Coffee economics

The rising price of green beans is shaping the future of the coffee industry

The year was 2002, and much like the last few months, the price of coffee was the subject of intense discussion. Unfortunately for farmers at the time, prices were nearing the bottom end of the cycle, averaging around 50 cents a pound, the lowest in real terms for 100 years. In a report to the World Summit on Sustainable Development, the International Coffee Organisation (ICO) commented: “There is little doubt that the exodus from rural areas and increased poverty in coffee producing areas caused by the current price crisis poses a very real and wide-ranging threat to sustainable development.”  How times have changed. Nine years later, reports from New York saw Arabica coffee futures selling for $2.76 a pound, the highest in 14 years, with the profits of increased margins trickling down the production chain. “For growers, these prices are a lot more stimulating,” remarks Jose Sette, Executive Director of the ICO, upon his return from the Eighth Africa Fine Coffee Conference held in Tanzania in February. “They have a better outlook on life at this moment.” So, what has brought about such a dramatic swing? Relative to the cyclical nature of coffee, Keith Flury, a Senior Commodity Analyst with Rabobank says it has actually been fairly incremental. “We’ve seen a steady stream of bullish factors that have built up on each other,” he explains – supplies have continued to dwindle while demand has steadily increased. In addition to the poor weather that has been largely attributed for low crop yields, Flury explains that an early crop renovation program by Colombia’s Fedecafe to replace trees that are susceptible to fungus has taken a portion of their coffee trees out of production for four to five years – a significant enough portion to reduce overall output. Add to that the terrible weather, and a country that in 2007–08 produced 12.5 million 60 kilogram bags, was recently down to 8 million, according to the US Department of Agriculture. As a cyclical crop, coffee in Colombia as well as Brazil is approaching its low cycle. And, record high prices caused by this shortage of stock is doing little to affect demand that continues to prove robust. Flury notes that investors have noted the rising trends, and this continues to drive up prices. “This is normal,” explains Flury. “It should spur investment into coffee in coffee producing nations… Coffee works in a cyclical nature, it always works in the ebb and flow of the market. This will create a production response.” For farmers who less than a decade ago struggled to pay their input costs, this is an important point to note, according to the ICO’s Sette, “I think farmers have to be aware that coffee is cyclical. It’s boom and bust. If they’re taking decisions now about planting, they should do it in a professional way with adequate productivity to maintain a steady remuneration. The world will need more coffee, but it has to be done in a professional manner – not to swing to over production.” Looking back to 2002, it is in this context that Sette offers some recommendations on how to keep prices steady in a free market system. “There is no way to prevent people from planting if they wish. But, you need to make information available so people make decisions based on the best data,” says Sette. With reports of government encouraged stockpiling in Vietnam (see page 24), Sette again emphasises it is up to individual countries to decide on whether or not to involve themselves in the process, but he does encourage general transparency to the market. “Any efforts should be communicated clearly on what is being done and when [the stocks] will be returned to the market. There’s no reason to stockpile coffee just for the sake of it – it should be made clear when it will be returned.” In addition to reports from Vietnam that the government has provided loans to farmers to hold onto stocks, a Brazilian government official told Reuters that the country has yet to release an estimated 1.2 million bags of exportable 2009 Arabica currently in storage. The supplies were purchased in early 2010 at $180 a bag to prop up prices, at a time when coffee futures were trading at half what they were at time of writing. For farmers, it may take a while for these high prices to filter through, explains Sette, as many of them sell beans ahead of harvest. He was nevertheless confident that these prices have already started to make their way down the chain. As for the extent that high prices will be passed onto consumers, Sette notes that they have gradually started, but the changes should be limited. “Generally roasters keep prices as stable as possible, they hold onto prices as long as they can,” he notes. “But, they have to pass on the increases in the price of their raw material at some point.” In this respect, Sette notes that there is a vast difference between how the cost of raw materials should affect the prices we see in supermarkets and how they should affect the price of a cup of coffee in a café. While raw materials are a significant percentage of the prices of a bag of retail coffee, they are a far smaller percentage to a cup purchased at a shop. “With a coffee shop there’s labour, tax, rent. All of these things lend themselves more to the price of a cup of coffee than the cost of raw materials,” says Sette, noting he’s seen reports from the United Kingdom market where the cost of coffee is only 2 per cent of a business’s operating cost. In this respect, however, the price of the specialty coffee that is often served in leading coffee shops is increasing at an exponential rate compared to the commodity market. Stephen Hurst, who specialises in specialty coffee trading as the Managing Director of Mercanta The Coffee Hunters, notes that he’s seen general demand for differentiated, defined provenance and specialty grade Arabica beans (i.e. specialty coffee) increase. The result, he says, is that prices for the top end Cup of Excellence Coffee, a global specialty coffee auction, have reached an top price of $25 a pound. “The problem is that specialty coffee has been… simply too cheap,” he says. “The issue now is not so much the outright price of coffee, but rather the speed of change in the price of coffee.”  The question now is how will these top prices, whether it be commodity or specialty coffee, affect the structure of the market? The ICO’s Sette says that in the short term, in a market heavily dependent on finance credit (see page 29) there is likely to be a considerable difference in the financing involved in the coffee sector. “A container that used to cost a certain amount now costs twice that amount,” says Sette. “Hedging strategies are going to need more financing to meet costs. When banks see prices rising too much, they are nervous on lending to the coffee sector and in that case it can become a self-fulfilling prophecy. If the banks think that coffee is too risky and they hold off on lending, then it becomes too risky. Now is a time when the sector will need more financing and not less.”

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