Due to the nature of coffee production prices are highly volatile with short price spikes alternating between longer periods of price depression. The main reason is sharp fluctuations in supply that, at times, can cause wild and violent fluctuations in price. The last 20 years or so have provided a classic demonstration of the recurrent boom and bust cycle that characterizes the coffee market. Prices boomed in 1986 and 1987 in response to a perceived shortage brought about by a drought in Brazil, only to slump again in 1989 when the International Coffee Organization (ICO) quota system collapsed and producers unloaded their stocks onto the world market regardless of price. Prices remained depressed for the next four years until the next boom, induced by a general reduction in overall supply and exacerbated by the 1994 frosts in Brazil. Oversupply in 1996 forced prices sharply downwards but this was relatively short-lived and prices boomed again in 19951998 over fears of shortages of good quality arabicas following poor harvests because of the El Nino phenomenon. High prices during the period from 1995 to 1998 triggered a major expansion process, fueled by higher production in traditional coffee growing countries such as Brazil and the breath-taking expansion of production in hitherto niche countries such as Vietnam. As a result, the industry plunged into its worst crisis ever, causing extreme hardship to coffee producers and destabilizing the economics of countries greatly depending on coffee export revenues.

ICO prices of not even 50 cents/lb at the beginning of this century compared with 130.61 cents in 1998 led to a frantic search for solutions with some like British charity Oxfam falling back into the age of central planning, demanding government steered market management. Luckily, it never came to a repeat of the illusions of the past, partly due to an improvement in coffee prices in 2004, which did not remain without effect on coffee production. Coffee production in 2003/04 of roughly 107 min bags turned out to be several min bags below global demand, estimated at around 113 min bags. Even though production rebounded in 2004/05 and once again exceeded global demand, speculation of a potential deficit in 2005/06 kept prices from falling back to their crisis levels not least with the tremendous help of hedge funds which nowadays have enough firepower to go against fundamentals, and moreover not just for short periods. Adverse weather in Vietnam, the off year in the Brazilian production cycle, low prices during the coffee crisis leading to lower input use and less husbandry all pointed to lower production in 2005/06. At the end of last year there was a strong belief that finally there was an opportunity to start eroding the considerable stocks that were being held in consumer countries. Popular opinion was that producers would hold back supplies in the hope of better prices to come in the months ahead. Buyers would outnumber sellers and prices would appreciate. The yearning for better times was re-enforced by hurricane damage to coffee warehouses in New Orleans and Central American crops, leading to later and lower coffee production. However, strangely enough, prices ignored warnings by some analysts that an acute shortage was around the corner making coffee a scarce cormnodity. The ICO price peaked in March 2005 at 101.44 cents, only to fall back in the following months to break below 90 cents in July this year.

What are the reasons for this unexpected price behaviour? First of all producers decided that holding back coffee was a bad idea and Brazil in particular shipped and shipped. The upshot of this action was that the ICO registered exports in 2004/05 (October/September) were nearly 89 mln bags, slightly more than in the previous year, and significantly above demand in importing countries of not even 86 min. The result was that stocks in consumer warehouses that were predicted to fall have in fact risen. This also explains the muted response by roasters to recent weather upheavals and predictions of an acute supply gap in 2005'06. Moreover, they were banking on a rebound in the Brazilian 2006/07 crop that would put the market back into oversupply next season. However, the game is not over yet. Even though weather in Brazil has favoured the outlook for the 2006/ 07 crop, this might not be nearly as big as some expect and will most likely remain below the 2002/03 record of 48.5 ml It bags. Moreover, the deficit in 2005/06 may turn out to be higher than so far expected, while coffee demand is forecast to rise by more than one per cent a year. Gordon S. Gillet, senior vice president, purchasing at Nestle S.A., Switzerland recently predicted that coffee consumption, under certain assumptions, could reach 130 mln bags in 2014/15. Based on our consumption estimate for 2005/06 of around 117 mln bags, this would be an increase of 13 mln bags or a modest annual rate of growth of 1.2%. Hence, more coffee will be needed to cover future demand.

The danger is that coffee producers overreact to higher prices. The ICO recently suggested that the experience of the coffee crisis should be used to create awareness in national and international bodies of the danger of embarking on any projects or programmes which will further increase supply without corresponding growth in demand.

Coffee production

Coffee production in Africa could turn out to be a little bit lower than had been expected in our previous estimate (September 21, 2005). The total is now forecast to reach 14.4 mln bags compared with our previous figure of 15.3 mln and noticeably below last season's 15.0 min.

Coffee production in Ethiopia is estimated at 4.5 mln bags, below last season's 5.0 mln. Coffee accounts for over 60% of the total foreign exchange earnings. Tax on coffee forms a significant and stable form of government revenue. It employs nearly a quarter of the population, either directly or indirectly, in the production,processing and marketing of coffee. Even though not quantified, the multiplier effect on other sectors of the economy, such as trading banking, insurance and transportation, is substantial. Even though exports may be a little lower in 2005/06, revenues could be higher thanks to higher world market prices. Even though exports dropped by 22.9% in July/September 2005 compared with the same period last year, earnings increased by 12.5%. Coffee production in Ivory Coast has been on the decline since 1999/ 2000 due to low global prices, reaching a little less than one into bags in 2004/05. Another reason was the political-military crisis, which has led to a further decline, since farmers have abandoned their plantations in the main producing area in the country's western region. The outlook for 2005/06 is not much brighter, despite the rise in global prices, with output forecast to rise slightly against the previous year.

Uganda's coffee production is forecast to rise to 2.8 mln bags in 2005/06 from 2.5 mln the previous season due to favourable weather and a new planting programme. The country's coffee industry has been plagued by a number of setbacks in the past ten years, including diseases, poor weather and price fluctuations. The Uganda Coffee Development Authority (UCDA) has financed a coffee tree replanting programme, in which up to 80 m%n trees have been planted since 2001. The benefits of this programme arc expected to be seen finally in 2005/06.

Cameroon produces both robusta and arabica with the former accounting for more than 90% of the national total. Total output peaked at 1.4 mln bags in 1999/2000 but has fluctuated considerably since then. Production could show another decline in 2005/06 from last season's 750,000 bags.

WORLD COFFEE BALANCE

(1000 bags green bean)

Kenya is a leading producer of high grown mild arabicas. Production peaked at 2.15 mln bags in 1987/88 but has been on the decline up to 2003/04 due to low global prices, mismanagement and high production costs. Production returned to near one mln bags in 2004/05 and could remain around that mark in 2005/06 as the government is seeking to boost output by overhauling the industry to combat poor management of farming cooperatives, corruption, over-regulation and producer debt. This, it is hoped, will raise production to the levels seen in the 1980s. There were fears that the coffee berry disease could hurt this season's crop but the Coffee Board of Kenya (CBK) said that the damage would be minimal. The disease had been triggered by wet and extremely chilly weather earlier this year.

North & Central Arnerica

Coffee production in North & Central America was forecast to recover to nearly 18 mln bags in 2005/06 from 15.5 min the previous year due to higher prices and better weather conditions. Output is still forecast to rise although earlier targets will be missed as Hurricane Stan, ripping through the region in October 2005, damaged and delayed the 2005/06 crop. Although reports from the region are still somewhat vague, the damage was apparently not as severe as had been feared at first.

One of the countries worst hit is Mexico. Before the storm the National Coffee Producers Union had said that 2005/06 coffee production could rise sharply to between 4.5 and 5.0 mln bags, compared with last season's 3.9 mln. The sharp rise was attributed to almost ideal weather conditions and higher global prices. The damage caused by Hurricane Stan is estimated by various organizations at between 400,000 to 700,000 bags. The agriculture ministry, which had not issued a production estimate before the storm, said that about 130,000 ha of coffee trees in Chiapas (almost half the state's coffee growing area), which produced 1.93 mln bags in 2004/05. are in areas damaged by the storm. It will take some more time before a clearer picture does emerge and our figure may have to be adjusted later in the year.

El Salvador's coffee producing areas escaped significant damage from two weeks of massive flooding linked to Hurricane Stan, and a volcanic eruption. However, infrastructural damage could cause some losses. Landslides caused by the torrential rains had blocked roads, which affected access to farms. The 2005/06 crop had been originally forecast to reach 1.488 mln bags up from 1.341 mln the previous season. However, the final size of the crop may be slightly lower due to the heavy rains. According to industry sources in Costa Rica, up to 10% of expected 2005/06 production, or 210,000 bags, could be lost due to Hurricane Stan. Torrential rains made ripe coffee cherries in lower altitudes fall off the trees just before harvesting. Trees in higher altitudes have suffered from a fungus infection, which emerged following the excessive humidity provoked by Stan. All the same, production is still expected to rise slightly from last season's 1.911 mln bags

Before Hurricane Stan hit the region, Guatemala's coffee production was estimated at 3.450 mln bags. The country's growers group Anacafe estimated the losses caused by Stan at 3.5 to 6% of expected production, meaning that it could fall below last season's 3.8 mln bags. However, actual production is difficult to assess, due to the illegal inflow of coffee from Honduras.

The Honduran coffee institute left its 2005/06 coffee production estimate unchanged at 3.07 min bags, up from 2.58 min the previous season, despite farmer fears that blocked roads and sodden coffee trees could delay and hurt the harvest. The anticipated good harvest this season is due to the biennial production cycle, increased fertilizing and replanting of exhausted trees. Industry sources said that the country could boost coffee output by up to 50% in the next five years by training small farmers in more productive tree care and fertilization methods.

Recent storms and rains have spared Nicaragua's coffee farms. Production in 2005/06 is estimated at 1.38 min bags up from 0.92 min the previous season. Higher global prices have allowed for additional inputs such as fertilizer and good farm management.

Coffee production in South America is forecast to fall sharply to 51.1 min bags from 59.4 min the previous season mainly due to the 'off year' in the Brazilian production cycle. Last season was an 'on' year in the Brazilian production cycle with output estimated at more than 42 min bags, up from 31 min the previous season. The increase was solely in arabica, while robusta or conillion production was lower than in the previous season. However, lack of investment in the crop over the past few years due to low prices and adverse weather led to quality problems and a lower than expected crop. It was clear from the very start of the 2005/06 season that production would be lower because the arabica crop entered a low production year in the biennial crop cycle. The 2005/ 06 crop is officially estimated to reach 32.9 min bags, of which 23.8 (31.7) are arabicas and 9.12 (7.56) robustas. The trade assumes somewhat higher figures of between 34 and 36 min bags. However, what is noteworthy is that the area under coffee is shrinking. Farmers are apparently not reinvesting and expanding the coffee park under cultivation. Replacement trees are more densely populated. This causes yields per tree to decline. As a result, there could be no significant rise in production in 2007/08 and beyond even if prices should rise sharply. Average production could stagnate as the trees age and are past their prime. Moreover, in some regions coffee is losing out to other agricultural products, namely sugar cane.

WORLD COFFEE PRODUCTION Million Bags

Despite the rise in prices on the global market Brazilian coffee producers are less than happy. They 1 complain that, while coffee prices remained far below- expectations, the minimum wage paid to the majority of workers has more than tripled and that all other costs have also risen far more than the price of coffee, eroding virtually all the advantage brought by the price rise of recent months. The strength of the real vis-a-vis the US dollar is another major worry for coffee exporters as this means lower returns in local currency and higher production costs. Moreover, it is feared that the average age of the billions of trees in Brazil continues to rise gradually, and now exceeds 20 years. This will inevitably mean lower yields in coming years. In some areas older coffee trees have been replaced by sugar cane, a crop now bringing much higher returns.

The 2005/06 season is almost history and all eyes are on the forthcoming crop. There is general agreement that this will be large but will remain below the 2002/03 bumper crop. Current estimates are in a range of 40-48 min bags, with most projections in the middle of the range.

Colombian coffee production reached 11.8 mln bags in 2004/05, representing an increase of 783,000 bags compared with the year before. The increase is due to continued plant renovations with higher tree densities and better management practices. Although the recovery in global prices has increased export value, the rising value of the peso has reduced considerably the income of coffee growers. Production in I 2005/06 is forecast to fall slightly to 11.6 mln bags, mainly due to excessive rains that have affected tree flowering. According to industry sources the renovation program and better management practices for higher productivity and quality will continue. Reduced production in marginal areas is being offset by increasing areas in the Huila region in the southeast of the coffee zone where the altitude and climate have the same characteristics for producing high quality coffee as the traditional central coffee zone. Future production will likely be between 11.0 and 12.0 mln bags as the reduced area is planted with higher tree density and is more intensively managed for higher production and quality. Industry sources in Peru forecast 2005/06 production at 3.1 mln bags due to the exhaustion of many coffee trees in many parts of the country following last season's record crop of 3.5 mln. The country has made advances in improving coffee quality in recent years, casting off its image as a producer of poorgrade beans. However, industry sources warned that Peru rapidly needs to renew many of its ageing coffee trees or quality and quantity will fall. Around 60% of the country's 280,000 ha of coffee trees are now more than 15 years old and some are nearing the end of their 30-year life. The agriculture ministry recently estimated that it would cost S500 per ha to renew the trees. The last time Peru renewed its coffee trees was in the 1980s, Coffee is Peru's top agricultural export, but the government does not have the money to pay for trees to be replaced. Therefore, the government is searching for finance from donors such as the United States.

According the US Ministry of Agriculture (USDA) Venezuela in the last five years has produced between 800,000 and one mln bags of coffee but has exported very little because of high internal consumption. In addition, in 2003/ 04 there was a government ban against exporting coffee in order to conserve internal supply. Production in 2005/06 is expected to show minimal year-on-year change. The government plans to reactivate roasting plants located in the western region of the country with most of the raw material imported from Brazil. This has created alarm among coffee growers arguing that there weather the storm by buying up a significant amount of the 2004/05 harvest under an intervention programme to shore up domestic prices. The sale of this coffee is apparently not without problems and in November 2005 the Commerce Ministry suspended all bidding sessions for coffee harvested in 2004/05 as buyers have apparently colluded in pushing prices below market values.

Papua New Guinea's 2005/06 coffee production is forecast to reach 1.232 min bags, up from 1.013 min in 2004/05. Arabica output is seen rising to 1.170 min bags in 2005/06 from 0.965 min las year, while robusta production is seen at 62,000 bags, up from 48,000 bags the previous season.

Cojjee Consumption

World demand for coffee in 2005/06 is estimated at 116.9 min bags, 2% more than in the previous year. Of the total expected for 2005/06, producers could account for 26% and importers for 74%. In 2000/01 the share of producers in global demand was only 24%, suggesting that consumption in producing countries is growing at a faster rate than that in the importing nations. This does not come as a surprise as most coffee producers arc developing countries with higher population growth. Moreover, per caput consumption is still very low, leaving significant room for expansion, while many markets in importing countries are saturated, with little or even negative growth in coffee consumption. Consumption in the developing part of the world shows greater sensitivity to price and income changes, while offtakc in the high-income countries is more resilient to economic changes, although larger price increases can clearly have a negative impact on demand as consumers partly switch to competing products such as tea or soft drinks. Other negative features in high-income countries are new trends in coffee drinking such as the use of efficient one-cup makers instead of brewing pots at home.

But this is counterbalanced not only by stronger demand in producing countries but also by the rapid development of a coffee culture in emerging markets. In these markets soluble coffee is the catalyst for expansion as it is in this form that new consumers arc usually introduced to the beverage and it has therefore been the engine in growing and accelerating demand. According to Nestle, Switzerland, soluble coffee consumption rose at five times the rate of roast and ground coffee in the in-home and more than twice as much in the outof-home market during the period from 1999 to 2004. In general, the coffee industry seems much more optimistic concerning future demand than a few years ago and is seeking actively for new ways to boost coffee offtakc.

PER CAPITA COFFEE CONSUMPTION IN ICO MEMBER COUNTRIES

Several other ways to boost demand have been suggested by producing countries. In traditional markets demand could be increased through product innovation and getting across the message that coffee is a healthy product. In emerging markets prices should be kept at reasonable levels. Moreover, marketing efforts should concentrate on solubles as they are the most easy to use. In producing countries emphasis has to be placed on coffee quality, which sometimes leaves a lot to be desired. It is predicted that greater marketing efforts, and barring exogenous shocks, world coffee consumption could rise to 130-145 mln bags by 2015, meaning that production will have to rise significantly to meet future demand. However, growth must be achieved without triggering new cycles of production expansion perpetuating the coffee crisis.

The largest traditional markets are in Europe and North & Central America. Coffee consumption in Europe is forecast to rise by 1.4% in 2005/06 to 43.9 mln bags after no growth the previous year. According to ICO figures per capita consumption in the EU was 5.17 kg in 2004 up from 5.01 in 2001. The highest per caput consumption in Europe and worldwide was Norway with 9.27 kg.

The largest coffee consumers in the EU are Germany, France and Italy. Coffee sales in Germany have fallen steadily in recent years due to competition from soft drinks and little or no income growth. Sales of coffee, recalculated to green coffee equivalent, fell from 541,050 tonnes in 2002 to 532,030 the following year and 525,903 in 2004. The decline is mainly a result of lower sales of roast and ground while soluble and espresso sales made some gains. The instant coffee drinks, which consist only partially of coffee extracts, made significant gains. Within this group the instant cappucinos are the largest sector. Their market share showed 8% growth in 2004, followed by icecoffee (5%) and "Wiener Melange" (4.5%).

Estimated global coffee consumption - October/September (mln bags green bean)

	2005/06	2004/05	2003/04	2002/03	2001/02	2000/0
Total	1169	1146	113 1	111.3	109.5	1071
Importers	865	853	849	83 7	825	81 1
North America	23 9	23.7	234	224	21 4	215
Canada	29	28	27	24	24	24
USA	21 0	209	20.7	200	190	19
Europe	439	433	43.4	43 5	43 4	42.6
EU (25)	38 8	384	386	388	38 3	380
France	5 0	5 0	5 1	5 4	5.4	5 3
Germany	9 0	8 9	9 1	9 2	9 3	9 4
Italy	55	54	54	54	52	52
Hungary	0 7	0 6	0.6	0 6	0 7	0 7
Poland	2 1	2 1	2 2	2 1	2 0	1 9
UK	24	2.4	24	24	23	22
Central and Eastern Europe	5 1	4 9	4 8	4 7	5 1	4 6
Russia	3 0	2 9	2 7	2 8	2 9	2.1
Africa & Middle East	5 8	5 6	5 5	5 4	5 3	5 1
Asia & Pacific	1 8	11 6	11.5	1 4		10.9
Australia	0 7	0 7	0 7	0 8	0.8	0 8
Japan	79	78	74	73	73	69
S.Korea	1 3	1 3	1 3	1 3	1 3	1 3
Latin America	1 1	I I	11	1 0	1 0	1 0
Producers	30.4	293	282	276	270	260

Statistically, in 2004 per capita consumption was 6.4 kg, green bean, compared with 6.5 kg the previous year. It is hoped that the negative trend will soon come to a halt as coffee-on-demand systems will conquer the market. The industry faces the challenge of developing and marketing new drinks, generally packaged in cup-sized portions, instead of selling roast coffee, as today, mostly ground and in 500 g packs. This, industry sources say, will turn the market upside down. It is predicted that the coffee-ondemand systems could attract young people back to coffee. On the other hand this could be partially counterbalanced by less wastage. However, the outlook for 2005 remains bleak. With retail prices rising, consumption has come under pressure. Reported household sales fell by 10% during the first nine months of 2005, pointing to lower offtake in 2004/05.