insanely steep. And the issue again this season is since Ghana has promised to deliver an estimated 350,000 tons plus another 100,000 tons that we believe they've sold forward at also low prices, they will struggle to produce enough cocoa to cover the rolled over cocoa from last season. I mean, this can go on basically endlessly as long as they keep moving their positions because they haven't received the physical cocoa. They can lose money on every movement of position. Does that just roll forward in perpetuity? Are we just continuing to double down and Ghana will just continue chasing its tail? Because a lot of these issues you described are going to take a while to recover from. Well, if they recover from them ever. But I think the industry was betting that this season would be better than last year. They were hoping that last season was an aberration that it was really just kind of the worst case scenario. And if you look at Ghana's production, it really was you go from producing over a million tons of cocoa in 2021 to producing under 500,000 tons last season. And a lot of people in the industry thought this was just a one-off, there would be a production rebound. Ghana said it themselves, they still considered typical production to be around 800,000 tons. And to be fair, production in both countries in both Ivory Coast and Ghana appears to have rebounded to a certain extent this season, though there's still a lot of doubt as to to what extent. Ghana has just gone through one of the most fraught periods of its economic history. It had a cost of living crisis coming out of the pandemic. It then had a sovereign debt default, it had to negotiate a program with the International Monetary Fund. It's just been one thing after another. And to be clear, in most commodities, if you have a bad season, the farmer gets some small consolation with a higher price for whatever crop they were able to harvest. But because of the structure in Ghana, the farmer hasn't even seen the benefit of these higher prices. That's because of the forward selling. And that's great because it allows governments to create stability. It's bad when you have this kind of skyrocketing global futures market, because what that also creates is an incentive for smuggling. So when you have farmers getting a price reflected of market conditions from a year, a year and a half ago, and the spot price for physical cocoa reflecting current demand, and there's a huge mismatch, if someone's willing to pay $8,000, $9,000 for a ton of cocoa in New York, and the farmer is getting $2,000 per ton in Ghana, you can see what can happen. And that was a huge factor in curtailing production in Ghana last year. A lot of cocoa that they actually did grow wasn't officially exported because it was smuggled across the border. That cocoa will find its way onto the international market one way or another, but it doesn't benefit the producer country's fiscous. And it also distorts our understanding of how much cocoa is out there. And what's happening in Ghana and Ivory Coast is having an impact elsewhere, right? To stimulate in production outside of Africa, right, where farmers get a much larger share of the final price of the product when it's exported. So the imperfect market situation in Africa is just helping the product be grow elsewhere, right? Like in Brazil, like in Ecuador, Colombia, Asia, apparently, exactly. So it takes three years at least to start production. So we're going to see that rebound in production probably along the way to three years, you're going to see a little bit more supplies coming from nontraditional producing countries, right? It's interesting because several years down the line, we may see this deficit, this global deficit erased. We'll get back to a balance between supply and demand. Prices may come down, but I think that the landscape might be very different. You will likely see other countries among the top tier of global producers. In Ecuador, Brazil has tons of land, and yeah, it may be the end of the era for West African cocoa dominance. Cocoa in Latin America is that it's indigenous to Brazil, certainly. So with consumers demanding sustainable cocoa, traceable, all of that. In Brazil, if you plant cocoa, it's not only is it not deforestation, it can actually count as reforestation. Exactly. Marcelo, you recently visited Brazil to look into what's happening in cocoa in Latin America. Yes. Brazil once was the second largest producer in the seventies. They had this rapid spread of this disease, and now Brazil is actually still a net importer of cocoa for its chocolate industry. But of course, with those prices, I was there recently, I talked to some farmers. As May said, some of the expansion currently happening in Brazil is in deforested land, so they are reforesting it with cocoa, which is a native species of the Amazon region. There's even some financing available from organizations that try to stimulate reforestation in Brazil, which is something hard to see, like an increase in farming area paid by companies trying to preserve the forest. That's one aspect of the production. The other one is what they call non-traditional cocoa cultivation, which is cocoa being planted under the sun in a system similar to the annual crops, as soybeans or corn or whatever. Irrigation, fertilization, so it's a new system that promises to deliver much higher yields and pay farmers much better than grains, for example. Some of them told me that they're going to make as double the money producing cocoa than what they're doing currently with soybeans or corn, for example. You have a different kind of model as well for plantations, I think, right? In West Africa, all of the cocoa is produced by smallholder farmers, hundreds and thousands, millions of individual farmers that have a few hectares of land that grow usually cocoa along with a few other crops on the same land. In a lot of Latin America, you have what are essentially bigger, more industrial plantations. Yes, exactly. They have all the mechanization, of course. They are developing new farms. But they told me the only thing that's going to be manual still is the picking of the fruit in the tree. All the rest is going to be mechanized. So they're trying to bring out the modern techniques from grains, for example, to cocoa production. Yeah. Wow. I can see a scenario then where if West Africa continues to struggle combined with the incentive for expansion other places and industrialization that lowers the cost and can rapidly spin up a scale, that there could be a dramatic shift in where the world's cocoa comes from. Yeah. That's what it seems, should they? In Ghana, in Ivory Coast, these are major pillars of the economies there. They are huge generators for an exchange. They are enormous employers. I think that those countries are in for a quite potentially painful transition as they figure out what happens when they're not the leading nations of cocoa. A big thanks to everyone listening to this week's episode. Thanks to May, Joe, Marcelo, and Max for their time and their reporting. You can read all their great work on Reuters.com and the Reuters app. Carmel Crimmins will be back next week. Sound design, music composition, and engineering for Econ World is by the ever-talented Josh Summer. Our podcast team includes Kim Vannell, Gail Issa, Jonah Green, David Spencer, Sharon Reich-Garson, and me, Christopher Walgesper. Our senior producers are Carmel Crimmins and Tara Oaks. Our executive producer is Leela Decretzer. Remember for all your daily news, check out our weekday show Reuters World News. You can catch it on the Reuters app or wherever you listen to podcasts.