"Cocoa\u2019s relentless rally is pushing the market to breaking point"

" Cocoa\u2019s relentless rally is pushing the market to breaking point \r\n\r\nThe global cocoa market is buckling under the strain of unprecedented shortages.\r\n\r\nA once-unimaginable rally that upended physical trading is now filtering rapidly through to the futures market. Prices that have more than doubled in just three months are forcing traders, processors and chocolate makers to stump up more cash to cover their trades or head for the exit.\r\n\r\nThat\u2019s raising the specter of company failures like the ones that plagued European utilities during the recent energy crisis, when gas prices spiraled out of control and governments were forced to bail them out. There are fears it could be worse \u2014 some traders are even alluding to a nickel-type meltdown that rattled the London Metal Exchange.\r\n\r\n\u201cIt\u2019s hard to understand the magnitude of the price rise with panic in the physical market and lack of performance by suppliers due to the crop failure being the driver,\u201d said Pam Thornton, a veteran commodity trader at Nightingale Investment Management, who\u2019s best known for her role at former cocoa hedge fund Armajaro Asset Management. \u201cWhen you have moves of this magnitude, there are usually casualties and I\u2019m amazed I haven\u2019t heard of any yet.\u201d\r\n\r\nCocoa futures have surged as poor harvests in West Africa, where most of the world\u2019s beans are grown, sparked a third year of shortages. There\u2019s a risk the crunch could be long-lasting, with climate change and crop disease ravaging trees and concerns mounting that production in Ivory Coast and Ghana has entered a period of structural decline.\r\n\r\nPrices in New York are heading for their best month ever, and there are already signs of stress building across the industry.\r\n\r\nSwitzerland\u2019s Barry Callebaut AG, the largest maker of bulk chocolate, in January said it expected \u201can industry wide impact on working capital requirements.\u201d It said it addressed the concern by issuing 600 million Swiss francs ($663 million) in bonds to refinance securities due in May, as well as increasing a credit line and securing another loan.\r\n\r\nWhile Barry Callebaut\u2019s shares have dropped by about a third in the past year, investor Artisan Partners Asset Management Inc. has just increased its stake, expressing longer-term confidence in the company.\r\n\r\nAcomo NV, owner of Dutch trader Tradin Organic, said last year\u2019s earnings were \u201cmaterially impacted by the unprecedented increase in cocoa prices, resulting in lower demand and hedging losses.\u201d Chocolate companies are also feeling the pinch, with BNP Paribas Exane downgrading Hershey Co. due to surging costs.\r\n\r\n Bean Shortages \r\n\r\nScarce supplies first sparked a race to secure beans where they\u2019re grown. In Ivory Coast, many traders and processors rushed to source supplies by paying farmers more than the prices set by the government. Others have turned to smaller producers like Ecuador and Indonesia, but it won\u2019t be enough.\r\n\r\nBarry Callebaut expects a deficit of about 500,000 tons this season, equal to about a 10th of the global market. The firm, a supplier to the likes of Mars Inc. and Nestle SA, predicts another shortfall of 150,000 tons next season.\r\n\r\nThe shortages are roiling the futures market. As prices rise, traders with short positions \u2014 including those who\u2019ve sold futures to hedge against physical holdings \u2014 have to come up with more money to pay margin calls, which work as an insurance policy to cover potential losses. Those who can\u2019t are forced to buy back contracts, pushing up prices further and creating a vicious circle.\r\n\r\nThat\u2019s exactly what happened in the gas market when Russia began restricting supplies to Europe. Prices spiraled out of control and companies started to fail one after another. German utilities including Uniper SE and the former European trading and supply unit of Gazprom PJSC had to be rescued.\r\n\r\nIn nickel, a runaway short squeeze centered on the world\u2019s top producer in 2022 created so much market stress that it put others at risk of failing too. But unlike the LME, Intercontinental Exchange Inc. is unlikely to intervene and halt cocoa trading to protect those vulnerable in the market.\r\n\r\nICE has however taken several steps to tame the rally and keep the London and New York markets orderly. The bourse increased margins several times this year and reduced the threshold for when market players need to disclose more information about their positions.\r\n\r\nIn London, where Ivory Coast and Ghana hedge their sales, the exchange is gradually cutting the amount traders can buy through its market. The so-called delivery limit is going from 75,000 tons in May to 50,000 tons in July, and down progressively until it reaches 25,000 tons for the December contract onward.\r\n\r\n\u201cIt is a moment of great uncertainty, and the exchange measures are to avoid the market from being even more squeezed,\u201d said Leonardo Rossetti, an analyst at brokerage StoneX.\r\n\r\n Exchange Role \r\n\r\nICE Futures Europe President Christopher Rhodes said the cocoa market is serving its function as a venue to manage price risk, and pointed to speculators curbing their positions.\r\n\r\n\u201cDerivatives markets facilitate price discovery, allow customers to manage their risk, and serve as a buyer and seller of last resort,\u201d he said in a statement. \u201cThese principles are especially important when the underlying demand and supply fundamentals change, as we are seeing in cocoa.\u201d\r\n\r\nWith beans harder to come by, agricultural trading giant Cargill Inc. recently turned to exchange supplies to source cocoa. The US merchant took delivery of 75,000 tons, the maximum allowed, when the March contract expired in London.\r\n\r\n\u201cWe do intend to use a part of those beans to offset some of the shortages of fresh cocoa from our suppliers in West Africa,\u201d said Job Leuning, Cargill\u2019s head of cocoa trading. \u201cWe are keen to continue offering our customers the cocoa and chocolate products that they need in 2024.\u201d\r\n\r\nCocoa continued to soar after Cargill took delivery and if the company does use the beans, it will further pressure already low exchange-certified stockpiles.\r\n\r\nReplenishing inventories won\u2019t be easy as new European Union rules due to kick in at year-end will require companies to show crops haven\u2019t come from deforested land \u2014 something the industry is still struggling with how to prove.\r\n\r\nThe EU has faced calls to delay the deforestation regulation and cocoa futures could drop significantly if the deadline is pushed back. Some traders also say that the rally to more than $10,000 a ton \u2014 a higher price than copper \u2014 may be enough to curb demand.\r\n\r\n Tough Environment \r\n\r\nFor now, the high costs are hurting processors, with factories in West Africa slowing down or shutting. Blommer Chocolate Co. is closing its 85-year-old Chicago chocolate plant as the facility is no longer efficient. Barry Callebaut, which began a reorganization before the rally took off, has cut 18% of its workforce. It plans to close a German factory and a facility in Malaysia.\r\n\r\nFor everyone in the market, the spike higher has been accompanied by huge volatility, with a gauge of price swings near the highest in more than a decade.\r\n\r\n\u201cThe cocoa market is currently not a confectioner\u2019s comfort zone,\u201d said Tristan Fletcher, chief executive officer at ChAI, a platform that uses AI to analyze commodity markets. \u201cIt\u2019s a battleground for those with a taste for volatility.\u201d\r\n\r\nFocus is now turning to West Africa\u2019s new harvest, though supplies will probably only start to ease next year after farmers have had time to react to higher prices and improve production. Another key question is how much supply is being held back in anticipation of the rally continuing.\r\n\r\nUntil more supplies arrive or demand craters, the industry should brace for a tough market and potentially higher prices \u2014 especially with liquidity in the futures market drying up.\r\n\r\n\u201cAll the dealers I talk to, somewhere in the middle of the conversation, I hear that the market is broken,\u201d Nightingale\u2019s Thornton said. \u201cI am talking about the overall market being broken, especially physical trading as counterparty risk and financing has become impossible to manage.\u201d"

"Cocoa\u2019s relentless rally is pushing the market to breaking point"

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