Valentine's Day: The chocolate crisis

Cocoa futures have broken records, passing $5,000 per metric ton after crop disease and extreme weather hit the main growing regions of Côte d'Ivoire and Ghana. That makes for a bitter Valentine's Day for chocolate makers and their customers, and a hard test of how much pricing power the confectioners really have.

The two West African countries grow roughly 60 per cent of the world's cocoa, so trouble there sets the global price. Heavy rains linked to El Niño spread black pod disease through the orchards last year, and swollen shoot virus has been killing ageing trees in both countries for years. The price has roughly doubled in a year, and the market is braced for another season in which demand outruns the harvest.

Why supply cannot respond

High prices would normally call forth more beans, but cocoa is slow to answer. A newly planted tree takes several years to bear a worthwhile crop, and much of West Africa's supply comes from smallholders with old trees and little capital. Both governments fix the farmgate price each season and sell much of the crop forward, so growers capture only a slice of the rally on the exchange. Farmers who see little of the windfall have little reason to spend on fertiliser or replanting.

Other constraints add to the squeeze. Illegal gold mining has spread across parts of the cocoa belt, taking land and labour away from farms. The European Union's regulation on deforestation, due to apply from the end of this year, will require importers to prove that their cocoa was not grown on recently cleared forest land, which limits the scope for expanding plantations into new areas. Production elsewhere, in Ecuador, Brazil and Indonesia, is growing but cannot replace West African volumes quickly.

That leaves the adjustment to demand. Grinders such as Barry Callebaut, the world's largest chocolate maker by volume, sell much of their output under cost-plus contracts that pass bean prices through to their customers. The branded companies at the end of the chain have no such cushion, and must decide how much of the bill to hand to shoppers.

How the futures market amplifies it

Cocoa trades on exchanges in New York and London, and the market is small compared with those for oil or grains. When physical supplies tighten, commercial buyers rush to secure beans at the same time as speculative funds pile into a rising trend. Exchanges respond by raising margin requirements, forcing traders to post more collateral, which drains liquidity and can make prices swing more violently. Futures prices can therefore overshoot what the physical shortage alone would justify, though the underlying deficit is real.

Hershey and Mondelez squeezed

Global chocolate makers such as Hershey and Mondelez face soaring input costs that ordinary hedging contracts cannot easily cover. Passing double-digit price rises on to consumers already tired of inflation risks lost sales as shoppers switch to cheaper treats. Smaller bars and changed recipes help only up to a point before the brands suffer.

Hedging buys time and nothing more. The big confectioners typically lock in their cocoa months ahead through futures and forward purchases, which is why today's price has yet to hit their accounts in full. As those contracts roll off, replacement cover has to be bought at the new level. A price that stays above $5,000 for a year becomes a cost that no treasury department can avoid.

The exposure differs by company. Hershey earns most of its profit from chocolate sold in North America, so bean prices go straight to the heart of its business. Mondelez owns Cadbury and Milka but also sells Oreo and other biscuits, which dilute its dependence on cocoa. Both face Easter at the end of March, one of the biggest chocolate seasons of the year, with costs rising under them.

The case for the brands

The confectioners have a strong rejoinder. Over the past two years packaged-food companies pushed through repeated price rises while keeping most of their customers, and chocolate is a small, habitual purchase that shoppers rarely scrutinise. Cocoa is also one ingredient among several, alongside sugar, milk, packaging, labour and marketing, so a doubling of the bean price does not double the cost of a bar.

That defence was built in a period when wages were catching up with prices and shoppers had savings to spare. Volumes across many food categories weakened last year as price rises accumulated, and supermarkets' own-label products have gained ground. Weight-loss drugs add a newer worry for snack makers about how much people will eat. Each fresh price rise now meets a customer with less patience than in 2022.

Past shocks suggest the pain can last. In 2011, after a disputed election in Côte d'Ivoire led to a temporary halt in exports, cocoa prices jumped before falling back once the crisis ended and shipments resumed. That episode was a political interruption to an otherwise healthy crop. This time the problem lies in the trees themselves, which disease and age have weakened, and no political settlement will fix it within a season.

What to watch

The signals are the West African mid-crop harvest that begins in April, arrival figures at Ivorian ports, and whether the rains return to normal. On the demand side, grinding data for each quarter show how much cocoa processors are buying, and falling grind numbers would suggest that higher prices are already denting consumption. The confectioners' own quarterly reports will show how much volume they are prepared to give up to protect margins.

Cocoa's surge shows the limits of brand pricing power. Hershey and Mondelez will probably have to absorb much of the cost this year, and their gross margins will show it, most visibly in the results that follow Easter as cheaper hedges run out.