Prudent Coffee Buyers Weigh Factors Affecting Future Cost

by Kevin Daw
Posted On: 2/28/2018

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Kevin Daw

This past week, I was asked by one of my salespeople to outline my policy on buying coffee as it relates specifically to differentials ("diffs" for short). This is a fairly straightforward process, but it involves a good many variables. For that reason, this is the first installment of a two-part article.

I have written about differentials before. The differential is the value of a particular coffee "chop" (a quantity of beans with identical characteristics shipped by one source). That value is either "plus" or "minus" in comparison with the average price of one of the two green coffee markets: the arabican that trades in New York City or the robusta market trading in London.

There are coffees, deliverable against futures contracts, that are "certified" to be of a quality deliverable against a contract. These chops of coffee are kept in warehouses, and their "certs" are at what is then  an "even diff." If they are not sold in a particular year, they become what is known as "past crop" and will be offered at a "negative diff." Even the best of coffees lose value once the next harvest for that origin begins.

So a coffee deemed to be of better quality than a cert would have a plus value applied to it versus the market, and a lesser coffee would trade at a negative to the market. My decision-making process for when to buy futures generally follows a set duration of time, keeping me from ever having too large a supply in a declining market, or too short a supply in a rising market. I will, however, at times vary this up or down in duration depending on where the market is at any time, general sentiment, market momentum in either direction, and forecasts. With differentials there are these considerations to take into account, but also a host of others, which is why there cannot easily be a set policy.

Here are the variables I look at constantly that inform my decision-making on when to book diffs of differing origins:

Quality: This is first and foremost, because it is how and why diffs exist to begin with. If a coffee at $.08 "over" tasted the same as, but slightly better than a coffee at $.18 "over" from a neighboring country, most would opt for the $.08 – over bean. This is obvious. The art of coffee blending itself likely came into being to take advantage of these opportunities, and to allow for a more consistent cup throughout the year. Exceptions might include situations in which the coffee's origins are to be listed on packaging that specifically requires those beans' usage. This is what drove Colombian coffees to historically high differential levels, 10 or so years ago.

There will almost always be a portion of each origin's crop left over, and these coffees are still marketed as "past-crop" coffee – although, depending on the ethics of the brokers/exporters, this may not be conveyed to buyers unless they recognize this in the cupping/buying process. Many lower diffs that are offered are due to the coffee being from the last season's crop.

Bid availability: The availability of bids, especially beyond six months, is affected by other considerations listed below. Market level, crop estimates, currency and origin-specific issues can affect the buyer's ability to even acquire bids to be considered. For example, farmers in Brazil facing a very low futures market will see that higher differentials make it appealing to offer diffs farther out at higher than historical averages. Brazilian farmers in a high futures environment might book futures but not be willing to offer diffs in the "out months," as those would likely be lower. Instead, they may prefer to wait for the market to soften, allowing diffs to re-balance.

Currency: All coffee is priced in U.S. currency. Depending on how that relates at any given time to local currency values, diffs can fluctuate to the advantage of the grower. In the case of Brazil, because that country's growers produce so much of the world's coffee, the difference in value between the real, Brazil's currency, and the U.S. dollar can affect the overall futures market.

Origin micro issues: Any local issues involving a crop, or politics, will affect differentials. If a country is suffering from a drought, rust, frost etc. and there is crop damage, any remaining coffee will see a sizable increase in diffs. Uncertainty in political direction, and therefore financial parameters, in a given country can have the same effect.

Supply and demand plays into this, as was the case with Colombian coffee several years ago when there was far more demand for than the supply of available Colombian, and diffs reached $1"over" before roasters were forced to remove Colombians from blends, which reduced demand and brought diffs back down to realistic levels.

Origin harvest seaso
n: This also has a bearing on market levels. When farmers have a harvest looming, or underway, they have a stronger motivation to get that coffee sold, so they often will be more willing to bargain on their diffs. Futures market levels affect this, as a low market will keep farmers from discounting too much unless an overabundance of supply forces their hand.

Volume purchase discount availability: At times, where several contracts are bid at the same time, exporters will come down slightly on their diffs. This can only be done with high volume coffees and the risk is that before the roaster uses up all contracts, diffs of that origin have decreased leaving the diffs originally paid no longer competitive.

Taste preference changes: This is another risk with volume purchasing, although it generally takes longer to play out. An example of taste changes affecting diffs was the shift in preference toward darker roast colorations, many years ago. It was found by many, including myself, that certain coffees handled a dark roast much better and resulted in far smoother cup quality. This had the affect of driving those diffs much higher, as demand outpaced supply. This has become evident in Costa Rican and Sumatran coffees especially.

Usage fluctuation and client use: The number of clients on a particular bean/origin affects volume buying and the ability to use volume purchasing as a tool.

When a contract is not used within its terms, usually a month, we pay interest and storage charges on the remaining coffee until that contract is used up. Should volume of a particular origin change due to demand, etc., we can end up paying as much as $.03 or more per month on a coffee.

As a custom contract roaster, our coffee is client-specific. Thus, if a client changes blend configurations, or loses a large account that buys a particular bean, we can become over-stocked on that origin.

In the second part of this article, I'll describe the remaining variables that influence diffs, and take a look at some of the related considerations that a green-coffee buyer will do well to recognize. Until then, as always, may your cup run full, and the brew, exquisite.