mycuppa March 2014 Newsletter
It is common knowledge that coffee has traditionally been the 2nd most traded commodity after oil.
Coffee, like any other commodity, is subject to wide price fluctuations.
These changes are influenced by the delicate balance between perceived supply and demand, negative news, and traders who may manipulate the market for gain.
Since January 2014, raw coffee pricing has spiked by an incredible 63% - making this recent set of increases the most dramatic rise over such a short timeframe in the last 20 years.
The intensity of the price rises has shocked even the most experienced and hardened operators in the industry - brokers and buyers.
The effect of recent changes to raw coffee prices has driven up raw coffee bean pricing for Australian buyers by more than $2 per kilo.
Roasting coffee results in shrinkage of up to 18%, so the net effect of the recent jump in raw coffee pricing is around $2.45 for the roasted finished product - assuming all other costs remain static.
We are also seeing the lower local AUD currency now factored into the spot pricing offered by the Australian raw coffee brokers, as all coffee contracts are traded in US dollars.
When was the last time something like this happened?
During the 2nd half of 2010, coffee prices spiked dramatically on the news of poor crop yields in Colombia from the Roya (Coffee Leaf Rust) epidemic and a season of very high rainfall.
This caused a run on the raw coffee price, with the C-index jumping from 150 points to a peak of 300 points over six months up until early 2011.
It took another 12 - 18 months for the spikes to soften back to what we know as more traditional.
Since those peaks in early 2011, raw coffee prices have gradually dropped to very low prices for commodity and commercial grades during most of 2013.
Some origins have remained relatively expensive despite the low global C-Index prices - coffees from Sumatra have sat at high prices for almost three years due to demand outstripping supply from adverse weather conditions.
Costa Rica, El Salvador and some of the nearby Nicaragua, Honduras and Guatemala coffees have remained expensive as almost 40% of their recent crops were destroyed by Roya.
Again, it seems we have reached a similar situation where the global demand is outstripping supply.
Ethiopia has also seen lower shipments and average yields, keeping prices high.
What's causing the latest changes in coffee prices?
We are seeing the cumulative effect of many factors playing out simultaneously.
What started the first round of spikes in Jan 2014 was the bad news of drought in Brazil, resulting in lower harvests and a drop in the available sales volume.
As Brazil is the world's largest supplier of raw coffee (around 5 - 10 times bigger than other origins), a shortfall in Brazil needs to be made up from different origins, creating a situation whereby demand will exceed supply - putting pressure on prices to rise.
Traders seeking profits - an area that I believe has the most influence in global coffee pricing - is independent (and divorced) from real costs incurred by the farmer in producing the product and completely separate from the expenses incurred by coffee roasters preparing and distributing the finished product.
Traders play the market for quick and easy profits.
When prices are low, farmers suffer.
As prices rise higher, it's the coffee brands and roasters who suffer because it is generally impossible to pass on all pricing changes at a retail level instantly the moment coffee rises.
Consumers and supply chains such as wholesale do not tolerate such volatile and unexpected price increases.
The current price at any moment is a function of contracts being exchanged globally on an averaged basis.
Traders love (or prefer) a volatile market, and they can make money on long or short positions, trading for or against.
Having experienced relative stability during 2012 and 2013 from weakening markets, traders are largely absent from price influence as there is little to be gained from strength or stability.
Often during those periods of low volatility, traders to shift their attention and focus to other commodities if they are experiencing volatile pricing cycles.
With the market now showing visible indicators of volatility and disparity, as the first signs of bad news emerged from Brazil, traders play heavy in the market by driving up the price and chasing profits buying futures - further putting pressure to drive up the price.
Currently, it is reported that the demand ratio is 400% of the supply - that is, four times more coffee is being bought than is physically available.
These extreme proportions only last a few months until the market gets fed up and buyers sit on their hands.
I liken the effect to what happens in Australia when storms decimate fresh foods like banana plantations - suddenly, the price can double or triple.
There are less traders in the middle of the Australian fresh food produce supply chain, except you could deem supermarkets as traders.
Kenya has also endured internal issues with the control of some export markets being restricted by government policy, increasing prices by 40%.
Roya (Coffee Leaf rust) remains a serious problem in Central America - harvests are down, and prices are up 30%.
How long will this pricing volatility last?
We will see at least six months of rising prices as traders play shorts and longs, looking to profit from the bad news, artificially inflating the demand versus supply ratio.
If the coffee bean price rises over six months, the fall is more instant than large inventories and contracts are held by brokers for coffees that are delivered up to 3 or 4 months in the future.
The falls can take around nine months to fully roll through the local market.
How does raw coffee bean pricing affect my cuppa?
The mycuppa business operates on much lower retail margins than our colleagues in the local Australian coffee industry, who may price their coffee at $35 - $45 per kilo retail.
A higher retail price for coffee means a company can absorb raw materials cost variations.
Raw bean cost is a larger proportion of the mycuppa Cost of Goods (COGS) than other suppliers selling at much higher retail prices.
Therefore, we tend to be more sensitive to input cost variations of the raw coffee price.
We have reasonable inventories and forward contracts to buffer for around 6 - 8 weeks, which can provide a partial buffer.
Our strategy involves constantly bench-marking our offer against the market to remain the value leader in Australia for fresh roasted premium coffees.
Based on history over the last ten years, I expect all coffee companies in Australia to be undertaking similar exercises in reviewing their positions concerning rapidly rising input costs.
Some coffee companies automatically switch to lower grades as a cost-saving.
Still, we do not change our sourcing practices - coffee is too competitive in Australia, and we do not have "locked-in" customers like cafe suppliers, so our performance needs to be why we retain our customers, not supply contracts.
Day-to-day Issues such as the proposed introduction carbon tax, plenty of new entrants in the coffee market, increased competition level and the value of the Aussie dollar.
Then there are fluctuating fuel costs, speculative interest rates, perceived status/strength of the economy, bad debts, insurance and compliance premiums rising and the jump in energy costs.
Those cost elements above are minor compared to the dramatic impact of the recent raw coffee price increases.
Retail and wholesale coffee pricing will be an interesting topic in 2014, and don't be surprised to see ~10+% rises across the entire market for quality coffees during the 2nd half of 2014.