Winds of Change — Coffee Report

From time to time I write a market report, usually triggered by a series of events that I feel link together in some way, looking for conclusions and potential consequences. Unfortunately (for you the reader), my scribbling has been galvanized by a set of fairly dry numbers. I am incapable of presenting them in a sexy or compelling form, so I would ask you to please persevere as the story flows from the numbers. They are important.

Recently, the US Department for Agriculture (USDA) released a report forecasting that global coffee production will rise in 2015 to 152.65 million bags, an increase of 4.2 percent over the previous year, due to record crops from Colombia, Honduras and Indonesia.

This comes in the same year that Brazil’s production is expected to break the magic 50 million-bag mark, viewed as the breakeven need from Brazil to satisfy local and export demand.

Vietnam, the world’s second largest coffee producer, is expected to increase production by 400,000 bags (to 28.6 million bags), as coffee trees continue to recover from the drought experienced earlier this year.

The message, in short, is that there is a rising tide of coffee coming to a market that already feels awash with stocks in the ports of the US and Europe rising as sales fall. This supply glut is reflected by the downward trend of world prices over the last twelve months.

In the same report, the USDA then takes a double step, reporting that global coffee stocks, over the same time period, will fall to the lowest levels in four years. (The stocks-to-use ratio is a key measure of a commodity’s availability and therefore of its pricing potential).

While global stocks remain healthy (21.6% of annual demand), that this fall could take place in a year of bumper harvests is somewhat surprising. Unlike the erratic production graph, the consumption graph holds a steady trend line with an upward trajectory that has historically held a steady 2%. (This year, demand in the US is down, dropping the consumption growth rate closer to 1.5%).

Consumption trends will prove pivotal in the next five years as Asia, (already at 23% of world demand), has hardly taken a sip from the world coffee cup. Current per capita consumption in China and India stands at 10 grams and 90 grams respectively. Consider this against Finland at 12 kilograms and the 4.1 kg per capita in the US and you begin to get a sense of the growth potential of the region.

Starbucks has recognized this for some time with the opening of the its 1600th store in China, reported last week . The retailer plans to expand to 10 000 stores over the next five years, and others are following suit.

The 60 million Bag Hammer

I recently spent some time with a friend who, like me, is very involved in coffee. I value his views, as they are formed by a clear understanding of the statistics, intelligent analysis and very healthy dose of cynicism that he calls reality. His forecast for Brazil (after a recent trip to that origin), is a whopping 50 to 60 million bags for 2016, based on increasing production efficiency and the young tree population. This number, reflecting a record crop, is now commonly accepted within the market.

The second piece of his one-two punch combination was to tell me that one farmer in Brazil stated that he could produce coffee at a cost of 68 cents per pound. While the industry believes Brazil’s cost of production to be closer to 110 cents per pound, this reflects the disparity with Central America, where cost of production is accepted to be at 140 cents per pound.

The price impact of a super-crop of 60 million would be a blow to the Arabica market, already struggling to keep its head above the 130 cent per pound mark. Sentiment, in my view the most powerful of all market forces, would potentially bring us back to the dark days of the early 2000’s, when the market languished below the cost of production for years, driving millions of farming families deeper into debt and poverty.

A market trading for a sustained period of time within the arbitrage between Brazil’s cost of production and that of Washed Mild Arabicas, is likely to do the same.

Scare Tactics

This would be apocalyptic. Beyond the devastating human and economic impact, the world coffee map would be redrawn in a few short years as high-cost origins such as Costa Rica and El Salvador could cease to exist.

The price collapse would trigger a Tsunami that would sweep away all low grown washed coffees, leaving only small islands of high altitude Arabicas, commanding such price premiums as to allow for their continued production.

Specialty coffee would become a scarce and luxury commodity, afforded by only a few, while the rest of us would be forced into coffee purgatory, drinking homogenized blends of Brazilian Arabica and Vietnamese Robusta.

There is intended humor in my melodrama, but there is also truth. Our coffee supply chains are incredibly fragile, under siege from poverty, rising production costs, urbanization, climate change and land pressure.

The Paradox

Paradoxically, those few countries with the potential to respond to growing global demand, also pose the greatest threat to diversity and quality as their ability to mechanically farm mediocre coffee at an industrial scale on the lowland plains at half the cost of the mountain farmers undermines the most vibrant part of our coffee community, the specialty coffee sector.

It is these mountain farmers, on tiny tracts of land, with a few trees hand-tended by their families, that feed the rapidly expanding specialty coffee markets of the world.

Perhaps the price dislocation we see today between high quality coffees and the Arabica futures market in New York is a sign of things to come, a universe where specialty grade coffees are priced without regard for where the commoditized price is trading. Buyers and sellers negotiate a price based on quality, not on what some far-away derivatives market dictates. There is something that feels fundamentally healthy about this development.

You Decide

If we are to meet the growing demand for coffee, both commercial and specialty grades, we will need to take responsibility for understanding what it truly costs to grow, both socially and environmentally.

The futures markets are incredibly powerful trading platforms that facilitate long-term price protection and offer risk negation, but we are not bound to or enslaved by them. When these markets are driven below the cost of production for sustained periods of time, millions of households and entire economies are placed in jeopardy. In these instances we must find ways to recognize the real costs, both direct and long term and decide the value for ourselves.

This searching for new ways; ways that are nurturing to vulnerable supply chains rather than predatory in their competitiveness, speaks to a broader global trend of consideration towards how we acquire, consume and discard.

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