by Ric Rhinehart, Executive Director, SCAA
Any time coffee folks are gathered, conversation will inevitably include a reference to “the market.” “Did you get the market today?” or “Where did the market close?” and similar conversation-starters are a mainstay in coffee circles everywhere. There are specialty players who take a particular pride in denying their involvement with “the market,” noting regularly that the coffees they buy do not trade there. Given the ongoing volatility in the market, and the real impacts this has in the lives and businesses of coffee producers, intermediaries, and roasters, it is worth taking a moment to examine this thing we spend so much time talking about. In the case of coffee, this is most often the New York “C” contract, operated by Intercontinental Exchange (ICE).
Commodity exchanges and futures markets originally developed to fill a variety of functions. In 2010, I wrote the below in a position paper on plans to allow semi-washed and washed Brazil coffees to be tendered to the market:
First and foremost, these institutions provide a highly liquid marketplace that allows for both buyers and sellers to be assured that they will be able to transact business involving the underlying commodity. Both physical and fiscal liquidity are important for both sides of the market. Markets also serve to create a mechanism for price discovery. While experts have debated for years whether price discovery is best served by commodity exchanges or futures markets, there is no doubt that the combination of a robust physicals market and an active futures market consistently perform the task of price discovery. Futures markets also serve to provide a mechanism for risk mitigation for both buyers and sellers, and long term price and cost structures can be managed effectively through a variety of market mechanisms. Finally, in recent years, markets have served to provide alternative risk management strategies for financial interests outside of the fundamental market activity. That is, speculators, funds and other institutional money managers have utilized commodity markets as a part of their overall money management strategies.
At its most basic level, the market is designed to allow for producers and sellers of coffee to find buyers and roasters of coffee, and transact business across a time horizon. Put simply, sellers can be guaranteed a selling price for future crops, and buyers can be guaranteed a known cost for future deliveries. This allows both sides of the supply chain to manage their risk and to focus on their core businesses. And for many years, the market has served this function reasonably well, albeit with real questions arising about access and equitability for some supply chain actors. This changed quite dramatically in 2008.
In May of 2011 the New York “C” contract crested the three-dollar mark for the first time in fourteen years. Persistent short supplies of Colombian coffees, coupled with continued strong demand and poor coverage for washed mild arabicas combined to create these exceptional highs. For months prior to this, Colombian differentials had skyrocketed, and buyers and sellers were both pinched as more and more of the value of coffee was invested in differentials, leaving both sides unable to hedge significant portions of their risk. Roasters quickly began to substitute Guatemalan SHB for Colombians, and pushed further substitutions down the line, with cash-crunched Guat buyers turning to Honduras and Mexico, and value-driven buyers forced to Brazil to find prices that were more in line with their ideas for value. Eventually, the market reacted as intended: the basis price rose, differentials stabilized at closer to normal levels, and farmers and roasters got along with the business of coffee. Or so it appeared…
Meanwhile, price-conscious roasters had traded down their blends to reduce costs, substituting from the top of the differential pyramid with Colombia all the way down, in a series of falling dominos to natural Brazils and further-processed Vietnam robustas. These substitutions slowly began to reduce pricing pressures, just as farmers in many countries began to see increased production and higher yields from additional inputs and more intense husbandry spurred by the high markets. From the trader’s point of view, things were working as they always had: that is, “the cure for high prices is high prices,” with increased production in key geographies answering the need for price relief, and demand for the most expensive coffees slackening. In less than a year, the market had slipped below two dollars, and supply-and-demand forecasts had begun to see increasing surpluses out into future years, with moderate consumption growth being offset by exceptional crops in Brazil and Vietnam, and Colombia showing real signs of recovery from its recent troubled production scenario.
By beginning of 2013, market prices for most of the deliverable growths had slipped below the real cost of production for those coffees, and as farmers in Mesoamerica struggled with the added pressure of a persistent coffee leaf rust epidemic, many saw little hope for a future in coffee farming. By the middle of 2013, many were starting to refer to the coffee trading structure, including the futures markets, as a “broken” supply chain. In spite of increased production costs, damage from rust, continued land and labor pressures, and good nominal demand, prices continued to decline, and farmers continued to suffer.
One can make a compelling case that most of the current market dysfunction stems from a shift in worldwide demand: from the washed mild arabica coffees that are the underlying commodity of the “C” contract, to robustas destined for soluble coffee production and natural arabica coffees aimed at decreasing costs for roasters. The contract simply no longer represents the bulk of the coffee traded in the world, and even for those dealing in washed mild coffees, the better qualities are increasingly traded for outright prices and generally off the market. Specialty roasters are not exempted from this scenario, as regardless of how much or how little roasters focus on quality, almost all find themselves, at the very least, using the market as a reference price discovery tool.
So what can be done to rectify this situation? Free marketers will insist that the market will find the correct solution(s) and should be left to struggle through the current difficulties. This may or may not be true, but in any case, for those living crop-to-crop in coffee the likely time required for the market to solve the problem will be akin to finding a cure after the patient has died. Others suggest market interventions at a large scale, or certification schemes that include a minimum pricing mechanism. These are challenging to implement and have not had the long term impacts needed. Many placed their hope in the increase in certified and specialty coffees, but weak recoveries from the global financial crisis of 2008 have found roasters with little stomach for high prices, and even less for unprotected long-term positions.
There are some bright spots in the marketplace, however. The most compelling are in two areas. First, we are seeing a continued desire on the part of large retail players and national food service chains to reinforce their coffee supply chains, and to direct roasters to more sustainable strategies. This would seem to reflect an increasing focus (in the boardroom at least) on sustainability in commodity value chains, particularly in the mature markets of North America, Japan, and Europe. Perhaps most compelling of all are the emergence of fully-realized trading partnerships, with roasters working directly with producers to increase yields, raise quality, and provide technical assistance and access to credit. In the best of these, such as the Nespresso AAA Sustainable Quality™ program, farmers have been able to see the possibilities for a more stable future: one in which “where did the market close today?” is a seldom-asked question, and coffee pricing is reflective of the real, intrinsic value of the consumer experience.
Ric Rhinehart is the executive director of the Specialty Coffee Association of America. He has more than 20 years of experience in the specialty coffee industry and has designed, developed, and produced a wide range of coffee and tea products. He has considerable experience in developing manufacturing and packaging capabilities, and has traveled extensively as a green coffee buyer.