Market Reports

ICO economic report: Sharing responsibility

The coffee market has been experiencing a continued downward trend since 2016. Coffee prices today are 32 per cent below the average of the past 10 years, with supply and demand, production, consumption, and stock movements all determining factors in the market decline. At this year’s Re:Co Symposium, Executive Director Emeritus of the Specialty Coffee Association Ric Rhinehart addressed the macroeconomic dysfunction in the coffee trade, noting that although the situation is like a “chronic disease”, it’s “cyclical market behaviour”. “The devastating Brazil frost occurred in 1975, recurring at lower impacts in ’76, ’77, and ’79. The 1975 frost is the one that is generally regarded as the most severe. It wiped out more than half of the 1975-76 coffee crop of Brazil,” Rhinehart says. “Prices began a long term downward trend in 1989 after the collapse of the ICA quota system, and spiked again in 1994 as a result of another Brazilian frost series.” The risk, Rhinehart says, is that when prices go back up, farmers put more effort into their land and invest, but if it drops again, they can’t sustain it. “There is a chronic failing in the fundamentals of our market, but at this point in time there’s millions of folks who depend on coffee for their livelihood who are in crisis,” he says. The immediate question is how can we address the situation and get the industry heading back to a healthy state? Production is consolidating dramatically, with the top five producing countries of the world responsible for producing and exporting just over 70 per cent of the world’s coffee volumes. Brazil and Vietnam remain the leaders followed by Colombia, Indonesia, and Honduras, with speculation growing that the industry is heading to a whole supplier scenario. According to International Coffee Organization (ICO) research, coffee is produced predominantly in countries that rank low in economic and social development metrics, with 31 out of 44 exporting members of the ICO falling into the low and lower middle income categories of the World Bank. Many of the approximately 12 million coffee farms worldwide are struggling to cover their operating costs while prices decrease and inputs, compliance, and transaction costs rise. As a result, farm income declines, and the livelihoods of coffee-producing households, the majority of which are smallholders in low- and middle-income countries, are increasingly at risk. A recent ICO survey shows that the income of coffee growers decreased by 10 per cent on average in 2018, among respondents. With farm incomes falling, poverty rates in producing areas are rising, with the survey results suggesting that the proportion of farmers living below the poverty line of US$1.90 per day increased between seven to 50 per cent. According to The Economist and Financial Times, 2019 qualitative evidence also suggests a link between low coffee prices and migration from coffee-producing countries, especially from Central America to the United States. The economic and social consequences of low coffee prices for producing countries can be severe, and include the pauperisation of rural communities, social unrest, domestic and international migration, abandonment of coffee growing, or even a switch to the production of illicit crops. Prolonged periods of low prices and resulting lower revenues from coffee production is also putting a serious strain on farmers’ liquidity, as well as their ability to buy inputs and undertake investments in the modernisation of their farms. This hampers future coffee production and could negatively affect farmers’ earnings as well as the supply of quality coffee. To solve the issues caused by low coffee price levels, the ICO says it’s necessary to first understand what causes them, and currently, it’s first and foremost a result of excess supply. Production is expected to increase by 1.5 per cent in coffee year 2018-19 to 168 million 60-kilogram bags, while consumption is estimated at 165 million bags. The supply overhang is likely to amount to three million bags, due to expected bumper crops in a number of producing countries. This is the second consecutive year of surplus, adding to the downward pressure on coffee prices. Additional factors can supersede the underlying fundamentals and thus influence coffee price behaviour and volatility. This includes exchange rate movements, trading activities in futures markets, and the consolidation in the roasting industry. Volatile prices also negatively affect those growers who lack access to price risk management tools, such as hedging in futures markets. Smallholders in particular do not have the scale or capacity to use formal risk management tools. Volatility in the exchange rates of the US dollar against the currencies of coffee-exporting countries can have a profound impact on the competitiveness of producers. For example, the nearly 44 per cent depreciation of the Brazilian real against the US dollar encouraged record volumes of coffee exports from Brazil in 2016 and 2018. This depreciation increased the earnings in local currency of Brazilian exporters, thereby creating an incentive to release their stocks to the international market. However, the appreciation of the US dollar can also contribute to higher production costs, caused by increased prices of imported inputs, such as fertilisers and fuel. International futures exchanges are important as a price discovery mechanism and instrument for market participants to hedge price risks. Over the past two decades, the main exchanges have been subject to a process of “financialisation”, characterised by a significant increase in the trading activity of non-commercial traders. This phenomenon causes some concern among sector stakeholders, since the increased participation of these investors or speculators in the futures markets may exacerbate price trends caused by fundamental factors. However, while recent ICO research finds a short-term causal link between speculative activity and spot market prices at the coffee futures markets in New York and London, fundamentals prevail in the long term. Finally, the coffee-processing industry has undergone a process of market concentration. For example, a series of mergers and acquisitions has resulted in the two biggest coffee companies in the US and Europe having a combined market share of about 39 per cent of global coffee sales. Many stakeholders are concerned that an increase in market power could have a negative impact on the relationship between buyers of coffee and upstream value chain actors such as farmers, in terms of contractual arrangements such as prices and payment terms. However, further research is required to better understand how seller-buyer relations may have changed over time, and if sustainable sourcing practices could result in measurable benefits to farmers. While coffee prices have significantly deteriorated in recent years, the trend for the consumer market points upwards. Why? Because coffee is a growth market. Over the past two decades, global production of coffee has increased by more than 78 per cent, from 94.6 million 60-kilogram bags on average in the first half of the 1990s to an estimated 168 million bags in coffee year 2018-19. Analyses of coffee trends forecast that global consumption of coffee will continue to grow at average annual rates of around two per cent. This increase is mostly due to steadily increasing consumption in emerging markets. In Asia, for example, consumption of coffee increased at average annual rates between 10 and 12 per cent over the past two decades. This also includes domestic consumption in coffee-producing countries, such as India, Indonesia, and Vietnam. Enabling farmers to benefit from growing global demand for coffee, and to find new markets for their products, including expansion of their domestic markets while addressing the enormous sustainability challenges of the sector, requires joint efforts of all sector stakeholders, both public and private. In the short run, the extreme poverty of some producers, which is exacerbated by current depressed price levels, needs to be overcome. Social issues must also be promptly addressed and significant investments made to increase the resiliency of farmers against the impact of climate change. Simultaneously, the sector needs to attract and nurture a generation of young farmers that are ready to adopt new technologies that can increase their productivity, living income, and the livelihoods of their families. The ICO discussed these points during the ‘Meeting the SDGs: Challenges for the Coffee Value Chain. Shared Solutions to coffee price levels, volatility and long-term sustainability’ Symposium on 6 June 2019 at the Albert Borschette Congress Center in Brussels, Belgium. This symposium, held in partnership with the European Coffee Federation, was the fifth event held as part of the ICO’s Structured Sector-Wide Dialogue to implement Resolution 465 on coffee price levels, and brought together coffee sector stakeholders, policy-makers, academia, civil society, and development partners to identify solutions for a sustainable and inclusive development of the coffee sector in a spirit of shared values and responsibility. Then in September, the sector dialogue on coffee price levels will culminate in the ICO’s first CEO and Global Leaders Forum, to be held as part of the 125th Session of the International Coffee Council in London. Here, high-profile representatives of the coffee sector and policy leaders will help set measurable commitments towards a sustainable future for coffee growers and the whole coffee sector in line with the UN Sustainable Development Goals. These are necessary steps not only to maintain current levels of supply but to ensure that coffee production will meet future consumer demand. Global Coffee Report has launched a LinkedIn Showcase page. Follow HERE for up-to-date news and analysis of the global coffee industry.

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