Implemented in November 2011 under the auspices of the sector’s new regulatory body, the Coffee Cocoa Council (Conseil du Café-Cacao, CCC), the cocoa reforms sought to address arguably the largest obstacle to local production: price insecurity for farmers. The enforcement of a minimum 60% cost, insurance and freight (CIF) price for farmers has produced major improvements in the sector’s performance, having provided farmers with an economic incentive to grow cocoa and reinvest in their crops while enhancing the volume and quality of cocoa beans. However, the CCC’s reforms have also created serious financial and strategic difficulties for small and medium-sized exporters, forcing many out of business.
Prices
Although reforms have empowered the farmers, the implementation of a minimum farm gate price has limited the ability of small and medium-scale players to purchase cocoa. For example, in 2012 there was a negative differential on Ivorian cocoa. However, now the CCC sets the minimum price for export rights by applying a minimum differential above the London price, and paid differentials are often higher still.
As cocoa prices continue to rise, exporters are obliged to deal with growing quantities of the commodity to benefit from economies of scale and remain profitable. The recent changes in the industry have meant that many company’s break-even point is very high. Even with the infrastructure to run 100,000 tonnes of cocoa, companies must run at least 60, 000-65,000 tonnes just to break even, where in the past only around 45,000 tonnes per year was required. In this environment, small players producing 15,000 tonnes face serious hardship, as even those with 60,000-tonne capacity are struggling.
Even if smaller sector players are able to secure large quantities of cocoa, they often lack the infrastructure and human resources to quickly secure and export it. “Soft commodities intrinsically have a low value; therefore, you need big volumes to make money, particularly with so much competition. In Côte d’Ivoire cocoa is a volume game, and smaller players cannot compete in this environment,” Edward George, head of research at Ecobank, told OBG.
Transport Costs
Small and medium-sized exporters are also disadvantaged by the CCC’s estimation of transport fees budgeted into the CIF price to bring cocoa to port. With CFA80 (€0.12) permitted in the cost structure, many exporters and processors have argued that the CCC underestimated the cost, leading some companies to boycott Ivorian cocoa in 2014, notably the British firm Armajaro.
One of the core issues arises from the fact that regardless of whether a company is deep in the bush or on a main road, or whether it is 500 km from a port or 50 km, companies are assumed to have the same transport costs. The allocated transport allowance is argued to be insufficient, as it does not reflect the various environments that exporters operate in, and the subsequent effect that this has on costs.
Ultimately, this impacts every producer and exporter, and has obliged the larger players to implement cutbacks to save on costs. However, this burden has disproportionately fallen on smaller players that lack the financial security of multinational trading houses.
The reforms are expected to impact small and medium-sized companies in such a way that only the most efficient big players remain. While this has the benefit for removing inefficient operators from the market and encouraging other players improve operations, it may have undesirable effects on employment over the short term, if smaller operators are forced to close.
The Futures System
Another crucial element of the CCC reforms was the introduction of a futures auction system, where 70% of the following season’s cocoa is purchased in two daily sessions, while the remainder is sold in spot sales. Exporters are required to register with the CCC, and during the twice-daily auctions the CCC sets the tonnage to be sold each day. Exporters then bid over an indicative CIF price calculated from averaging cocoa future contract prices with a differential. Exporters are permitted to bid on beans in portions of 25 tonnes each, and the highest bidder acquires half of the tonnage, after which the second highest bidder receives a quarter, and the remainder of the beans is divided between the next two bids.
The futures system was designed to safeguard farmers by ensuring a market for their crop and by buffering them from changes in the global cocoa price. Rather, the system has disproportionately limited the ability of small and medium-sized exporters to compete against larger firms due to the resources needed to purchase beans in the auction.
Limitations
The CCC restricts the tonnage that each exporter can purchase to 70,000 tonnes from October to December, and 40,000 tonnes from January to March, while no restrictions apply to mid-crop purchases. Although this system theoretically ensures that small trading houses have volumes available to them, purchasing power is constrained by the amount of capital needed to make such purchases.
For example, many larger companies have integrated activities and also have operations abroad, and therefore, they have the capacity to pay a certain premium to obtain needed cocoa volumes. For small exporters who buy and sell locally, Côte d’Ivoire is the centre of their profile, and they have difficulty competing in the bidding system with large firms.
Financial constraints for smaller players are not limited to the capital needed to purchase cocoa. For a small or medium-sized exporter to open, the business must provide €300,000 as a bank guarantee, and an additional €300,000 guarantee to receive the right to export from the CCC. This is in addition to the other costs associated with opening a company and exporting cocoa, putting exports out of range for small firms.
Access to credit is another constraint on smaller exporters, who must put a down payment of up to 50% on loans with an interest rate of 10-13%. However, multinational companies are able to borrow in more competitive banking economies, where interest rates are between 1% and 3%. Local Ivorian firms are obliged to borrow in less competitive banking markets, thereby incurring a major financial burden.
Another factor that favours multinational companies over smaller players is the premise of buying beans a year in advance. Due to their international presence, large firms have regular contracts with buyers in need of cocoa beans and therefore have relatively little trouble securing clients a year ahead.
At present, companies must put up large amounts of money one year in advance, take view of the differential and find a physical buyer. However, small and medium-sized operators often do not have the means to do this. Instead of simplifying the buying structure for local Ivorian companies and medium-sized businesses, the reforms have complicated things further.
One remaining outlet for smaller export cooperatives to survive is to go into partnership with large companies. “A lot of smaller players buy beans and then sell them to big trading houses. The system is forcing smaller firms to become the unofficial subsidiaries of big corporations. Around 70-75% of purchased cocoa is processed by four or five big companies, while another 20% is bought by small trading houses and sold to big ones,” George told OBG.
The futures market bears an inherent risk for large and small exporters alike. Although the system ensures that producers are able to sell their cocoa stores, the CCC estimates the amount of cocoa to be produced a year ahead, and therefore the majority of the crop is purchased before it is even produced. This opens purchasers to the risk that poor estimations and bad weather may hurt total production. For example, Ghana also has a forward auctions system, and in the past there have been times when there were not enough beans because predictions were too optimistic. This has the potential to cost purchasers significant amounts of money if they cannot secure enough cocoa.
Survival Of The Fittest
All of these factors have culminated in a rapid disappearance of local Ivorian exporters since the implementation of the CCC reforms. Prior to the reforms, it is estimated that there were over 20 local Ivorian exporters and small cooperatives involved in exporting cocoa. However, in recent years this number has dwindled to under 10.
The cocoa sector reforms have in part skewed the industry in favour of larger enterprises, which has resulted in many local exporters leaving the market or beginning to explore alternative arrangements. One option is branching out to other products. For example, some medium-sized cocoa exporters trade in a range of agricultural products including cashew nuts, cocoa, coffee, sesame and sheanut, thereby allowing them to replace any lost revenues on cocoa with those from other products when cocoa prices are too low.
Though the CCC is currently considering adjustments to the futures system to aid small exporters to provide financial guarantees and compete in the bidding process, no tangible reforms were announced at the time of writing, and many exporters remain sceptical that allowances will be made for small players.
Read More from OBG
