Shea Butter – Solidity Trade Blog

Cocoa largest producers market has begun to be affected by the global market liberalization at the same time with the entire agricultural goods markets, in the eighties. The same phenomenon has exposed the small cocoa producers to the fluctuation of the international global prices.

The increasing cocoa price instability made it more difficult for the cocoa producers to plan their production activities. The same reason affected long-term investments and the chances to obtain credits for cocoa farmers. Especially the small cocoa producers faced the increasing financial and economic problems because of the instability and unpredictability of their farms income.

In the late twenties, cocoa production was found to be appropriate for the implementation of the price risk management strategies by assessing its feasibility by using derivative contracts in order to migrate the instability of prices. The idea of this strategy is to reduce the exposure of the small cocoa producers to the world market prices fluctuations, this way offering them the opportunity to drive their incomes to become more secure.

The general intention of these measures is to create and implement a price risk management strategy for cocoa producers, having some specific objectives such as:

Ø  to decrease the exposure of small cocoa producers to price instability on the international market;

Ø  to develop the capacity that enable small cocoa farmers and cocoa producers organizations to make more judicious production and investments, based on more realistic decisions and price expectations.

#1 The first step in managing the price risk is to consult cocoa producers, hedging service providers and local banks in order to establish a clear agreement on the stages to be followed in their collaboration.

#2 The next step in managing the price risk is to measure the price risk faced by cocoa producers, to select the suitable hedging tools, to instruct cocoa producers, exporters and local banks and to draft the hedging contracts.

#3 Executing the hedging contracts and measuring the results of these actions, while offering management, monitoring and supervision to the precedent stages, is the third step in this action.

#4 The introduction of market-based price insurance is of great benefit to cocoa producers. This is especially so for those small producers who rely heavily on the income from cocoa farming. The market-based price risk management system help small cocoa producers to make more competent production plans and long-term investment choices, by reducing downside price risk.

Local institutions also benefit from this kind of operations because the prices risk management is an expression of a potential policy device made to provide cocoa producers with a floor price. A part of the resources of the price risk management must be allocated to contracting consultancy service, international/local banks and exporters that are usually reluctant to participate in this. Authorities have the power to improve the accessibility to the cocoa terminal markets by adapting the financial and legal institutions. Direct accessibility to futures and options markets allows cocoa groups of producers to have cocoa trading financial facilities and lower brokerage fees.

The price risk management strategy sometimes must be updated and new procedures to be developed. The consultancy groups approach international cocoa exporters to better examine their possible role in this kind of operations. The general development of the world cocoa market might press to a rethink of this approaching mode. Usually, the minimum price set by the price risk management strategy is well below the farm-gate cocoa price and this is why, sometimes, the strategy needed to be reformulated. As a conclusion, the price risk management can be an efficient instrument in maintaining farm-gate cocoa prices at a certain level to help cocoa producers, especially the small ones.

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The practical advice from manufacturing companies to farmers is to produce a better quality of cocoa beans. Most of the European and American companies will buy cocoa bean from cooperatives established in the Countries that grows cocoa trees. The cooperatives lack the means of transporting the beans to the ports that result to establishment of buying stations.

These buying stations facilitate the flow of buying cocoa beans from small trading farmers
to the manufacturing companies. The stations are the export terminals where qualities are
checked with every individual sack of beans from top to bottom. The checking of qualities of beans is checked in buying stations but there will be more extensive testing prior to processing in manufacturing plants.

The analysis that determines the quality of a cocoa includes odor, color, moisture content,
and the cutting test of beans. Moisture content of beans must be determined and analyze if it was dried properly or not. Those that obtain high level in moisture will result to short shelf life and needs more process of drying. The color inside the beans must also be analyze and check to determine if it was harvested early or not. The colors inside the bean are check through a cutting test in half. Colors are judged through percentage of violet and slate colored beans.

Violet colored beans is defined as those that have been sufficiently fermented while the slate colored beans are those that have not been fermented well.

The odor is tested through the absence of hammy off flavors and absence of smoky odors. If these odors are not present they are of good quality. Other analysis is checking the number of beans and the percentage of double beans. And also the percentage of foreign materials and dust should be found in maximum limits. This is the standards in checking of beans at the buying stations. When the beans arrived at the manufacturing company another analysis must be introduced. A sample of beans must be checked and tested through chemical reaction of its odor, appearance, and odor.

The chemical testing is to determine fat contents, free fatty acids, and ph. The ph value should be present to obtain proper fermentation in acquiring the desired flavor of cocoa products. Fat contents should be determined before processing to obtain production of cocoa mass. The required level of free fatty acids must be low in cocoa seeds to obtain the maximum values needed. These are the analysis to determine the qualities of all cocoa products. It should meet the required testing and checking before the process of manufacturing. This is to ensure a quality cocoa product which comes from quality testing and analyzing.

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Cocoa consuming countries use to create obstructions to the increasing of cocoa
consumption by using indirect taxes and custom tariffs to cocoa and cocoa semi-
products (cocoa liquor, cocoa cake, cocoa butter, cocoa powder) coming into their
markets.

The most important cocoa importers are the European Union, USA, Malaysia,
Canada, the Russian Federation, Japan and Switzerland. The total imports of cocoa
beans and cocoa semi-finished products made by the above mentioned countries
represent over 75% of world trade in cocoa beans and around 50% of world trade in
cocoa semi-finished products.

The administrative authorities of these countries gather revenues from imports of
cocoa beans and cocoa semi-finished products. The average (weighted) Value
Added Tax rate of these countries is about 6.7%, where weights are derived from
imports of cocoa beans and cocoa semi-finished products. Value Added Tax
revenues gathered from the domestic processing of cocoa beans is much lower. In
the latter case, the average (weighted) Value Added Tax rate is about 8.5%, where
weights are deduced from apparent cocoa utilization.

The administrative authorities of cocoa consuming countries gather hundreds
of millions in Value Added Tax revenue. Netherland, Germany and the Russian
Federation occupy the first three positions of this top by gathering the largest sum of
indirect taxes from cocoa beans and cocoa semi-finished products.

Statistics say that imports of cocoa beans and cocoa semi-finished products from
cocoa producing and cocoa consuming countries face an average (weighted) import
tariff of 1.2%, where trade values are used as weights.

Taxes and tariffs used to cocoa beans and cocoa semi-finished products are rather
low compared with standard Value Added Tax rates and import tariffs on agricultural
goods in general.

Imports of cocoa beans and cocoa semi-finished products are generally subject to
either an import tariff or an indirect tax such as Value Added Tax, or both, before
they enter the markets of cocoa consuming states. Both taxes create barriers to the
process of enlargement of cocoa utilization by raising cocoa prices.

Import tariffs augment the landing values of imports by a constant amount per unit
of the product – the specific tariff or a constant percentage of the product’s value
- ad valorem tariff. This way, they generate a wedge between the exporter’s price
and the importer’s price by augmenting the landing price of the imported goods.

Consequently, the imposition of an import tariff reduces the consumption of the
imported cocoa or cocoa semi-finished produces. Import tariffs are above all an
instrument of trade policies to defend domestic industries from external competition.

Value Added Tax, called Goods and Services Taxes in Australia, Canada and
New Zealand, for example, is a significant resource of the national administrations
revenues. This tax is considered to be an indirect tax, as it is gathered from a person,
other than the one who actually support the cost of the tax. It is collected through a
staged procedure where consecutive businesses are allowed to deduct the input tax
on buying and to account for an output tax on sales.

A business estimates the tax due on its sales, than it usually subtracts a credit for
taxes paid on its purchases and remits the difference to the government. Value
Added Tax does not create any incentives/disincentives in favor or against certain
products or services as a result of this staged collection process. In other words,
Value Added Tax has a neutral impact on the consumer’s choice.

Value Added Tax has a neutral effect on the international trade, because the same
rates of Value Added Tax are applied to domestically produced and consumed
products as to imported products. For example, Value Added Tax is not a subject of
discussion in any trade agreement of the European Union though key differences
between import tariffs and Value Added Tax are discussed.

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The terminal markets for cocoa in London and New York play a very important role in the development of prices of cocoa for the entire world. London and New York terminal markets have the role of a standard for the paid prices. If the value of cocoa in these two terminal markets increase, the rate paid to cocoa’s producers increase; if prices in these terminal markets decrease, traders react by paying smaller prices to producers. The terminal markets offer an instrument for the market partakers to protect against price risks, when they are long or short in the physical cocoa market.

It is very important that the terminal markets to be well-organized and competitive markets. The concerns related to efficiency and competitiveness was examined by the authorities in this domain and appears in some official documents. These investigations have found that the price mechanism in the centralized terminal market exchanges is efficient and that futures prices are biased on the forecasts of the spot prices. An examination on the effect of speculators in the New York market shows that non-commercial traders do not worsen the instability of cocoa futures contract prices; on the contrary, their actions seem to have a level maintaining effect.

The activity of the New York market is based on a limited data set while London market does not divulge any data on the trading positions of its market partakers. This is the reason for the events on the London market caused great worries about market clearness and efficiency.

Sometimes it is possible that not enough cocoa in the spot market to be accessible for delivery to the terminal market. At that moment, many shorts are forced to settle their formal agreements in cash with the longs. If one trading house controls an important part of the long positions in a certain year, the trading house will extract profits from the shorts by bidding up the settlement price. This kind of market manipulation also got the name of “squeeze”.

Such a market manipulation necessitate that the speculators to buy of a big number of the futures contracts. Only a share of these long futures contracts are used to “squeeze” the shorts and are exchanged with the shorts at an inflated value.

The company taking this big quantity of cocoa has to dispose of this great volume until a certain date. It will face the risk that cocoa value decrease, so to avoid this risk, the company will sold a very large quantity of cocoa futures contracts on the market. This strategy enables the company to get a profit, on top of the profit realized through “the squeeze”, equal to the difference between the selling prices.

On all terminal markets, as on the cocoa terminal market, everything is done in accordance with the rules governing the exchange of cocoa futures contracts, although there always have been concerns among market partakers about the transparency and efficiency of the cocoa futures market. Important questions related to the efficiency and functioning of the terminal cocoa market and the implications of the current regulations still rises.

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