Caffeinated Commodities

Written By Brian Hicks

Posted August 29, 2006

Every day it’s a new brew. Coffee can give you a heart attack. Or it can fight cancer. It can make investors rich or turn poor farmers towards the cocaine industry. Here we filter the economics inside a cup o’ joe.

In the summer of 2002 I attended a conference in Boston that addressed a broad spectrum of differences between "free trade" and "fair trade." The latter focused on the human element of world consumption and supply, and I was introduced to a Guatemalan coffee farmer whose financial bottom had dropped out with a major dip in coffee’s commoditized price.

This was just after we had hit the nadir of world coffee prices, as traded values per pound and ton dropped by a full 70% from 1997 to 2001.

Tuesday, coffee hit a seven-year high, with the inferior, yet much sought-after Robusta variety fetching over $2000 per ton. Robusta is the bitter, high-caffeine bean that is used to make instant coffees like the ubiquitous Nestle’ product Nescafe.

As an editorial aside but one pertinent to the discussion, I count myself among the many for whom drinking a cup of instant coffee is an absolute last resort.

Arabica beans produce a far smoother cup than Robusta, are grown in shade, and somewhat counter-intuitively account for 60% of the total worldwide coffee trade.

Arabica is also harder to grow, and only flourishes under certain conditions that rely not only on skillful planters but a fairly narrow range of hospitable moisture conditions.

So when the bottom of the curve swept up farmers in places like Guatemala and Ethiopia early in this decade, many found themselves turning to sustenance from other crops that grow in similar conditions – illegal crops like coca and African chat.

Both of these are banned narcotics in the US, used in native ceremonies but also highly lucrative once peddled to those who add chemicals and turn the finished product around to the world’s city streets. It’s a dangerous tightrope these farmers tread between legitimate java cultivation and a dangerous web that can entangle them quickly in drug wars.

Free vs. Fair?

When I spoke to Jorge, the farmer, he urged me and others to buy "fair-trade certified" coffee. This system, developed during the downturn in prices by activists who foresaw harmful consequences to farmers’ lives, has caught on in supermarkets and coffee shops throughout North America.

Coffee purveyors from corner cafes to campus cafeterias often offer fair-trade blends, with the promise that farmers who participate in the program receive a just price for their harvest. But isn’t it the market’s job to determine what a fair price is?

The argument is of course one of margins. Before the late-century nosedive in coffee prices, there was of course a period of higher margins for farmers, where the price of production was lower than that of sale.

Many chose to invest the windfall in planting more and more, rather than increasing efficiency in what was already fertile. There was also a massive investment on the part of major roasters like Sara Lee in Vietnam, helping that country rise to the world’s #2 coffee producer today. The result was a glut that led to the 2001 low.

Interestingly, though from 1986 to 2000 the price of Robusta as grown fell by 86%, the retail price of a cup tripled. Part of this is surely be the increase in highfalutin chains like Starbucks, but without question the marginal effect of these price fluctuations seems to primarily benefit those who are in a price-setting position, i.e. large-scale roasters and traders.

Tea Gets a Rival

There is also the ever-important factor of China’s consumption. As with copper, nickel, platinum, and cotton, where the Middle Kingdom is now the world’s top consumer, we can expect a jump in the number of mugs per Shanghai mouth. While US per capita consumption dropped from 36 gallons per year to 17 over the three decades from 1970 to 2000, China could make up the gap if it comes anywhere close to Japan’s current consumption.

Japan currently downs ten times more joe per day than China, showing that not all Asians agree on tea for their daily caffeine of choice.

The United States also plays a role in how coffee is traded, because its departure from the International Coffee Organization in 1992 sent ripples through the commodity world, as the free-trade Washington regime eschewed the ICO’s quotas. Many observers imagine a 50 cents-per-pound increase if the US were to rejoin the group of concerned countries.

The general manager of Colombia’s National Federation of Coffee Growers said this week that he expects the price per pound of Arabica beans to remained within a band of 85 cents to $1.30 over the next three to four years.

"What we’re seeing is that the market has changed, with a greater synchrony between supply and demand,” General Manager Gabriel Silva told Bloomberg News. "Demand is growing at a good pace, which is important to sustaining the natural expansion of coffee in specialized economies such as that of Colombia.”

Hopefully a steady push on both levers will make everyone content, from pick to perk. So tomorrow morning, drink one for energy – and balance.

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