A hot year for coffee? The signs look good

International Herald Tribune
Saturday, March 19, 2005

Punta da Sarra is a vast coffee plantation in the Ribeirão Preto valley north of São Paulo. For a few years now, lush sugar cane has filled half the fields, a response to rock-bottom prices in the $80 billion world coffee market.

Things are looking up for coffee farmers in 2005, and the plantation's owner, Flavio Filho, says he now covers his costs.

"Prices are better," he said from the porch of his family hacienda, amid red-clay fields and towering trees set high in a region that has the perfect climate for growing premium coffee.

Coffee growers from Costa Rica to Colombia share Filho's optimism, buoyed by new consuming markets and tighter supply.

"I'm bullish," said Juan Moya, executive director of the Costa Rican Coffee Institute, citing a 28 percent rise in prices for beans in a year. "Prices will continue to rise because there's not enough supply."

Filho and his fellow coffee farmers around the world, 25 million families strong, have several factors to thank for those higher prices. Coffee stocks are lower, supply is down and demand is rising from the traditionally tea-drinking nations of Russia and China - all this a year before Brazil, the top coffee exporting nation, plans to grow less coffee because of a seasonal crop rotation.

That's a far cry from the devastated coffee industry three years ago. Then, tepid demand, low prices and a glut of supply brought by Vietnam, a new low-cost grower of the cheapest Robusta bean, pushed thousands of migrant coffee pickers and growers out of work and their families into poverty.

Two varieties of coffee are grown: the milder Arabica bean, and Robusta, which has a more bitter taste, is most often used in instant coffee and currently sells at a more than 66 percent discount to Arabica. The bulk of Robusta originates in Vietnam; the next biggest producers are Uganda, Indonesia, India and Brazil.

But coffee prices are now hitting five-year highs. Composite prices of $1.05 a pound are firming after more than doubling from their 2001 lows. In February, Brazilian Arabica coffee crossed the $1.00-a-pound threshold for the first time since 2000.

"It's a seller's market," said Judy Ganes, a financial analyst at Judy Ganes Consulting in Katonah, New York. "The market continues to explode."

Coffee is a tale of small farms, big business, and local tastes. Coffee's reach is wide and powerful. It is the second most extensively traded commodity, after oil. In Burundi and Ethiopia, two of over 50 countries that produce coffee, it accounts for more than 57 percent of export earnings.

Booms and busts come with the territory, as they do for all commodities. Coffee, in particular, percolates in sync with uncontrollable factors affecting supply, like weather conditions and geopolitical tensions, and demand, including economic health and consumer tastes.

On the supply side, the biggest issue was the arrival of Vietnam to the ranks of coffee exporting nations by the mid-1990s. The explosion in the number of small growers drove real prices down to their lowest level in 100 years. A shakeout was inevitable, and now supplies are lower, along with the number of growers.

As for demand, coffee consumption has held steady in the mature markets of the United States and Europe, which absorb the most exports. Worldwide, demand is growing at a tepid 1.5 percent. As a result, composite prices plunged to 42 cents a pound in 2001, picked up again in 2003 and have only started to gain steam as importers worked through their stocks over the winter.

U.S. coffee supplies in the 2004-05 year, which began last Oct. 1, are down 20 percent.

It is the developing world that is driving new demand. And as with many markets, the greatest promise is ascribed to China.

Experts point to the growth of Western-style coffee chains like Starbucks, which has roughly 303 outlets in China, a rise in the number of working women and growing affluence among China's new urban professionals. China's coffee consumption by volume shot up 83 percent from 1998 to 2003.

Tata Coffee of India sells beans to Starbucks and is looking to China for growth.

The Asia-Pacific region is, at 26 percent, by far the fastest-growing coffee market by volume, according to Euromonitor, a London-based company that studies consumer markets.

Russia and Eastern Europe are also posting big gains in coffee consumption, prompting top processed coffee sellers like Sara Lee and chains like Starbucks to focus on markets with rising middle classes, like Russia, India, China and Brazil.

"People want to be trendy," said Marc Faber, a Hong Kong-based portfolio manager who runs his own fund. And trendiness, in many markets, is equated with drinking coffee.

Though tea still dominates in much of Asia, coffee is becoming increasingly popular in the region, with packaged, specialty and instant blends gaining favor for their convenience.

As a sign of what is possible with more promotion and surplus spending money, trade associations single out Japan's 15-year rise into the top coffee-drinking ranks.

"The worst of the crisis is behind us," said Néstor Osorio, executive director of the London-based International Coffee Organization, which brings together 74 coffee producing and consuming countries from around the world, including the United States.

Next year, or 2005-06, total production of coffee is forecast at 106 million bags, down from 114 million a year earlier and up to eight million bags less than projected demand. Brazil's production over that time is forecast to fall below 32 million bags from about 40 million the previous year. Part of that reduction is due to the biannual crop rotation in Brazil, or the harvest of fewer beans every other year to allow the fields to rest.

"We are no longer in the eye of the storm," Osorio wrote in the International Coffee Organization's monthly report in November.

All of this is good news for producers, but especially for Brazil, which sells more than one-fourth of the world's supply.

Because two big drivers of the consumption of Arabica in new markets are café culture and specialty blends, which tend to use Arabica beans, Brazil stands to win most. Other beneficiaries include Colombia, Peru, Ethiopia and Guatemala, which account for the lion's share of Arabica coffee, after Brazil. Brazil exports as much Arabica coffee as all the others combined.

Coffee first cropped up more than 1,000 years ago in Ethiopia and made its way to Arabia.

In the 17th century, seafaring merchants from the Netherlands carried coffee to Indonesia and, along with the Venetians, to Europe.

Coffee came into its own during the colonial era, when Dutch, English and French settlers established enormous plantations across Latin America and the Caribbean and shipped the valued crop home.

Today, Brazil, Vietnam and Colombia account for nearly half of world coffee production. The United States is by far the world's biggest coffee importer, trailed by Germany, Italy and Japan.

As in many another commodity market, occasional attempts are made to smooth out the cycles. The 1962 International Coffee Agreement capped exports and propped up prices as high as $3 a pound by the late 1970s. The unraveling of that agreement in 1989 unleashed a boom-and-bust cycle that persisted until 1997, when coffee prices hit a high of $3.18 a pound.

Market dynamics changed drastically in the mid-1990s with the quiet but aggressive entry of Vietnam into the coffee market. Vietnam's fledgling coffee industry flourished after communism ended, on generous subsidies from Europe and international aid agencies. In less than 10 years, Vietnam expanded its planted area elevenfold to nearly 400,000 hectares, or a million acres.

The flood of its cheaper Robusta beans after 1994 was a boon to drinkers, who saw the price of their favorite brew drop to levels not seen since the 1980s. But it wreaked havoc on farmers in impoverished economies.

When prices fell well below cost, many indebted growers were forced to shut down or move on. Or, like Filho, they diversified into more lucrative crops like sugar cane or soybeans.

The oversupply cost some 260,000 farmers in Costa Rica, El Salvador and Nicaragua their jobs, pushing many families to near-starvation. The U.S. Agency for International Development estimates that because of the glut, 600,000 growers in Central America found themselves without work.

The devastation helped give rise to the Fair Trade campaign, a global movement to help ensure that farmers can continue to make a living.

Parallel efforts to facilitate the formation of cooperatives selling internationally certified sustainably harvested and organic coffee, coupled with campaigns to educate consumers about the harsh realities of the coffee industry, have made such specialty coffees a fast-growing niche market.

Though a tiny market, U.S. imports in the Fair Trade Certified category have shot up 75 percent a year since the label arrived in 1998. The mass market has taken note: Dunkin Donuts, the roadside restaurant chain, now sells Fair Trade-branded espresso, and Procter & Gamble, which owns Folgers, has a Fair Trade brand.

The coffee glut finally eased up by 2003, giving the farmers that had survived the breathing space to pay off debts and expand plantings.

Fewer producers, bad weather in Brazil and rising demand in a few new markets now are bringing coffee stocks down to their lowest level since 2000.

As for prices, Ganes projects global prices for Arabica coffee of around $1.50 a pound, perhaps higher, depending on the output of Brazil and other Arabica-producing nations.

"Prices could go sharply higher as Arabica supplies get tighter," she said.

Does all this mean that the coffee market is getting frothy? China drinks only a small fraction of the 88 million bags of coffee exported worldwide. And Brazil's production will return to normal levels in a year.

But to those closest to coffee, there is plenty of steam left this year.

Ganes highlights production declines among several nations most affected by the coffee price collapse that are also medium-size Arabica coffee growers.

Their projected collective output of 14.4 million bags is more than one-third below the 22.2 million they registered in 2000.

Drought in Vietnam and rising consumption of coffee in Brazil, coupled with its biannual output next year, may be recreating a 1997 scenario that would send prices soaring above $2 again, Ganes said.