Why is Chocolate so Expensive?

This article was written by UC Davis ARE PhD student Felipe Grimaldi Avileis.  It is the second of several excellent articles written by students in my ARE 231 class in Fall 2023 that I'll be posting here.

Global chocolate prices have gone up by 25% in the last two years. The reason for that price increase is still up for debate. In this article we will travel to Asia and Africa to try to explain what is going on with the two main ingredients of chocolate: sugar and cocoa. Along the way, we will figure out what has led to this increase in prices and what the outlook might be. 

Chocolate has three main ingredients: cocoa butter, cocoa liquor and sugar. These three components represent 80-90% of chocolate ingredients. Hence, a big portion of chocolate costs come from two commodities: sugar and cocoa. Any significant change in the price of these commodities directly affects chocolate prices. Both prices of sugar and cocoa are near all-time highs, each increasing by 40% in the last year.

The first culprit is sugar. Sugar is produced around the globe. Brazil leads global production with 38 million metric tons, followed by India (32MMT), European Union (15MMT) and Thailand (11MMT). However, India and the EU consume a vast majority (if not all) of their production, leaving Brazil and Thailand as the main two main exporters.

Brazil is close to having one of its biggest sugar producing years, due to good weather and bad ethanol parity (meaning it is more profitable for sugarcane mills to produce sugar for humans rather than ethanol for cars). However, Thailand was hit by one of the biggest droughts in its history this year, with estimates of yield dropping 18%, per Bloomberg. With no significant demand reduction, recent USDA forecasts point to global stocks dropping to the lowest levels in more than 10 years.

What does that mean for sugar prices?  A central feature of a commodity is that you cannot consume it before it is produced, but it is possible to store this year's production for future consumption. This rationing capacity is what generates stocks. Stocks are a fundamental mechanism in these markets, as they act as buffers for production shocks. For example, carrying high stocks from one year to the other helps to ease negative production shocks on that year. 

Commodities supplies for a given year are scarce, as they are formed by that years production and last year final stocks. Stocks, then, are viewed as a "scarcity" indicator for a market, and prices change to account for stock levels. Thus, low stocks push prices upward, which is why sugar prices have 40% increased this year.

Similar to sugar prices, cocoa prices are also on the rise, also trading at 40% higher than last year. However, unlike sugar, the reason behind it is somewhat of a mystery. Cocoa production in highly concentrated in West Africa, with 80% of global supply coming out of that region. More than that, 50% of global output originates solely in Ivory Coast. The second largest producer is Ghana, producing close to 20% of the total. Thus, any significant yield shock in one of these two neighboring countries strongly affects global production. 

The main yield factor in cocoa production is rain. In general, if it rains well and at the right time, cocoa plants perform well. If there is a drought, they do not. This year’s mystery relies on the fact that rain has been abundant in West Africa, but most recent estimates of yields in Ivory Coast point to a 20% reduction in cocoa pods compared to last year, with pods per tree count falling from 17 to 13. A similar trend is also observed in Ghana. 

Why has yield dropped? Market agents are split between two theories that can be summarized in a paradox: it rained too much versus it did not rain enough.

So, who is right? It is hard to tell. The “too much rain” argument relies on the fact that precipitation last July was significantly above average, according to NOAA data. Excess rains are not only bad for the pod development, but it also opens the door for a feared disease: Swollen Shoot.  This combination could be the killer of this year’s yield.

The "not enough rain" argument emphasizes that soil moisture levels were poor to start 2023. Following a bad drought in the end on 2022 that extended until the beginning of 2023, especially with an extremely dry February, excess rains later in the year were not enough for the cocoa trees. This paradox highlights the importance of not only looking at aggregate yearly weather to determine yields. 

Source: NOAA

The bottom line is that cocoa tree yields are down, which poses a challenge for balanced stocks. Given the projected negative yield shocks, we project conservative estimates that global supplies would go down 10% versus 2022/23, projected stocks would go down to 1,4920KT, the lowest ever recorded. Not surprisingly, cocoa futures prices hit its all-time highs in October. 

Source: ICCO (with author) and ICE

What does this all mean for chocolate? It looks like it will get worse. The Brazil sugarcane crop year is close to ending, and the country will not harvest until April. Thailand’s sugarcane crop is already settled, with slim chances of getting any better. The scenario is very similar for cocoa. While we do not know if it's too much or too little rain, the crop this year is doomed and market speculators think it will get worse, with funds being long cocoa in futures markets.  Some companies, like Hershey’s, announced price hikes "in the high single digits” on their bars.

Chocolate lovers, like me, should brace for impact, as this sugar (and cocoa) high might be far from over. 

I made the figures using this R code.