Andreas Anastasiadis
April 3, 2024
Surging cocoa prices are the talk of the town among traders trying to decipher how cocoa futures exceed $10,000 per metric ton, hitting an all-time high with a +143% YTD return. The explanations vary, but fundamentals prevail amid a combination of supply shortage and speculation, which could explain this tremendous increase in a plain vanilla way.
To begin with, this surge is primarily driven by a record supply shortfall, with the global cocoa market expected to face its third consecutive year of deficits (2022, 2023, 2024) after four years of surplus during the period 2017-2021. The International Cocoa Organization (ICC) forecasts a shortage of supply by 374,000 tons in 2024, while major chocolate manufacturer Barry Callebaut AG anticipates an imbalance of around 500,000 tons, equivalent to roughly one-tenth of the global market.
Unlike most globally traded crops, cocoa is predominantly produced by small-scale farmers, particularly in West Africa which has been the dominant region in the cocoa trade for decades. Ivory Coast and Ghana are projected to supply 53% of the world’s cocoa in the current season, although this share was even higher in previous years before current crop issues arose. The key elements that have caused production to decrease are excessive rain and severe droughts which have intensified beyond typical levels, leading to the spread of diseases such as black pod disease and swollen-shoot virus that causes pod decay and tree mortality, compounded by an aging tree stock. Besides environmental drivers, the inadequate compensation that small-scale farmers in Ivory Coast and Ghana have historically faced (due to the government’s decision to determine prices before each new growing season) has hindered farmers’ capacity to invest in enhancements and disease prevention, thereby restricting cocoa yield potential from their trees.
The surge in cocoa prices has also been supported by the fact that traders who are hedged against a fall in prices cannot sufficiently meet the margin calls stemming from losses on their futures positions. The typical hedge works well when prices are rising, with losses on the short positions covered by gains on the value of the physical holdings. Normally, trading firms utilize their cash reserves or opt to borrow to address margin calls. However, during an extended market upswing like the current cocoa market, margin calls can surpass the financial capacity of otherwise healthy companies, compelling them to unwind their hedges to prevent cash depletion. In such circumstances, the sole recourse is to liquidate short positions by repurchasing futures at market prices. This sets off a cyclical issue: escalating cocoa prices trigger higher margin calls, prompting traders to close their positions by purchasing futures, thereby driving prices even higher and perpetuating the problem for others. This is somewhat reminiscent of GameStop’s short squeeze in January 2021, which caused major financial consequences for certain hedge funds and large losses for short sellers.