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Coffee Prices Reflect Supply And Demand - But Unpredictably

by Kevin Daw
Posted On: 2/16/2014

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TAGS: Vending Times columnist, vending, office coffee service, OCS editorial, coffee industry, coffee market, coffee roasting, Heritage Coffee, Kevin Daw, coffee prices, Columbian coffee, coffee costs

Last month, Vending Times and several broad-based media companies reported on the recent decline in coffee prices. When stating numbers in percentage terms, headlines can sound compelling, and this is as true for coffee stories as for anything else.

For example, a 2013 decrease of 23% sounds impressive, but as of this writing, the dollar drop from 13 months ago totals about 40¢, depending on which exact dates you compare. It has been a slow decline, and most of it happened in the first half of 2013 -- as with the recent runup from the lows, we are within 10¢ of where we were in June 2013.

Basically, we are what traders would call "range bound," and we have been for the last seven months. In the very first article I wrote for Vending Times, I discussed the alarming projections by some industry pundits that the market was going above $3, and would stay there. Some suggested that operators "back the truck up" and buy as far out as they could, since the days of $1.20 coffee would never return. By contrast, I suggested that, based on historical price events, we would just as likely see coffee settle back down below $2 within 12 months.

Every time coffee has skyrocketed over the past 50 years, it has come back down to earth within a year of the peak. Why is this? How was I able to see that happening in the face of so much evidence and sentiment to the contrary, and where is the market headed next?

Layering old charts one atop the other shows the coffee market behaving in an eerily similar way during each of these jumps. There are many factors at work that create this mirroring effect, but there is no better driver in any business than profit, and when a product has suddenly tripled in raw cost, the ability of producers to deliver more of it is astonishing, verging on heroic. My dad used to say, "When the market goes up like this, every farmer with an old silo filled with beans from a down year will suddenly drag those beans to market." That effect, plus the ability on the part of producers to afford more fertilizer and better field husbandry when their crop is selling high, sets the stage for much greater output. Because traders buy and sell "futures," they are looking ahead at what might be expected -- and it doesn't take long to notice warehouses filling up with the sudden bounty of outsized crops. Brazil, the world's largest coffee producer, has been "knocking the cover off the ball" when it comes to output, producing record crops over the past few years.

Added to this improvement in supply, the U.S. dollar, the currency with which all coffee is traded, has strengthened over the past few years, allowing producers to realize more per pound in their native currencies and thus easing the pain of a falling market. All of this brings us to what we see today, which is as mentioned a range-bound market that has been oscillating between $1.10 to $1.30, just as it was back in 2009 when the fireworks began.

There is an awful lot of daily "noise." During the week of Jan. 14, for example, three separate sources all changed their predictions for the upcoming total volume of the Brazilian crop, sending the market swinging over 5¢ in range on a daily basis for the week. Though I refuse to make written predictions (that is a fool's folly), I can suggest that at these levels, the downside reflects a smaller per-pound dollar figure than the potential upside. Back in the 1980s, we saw coffee get to 50¢, and although very unlikely that we will see that again, that reflects 70¢ to the downside, while if we should return to decade highs, the upside potential is over $2 from here.

Based on history, we are midway through a long-term trend that is usually bumpy but not hysterical. Unless there is a large event such as a Brazilian frost, which -- given that Brazil sits in the southern hemisphere -- would be a summertime event, pricing should not be quite so volatile. Differentials, or premiums/discounts paid depending on the perceived difference in quality of a particular chop or origin to the market, may well be the pricing mover over the coming months. Central America, for example, has been suffering from coffee "rust," which dampens output. With many popular blends containing a fair amount of these beans, even with a flat market, certain coffee blends may see increases in price, regardless of a flat futures market.

Colombian coffee ran into this type of trouble five years ago and saw the differential paid for it rise from roughly 30¢ over to as much as 95¢ over the futures contract price. Today, Colombian coffee costs are historically low, while Central American coffees are rising, and we could see an "inverse" pricing going forward whereby Colombians, though a slightly better coffee on average, may actually become cheaper than Centrals.

Back when the market hit that 50¢ low in the '80s, we actually saw robustas trade higher than arabicas for a very brief period. Sometimes the vagaries of supply and demand can swing markets to crazy extremes, the likes of which can never be predicted. "Buyer beware" is a good adage to operate by.

Kevin Daw KEVIN DAW is president of Heritage Coffee Co. (London, ON, Canada), a private-label roaster serving the breaktime management industries. A 30-year veteran of OCS, water delivery and vending operations, he has concentrated on coffee roasting for the past two decades.