Laurent Pipitone has worked for the International Cocoa Organization since 2004 and has been Director of its Economics and Statistics Division since 2011. He holds a master's degree in economics from the University of Paris, Panthéon Sorbonne (Paris 1) and has previously undertaken a number of research and consultancy projects at the Organization of American States (OAS) and the London Business School.
Since the collapse of the International Commodity Agreements in the 1980s, the international cocoa trade has been ruled by the futures market. Developments in 2007–2008 led many participants to question the operation of speculative markets of this kind, and in particular to examine their impact more closely. What is the current situation? How are these instruments viewed today?
Laurent Pipitone, Director of the Economics and Statistics Division of the International Cocoa Organization gives us his analysis.
Q: There are a number of current initiatives aiming to make the cocoa supply chain more resilient and so increase global production. Is there a risk that these will eventually affect cocoa prices?
Chocolate manufacturers are expecting significant supply deficits over the long term, with cocoa plantations aging and the average age of cocoa farmers also rising. In their view, much remains to be done before this trend is reversed.
Several years ago, after a number of consecutive years of deficit, the International Cocoa Organization (ICCO) was also concerned that we were entering a period of structural supply deficits. But the crisis that began in 2007–2008 led to a dramatic change in demand trends for cocoa and chocolate, and we are once again seeing supply surpluses. But for the economic crisis, it is estimated that 6 of the past 7 years would have recorded supply deficits.
In consequence, the ICCO thinks there is no real cause for concern in the short term, especially as cocoa stocks are high. But the problem of structural deficit persists in the medium term. Cocoa growers remind us that, while we are constantly asking them to invest, they have no wish to produce surpluses that would prompt a fresh round of falling prices.
Long-term trends remain difficult to assess. It is hard to measure the impact of the various initiatives designed to promote more sustainable cocoa production. We have very little country-by-country information, with no data on the exact size of the planted area, and nothing profiling the plantations in different regions. Thus far our main long-terms concerns centre on the risk of supply deficits, so this is where we must focus our activity, while still endeavouring to improve our assessment of the situation on the ground.
Q: Futures markets respond to speculation as well as market fundamentals. Given current levels of concern over the resilience of the cocoa supply chain, is this still the most appropriate market mechanism? Are the ICCO, multinationals and governments considering other pricing arrangements, alongside their training projects and schemes to distribute seeds and fertilisers?
Supply and demand remain the best means of determining prices on the international market. The cocoa futures markets in London and New York play a particularly important role, providing a benchmark figure which helps to determine the price payable. When prices rise on the two futures markets, so too does the farm-gate price, and vice versa.
The ICCO in the past acted to stabilise prices by releasing buffer stocks and maintaining prices within a given range, but this proved ineffective.
However, the operation of the market in general, and financial markets in particular, is far from perfect. For example, there is a lack of transparency regarding transactions concluded on the London cocoa market. We have insufficient information on the positions adopted by different market participants, whether speculators or the chocolate manufacturers who buy cocoa beans on the physical market, and on the concentration of these positions.
An external regulatory authority is required to prevent the acquisition of dominant positions, place limits on the positions taken by speculators, provide comprehensive statistics on authorised stocks, and publish the movements of market participants. Some progress has been achieved recently but it has not yet gone far enough.
Then, for the cocoa-producing countries at least, there are problems of making this data accessible to strengthen their position vis-à-vis the buyers, and especially of a lack of agricultural organisations and access to services.
We are addressing all these problems: transparency of markets and information, data collection, regulation of the futures markets etc.
A few years ago, we looked at the impact of financial markets on prices. Do they produce more or less price volatility, i.e. price increases and decreases linked to speculation? We also examined the purchase by a London-based hedge fund of more than 240,000 tonnes of cocoa futures contracts expiring in July 2010. The size of this trade gave the operator de facto control of the July futures market. Why did this happen and how can we avoid this kind of problem in future? We issued recommendations, and the London futures market responded by implementing a number of measures – insufficient maybe, but measures were taken.
So we have no problem with futures markets in principal, but we are working on ways of improving the way they operate.
Q: So you are not questioning the existence of commodities futures markets, in themselves a type of financial market?
What we do question is their operating environment and their regulatory regime. But, for us, the principle of a futures market is essential, because it is this financial market that provides us with a benchmark world price. We have no idea, for example, how much Barry Callebaut pays such and such a cooperative for its cocoa beans. Only the financial market gives us a benchmark price for use by mutual agreement for all transactions on the world market. It provides a transparent means of conveying information.
Q: But in the case of other commodities – such as flowers at the clock auction in the Netherlands, tea at the auctions in Mombasa, Calcutta etc., even tobacco in Zimbabwe – supply and demand are matched on a significant scale without the element of speculation evident on the cocoa futures market. These are markets that exist to provision the supply chain, not speculative financial markets...
The ICCO is thinking about setting up commodity markets in producer countries with a view to reducing transaction costs and rendering cocoa growers less vulnerable to price volatility and other risks, shortening the value chain and improving its effectiveness, strengthening the negotiating position of small growers, improving the supply and transparency of market information, and increasing access to sources of finance at reasonable cost. We are about to commission a feasibility study on creating such a system in Côte d’Ivoire. We are optimistic that it will help to improve the income of cocoa growers and their standard of living, so contributing to a more sustainable cocoa economy. But bear in mind that there are a number of constraints. A variety of experiments conducted in East Africa in sectors other than cocoa have not all been productive. We are currently evaluating the situation.
However, the financial market as presently defined retains an important role in the transmission of information on prices, market liquidity etc.
Q: But markets such as those for flowers and tea also fulfil these conditions. In reality doesn't the role of speculation in food commodity markets still remain open to question.
This topic has prompted significant debate. The IMF, World Bank, UNCTAD, IFPRI and FAO combined to produce a number of studies under the auspices of the G20 during France's presidency 2 years ago. These studies did not conclude that financial markets produced distortions in physical markets. Although such distortions may occur in the short term, this is not the case in the long term.
We conducted similar studies a few years ago, examining price volatility and price levels, and we too were unable to identify any medium- or long-term distortions engendered by financial markets. So short-term distortions may occur from one week to the next but they have only a short-term impact.
Overall, the majority of international organisations investigating the issue agree that, in a futures market, price movements are nearly always determined by fundamentals. Spikes may occur over a period of weeks, but these are almost always the result of an underlying fundamental, such as drought.
Q: So can we conclude that futures markets contribute in some degree to the resilience of the cocoa supply chain?
They play an essential role in the smooth running of the market. Despite a number of flaws and areas for improvement, they are integral to the smooth running of physical markets.