Article: The cocoa LID is a moral hazard and a wasted opportunity

The Living Income Differential (LID) was set to be the game changer for West African cocoa this season. However, with the arrival of Covid-19, its timing could not be worse.

IHS spoke to Tedd George, Chief Narrative Officer at Kleos Advisory UK, who indicates whether the LID is actually being paid, how it is likely to impact farmgate prices and if it is generally a good idea. He also discusses whether the African cocoa sector sees South America as a potential threat.

This is the second of several parts from this interview. The first part covered the impact of Covid-19 on the sector as well as the upcoming elections in Ivory Coast.

Q: How have West African governments provided aid/support for its cocoa markets?

In terms of support, as far as I know, the financing has been flowing OK, which is to say that there's money to buy the cocoa and it is getting to the buyers who are able to buy the cocoa. Though, obviously, there are some localised problems.

Cocobod (Ghana Cocoa Board) got its PXF for the last season, that's all being disbursed and I think that most of it has been repaid. And they took out an addition loan. They tend to do this every season as well, which is really for improvements. And I think it was quite smart what they were doing and a lot of the improvements they wanted, like farmer education, better registration of farms, improved inputs, etc.

Q: And what of the Living Income Differential (LID)? Has this been implemented properly?

It's a very difficult one, and you won't get the same answer from two people. I did a bit of probing on this and my understanding is that: exporters and some of the off-takers have been paying the LID, since the beginning of the season. But I haven't been able to get any clarity on where the money has gone. Has it gone into a specific LID account? Where is the evidence of it having been paid? But the idea is it's going to be used to prop up the farmgate price next season. This is my understanding of how the LID will get to the farmers. It's not a case of Cocobod or the CCC (Ivory Coast's Conseil Café Cacao) going to each farmer and saying, you produced this much cocoa so you get this much money of the LID, no. Instead, Cocobod and the CCC will take the LID and use it to support the farmgate price next season and make it higher, and that's how the farmer gets the money. So that is my understanding of how it's supposed to work. And this will mean we should see the farmgate price go up next season, propped up by the LID.

But there is very little transparency over exactly how the LID is being collected, where the money is being stored and how it's going to be spent. It's all very wishy-washy. Even if you asked them how much they have raised so far, they won't tell you. Why not? It is something they should be celebrating, 'look, we've raised this much money'. But then you'll be letting on how big the pie is. And then everyone will be like, 'well I want 10% of that pie'. So, they want to keep the size of the pie a secret so they can carve it up as they wish. So yeah, I think there's huge uncertainty on that front.

Q: Do you see the LID working?

For me, the big problem with the LID is, they really missed a trick with not demanding anything in return from the farmers. With the LID it's a huge disincentive for farmers to certify their production. I mean, you can make all the criticisms you like about Rainforests Alliance, Fair Trade et al and the inadequacies in their certification regime. But anyone who does certify, they go through a process where they try and ensure that there is no child labour, that there's forestry protection, that production is sustainable. They have to meet a series of standards and in return they can sell their cocoa certified and they get a premium. And the premium exists because they tried to be more sustainable in the way they produced their cocoa. Now there's the LID. Turn up, sell your beans and you get a bonus. So why would the farmer bother to certify? Currently there's little traceability in Ivory Coast's cocoa value chain, I mean only around 25% of Ivory Coast cocoa is actually traced, though that figure would be disputed by some. And there is between 500,000-700,000 tonnes of illegal production on protected forest land in exactly the worst possible way, which goes into the value chain every year. So, they have just incentivized this production and basically said, 'go, cut down some rainforest, grow some more cocoa for a couple of seasons till you've exhausted the soil and we'll give you the LID'. So, I think they misses a big opportunity there. They could've said, 'in return for the LID, you will do the following…' it could've even been, 'you will register your farm with geolocation mapping'. But they haven't and that for me is a moral hazard and a wasted opportunity.

Q: Yes, and all of this coinciding with Covid, is not very timely is it?

I think this is one of the worst decisions that could be made, the idea of increasing the farmgate price now. But that's exactly what they're going to do. I am sure they are going to do it in Ivory Coast. You have an election literally coming one month later, so it's unlikely they would not raise the price. And they can probably get away with it as well. Currently the international price is at around GBP1,600 tonne and it's been relatively strong this season, the price. And they have the LID as well. But yes, in terms of an incentive, its exactly the wrong time to give a price incentive to producers.

The key thing about certification bodies like Rainforest Alliance/Utz and Fairtrade is they are focused on helping increase yields from existing plots, through better farming practices, and they are specifically aimed at reducing incentives for deforestation. The danger with increasing the farmgate price next season is that it will send out a very strong message which is, producing as much cocoa as you can. And then you're going to ship it to a market that's not going to want it.

Q: Would an OPEC style work in with cocoa?

The only thing that is similar about West Africa's cocoa sector and OPEC is the control over supply. Yes, West Africa accounts for about 70% of the world's production, but cocoa is a soft commodity, it rots. With oil, if there is a slump in prices you can just leave it in the ground for another ten years and it makes no difference. But with a perishable commodity like cocoa, how are they going to manage having stockpiles of cocoa in Africa, a hot tropical country? The cost of maintaining that…I mean there is a reason cocoa is stored in places like Amsterdam and Estonia. They're cold! So yeah, the idea that they could run that system in Africa and keep half a million tonnes of cocoa there in perfect condition, no way. Logically, you need to have your cocoa stocks in another country, but then that immediately undermines the concept of having sovereignty over the cocoa. So the idea of a cocoa OPEC - I just don't see it working at all. Not even as a concept.

Q: Does the West African cocoa sector see South America as a threat?

Well, in Africa, it's all about volume. It's the same in Vietnam for Robusta coffee. West Africa can just pump out cocoa and nobody can meet that level of volume. It's not about quality there. The only reason Cocobod cocoa from Ghana tends to be priced higher is that there is a perception of reliability around the Cocobod contract that doesn't exist for the Ivorian one. But really, there's no difference in the quality of beans. Though people argue about that endlessly.

Any cocoa coming out of South America, either it is going to the North American market, because of proximity which makes logical sense, or it has some sort of speciality around it so it can have command a premium (for example Venezuelan cocoa which is arguably the most exquisite in the world).

I think the long-term threat to Africa could come from the plantation models they are experimenting with in Ecuador and Peru. No one has ever managed to successfully run organised cocoa plantations - with trees in neat rows and packed closely together - because cocoa is so susceptible to disease and pest infestation. It's a very delicate crop, you could have a plantation and then lose the whole lot in 24 hours if you're not careful. So they haven't yet managed to make that model work. But if they do make it work and they can get their yields up significantly, then yes, they will be a threat to Africa. But it hasn't happened yet.

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This article was published by S&P Global Commodity Insights and not by S&P Global Ratings, which is a separately managed division of S&P Global.