Surplus not sweet news for last year’s best commodity

January 7, 2016, 5:39am

Women harvest cocoa in eastern Côte d’Ivoire. Picture: REUTERS

By Isis Almeida, Bloomberg on Business Day Live

LAST year’s best-performing commodity is poised to become the market’s worst nightmare.

After the longest rally in London cocoa futures since at least 1989, farmers from Côte d'Ivoire to Peru are preparing to revive supplies in the 2016-17 season that starts in October, creating a surplus that Rabobank International says will be the biggest in six years. With demand slowing, the bank is most bearish about prices for the chocolate ingredient this year among the dozen agricultural commodities it tracks.

Prices surged 60% during a four-year rally through last year, forcing candy makers from Hershey to Lindt & Sprüngli to charge more for their products. Last year, El Nino weather patterns left dry conditions that hurt cocoa crops, including in West Africa, which produces about 70% of the world’s beans.

London futures last month reached £2,332/tonne, the most since 2011, when a civil war disrupted exports from Côte d'Ivoire, the top supplier.

"We expect these very good international prices to incentivise production," says Carlos Mera, an analyst at Rabobank in London. "We don’t think that these levels are justified given the political stability in West Africa."

Cocoa was an anomaly last year, rising 14% in London, when almost every other major commodity tumbled.

The gain was the biggest of the 24 commodities tracked by the Standard & Poor’s GSCI Spot index, which slid more than 25%. Rabobank says cocoa futures in London may slide to £1,800 by the fourth quarter, down 17% from Tuesday’s close at £2,163.

There are five reasons for the bearish outlook.

Firstly, farmer profit.

The government in Côte d'Ivoire, which accounts for almost 40% of global production, raised prices paid to farmers for a third consecutive year.

Growers will receive 1,000 Central African francs ($1.62) per kilogramme during the bigger of two annual harvests in the 2015-16 season, an 18% rise from a year earlier. It is the first time farmers across the country have had such a high fixed price for an entire growing season, says Edward George, head of soft commodities research at Ecobank Transnational. Previously, if prices ever rose that high, they were only in certain areas or did not last long, he says.

Secondly, weaker demand.

With the cost rising for chocolate makers, many have tapped into inventories, cutting demand for new supplies.

Global grindings by processors, an ind ication of consumption, will probably be unchanged or rise as little as 0.5% in the 2015-16 season, according to a November estimate by Cargill, the world’s second-biggest processor.

Barry Callebaut, the top processor and largest maker of bulk chocolate, is closing a factory in Thailand and reducing output in Malaysia. The company says overcapacity, high prices and slowing demand make grindings less profitable.

Thirdly, rains return.

Dry conditions from El Nino probably will be replaced by a more favourable La Nina pattern that will bring more moisture to cocoa crops, according to MDA Weather Services. Three of five strong El Ninos since the 1950s were followed by La Nina, says Kyle Tapley, a forecaster for MDA.

"As far as cocoa is concerned, La Nina generally leads to wetter-than-normal conditions across West Africa," he says.

Fourthly, Latin America.

While farmers in Côte d'Ivoire and Ghana continue to dominate supply, production is growing in Latin America. Countries in the region have been planting high-yielding trees, according to the London-based International Cocoa Organisation. Production in Ecuador rose 6.8% in 2014-15, and expansion is occurring in Colombia and Peru, the industry group says.

"Offers are starting to increase from places like Central America as producers look to cocoa to replace coffee," Jack Scoville, vice-president at Price Futures Group in Chicago, says.

"This is small now but has really gained traction over the last couple of years and will expand," he says.

Fifth, surplus ahead.

After a production deficit of about 150,000 tonnes in the 2015-16 season, the world will soon have more supply than it needs. Output will exceed demand by 93,000 tonnes in the 2016-17 season, according to Rabobank. That would be the biggest glut since 2010-11.