Ivorian Cocoa: A Bittersweet Disposition

Background 

The Ivorian agricultural sector is responsible for about a quarter of Ivorian GDP, and cocoa alone is responsible for more than 7.5 percent. The vast majority grows in the southern states: regions including Sud-Bandama, Comoé, Lagunes, Bas-Sassandra, Sassandra-Marahoué, and Montagnes.

Immediately upon Ivory Coast’s independence from France in 1960, Félix Houphouët-Boigny took office as president, and the leader, often referred to as the “father” of Ivory Coast, was widely credited for establishing and building up the country’s cocoa and coffee industries. The industries quickly grew to dominate the Ivorian economy, and by the 1970s, policymakers grew increasingly concerned about the potential vulnerability of an economy dependent on just two crops. At the time, over 50 percent of total export revenues, or roughly 15 percent of GDP in Ivory Coast was directly tied to ever-increasing exports of cocoa and coffee. This meant it would only take one season in which weather deviated from average climatology for the broader economy to be devastated.

As a result, policymakers spent nearly $200 million each year to incentivize the production of other viable crops. The effort catapulted the country’s palm oil industry from one that was producing just 24,000 metric tons of palm oil in 1966 to 227,000 tons in 1986: a more than eight-fold increase. The palm industry continued to grow in subsequent decades, and Ivory Coast’s current annual production of nearly 400,000 tonnes each year puts it firmly in the list of top-ten producers in the world. Despite success in palm, diversification efforts were only mildly successful, and Ivory Coast remains highly susceptible to supply shocks in cocoa. Moreover, the fact that the lion’s share of world cocoa comes from Ivory Coast means that the global sector can fall prey to any situation which threatens Ivorian supply. And unfortunately, these sorts of situations have proliferated in recent years.

In many ways, the Ivorian political system was tied to President Houphouët-Boigny and his cult of personality. When his thirty-year rule came to an end with his 1993 death, there was substantial uncertainty—politically, socially, and economically. These uncertainties helped to exacerbate existing divisions and tensions along ethnic, nationalist and religious lines, and eventually culminated in the outbreak of the First Ivorian War of 2002. That conflict delivered a major blow to the Ivorian cocoa industry, and the economy more broadly. The battling stopped in 2007, thanks in large part to an agreement that promised a fresh presidential election in 2010. Unfortunately, this agreement proved to be more of a postponement of conflict rather than a resolution to it, and war broke out once again following the “fresh” 2010 election. Although Alassane Ouattara was announced the winner of the election—and was internationally recognized as such—incumbent President Laurent Gbagbo refused to cede power. Ouattara, attempting to use financial pressure to push the Gbagbo government out, announced a one-month ban on all cocoa exports. Prices shot up 10 percent as a result of the result of the announcement, and shot up 25 percent within a two-month period following the election. Even though the 2010 crop was healthy and robust, the instability translated into lower harvest estimates and a larger gap between supply and demand. Gbagbo was eventually captured by Ouattara supporters, and sent to face trial by the International Criminal Court.

The most recent bull run has been unrelated to the usual suspects of politics and weather, and has instead been a story of epidemiology. According to the International Cocoa Organization (ICCO), Ivory Coast and Ghana’s proximity to Ebola hotspots Guinea, Liberia, and Sierra Leone have spooked stakeholders, as the spread of the virus into either country could devastate world supply. In fact, the existence of Ebola in these other countries in and of itself is disruptive to the Ivorian cocoa industry, as migrant workers from these countries typically play a major role in the harvesting of cocoa crops. Many have been prevented from doing so due to Ivory Coast’s closing of its borders with Ebola-stricken countries.

Although the ICCO maintains that the market has priced in the risk of an Ebola outbreak in the major producing countries, investors are not convinced. One investment professional believes prices will be highly volatile for several weeks to come, and should a confirmed case of Ebola appear in either Ivory Coast or Ghana, prices could rise by another 10%. In a gesture that highlights the extent of the threat posed by Ebola to cocoa, the World Cocoa Foundation (WCF) recently announced a $600,000 donation to help fight the contagion in West Africa.

Processing reform 

Beyond Ivory Coast’s top position as a cocoa producer, the country is also an emerging leader in cocoa processing and grindings. Between 2000 and 2012, thanks to concerted efforts from corporates and the government, Ivorian cocoa grindings doubled from 230,000 metric tons to over 450,000 metric tons. If this trend continues, Ivory Coast will soon overtake the Netherlands as the world’s top cocoa grinder.

The process of transforming beans into chocolate is complex—beans must be cleaned, roasted, shelled, ground, alkalized, and then milled to create cocoa liquor (cocoa particles suspended in cocoa butter). As different types of beans are often used, the liquor must be blended to a required formula, then pressed to extract the cocoa butter. Then the cocoa butter is used to manufacture chocolate, which is an entirely separate process. Cocoa’s lengthy and intricate value chain means that producing countries have significant opportunities to extract more value from the crop by encouraging more domestic processing prior to export. Along those lines, the Ivorian government has offered incentives to grinders. This move prompted companies like SACO-Barry Callebaut to triple capacity at its San Pedro facility, and Olam to build a $43.5 million plant with a 60,000 tonne capacity in Abidjan. The proportion of the crop which is ground has recently hovered around 33 percent, and the government has expressed intentions of increasing this figure to 40 percent in the short-term and 50 percent in the medium-term.

In 2012, the government of newly elected President Ouattara consolidated several administrative marketing boards into one centralized governing authority, the Café Cacao Council (CCC). Interestingly, recent reforms have transitioned government-issued economic support away from conglomerate grinders and towards smallholder farmers. Smallholders, defined in this context as those having farms of less than five hectares in size, are responsible for over 80 percent of Ivorian production. Understanding and meeting the needs of this vast majority of producers is essential for sustainability. In the previous system, the overall aim of the regulating bodies was to ensure that Ivorian cocoa products remained competitive in the western world. By contrast, the current system ensures farmers will receive 60 percent of the world cost, insurance, and freight price (CIF).

In the old system, marketing boards published “indicative” farm gate prices, which middlemen were encouraged to pay. More often than not, farmers received much less than this indicative price—about 65 percent of it, and only somewhere between 20-40 percent of the international CIF price. In 2011/12, farmers on average earned about $1.29 per kilogram, despite a recommended price of $2 per kilogram.

Farmers are better off in the current system—in 2012 they received nearly 65 percent of the international price, or 2-3 times higher than they did when middlemen could undercut producers. The CCC hopes the measure will also increase bean quality, as farmers had historically expedited the drying process and rushed their beans to market in order to lock in favorable pricing. The CCC stands firmly behind these measures by enforcing hefty penalties against buyers who disregard the minimum price. In 2012, five middlemen were arrested and at least one was both fined and sentenced prison-time for attempting to purchase beans below the price floor.

Another major revision was the abandonment of spot purchases in exchange for a forward-auction platform, the Système Intégré de Vente À Terme du Café et du Cacao (SIVATC2). Introduced in January 2012, the forward auction system facilitates two daily auctions for export contracts. Contracts, which detail bean quantity and export period, are allocated after the marketing board has considered all bids, but there is little transparency in the selection process. The CCC believes the use of forwards helps to maintain the price floor and encourages investment in aging plantations. In a recent release of new reforms for the 2014/15 harvest period, the CCC is also prohibiting exporters from purchasing more than 10 percent more beans than they have the right to export. In theory, this will minimize secondary market trades between exporters.

Exporters will be barred from paying above the government-fixed price scale. The 2014/15 fixed price has been set at $1.81 per kilogram for beans arriving at either the Abidjan or San Pedro ports during the main harvest (October through March). By restricting pricing power, exporters will no longer be permitted to pay merchants more than $0.03 per kilogram above the government-fixed price scale upon delivery in order to guarantee adequate volumes. This evens the playing field for smaller exporters who cannot compete with the financial resources or scale of larger traders.

For the 2013/14 grinding season, five major exporters controlled nearly 85% of total processing. They are: Barry Callebaut with 28.4 percent (liquor, powder), Cargill with 17.9 percent (liquor, butter, powder), Cemoi with 14.9 percent (liquor, butter, cake, chocolate), ADM with 12.8 percent (liquor butter, cake), and Olam with 10.4 percent (liquor, butter, cake). One new requirement is that bean stocks may only be held for up to 30 days, and any difficulty in distributing stock must be reported to the CCC. This attempts to increase liquidity in the market, and no longer allows merchants to build large stockpiles in hopes of more competitive pricing.

Climate considerations and impacts 

In addition to geopolitical risk factors, natural risks like weather play a central role in the strength of the Ivorian cocoa market in any given season. Ideal climate conditions for cocoa include temperatures between 21-32°C and abundant sunshine. Temperatures outside of this range, particularly lower than 10°C, can be fatal to cacao trees. Defoliation and dieback occurs between 4-8°C. Rainfall below 1500 millimeters may be insufficient for full seed growth, while rainfall in excess of 2,500 millimeters can also prove detrimental to both quality and yield.

Most Ivorian production occurs between October and March, so the rains that occur between April and July as well as the supplemental rainfall in October and November are critical to the production season. Later on, the crop must avoid strong northerly winds bringing hot dry air from the Sahara, known as “harmattans.” In December 2011, a harmattan wind pattern formed. A harmattan is especially dangerous for cacao trees, as it not only reduces any chances of rainfall, but also produces a strong wind capable of knocking weak pods and flowers off of trees—a direct reduction to bottom-line yield. As a result, production for 2011/12 slipped by over 2 percent, which arithmetically caused a 1 percent decline in global supply.

The International Center for Tropical Agriculture (CIAT) recently released studies on the potential impacts of climate change on cocoa in Ivory Coast and Ghana. The studies concluded that yearly and monthly minimum and maximum temperature bounds will increase by 2030 and continue to increase through 2050 by up to 2.0°C. They expect these increases to drastically reduce the amount of land suitable for cocoa production. Although coastal regions may experience an additional 20-30 millimeters in mean annual precipitation, higher elevations that will become temperature-appropriate to cocoa growth may see mean annual precipitation amounts fall by over 40 millimeters. Currently, the optimal altitude for cocoa is between 100 and 250 meters above sea level—this is expected to increase to 450 to 500 meters above sea level by 2050. As a result, southern and coastal regions including Agneby, Lagunes, Moyen-Comoe, and Sud Comoe are likely to become less suitable for cocoa production, while regions with higher elevations like Montagnes are expected to improve.

The authors of the study also highlighted the need for more research on drought-tolerant cocoa germplasm, alternative crops for areas where cocoa production will no longer be viable, increased access to credit for cocoa farmers, improved access to irrigation, and an increased awareness of climate change through public information campaigns.

Lights, camera, CocoaAction! 

Despite recent regulations favoring small-scale farmers and promising forecasts of growing consumer demand out of Asia, it is unclear whether or not a new generation of West African cocoa farmers can rise up to meet future global demand. In an aggressive effort to educate farmers on better techniques and growing practices, a private-public cooperative named CocoaAction was formed in May 2014. Spearheaded by the World Cocoa Foundation, the movement is comprised of twelve major private-sector stakeholders: ADM, Barry Callebaut, Blommer, Cargill, ECOM Agrotrade Limited, Ferrero, The Hershey Company, Mars, Incorporated, Mondelez International, Nestle, and Olam. The governments of Ivory Coast and Ghana have also endorsed the program.

CocoaAction aims to address many of the challenges facing the West African cocoa industry: unproductive orchards due to aging trees; declining soil fertility; lack of access to fertilizer knowledge; poor agricultural practices; and increased competition from other cash crops. The organization hopes to build awareness of good agricultural practices, create sponsorships to provide incentives to the planting of new saplings, increase access to improved planting material, and boost access to and knowledge about appropriate fertilizer use to over 300,000 farmers (200,000 in Ivory Coast and 100,000 in Ghana) by 2020.

Though the success and impact of CocoaAction is yet to be seen, the stated objectives of the organization are promising. If nothing else, the creation of CocoaAction highlights the private sector’s growing concern about West African cocoa production and its desire to maintain and improve current production capabilities.

Conclusions 

Responsible for nearly 40 percent of global cocoa production and over 11 percent of global grind, Ivory Coast is undoubtedly the world’s most important cocoa source. As the deficit between supply and demand of the coveted crop grows, any unforeseen hindrances, like Ebola, could severely alter global supply and send prices to new heights.

Beyond these short- and medium-term considerations, investors and stakeholders must consider the long-term factors of aging trees, decreased soil fertility, and potentially detrimental changes in climate. Fortunately, the industry can mitigate the effects of all of these factors, and actors across the private and public sectors are uniting in their attempts to do so. Partnership-based efforts, like CocoaAction, are an important engine of change. Increased education for smallholder farmers about the advantages of new saplings, appropriate fertilizer use, and adaptations to weather can guide West African cocoa producers onto a path of sustainable growth.