Low Coffee Prices – We’ve Been Here Before
Posted by Will Tomlinson, International Development Consultant and Twin Board Member, on 12 October 2018
Once again, much of the coffee industry is struggling with low prices. Well, at least many of the smallholder farmers are. Current coffee prices are below cost of production in many countries, making coffee a path to continued poverty for smallholder farmers, rather than a chance to grow income and wealth. This is certainly not the first time the commodity benchmark price for arabica coffee, the famous NY ‘C’, has fallen below $1 per pound. In fact, coffee fell below $0.50 per pound in 2001 and 1975. Adjusting for inflation, the current price of $0.97 per pound is not much above historic lows. We have been here before.
Why is the global price of coffee once again below $1? Is the global coffee market pricing system a failed or broken market? Are speculators and big international coffee companies to blame? Are NGOs and international development initiatives increasing the supply of coffee beyond what the market can support? What are the solutions to low prices?
The coffee commodity market is not broken or failing, but it is flawed. As with most markets, not all stakeholders have an equal voice. The two largest producers, Brazil and Colombia, have seen their production hit new records. Brazil is having a “big year” of high production in a bi-annual cycle, and Colombia has recovered from rust problems and is back to historically large production levels. When coffee prices rise to $3.50 per pound, as they did in 2015, farmers are motivated to plant more coffee. Both countries continue to provide subsidies to their coffee producers that distort the market and benefit from depreciated currencies that keep pricing strong in the local currency. These two countries’ ability to increase supply has by far the biggest impact on NY ‘C’ prices – supply growth drives down prices. Many Brazilian and Colombian farmers – with depreciated currencies, large scale farms, value chain efficiency, and government subsidies – are still largely profitable while smallholders elsewhere struggle.
Are NGOs the villain on the supply side? It seems the Brazil and Colombia coffee bigwigs would like us to think so. But no amount of NGO or development donor funding will impact supply like Brazil (although the World Bank’s historic effort in Vietnam might be of interest). Meanwhile, development organisations are working hard for incremental improvements for smallholder incomes through productivity improvements on the farm (improved varietals, soil quality and good agricultural practices) and through the cooperative (scaled processing with a quality focus) as well as to improve market linkages and pricing transparency. There is more work to be done, especially on passing through good freight on board (FOB) prices to the farm gate, but clearly smallholders themselves don’t have the resources for this kind of investment.
Demand for coffee has a very reliable and steady growth pattern. We are unlikely to ever solve the problem of low coffee prices with growth in demand. The simplest solution to low prices is less supply. A coffee farm is a long term investment; four years before trees are at full production and a minimum 25 year productive life, so switching costs are very high. Where farmers have planted their farms with coffee, they are pot committed. So now we largely wait for the next bout of disease or bad weather to limit supply and boost price or for demand to catch up with the current oversupply.
Industry has also consolidated into an oligopsony of three large companies and they do appear to have an effect on premiums paid above the NY ‘C’ market price. There are fewer buyers chasing the same specialty producers leading to concentration of green bean buying power. But there is no clear evidence they are impacting overall arabica supplies and NY ‘C’ pricing. Maybe, these buyers are even enhancing consumption as they look for revenue growth themselves. These big buyers are perhaps guilty of abusing the payments system; they have pushed payment terms to as far as 350 days – meaning the rest of the value chain has to finance the oligopsonists’ coffee. Legal but unfair.
Speculators and the Big Consolidation
Charging speculators with market manipulation is an old shibboleth; while they may have an impact on short term pricing, they do not appear to be responsible for sub $1 per pound arabica prices. In a market as big as coffee, speculators provide liquidity which allows for price discovery and the clearing of markets. They bring a fair value price based on supply and demand faster than any artificial pricing mechanism would. Speculators make money, no question. In the current market they profit from rolling short arabica futures contracts over from month to month and from trading robusta futures contracts against arabica, generating a few percentage of yield annually. Of course, without this yield (what market participants call “carry” or “arbitrage”), there is no reason for speculators to engage in the market, carry inventory, provide liquidity – all important to an efficient market pricing mechanism.
It is also important to remember that the coffee market can experience significant changes in supply and demand from weather, the spread of disease, the renewal of subsidy programs – and all these factors play a role in the historic volatility of coffee prices. As to the role speculators play in coffee price volatility, yes they have some responsibility, but it is unclear how short term volatility impacts smallholder farmers or their cooperatives.
So, what can we do about low coffee prices and unsustainable coffee farmer income for so many of the smallholder farmers? Are we trying to increase prices for the entire market or just improve differentials against Notorious ‘C’ and throw more support behind sustainable income-based price floor programmes like Fair Trade?
First, let’s recognize not all smallholders are alike. Cost of production can vary dramatically – from $1.90/lb in Ecuador to $1.5/lb in Peru – just in Latin America. Farm sizes allowing for big differences in economic scale can also vary dramatically from 3+ hectare in Colombia to a half a hectare or less in Rwanda (not to even mention the share croppers in other markets). Not all currencies are dollar linked and not all farm sizes and local costs are the same. There are many Congolese coffee farmers that would be very happy with ‘C’+ 50c today, even if they only received 75% of that FOB price.
Many smallholder farms in Brazil and Colombia are economically strong. It is entirely possible that supply growth from coffee sources with low marginal costs will displace the farms with high marginal costs. We can support productivity gains to lower cost of production for the struggling farmers, but some coffee smallholders may never escape poverty until they leave coffee behind.
There is talk of finding a market mechanism to replace the current ‘C’ market, but given the global scale of the coffee trade, there is unlikely to be a more efficient market than the one that exists today – financing, moving and trading the vast amount of coffee around the world (a controversial statement for some, and worth much more discussion). It might be helpful for governments to stop subsidising coffee farmers – programmes that usually benefit the larger, more prosperous farmers. But simply put, if a Brazilian farmer can make good returns at $1 per pound, that will likely be a proxy for the global market price, given how much coffee the country produces. Can we change the behavior of the big three coffee buyers? Again unlikely, as they are not acting illegally and they are maximizing profits for their shareholders, even if its on the back of small farmers. Thus, we seem to be stuck with ‘C’ and market dynamics that we can’t control.
Price Floors, Fair Trade and Differentials
We can try to support high differentials and price floor programmes, supporting the part of the coffee value chain that believes in income sustainability. The idea of a price floor for the entire coffee market has been tabled, but a quick review of the International Coffee Agreement should quiet those voices. The specialty coffee market has grown up – thanks largely to the Speciality Coffee Association – specifically to address sustainable coffee incomes. It requires a matching quality product and has so far scaled well in the past 35 years. It has evolved in conjunction with Fair Trade, which provides a price floor for certified programs. Together, matching quality coffee with high differentials and price floors still looks like the way forward.
Fair Trade is still the by far the largest price floor system and maybe the most important stakeholder in the effort to improve smallholder coffee income. Is it time for coffee stakeholders that believe in smallholder sustainability to revisit their understanding and commitment to Fair Trade to add to its market power? At the very least, it would be a constructive conversation to explore why new floor pricing systems have been established, such as Cooperative Coffees in the US, instead of relying on Fair Trade.
As for improving differentials, or the premiums above ‘C’ that farmers and cooperatives earn for their quality and certifications, there is a significant opportunity for the development community to support cooperatives, famer access to training and inputs, quality education and premium/specialty market linkages. With the continued growth in specialty coffee consumption, every cooperative that can help farmers improve soil quality, increase yield, reduce disease and pests and learn harvest and post-harvest standards can find more buyers at higher volumes and better prices
Farmers or Coffee Farmers?
There is a clear role for coffee development organisations to continue their work in farmer training, supporting cooperative development and facilitating market linkages focused on the specialty coffee market where price floors exist. But, it might also be time for the coffee development community to broaden the tools of development to include educating farmers who have non-coffee land and can intercrop with their coffee to access other value chains. How many farmers actually know the gross margin of coffee per hectare versus maize or beans? Similarly, development effort could continue efforts to expand international market access for products like avocados and macadamia nuts – things that grow well in coffee fields.