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Coffee and the Market: An Overview

July 07, 2014

 
    If you've been watching the headlines, chances are you've heard that coffee prices are rising. Wait, let's try that again with the appropriate emphasis.   Coffee Prices to Skyrocket - Your Cup of Coffee Just Got More Expensive   Here are just a few of the headlines we've seen in our newsfeed in the past couple of months:   Brace Yourself for Higher CoffeePrices Due to Costlier Beans Kraft Follows JM Smucker, Ups Coffee Prices Can't Live Without Your Morning Coffee? If So, It's Going to Cost You More   In fact, since the early spring, a number of major coffee companies have announced that they'll be raising their prices due to the rising prices for green coffee beans. They include JM Smucker, Kraft, Starbucks and Dunkin Donuts. You might notice that those are all major corporations that place coffee orders by the ton rather than by the pound. Nevertheless, a lot of the factors that affect the prices for coffee on the commodity market will also affect prices on the specialty market, even for those roasters who buy their coffee through direct trade.  

Coffee as a Commodity

  In most cases, when you see headlines about the price of coffee, they're talking about the price on the commodities and futures markets, where coffee is traded just like sugar, corn and pork bellies. Specifically, coffee is mostly traded on the New York Board of Trade [NYBOT], the Kansai Commodities Exchange [in Osaka, Japan], the Singapore Commodities Exchange [SICOM] and Euronext [London]. It's one of the most volatile commodities to trade, in large part because there are so many undefined variables that can affect the production of coffee. All it takes is a few days of cold weather or rain at the wrong time to completely decimate a season's coffee crop. Investors are well aware of this, so even a vague rumor about bad weather can be enough to spark a coffee trading frenzy on the commodities markets - and that trading frenzy drives the prices for green coffee higher and higher.  

How Commodity Exchanges Work

  Disclaimer: This is a very, very simplified explanation. If you want a deeper view, check out this article at Small Farmers, Big Change.   Like any goods, the price of coffee - or any other agricultural products - is based on the current supply and demand. If there's enough supply to meet the demand for a product, prices will be lower. When supply is lower, buyers are willing to pay more for the product. When supplies are really plentiful, farmers are often forced to accept prices that may not even cover their production costs. Since agricultural production is so much at the mercy of the weather and other factors outside the control of farmers, commodities exchanges and futures contracts help provide a little security to both farmers and those who buy from them.   Imagine, for example, that you are a coffee farmer and you anticipate that your farm will produce 1,000 pounds of coffee this year. The coffee will cost you 75 cents a pound to produce. The current price for coffee is $1.05 a pound, but your coffee won't be ready to ship for six months. A lot can happen in those six months, so when a trader approaches you and offers you a contract to buy all the coffee you can deliver, up to 1,000 pounds, at a price of $1.25 a pound, you have a sure profit of 50 cents a pound for your crop. The trader, for his part, has ensured that in six months, no matter what the going price is for coffee, he will pay $1.25 per pound for your coffee. You both have injected some certainty into your positions, which makes it easier for you both to stay in business.  

Commodity Trading Gone Wrong

  Unfortunately, there 's a wild card in this scenario - and it's not the weather. It's the traders on the market. Very few of them are farmers and coffee roasters. In many cases, those who are buying and selling futures coffee contracts are traders who have little interest in coffee other than as a vehicle for profit. They may never set foot in the country of origin. Instead, they spend their time watching the weather, analyzing perceived demand and making educated guesses about the price of coffee six months out. If a trader believes that there will be a shortage in six months -- thus, higher prices for coffee -- he'll hedge buy coffee contracts at today's price with the anticipation of selling those contracts at a profit when the time comes. The very fact that he's buying up coffee contracts - future coffee production -- artificially induces a perceived shortage, driving coffee future prices higher. Reporters who cover the futures markets not the rising price of coffee futures and report that you can expect coffee prices to go up.   The roasters we work with don't buy their coffee on the commmodities market. Instead, they buy through a variety of other schemes, including Fair Trade markets, trading directly with coffee farmers or coops and buying from importers who engage in Fair Trade or direct trade. In the next part of our Coffee and the Market series, we'll look at the differences between commodity coffee and specialty coffee, and talk about the reasons we support roasters who source their coffees outside the traditional commodities market.  



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