Coffee farmers getting roasted

Finishing my second cup of coffee this morning brings to mind the near 70% rally in coffee futures that we have seen over the past four months. After making a seven-year low near $1 per pound in November 2013, coffee has been on a tear with futures closing at $1.80 as of Feb. 28. While this would appear beneficial for producers, coffee farmers the world over are struggling to adapt to ever-changing, and perhaps worsening, growing conditions.

Brazil – by far the single largest coffee producing nation – is currently in the midst of a severe drought the likes of which have not been seen for the better part of a century. Not only is Brazil’s coffee crop expected to come in 10% below the output we have seen for the last two years, but over 140 cities throughout the country have imposed water rationing with some cities reportedly receiving water as little as every three days. 

Brazil is not alone. The Arabica crop throughout Central America is in the midst of an epidemic of coffee leaf rust – a highly contagious fungus that has been known to wipe out entire crops – resulting in a 35% decrease in Central American output with no end in sight.

Even in Colombia, a nation largely spared by the worst effects of both drought and disease, coffee farmers cannot seem to catch a break. In reaction to the staggering rally in coffee prices, Colombia last week halted subsidies to coffee farmers for the first time since they were initially implemented in October 2012. While not a negative development in and of itself, the impact of this policy change will be hard felt. In 2013, up to 50% of Colombian coffee farmers’ income came from government subsidies.

Indonesia, the world’s third largest producer of Robusta beans, is having production difficulties as well, with coffee output projected to come in 10% to 15% lower year-on-year, Indonesian production is set to fall to the lowest levels since 2011-2012. Meanwhile, the Association of Indonesian Coffee Exporters and Industry believe that domestic demand will jump 7.5% from 200,000, compared to the average 5% growth annually over the last three years. Given Indonesian domestic conditions forecast for 2014, analysts are projecting a 17% drop in coffee shipments out of Indonesia this year.

With the Arabica crop threatened throughout the better part of Central and South America and Robusta producers struggling in Indonesia, there are a few bright spots globally. The real benefactors of these developments are the Robusta farmers in Vietnam. Robusta is a lower quality coffee bean generally used in instant coffees, with Vietnam being the largest producer.

Well aware of the poor conditions that key coffee producing nations such as Brazil have been afflicted with, Vietnamese farmers are taking note of the recent spikes in prices, committing less than 40% of their total 2013-14 crop to the market (compared with 53% the same time last year). We are also seeing beans trade locally at a $40 per metric ton discount to futures – a spread that has doubled over the past two weeks. In light of the favorable market conditions, Vietnamese producers are reluctant to part with their crop prematurely in anticipation of further price appreciation. 

Between the significant decreases in Arabica production in South America, the drops in Robusta output in Indonesia and the growing global demand for coffee, a further rise in coffee prices globally appears a viable option. After all, it was less than three years ago that coffee was trading at more than $3.30.

About the Author

JW Reynoso, Investment Advisor at RCM Asset Management, began his career on the floor of the Chicago Board Options Exchange before working as an options broker at the Chicago Mercantile Exchange. JW provides RCM Asset Management clients with risk management and trading strategies that focus on Managed Futures and options. JW can be reached at jreynoso@rcmam.com.

Trading futures, options on futures and retail off-exchange foreign currency transactions involves substantial risk of loss and is not suitable for all investors. You should carefully consider whether trading is suitable for you in light of your circumstances, knowledge and financial resources. You may lose all or more than your initial investment. Past performance is not necessarily indicative of future results.

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