NEW YORK, Dec 17 (Reuters) - Olam's $1.3 billion deal to buy rival Archer Daniels Midland's cocoa processing business may reduce liquidity in the niche cocoa bean trade, raising concerns about volatile prices and a potential shake-up of customer relationships.
In the biggest deal to roil the cocoa trade in recent years, Olam scooped up a larger rival's business and catapulted into the top league of cocoa merchants and processors behind Barry Callebaut and Cargill.
For Olam, the reasons are clear: its vast bean sourcing operations stretching from Ivory Coast to Indonesia will feed newly acquired bean processing assets.
This gives it more control over prices of beans, the butter that gives chocolate a melt-in-the-mouth taste and the powder that goes into cookies and drinks such as hot cocoa.
For merchants and processors who buy beans from Olam in an already tight-knit market, the reshuffling of the pack is unsettling as it removes a major supplier from the market.
Olam buys around 500,000 tonnes of cocoa annually, and it said it will increase its processing capacity to more than 700,000 tonnes, or 16 percent of world supply, with this deal.
They worry that a big portion will likely go to feed its newly acquired eight processing plants that produce powder, butter and liquor as it becomes a net buyer in the 4-million-tonne market.
It could create opportunities for new dealers to fill the void left by the Singapore-based commodity trade house.
But the additional buying could add strain to prices.
This could force users supplied by Olam, including chocolate manufacturers like Mars and Nestle and processors such as Blommer, to look elsewhere for many of their beans.
"It puts the grinders in a sticky situation as they will have to buy larger quantities from smaller firms, thereby increasing their risk," said John Palabrica, president of MJMB LLC, a private commodity trading company in Newark, Delaware, a supplier of ADM.
Still, the deal brings uncertainty to merchants such as MJMB, suppliers of beans to ADM's processors, which will become part of what traders said would likely be a more self-sufficient operation, Palabrica said.
Other industry sources noted Olam does not source enough beans to depend solely on its own supply.
"I don't see Olam walking into that business and saying every supplier from ADM is no longer wanted. They will need much more cocoa than they used to," a European industry source said.
Wooing ADM was an opportunity Olam could not miss, but convincing its executives who had only recently decided to hold onto the business, which had turned into profitable after a round of cost cutting, took some doing, according to Gerald Manley, Olam's managing director and global head of cocoa.
ADM sold its chocolate business to Cargill, which had also been interested in its cocoa processing operations, in September.
The deal underscores the bullish outlook for cocoa, with more market participants moving downstream.
Some say it is a risky business with margins often squeezed by volatile bean prices and competition increasing on a boon in capacity in Asia.
The deal is the latest in a consolidation spree that has seen volatile prices squeeze margins for dealers, raising questions about the viability of a cocoa trading business lacking any downstream processing or production assets.
"On a combined business, we can even out the volatility," said A. Shekar, Olam executive director in finance and business development.
The merger widens the gap between these top three processors and the rest of the market. Dealers said such consolidation could reduce price transparency, but were pleased to see the business fall into Olam's hands rather than Cargill.
The Minnesota-based trade house is already a major player in cocoa processing, and traders feared acquiring ADM's business would have made it too big.
Olam has been open about its bullish forecasts for the cocoa market, projecting a global deficit of more than 120,000 tonnes in the 2014/15 crop year, despite surplus projections from Barry Callebaut and softs broker JSG Commodities.
It repeated those expectations in a briefing on Tuesday, arguing that growing emerging market demand for chocolate would necessitate additional grinding and pressing capacity, despite concerns about over-capacity as some bean processors have cut back on grinding amid high stocks of butter powder. (Reporting By Luc Cohen and Marcy Nicholson; Editing by Grant McCool)