Coffee economics

Will it be a coffee deficit in 2014?

It’s been a hard fall from the top for Arabica prices over the past two years. Long gone are the glory days of US$3.19 a undefined

pound in the New York ICE market, which marked a 14-year-high record in May of 2011. While the fall was slow, with Arabica continuing to trade at over $2 per pound for a full year, the party was over when the positive crop reports started flowing in.

First was news of the some of the best flowerings ever seen in Brazil for the 2012-13 harvest. Two more large crops from the world’s largest grower have since driven the market to near five-year lows. The bear camp has ruled on a negative price sentiment, saying that these back-to-back, bountiful Brazilian crops must have resulted in ample stocks.

GCR first reported in August 2013 that the current and future crops in Brazil were set to fall short of expectations, following multiple weather issues. It’s looking now like those warnings are coming to life.

“We have found evidence in the field that encourages us to settle on a 51-million-bag crop estimate for the 2014-15 season, with around 35 million bags of Arabica and 16 million bags of conillon [Robusta],” Swiss-based Volcafe, the trading arm of UK-commodity trading group Volcafe/ED&F Man, said in a special research note released in early January that sparked the initial rally in prices.

This is a cut of a whopping 9 million bags from initial forecasts. Volcafe also cut its figure for the 2013-14 crop in Brazil by at least 3 million bags, putting final output of the current harvest at 57.2 million bags.

Volcafe isn’t alone in cutting its figures. Three out of four major forecasts issued in January for Brazil made similar corrections. These groups seem to be agreeing that the world is headed for a coffee deficit in 2014-15. “With a 51 million-bag Brazil crop figure, our 2014-15 statistical balance becomes a deficit of around 5 million-bags, coming after two years of statistical surplus in 2012-13 and 2013-14,” said Volcafe.

By mid-February, Arabica coffee had strengthened almost 30 per cent since the beginning of the year, by over 31 cents per pound. The price drop reflects market concerns over the looming deficit in the next 2014-15 world crop, for which harvesting starts in Brazil in April. Reports of the driest weather Brazil has seen in over 20 years are only adding to the jitters. It looks now like it might be impossible for the 2014-15 harvest to escape damage from what already is considered a severe drought.

Independent Commodity Analyst James Roemer, who writes for the online investment forum Seeking Alpha, says that among all the commodity markets that are watching the development of the Brazilian drought, coffee could be the hardest hit.

“This drought has bullish implications on the commodity market. But the greatest potential may still be in coffee, in which the driest five-week winter period in 20 to 30 years could pose a serious threat to coffee trees and the present cherries,” Roemer tells GCR. “Now you have a double whammy, where it’s too dry in the south. Production could fall as low as 50 million bags from the earlier 58 – 60 million bag estimates. I look for coffee prices to trend towards US$1.50 per pound later in February given this dry overall February outlook.”
Roemer’s comments, made in early February, quickly came to light when the 18th saw the biggest rally in a single day in close to a decade. Active March Arabica futures surged a stunning 9.1 per cent to settle at $1.53 cents per pound.

Brazil’s agronomical weather forecasters Somar, as well as Brazil’s official crop supply agency Conab, support Roemer’s and Volcafe’s predictions. Both reports were released in mid-January with decreased predictions for final production in the 2013-14 harvest based on weather problems.

Conab said that the next 2014-15 harvest will come in below the last harvest, even though it is an “up-cycle”. This is where trees have fully recovered and are ready to produce a bumper crop. This won’t happen this year, said Conab, because of the stress caused by two large consecutive crops. It says production in the 2014-15 crop is expected to reach between 46.5 and 50.2 million bags.

Somar, meanwhile, lowered its 2013-14 figure to 51 million bags from its previous forecast of 54 million. It said excess rain in December across the key coffee growing belt of Southern Minas could cause damage of between 30 – 40 per cent of the new Arabica crop currently in development.

Between Volcafe, Somar and Conab, the average prediction for the current crop is 52.5 million bags, and between 49 – 51 million bags for the new 2014-15 harvest. Swiss traders ECOM are alone in insisting that the new 2014-15 harvest in Brazil still has the potential to yield 60 million bags.

Brazilian Coffee Grower and Analyst Luiz Hafers.“The worries are for real,” says Carlos Brando, Director and Partner in Brazil’s P&A International, and a long-term consultant on market conditions for the International Coffee Organization (ICO). Brando, speaking to local press in Sao Paulo last month, said he has heard the same story across producing areas in Brazil and that ultimately, “it has been the hottest summer in Brazil in my life.”

Somar backs up Brando’s sentiments. Its last weather report said the current conditions are the driest in more than 70 years in Sao Paulo. In Brazil’s largest coffee producing belt of Southern Minas, Somar said rainfall was down between 40 – 50 per cent in January.

“At a minimum, we have a balanced market, but we could very easily move into a deficit with the Brazil situation,”  says Jack Scoville, Senior Commodity Analyst and a Vice President of Chicago-based brokers The Price Group.

Adding pressure on prices is the slow pace of 2013-14 exports from Vietnam. The most bearish predictions say that it could produce a record 30 million bags in the 2013-14 harvest.

Exports figures through January, however, show that four months into the new crop cycle, Vietnamese exports are at 6.87 million bags, 32 per cent below the last crop cycle.

“Between uncertainty over the situation in Brazil and the lack of offers from Vietnam – I am starting to wonder about the Vietnam figures myself – I see the market moving in a range between US$1.25 and $1.45  per pound for now, with potential spikes of up to $1.50,” Scoville told GCR before the 18 February rally. These factors may now see prices heading towards the $2 mark.

Export figures aren’t necessarily a sign of a short crop. Producers could be holding on to their coffee to wait for better prices. Vietnamese coffee growers harvest most of their crop in November and December. By the end of January, in any average crop year, farmers should have picked 80 – 90 per cent of their crop. This leads to the question as to whether farmers and private exporters with limited financing are capable of holding on to that much coffee.

If the 2013-14 crop is to reach 30 million bags, with 80 – 90 per cent picked, local stockpiling would at this point be at about 20 million bags. So where would they be keeping all of that coffee?

“The figures don’t add up,” says local Vietnamese trader Thao Nguyen in Dak Lak’s coffee capital of Buon Ma Thuot. “Sure Vietnam’s growers are holding on to their coffee, but nowhere near the volumes needed in order to reach a crop of 30 million, or even 27 or 28 million, bags.”

In addition to crop woes, overall sentiment in the market has improved because of a more rosy outlook for the global economy. This, some analysts say, could provide a boost to commodity markets as it adds upwards pressure on prices.

“The global economy is expected to improve. Europe will leave the recession behind, and the US will report a more defined advance,” says Alfredo Coutino, Chief Latin America Economist for Moody’s, a subsidiary of Moody’s Corporation. “A better global environment and a wave of domestic structural reforms will create conditions for healthier and higher growth for the Latin American region as a whole, with the region starting a new cycle of expansion in 2014.”

These are the kinds of global economic indicators that are particularly supportive to coffee prices. Improved financial outlook should boost demand across consumer markets. This is where the consumption equation for coffee becomes all the more interesting.

In the ICO’s first forecast for the 2013-14 crop cycle, it pegs world production at 145.8 million bags, slightly up on the 145.1 million bags produced in the 2012-13 cycle. Although this figure indicates an initial surplus, the ICO also stresses the importance of the continuing “buoyant demand” for coffee. “With certified stocks on the London futures market approaching record lows, and consumption continuing to grow at around 2.4 per cent per year, demand for coffee remains buoyant,” said Roberio Silva, the ICO’s Executive Director, in a recent ICO market report.

Based on this growth rate, which Silva says is expected to persist for the time being, world demand is set to rise to 145.4 million bags in 2013, from the 142 million bags consumed in 2012. This would put global demand for coffee in 2014 as high as 148.9 million bags, hence creating a deficit of 3.1 million bags, as production in the 2013-14 crop cycle feeds world demand in calendar year 2014.

In the end, all roads to market and price predictions lead back to Brazil. There, Volcafe and local producer officials say that it’s not only drought and other weather complications that are at stake, but also the poor state of farms in general.

“Even with the latest rise in prices, the main problem is that the prices have been below the cost of production for a very long time. The average producer in Brazil is in very bad shape and we are talking about growers who represent over 70 per cent of the total Brazilian harvest,” says Luiz Hafers, Head of the Coffee Department at the prestigious Brazilian Rural Society, or SRB.

Volcafe said many farmers have opted to carry out excessive pruning of trees, taking advantage of the low prices. In addition, concerns remain as to how efficiently Brazil’s coffee growers will be able to fertilise given current low prices. “In regards to current fertilisation, due to the low price of coffee, Brazilian producers need to pay the equivalent of the money received from eight bags of coffee to fertilise one hectare. We will carefully watch farm treatment over the next months,” it said.

Not only Volcafe, but the entire world of coffee will be watching Brazil, even more than normal, in these coming months.

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