West Africa’s important role in cocoa production emerged during the first chocolate boom in the early twentieth century, when chocolate consumption in Europe and North America grew by a factor of 10 between 1900 and 1940. West African countries obtained a production share of almost 70% by 1930 (Poelmans and Swinnen 2016), with growth particularly strong in the Gold Coast (now Ghana). While British and, to a lesser extent, French colonial authorities initially tried to enforce the implementation of large estates, indigenous farmers’ successful resistance in favour of small-scale farming was viewed as a main driver of the expansion, in addition to the use of the more robust and productive Forastero cocoa bean type (Ross 2014; Clarence-Smith 2000; Dand 2011). Cocoa production also benefited from this smallholder production system when declining prices during the interwar period made cocoa production unattractive in Latin America’s more plantation-based systems (Kofi 1976; Hecht 1983). Côte d’Ivoire’s cocoa sector experienced notable growth only after attaining independence in the 1960s when national policies incentivised expansion of the sector (Hecht 1983). West Africa remains the dominant global region for cocoa production, with a 76% share of global production in 2020, followed by Latin America, with 18%, and Asia, with 6% (ICCO 2020).
National and International Institutional Changes
At the producer country level, different regulatory frameworks played a role in internal and external cocoa marketing to stabilise prices of outputs and inputs for smallholder producers after World War II (WWII). In West Africa, price stabilisation was introduced under colonial rule during WWII in the context of high price volatility during the largely unregulated interwar period. In Ghana, this also was related to resistance to the oligopsony of British traders and related local struggles (known as ‘cocoa holdups’). However, European traders’ interests were still entrenched in the new institutions (Alence 2001). While Ghana and Nigeria established marketing boards with direct interventions in physical trade, Côte d’Ivoire and Cameroon operated price stabilisation funds based on the French caisse systems, leaving physical handling to private actors (Kofi 1976; Gilbert 2009). The stabilisation mechanisms largely remained after these countries attained independence. In Ghana, the price stabilisation mechanism secured public revenues that were used for general public expenses (as was also the case during the colonial period; Bauer 1954) and for industrialisation efforts, with party politics playing an important role (Whitfield 2018). In Côte d’Ivoire, revenue generation was also an important motivation, along with expansion of cocoa production (Hecht 1983).
National price stabilisation measures in the cocoa sector were accompanied by international regulations after WWII. This included the creation of the Alliance of Cocoa Producing Countries (COPAL) in 1962, comprising West African producers and Brazil, which aimed to coordinate national regulations and unsuccessfully attempted to increase cocoa prices in 1964–1965 by limiting supply (Hütz-Adams et al. 2016). In 1972, the International Cocoa Commodity Agreement (ICCA) was initiated to keep cocoa prices within defined price ranges through buffer stock interventions. However, the ICCA was not effective (unlike some other ICAsFootnote 4) due to internal conflicts, lack of financial resources, initial non-participation by the US and Côte d’Ivoire’s temporary exit in the 1980s, as well as the rise of Indonesia as an important non-member producer country (Varangis and Schreiber 2001; Gilbert 1996). Throughout the 1970s, the world cocoa price remained above the price ceilings set, but this trend was reversed during the 1980s, when buffer stocks were unable to lift the world price above the set floor price (Gilbert 1996; see Fig. 1).
Also, an attempt by Côte d’Ivoire, which became the top producer country in the 1970s, to halt decreases in world prices through an export embargo from 1987 to 1989 (known as the ‘cocoa war’) was unsuccessful (Gombeaud et al. 1990; Losch 2002). The Ivorian Caisse de stabilisation (CAISTAB) engaged the French trader SUCDEN to store 200,000 tons of cocoa. However, most buyers anticipated this very costly stockpiling and waited until Côte d’Ivoire lifted the blockage in 1989, drawing on their own stocks or turning to other producer countries, such as Malaysia or Indonesia. Ivorian producers were the ‘forced funders’ of the embargo, given that they sold their beans at lower prices (Gombeaud et al. 1990). This demonstrated producer country governments’ limited power to control global exports, even in the case of the largest producer.
In the context of the non-functioning of the ICCA, price declines in the 1980s, financial constraints and rent extraction in national price stabilisation systems, and broader shifts towards market reform under the SAPs, state-controlled cocoa-marketing systems largely were abolished or reformed in the 1980s and’90s (Varangis and Schreiber 2001). Major donors considered liberalisation, i.e. changing the state’s role from a ‘marketer’ to a ‘regulator’ (Akiyama et al. 2001), as a way to increase transparency within sector institutions, lower marketing costs, raise farmers' incomes and increase competition through private operators (Varangis and Schreiber 2001). While Cameroon and Nigeria liberalised their marketing systems in the 1980s and’90s, Côte d’Ivoire and Ghana held on to their institutions, but reformed them, with Côte d’Ivoire abolishing price stabilisation from the late 1990s to the early 2010s. Through the lapse of the economic clauses, price regulation also was removed formally from the new ICCA in 1993 (Fold and Neilson 2016).
Continuing efforts to promote and (re-)regulate the national cocoa sector have been particularly pronounced in Côte d’Ivoire and Ghana, given their high dependence on cocoa. This dependence remains most significant in Côte d’Ivoire with 1.3 million smallholders in the cocoa sector (Hütz-Adams et al. 2016) and an export share of cocoa products, including beans and semi-processed products, in merchandise exports totalling 48% in 2020. In comparison, Ghana has around 800,000 cocoa smallholders, but the export dependence has decreased to 16% in 2020 because of gold and oil extraction since 2018 (UN Comtrade 2021). In other cocoa-producing countries in West Africa, Latin America and Asia, government intervention largely has been limited to productivity and quality improvements since the 1980s and’90s (Oomes et al. 2016).
Grinder-Traders and Commodity Derivatives Markets
Through liberalisation in producer countries, transnational companies, i.e. chocolate manufacturers and grinder-traders, increasingly have dominated the cocoa GVC (Fold 2002). As chocolate manufacturers divested from producing semi-processed products (liquor, butter and powder) and related warehousing to focus on their higher-value core activities, the processing (grinding) and trading segments consolidated. Traders specialising in cocoa who traditionally acted as intermediaries between state-controlled exporters and chocolate manufacturers largely disappeared. Instead, large multi-commodity CTHs took over cocoa grinding and trading, using new processing technologies, their know-how in newly introduced bulk transportation of cocoa beans and their financial capacities to generate economies of scale and scope (Fold 2002). Considering that bulk cocoa can be transported in grain carriers, traditional grain traders, such as Cargill and ADM, entered the cocoa sector, allowing them to conduct business on both arms of the Europe-to-West Africa trip (Fold and Neilson 2016).Footnote 5 Large cocoa grinders also merged with cocoa traders and integrated sourcing and trading activities (Fold and Neilson 2016). We term these actors grinder-traders because they fulfil a dual role in the cocoa GVC by buying cocoa beans from exporters, processing them and selling semi-processed products to chocolate manufacturers. Given their intermediary role and considering that both cocoa beans and semi-processed products are priced relative to futures prices (Araujo Bonjean and Brun 2016), price risk management is crucial for these actors, as with other CTHs.
Thus, the cocoa GVC today is characterised by two highly concentrated downstream segments, which has been described as ‘bipolar’ governance (Fold 2002); some scholars also refer to ‘tripolar’ governance given the increased role of retailers (Fold and Larsen, 2011). Since the 1980s, the Big 6 chocolate manufacturers (Mars, Mondelez, Nestlé, Ferrero, Hershey and Lindt & Sprüngli) have dominated the production of chocolate products, accounting for 65% of cocoa consumption in 2016–2017 (Fold and Neilson 2016). After several large-scale mergers and acquisitions in the 2010s, the top four grinder-traders (Barry Callebaut, Cargill, OlamFootnote 6 and EcomFootnote 7) accounted for 75% of global cocoa processing and trading in 2016–2017, with only two—Barry Callebaut and Cargill—being in charge of nearly half of the market (Fountain and Hütz-Adams 2018). The main grinder-trader factories are located in the Netherlands, Germany and France, and often are located near those of chocolate manufacturers, thereby generating economies of agglomeration in addition to economies of scale and scope (Araujo Beaujean and Brun 2016).
This concentrated structure on the buying side leaves cocoa exporter countries with few counterparts that have large-scale and often multi-commodity operations and have pursued increasingly similar price-setting and price risk management strategies that centre around derivatives markets. Commodity derivatives markets for cocoa were established in 1925 in New York and in 1928 in London during the first cocoa boom and have served as a reference point for world prices since then (ITC 2001).Footnote 8 According to grinder-traders interviewed, prices of only a minimal share of cocoa—estimated at less than 5%—are delinked from futures prices, encompassing high-quality fine or flavoured cocoa that largely originates from Ecuador, the Dominican Republic and PeruFootnote 9 and often is produced under traceable conditions (see also Fold and Neilson 2016). As a sector expert noted, ‘there is only marginal trade from origin to chocolate manufacturers, and the large entities buy and trade cocoa beans to feed their grinding facilities. They also have the financial power to serve the capital requirements to hedge with futures’. Thus, large grinder-traders hedge all their physical transactions, whereas smaller traders have faced challenges to meet financial requirements for derivatives trading in addition to difficulties in pursuing high-volume bulk trade. These factors have contributed to consolidation and pushing remaining small actors towards niche markets (Gilbert 2009).
For hedging to be effective, prices in physical trade must reflect futures prices. Hedging requires taking a position in derivatives markets that opposes a physical position by holding the right (‘options’) or obligation (‘futures’) to buy or sell a physical commodity in the future at a given price. This allows for profits and losses from derivative and physical transactions to add up to zero and eliminate price risks. Price-setting practices that grinder-traders use in buying and selling transactions ensure these interrelations. After market liberalisation, transactions between grinder-traders and exporters moved generally away from ‘fixed-price-forward’ (or forward or outright) contracts to ‘spot price’ and ‘price-to-be-fixed’ (PTBF) contracts in producer countries without parastatals. While forward contracts can mitigate price risks for the duration of the forward contract by fixing prices when the contract is signed in advance of delivery, spot and PTBF contracts expose exporters to price variations because prices are fixed only at the time of delivery (which is the same as the time of signing the contract) for spot contracts or at the time of fixing (i.e. between the time of signing the contract and delivery and based on the counterpart’s decision) for PTBF contracts. Grinder-traders, like other CTHs, can integrate all three contract types into their price risk management as long as the reference price in physical contracts is based on futures prices. However, they generally prefer spot contracts on the buying side because they avoid counterparty risks.Footnote 10 For exporters in producer countries, spot and PTBF contracts increase price risk exposure because prices are linked more closely to short-term price movements on commodity derivatives markets.
On the selling side, grinder-traders sell semi-processed products such as cocoa liquor, butter or powder. A leading grinder-trader interviewed summarises: ‘On the buying side, we generally buy spot where there is no government involvement. And PTBF contracts are industry standard with chocolate manufacturers on our selling side’. PTBF contracts ensure delivery of specified volumes of semi-processed products in advance, while prices are included as a ratio to futures prices but not determined yet. This enables chocolate manufacturers to lock in prices according to their own assessment of price developments and allows grinder-traders to hedge their price risks flexibly through futures contracts. As liquor is produced first, then either butter or powder, the price ratios for butter and powder are related and typically offset each other, i.e. combined butter/powder ratios remain relatively constant. Some grinder-traders also supply industrial chocolate, which is not priced relative to futures (Fold 2002; Araujo Bonjean and Brun 2016).
Since the 1990s, grinding increasingly has taken place in producer countries— particularly in Côte d’Ivoire, Ghana, Indonesia and MalaysiaFootnote 11—related to shifting GVC dynamics due to technological advances in transportation and producer country governments’ incentives (Grumiller 2018; Fold 2002; Gilbert 2009). However, this largely is done by grinder-traders that buy cocoa beans in producer countries, process them in their facilities in producer or consumer countries, and then trade processed products internally with their headquarters before they sell to chocolate manufacturers (van Huellen 2015). Thus, the key external transactions from a grinder-trader perspective, in which price-setting is relevant, entail buying cocoa beans from actors based in producer countries and selling semi-processed products to chocolate manufacturers.
Industry standards concerning contracts are important in terms of ‘working rules’, as van Huellen (2015) calls them, for actors engaging in physical trade. The two major trade associations in the cocoa market—the FCC for European markets and CMMA for North American markets—provide such contract rules, which generally are the basis for negotiations on actual contracts and for arbitration services (Dand 2011). The FCC currently has around 190 members, including cocoa grinder-traders and chocolate manufacturers, as well as financial actors, such as hedge funds and futures exchanges, along with producer country institutions from Ghana and Cote d’Ivoire. The FCC has drafted contracts and contractual rules for trade in cocoa beans, which are used in around 80% of the global cocoa trade, as they are the standard for West African exports. These rules are particularly important with regard to delivery/transport and arbitrage, as well as quality standards and payment terms, but they do not say much about price benchmarks and other price-related stipulations. The exception is PTBF contracts, in which the use of futures prices is recommended, given the higher chances for disagreements.
Financialisation of Commodity Markets
Since their establishment in the 1920s, cocoa derivatives markets have served as a means for price discovery and hedging, and as a place for speculative activities (Close 1959; Hieronymus 1977). Derivatives markets for cocoa and other commodities experienced strong inflows of speculative funds, particularly in the 1970s (Labys and Thomas 1975; see Mallaby 2010 for an example of the Commodities Corporation Fund, arguably the first hedge fund) and 1980s, when tradeable commodity indices were launched (Berg 2011). Financial actors’ role grew in the 2000s as investment banks, hedge funds and institutional investors entered these markets on an even larger scale linked to deregulation in the EU and particularly the US, and the spread of electronic trading, which allowed for new, more complex and short-term trading strategies (Engel 2019). Between 1986 and 2005, open interest in New York cocoa derivatives, i.e. the number of futures and options contracts not yet settled, grew five-fold, but commercial traders, which use futures contracts for hedging, remained the dominant trader class, comprising 70% of open interest. However, since 2005, this share has decreased, and the further doubling in open interest has come primarily from financial actors. Disaggregated open interest data available since 2006 indicate that the share of the producer/merchant/processor/user (PMPU) category, comprising commercial traders, actually declined to 43% in total open interest and to 34% in long contracts’ open interest. Most open interest positions in 2020 were held by financial actors, including managed money (32%), swap dealers (also called index investors) (7%) and other reportables (14%) (CFTC 2021). Open interest data for London cocoa derivatives also indicate that financial actors hold a substantial share of open interest, but the average share of PMPUs with 67% remained higher compared with New York (ICE 2021).
Financial actors’ growing activities and dominance on commodity derivatives markets since the early 2000s, known as the ‘financialisation of commodities’, have triggered debate over their impact on commodity price dynamics (see, e.g. Ederer et al. 2016). Similar to other commodities, the empirical evidence for cocoa is mixed, as Haase et al. (2016) demonstrated in a meta-review. Cocoa often is included among other agricultural commodities in studies that look for commodity index investors’ impacts on commodity prices (Wimmer et al. 2021). Even though most of these studies find no general impact of index investor activities, several findings indicate a stronger effect on cocoa prices and other studies find impacts on cocoa futures returns (Sanders and Irwin 2017; Aulerich et al. 2013; Capelle-Blancard and Coulibaly 2011; Guilleminot et al. 2014), but Sanders and Irwin (2011) see a dampening effect from index investors on realised volatility. Van Huellen (2015) show that index investors impact the cocoa futures curve; thus, it can be a misleading indicator of fundamental demand and supply conditions. However, no extant studies exclusively have assessed the impact of money managers (particularly hedge funds) that generally pursue more short-term, long- and short-trend-following or algorithmic-based trading strategies on cocoa futures’ price dynamics.
In the context of increased volatility in cocoa futures prices since the mid-1990s, the interviewed sector experts and industry actors also view increased speed, complexity and short-termism of derivatives’ trading as a challenge for hedging, but also as an opportunity for actors with financial capacities. A top grinder-trader interviewed stated that ‘the role of other actors [on futures markets] using algorithms has grown (considerably), leading to much greater spikes, greater trading range (than) we have ever seen and greater dislocation from the fundamentals, which is challenging’. Another grinder-trader interviewed added: ‘Things happen in cocoa prices that fundamentally make no sense—algorithms make that happen’. However, he noted that this also ‘provides liquid markets and presents opportunities for us’. In particular, large multi-commodity grinder-traders, such as Cargill and Olam, have used these markets for financial business strategies, creating their own financial services units or hedge funds, investing on their own account, managing third-party money and selling investment products to physical and financial clients in the 2000s (Gibbon 2014; Murphy et al. 2012; Salerno 2016). However, most grinder-traders have closed or spun off their own funds in recent years and are focussing more on complex, structured and customised financial hedging services, as well as on over-the-counter markets that allow for more complex products and on market intelligence as part of their core business (Trafigura 2019; van Huellen and Abubakar 2021). A trader at a top grinder-trader explains it: ‘We can offer price-insurance with profit opportunities to chocolate manufacturers on top of the physical sales. We build on PTBF contracts and integrate exotic derivatives that are increasingly traded over the counter in London and New York’. These processes have contributed to further consolidation among grinder-traders, as well-developed financial units provide a competitive edge, compared with smaller traders with limited access to financial markets, information and resources (Newman 2009; van Huellen and Abubakar 2021).