In today’s Finshots, we tell you why cocoa prices are hitting record highs.

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The Story

People are calling cocoa the new Bitcoin.

Not because cocoa is becoming tech-savvy or decentralised or any such thing. It’s simply because of how its prices have shot up. At the start of this year, cocoa was trading at $3000 a ton. Cut to today, and it’s hit a record high of $10,000 a ton.

In just 3 months!!!

Now I know what you might be wondering — will our favourite chocolate get more expensive?

But before we answer that, we need to address what’s on earth is happening.

Now the first thing you must know is that cocoa production is extremely concentrated. Globally, the world produces 6.5 million tonnes of cocoa. But just two countries in West Africa — Côte d’Ivoire (Ivory Coast) and Ghana make up over half of the production.

And this sort of extreme concentration means if anything goes wrong in West Africa, it affects the world’s chocolate.

Today, it’s the weather causing havoc. It’s a culprit known as El Nino.

Just think of this as a situation where the winds don’t blow the way they’re supposed to. And this creates a problem. West Africa first experienced heavy rains in December due to El Nino. And the extra moisture led to diseased crops. And then, the region failed to get rain when it needed and things became too dry. The harvest suffered again.

The end result?

We now face the largest deficit of cocoa supply in more than 60 years

And that’s probably compounded by two other factors too.

For one, soil fertility is declining in West Africa. So farmers are rethinking their cocoa production efforts. Some of them are already setting aside part of their farmland for rubber and other crops.

In other cases, many cocoa trees are already past their maximum yield potential. There hasn’t been a major round of replanting in over two decades. So the old trees aren’t able to deliver as much.

And that put upward pressure on cocoa prices.

But that’s where the fundamentals end. And then, the financials take over.

Yup, there’s more. Because you have the wolves of Wall Street* in the mix too.

See, many funds have decided that the best way to make money is to jump onto the cocoa bandwagon. So they’re lapping up financial contracts — which we’ll explain about in a bit — related to this hot commodity.

And this sort of speculative demand is pushing prices even higher. In fact, the Financial Times says that such speculative trades in cocoa are now worth $8.7 billion at least. And it’s the highest ever in dollar terms on record.

But that’s not the end of this.

If that were true, this wouldn’t be the first time these investment funds have orchestrated such a price rise. In 2010, Anthony Ward, who ran a London-based fund Armajaro, cornered the European cocoa market and pushed prices higher. The trade even earned him the nickname “Chocfinger.

So yeah, it looks like there might be a few Anthony Wards operating in the cocoa market right now.

And that means, the $10,000 a ton price we mentioned at the start is not really the price that farmers are selling at the ground level. It’s just the financial markets being silly.

Now the only question that remains is what we asked right at the start — will chocolate get more expensive?

Well, some reports say that the manufacturers are already bumping up the prices of chocolate. Or if they aren’t, they’re resorting to the sneaky practice of shrinkflation. You know, when they reduce the size of the chocolate but keep the prices the same. So you get less bang for your buck.

And that might be true for many smaller chocolate makers.

But the big ones such as Hershey’s and Lindt might have had a trick up their sleeve.

See, these folks need a lot of cocoa to produce their truckloads of chocolate. So they have to forecast their demand well in advance. They can’t be running from pillar to post at the last moment trying to source cocoa, no? Now these folks know that cocoa prices can be quite volatile. So the first thing they do is try and protect themselves against the adverse event of cocoa prices rising when they need the beans.

How do they do this, you ask?

Well, they enter into an agreement with a counterparty — someone who owns rights to a lot of raw cocoa beans. They tell the cocoa farmers that they’ll pay $3500 for 1 tonne today. And the farmer has to deliver this 1 tonne in six months.

The chocolate maker does this because they fear prices will be higher then. And the farmer agrees because he’s worried it will be lower.

So both of them shake hands on the deal and call it a “cocoa forward”.

Now imagine a stock exchange-like entity that can help connect sellers and buyers for such commodity trades. The contract is standardized. There will be rules on the minimum quantity of cocoa that can be traded per contract. There will be certain fees to be paid in case one person backs out of the contract. Stuff like that. And this is called a “Futures contract”.

And that’s how some of the big chocolate makers have already hedged against these prices. During a February earnings call, Hershey’s CFO claimed the company had locked in its costs for a year. And even Lindt had said it had felt prices would get more expensive and had ‘bought’ cocoa much in advance.

But if the prices remain elevated for long, it won’t matter. And our sweet treats will get more dearer.

Until then…

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PS: Typically, cacao refers to the raw material or the beans from the tree. And cocoa is the roasted powder. We have used the term cocoa throughout this story for ease of understanding.

*There’s also noise about some hedged trades going wrong. And if you want to get a sense of what might be happening on that front that’s pushing the prices of cocoa futures even higher, you should read this story in Bloomberg.

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