Reforms to cocoa regulation in Ivory Coast, the top producing country, could fuel a "self-fulfilling" spiral of price rises, fuelled by defaults among producers, Macquarie said.

Ivory Coast has attempted to improve visibility for cocoa producers by setting up a Cocoa and Coffee Council which, in selling most of the national crop well in advance of harvest, protects farmers from price volatility.

However, the regime's benefits could unravel if its guaranteed payout to farmers of 60% of advance the sales price falls below the value they can receive in spot market, Macquarie said.

The bank estimated that Ivory Coast, which had sold 70% of its 2012-13 cocoa crop ahead as of the end of July, had realised about £1,600 a tonne, implying a payment to producers of some 600-700 CFA francs per kilogramme.

'All kinds of issues'

"If futures keep rising into October, then the prevailing market prices could be significantly higher than what the Ivory Coast will end up paying farmers… prompting all kinds of issues," Macquarie analyst Kona Haque said.

The payout price "could easily fall short of market prices if futures keep rising the way they are now – prompting potential defaults on sales agreed, selling spot at market prices or even smuggling across the border to Ghana."

"There are risks on whether farmers in Ivory Coast will actually deliver physical cocoa against the forward sales sold through the government."

A "subsequent scramble for supplies "and probable hedge lifting or margin financing issues could arise – leading to potentially even higher prices in the fourth quarter of 2012.

"In a sense, the current price rally is a self-fulfilling prophecy."

Butter prices revive

Furthermore, funds "will want to participate in any further upside on the risk that farmers default from contractual forward selling when the new regime kicks in", Ms Haque said, noting that speculators were already increasing their net long exposure to cocoa derivatives.

Managed money, a proxy for speculators, increased its net long position in New York cocoa futures and options by 2,350 lots to more than 18,500 in the week to last Tuesday, US regulatory data shows.

Investors have other reasons to foresee cocoa price rises beside Ivory Coast regulation, with processing margins improved thanks to a sharp pick-up in demand in cocoa butter, the basis for chocolate, and whose price has been depressed by large inventories.

The so-called combined ratio - of the value of processed product, cocoa butter and powder, compared with the price of raw beans – "is now turning attractive again", Ms Haque said.

'Sizeable deficit'

Furthermore, production is set to fall for a second successive season in 2012-13, leaving the market facing an output shortfall of more than 100,000 tonnes, on Macquarie estimates.

"The weather in West Africa has been drier than normal in this critical period for pod development for the main crop," Ms Haque said.

"We are aware from our industry contacts that some pod counts have been showing deteriorating results in the past few weeks.

"For 2012-13, we expect the market to slip further into a more sizeable deficit on account of less favourable weather so far. The bumper crop of 2010-11 seems increasingly to have been a one-off."