Coffee – From a Tree to a Cup
I’m an addict, and I’m willing to bet some of you are too. Coffee is an essential component of my day and without it I would be half asleep until four in the afternoon. I never stopped to think about where my coffee comes from until a friend sent me an article about roasting my own beans. I decided to dig deeper and was surprised by what I found. Coffee is an incredibly complex market with a history dating back to the Cold War. So, let’s get into the coffee market.
Coffee is the second most traded commodity in the world behind crude oil. It is also the most commonly consumed beverage in the United States, more coffee goes into cups than tap water goes into faucets.
Not to mention the price tag; U.S. consumers spent $74.2 billion (1.6% of U.S. GDP) on coffee in 2015. Over half of American adults consume at least one cup of coffee a day and the whole market is responsible for 1.7 million jobs in the United States alone. Not to mention the market is growing at about 5% annually. See? Coffee is crucial to our economy.
Anything in a relatively free market has two basic forces that affect the price you pay for it. I’m talking about supply and demand, and they’re especially important in the commodity markets. You see, there are so many suppliers for coffee today that consumers have control of the price. By consumers, I mean the coffee roasters that buy the beans from the farmers. When the market is structured this way, it’s called a monopsony. A monopsony is the reverse of a monopoly because the people that buy control the price. Nestle, Kraft, Proctor & Gamble, and Sara Lee consume about half of the annual production of coffee beans, and therefore control the price of coffee. Coffee is also price inelastic, meaning that regardless of the cost, coffee drinkers drink the same amount that they always have.
If you’re thinking about getting into the coffee growing game, there are a few things you need to know. First, one coffee tree can provide enough coffee beans to fill a one-pound can of ground coffee per growing season. Coffee beans are the seeds of cherry-size berries which are the fruit of the coffee tree. After planting a coffee tree, it will take about three to five years before the tree can produce marketable beans. There are only two types of coffee trees too! You may think you are getting a different kind of coffee when you get a different roast, but you are just purchasing beans roasted in a different way. Arabica makes up about 70% of production. It comes from Brazil and other Western Hemisphere countries, and is sometimes blended with Robusta which makes up the other 30% of the market. Robusta is usually grown in Southeast Asia and Africa, especially Vietnam. Arabica is considered higher quality, but is sometimes mixed with Robusta when Arabica gets expensive.
90% of the world coffee production comes from the developing world, with Brazil and Colombia accounting for 40% of that production. Brazil alone grows over 1/3rd of the world’s coffee. Coffee is interesting because the countries that produce it don’t consume it, and vice versa. On the list of the countries that consume the most coffee per capita, Brazil is the first coffee producing country and it comes in at number 13. Europe, America, and Japan consume over half of the world’s coffee. An important note is that U.S. coffee consumption tends to rise in the winter, which may be good to know if you’re trading coffee. Finland holds the title for most coffee consumed per-capita of any country other country, but the United States consumes the most coffee of any country.
So, rewind to the 1960’s. The United States was worried that communism would spread down to South America, and so to stop this, the U.S. and the United Nations devised the International Coffee Organization (ICO) In 1963. This organization was supposed to stabilize the price of coffee for producers and consumers while empowering the developing South American countries. The United States was an avid supporter of the ICO to keep friendly governments in power. The agreement worked by using a quota system to keep prices artificially high. In 1989, The United States backed out of the ICO as the Soviet Union lost power and coffee prices shot through the floor. This is when Vietnam got into the coffee making game and flooded the market with Robusta.
Suppliers cropped up everywhere and the market power shifted to consumers. The 1990’s and early 2000’s did not find coffee growers faring well. In 2001, the world coffee production was around 116 million bags while world consumption was only 5 million bags.
Y-Axis: US Cents/Pound
Now, knowing this, how can you trade coffee? It can be lucrative if you know what you’re doing. There are two pieces of advice that traders will tell you and that’s to never be short orange juice into January and never be short coffee going into July. The reason is the same for both commodities; winter is coming. Being in the Southern Hemisphere, Brazil’s winter starts in July, and this could mean frozen coffee trees. This is partly unfounded though because Mexico tends to step in and fill any holes in production. And while the supplier market is fragmented, there are only 19 producing countries. This means you should consider political risk. Another consideration is geographical concentration. Coffee is grown in Southeast Asia, Southern Africa, and Western Hemisphere Tropical Highlands. It’s probably a good idea to be watching the weather during the winter months in these places.
r = Robusta, a = Arabica, m = Mix
Hopefully you’ve found out a little more about where your hot cup of joe comes from in the morning. Another important note, Coffee has the largest fair trade market of any fair-trade commodity. Fair trade coffee increases the profits for coffee growers by anywhere from 75 to 100%. Fair trade coffee is sold at Starbucks, Dunkin’ Donuts, and McDonald’s, so take a little solace in that the next time you get to the drive through window.
Francis, N. &. (n.d.). Economics of Coffee. Retrieved from Black Gold, A Film: http://blackgoldmovie.com/economics-of-coffee
Goldschein, E. (2011, November 14). 11 Incredible Facts about the Global Coffee Industry. Retrieved from Business Insider: http://www.businessinsider.com/facts-about-the-coffee-industry-2011-11
National Coffee Association . (n.d.). The Economic Impact of the Coffee Industry. Retrieved from NCA: http://www.ncausa.org/Industry-Resources/Economic-Impact
Riley, G. (n.d.). Coffee Market. Retrieved from Tutor2U: http://www.tutor2u.net/economics/reference/coffee-market
The Economist. (2013, July 13). Coffee Prices; Brewed Awaking. Retrieved from The Economist: http://www.economist.com/news/finance-and-economics/21581727-plenty-coffee-too-few-drinkers-brewed-awakening
VantagePoint. (n.d.). Investing In Coffee: Coffee Futures Contracts. Retrieved from VantagePoint: https://www.tradertech.com/trading/coffee