Extreme Price Volatility Undermines The Coffee Sector

In a recent post, I wrote that the C-Price for coffee is flawed and there is an urgent need for viable solutions to improve the coffee market. The post was picked up by Daily Coffee News and got a lot of attention – both positive and negative, which is well appreciated. The goal of the original post (and ones to follow) is to engage coffee experts to propose and discuss viable solutions to improve the coffee market, in ways that benefit farmers and farmworkers. The next few posts will focus on specific solutions.

In the meantime, this post illustrates how price volatility negatively impacts the coffee sector and exposes farmers and farmworkers to unnecessary risk.

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What is the C-Price?

In response to the last post, a couple of people requested a better explanation of the C-Price. For readers willing to click, here is a good, brief explanation. Formally, the C-Price is the futures contract price for a shipping container of arabica coffee (37,500 pounds – or about 250 sacks). The C-Price is managed by Intercontinental Exchange (I.C.E.), a company that manages electronic trading platforms. In practice, the C-Price is the benchmark price for delivery of exchange-grade arabica green coffee beans. The key here is that the C-Price is the benchmark for most coffee traded in international markets. Virtually any farmer, roaster, and trader can tell you the daily C-Price because they use it for business planning and negotiating deals. This does not mean that the C-Price is the price of a sack of coffee, but it is the benchmark most people use to make decisions.

I should clarify that my criticism of the C-Price is not a wholesale attack on the principles of a market-based economy. The complaint is that the C-Price is not working very well to stabilize coffee prices – but this should be one of its key functions. The C-Price is known for being extremely volatile, and this volatility negatively affects the coffee sector, where farmers and farmworkers suffer the worst. I believe that we urgently need to find solutions that smooth out coffee prices, to ensure sustainability of the coffee sector and create an enabling environment where coffee farmers and farmworkers can earn a livelihood, escape from poverty, and live in dignity. This, after all, should be the goal of a healthy economy, and markets should contribute to this goal.

The premise here is that making coffee prices more stable would be better for everyone. More stable prices would enable coffee producers to plan and invest based on prices they can reasonably expect for their product, and mitigate the boom-and-bust cycle that has characterized the coffee market the last many years.

Why is Coffee Price Volatility Detrimental to the Coffee Sector?

Coffee price volatility is detrimental to the sustainability of the coffee sector because coffee producers can’t possibly react in a timely way to short-term price signals: coffee is a perennial crop while the C-Price fluctuates on a daily basis. The problem is that coffee beans are not widgets produced in a factory, where production can be changed in the short-term. Decisions a farmer makes on her farm today will only be seen in the next harvest season, or potentially in three to four years if, for example, she decides to plant new trees. Because of the delay between price signals and on-farm responses, market fluctuations get amplified. Why do market fluctuations get amplified? When farmers see a high C-Price, they decide to plant new trees or buy extra fertilizer to increase production, and when farmers do this in mass there will be at some point in the future too much coffee in the market, causing prices to crash. Conversely, when farmers see a very low C-Price, they will cut investments, leading to scarcity, causing prices to spike. This is basic supply and demand market forces, but for a variety of reasons coffee is an especially complicated market. For example, here is an article from the Financial Times in 2017 predicting coffee prices should rise because of projected shortfalls in coffee inventories in Brazil, but coffee prices continued to fall, in part because of the devaluation of the Brazilian currency. Complicated. If experienced coffee traders have a hard time reading the market, how much harder for farmers?

The C-Price exchange market is supposed to smooth out price volatility, however, whereas the mean coffee price was about $1.50 per pound over the past decade, the high was over $3.00 in 2011 and the low was $0.91 on September 17 (yesterday). This volatility is extreme, far more than the stock market as a whole. This scenario makes it very difficult for farmers to plan and manage their farms, especially when the C-Price falls below the cost of production, which is somewhere around $1.15 per pound. In a more functional and sustainable market for a long-term perennial crop, prices should cleave closer to the long-term average, which – logically – should cover the cost of production plus transaction costs, i.e. about $1.50 per pound!

How does extreme price volatility affect a farmer?

When farmers face uncertain prices, especially prices that do not cover production costs, they hedge their bets, and reduce investments, creating a downward spiral of poor production and low income.

How do farmers operate in this context? They cut costs: they cut back primarily on labor; they don’t renovate farms; they rely on chemicals more than labor; and generally, they minimize efforts (read: cheat) to meet certification standards. Unsustainability is a vicious cycle: as farmers cut investments, production goes down, revenues suffer, and farmers find it extremely difficult to recover and renovate their farms. The people that suffer most in this scenario are farmworkers. They work less and earn less, and the way they cope is to eat less and pull their kids out of school. And they migrate. This is the harsh reality of the real economy in the coffeelands.

What would a more stable coffee price mean for farmers?

What would happen if a farmer had reasonable confidence that the price of coffee would cover costs?  She would have a strong incentive to invest in her farm to increase production and raise cup quality. She would have the confidence to hire laborers and enable her to pay fair wages. She could invest in periodic farm renovation, thereby employing more people.

More stable price signals would mitigate boom and bust cycles in the coffee sector, because farmers would be less likely to overreact to short-term price fluctuations. Farmers would invest their scarce resources more wisely.

Most importantly, stable prices would stabilize incomes for farmers and farmworkers, enabling them to feed their families, send their kids to school, and pay for healthcare.

Structural Solutions

The goal of making prices more stable is not controversial, per se. The key question, of course, is how to make coffee prices more stable? After talking and debating with some experts in this field, I’ve come to realize that there needs to be a combination of solutions at multiple levels, including as examples: evaluate alternative ways to calculate a benchmark price; expand farmer insurance programs; expand application of tools for Price Risk Management; expand participation in innovative mechanisms such as “Return to Origin” (RTO); and/or encourage direct trade and minimum pricing agreements like Fair Trade.

Critically, we need to evaluate structural solutions, that go beyond adjustments on the margins, or pilot initiatives for only a few players.

The next posts will propose and evaluate some potential solutions.