Readers have posed some interesting questions following my blog last week on cocoa.
One asked me to explain why I said a minimum sales price becomes a ceiling on the market. The answer is that if the price can’t go up, it will go down. If traders and manufacturers know that they can buy at a specific price, they have little risk in being short below that price. If the price rises, they can cover their shorts at a predictable loss. Minimum prices skew the risk/reward ratio and encourage people to sell short.
On a broader level, one commented that, because Ghana and Ivory Coast account for 60 per cent of world cocoa, they have the market power to set cocoa prices. He suggested that cocoa producers should get together to form COPEC, cocoa’s equivalent of OPEC.
Unfortunately, cocoa is not the same as oil. Oil producers can reduce supply by turning off a tap; they can leave it in the ground. It doesn’t deteriorate. Cocoa producers can’t turn off a tree. The trees keep producing, cocoa builds up at the ports, rots in the warehouses, and loses some, or all, of its value. In the meantime, farmers are left unpaid – with all the dire consequences that entail.
Cocoa is a front-loading crop: grinders and chocolate manufacturers tend to hold large stocks that they can run down if producers hold off new sales. Cocoa buyers are more affluent and better financed than producers – and they probably have better infrastructure.
One reader argued that the market is almost as concentrated on the buy-side as it is on the sales side. I very much doubt that cocoa buyers work together in the same way that cocoa producers do. Still, I would guess the balance weighs in the buyer’s favour in terms of market power.
A couple of readers pointed out that as growers only receive around 5 per cent of a chocolate bar’s cost, increasing the cocoa cost by $400 per tonne would only increase the bar’s price by one or two per cent. They have a point. Besides, Cargill recently conducted a survey that showed consumers would be willing to pay more if they thought that the farmer would benefit. ‘Surely,’ asked one reader, ‘consumers would pay 2 per cent more for their chocolate if they thought that it helped the farmers?’
The answer is that it would, but, increasing the price that farmers receive would encourage them to produce more, adding further pressure on prices.
Expressing this problem differently, another reader said that producing and consuming countries should cooperate in setting a fair price for cocoa.
In the past, the United Nations has done that by setting up commodity organisations to ‘manage’ the markets; cocoa, coffee, or sugar were three such examples. These commodity organisations tried to use stock management to bring supply and demand into balance at a price that gave a decent return to growers and a reasonable price for consumers.
When world prices fell, the various commodity bodies set to work by either purchasing (in the case of cocoa) physical cocoa to hold off the market or asking (in the case of coffee and sugar) producers to build stocks and limit exports. When prices rose again, they released these stocks.
These noble efforts, sadly, failed. When prices fell, coffee producers continued to export; they desperately needed the money to feed themselves. In the case of cocoa, the ICCO ran out of funding. In the case of sugar, producers failed to build the stocks they were supposed to. (Brazil famously said that their inventories were in the cane in the fields.)
As a consequence, when prices rose, either the stocks weren’t there or were insufficient to stem the prices’ rise.
As we saw earlier, market participants will tend to sell short ahead of a stock release price level; if stocks aren’t there, then the price explodes as shorts run for cover. It means that not only do international price agreements not work, they also actually increase market volatility. They are like communism: a great idea in theory, but a disaster in practice.
It is true even if the producers are in rich, developed countries.
The EU used to fix minimum prices for many agricultural products, maintaining them through a mix of quotas, stock management and subsidised exports. Over the years, production costs dropped as farmers became more efficient. Still, the EU continued increasing their minimum prices in line with general inflation. In the end, sugar prices were so profitable that French farmers used to call sugar beet quotas’ white gold’. Butter mountains and wine lakes built up. So did subsidise exports – to the detriment of farmers in importing countries.
The EU has gradually wound down their market management schemes (sugar and milk were the last to go), along with, thank goodness, subsidised exports. The EU has replaced them with direct income support. Agriculture is still the largest item in the EU’s budget at 38 per cent, but down from 73 per cent in 1985.
Finally, one, rather astute, reader argued that the Ivory Coast should have thanked Hershey for taking delivery of the December futures market. By doing so, Hershey pushed the world cocoa price higher, taking some of the old crop cocoa (that had been weighing on prices) off the market. He may have a point.
Instead of manipulating the world price, what should Ghana and Ivory Coast do to help their impoverished growers? I posed that question this week to the head of one of the leading NGOs in the sector. I will publish his replies shortly.
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