The World Price of Cocoa

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The World Price of Cocoa

• Pamela Thornton

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Most Popular Questions

• Why is the price I am offered for my cocoa so
  much lower than the price I read about in the
  newspapers and hear of on the radio?
• Implication It is a conspiracy I am being
  cheated and it is the traders/manufacturers who
  are making all the money

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• Why is the price of cocoa moving as the result of
  speculators in London and NY? What do they have
  to with the crops and the physical supply?
• Implication They have no right interfering with
  my livelihood

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Benchmark prices

• London Liffe cocoa
• New York Board of Trade
• ICCO daily price average of first 3 months on
  both markets available in and SDR
• CMAA published daily physical cocoa prices

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Percentage of World Price

• Most cocoa farmers are now subject to free
  competition and moving world prices Ghana
  exception
• The general quality of the cocoa is the single
  biggest determinant of its value eg Venezuela
• Costs of transporting cocoa and associated import
  charges are also a major determinant eg Papua New
  Guinea
• Taxation can be important element -CDI

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Comparison of Farmer Prices 05/06

• Ghana
• Farmer price established by government
• Accomplish this by selling of the crop forward
• Estimate world prices and currency
• 2005/06 estimated farmer would get
  1053/mt.Actual about 990/mt

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• Internal costs in Ghana about 200-220/mt
  including margin for LBCs
• Cocobod costs 165/mt
• Costs from FOB to Ex Whse USA 207/mt
• Ivory Coast
• Free market internally
• Indicative price only
• Approx derived farmer price of 700-720/mt
• High level of taxation - 600/mt

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• Internal costs about 240/mt
• Costs of Fob to Ex Whse USA 200/mt
• Indonesia
• Free and efficient internal market costing
  approx 110/mt to get cocoa to port
• Minimal taxation - 6/mt
• External costs FOB to ExWhse 235/mt
• Derived farmer price approx 1150/mt

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Which farmer does best?

• Despite his poorer quality the Indonesian
  farmer benefits from a higher world price than
  his fellow farmer in Ivory Coast and Ghana
• The Ghana farmer does relatively well versus his
  neighbour (990 v 700)in a stable price
  environment but the gap narrows when the market
  is strong and vice versa.

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• While geographic proximity to markets, taxation
  and the efficiency of the cocoa sector all play
  important roles, the price that most farmers get
  is essentially determined by underlying global
  supply and demand
• Cocoa prices have been stable over the last few
  years but there is a delicate balance which needs
  to be appreciated before we plan to boost global
  production

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Historic Prices

• In the mid 1970s after poor crops in West Africa
  and in the midst of a global commodity boom NY
  cocoa prices reached 4800/mt and London 3410
  pounds
• They re-traced and then hovered around 1200/800
  pounds until dry weather caused a strong rally in
  1985.Prices rebounded to 2800/2250 pounds.
• The extreme drought in Mali/Burkina led to a huge
  influx of immigrants into Ivory Coast, many of
  whom planted cocoa.

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• Ivory production grew from 400k in 1980/81 to
  580k(85/86) to 804k(90/91) before plateauing at
  1200k (95/96).
• The expansion in production was not matched by a
  similar growth in grind. Cocoa experienced 7
  years of surplus and prices fell to 785/520
  pounds in 1992.
• Prices recovered as Brazil and Malaysian
  production declined enough to offset African
  growth

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• Further expansion especially in Ghana where the
  crop grew from 300k in 1990/91 to 400k in 95/95
  and 620k by 03/04 eventually undermined prices
  and in 2000 we again reached 700/520 pounds.
  Political unrest in CDI prompted a recovery.
• Since then, against a background of balanced
  supply and demand we have hovered between
  1400-1600 in NY and 800-1000 pounds in London

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• Prices are underpinned by the political
  uncertainty in CDI
• But we have enormous global stocks of 1.5 mil
  tons
• Expansion of grind is limited. Cocoa is a mature
  market. Consumption is growing at a steady 2-2.5
  pa rate
• Significant increases in yield caused by
  improvements in husbandry or rehabilitation and
  the potential introduction of new cocoa areas
  must be carefully balanced against the prospects
  for growth in demand

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Base Grades v Fine Grades

• Demand for fine grade cocoas for use in dark
  chocolate production is growing
• Dark sector 5-10 total chocolate
• varies according to region/tradition
• 30 in former Eastern Bloc
• 10-15 Continental Europe
• 4-8 in US and UK

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• If we assume 10 of a total annual demand of 3.5
  mil tons we need 300-350kmt flavour grades
• Reason why Venezuelan/Ecuadorian beans have
  de-coupled from world market which represents
  base grades
• Prices 400 to 4000 over NY and London prices
• Production of all fine grades
• Balance the best West African

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• Offers opportunities to niche producers who take
  particular care of quality
• Requires marketing along coffee lines to expand
  interest in these finer grades
• Even large producers should consider entering the
  quality market eg Indonesia with Irian Jaya,
  Sumatra, Moluccas island beans

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The Role of the Futures Exchanges

• Futures play a vital role in enabling origins to
  sell when the price is high
• And end-users to buy when the price is low
• They do this by attracting a wide range of
  participants who then provide liquidity to the
  cocoa market as a whole
• They are highly transparent markets open to
  anybody who meets the capital requirements

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• By exchange traded we mean that Buyers and
  Sellers freely exchange contracts which conform
  to a set of fixed rules
• Although they evolved from, they are no longer,
  venues for the auction of the physical commodity
  itself
• They represent a forward financial commitment to
  deliver cocoa

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• Using the futures markets enables contract
  parties to hedge the risk of a price movement
• Hedge means Offset or Limit or Lock-in
• You hedge when you are effectively content with
  the current price
• When you hedge with futures you give up the
  opportunity to make more money tomorrow than
  today
• But you also protect against the market prices
  deteriorating

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Properties of a cocoa futures contract

• A) Quantity 10 met tons
• B) Quality depends on contract
• C) Location designated warehouses in specific
  ports
• D) Time frame exact delivery schedule

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NY Criteria

• Each lot needs to be
• Single warehouse location
• Approved exchange port zone
• New York
• Delaware River
• Hampton Roads
• Licensed by NYBOT

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Criteria (contd)

• Each lot must also be
• Marked and separated
• Single Origin and Description
• 6 chop maximum
• Original Bags
• 10 MT /- 1
• Bags of typical weight for specific crop
• Exempt of external condition to the bags
• Received US FDA approval

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Criteria (contd)

• The cocoa within the bags should be
• Of sound condition
• Dry with no hammy or smoky flavor
• US FDA approved with respect to quality
• Max 4 mold
• Max 4 insect
• Damage/combined max 6
• Under 140 beans/100 grams (as of July 2004)

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Criteria (contd)

• Assuming compliance to this point
• Any origin of cocoa can be tendered
• Fermented and Unfermented cocoa is acceptable
• Growths and description are tendered at specific
  premiums or par as indicated below
• Group A (160 Premium)
• Group B (80 Premium)
• Group C (Par)

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Criteria (contd)

• Group A notables
• Ivory Coast Main
• Ghana Main
• Nigeria Main
• Group B notables
• Arriba
• Ivory Coast Mid
• Ghana Light
• Group C notables
• Sulawesi
• Other

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Buyers criteria for buying

• Do I need it? Do I owe it?
• If not what is a fair price to pay?
• What are my costs?
• What is my break-even price?

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Cost of bringing cocoa to delivery

• Origin seller normally sells FOB
• A Transit costs (FOB to CIF)
• Freight
• Financing to point of delivery
• Maritime insurance
• Weight loss

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• B Delivery Costs (CIF to Ex WHSE)
• Customs and harbor user fees
• Fumigation
• Transit into store
• Weighing of cocoa
• Storage
• Warehouse insurance
• Futures commission

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• C Tendering costs(ExWhse-NYBOT)
• Tiering into exchange lots
• Detailed weighing
• Sampling
• Grading costs
• Extra Storage costs
• Extra commission
• Penalties of Rejection

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Costs - Indonesian cocoa to US

• Freight 150
• Financing 13
• Insurance 10
• Weight loss 26
• Import costs 3
• Fumigation 6
• Transit 12
• Weighing 6
• Storage 6
• Insurance 1
• Commissions 1.50
• TOTAL 235

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Extra costs for Exchange Delivery

• Tiering 3
• Weighing 2
• Sampling 4.50
• Grading 4.50
• Storage 3.50
• 90 pass rate 2/mt
• EXTRA COSTS 19.50

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INDONESIA TO USA

• Delivery Costs to Industry 235
• NYBOT Delivery Costs 254.50

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NYBOT BREAKEVEN PRICE

• NYBOT value Dec 1st 1600
• Costs to NYBOT - 254
• BREAKEVEN OR FOB PRICE WE CAN PAY EXPORTERS
  1346

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• Indonesian cocoa tenders at par
• No discount no premium provided bean count at
  120/100g or below
• 130 bean count 20 discount
• 140 bean count 72 discount

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BREAKEVEN PRICE TO INDUSTRY

• NYBOT value Dec 1st 1600
• Possible Sale to Industry
• at level NYBOT 1600
• BREAKEVEN OR FOB PRICE WE CAN PAY EXPORTERS
  1600-235 costs 1365

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Anatomy of a typical trade

• Price in NY is 1600
• High
• Indonesian Origin supplier wants to sell
• Can he find a physical buyer?
• What price can he get?
• What are the mechanics of the trade?

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Day 1 Hedging beans

• Assumption Market at 1600
• Buyer sells Dec NY futures at 1600
• Buys physical Indo FOB at 1350
• Equals FOB differential of - 250
• Or after costs of 235
• EX WHSE differential of - 15

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2 weeks later

• Buyer makes unfixed sale to end user at NY 20
• This results in a theoretical profit of 35/mt
• (Purchase price NY - 15
• versus
• Sale NY 20)

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One month later

• Assumption Market 1750
• Incurs loss on futures
• 1600 -1750 150
• Has to pay margins equal to loss daily
• Accrues gain on value of unfixed physical sale
• 1770 - 1585 185
• Only books gain when makes delivery
• 35/mt profit intact

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Two months later

• Assumption Market 1480
• End user fixes price at 1500(market price
  148020 differential)
• Accrues gain on futures
• 1600 -1480 120
• Gets paid margins equal to daily gain
• Incurs loss on physical sale
• 1500 - 1585 85
• Only absorbs loss when makes delivery
• 35/mt profit still intact

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Sale of last resort

• If he was unable to make a sale to industry and
  had to deliver to NYBOT
• Purchase price _at_ NYBOT DEC- 250 Costs to deliver
  254
• Total cost NYBOT DEC 4
• Tender Parity LEVEL DEC
• Loss on delivery 4/mt

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• Even if he had not made the sale to industry
  Buyer, because he bought at an outright price,
  would have hedged purchase or run risk of heavy
  losses or windfall gains
• Purchase price 1350 when market trading 1600
• If market climbs to 1700 gains 100
• If market falls to 1450 loses 150

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• To function well as a market we have to attract
  participants from different areas with different
  motives for trading. If we all have the same
  interest there will be no buyers when we want to
  sell and vice versa

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Origin Motives

• Crop yields profit over production cost
• Crop pressure to sell nowhere to store cocoa
  quality deteriorating bills to pay no ability
  to finance stock

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Industry Motives

• Prices are low enough to protect or enhance
  existing profit margins
• Risk of future volatility in price as result of
  supply and demand imbalance caused by climatic
  conditions political upheaval aging tree stock
  and stock changes

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Other Players Motives

• Biggest single source of activity in NYBOT market
  is the soft floor traders who contribute 40 of
  daily volume. They seek short-term profits by
  constantly buying and selling throughout the day.
• Trade specialists seeking to capture moves
  between market components Arbitrage trade
  london against ny
• Switch trade calendar month positions

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Speculators Motives

• Capital gain by
• Capturing a directional move either up or down
  based on expectations of changes in supply/demand
  caused by weather, politics, consumer patterns,
  stock changes
• Price change caused by the cost of freight
  (energy)
• Movement caused by currency fluctuations
• As part of an investment hedge against bond and
  stock performance
• As a component of a commodity portfolio

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Need for Liquidity

• We need the involvement of a wide range of market
  players to give us the liquidity we need
• They enable the market to work more efficiently
  and offer us all more opportunities

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• While speculative excitement and pressure can
  distort prices in the short-term over time the
  basic fundamentals of supply and demand re-assert
  themselves
• We see this situation currently as prices have
  been stable but unexciting these last 2 years
  reflecting our balanced SD situation despite a
  generally buoyant commodity sector

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Questions