Commodity price hits 12 year high

On Monday (2 August) Arabica coffee for September delivery reached a high of US$1.815 a pound on the ICE US futures in New York. It has since fallen back slightly, closing at US$1.6985/lb on 5 August. To put this into perspective, the Fair Trade minimum price is US$1.35/lb, a typical price for specialty coffee beans is US$2.00-$4.00/lb, and the commodity price had recently been hovering around US$1.25-$1.40.

At Mercanta we have gone a long way towards ‘de-commoditising’ our product, by establishing direct, independent relationships with premium quality coffee growers. The specialty coffee market is not pegged to the commodity price and, usually, we remain largely immune to the daily price fluctuations in New York.

However, we cannot help but be affected by major commodity market trends. The majority of coffee farmers, including specialty coffee farmers, reference the market price when negotiating sales. The bottom line is that, when the market is up significantly, this inevitably pushes up the specialty price.

Put simply, when Mercanta negotiates prices with growers the following factors come into play:

• What price is available to the grower in the local market for partly processed coffee parchment or cherry? (This rate generally fluctuates in line with the commodity price).

• What price are other buyers paying for specialty beans, thus benchmarking a level for that farm?

• What is the production cost for the farm? Typically this ranges from US$1.00-$1.40/lb, so the so called ethics of buying rarely come into play in the true specialty business. Invariably Mercanta is paying 30-150% MORE than the cost of production.

• What is the grower’s quantity expectation? Mercanta can pay any price for coffee - but if the grower seeks a substantial premium for his product, there may well be a quantity impact on what we can buy.

Undervalued?

The recent developments in the commodity market emphasise a point that we have been getting at for several years now - specialty coffee as sold by Mercanta is undervalued as a product. All the more so when you consider that the average price for a Cup of Excellence coffee in 2009 was US$6.69/lb and so far in 2010 is US$7.75/lb, with winning lots reaching as much as US$35/lb. The Cup of Excellence brand offers fine coffee in small lots, judged by expert cuppers – this is exactly what Mercanta sells. Yet our (non COE) coffee typically commands only US$2.00-$4.00/lb – ie. it sells for prices that are far closer to the market rate for commodity grade coffee, even though an increasing number of the farms that Mercanta offers have a Cup of Excellence pedigree.

This point is well-illustrated in the below graph, showing the evolution of coffee prices following the collapse in 1989 of the International Coffee Agreement, which had regulated prices and exports. The graph shows: the International Coffee Organisation’s annual average commodity price for coffee; the ICO annual average commodity price for washed Arabicas (non Colombian); the Fair Trade minimum price; and the Cup of Excellence annual average price since the first auction in 1999. The dashed rectangle shows the typical price range of non-COE specialty coffees – ie. what Mercanta sells.

This data makes two things clear:

1) Specialty coffee demands a far ‘fairer’ price than Fair Trade (which will either pay farmers the minimum guarantee of US$1.35/lb, or the market price plus US$0.10/lb premium).

2) The gap between COE lots and ‘normal’ specialty coffee is growing ever wider.

Coffee Price Evolution 1990 - 2010

What now?

It is difficult to predict what the market will do next. The current high was triggered by short supplies from Colombia after last year’s Arabica production fell to a 33-year low, and has been inflated further by market speculation. The ICO warned on Friday (30 July) that “the current tight demand and supply situation” was “likely to persist in the near to medium term”. A technical analysis published this week forecast that prices will continue to fall back slightly in the short term, before easing with the arrival of the new Brazilian crop in October.

A note from Brazil

This year’s crop is set to be very large, which should take pressure off the commodity market price later in the year. However, because of very uneven flowering/maturation the harvest will yield an unusually high percentage of naturals, and the price difference between pulped naturals and naturals will be as wide as it has ever been. This is because multinational giant roasters are buying up pulped natural Brazils in place of washed Arabicas from Colombia and Central America (which are scarce and expensive). This is pushing up the pulped natural price. In contrast, natural Brazils have a taste profile unsuited to substitution for washed Arabicas meaning that they are likely to be more plentiful, and therefore comparatively cheaper.

Robusta is no alternative

Another point to take from the commodity price high is that, despite a plentiful supply of Robusta at around US$0.80/lb, multinational giants are still paying up for Arabica at more than twice that price. Consumer tastes are becoming increasingly refined – these days there is only so much Robusta that even the multinationals can get away with.