Photographer: Jose Cendon/Bloomberg

Cocoa Slump Testing Top Producer Is Deja Vu for 80s Traders

Updated on
  • Slide in futures may force Ivory Coast to cut farmer payments
  • Country reduced prices for growers by half after drop in ’80s

Slumping cocoa prices are testing to the limit top producer Ivory Coast’s efforts to ensure stability for farmers, heightening risks for the domestic economy and world markets.

Authorities have warned they’ll have to cut payments to growers. That follows a wave of defaults by local exporters who’d bet on higher prices, costing the government more than $300 million and pushing cocoa futures even lower.

The more than 30 percent drop in London benchmark prices from a six-year high in July has parallels with a 1980s crisis that saw farmers’ payments shrink by half and bankrupted the marketing system. Like then, they’ll see sharp cuts, with a reduction for the smaller of two annual harvests starting next month from the current 1,100 CFA francs ($1.80) a kilogram of beans.

At the same time, the government that’s already been shaken by an army mutiny this year will be wary of going too far and sparking social unrest.

"On today’s price, the farmer price would probably be around 700 CFA to 800 CFA francs," said Jonathan Parkman, co-head of agriculture at Marex Spectron Group, a follower of the market for more than 30 years. "It could be vastly different from that depending on what the political agenda is in Ivory Coast. It’s way more political than just doing the maths."

Laissez Faire

The current system, which aims to protect 800,000 cocoa farmers from swings in global futures markets, was set up in 2012 in a move that ended more than a decade of laissez-faire policies. The shift was a condition for International Monetary Fund debt relief.

Under the changes, part of the crop is sold before the harvest starts to ensure more stable prices for growers. The regulator Le Conseil Cafe Cacao, or CCC, sells as much as 80 percent of the nation’s larger crop before the season starts, setting prices for farmers based on those sales.

Like the system that operated in most of the 1980s and 1990s, it relies on funds accumulated when prices are high to support farmer payments during downturns. But after four years of a rising market, a slump beginning in mid-2016 is bringing the arrangement to its knees.

"Until mid-2016, the CCC had a fairly easy time," said Charlotte King, an analyst at the Economist Intelligence Unit. "Cocoa prices were high, the CFA franc was weak, and profitability throughout the supply chain was relatively robust. The latest crisis has exposed its weaknesses."

Ivory Coast’s forward selling system was set up with promises to avoid a repeat of past mismanagement. While the government has pledged to make markets more transparent, it has failed to regularly publish data such as delivery to ports, the status of the sales and forecasts for the crop.

“What we are seeing now is exactly what the forward selling regime is designed to avoid, so you don’t have these situations that you have to go out and cut the farmer price,” Parkman said. "Hopefully they will introduce reforms to the system."

Red Flag

Ivory Coast had to resell 350,000 tons of cocoa after some shippers defaulted on contracts to supply beans, and this season’s main crop turned out to be bigger than expected, Agriculture Minister Mamadou Sangafowa Coulibaly said last month. That’s about 18 percent of the record 1.9 million tons the International Cocoa Organization expects the nation’s growers to gather this season.

PriceWaterhouseCoopers flagged the risk of exporter defaults and a lack of monitoring in its audit of the 2012-13 season after the introduction of the new market structure. History is also a guide. Weak prices led to a rise in unfulfilled contracts in 1998-1999, according to Commodity Market Reforms: Lessons of Two Decades, published by the World Bank in 2001.

With the latest crisis, the regulator has again failed to prevent speculation by exporters, said Alexandre Andrey, an analyst at BMI Research, a unit of Fitch Ratings Ltd.

Exporters were also at the center of market problems in the late 1990s, though in different circumstances. Shippers then overbid in auctions to obtain the right to export, with defaults increasing after prices declined in late 1998 and early 1999, according to the World Bank’s book.

Damage Trust

"Export defaults have the potential to weigh on cocoa farm income in Ivory Coast through lower farm-gate prices for the mid-crop and/or future seasons," Andrey said. They also damage trust in the system "which could induce farmers to smuggle beans to neighboring countries."

While Ivorian authorities have pledged to curb speculation and produce another audit of the system, shippers question whether they have enough money to stabilize the market. The audit for the 2012-13 season is the only one carried out so far.

The regulator faces losses of more than 200 billion CFA francs due to defaults, a person familiar with the matter said this week. That’s more than the 170 billion CFA francs the nation had set aside as of Dec. 31 for market slumps in its Reserve Fund held by the Central Bank of West African States, according to the government. Ivory Coast also has access to some stabilization funds in domestic banks.

"The response from the CCC to the current pressures in the cocoa market has been slow and lackluster," EIU’s King said. "Ivory Coast’s cocoa industry is notoriously secretive. Even with drastic reform, it will take a long time to really change this."

(Updates with comment in 11th paragraph.)
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