Times are tough for cocoa processors. A series of supply disruptions beginning with the outbreak of the Ebola epidemic in West Africa midway through 2014 and stretching to the droughts seen in 2015 in key producers Ghana and Indonesia have kept bean prices elevated and markets inverted.1 In late July, these supply fears drove the cocoa futures (CC) contract – the global benchmark for the cocoa bean market, which trades on the ICE Futures Exchange – to four-year highs. While a market correction followed shortly thereafter, most analysts are forecasting a global cocoa bean deficit – the world’s third consecutive – in the 2015/2016 harvest year, which will likely support bean prices in the near term.

On the cocoa product side, stocks remain heavy, due in large part to a substantial expansion of processing capacity worldwide. Over the past decade, growing global consumption, paired with strong domestic subsidization in a few key origins, has engendered a large-scale build-out of facilities outside of the traditional grinding hubs of Germany and the Netherlands. According to the International Cocoa Organization, grinding capacity has grown by approximately 240% in Indonesia, 40% in Malaysia, 50% in Côte d’Ivoire, and 250% in Ghana in the past seven to 10 years.2

The result of this expansion has been a severe capacity overhang in the cocoa processing market, as demand sufficient to counterbalance this new supply has yet to materialize. Global confectionary demand has fallen approximately 2% in 2015, as consumers in Europe and Asia – particularly China – appear to have lost their sweet tooth as a result of slowing economic growth and rising candy prices. Confectioners worldwide are scaling back orders to match their buyers’ needs, and this demand deceleration, coupled with the supply expansion outlined earlier, has created a glut in the cocoa product market, driving prices down sharply.

Cocoa_Bean_Price

Cocoa bean prices continue to rise. They are up approximately 11% since the beginning of the year, having closed at $3,168 per metric ton on September 4, 2015. Meanwhile, product values have moved in the opposite direction. The combination of higher raw material (i.e., bean) prices and lower refined product prices has been distinctly unfavorable for grinders worldwide. The “combo ratio,”3 which may be viewed as a proxy for cocoa processing margins, has recently made lows unseen in nearly a decade, falling to levels well below cost for many processors worldwide. Put another way, the combined revenue that processors currently earn for the sale of cocoa products is less than the costs associated with buying cocoa beans and grinding them.

Negative processing margins are the hallmark of an imbalanced market, and a correction seems inevitable. The bad news for processors is that it will probably come at their expense.

Cocoa_Combo

Given the cocoa bean fundamentals described, the relationship between beans and products – i.e., the combo ratio – is unlikely to improve materially via a downward correction in the price of beans. The work must therefore be done on the product side. In a market as fickle as cocoa, it is difficult to predict whether the correction that pushes processing margins back into positive territory will be driven by higher demand, lower supply, or a combination of the two.

Either way, product prices will have to remain low for the near future, to both incentivize consumption and curtail the production of new supply, and this should mean pain for cocoa processors worldwide.

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1 Inverted market: market structure when the spot or current contract prices are higher than long-term contracts.
2 Source: International Cocoa Organization (ICCO) and Financial Times.
3 Combo ratio: the relationship between cocoa beans and refined cocoa products.