Following widespread reports of failing crops in Latin America, some producers are dismayed that ICE futures prices in New York show little indication of recovering. The rust outbreak, which is affecting an average of 20 to 30 per cent of the entire Central American coffee belt, has come at a time when Latin American farmers are worried about the future of their industry. As tree populations are getting old, unproductive and lower yields have left smallholder coffee farms in a state of semi-abandonment, and prices are hovering well below the cost of production at around US$1.80 per pound. So why – some producers are asking – with production in a downfall and buoyant demand, is the market defying against higher price? The sad answer, recent history has proven, is likely found in the multiple factors of outside influence, drive by the global economy, which are the main drivers of prices in the market. Most of these have nothing to do with the core fundamentals of the physical market. At the onset of the world 2012-13 crop cycle last October, the International Coffee Organisation had pegged the new crop to reach a record 147 million 60-kilogram bags. The US Department of Agriculture (USDA) was just slightly more ambitious, saying it expected 148 million bags. After years of significant difference between the two main forecasting institutions, many would have welcomed a more unified view. Optimism on both accounts, however, has quickly fizzled out. Following the rust outbreak in Central America, and the ensuing announcements of national emergencies, the ICO has since lowered its figure to 144 million. Incidentally, the USDA actually lifted its estimation figure to 151 million, citing higher crops in Indonesia, Vietnam and Brazil. And so the market finds itself in another tug-of-war between the trade-led USDA and the producer-led ICO. Much of the dispute surrounds differences in projections of Arabica and Robusta supply. The USDA has supported bears in the market, saying the world’s top Robusta producer Vietnam is expecting another bumper crop this cycle. Indonesia is now posting a significant recovery. Brazil by most accounts is pegged to produce its best off-cycle crop of close to 50 million bags. Early reports indicate that flowering for Brazil’s new 2013-14 crop is looking good, with harvesting set to begin in May. The ICO, meanwhile, says that rust disease could lead to losses of 2.5 to 3 million bags in Central America. As consumption should grow by at least 2 million bags, these factors could bring the 2012-13 cycle to end at a tight balance, with either a small surplus or a small deficit in the supply-demand balance. Part of the explanation for Arabica’s struggle to recover could be found in Robusta’s success. Robusta has enjoyed a sharp increase in both demand and prices. This could be a sign that demand is shifting away from Arabica, and thus creating a potential over-supply by Arabica producers. “The market has been coming down and we are fundamentally justified,” said Analyst Judith Ganes-Chase, speaking at the 10th AFCA convention in Uganda last month. “I am negative on the market and I still think there is room for a further downside to come.” Ganes-Chase cited a “massive shift in demand from Arabica to Robusta” as explaining the downward correction. Not everyone agrees. While some analysts say that recent indications in differentials suggest prices could be on the verge of recovery, the real issue that has to be addressed is the imbalance in Arabica-Robusta markets. “I continue to believe the futures markets are struggling to accommodate the reality of three distinct underlying commodities being served by two exchanges,” says Ric Rhinehart, Executive Director of the Specialty Coffee Association of America. He is referring to the competition between mild washed Arabica, Robusta and Brazilian natural Arabicas. Most roasters are cautious, however, working in an environment of disagreement and uncertainty. Climate change has added an increased level of volatility to the supply chain. One senior coffee trader said that as a result, many are preparing themselves for more dramatic needs to increase flexibility in coffee purchasing, based primarily on the availability of supply and price. He notes that funds are currently holding a net short position equivalent to at least 5 million bags, meaning that any sudden impact could set off a “destructive volatility” in prices. “Many in the market actually agree with the ICO and we believe the market is becoming too bearish, which is not good for anyone as this leads to more volatility,” says the trader. “And more volatility could lead to a situation where coffee just becomes coffee, regardless of the bean type.” This is where the Latin American differentials become all the more important. These differentials are premiums or discounts quoted against the New York Arabica futures and paid in the cash market in producing countries. History has proven that an increase in differentials could be an early indication for a surge in prices. In the spring of 1997, cash differentials started moving higher long before the New York Arabica market rallied to near historic highs of US $3.19 in May that year. Colombian premiums started rising in earnest in late 2008, alerting the market to the extent of serious supply problems that eventually lead to the highs seen in May 2010. In early February this year, top quality strictly hard beans from Guatemala climbed to differentials of around 10 US cents per pound, then spiked to 15 cents by mid-February, according to trader and exporter reports. Nicaraguan and El Salvadoran strictly high grown beans, meanwhile, have risen to premiums of 5 US cents per pound after being quoted at around level money for most of the past four months. Honduran strictly high grown beans have moved back into premium territory at around 2 US cents per pound. “The rust issue can be a real factor on both sides and differentials could get back to last year’s levels soon, once producers sell most parts of the current crop toward the end of March,” says Davide Rocca, a Trader with Genoa-based Italian coffee buyers CICE Spa. “In my opinion, at this point it’s becoming worthless to tender crop against the ICE. So even if the rust outbreak has ruined some countries more than others, we are going to see certified stocks piling slowly.” The main alternatives considered as replacements for Central America come from Peru, or natural Arabicas from Brazil. With these in limited supply, many say the market could be headed for a correction within the next six months, before the 2013-14 cycle starts in October. Whether this correction will be reflected in the cash market via differentials, or in the futures prices, is yet to be seen.
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