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The Ivory Coast initially defaulted on a $29m coupon payment to its $2.3bn dollar-denominated eurobonds due 2032 and looks to do the same again vis a vis a $28.6m interest payment due by June 30, per Finance Minister Charles Koffi Diby, though in fairness if the Greeks can get away with putting lipstick on a pig and deeming it a “soft reprofiling” so should anybody else.  To that end at least in the case of West Africa’s jewel there’s cocoa (not to mention oil, coffee, gold, cotton, palm oil and rubber) in them thar hills, a fact not lost on debt holders whose paper has now rallied 58 percent to roughly 55.286 cents on the dollar since its record low on March 16.  Moreover it seems that the path to normalcy is at least doable in one case–the African Development Bank just gave $169 million in budget-support funding while the IMF’s Rapid Credit Facility (RCF) may disburse as much as USD130mn (as well as start talks on a new three-year program which in theory could grant relief for some $3bn of external debt) to repair public infrastructure, production facilities and private property when a committee considers the Ivory Coast’s request for support in July–whereas the other conjures up images of square holes and round pegs (Moody’s now gives you 50/50 odds).  That said, as the IMF is quick to point out per the Ivory Coast, the security situation especially remains “a major concern,” adding that the state’s growth target of -6.3% (+2.4% in 2010) is “ambitious” and its fiscal position can be expected to “weaken substantially” in 2011 (a budget deficit of 8.5% is projected) given lower tax revenue collection and higher expenditures.  Thus, as analysts with Barclays noted, “while the IMF viewed that budget support from bilateral and multilateral donors was likely to be sufficient to cover most of the deficit, it noted that it is unlikely to be enough to cover substantial external debt service obligations due to official creditors this year.”  For now the wildcard continues to be cocoa, exports of which were halted during the crisis, and more pointedly how well President Ouattara is able to smooth over social division and quell ongoing violence–particularly in the western portion of the country which grows 250,000 tons a year, a fifth of national output, but [where] many farmers abandoned their plantations for months because of daily attacks from ethnic militias allied to one side or another [and where] villages were razed, and thousands of people displaced.”  Keep in mind even pre-crisis the infrastructure underpinning yields was questionable at best; throw in deserted farms and the looming threat of black pod disease and the IMF may be right to question future cash flows.

Cocoa prices continue to seemingly stall now a full week now into the one-month export ban imposed by the UN-backed government of Alassane Ouattara, strengthening the case for at least an intermediate top.  May Cocoa surged 7.5 percent last week to an intraday high of £2,307 a ton in London on first word of the impending physical flow disruption, though it just as quickly pared gains and finished up just 2 percent at £2,160.  While later that week the price closed at a six-month high of 2,269, it currently sits at 2,175/ton and–to the degree that the overall market is in surplus (the FT noted that “even taking into account the problems in Ivory Coast, there may be a surplus of about 50,000-100,000 tonnes, breaking four consecutive years of poor crops, the longest shortage period in the cocoa industry since 1965-69″) thanks in part to an above average October-February harvest not only domestically but also in neighboring Ghana (which supplies roughly twenty percent of global supplies, or half that of the Ivory Coast; see chart right), the 33-year high of £2,714 realized last year will likely stick.  Lackluster demand growth will also tend to be bearish for short term prices: Rabobank wrote to clients in December, for instance, that “the slow rebound in growth [in the U.S. and Europe] after the financial crisis is a function of confectioners’ using substitutes such as palm oil and reducing product sizes to support margins” and is likely to continue in 2011.

Political uncertainty aside—a prolonged struggle could disrupt this spring’s mid-crop which in turn could fundamentally disrupt hitherto hedged trading houses and production makers—a long-term secular rise in cocoa remains viable given the lack of infrastructure and investment to date in the Ivory Coast.  Analysts note that “issues range from aging and mature trees which need renewal (cocoa trees mature approximately four years after planting while peak yields can be maintained for about 30 years); the lower usage of fertilisers and pesticide by farmers for tree maintenance and substitution away from cocoa into rubber.  Tempering this envisioned supply shock, however, is the possibility of an enduring uptick in Ghana’s cocoa production capacity—Cocobod, the state’s cocoa board, estimates this year’s crop is already 40 percent higher than last year and believes it will reach its 800,000 ton target by the close of the season (which thus far has helped make up for the estimated 100,000-300,000 tons trapped in Ivory Coast warehouses), and aims to raise annual production to one million tons within two years.  Thus far, officials state, better weather, increased use of pesticide and fertilizer and overall better planting techniques have underpinned the bumper crop.  An additional amount of uncertainty in the market stems from smuggling as well as the possibility of price differentials across countries—Ghana lost around 100,000 tons of beans to the Ivory Coast last year due to price arbitrage.  That said, increased border security and additional quality and monitoring personnel have largely curbed reverse flows, a Cocobod source claimed.

Cocoa’s political impasse-inspired climb (said presidential fracas actually dates back to late 2005, the initial election date) may have legs (March futures hit four-month highs in both London and New York yesterday) if indeed the row in Côte d’Ivoire between Alassane Ouattara and incumbent Laurent Gbagbo (both of whom have sworn themselves in as president) doesn’t subside.  Per one trader: “We need a resolution pronto or the likelihood of unrest could continue. If it gets too hostile at origin, the steamship lines are less likely to visit [Ivory Coast] ports.”  Still an ag-based economy (cocoa, coffee, palm oil), the country is also the continent’s largest rubber exporter and is seeking a bigger presence in oil and gas a la neighboring Ghana.  Yet as The Economist glumly noted over two years ago, any return to the [relative] stability and prosperity it was once known for in West Africa may be difficult to achieve (for vastly different reasons) with either man in control:

“The candidates are not a reassuring lot.  Mr Gbagbo was a fiery opposition leader who fought for years against Félix Houphouët-Boigny, who ruled Côte d’Ivoire for decades. Mr Gbagbo’s clan indulges in rampant corruption, especially in cocoa, which accounts for a third of exports and is worth $1.5 billion a year. With oil soon to be extracted in large amounts, Mr Gbagbo’s people will be keener still to hang on to power. Mr Bédié became president after Houphouët-Boigny died in 1993, made a hash of things, and offers little new. Mr Ouattara, long kept out of politics because his foes said he was not a native Ivorian and so was disqualified, proved his economic credentials at the IMF and in regional economic bodies but might find it hard to hold the fragile country together.”

That said, conditions underpinning the country’s latest crop are drawing kudos from farmers and analysts alike as unseasonal rain mixed with lengthy spells of sunshine during the typically-dry December season should yield higher-than-expected volumes.  Keeping this in mind, says one commodity analyst, markets may be ripe for a sharp correction if, for whatever reason, tensions pass sooner rather than later.

The plight and root cause of surging physical rubber prices in Thailand (the world’s largest producer with 31% of global natural rubber output), Malaysia and Indonesia, as well as rubber futures across various exchanges, somewhat echo that of the cocoa industry in the Ivory Coast: persistent underinvestment in the past and thus a continual dependence on aging infrastructure (i.e., rubber-yielding trees planted in the 1980s and thus just beginning to enter the stage of declining yields, per Macquarie, an investment bank) and a stable-to-shrinking supply of agricultural land–is finally translating into increased volatility in quality and yield.  Coupled with ever-changing weather patterns and voracious demand from emerging markets for tires, condoms and gloves–led by China, whose tire consumption according to the FT grew 57% y-o-y for 1H2010 per Pirelli–and prices are likely to stay trending upward.  The cash price in Thailand gained 1.6 percent to 130 baht ($4.40) per kilogram this week, just shy of the record 130.55 baht on April 27th.  Yet “prices may surge above 150 baht by the end of this year as demand remains robust while supply is limited,” said Supachai Phosu, the country’s deputy minister of agriculture and cooperatives.  Chinese demand, by the way, is likely to increase its upward rate of acceleration, if for other reason than the continuation of a government subsidy for fuel-efficient cars and also the enduring prospect of further surprise rate hikes underpinning current consumption.

Reuters notes in its coverage of the Ivory Coast’s first election in over a decade that “if it goes smoothly, analysts expect it will unblock foreign investment in construction and telecoms and enable reforms to an ailing cocoa sector that feeds 40 percent of world demand.  It may also trigger a rally in Ivory Coast’s $2.3 billion Eurobond (due in 2032), Africa’s largest and one of its most high yielding (roughly 10.2 percent), issued in April in exchange for defaulted debt.”  The country has been effectively split between a rebel-held north and a state-controlled south since a 2002 civil war.  Similar to Botswana’s dependence on diamonds, the Ivory Coast’s fortunes are tied to cocoa (six million of Ivory Coast’s 21 million inhabitants make a living out of cocoa, according to the IMF), a concondrum the country hopes to alter by eventually diversifying its revenue into the rubber industry, power generation and oil exploration.  “With respect to investment, there is a lot of interest in Cote d’Ivoire, but people are waiting to see what happens,” said Wayne Camard, the International Monetary Fund country head.  “There could be substantial inward investment as well as local investment once security, and belief in the system, has been re-established.”  Cocoa prices hit their highest level in 33 years on the back of Ivory Coast’s low output, and many analysts wonder whether the country’s ability to meet rising demand will ever be adequate given the woeful state of its infrastructure and other supply-related issues.  That said, Blooomberg notes that “donor nations have linked the scrapping of $3 billion of Ivory Coast’s $14 billion in international debt to an overhaul of the cocoa industry,” meaning there is certainly incentive for more state investment going forward that would theoretically improve the industry’s aggregate supply.

Per the FT’s latest piece on the cocoa industry, the International Cocoa Organization expects a surplus of 80,000 tons in the coming year as global production will rise by some 6 percent, while renowned cocoa analyst Hans Kilian sees an even greater imbalance.  All told, analysts expect that the Ivory Coast’s production (responsible for 40 percent of global supply) will surge in 2010-11 to about 1.4m tons, up 15 percent from 1.19m tons in 2009-10, following a shorter “mini-dry” season (July and August saw periods of downpour followed by sunshine–“a perfect environment for the delicate cocoa trees . . . [and] largely favourable to avoid diseases such as the black pod, which ruins the beans’ quality.”  Furthermore, this year has seemingly provided at least some supply response to last year’s price spike: “even if still negligible by the standards of other regions, farmers in west Africa – especially in Ghana – have used this time to buy more fertilisers and pesticides,” the article notes.   And per Gerry Manley, head of cocoa at Olam International in London, “high prices have also encouraged farmers to take better care of their cocoa plantations and to harvest more frequently, particularly in the Ivory Coast.”  Needless to say, cocoa for December delivery (see chart, inset) continues to suffer.

That said, structural issues–down to the age and quality of the trees themselves and all the way up to political instability and corruption hindering the incentives and know-how of farmers–seem destined to return at some point.  Moreover, traders must also be mindful to the possibility of further instability in regional weather patterns caused by the annual harmattan, a dry wind that, according to the Ivory Coast’s head of meteorology Guehi Goroza, usually sweeps down from the Sahara between December and March and can cause a sharp drop in temperature and humidity while blowing cocoa pods from trees or damage them with dust. To that end, Goroza warns , “it’s clear that the harmattan is changing its form as a consequence of climate change,” likely manifesting in erratic weather such as longer, harsher dry spells and unpredictable rainfall.  For now, however, that’s small beans to those fund managers keen on exploiting the industry’s structural dilemma sooner rather than later.

Anthony Ward, founder of London-based commodity hedge fund Armajaro Holdings, not only gave new meaning to the phrase ‘putting your money where your mouth is’ last week when he took physical delivery of 240,000 tons of cocoa beans following a $1b bet in London’s NYSE Liffe (limitless) futures market on July contracts the fund then held to expiration–but also, per John C. Thomas over at Diary of a Mad Hedge Fund Trader, evoked memories of “fabled economist John Maynard Keynes, [who] once rented all the available warehouse space in London to avoid taking delivery of a bad position in copper.”

Chart: Cocoa futures price

So what’s on Ward’s mind precisely?  Prices following the stunt hit a 33-year high of £2,732 per ton, and moreover have been on an upwards tear the past two years in particular (see chart, above) on the back of poor harvests and what Ward sees as increasingly diminishing production quality in Ghana and moreover the Ivory Coast, which is accountable for approximately 40 percent of a given year’s annual crop is grown (see chart, below).  And while manufacturers have hitherto responded to this market dilemma by raising prices, manipulating portion sizes and altering recipes, such measures are surely just a stopgap, especially given the increasing demand from relatively newfound and ever-burgeoning consumption in countries like China.

Chart: Global cocoa production

Per an exceptional and indepth FT article from late May, for instance:

“Cocoa trees are getting old and sick, and a byzantine world of smallholder farmers, corrupt politicians and travelling middlemen is resistant to change . . . unlike almost every other major agricultural commodity – corn, ­coffee, palm oil, sugar – the world’s cocoa is still grown overwhelmingly by smallholders, each owning less than four ­hectares of land. The task of increasing production does not lie with the managers of big agribusiness plantations, but in the individual actions of thousands of mainly poor west ­African farmers.”

The piece lays out in the depth the incredible challenge facing the cocoa industry going forward, from Nestle’s aim to replant 12 million trees over the next decade which will be more impervious to disease and able to yield quicker, to efforts by trading houses to go out into the country to improve farming and fermentation methods, and finally to the volatile political backdrop–where onerous cocoa levies line coffers but also dissuade production.  Thus, while the long-term looks opaque, the present price trend is clear, according to Jürgen Steinemann, chief executive of Barry Callebaut, the chocolatier supplying many of the world’s top foods groups: “At this moment, cocoa is a scarce material: demand has been rising, supply has been stable, so prices have gone up.   [And] there’s no fundamental reason why cocoa should become cheaper.”

Beirut’s “luxury” chocolate chain Patchi, named by brand consultancy Wolff Olins as one of the world’s five most successful new brands from emerging markets, recently hired financial advisers for a primary listing in Dubai and a secondary listing in London that will see up to 49% of the company floated. The firm generated $165m in sales last year, and ultimately plans to expand into a line of cafés that would make it “like ­Starbucks, but at a higher level,” per its executive general manager, Mazin Obeidi. Its first cafe will likely open in Lebanon sometime next year, he added. More importantly for investors, Patchi’s IPO would be the first public offering on the Dubai Financial Market in the past 14 months, despite the emirate’s open-arms towards would-be foreign floaters.

According to Dr. Yeboah Woode, Research Scientist and Lecturer for the Department of Chemical Engineering, Kwame Nkrumah University of Science and technology (KNUST) in Kumasi, and Executive Director of Marglas Potash Industries (MPI), potassium carbonate (potash salt) produced from cocoa husks has large economic potential that should be exploited for cocoa farmers and the country.  Dr. Woode recommends that the government support individuals and organizations to produce potash salt extracted from cocoa husks in commercial quantities to boost incomes of cocoa farmers and create employment for the youth and women in cocoa growing areas.  Currently, MPI cannot meet the foreign daily demand of roughly 1,000 tons of potash salt produced from cocoa husks.  However, Dr. Woode said that management could meet the demand with government assistance to establish more factories in major cocoa growing areas throughout the country, further explaining that this would not only offer employment for the youth provide extra income to cocoa farmers but also generate about two million dollars in foreign exchange to the country. “Ghana needs to realise the full potentials of cocoa to benefit farmers and the country,” he added.  Moreover, he said, salt extracted from potash would help to reduce the importation of potassium salt into the country and also to diversify the country’s export earnings.  At present, MPI plans to establish more factories in major cocoa growing areas by 2010 and is appealing to both government and the Ghana Cocoa Board (COCOBOD) for assistance.

Ghana’s Cocoa Processing Company (CPC) Limited completed expansion will increase revenue and widen target markets, according to Managing Director Richard Amarh Tetteh.  Operations for the past financial year were hampered by high crude prices as well as by an unreliable power supply which resulted from the global financial crisis; Tetteh projects an increase revenue of $208 million, however, for 2008/09.

CPC operates, in addition to a confectionery factory, two modern state-of-the-art cocoa processing factories with a combined capacity of 64,500 tons of raw cocoa beans per annum, up from an initial installed capacity of 25,000 tons.  According to Tetteh, Asia, Middle East, Eastern Europe and other African countries are new market targets the company is considering.  Currently, CPC exports roughly 95% of its semi-finished products to Europe and the Americas.  CPC only deals with buyers on a spot-sale contract basis, a measure which is aimed at reducing the company’s exposure to “the volatility of the international cocoa trade.”

JGW

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