In a bid to tackle the main problems facing the cocoa sector – flagging production, mediocre quality and growing numbers of farmers quitting the crop – the government launched a sweeping reform programme in November 2011 that seeks to remedy the underlying cause of the structural problems in the segment: low prices for farmers. The sector’s new regulatory body, the Coffee Cocoa Council (Conseil de Cafe Cacao, CCC) began to enforce a minimum 60% cost, insurance and freight (CIF) price for farmers. The CCC is also in charge of managing the daily auctions that forward-sell 70% of next season’s cocoa in two daily sessions. The remaining 30% of the season’s production is then purchased in spot sales.
PRICES: Cocoa stakeholders agree that the reforms are working – farmers’ prices are being respected and cocoa quality is undoubtedly better. Under the aegis of the World Bank and IMF, the domestic marketing system has been for the most part successfully designed to limit manipulation of prices. However, it is up to traders, exporters and processors to implement new business models that navigate the risks in the post-reform cocoa landscape.
To calculate the farm gate price, the CCC averages futures contract prices for 70% of the crop and then calculates an estimated value of the remaining 30% based on an average of Liffe cocoa prices. After averaging these two figures to arrive at the national CIF price, it subtracts the schedule of guaranteed costs, including freight, insurance, loss of weight upon arrival and taxes, to arrive at the CFA725 (€1.1) minimum farm gate price for the main crop. Upon the insistence of the World Bank and IMF, the government’s share in taxes was fixed at 22%.
Given the complicated formula for calculating the CIF reference price, some have said that the figure’s derivation lacks transparency and is to a certain degree arbitrary. However, whereas the CCC will not budge in adjusting the farmer’s price, it has shown flexibility in modifying the official cost structure to accommodate stakeholders. Under pressure from exporters, the CCC lowered taxes from 22% to 20%, increasing exporters’ share to above 20%. In order to stay profitable, stakeholders will need to keep their bean-sourcing costs down, which will likely require changes to their business models.
EXPORTS: While exporters initially boycotted the forward-selling auctions in 2012, all are now participating, with the CCC announcing that it sold 70-80% through the auctions for the 2011/12 season. The initial reticence was partly due to uncertainties about the auctions and initial concerns over the minimum farm gate prices. Traders also thought that the CCC underestimated the cost structure of delivering cocoa to port. The auctions aim to protect farmers from fluctuations in the world cocoa price by spreading sales throughout the season and ensuring a market for their cocoa production. In the twice-daily auctions, exporters are required to bid above an indicative CIF price that is derived from averaging Liffe cocoa prices with a differential. The differential is a function of several parameters, including bean quality and whether tonnage for sale is main or mid-crop. Exporters are allowed to bid on bean quantities in shares of 25 tonnes, with the CCC determining the tonnage that is up for sale each day. In the auctions, the best bids receive half of the tonnage while a quarter goes to the next highest offer, with the remaining quarter split between the next two bids.
TRANSPARENCY: However, the CCC has not published any data on the forward-selling auctions, which has raised some concerns about transparency. “The problem is that the CCC has not released any information about the auction. It hasn’t released daily prices, lots, or volumes of futures being bought or traded. Basically, there has been an auction for futures and no one knows how much is being traded or at what value except for traders themselves. There is no transparency at all when it comes to the auction, and in some ways, that defeats the purpose,” Edward George, the head of soft commodities research at Ecobank, told OBG.
The release of some information on the auctions could make the domestic marketing of cocoa more efficient. There were some proposals suggesting that exporters would be able to plan for additional purchases in spot sales for the remaining part of the crop if they had information on the volumes sold through the CCC’s auction and the volumes of beans left after that. However, exporters can only buy according to the amount of contracts that they engage through the online auctions. Otherwise they face a steep penalty. If exporters buy an excess amount of beans in the auctions, the other option is to sell these on to another exporter, which is difficult given the lack of information on buyers’ purchased volumes.
However, the CCC holds back information on the auction to prevent lowering international prices. If figures on bean quantities for sale were released to the market, excess supply could push down prices. Derek Chambers, head of cocoa at Sucden, told OBG, “Published data on the auctions would be held against the CCC. I do not see why the CCC should be expected to give information on the market that might be beneficial occasionally, but most of the time would not be. They promise to give data three months in arrears, which is already generous.”
REFORMS: The new reforms have proven successful in that minimum farm gate prices have been upheld due to the CCC’s enforcement of stiff sanctions for violations. Middlemen that do not pay the minimum prices face prison sentences and traders and exporters risk losing their licences.
Minimum farm gate prices and the new cost structure have also incentivised producers and middlemen to maintain quality standards. Whereas farmers had no incentive to keep the moisture level of beans down under the liberalisation regime – they were paid the same amount regardless of quality– they now need to sufficiently dry cocoa, maintaining 8-9% moisture levels, down from 14-15%, or risk not finding a buyer (traitant) for their beans. Traitants in turn face the same buying requirements from traders. The enforced quality standards have opened an opportunity for small-scale players to enter the value chain. Small local operations now offer drying services for producers. With the new pricing structure, the sector will see improvements in the efficiency of domestic marketing, with producers assuming more responsibility for delivering good-quality cocoa. Indeed, having farmers dry and ferment cocoa supplies up country is much more efficient than having exporters operate drying and fermenting operations at the ports.
SEEKING COMPROMISE: In addition to sweeping changes in the cost structure of cocoa, the government removed fiscal advantages for companies with local grinding operations, provoking an outcry from processors. Previously, processors received a discount on export taxes for raw cocoa beans used in making semi-finished goods, such as cocoa butter, liquor and powder. The tax break was meant to encourage the development of local processing activities, which reached 35% of total cocoa production over the last 20 years. Côte d’Ivoire is now the largest cocoa grinder in the world, with installed capacity of 532,000 tonnes. However, the fiscal advantages were contentious among exporters, who claimed that they gave processors a commercial edge. Major processors like Cargill and Archer Daniels Midland have reportedly used the tax break to buy larger quantities of high-quality beans.
While a compromise between processors and the government seemed to be on the horizon, the industry was caught by surprise in November 2012 when the government announced that it would calculate the export tax based on semi-finished products’ equivalent weight in raw beans, instead of the weight of the products themselves, which effectively meant there was a 25% tax increase.
SUPPLY CHAINS & SUSTAINABILITY: Still, it creates interesting opportunities for well-capitalised trading companies to supply cocoa to large firms that are exiting non-core operations. “The idea of sourcing from tree to chocolate bar is a myth. Other companies can do certain aspects of the chain better. And sourcing at the origin, under a marketing system like in Côte d’Ivoire, can certainly be done equally as well – if not better – by companies that treat it as their main business,” Chambers told OBG.
To assure the sustainability of domestic cocoa production, the CCC needs to guarantee that farm gate prices increase or stay at the same levels. If not, farmers may switch to other cash crops, like natural rubber and palm oil. These are seeing rapid growth on the back of rising global demand and increased foreign direct investment in West Africa, which is attractive given its unused arable land for plantations. In the long term, cocoa faces other risks like decreasing arable land and population growth, which translates into greater demand for staples. Mitigating these risks starts with assuring guaranteed prices, a move that the cocoa reforms have upheld well thus far.
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