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story.lead_photo.caption Hershey’s Chocolate World holds a media preview for its Hershey’s Unwrapped attraction in Hershey, Pa., in May 2019. Hershey’s recently made a large cocoa purchase on the futures market to avoid paying a 15% premium being charged by Ivory Coast and Ghana on private purchases. (AP)

One of America's top chocolate makers is upending the New York cocoa market.

Hershey Co. is taking the unusual step of directly sourcing a large amount of cocoa through the ICE Futures U.S. exchange instead of buying beans in the physical market, according to people familiar with the matter who asked not to be named because the deal is private.

The huge trade has sent December-delivery futures to a record premium over the next contract. The purchases were so large that they required special permission from the exchange, the people said.

The trade comes after top cocoa growers Ivory Coast and Ghana added a hefty premium for their beans in a move they say will boost farmers' incomes. While most cocoa changes hands via private deals around the world, the purchase through the exchange allows Hershey to obtain cheaper supplies, saving the company millions of dollars. That's because beans sourced from exchange stockpiles don't incur the premium, currently about 15% of the futures price.

Hershey said it doesn't discuss details of its buying and hedging activities and that it purchases cocoa from a variety of suppliers and sources to meet its needs. The Pennsylvania-based company said it has long supported initiatives to improve farmer livelihood and that includes Ghana and Ivory Coast's Living Income Differential, as the $400-a-ton premium is known.

"The move by Hershey was smart and a perfectly legitimate use of the futures market," said Derek Chambers, a former head of cocoa at Sucden who retired in 2018 after trading for 50 years. "It works for them on many levels, not least in giving them a competitive advantage against other U.S. chocolate makers. It should also ensure that they can buy the cocoa they need at cheap differentials in the months to come, through the futures or commercially."

Chocolate makers usually use cocoa traders and processors as intermediaries when buying beans. The large majority also don't process their own cocoa, having their beans ground by others or buying cocoa butter -- which accounts for about 20% of a milk chocolate bar -- and cocoa powder, used to make cookies and ice cream. Hershey processes a large chunk of its beans through Chicago-based Blommer Chocolate Co.

Ivory Coast and Ghana, which account for almost 70% of global cocoa production, started charging the premium for beans from the 2020-21 harvest that started in October. That came on top of a quality fee depending on where the cocoa comes from, and in some cases a sustainability surcharge.

While many chocolate makers and cocoa processors had initially agreed to pay the high prices, lockdowns from Paris to Los Angeles lowered chocolate demand and now mean they don't need as much cocoa or need to seek cheaper supplies, said Judy Ganes, president of J. Ganes Consulting.

"Hershey's expectation is that 2020-2021 cocoa purchased within our supply chain since the implementation of the [Living Income Differential] in West African countries includes this price premium," the company said in an emailed statement. "Beans sold prior to the implementation of the [Living Income Differential] would not include the premium."

U.S. futures will remain off balance "as other companies will almost certainly see the benefits of replicating what Hershey has done," Chambers said. "The volume of cocoa on the exchange cannot be replenished quickly although surplus supplies from at least Ecuador will build up in warehouse over time."

The West African nations still have a lot of cocoa from the current crop to sell, putting them in a vulnerable position, said Ganes, who has followed markets for more than 30 years, having worked at Wall Street giant Merrill Lynch. To try to resolve the standoff, the countries are threatening to suspend sustainability programs by chocolate makers and cocoa processors, a tactic that in the past worked out as companies fear consumer backlash.

Ghana Cocoa Board Chief Executive Officer Joseph Boahen Aidoo said companies aren't following through with their promises. While he didn't specify any companies, he said he is prepared to "name and shame" firms. He also didn't call for a suspension of sustainability programs at a World Cocoa Foundation virtual event.

Hershey said it continues its "substantial cocoa sustainability work with producer governments on our mutual goals to tackle the root causes of poverty that put youth at risk as well as ending deforestation," according to a statement. The company added that on top of paying the Living Income Differential, it's investing in farmer training to grow more cocoa in less land and helping farmers diversify incomes with measures including growing alternative crops.

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