Where We Sit While They Drive the Market

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This past Monday marked the beginning of the National Coffee Association's Fall Education Conference. For me, it began with an instructional cupping at one of the most important locations for coffee in the world: the Coffee and Cocoa Grading Room of the Intercontinental Exchange (ICE). It is in this room where coffee is evaluated based on Exchange grade standards, where it can either become certified stock against C contracts, or fall short of expectation, diminishing world supply. Ironically, the course for which I was assistant instructing was a tutorial on evaluating Specialty grade coffee.
"What's the difference between Exchange grade and Specialty grade," you ask? These days, anywhere from $.30 - $2.00. But seriously, the main difference is quality. In Exchange grade coffee you can find up to 23 defects per sample, and as long as the coffee is essentially 'sound', of adequate color and odor-free, it can be tendered. Specialty grade, on the other hand, must have 0 primary defects, and score 80 points or above based on fragrance, taste, aftertaste, acidity, body, balance, sweetness, cleanliness, and uniformity. In other words, Specialty coffees are highly scrutinized, and found in much smaller quantity than the millions of pounds of Exchange grade stock that are certified each year.

Millions of pounds of Exchange grade stock... and yet as global coffee consumption grows and weather patterns remain adverse to crop yields and deliverablilty, the supply of certified stock is lacking. The limited supply of tenderable washed mild coffees is not only causing the staggering minute by minute fluctuations in the price of the C contract that you read about in the news, but it is also forcing unprecedented action from the ICE board to increase the world supply of certified stock- namely, with the consideration of bringing washed and semi-washed Brazilian coffees into the mix. So we are left to think, in the face of the current problems of commodity coffee, what is the future of quality coffee?

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From the left: Jonathan White, Christian Wolthers, John Meyer, Jon Stefenson

I was recently told by a supplier, "Buy this coffee now, or it will be gone by Monday. There is nothing left in Brazil." Well, Christian Wolthers, CEO of Wolthers America, a green coffee importer promoting Brazilian estates, testified to this as he presented the current state of the Brazilian green coffee market. Mr. Wolthers reported that as of July 30, 2010, Brazil had a historic 0 bag carry over from the previous crop year. He anticipates that in July 2011, Brazil will only have a 1 million bag carry over, and in July 2012 we should anticipate an 8 million bag deficit. He credited the steady 4 - 5% annual increase in internal consumption and the biennial short crop in 2012 for that deficit.

Meanwhile, John Meyer, VP of the Coffee Division of ADM Investor Services, and active member of the ICE US Coffee committee, indicated that due to low plant and harvest productivity, along with unfavorable weather conditions, the Colombian crop has been steadily decreasing over the past 2 years to the tune of 35%. It was speculated that in the next 2 years, the Colombian crop will not produce the 10 - 11 million bags needed to supply the world market. Colombia, the panel concurred, has no clear recovery in sight, regardless of the promises of the Colombian Coffee Federation. 

The steady decline of ICE certified stock and anticipated short yields caused C futures to rise above $2.00 on Thursday, in part as a response to the discussion of this panel. Within a few short hours, the news hit that arabica coffee will be in tight supply throughout 2011, and we saw the market jump $.05 Tuesday, $.06 more on Wednesday... and it kept climbing throughout the rest of the week.

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So, regardless of the quality discussion, you might be asking yourself this question: What's going to happen to the cost of coffee in general in the coming months? It mainly depends on supply, how strong the dollar is, and also knowing exactly who will be participating. Who indeed. "We're the insiders," said Jon Stefenson, Director of Marketing at Atlantic (USA) Inc., referring to us actual coffee people, "and we have no idea why the market is up or down. Speculators are more than half of the market now." That is, in the day to day trading of coffee contracts, over 50% of the participants are outsiders who will never have physical involvement with the coffee. These people use the volatility of the market, and live in the face of risk in order to make a buck. Needless to say, they aren't concerned with the physical quality of the coffee.

What about supply? As stated above, it doesn't look likely that supplies will increase by any substantial amount, although the fly crop from Colombia, as well as the early spring production from Central American countries, will ease prices slightly for a short period of time. While it was initially anticipated that Guatemala will produce over 4 million bags this year, the dramatic effects of last May's tropical storm and volcanic eruption has created temporary infrastructure problems. However, the early rains from the storm are likely to have increased production in neighboring El Salvador, and those infrastructure problems are likely to be solved by the harvest. What is also in favor is that Honduras's steady increase in production over the past few years is anticipated to finally surpass 4 million bags.

Moving past June 2011, however, the world will be looking to Brazil to gauge the efficiency of their yields and the possibility of their future in the C market. Currently, Brazilian coffee cannot be tendered to the C contract, as the C contract is a 'washed mild contract', and 90% of Brazil's production is naturally processed coffee. The proposal of tendering washed and semi-washed Brazilian coffee is now at the hands of the ICE board, and camps on both sides of the debate await the decision. Some anticipate a slight loosening of the tight supply, while others anticipate an utter flood... substantially easing the risk of investment, at which time those 'outsiders' will leave the game as quickly as they came in, causing prices to tank.

Alex_horizon.jpgGiven the instability of faceless Exchange grade coffee (not even Specialty coffee), is it any wonder that we invest in quality the way we do? Oren Bloostein said it right: the enemy of high quality is low price. Still, so are artificially high prices. Why do more work than your neighbor and get paid the same? Directly communicating the need for quality, meeting the costs of production and paying stable premiums are the only ways to ensure a constant and consistent supply in the future. In the Specialty industry, there is no better hedge. Because when prices come down, and they will, we don't want to be in the backseat of what's currently driving the market.