Chocolate binge turns to slump as cocoa prices fall to 1-year low

Only a few weeks ago the chocolate manufacturers Cadbury’s announced that it was changing the recipe for its Creme Eggs provoking an eggstreme reaction from its British fans. The change – a reduction in the cocoa content from 20% to 14% has been blamed on recent high cocoa prices. This is unlikely to have been the first or indeed the last example of so called ‘shrinkflation’ by manufacturers desperate to sidestep rising commodity costs. So are consumers going to have to get used to less cocoa in their favourite chocolate?

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Source: London Strategy Unit

To recap, cocoa futures prices surged by almost two-thirds since early 2013 as Asian consumers rapidly developed a sweet tooth, leading to a depletion in cocoa inventories. Prices reached a three year high in September of $3371 per tonne amid concern that spread of Ebola would disrupt the harvest and shipments of cocoa from West Africa (home to 70% of global cocoa supply). In the end there was no disruption to supply and the spread of Ebola in the region appears to now be under control.

Manufacturers were left spooked by Ebola. Many are thought to have taken precautions, bulking up on purchases to assure themselves of not facing a shortfall if the worst case scenario of Ebola disrupting the Ivory Coast occurred. Now that fear has subsided it has left the market vulnerable to a further spill as those that bought forward aggressively no longer needed to shore up stocks.

Cocoa futures prices fell to a one year low on Friday of $2755 per tonne as demand from cocoa processors fell sharply. The Cocoa Association of Asia announced that grindings in the fourth quarter of 2014 fell 17% from a year earlier. Grindings data measure the tonnage of cocoa beans factories process and are considered a barometer of cocoa demand. European and North American processors also announced larger than expected declines.

While weaker economic growth is likely to keep cocoa prices under pressure, the longer term outlook looks a lot more challenging. According to agricultural trader Olam, global consumption of cocoa powder used in ice creams, cereals and beverages will rise by 44% by 2024-2025 while demand for cocoa butter, a product that accounts for as much as 20 percent of the weight of a chocolate bar, will grow 48% over the same period.

Olam estimate that prices will need to rise to $3300-$3600 per tonne to boost cocoa production currently constrained by land scarcity and low yields. Given that it takes 3-4 years for cacao trees to mature and produce blossoms it could be some time for recent high prices to result in a supply response and an improvement in yields.

In summary, the recent downturn in cocoa prices is likely to be brief. Enjoy your favourite chocolate while it lasts.

Related article: What risk does Ebola represent to commodity markets?

What impact will Euro QE have on commodities?

Following (but not exactly hot on the heels) of the US, UK and Japan, the Euro-zone is finally about to pump billions of Euro’s into their economy in the hope of getting it kick started and avoid the threat of deflation. The size of the monthly bond-buying stimulus, expected to be announced on Thursday, could total as much as €1.1 trillion (£840bn), or €50 billion per month according to reports. So what, if any impact will it have on commodity markets? The first thing to note is that markets have already priced in a very high probability of some form of quantitative easing being announced today. Having said that the size of the stimulus now being thought likely is twice what was originally expected.

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La2-euro” by This photo (C) Lars Aronsson – Own work. Licensed under CC SA 1.0 via Wikimedia Commons.

If you look at commodity prices after the introduction of quantitative easing (QE) in the US by the Federal Reserve, they initially jumped as expectations rose that the waving of a magic wand would lead to a return to growth giving a boost to commodity demand. This played out for a while but commodity prices plateaued and then fell as demand growth disappointed.  Indeed a large bout of QE may be seen as a sign of how bad things have got in Europe and do little to revive demand. The key commodity where the impact is likely to be felt is gold. When coupled with the uncertainty over the Greek election this Sunday and other recent events  this could boost demand for gold as a safe haven asset.

The Euro has been under pressure versus the US dollar and is likely to see further weakness if full blown QE is announced. One impact of this will be to increase demand for those commodities that the Euro-zone exports, wheat and barley for example. Commodity buyers in the Euro-zone are also likely to face higher commodity import bills. Despite the recent media attention, in Euro terms commodity prices are actually up by almost 5% over the past year according to The Economist commodity price index.

More on Goldman’s oil price forecast

 Goldman Sachs has warned that WTI crude prices could fall below its 6 month forecast of $39 per barrel (~$43 per barrel for Brent).
To accommodate the substantial expected first half inventory build and using the storage arbitrage to the one-year ahead swap, we are revising down our 3-, 6- and 12-month price forecasts for Brent to $42/bbl, $43/bbl and $70/bbl, respectively, from $80/bbl, $85/bbl and $90/bbl, and for WTI to $41/bbl, $39/bbl and $65/bbl from $70/bbl, $75/bbl and $80/bbl. The later expected trough in WTI prices is due to excess US storage capacity.
Looking further ahead the market is expected to balance perhaps providing a floor to prices.

Once a 2H15 US supply growth slowdown is more certain and given the very high decline rates on US production, renewed Libyan disruptions and an already visible demand response in the US, we expect the market to rebalance with inventories drawing rapidly from 3Q15 onwards.

However, future rallies could be thwarted by the speed at which any lost shale output can recover.

“Shale has fundamentally changed this market…The lead time between when you put money in the ground and when you get production has collapsed from three-to-four years, all the way down to 30 days.”

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Related article: Oil price floor now $35-$40 per barrel