Coffee price extremes require a stable remedy

    Blog

    Commodities have always been known to have large price swings based on supply and demand. However, what we are seeing in coffee prices today is not just a result of supply and demand but a complex interplay of trends that will continue to move prices from one extreme to the other. These threaten the coffee industry, the famers whose livelihoods depend on it, and the diversity of coffees we enjoy.

    Average prices over the last 10 years have been reasonable for sustainable production but there have been long periods of prices at the extreme high and low. It is prolonged low prices that place a huge strain on the subsistence farmers who make up the bulk of the world’s millions of coffee growers.

    These feast-to-famine swings condemn smallholders to misery, abandonment of farms and, potentially, to illegal immigration.  That in itself should be enough to prick our collective conscience – but also there is the potential threat to the diversity of coffee origins that coffee roasters and consumers are currently able to choose from.

    While not without its complexities, establishing an international price stabilisation mechanism would provide a remedy to these extreme price swings and provide much needed stability to smallholder farmers’ incomes.

    The damaging price extremes are driven by three principle factors, which are interconnected and reinforcing. Firstly, the increasing participation of speculators in commodity markets -- quantitative funds with trend following strategies that can amplify and extend the periods spent at extremes. In a downward trending phase, the high financial returns that can be obtained by these funds when they are short attracts even more capital.

    Secondly, we are seeing an increasingly duopolistic market with Brazil and Vietnam gaining share at the expense of Central/south American and African producers; today these two countries account for over 55% of the world’s coffee.

    Finally, the impact of climate change is already being felt in coffee growing regions. For example, it is estimated that over half of Central America’s coffee land will lose suitability for growing by 2050. The number of extreme weather events globally is on the rise and such damaging events, as already seen in Brazil and Vietnam, have an exponential impact on prices.

    With coffee prices at 15-year lows, one proposal has been to put regulatory limits on total speculative positions. It’s an idea not without merit but we must accept that speculators provide essential liquidity to exchanges and it would be difficult for any regulatory body to put an aggregate limit on any one category of participants. The best they could do is put individual limits which already exist in the form of position accountability.

    Forcing industry to publicly declare volumes that they buy from each origin and how much is sustainably sourced would mitigate the duopolistic nature of coffee production, help niche origin producers, and push the industry towards sustainability; but the small price premiums on sustainable and certified coffee would not alleviate the price situation overall.

    Another proposal is for large branded coffee companies to create a fund to subsidise farmers at low prices. Indeed, some companies laudably have already initiated additional pay-outs for farmers in their supply chains. At best this provides a minor reprieve to a small number of farmers and, realistically in an industry which is highly competitive runs counter to shareholder expectations.

    An international price stabilisation mechanism would provide much needed stability and reduce the damaging impact of price extremes. At extreme low prices, the fund would subsidise farmers to take-out short-term production capacity by pruning, stumping or replanting newer varieties. In the mid-range, it would be largely inactive except for low risk investments. At extreme high prices, it would recoup its subsidies and costs through a system of levies.

    The failure of such mechanisms is often because at low prices they subsidize production and hence delay the supply response that would automatically raise prices. This extends the low-price cycle till finally the fund runs out of money. There are two keys to avoiding this scenario. Firstly, the fund should be run on principles designed to align, and not conflict, with the normal economic principles of demand and supply. Secondly, the fund must be run as an independent viable enterprise.

    The viability of such a mechanism succeeding is underpinned by continued growing demand. In fact, at Olam we estimate the world needs to produce an additional 40 million (60kg) bags of coffee over the next 10 years.

    For this to succeed it needs the participation of multiple stakeholders: the industry, development financial institutions, commercial banks and governments of origin countries. Initial discussions acknowledge the merits of this approach and a taskforce set-up by The International Coffee Organization (ICO) will further explore this, amongst other solutions, to tackle price volatility and long-term sustainability.

    Aside from the short to mid-term socio-economic impact of lifting millions of farmers from the misery caused by extreme low prices, the fund would have positive longer-term benefits. The subsidised replanting initiatives would lead to sustainable varieties more adaptable to climate changes. More predictable income prospects would encourage next generation farmers.  And more stable prices would be good both for growth in consumption and industry investment.

    Of course, we could choose to do nothing, accept boom and bust prices, and see millions of farmers lose their livelihoods while we lose the amazing diversity of coffees that we currently enjoy. 

    Author

    Vivek Verma Managing Director and CEO Coffee and CFSG

    Vivek Verma is currently responsible for the Coffee and Commodity Financial Services businesses. Originally trained as an engineer, Vivek has over 30 years’ agri‑commodities experience.

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