By Hauke Goos and Ralf Hoppe
The cocoa business is actually very straightforward. During the harvest, traders buy cocoa beans directly from farmers in places like Ghana and Ivory Coast and, later, they resell them to chocolate makers in Europe. Since traders can't know when manufacturers will buy their cocoa, there is an exchange, where traders and others can buy and sell goods at any time. Still, the downside for traders is that the price that the exchange offers is generally lower than the price that chocolate companies pay.
To make cocoa scarce, Ward had to manipulate how the cocoa business works. He had to lure traders away from the chocolate factories and convince them to sell their cocoa on the exchange, instead, because it was only there that he could buy large quantities of cocoa in an ambush-like maneuver.
Ward did this by buying thousands of cocoa contracts at the current daily price for delivery at a later date, when the price would presumably be higher. He was going long, betting that cocoa would become scarce. And he did his utmost to ensure that this would be the case.
On the London exchange, other speculators also started believing that cocoa would become scarce based solely upon the fact that Ward was going long. Asset managers, hedge funds and the fund managers at major banks also went long, betting that the price would continue to rise. In doing so, they drove it up even further. They also increased the share of cocoa in their overall commodities funds. The true value of the cocoa was no longer relevant; only the presumed value was.
Ward had set a trap. The bait was the attractively high price on the exchange, which allowed the traders to forget that they earn their bread and butter from the chocolate manufacturers. In the words of one trader, the price was as attractive "as two Swedish nymphomaniacs standing outside a gas station at night." The traders forgot their traditional customers and sold their cocoa on the exchange -- where Ward was waiting for them.
Ward apparently had to disguise his simple plan with red herrings. To cover up his tracks, he had several different brokers handle his buying orders. He pushed positions back and forth. And he juggled with the expiration dates, sometimes going long and sometimes going short. Or at least this is what everyone who was caught off guard by Ward's tactics says. Ward, who has decades of experience in the market, masterfully used the instruments of the exchange to deceive the market. And it was all completely legal.
Insiders estimate that Ward purchased about 50,000 futures contracts in the spring of 2010 alone, at an average price of about £2,300 a ton. Each contract entitled him to take delivery on 10 tons of cocoa, for a grand total of 500,000 tons of cocoa.
By mid-June, Ward probably owned futures contracts for more cocoa than was available on the exchange. Unfortunate speculators had bet against him in anticipation of falling prices. But now Ward had them in what market insiders call a "squeeze."
Belt-Tightening
This betting game is virtual. Its currency consists of claims, sometimes even claims to claims held by a third party. But it can still have a dramatic impact on the real world -- and on people like Nauck and those of his competitors who were not well stocked and were now starting to panic.
Nauck can try to buy cocoa at a good price. To do so, he has to pay attention to daily prices and to minute-by-minute fluctuations. But this only takes time away from what he really wants to do: make high-quality chocolate.
In the last two years, he has streamlined production, cancelled Christmas bonuses, waived his right to a significant share of the profits and, after lengthy negotiations with the works council, implemented cost-cutting measures among employees. For example, one worker now operates a stamping machine that was previously operated by both a technician and a machine operator. Nauck knows that the day could arrive when chocolate production is no longer profitable for Hachez.
The Grind Statistic
According to sales figures on the London exchange, at the beginning of July, Ward still owned about 24,000 contracts, each for 10 tons of cocoa. At that point, he could have closed out his positions by selling them and collecting his profits.
Or he could have waited. He could have gone all out and held the contracts until their expiration dates and then taken delivery on all the cocoa. The key question were: What would happen to demand? And would he be able to sell all the cocoa?
No one knew. Still, there is one critical number in the industry that can indicate demand. Once every three months, the Brussels-based European Cocoa Association (ECA) publishes the so-called "grind statistic," which indicates how many tons of raw cocoa are being ground into "cocoa mass," or paste, to actually make chocolate.
Three large companies dominate the global market for processing raw cocoa into cocoa paste: Barry Callebaut, Cargill and ADM. These big three have giant warehouses, and only they know how much cocoa paste they have in these warehouses. Indeed, by controlling the amount of cocoa mass stored in their warehouses, they control a large share of the demand for cocoa.
During the economic crisis, the grind statistic declined. Since consumers bought less chocolate, the industry processed less cocoa. The grind statistic increased in the first quarter of 2010 and, again, in the second quarter. The second-quarter statistic, which was published on July 14, must have confirmed Ward's suspicion that demand was up. If his plan was to corner the market, now was the right time to do it.
The Trap Is Sprung
On July 15, when the contracts expired, Ward took delivery on 240,100 tons of cocoa. And although the cocoa remained in the exchange warehouse, it was now his. It constituted about 7 percent of the annual global harvest. It was a bold move. He now owned vast amounts of cocoa. Ward hoped -- and many experts expected -- the price to continue to rise, to £3,000 or more per ton. If that happened, his plan would work out spectacularly in his favor.
But the price didn't rise. In fact, instead of rising, it began to fall. Within only one day after Ward had taken delivery on the 240,100 tons, the cocoa price fell by 3 percent in London, and it continued to fall thereafter. Within the first four weeks, it was down 13 percent.
Ward had no alternative but to wait it out. But every day was costing him money. For cocoa worth an estimated €775 million, and at an interest rate of perhaps 3 percent, he would have been paying about €1.9 million in interest every month and another €1.7 million in storage costs.
In early October, the number was released that Ward must have been pinning his hopes on: the grind statistics for the third quarter. But something had happened that no one in the industry had expected: At 331,192 tons, the figure was even lower than the grind statistic for 2009, the year of the financial crisis. Indeed, it was the worst figure in four years of steady increases. The big three were apparently reducing their unexpectedly high inventories of cocoa paste.
Saved by Civil War
The number sealed the fate of Ward's plan. What he needed now was a miracle. But what he got instead was a civil war.
In late November, Alassane Ouattara was declared the winner of the presidential election in Ivory Coast. But his rival, President Laurent Gbagbo, refused to abandon the presidential palace, leaving Ouattara no choice but to run the country from his hotel. Then fighting broke out and cocoa exports broke off. The raw cocoa sitting in the port of Abidjan was not being shipped. This drove up the price of cocoa to £2,400 per ton.
Things have since calmed down in Ivory Coast, and cocoa prices have once again fallen. But no one but Ward knows whether the turmoil protected him against a loss or helped him make millions with his massive speculation. He may have sold his cocoa too early, or he may have kept his cool and waited for the right time. Unlike the New York exchange, the London exchange does not require its traders to disclose the details of their deals.
Nauck was lucky. He bought his raw cocoa at the moment when the price reached its lowest point, £1,900 a ton. Though he made his move at the right moment, he knows that -- just like the cocoa farmers in Ecuador and West Africa -- he is still a hostage of the market.
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