Why coffee prices keep rising
A seismic power shift - are coffee farmers flexing their muscles ?
Understanding how the price of global coffee is influenced may appear just as confusing as trying to predict where the Australian property market will be in 12 months time - it's not easy, nor does it make much rational sense.
You'd think that coffee farmers, the hard working people that grow, cultivate, pick, process and ship this prized commodity would have a fair bit of control in how it's priced, but unfortunately it seems that we are all beholden to those futures traders wearing suits in the New York commodity exchanges, none of whom ever visit coffee farms as these "masters of the financial universe" are the ones with their hands firmly grasping the big price levers.
The lifting of pandemic restrictions has been good news for everyone in Australia, unfortunately the situation in the global coffee market remains at the most difficult levels in a decade, specifically the demand side as roasters and consumers bear the pain of rising costs rapidly outpacing the retail pricing.
It's certainly been a challenging year in coffee with the global index doubling in the last 12 months driven by ongoing shortages from low inventories in exporter/importer warehouses, escalating and firm differentials across every coffee growing origin, shortages of food grade shipping containers, ridiculously expensive sea freight charges and the leap in exporters deliberately breaching and defaulting contracts to chase higher spot prices, sometimes up to 40% of contracts are being savagely broken without notice at the very last moment prior to shipment.
With the price of coffee climbing a further 25% over the last 2 months on top of a staggering 35% gain since the start of 2021, the Australian coffee industry is bracing for a difficult 2022.
If the higher prices of raw coffee were not enough to deal with, when coffee rises so steeply at the farm gate, there's an equal risk that quality may proportionally fall.
Whilst it's true most coffee producers, like all farmers, possess immense pride in their crops, when raw coffee prices are high and demand so strong, there's a "rush" to get product shipped urgently as they chase the eager cash carrot dangled out in front and right now it’s a motza.
You can hardly blame as this is indeed an equivalent "gold rush" era for coffee farmers globally, it does not come around too often, generally only once a decade.
Pushing speed to bank the fast cash may lead to bypassing normal levels of care during the important processing, washing, grading, drying, etc. so when the pressure is on to get coffee out quickly, quality may be compromised. It’s a seller’s market.
We have seen plenty of coffee ruined in shipment from origin - sweating in a container for 4 months instead of the normal 1 month journey, stuck at ports and trans-shipment depots waiting on sea freight connections. Damage from sea transit is not the fault of the coffee farmer, but it's another risk factor that importers are dealing with on top of many other glass balls being juggled in the air at the same time.
So there you have it folks, a perfect storm in a coffee cup - higher prices, lower qualities and less choices. It's hard to imagine a story getting any worse !.
Let's unpack what's going on with coffee pricing and how the supply side is continuing to flex it's muscles.
Our earlier estimates in August of +$2.40/kg rise was premised on an assumption the global index would find support to stabilize around 185 - 200 mark during November, but the index kept on climbing almost on a daily basis and touched 240 - up from 110 barely 12 months ago.
November was a particularly bullish month and that might have been partly driven by December futures expiring - again it's the nature of "trading on a supply deficit" and not the underlying fundamentals that is pushing up prices.
That original $2.40/kg is now looking decidedly cheap and quite frankly is well under water in the current market as buyers (coffee companies) struggle to source inventory.
On top of the known factors pushing up the price of raw coffee, there's a continued exploitation on the sell side by participants engaging in a contagion of contract defaults - forcibly breaking commitments and agreements to chase a higher spot prices.
We are not sure if this defaulting behaviour will continue when the market inverts as it certainly comes with risks of reputational damage.
Fears of drought in Brazil along with the worst frosts since 1994, Colombia's 9 week total transport shutdown during the first half of 2021 had been stoking the fire under raw coffee prices.
The drought risks have since been resolved with recent rains setting up ideal soil conditions for the next crop, in fact the situation is emerging as almost perfect for flowing, however this optimism is still another 8 months away and it doesn't solve shortfalls at most coffee growing origins of close to 20%.
Even low grade, poor quality coffees - the stuff we and most quality companies never touch - are commanding high premiums so there's nothing coffee roasters can do when trying to hold onto their current pricing or margins - inevitably the ransom must be paid to keep the roasting machines fed with raw coffees else the business stops.
There has been a lot of discussion inside the Australian coffee industry about shifting to lower quality grades to offset the rising prices, but even the entry level lowest grades are priced today at levels that matched high-end specialty 12 months ago.
The impact of higher raw coffee pricing since August is now filtering through the retail side with wholesalers finally lifting prices after many months of playing chicken to see who would blink first.
Comically, this game of chicken is regularly played when raw coffee prices rise as many coffee companies sit on the fence and do nothing - either too frightened to act in fear of losing or upsetting customers.
Some are obsessed with a blind belief that imagines they are increasing market share by waiting until everyone else has lifted prices before them, thinking customers will flock to their lower prices - it does not happen and certainly in the short period between warehouse inventory turns.
The strategy of ignoring sharp rises in raw ingredients can only be sustained for a few months and that period is now well and truly expired.
There's not one Australian coffee roasting company who can hold more than a few months inventory, the free space inside warehouses simply does not exist - many are barely able to hold 1 month of raw coffees and some are ordering on a weekly basis based upon limited cash flow and/or available storage space.
Australian import brokers are also sitting on dangerously low levels of holdings with many below 50% of their normal or desired capacities due to the ongoing sea freight and shipping container shortages and coffee stranded at origin.
Laggards failing to address the surge in raw coffee by resisting price rises will see either pain or failure within the coming 6 months - it's not sustainable by any measure and this time it's a lot different to 2010 when we saw the last big spike - there are many other factors at play including Brazil shortages, shipping constraints and increased levels of contract defaults.
At a wholesale and contract pricing level, the decision to move with the market is a no-brainer.
On the retail side there is a bit more buffer as companies selling direct to consumer may already have decent margins or be willing to sacrifice returns for a short period by holding prices or limiting the increases.
In all of the disruption of rising costs there is one glaring exception......those players in the online segment that persist with a bizarre strategy of seriously overcharging consumers - you know the brands asking $50 - $70 a kilo for coffees dressed up as "something so very special because we can get away with it" - who also sell the exact same coffees for $28 - $35/kg outside of the online segment.
Those brands with exorbitant online prices won't even blink at the cost increases of raw coffees with their fat margins they can well afford to keep prices unchanged.
It's certainly not our intention to create alarm or anxiety, or to dissuade you from enjoying one of life's most important and cherished luxuries - our advice is a simple and transparent explanation of the current and short-term environment for coffee and why it's going to change in 2022.
The average impact on retail coffee is currently measured at $4 per kilo, but with raw coffee rising $5 and allowing for the normal 18% shrinkage during the roasting process, even that $4 rise is undercooked and the eventual impact is likey to be closer to $6/kg.