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Coffee price shock: Justified?

Posted by Joseph Verbeek on
Coffee price shock: Justified?

Coffee price shock: Justified?

We all have seen the news: coffee prices almost at an all-time high. Why? What is driving this?

Over the last 2-3 decades we all have seen the proliferation of ethical seals since the coffee price was too low and many small farmers could not make an adequate income.

There are two sides to this story. In places like Peru, as the jungle opened up, many impoverished people looked for a better place to live and create some cash income compared to sustenance farming on a small plot in the high mountains. So in the last 60 years they moved into high altitude primary forests to grow coffee, trying to make a better living and claim a piece of land for their own. 

In countries like Peru there was lots of unclaimed land and when people could demonstrate an economic activity on that land they could eventually get a title or them living there was condoned. The value of some of the trees on the land would give them a little head start.

So to a large degree, the low coffee-farmer incomes were a result of overproduction due to many people moving into forests trying to make a living out of coffee.  Of course, there was exploitation too because of the power that big exporters had, but certainly in the last 2 decades that power has been reducing and overproduction was the main reason for low farm incomes.

Due to a combination of factors this overproduction is reduced and now there is a tight balance between demand and supply. For a long time, there were big stockpiles of coffee that allowed the buffering of prices.  These stockpiles are gone. When the coffee prices start to go up, farmers tend to hold on to their crop to get the best price, and only when the price has clearly stabilised they may start trickling the coffee into the market. In the past there was a lot of stock available that could be used to stabilise the price, and due to lack of modern communication farmers were not aware of market prices and trends or could not find alternative buyers so they would let easily go of their stock. Small coffee farmers now have much better means to read the market and sell their coffee. Hence there is somewhat of a speculative nature to these price increases as farmers are holding onto stock and creating undersupply. There is also a lot of consolidation going on with very big traders buying medium sized traders. These large traders will be able to manipulate pricing more to benefit them. Higher prices will help for example their contract growing profits.

The main reason though for the tight balance between supply and demand is climate change. It was predicted 10 years ago that coffee would be one of the worst affected crops and it is happening... Two of the places that are heating up at an above-average rate are Brazil and Vietnam. Guess what? These countries produce about 60% of all coffee and both countries had droughts last year. Coffee plants are resilient, but heat makes the coffee ripen quicker resulting in smaller beans ie lower yield. Moreover, too much heat damages plants and that has been happening in both countries. It takes 3-4 years to have new plants produce, so there could be a significant time gap to reach full production again after significant damage and in the meantime the heating gets worse.

Most coffee growing countries are experiencing more heat so despite expanding plantations and mostly more use of fertilisers and sprays, they cannot compensate for reduced yield. In many countries potential to expand is only on the actual plantation by taking more trees out which in turn accelerates heating up. In Brazil there is limited scope for expansion of coffee growing areas as they don’t have the altitude. The plantations are already occupying the higher areas and putting coffee in lower areas means more heat and much lower quality coffee. In Peru there are still a lot of zones of altitude that could be cultivated but luckily the EU has adopted laws to contravene deforestation of sensitive areas for the sake of expanding production. So in general there is not a lot of scope to increase production and in fact stabilising at current production levels will be a real challenge. 

Moreover, all these coffee growing countries are developing quickly, and the children of these small coffee growers get better education and have opportunities to do other jobs for similar or better incomes, so there is less labour available in mountainous areas with difficult terrain, unless incomes go up, a lot.

Until this year, coffee prices had not corrected much for inflation since the 1970s. If one works inflation into the coffee price then the current coffee price should be even higher but we are getting in the right ball park with current pricing. So you could argue that we are finally seeing belated income inflation, coupled with more emancipated farmers that have more of a choice of what they will produce on their piece of land and whom to sell it to and when. There will be farmers that will have to switch from coffee as their land is getting too hot. There will be farmers that have taken all the shade of their coffee plantations and who will struggle. There will be farmers that will be looking to use more fertiliser, sprays and irrigation to combat lower yields. Well-run organic and other shade grown plantations with very low input costs should see a fairer income with these higher prices and it is an incentive for other growers to reforest coffee plantations.

The last point why the coffee price increase is exacerbated in NZ and Australia, is that coffee prices are determined in US$. Most economies that grow coffee have economies very much tied to the US$. So their local currency tend to track the US$ better. The NZ and Australia's economies are closely coupled with that of China. Since around election time in the US, the US$ has appreciated against the AUD and NZD with more than 10% as there is now the expectation that inflation in the US will remain fairly high, requiring high interest rates to combat this. All the trillions of liquidity floating in the world will seek the highest interest rate and that is in the US at the expense of other currencies supported with lower interest rates, especially a high risk currency like the NZ$.

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