Coffee Pricing Update
September 02, 2010
We recently received a report from our roaster indicating that increasing demand, combined with lower production from farms in South America, will result in price increases on coffee across the board. We want to keep consumers informed, so here is a letter we received from our supplier detailing the causes of this increase:
THE FOLLOWING REPORT WAS IN RESPONSE TO A CUSTOMER’S REQUEST FOR A MARKET AND SUPPLY/DEMAND FORECAST OVER THE NEXT 18 MONTHS…
There is no debate that Brazil is the prime mover of the worldwide supply/demand equation, but unlike the analysis of an annual crop, the large differences between on-year and off-year harvests mean that a more accurate way to view it would be a two year span. Brazil is not only the largest producer of coffee, they are the second largest consumer of coffee (19 million bags/year) as well, trailing only the U.S. (22 million). Brazil has also committed to an aggressive commodity export policy that has seen her coffee shipments rise to, and persist at, 30 million bags/year. As a result, Brazil needs 98 million bags every two years simply to meet current needs. The 2009/10 harvest of 43 million bags, coupled with the 2010/11 projection of 55 million bags, if accurate, totals 98 million bags.
By focusing only on the 2010/11 crop projection, the coffee trade universally believed that the record 55 million bags would prove to be an anchor on prices throughout the second half of 2010. We either forgot, or neglected to focus on the demand side of the equation as well. Over the last several years, worldwide demand has grown to 131 million bags at the same time that washed Arabica production was declining in the Western Hemisphere. Chronic low prices during the first half of this decade caused many coffee farmers to uproot their trees and plant annual crops such as corn and sugar, partly as a response to the expected demand for ethanol raw material. Only Brazil has consistently increased productive capacity, and she has benefited most directly from the consecutive years of low Colombian production. No one would willingly make the argument that Brazils are a substitute for Colombians, but that is what the export statistics show.
Even if we assume that world consumption will not grow due to the poor economic situation, we have not yet seen proof of any decline either. There is some anecdotal evidence that disappointing yields from this Brazil harvest may cause the total to fall below 55 million. Today is First Notice Day for Sep Bolsa (the Brazilian coffee exchange) and there is a $12/bag premium for Sep over Dec, indicating shortage! The Co-ops oversold the September and their yields are not allowing them to make physical delivery in time. If the new total for 2010/11 is only 50 million bags as many now believe, the two year equation falls into deficit (93 i/o 98 million) and the following year will of necessity be a smaller crop again.
When you add in the facts that world producer stocks continue to be at all-time lows (ever since USDA began tracking such data 47 years ago), U.S. Green stocks are at a 10 year low (4.4 million bags), certified stocks worldwide of washed Arabica have fallen over 56% in less than two years (from 4.6 million to barely 2 million today), back-to-back crop failures in Colombia (down 20% or more each year), the impending inversion of the futures market, and a 75,000 lot imbalance of price-fixations (producers have fixed/roasters have not), it is small wonder that any sell-off meets aggressive buying.
We see no immediate solution to the above problems. Yes, the market fire was lit by speculative funds and they have pushed it higher and faster than it could have happened without them. But they could not have maintained this direction for almost 3 months if the fundamental under-pinning was not present. As an industry, we have preached the gospel of drinking better coffee, but we clearly do not have enough of it. Colombia needs to have at least an 11 million bag harvest this year, but that now seems unlikely. As a result, it is hard to envision any significant, long term relief in either futures prices or differentials. If Colombia surprises us with an 11 or 12 million bag harvest, we will be among the happiest beneficiaries. That would portend a noticeable drop in differentials, if not the futures market as well.
A $2.00 market seems inevitable, and I fear higher than that is likely as we move into 2011. Only a significant rebound in Colombia’s production coupled with good harvests in Mexico and Central America can cause differentials to weaken. The problem is that heavy rains have been prevalent in these areas and a developing La Nina means there is more to come. I believe that the high differentials are the companion of the strong market, and neither shows any sign of weakness. It is a grim forecast, but only a drop in worldwide consumption can significantly alter the supply/demand equation, and no one wants to see that. The dollar will occasionally rally, chasing out speculators and providing corrections along the way, and you are wise to jump on them as opportunities. If we have a roaring bull market in equities, or some other investment vehicle, that could siphon off some fund money too.