March 2014 - coffee price shock, up 63%

Date Posted:1 March 2014 

 

It is common knowledge that coffee has traditionally been the 2nd most traded commodity after oil.

As with any commodity, coffee is subjected to both mild and severe levels of price volatility influenced by the effects of supply and demand ratios, bad news and of course the traders who can manipulate the market for profit or gain.

Since January 2014, raw coffee pricing has spiked up by an incredible 63% - making these set of increases the most dramatic rises over such a short timeframe in the last 20 years. 

The intensity of the price rises has shocked even the most experienced and hardened operators in the industry - brokers and buyers.

The effect of recent changes to raw coffee prices has driven up raw coffee bean pricing for Australian buyers by more than $2 per kilo.

Roasting coffee results in shrinkage of up to 18%, so the net effect of the recent jump in raw coffee pricing is around $2.45 for the roasted finished product - assuming all other costs remain static.

We are also seeing the lower local AUS currency now being factored into the spot pricing being offered by the Australian raw coffee brokers as all coffee contracts are traded in US dollars.

When was the last time something like this happened ?

During the 2nd half of calendar 2010, coffee prices spiked dramatically on the news of poor crop yields in Colombia from the Roya (Coffee Leaf Rust) epidemic and a season of very high rainfall. 

This caused a run on the raw coffee price with the C-index jumping from 150 points to a peak of 300 points over a period of 6 months up until early 2011. 

It took another 12 - 18 months for the spikes to soften back to what we know as more traditional.

Since those peaks in early 2011, raw coffee prices have been gradually dropping to very low prices for commodity and commercial grades during most of 2013. 

Some origins have remained relatively expensive despite the low global C-Index prices - coffees from Sumatra have sat at high prices for almost 3 years due to demand out-stripping supply from adverse weather conditions.

Costa Rica, El Salvador and some of the nearby Nicaragua, Honduras and Guatemala coffees have remained expensive as almost 40% of their recent crops were destroyed by Roya. 

Again, we have the demand outstripping supply. Ethiopia has also seen lower shipments and average yields keeping prices high.

What's causing the latest changes in coffee prices ?

We are seeing the cumulative effect of many factors playing out at the same time.

What started the first round of spikes in Jan 2014 was the bad news of drought in Brazil resulting in lower harvests, dropping the available volume for sale. As Brazil is the world's largest supplier of raw coffee (around 5 - 10 times bigger than other origins) a shortfall in Brazil needs to be made up from other origins, creating a situation whereby demand will exceed supply - putting pressure on prices to rise.

Traders seeking profits - this is an area that I believe has the most influence in the global coffee pricing - it's totally independent (and divorced) from real costs incurred by the farmer in producing the product and completely independent of the costs incurred by coffee roasters preparing and distributing the finished product.

Traders play the market for quick and easy profits. When prices are low, farmers suffer. When prices are high, roasters and coffee companies suffer because it is impossible to pass on all pricing changes at a retail level - consumers will not tolerate such imposts.

The current price at any moment is a function of contracts being exchanged. Traders love a volatile market and as we have experienced relative stability during 2012 and 2013 from weakening markets, traders have been largely absent from price influence as there is little to be gains from stability.

Now the market has shown visible indicators of volatility when the first signs of bad news emerged from Brazil, traders are now playing heavy in the market and driving up the price seeking profits from buying up futures - further driving up the price.

Currently, it is being reported that the demand ratio is 400% of the supply - that is, 4 times more coffee is being bought than is physically available. These sort of extreme ratios only last for short periods of a few months until the market gets fed up and buyers sit on their hands.

I liken the effect to what happens in Australia when storms decimate fresh foods like banana plantations - suddenly the price can double or treble but of course there are no traders in the middle when it comes to the Australian fresh food produce.

Kenya has also endured internal issues with the control of some export markets being restricted by government policy, increasing prices by 40%.

Roya (Coffee Leaf rust) remains a serious problem in Central America - harvests are down and prices are up 30%.

How long will this pricing volatility last ?

I expect we will see at least 6 months of rising prices as traders play shorts and longs looking to take profits from the bad news, artificially inflating the demand versus supply ratio.

If the coffee bean price rises over 6 months, the fall is not so instant as large inventories and contracts are held by brokers for coffees that are delivered up to 3 or 4 months in the future.

The falls can take around 9 months to fully roll through the local market.

How does raw coffee bean pricing affect mycuppa ?

The mycuppa business operates on much lower retail margins compared to our colleagues in the local Australia coffee industry that may price their coffee at $35 - $45 per kilo retail. A higher retail price for coffee means a company is able to absorb raw materials cost variations.

Raw bean cost makes up a larger proportion of the mycuppa Cost of Goods (COGS) compared to other suppliers who are selling at much higher retail prices - therefore, we tend to be more sensitive to input cost variations of the raw coffee price.

We have reasonable inventories and forward contracts to buffer for around 6 - 8 weeks which can provide a partial buffer.

Our strategy involves constant bench-marking our offer against the market to remain the value leader in Australian for fresh roasted premium coffees.

Based on history over the last 10 years, I would expect all of the coffee companies in Australia are currently undertaking similar exercises in reviewing their positions with respect to rapidly rising input costs.

Some coffee companies automatically switch to lower grades as a cost saving, but we do not change our sourcing practices - coffee is too competitive in Australia and we do not have "locked in" customers like cafe suppliers, so our performance needs to be the reason we retain our customers, not supply contracts.

Day-to-day Issues such as carbon tax, new entrants in the coffee market increasing competition, current value of the Aussie dollar, fluctuating fuel costs, speculative interest rates, perceived status/strength of the economy, bad debts, insurance premium rises or the jumps in energy costs - are just minor compared to the dramatic impact of the recent raw coffee price increases.

Retail and wholesale coffee pricing is going to be an interesting topic in 2014 and don't be surprised to see ~10+% rises across the entire market for quality coffees during the 2nd half of 2014.