Market Trends

Chocolate and Caffeine Markets Entwined: The Soaring Prices of Cocoa and Coffee

As the year progresses, the intertwining fates of cocoa and coffee are becoming increasingly evident. Both commodities, essential to the global palate, are experiencing rallies driven by extreme weather events and supply shortages, pushing the boundaries of trading firms and market liquidity.

The Coffee and Cocoa Conundrum

Much like its counterpart, the coffee market is in the midst of a severe supply shortage. A parallel of sorts seems to be unfolding; both commodities are largely produced in just a few countries, leading to their interlinked fortunes. Major trading firms, which often engage in transactions involving both cocoa and coffee, are being financially strained as they grapple with cocoa's rising prices and are subsequently being driven out of the coffee trading business.

This linkage is not to be underestimated as it explains the surge in coffee prices and how liquidity issues are effectively barring traders from the market. It is noteworthy to mention that the correlation existing between cocoa and coffee serves as a partial explanation of the current tumultuous scenario where coffee prices soared to new heights.

The Financial Chain Reaction

Carlos Costa, the head of sales for Hedgepoint Global Markets LLC, suggests that coffee trade has been "contaminated" by speculative buyers who were betting on price increases following cocoa’s troubles. This wave of speculation may have caused robusta coffee futures to rally over 70% in the six-month period through April, reaching the highest price in several decades. Additionally, cocoa prices have more than doubled this year, escalating to a record high, which points to a broader financial impact across the industry.

Andre Acosta, a director at Marex Group Plc, elaborates, saying that the "psychological effect" of the cocoa rally has also impacted coffee, inducing comparisons between the two. As prices soared, the markets saw "significant margin calls" which may have prompted traders to adjust their strategies, lifting hedges or resorting to option trades to protect positions. For companies sourcing both commodities, this might translate into squeezed margins.

Reduced aggregate open interest in both markets—reflecting the total number of outstanding contracts—has been observed as prices increase, igniting volatility. Cocoa's concentration in West Africa’s nations presents a particular challenge that is anticipated to be more severe and long-lasting than coffee's difficulties, according to Acosta.

Fragile Global Supply

Our coffee and cocoa supplies are confined to a select group of countries, with Vietnam and Brazil accounting for the majority of coffee bean exports. Notably, Vietnam has recently been stricken with severe drought conditions. Similarly, cocoa production is predominantly in the grasp of Ghana and Ivory Coast, where production shortfalls have resulted in unprecedented market fluctuations and a spike in prices to their highest levels ever recorded.

"Due to cocoa's large concentration in just two countries, we have encountered the present problems, and we must prevent coffee from following a similar trajectory," asserts Vanúsia Nogueira, the executive director of the International Coffee Organization. Though the state of the coffee markets might not be as acute, she observes, it is treading along comparable paths to those of cocoa.

Read More: Pricey Coffee Here to Stay as Hoarding, Heat Hit Vietnam Supply

Coffee's Prospects vs Cocoa's Perils

Supply concerns are already driving coffee prices upward, but market analysts suggest coffee is likely better positioned than cocoa for a variety of reasons. Thiago Cazarini, who operates a brokerage firm in Brazil's coffee-rich region, notes that coffee growers are on a continuous effort to rejuvenate their crops, replacing older plants with new, more yield-friendly and disease-resistant ones annually. The motivation for such investments is markedly robust, given that growers are positioned to capitalize almost immediately on the climbing market prices.

This dynamic contrasts starkly with cocoa, where government-fixed prices in major producing countries like Ivory Coast and Ghana mean that, despite the rally, farmers receive significantly less financial compensation than current market levels suggest. A historic underinvestment in the sector has hampered the ability of cocoa farmers to update their crops or afford the necessary products, such as fertilizers and pesticides, that could enhance productivity.

Europe's Role in Commodity Consumption

The anticipated introduction of European Union regulations aimed at curbing deforestation by the end of the year is poised to affect both markets. Coffee's broader appeal across the global market, in contrast to chocolate, whose sales are heavily concentrated in Europe, may prove to be its saving grace. According to research by Megan Fisher from Capital Economics, the EU accounts for an import of nearly 60% of the world's cocoa beans and more than three-quarters of all chocolate sales, placing cocoa in a more vulnerable position relative to the upcoming regulations.

Moreover, when it comes to substitutability, cocoa is at a disadvantage, while coffee, with its two main varieties—arabica and robusta—offers more flexibility. Companies can compensate for robusta's price increases by blending in cheaper arabica beans. This tactic has been reflected in the market, with New York arabica futures witnessing an increase of 20% before stabilizing their gains this year, despite expectations of surplus supply.

Brazil's Coffee Supremacy and Global Concerns

Brazil's ascent as the world leader in coffee production has not gone unnoticed, with experts like Rabobank analyst Guilherme Morya acknowledging the country's “consistent improvements” in arabica production. Even with a fluctuating market, consumers can still find alternatives in terms of bean origin, price, and variety, though concerns persist about market concentration as Brazil increases its global shipment share.

Such a lack of diversification in sourcing origins might lead to profound changes in industry models, warningly suggests Trishul Mandana of Volcafe, one of the biggest traders in the market. Drawing parallels with the current woes in cocoa, he intimates that the coffee industry must heed the lessons from these parallel events or risk facing a similar fate.

©2024 Bloomberg L.P.

Although the myriad factors influencing the intertwined coffee and cocoa markets are complex and multi-faceted, industry stakeholders from farmers to traders and consumers are closely monitoring these developments. With the potential ramifications extending far beyond just market dynamics, the tale of these two beloved commodities is one of caution, adaptability, and insight into the interconnected nature of our global economy.