Rally is driven by uncertainty over a plan designed to aid farmers in Ghana and Ivory Coast
By Joe Wallace
Cocoa prices are surging as traders grapple with a new method for pricing exports designed to alleviate poverty among farmers in Ivory Coast and Ghana, the world’s largest growers of the chocolate ingredient.
At a time when weakness in the world economy is hurting assets such as oil and industrial metals, cocoa has been one of the top performers in commodities markets. Futures prices have climbed 18% to £1,912 ($2,335) a ton in London since Aug. 29, and have risen 10% to $2,408 a ton in New York. Prices were even higher in both markets before slipping back in recent days.
Uncertainty about the new way of pricing West African cocoa exports, designed to improve living conditions for farmers, is driving the rally. According to the World Bank, 80% of cocoa producers, or four million people and their families, live on less than $3 a day.
In July, Ivory Coast and Ghana said they would introduce a “living income differential” of $400 a ton, to be charged on top of the London futures price. The neighboring nations have the ability to swing prices because they grow around 60% of the world’s cocoa. Both their harvests dwarf those of Ecuador and Nigeria, the next-largest producers.
When physical cocoa prices, including freight costs, exceed $2,900 a ton over the course of a season, the premium will be funneled into rainy-day funds for farmers.
Traders say the derivatives market is having difficulty adjusting to the shake-up. Buyers and sellers of cocoa beans typically use futures and options to hedge against moves in prices, while investors use them to bet on whether the market will rise or fall.
“If you look at the fundamentals, by which I mean simple supply and demand, there’s no big story at all,” said Jonathan Parkman, co-head of agriculture at brokerage Marex Spectron. “The difficulty that pretty much every cocoa professional is having is how exactly to interpret the effect of the [living income differential], the new pricing system.”
The premium applies to next year’s cocoa crop, which the two countries will start to ship from October 2020. However, it has already been used in export contracts because large Western chocolate companies have locked in purchases well in advance of receiving their cocoa.
One factor pushing futures prices higher: Companies that normally buy cocoa directly from West Africa appear to have been buying beans from exchange stores instead. The Ports of Delaware River and New York, where futures traders can hold cocoa in Intercontinental Exchange warehouses, housed 243,512 bags of Ivorian cocoa Monday. These stockpiles have depleted by 44% since the end of August, a steep decline in what is normally a source of last resort.
“It’s a different negotiation every time someone wants to buy cocoa from West Africa,” said Carlos Mera, an analyst at Rabobank.
This uncertainty has emerged since the price-relief system was introduced and “creates a huge amount of risk that is not hedgeable,“ he added. ”The market is scrambling for every good quality bean outside West Africa.”
Prices would be even higher if not for abundant cocoa bean supplies. Producing countries grew 4.85 million tons in the 2018-19 season, according to the International Cocoa Organization, the biggest crop on records dating back to 1960.
Improving rainfall in the Ivory Coast and Ghana has eased worries that the 2019-20 harvest would be hit by dry weather. In Ghana, the spread of swollen-shoot virus in cocoa trees is considered a slow-burn concern rather than an immediate threat to production.
In the long run, economists say the pricing system could encourage farmers to grow more beans, pulling prices down instead of pushing them up.
“The pricing mechanism itself could also motivate farmers, including in other countries, to raise their production as they will benefit from higher prices,” said Jacques Morisset, who was the World Bank’s chief economist in Ivory Coast until July. “Unfortunately, if it happens, such an increase in the global supply of cocoa would eventually push international prices downward and put pressure on the mechanism.”
For now, investors are wagering that prices have further to run. In London, hedge funds and other speculative investors last week held 45,244 more futures and options contracts betting that prices will rise than contracts betting they will fall, according to Intercontinental Exchange.