Economics of cocoa

London - To get an idea how emerging markets are reshaping global consumption patterns, look no further than the cocoa bean.

Hundreds of millions of new consumers in Asia and elsewhere are boosting demand for chocolate cakes, biscuits, drinks and ice cream. This is increasing demand for cocoa, but it is also changing the cocoa market.

When a cocoa bean is processed it makes roughly equal parts butter and powder. The butter goes into melt-in-your-mouth products, as well as soaps and cosmetics. The powder is used in cakes, biscuits and drinks.

Until recently, suppliers had so much extra powder it was sometimes burnt in boilers as a fuel. But over the last two years, powder prices have more than doubled and grinders can barely keep up.

"In recent years powder demand has definitely outpaced butter demand, which has been based on the fact that most of the applications in emerging countries are powder-based," said Jos de Loor, managing director of cocoa and chocolate at US agribusiness Cargill.

Global chocolate sales rose 2% to $83.2bn in 2010, according to market research firm Mintel. This was helped by growth in places such as China, where sales rose 21% to $976m, and Indonesia - the biggest chocolate-eaters in Southeast Asia - where sales climbed 26% to $888m.

Importantly, it was demand for powder which rose fastest. Singapore-based Petra Foods, the world's third-largest supplier of cocoa ingredients, estimates annual global cocoa butter consumption is now between 900 000 and 1 million tonnes, an increase from 850 000 to 900 000 tonnes two years ago. Demand for powder has risen faster, to 1.1 million to 1.2 million tonnes from 800 000 to 850 000 tonnes two years ago.

"In the past, emerging markets grew a lot but they were very small, so they didn't affect the world market that much," says Marcelo Melchior, head of confectionery at Nestlé, the world's biggest food group. "But now they are gaining critical mass and are continuing to grow, so it's influencing the total market."

In some ways, the cocoa business is turning full circle. Chocolate first came to Europe from Latin America as a drink. Since 1828, when the Dutch worked out how to extract cocoa butter, chocolate products like bars, pralines and pastilles have been in the ascendant.

People in North America and Western Europe have been eating solid chocolate for more than a hundred years since it was sold to the British public in the mid-1800s.

Now emerging markets - particularly in Asia - are driving a taste for lighter treats.

"If you consider Eastern Europe and Latin America, the markets are much more established in the cocoa taste than in Asia," Nestlé's Melchior said. "Culturally people are not as used to this flavour."

Sweet tooth

You can plot the two-speed cocoa economy on a map. In the rich world, growth in chocolate sales is in the single digits according to Nestlé. A bar of chocolate may be an affordable luxury, but it is proving less recession-proof than popular wisdom would have it.

In emerging markets, though, growth is well into the double digits. In many parts of Asia, Latin America and Eastern Europe, consumers' first taste of chocolate is typically through milder products based on cocoa powder rather than chocolate bars.

"A Kit Kat can be considered a lot of chocolate for the consumers in some emerging markets and in Europe it's a lighter product where nobody gets concerned about the amount of chocolate," said Melchior.

Marc Donaldson, director of cocoa sustainability at Petra Foods, which has over 50% of the chocolate market in Indonesia, points out that powder products are "generally more within their budgets".

Melting moments

That could change. Higher prices for cocoa powder are probably here to stay. Global cocoa demand is on course to outstrip supply in 2011/12, as ageing trees and a lack of investment in some of the world's top producers limit production.

Cargill has said that with average annual cocoa demand growth of 2.5% to 3% - about 100 000 extra tonnes of cocoa per year - there are likely to be serious supply concerns in the next few years.

And it's powder that's poised to feel the squeeze most. Emerging market consumers might eventually develop a taste for richer, butter-based products, but that will take time. The hot climate, lack of widespread refrigeration and unreliable supply chains in a market such as India, for instance, make it a lot harder to keep butter-based products in good condition.

"In cooler climates such as in Eastern Europe, consumers have migrated from powder products to chocolate confectionery. In warm places like Asia and the Middle East, the migration to chocolate probably will be much less because chocolate melts in your hand," says Steven Haws, of cocoa research firm Commodities Risk Analysis.

The melt factor can change how a product is made. Nestlé's Melchior says his company sometimes uses vegetable oil instead of cocoa butter in some markets, because it raises a product’s melting point so it can be more widely distributed.

When Kraft Foods bought British chocolate maker Cadbury in 2010, it gave the US giant a foothold in India, where Cadbury was the largest confectioner. One of the first products Kraft launched there was Oreo biscuits - a powder-based product.

Butter mountains

But it's more than a story of increased demand for cocoa powder. Earlier this year, fighting in top cocoa producer Ivory Coast ignited fears of supply disruptions, and cocoa prices rallied to their highest in 32 years in March.

Meanwhile, the tough competitive environment for confectioners is hitting butter demand. Chocolate makers have trimmed products to avoid having to pass on higher costs to consumers. Earlier this year Kraft quietly reduced the size of its Toblerone by one triangle and shrank the iconic Cadbury Dairy Milk bar by two squares to 120 grams.

"When a manufacturer reduces the size of a bar or the count in a bag, its action immediately reduces by a large amount the quantity of cocoa butter that the manufacturer buys," said analyst Haws.

He estimates a massive 150 000 tonnes of butter is stored around the world at present: working stocks are usually between 20 000 and 40 000 tonnes. As a general rule, powder and butter can both be stored for up to 18 months.

"Some people have suggested that butter will find other uses if its price falls to $1 500 a tonne. This might include replacing palm oil in some applications. However, that price is more than $1 500 away," Haws said.

Cocoa locomotive

At the moment, just 10% of the world's cocoa is consumed in emerging markets, against 30% in North America and 40% in Western Europe, according to Jonathan Parkman, joint head of agriculture at brokerage Marex Spectron.

But in the future emerging markets "will continue to be the locomotive of growth. Cocoa demand has closely followed global GDP (gross domestic product) for over 50 years and we expect this to continue," said Petra Foods' Donaldson.

The cocoa business has already gone through enormous changes over the centuries, reflecting broad historical shifts. For instance, even though cocoa was originally found in South America, as Europeans consumed more they increasingly used their newly colonised lands in Africa to grow the crop. Since the start of the 20th century, Africa has been the world's biggest cocoa producer.

The swelling middle class in China have seen their choice explode in recent years. Li Peng Fei, a middle-school teacher in Beijing, loves "dark chocolate; Dove and Ferrero are my favourites. When I was a child, the variety of food in China was not as abundant as today".