July 28, 2014    7 minute read

Cocoa: An Insight

   July 28, 2014    7 minute read

Cocoa: An Insight

When Cocoa was founded by Spanish explorer Hernán Cortes on the land of Mexico in the 1500’s, he would have not have expected the commodity to grow into a $80 billion market, that employs over 6 million people, 500 years later. Today, 4 million tonnes of cocoa beans are produced every year globally and consumed by the public.

 Fundamentals 

 Cocoa is grown on trees, where, upon maturing at full harvest, farmers pull cocoa pods off the trees and cut them open to collect the beans. This process is carried out once every six months to coincide with the mid/main crop periods where cocoa is primarily procured.

Farmers who grow the cocoa receive a farm gate price from cocoa suppliers who buy the cocoa. These prices are usually at marketplace level, influenced by cocoa futures listed in London and New York.  

 

When it is taken from the trees, cocoa is transported by sea across the globe to manufacturers. Here, it can be manufactured into any of three cocoa products; powder, liquor and cake through the process of roasting, grinding or pressing the beans. Thereafter, these semi-finished products are then sold on again to end buyers, usually represented by the large chocolate makers such as Nestle, Mars and Mondelez. These chocolate makers are the companies who put the product on the wholesale market for the public in the form of familiar favourites such as ‘Milka’, ‘Snickers’ and ‘Twix’ to name a few.

Unfortunately, in the last three years the cocoa market has faced a structural supply deficit caused in part by weather problems, increased demand outweighing supply, domestic political trouble, as well as issues with farmer land and financial difficulties.

The Market

 Africa leads the way in cocoa bean production, with 70% of the worldwide 4mn tonnes supplied directly from this continent. Three countries with a large share in this monopolistic dominance are Ghana, Ivory Coast and Nigeria who together account for a staggering 90% of this figure. After the cocoa is transported from the origins, it is roasted and ground into cocoa liquor and cake. The amount of liquor and cake produced is an accurate indicator for the demand of the commodity as it represents the total quantity of orders the chocolate makers are trying to fulfill in the market. 

 In Q2 2014, grind figures in Europe have fallen 0.7% year-on-year, a figure that caused futures prices to shift lower initially. This lower demand for cocoa seems to have been insinuated by increasing prices and a lack of economic growth in mature markets in Europe.

On the other hand, overall the number of tonnes that is purchased from the end buyer, the chocolate makers, by the public, represents consumption. This is essentially the sale of chocolate bars (cocoa liquor and butter) and powder (cocoa cake) in the market.  This number has been steadily rising over the last three to four years, as emerging economies’ consumption rises. The market share of these countries has risen by 19% in last 3 years alone and emerging economies, including the BRICS, now account for 23% of total cocoa consumption worldwide. 

 

However, the largest consumption figures exist in the USA, where 1.73 million tonnes of cocoa was consumed in 2012. This figure represents 24% of the total market share in consumption, largely outweighing the second largest consumer, Russia, which stands at 12%.  Thus, it is apparent that the cocoa market is concentrated in mature markets, where customers feel cocoa is less of a treat and more of an everyday habit. However, the trend is changing with emerging markets increasing demand. In China alone, cocoa consumption has grown 50% every year for the past three years to 2013, yet still customers only eat 200g of cocoa per capita. In contrast to Western Europe, where the average person eats 4 kg of cocoa a year.

 Moving Forward

 So, as Chinese consumers start treating cocoa as more of an everyday ritual rather than an infrequent family treat we will see the cocoa market change. This is especially important, as the current structural deficit in supply will struggle to keep up with growing demand of emerging nations and as a result cause prices to increase.  Early sings of this are visible in the cocoa futures market, where in the last 4 weeks Cocoa futures have reached lows of £1900 (Wednesday 10th July) on the London Liffe Exchange before rebounding to £1990 (Thursday 24th July), a £90 pound swing. 

If prices continue to rise at this rate, the direct costs from the supply chain, that includes procuring the products and carrying it (the costs related to warehousing, shipping and the effect of interest rates) will be passed on to consumers and create a depressed demand. 

 

 

 Oil, Natural Gas, Coffee and Corn face similar fates in the same scenario, but the difference is, if Cocoa as a plant went extinct today, there would be no direct life threatening consequences. On the contrary, a mass deficit in a commodity such as corn or oil could cause a worldwide famine or energy deficit, as many foods and services  are dependent on them.

 In conclusion, it is evident that the future of cocoa is very much dependent on the way demand pans out in emerging nations, a prospect it has in common with other commodities in the market. Although, if the market price does spiral out of control in the coming years, there certainly won’t be a huge rush from governments to deflate the bubble because the situation, in perspective, may not be their biggest priority.

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