Sweet, sweet cartels (Cocoa producers give it a try)

For those who are not paying attention, some news has been going around the (limited) circles of Cocoa trading.

Ivory Coast and Ghana, the world largest Cocoa producers, accounting for about 2/3 of the world production, are trying to set up a cartel in order to support the prices of Cocoa bins.

The move is, at least on paper an interesting one.

The ability to keep capture a higher portion of the value would allow the farmers to have a better shot at developing and would possibly reduce the amount of child labor which is connected with cash crops like cocoa.

On a theoretical level I am usually averse to Monopolies and Oligopolies, however I would make an exception to this case.

See, the thing is that for every 100 USD of confectionery revenues in developed countries, only 6USD are staying in Africa. Which means that confectionery companies enjoy super high margins (which are higher than trading margin for intermediaries, but this is a different issue) all the while most of the people employed in farming are barely above the UN poverty line.

There is something inherently wrong with this, no matter how much of a free-market capitalist one might be. It is essentially a capital drain from poor to rich countries.  Which together with transfer pricing techniques and other niceties, keep the populations of producing countries obscenely poor.

For trade to work its way and lift farmers and processors out of poverty in the region, something indeed must be done.

Where I have a problem  with this solution is that in practice, cartels very rarely work. The OPEC is a case point int the world of commodities, as its pricing power is way overstated in the media. Reality is, OPEC can somehow stir the expectations, but in no way can set quantities or prices.

Don’t believe me? Then why OPEC countries price their crude Brent-based?

Plus it is a known fact that there is a fairly big inventive for OPEC countries to cheat on their production quotas, render the production targets more a wish than a real commitment.

Oil is not Cocoa, you might say.

Fair, but Oil is much more fragmented in terms of clients, if less concentrated in terms of producers.

Which means that, at least in Theory, producers have a higher power than consumer to set prices and terms.

On top of this, the area where potentially Cocoa can be grown is essentially bigger than the current traditional area. Vietnam has started to push into this commodity (after itn became one of the biggest exporters of Coffee) and so does Malaysia. Thailand and Philippines are also significant producers.

In essence, maintaining the cartel  might be a very difficult endeavor.

Also, in terms of practical issues, there is the fact that whereas oil cans stay on the ground, Cocoa beans have a shelf life. And farmers who rely on the crop might be reluctant, to put it mildly, to produce less for the theoretical higher price.

Another issue is purely financial. Cocoa is priced in hard currencies such as the GBP, and developing countries in West Africa are chronically starved of those. And they would anyway be caught in the risk of FX fluctuations, which with Brexit and trade tensions are going to affect the market substantially.

At the end of the day, the financial shoulders of Cocoa producers are nowhere close to the firepower that oil producing countries have. And that makes a big difference.

At the end of the day, the financial shoulders of Cocoa producers are nowhere close to the firepower that oil producing countries have. And that makes a big difference.

A view from the consumers

Many of the big consumers of Cocoa, such as Nestle and Cargill, have expressed the view that they support the cartel. This might seem counterintuitive as higher prices would hurt their bottom line.

However if we consider the share of the margins that goes to farmers, Consumers are more concerned about potential disruption to the value chain (such as farmers turning to more lucrative crops or going bust) than losing a few cents on the dollars of profit.

On top of that, more and more end-consumers are interested in ethical sourcing of Cocoa, and any initiative that might put a bit more resources in the pockets of farmers is a good marketing opportunity for the likes of Mars and Nestle.

Reality is though that most of the initiatives around fair trade or a support for this cartel are hardly going to make a dent in the poverty of the region.

Reality is though that most of the initiatives around fair trade or a support for this cartel are hardly going to make a dent in the poverty of the region.

How is the market reacting?

So far the effect on the market seems to be close to nonexistent. The Wall Street Journal published an interesting article on the topic last weekend,( https://www.wsj.com/articles/new-cocoa-cartel-could-overhaul-global-chocolate-industry-11578261601?mod=hp_lead_pos5) however so far, to cut the story short, Cocoa futures have lost value both in New York and London, as the news connected to production(a bumper crop is expected) are impacting the market much more, a sing that the market probably does not buy in the credibility of the cartel.

So what should be the right approach for Ghana and Ivory Coast?

In this, they should really take a page from the playbook of the gulf states, Saudi Arabia in primis, and try, by coercion even if necessary, to move on their shores a bigger piece of the value chain and of the processing. This is also not a risk free strategy, but one that, historically, has yelded better results, as Soybean mills in Latin America and refineries and Petrochemical plants in the Middle East are demonstrating. Then, whether this higher value added will transfer to the farmers, is a different problem and outside the scope of this brief article.

I wish best of luck to the thousands of farmers that make our life a bit better thanks to Chocolate. And would also love to hear the opinion of people in the industry