The absurdity of the C

Over the last couple of months I’ve started paying more attention to the ‘C’ price for coffee.  This is the price paid for coffee in the Intercontinental Commodity Exchange (ICE).  Now, only a small amount of coffee gets traded through the ICE but the price paid is important because it acts as an indicator.  For anyone involved in coffee production it is a measure of what that coffee is worth now.  Often a differential is paid, a premium on top of the C price – perhaps based on the coffee’s country of origin.

In the past prices paid to producers for higher quality lots were usually a lot more than the C but still tied to it, often in the form of a differential.  For this reason, when coffee’s C price spiked they had an impact on every price paid.

Looking back historically you can see prices were depressingly low, then stabilised around the $1.20 mark and then in the last two years things spiked dramatically.

The more you watch the ‘C’ the less comfortable you get with its existence, because it doesn’t really seem to be a very sustainable way to do things.  I understand the concept of the open market, of abundance and scarcity affecting price.  As you watch the C you realise that perhaps, perhaps these things have an effect on macro movements but in the day to day they really matter very little.

Looking at this chart you would think that a growing global demand, against generally insufficient supply would push prices up.  You’d also understand that Brazil having a great crop this year – to the extent that we may have a surplus – would surpress prices.  Often though you see price movements based on a host of other factors.

To give you an example of this:  On March 22nd coffee’s price fell by 8cts, to a recent low of 174.45.  This rapid drop was caused by data released concerning Chinese and European manufacturing and its decline.  News that China’s manufacturing activity had declined for the 5th consecutive month had an impact across all commodities that day, rather than coffee specifically, but that still doesn’t make one feel any better about the fact that for producers the price is massively out of their control.  You could argue that given enough money, you can influence things.  I read a little about rumours that Brazil’s government was looking to lend producers money to prevent them selling when the market was too low and wait until prices improved without immediate pressure.  This seems like a relatively difficult thing to pull off if you don’t have one of the largest economies in the world.

As purchasers of coffee, we’re generally able to control our sale price.  If our cost of goods goes up, we maintain our margins and our retail price increases accordingly.  Impacts of spikes in coffee’s price can be dealt with, and we are able (in theory, anyway) to run sustainable businesses.

Back to producing coffee – we should probably look at the other major impactor on the economics of this: the cost of oil.  This is a pretty good metric for looking at how the cost of production may change year to year, month to month, or even day to day.

With oil we see massive fluctuations.  I’m aware that oil affects us, that it affects the cost of goods for many businesses.  It doesn’t really reflect the changing cost of coffee though, because that baseline price has become so disconnected.

I am aware, writing this, that I still know very little about commodity trading, about why we have ‘C’ price at all or why we remain so wedded to it.  I don’t know if it is possible for organisations in producing countries to produce a price indicator – calculated on the price of production, as well as a margin in there too.  This kind of thing is way above my pay grade but using a moving average of crude oil’s price across the period of time where producers are typically putting in a lot inputs may give some insight into the cost of production in a particular country at a particular time.  This would give some level of predictability – because as a producer you know that the cost of production may vary but your margin will remain reasonably intact.

Surely something that is at least sympathetic to the unique conditions rather than tied to global macro-economics would allow a more sustainable industry.  The free market would end up having an impact on the prices actually paid – but I’d rather look to an indicator that is relevant.  The ‘C’ is not a good thing for coffee, but we’re currently stuck with it because – as an industry – we choose to be.  I suppose this is because it suits those with the largest financial interests more often than not, but I don’t know how we can talk about sustainability long term when we are at the mercy of such wild swings and unpredictability.

Within specialty I expect more producers to begin to work in a way that is less bound by the ‘C’.  Long term I don’t see the ‘C’ staying high, because technology will rise to meet the demand for commodity coffee.  Speciality will likely split in its pricing structure, but I don’t really know what kind of timeframe we’re looking at for this.  Writing this is mostly about getting various thoughts out of my head.  I may well have just made myself look pretty stupid and ignorant, I just don’t know… I’d love some input on why my ideas are stupid, or why the ‘C’ is good for coffee.  For that reason I’m going to open up comments on this post. a

  1. I would ask that comments stay on topic – not about the fact that comments are not open on other posts.  Thank you.  (back)

14 Comments The absurdity of the C

  1. Colin

    I think most commodities are seeing a rise not only due to supply reasons but also because traditional trading stalworths and associated funds are becoming increasingly unpredictable in current conditions. Investors must invest and commodities are essentially a safe haven in stormy seas as there are more fixed variables in place in terms if supply/demand. It is also worth noting that the vast majority of people that buy futures never actually receive the commidity concerned, i.e the coffee, so they have little or no interest in quality, industry development or social responsibility.

  2. James Hoffmann

    Looking at commodities:  

    Coffee – down
    Cocoa- down
    Cotton – down
    Sugar – flat, but technically up I guess.

    These were just the first 4 on the ICE home page.  I don’t think commodities are on the risen generally right now – perhaps a sign that people are ready to play in stormy water again.  Then again – I am way above my pay grade here.  Is there a general indicator of commodities health online somewhere?

  3. Mark Wain

    Following a market on a day-to-day basis is by its nature maddening.  Similar to watching the Dow Jones (in the USA) or the FTSE in the UK, the market will go up and down on a whim – and then the analysts will pontificate as to why. The long-term trends are the ones that are necessary for predicting, unless you’re hedging investments (or worse, gambling).
    We have seen a broad rise in the market price of commodities over the last few years as new developing markets have emerged, and then a precipitous drop due to: GFC, EU Debt crisis, famines, natural disasters and war, and China’s slow (only 8-12%) yearly growth, etc. However, how you brought it into context with the price of oil was a brilliant insight. I’m sure you could have also brought in the price of food (wheat, grain). 

    Coffee producers’ inability to produce a price is because the global C market is the market for ALL coffee produced worldwide, and as you know most of it is commercial-grade, not specialty.  Until or unless producers can differentiate their coffee production from the global commodity, they will unfortunately be bound to the C market.  (As a Gedanken experiment, think about growing Oranges, Wheat or Cotton…all commodities and all bound by commodity market prices.  Contrast that with grapes for wine, and you might be able to see how producers can create a price that sustains themselves).

    Thank you for your insightful posts, and keep them coming!

  4. Nate Jones

    I’m documenting my thoughts here after a exchanging a few rapid-reaction twitter messages with James.

    I think the problem isn’t so much the volatility of the C market as it is the absence of risk instruments for retail producers. In the US, farmers are able to purchase futures on their corn or wheat that allow them to lock in a harvest price for the season before their corn is even planted. In other words, they trade away their risk to an investor who is less risk averse. If the crop should fail due to weather, a complex government insurance scheme covers them.

    Small-scale producers in most coffee producing countries don’t have access to these kinds of financial tools, so they are forced to compete in a local market that is relatively inefficient and take what they can get. If their crop should fail, they may not have any coverage at all.

    Furthermore, most marginal producers don’t have the financial skill sets to successfully read the downstream supply-side indications of a price bubble. Last year’s spike will yield record downward price pressure on the C in 2014-16 as the marginal land planted during the spike comes online.

    I think two changes would dramatically alter the relationship between retail producers and C:

    1. Financial product growth amongst small-scale producers. Access to financing means choices and power in the marketplace.

    2. I’d like to see an indexed 5 year future on the C become a standard reference for coffee production planning. This would take care of the confusion that stems from projecting peak C prices forward five years without taking supply growth into account.

  5. Patrick Hughes

    Looking at this issue from a farmer’s perspective, the C market creates a double-edged sword. When the C market is based largely on the actions of large producing countries, international macro-economic factors like the decline of Chinese manufacturing, and speculation by traders who have little to do with coffee, it presents the possibility for production costs to increase and sales prices to decrease. This is something that we saw in Honduras this year—since the 2011 harvest fertilizer prices went up 50%, labor prices went up 30%, and picking prices went up 60%. Meanwhile, farmers are selling their coffee for barely 50% of the 2011 price due to the drop in the C in 2012. Costs increased from 2011 to 2012 for a couple of reasons, but a large reason was local inflation following the 2011 spike in the C market. This means that the C market has not only caused production costs to rise but is also responsible for declining sales prices. 

    In regards to basing production costs off of an indicator, I think that it would be very difficult to tie production costs to a macro-economic indicator like oil prices. Although oil prices do account for a small amount of the change, there are too many national or regional influences for this to be accurate. An example—the vast majority of coffee fields in Honduras this year had one, not three, main pickings. This led to a labor shortage and an increase in picking costs that we saw during the harvest. Production costs also depend on many other local and/or regional factors. The bottom line is that, without looking at coffee-specific factors for a given farm or region, I think that it would be difficult to make accurate predictions of production costs.

    Overall, dependence on the C is damaging to both growers of specialty coffee and the purchasers of this coffee. In my opinion, the only way to overcome this dependence is through direct relationships. Relationships in which farmers and buyers are able to base purchase price on quality, but also understand variable production costs of a given year. This is a slow process that requires the building of trust on both sides but, I believe, is the only way to create long-term sustainability for the farmers that grow and harvest specialty

  6. GabrielaCordon

    Totally agree with Marvell St. Roasters. Growers need to learn to cup their crop and do a segmentation of those regions of the farm that produce just commercial lots, those that produce distinctive attributes in order to sell them accordingly. All the crop would be commercial since he/she is blending varieties grown at different altitudes, with different sun hours per day at different regions, lots picked at once, etc.  Of course, it would be more work, but also the type of price he will receive based on qualities he can manage to produce.

  7. Justin Archer

    The C is the only tool at our disposal for trading coffee ON A VOLUME BASIS. Without a hedging mechanism to protect long or short positions, the coffee industry as we know it would not exist (and I am not here to debate how desirable that is or not). As has been pointed out, the volume of paper traded on the C market is far greater than the actual volume of physical business transacted. That’s not to say that a lot of coffee is not traded on the C – it is. In fact most of the world’s production is traded through the C at some point, but a far greater share of the activity on the trading floor is taken up by non-commercial speculators who are acting on behalf of private or institutional investors who are simply making a living trading paper contracts for profit. Is this always desirable? Probably not. Can a futures market exist without sufficient liquidity? Definitely not. So in some ways, the activity of non-commercial speculators is a necessary evil for the C market to exist.

    Inevitably, given the ever growing size of hedge funds, their activities tend to have majorly distorting impact on commodity prices. This has been well documented and commented on over the last decade. Would the coffee market have reached 320cts/lb last year without speculators taking a long position on coffee futures in anticipation of the shortfall in supply? Of course not. The opposite is also true when the market declines due to excessive selling pressure. So yes, these actions are distorting. BUT, look at any of the commodity markets, and the FUNDAMENTALS never lie. James’ graph of the C market is very revealing. Since the early 2000’s the market has moved in only one direction (on a trend basis): upwards. Well guess what? In that period, World coffee consumption is up almost 20% – and production is really struggling to keep pace. And yes, that’s 20% increase in just over 10 years – in the history of coffee consumption. And as far as I know we’ve been drinking coffee in the Western World since at least the 17th Century… So it’s hard to argue that real fundamentals aren’t driving the direction of the C market. Sure, highs would be less high, and the lows probably less low without speculators, but they are all trading to a plan: coffee is in long term undersupply.

    Does this help the producers? Big brazilian producers are becoming very adept at reading the market and hedging their production at the right time, usually because their buyers (the trade houses) are comfortable to share their access to price risk management tools. The same traders struggle to offer the same support to smallholder producers (ie most of Africa and Asia) because the risks of default are usually still too great and the decision making processes are very different (contrary to what some people think, there is no such thing as a guaranteed financial price risk management tool even when using futures and options – someone ALWAYS has to carry part of the risk, and this risk is only covered when the producer delivers the product in the agreed quantity at the agreed price).

    Rambling a bit here now….but to finish, the point this blogg is trying to make is that producers will only ever have control over their business once they can start selling a DIFFERENTIATED product that is discernibly different from the rest of the commodity. If somebody is prepared to pay a better than market price for that product, then the farmer is in a stronger position. This goes back to the role of the specialty industry and the need for farmers to really focus strongly on quality and standards of production. When farmers understand that good productivity and good quality can lead to an income curve that is more stable than the C, they will be running a better business than their neighbours. Sounds like all our businesses actually!?

  8. Skadttam is a good visual indicator of the commodities market.  on the ICE topic though, the market does trade a lot of coffee, thousands of container loads a day sometimes, but you need to draw a distinction between paper coffee, and physical coffee.  you are correct that very little physical coffee trades hands via the ICE market, but the paper trade provides liquidity to both producers and purchasers which is absolutely vital to a sustainable market.  brazil is indeed offering loans to producers to store their coffee.  this is so that producers can hold on to their coffee if they choose, to speculate that the global market will raise again.  this has the added effect of limiting supply, providing support for the overall market.

  9. Wmark

    If you look at commodities like lentils, it is a market between buyers, sellers and some middlemen who take delivery of the product. Prices are very stable and change weekly, if they change. Gone are the speculators and investment funds.

  10. Kurt

    Markets do not operate on on supply and demand.  The market is a device that will always benefit the fewest number of participants.  That’s why there is a pyramid on the dollar bill.  The guys at the top are held up by the believers at the bottom.  Supply and demand are just convenient scapegoats that the uneducated and the uniformed capitulate to.  The market will return to historic lows the moment everyone is convinced that it can only go up.  If you want to educate yourself about the markets, read “Extraordinary Popular Delusions & the Madness of Crowds”.  

  11. Rich Ottenhof

    James, thank you for your post.  I’ve been fascinated by the C for quite some time and have come to an uneasy truce with how it functions.  Contrary to popular belief, speculators can make as much money when the price moves down as when it moves up.  By operating in the Options Market rather than the Futures, traders can revel in volatility and benefit from moves up and down.  I’ve posted several times on my own blog about the problems with the C and the price rise last year, predicting the drop over a year ago as the USD regained favour.  I’ve been very frustrated with the media’s reliance on industry experts who repeat nonsense about supply and demand issues related to BRIC nations increased consumption, and even more unsettled by the constant stream of fabricated negative news stories at origin intended to mislead the market.  The truth is that the C has been tracking opposite the American Dollar very solidly for the past 5 years, and the recent drop has more to do with the bad news streaming out of Europe than crop size.  Capital goes where it feels loved, and the USD offers better  prospects than the alternatives.  As the USD appreciates, the goods valued in USD become cheaper.  
    There is a clever method I’ve been developing (but not ready to publish) which would offer a mechanism to stabilize Specialty Pricing and I would appreciate the opportunity to correspond via email as I flesh out the details.

  12. Www Gavinfolden

    Gavin Folden
    The trading of commodity through this system should be outlawed!!
    Farmers should know their pruduction costs , and charge accordingly.
    Buyers of commodity should have to receive the bought goods .

  13. James McLaughlin

    Interesting post and comments.  As a small grower of specialty coffee, I don’t understand the specialty coffee world’s fascination with the C market.  The coffee that we produce and that you buy is of a totally different quality than that sold on the C market.  So the price paid for a totally different grade of coffee (on the C market) should have a very limited value in determining the price of specialty coffee (at best it is a pricing floor).

    I would love for someone in the specialty coffee industry to harness all the time and energy spent tracking the C market and develop a transparent market (or pricing scheme) for SPECIALTY COFFEE.  To my knowledge, there are only two companies in the world (Counter Culture & Tim Wendelboe) that publish the prices they pay to growers.  The entire specialty coffee industry (from growers to final consumers) would benefit from a transparent marketplace for specialty coffee.

    This is, perhaps, the topic for another blog post but I’ve read so much about the C market lately that I wanted to raise this issue.  Otherwise, I enjoyed the blog post and follow-up comments.

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