U.S.-China Soybean Tussle Affects Pricing Of Coffee Futures

by Kevin Daw
Posted On: 12/11/2018

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  Kevin Daw
Everyone in the industry, at least everyone involved in the buying or selling of coffee, is likely to be well aware of the decline in coffee futures so far this year. At  this writing, we are quite close to a 13-year low, and by the time you read this, we may well have broken through that level as well.

Every long-time coffee broker I've spoken to is quite in awe of this particular market occurrence, as the "short positions" – contracts only profitable if the market drops – held by the "smart money" (those not in the coffee market directly, but rather commodity traders), are at an all-time high, even as we descend towards $1 per pound for the current trading month. Coffee futures allow us to price coffee to clients for extended periods of time, often under a fixed-price contract that requires us to have a vehicle for price-fixing ourselves to protect our margin. The futures market can be bought out well past a year, although the "out months," those far off in time, usually are much higher than the current month due to time value.

Where the market goes from here is, as usual, anyone's guess, but when the smart money is weighing so heavily to the downside, it feels very risky to bet against them by being too quick to buy in. When the smart money changes their mind, starts to book profits, and either reverses their trading and goes bullish on coffee or just looks to other markets altogether, coffee will see quite a recovery. For every short position they hold, they must buy a contract to "cover" that position, making for a far greater number of buyers as sellers potentially. This means that sellers can wait for the futures level to be bid up as buyers scramble to fill positions.

All this is to say that we may be in for quite a reversal going forward. In the meantime, differentials are a whole different story, and one with interesting dynamics at play.

I have written in the past on coffee differentials. These are the prices for specific origin coffees, and represent the plus or minus cost at which a particular origin of coffee is selling versus the market. So if an origin is asking for "30¢ over" a futures level of $1.10, the actual green cost of the coffee in question would be $1.40.

This cost is usually for coffee sitting in a bonded warehouse near the port of entry of the country it is being sold in, although when buying direct from origin, the quote is often from the port of origin/departure.

So how about soybeans and China, and how on earth are they related to the price of coffee differentially?  With the recent rounds of tariffs placed on imports, and the commensurate backlash by exporting countries against U.S. goods, soybeans got caught up in the shenanigans when China decided to levy a large fee on any soybeans coming from the U.S. This is supposedly to upset U.S. farmers, known to be larger Trumpets than average, and may well be a ploy to get the President to back down or risk losing his voter base.

That's a whole other story, but the unintended consequence of all of this is that Brazil has stepped in to fill the need for soybeans in China at non-tariff pricing. This is at first blush no biggie, as coffee farmers aren't pulling up trees to switch to soybeans just yet. Where the problem lies is that, to get soybeans to China, one must use the same ships that are used to haul green coffee around the world.  This has created a huge demand for shipping and driven rates up drastically. The only way to mitigate this cost is through increasing those differentials, and we are seeing these increases – not only from Brazil, but from all origins of late.

Interestingly, the robusta market has not gone down lockstep with the arabican market. The same dynamic of soybeans-to-China is at play there as well, but it is also due to robustas already being quite low overall versus the arabicas, and they can only get so low.

The good news is that you won't have to be leery of cheap offerings stealing away price-conscious clients, as often happens when there is a large arabica/robusta price spread. So, while it is nice to see a low "C" futures market, and the gap narrowing between its cost and robustas', don't be surprised if the net price you pay doesn't follow equally. Differentials are, after all, our own little tariffs.

» 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.