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Cocoa Tops $10,000 as Easter Approaches

Mar 28 2024

On Tuesday 26th March, prices for the May contract for New York cocoa futures briefly crossed the $10,000 mark, before settling to $9,622 per tonne at close. Cocoa’s price rally has been relentless, with the May 2024 contract climbing by over 120% since the start of the year, over 170% over the past 6 months and over 250% over the past 12 months. Until this year, the record high price for cocoa of $5,379/t had stood since 1977 but that benchmark has long since been eclipsed by the current rally.

Fundamental Beginnings

The extent of cocoa’s increase appears almost unexplainable, but it is worth recalling the fundamental factors which first drove the market upwards. Global cocoa production is concentrated in West Africa, with Ivory Coast and Ghana being responsible for around two-thirds of the world’s total. The region has suffered from poor weather, from droughts to flooding, and several cocoa pod diseases over the past few years. Cocoa yields in Ivory Coast and Ghana have suffered as a result while demand has remained resilient, a situation which has led the global cocoa supply and demand balance entering a third consecutive year of deficit.

The supply shortfall from West Africa traces its roots back to before the recent years of poor production. Cocoa has more often traded at low prices over the previous decades, creating an environment in which small, independent cocoa farmers in West Africa were unable to invest in improving infrastructure. For example, many cocoa plantations have predominantly old trees, which are more susceptible to disease and typically produce lower yields.

The options for resolving the supply shortfall in the near future are limited, in part due to new legislation targeting deforestation which has been passed by the EU. The regulation, which has also caused tension between the EU and palm oil producers Malaysia and Indonesia since its announcement, mandates that agricultural products must not contribute to deforestation. The law is intended to reduce the environmental impact of mass-market supply chains for commodities such as cocoa and palm oil. While the intentions are worthwhile, it will also reduce the ability of cocoa farmers to expand their plantation in the near-term to increase supply to take advantage of, and subsequently reduce, the current high prices.

Chocolatiers Scramble for Solutions

An inevitable consequence of the cocoa price rally is the cost of chocolate has also increased. Which? recently reported that “easter eggs from popular brands including Maltesers, Lindt and Ferrero Rocher have jumped 50% or more in price since last year” as manufacturers pass through some of their cost increase to consumers. However, the price of chocolate on the shelves now reflects the price rally in 2023 and not the record-breaking levels witnessed so far this year as chocolate manufacturers will typically hedge their purchases ahead by up to 12 months. This means consumers should expect to see even higher costs for Halloween and Christmas chocolate later in the year as the current cocoa prices filter down the supply chain to supermarket shelves.

Chocolate manufacturers are already trying to find alternatives to raising prices. ‘Shrinkflation’, the approach where the price stays constant but the product decreases in size, is among the tools available to major chocolatiers to retain their customer base. Reuters also recently reported how major companies are promoting products which contain less cocoa than traditional Easter eggs. For small, independent chocolatiers the current price rally may prove an insurmountable challenge. The current cocoa market certainly has echoes of the 2022 natural gas crisis which forced many small energy providers out of business.

Cocoa positions 28th march 24

Speculative Positions on NY Cocoa Futures, shown in ChAI

Impact of the Futures Market

While originally grounded in fundamentals, a crucial element in the cocoa bull run has been trading activity in the futures market, both by speculators and physical traders. Speculative long positions on cocoa futures ballooned in the first half of 2023, as shown in the graph above from ChAI, with the total number of positions peaking in the week June 13th. Given the strength of the upward price trend, cocoa unsurprisingly attracted hedge funds and other speculators to its derivatives market and this surge of activity helped propel the price through the $3,000 and $4,000 marks in the second half of last year.

In a recent article covering the success of systematic hedge funds in cocoa trading, Nell Mackenzie noted longevity and consistency of the upward trend has provided a “bonus” for these firms and allowed them to outperform their rivals. As with natural gas in 2022, the returns recorded by hedge funds have attracted criticism from the cocoa industry and been perceived as profiteering from a crisis. The situation underlines the need for manufacturers to implement similar price tracking and forecasting technology - such as ChAI - to the hedge funds to keep ahead of the speculative influence on the market.

ChAI’s graph also shows that since late January, when the steady climb of cocoa prices became the astronomical ascent we have seen since, speculators have actually fled the futures market. The recent price levels will have been too high for many trading firms to continue trading because of their Value at Risk limits and the higher margin calls required to maintain their positions, so only those with deepest pockets will remain. The fall in open interest increases the price influence of the players still at the table, which has been a key reason for the historic volatility over the past two months.

Furthermore, as Javier Blas noted in his explainer of the cocoa rally for Bloomberg, many cocoa traders face a misalignment between their financial hedges and physical contracts due to the lack of available cocoa beans. This forces them to buy back their hedged positions at higher prices, which further drives up the market. Blas succinctly summarised this self-sustaining problem: “the higher cocoa prices rise, the bigger the margins calls and the scale of over hedging. And as some traders buy back their positions, they push prices up further, creating the same problem for others”.

How much higher cocoa prices will climb remains to be seen. One certainty is that there will need to be significant demand destruction to enable the price to fall back to a historically normal level. Once more, the natural gas crisis of 2022 could provide insights on this matter. European gas prices now stand at less than 10% of the peak price recorded in August 2022, but the continent is still recovering from the industrial recession that enabled this downturn, with many businesses and production facilities having been lost along the way. Energy is, of course, far more ubiquitous than cocoa and the impact of its rally will not have the far reaching effect of the gas crisis, but for those in the cocoa industry the current rally will be extremely challenging. A couple of years ago, the idea that cocoa would cost more than copper would have been laughable. No one is laughing now. 

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