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What happened? 

Cocoa prices have dropped from their record highs seen only a few weeks ago. Cocoa futures have also dropped 30%, a significant drop from the all-time highs they were experiencing only a few weeks ago. The surge was driven by a buying frenzy after factors such as poor weather weighed in on the likelihood that there could be a shortage of cocoa supplies. 

The drop comes after commodities traders have exited their long futures positions. 

More on this story: 

To understand this story a little better, we need to take a trip back a few weeks ago, when cocoa prices surged. Cocoa prices briefly increased to never before seen prices of over $10,000 per ton. During this period, the crop increased by 19.8%. In the past year alone, cocoa prices have jumped about 231%. 

Cocoa prices have been steadily rising over the past few months due to worse than anticipated crop harvest from West African nations, including Nigeria and Cameroon. El Nino, which is a weather phenomenon, caused heavy rainfall in December 2023, leading to the spread of black pod disease among the crop. Furthermore, the continuation of El Nino as well as the effects of climate change led to extreme heat, which further disrupted harvests. Such factors have led to a tightening of global cocoa supplies, and hence, increased prices for the popular commodity. 

Cocoa: A quick glance 

What is Cocoa used for? This is a popular commodity widely used in a number of chocolate products and confectioneries. It is also used for cosmetics, fragrances, health supplements and much more. 

How long does it take for a cocoa tree to yield crops? Around 3-5 years 

What countries import the most cocoa? Ivory Coast is the world’s largest producer of cocoa, followed by Ghana, Nigeria and Cameroon. 

What is the market size for the chocolate industry? In 2022, the global chocolate market size was $115.8 billion. 

Could surges in Cocoa prices happen again? Yes. Surges in any commodity, be it oil or wheat, is always bound to happen. Prices experience their highs and their lows, so we should keep this in the back of our minds. This question makes me think of the economic cycle theory 

Futures: A quick glance 

What are futures? According to this website, “futures are contracts to buy or sell a specific underlying asset at a future date. The underlying asset can be a commodity, a security, or other financial instrument. Such contracts allows a buyer to essentially speculate on a commodity’s price.  

Why are they used? One reason they’re used is to diversify a person or a financial institution's portfolio. Due to how they work, they aid in having accurate prices ensures market transparency and enhances liquidity. 

How do futures work? According to this website, “futures contracts are standardised by quantity, quality, and asset delivery, making trading them on futures exchanges possible.” If the price of the underlying asset goes up, the value of the futures contract will also go up- the same process works when the price of the underlying asset decreases. 

Are they a safe form of investment? It depends on who you’re asking. An important feature of futures contracts, is that they are based on prediction. An individual with limited knowledge may predict that the price of an underlying asset will go up by a certain day and time, and the opposite may happen. Futures contracts become somewhat easier to navigate if a professional is behind it. 

What types of futures exist? A wide range are available right now. For example, currency futures, commodity, cryptocurrency, interest rate futures, equities futures and many more. 

What factors have caused this? 

• A shortage of fertiliser. Applying fertilisers is a method farmers use to maintain a soil’s fertility through maintaining soil acidity and replenishing nutrient stocks. This leads to an increased level of cocoa production, which means more can be imported to various countries and sold to consumers and companies. The price of fertilisers has increased throughout the months, meaning many farmers are unable to afford it. A shortage of fertilisers leads to supply shortages of cocoa. This isn’t something companies and chocolate lovers want to hear. 

• Poor weather and crop disease. As I briefly stated above, El Nino, a weather phenomenon that causes rain, has impacted the cocoa trees in the region. Dr Andrew Daymond of the University of Reading stated, “The El Nino event of the past year has meant that the rainy season in west Africa has been wetter than usual, which likely contributed to greater losses of cocoa pods...” Alongside El Nino, has been the effect of climate change. Dr Daymond went on to say, “However, with more frequent extreme weather events, there is likely to be greater year-to-year fluctuations in cocoa farm yields.” Moreover, such weather conditions mean the likelihood of disease continues, which will lead to more disruption for crop yields. The effects of climate change is something that is becoming more and more prevalent in our lives and society. With this, it adds to the uncertainty of whether or not the shortfall in cocoa production will continue in the short, medium and long term. 

• The EU’s new regulation. The European Union introduced the EU Deforestation Regulation in June 2023. In a nutshell, the new rules, “guarantee that the products EU citizens consume do not contribute to deforestation or forest degradation worldwide.” The new rules can further impact the supply and production of cocoa beans, especially because illegal mining is on the rise. It also adds more time to the production of cocoa, as companies trading in cocoa, rubber, cattle, soya, wood (as well as products derived from these commodities) have to now carry out time-consuming and extensive due diligence to ensure they’re being compliant. 

• Underinvestment in cocoa farms. Crops are largely cultivated by independent and smallholder farmers. Many of them struggle to make a living, and this has a knock-on-effect on them being unable to reinvest back into their land to buy say, better equipment, hire more workers or purchase fertilisers. This lack of nurture can lead to lower yields of cocoa production in the future. Maintenance of the land is needed and many are unable to do just that. Will this change? I hope so. In my opinion, paying farmers higher prices for their cocoa is one way that can lead to lower prices for cocoa beans and chocolate in general. 

What implications could this have? 

For the cocoa market: The price decreases are being welcomed with open arms by many. It could mean that production lines that had to close their doors, can reopen them once again, however this isn't certain. One reason for this, is that cocoa prices will rise again, just like with any other commodity. One way to mitigate this however, is for such farmers and people involved in the manufacturing process to prepare for such happenings. They could do this by planting more cocoa trees, but of course, there are risks to this, such as further poor weather conditions occurring for example. 

For chocolate companies: The price hikes were mainly affecting cocoa manufacturers. However, this isn’t to say that the price hikes weren’t passed down to consumers. For example, during the easter period this year, the price of easter eggs soared. The higher prices for cocoa has resulted in price hikes for some chocolate brands and has lead to ‘shrinkflation’ to many of their products. Less product for higher prices? This isn't something that consumers want to experience, but this is just one way companies are trying to weather the cocoa storm. 

For commodities traders: Even though the price of cocoa futures have dropped, a high level of uncertainty still exists, and for good reason. With such futures, it will become harder and harder to predict the price of cocoa in the future, which means the level of risk for such commodities traders will inevitably go up. 

For the Ivory Coast, Ghana and other cocoa-producing nations: These handful of west African nations contributes to around 80% of the world’s cocoa output. The government in Ivory Coast is encouraging farmers to hand over their cocoa beans for processing, rather than stockpiling them in the potential likelihood that prices will increase again in the future. Doing so enables the flow of production to continue, at least in this moment in time.  

Governments can take more measures to encourage such farmers to rake up their production, by providing incentives, such as increased pay to them. 

What could the future hold? 

• Increased diversification. This story has highlighted just how many parties are reliant on just a few west African nations for the popular commodity. If production and supply fumble, then it will affect a large proportion of the market, on a national, regional and international level. Other countries can see this as an opportunity to increase their production, in the hopes of attracting potentially new buyers when things get tough. Diversification of producers within the cocoa market is needed, I believe it’ll happen, it’s just a matter of time. 

• The future of the cocoa market is uncertain. Recent happenings aren’t new, and it is bound to occur again. How can players involved hedge the impact of this? At the heart of the cocoa production, is the cultivation of cocoa beans and pods itself. Without this, the cocoa market practically wouldn't exist and thrive. There are also concerns that producers may not have enough cocoa to fulfil contracts. This may pose issues in the future and can even lead to the annulment of them.  

Closing thoughts: 

I think that we will continue to see shrinkflation from chocolate companies. The higher prices seem to be benefitting them (financially), especially in a time of higher interest rates and inflation. The hikes don’t seem to be having too much of a negative effect on consumers, so these two strong reasons may mean companies will continue to adopt this practice. For chocolate-lovers (like me), this will be unfortunate, but I don’t think it’ll stop me from buying chocolate in the long-term. 

It may be weird to say, but will artificial chocolate become a thing in the future? Am I thinking a bit too broadly? What are your thoughts on the story? Will cocoa futures shoot back up soon, or should we wait a bit longer for this to occur? 

That’s it for this week!

Until next time, remember to stay curious! 

Further resources: 

‘Cocoa prices rise to fresh records: Will we run out of chocolate?’ - Article by EuroNews Business 

‘What is Futures Trading?’- Article by Investopedia 

‘Easter egg prices soar as cocoa crops are hit by climate crisis and exploitation’- Article by The Guardian 

‘10 key things to know about the new EU Deforestation Regulation’- Article by White and Case 

‘Will rising cocoa prices trigger a chocolate crisis?’- Article by J.P.Morgan 

DISCLAIMER: 

This blog is for informational purposes only. Parah Insights is not associated with the news sources in this blog, and sharing does not equal endorsement. Parah Insights does not provide financial, tax, legal or accounting advice – always consult your financial and legal advisors to determine what’s right for you and your business.