Coffee Production and Trade

Introduction to the coffee market

Overview

Coffee is an important commodity in the global economy, and, until the onset of the recent international 'coffee crisis'¹, was the second most valuable traded commodity in the world after oil. In 2000/2001 it had a traded value of approximately US$5.6 billion², which was down from over US$12 billion just a few years previously.

Between 20 and 25 million families (mostly smallholder farmers) in more than 50 developing nations and on over 5 million farms, produce and sell coffee. It forms the major share of total exports by value for a number of developing countries, especially in Africa.

Total world coffee consumption is over 6 million tonnes per annum. Europe is the largest market, followed by the USA and Japan. According to International Coffee Organization (ICO) estimates, producing countries consumed 28 million 60kg bags in the 2003/2004 crop year, around 27% of world output. Recent projections for global 2005/2006 production are in the region of 110 million bags, though these kinds of estimates are fraught with uncertainty.³

Price volatility

Like all primary agricultural commodities, coffee can suffer from sharp variations in supply that can cause violent price instability. The past two decades have been symptomatic of this 'boom and bust' cycle. There was a boom in the late 1980s due to a drought in Brazil, followed by a slump when the ICO quota system collapsed. Subsequent undersupply (and frosts in Brazil in 1994) led to another price increase, followed by a price reduction due to oversupply in 1996. During the following year prices reversed, and increased to record highs.

However, these fluctuations were followed by the current international coffee crisis where prices at the turn of the century hit their lowest ever in real terms for over 100 years. The ICO composite indicator price⁴ fell from 133.91 cents/lb in 1997 to 51.91 cents/lb in 2003, which is below marginal costs for production and attributable to oversupply, sluggish demand and rising stocks.

Persistent low prices since the late 1990s led to supply reductions, which have recently allowed prices to strengthen. Indeed, coffee prices rose 33% between 2001 and November 2004, as total production for the crop year 2003/04 plateaued at 6 million tonnes, the lowest level since 1998/99. In December 2004, composite coffee prices went through the US$1 a pound mark for the first time since July 2000, though it has recently fallen back by 5%.

Structural changes

Under 'normal' supply conditions, market prices are highest for Colombian Milds, followed by Other Milds, Brazilian Naturals and Robustas. Until recently, Brazil and Colombia were the undisputed main coffee producers, but this situation changed in the 1990s with the growth of coffee production in Vietnam, which replaced Colombia as the world's second largest producer in 1999/2000. These three countries now make up around 60% of total world production.

In addition to fluctuations caused by weather shocks, recent significant structural changes in the coffee market means new and emerging paradigms are dictating coffee's future, which will almost certainly have permanent effects on the livelihoods of the millions who depend on it. These include:

• Market liberalisation in many producing countries has meant new (and evolving) systems of coffee marketing;
• The nature of supply, particularly with regard to increases in both the quantity and quality of Brazilian and Vietnamese coffees;
• Adaptation of technology by roasters, increasing the use of lower-cost natural arabicas and robustas;
• Increased flexibility of blends by roasters in a response to lower-cost availability.

International markets

Most international trade consists of green coffee shipped in 60kg bags, or, increasingly, in bulk containers. Essentially, two sets of prices are available for coffee: i) the ICO published prices which are indicators of physical trade, and where each contract refers to a specific quality, origin, shipment, currency and destination; and ii) prices determined by futures markets, which reflect underlying market fundamentals (production, consumption and stocks) and technical trading factors (hedging, trends etc.).

Green coffee is available to buyers either directly from origin or via spot markets in the USA and Europe, and the dominant trade paradigm for the coffee industry is pricing based on two commodity exchanges: the New York Board of Trade (NYBOT), and the London International Financial and Futures Exchange (LIFFE), in London.

These commodity futures markets are a way of managing risk by establishing a basis to determine the price of the product for producer, exporter, shipper and consumer. At inception there were, in the main, only coffee-related companies involved. However, today, with the active presence of investment funds playing in this field, futures markets actually risk adding to the volatility of international coffee prices. This is evidenced by the fact that the volume traded on international coffee markets exceeds the global production of coffee by a factor of ten.

The future

The immediate challenge for the coffee industry is how to sustain recently improved market conditions to avoid a return to damaging 'boom and bust' cycles. Though there appears to be some evidence of a recovery in coffee prices, the fundamental underlying problem of over supply remains.

The recovery is still fragile and uncertain, and most coffee producing countries and farmers continue to struggle. Interestingly, coffee exporters have recently underlined the importance of promoting higher quality coffee with the aim of boosting consumption.

However, continued low prices, reduced farm revenues, and a lack of financial incentives from the industry to produce quality coffee have made it difficult for many coffee producers to invest in their crops - which invariably adversely affect the quality of the coffee they can produce. This is one issue, amongst many, that must be addressed if the industry is going to recover on a sustainable basis.

¹ The current 'coffee crisis' came into being as the international price for coffee collapsed in 1998 to levels often below production costs. Low prices have persisted, having a massive impact on coffee farmers across the globe whose incomes have been slashed. This has resulted in increased rural poverty, lack of investment, inaffordability of education and healthcare, and societal upheaval.

² The total annual retail market value of coffee is far higher than this, with current estimates putting it at around US$55 billion, of which exporting countries receive approximately 15%.

³ Second Estimate of World Coffee Production, International Coffee Report, Vol. 19 (21), April 4^th 2005.

⁴ This is a weighted composite price derived from the prices of the four traded categories of coffees - Colombian Mild Arabicas, Other Mild Arabicas, Brazilian Natural Arabicas and Robustas.