If the fundamentals of coffee are similar to those of other commodities, the prices of which have doubled in the past year, why hasn't _Lhe price of beans shot up as well? Some growers say they soon will, while officials in Brasilia are to investigate the matter. Being paid $100 dollars for a 60 kg bag of Arabica coffee used to be something Brazilian farmers could only dream of, says Aguinaldo Lima, a grower and co-operative official in Patrocinio, Minas Gerais State and who now heads the Ministry of Agriculture's Centre for Coffee Intelligence in Brasilia. But although a bag of Arabica now fetches $160, growers say they are no better off, than before. This is because costs have increased far more than prices in the past few years. Also the Brazilian currency, the Real, has gained about 10% against the US dollar in the past 12 months, 40% in the past five years, and more than almost any other currency. The Real has gained ground against most other currencies as well but a strong currency is something that Brazil's coffee community is just going to
have to live with.
Following the discovery of very large reserves of crude oil under deep waters, Brazil has become an extremely popular destination for investors. Not all the news is good, however. With imports now growing much faster than exports, Brazil's current account has slipped into deficit after several years of comfortable surpluses. If the trend continues, the currency could weaken in two or three years' time. Demand for coffee has been increasing faster than supply in recent years, while stocks, both in Brazil and elsewhere, have fallen to their lowest levels for decades, if not ever.
For several years now, Brazil has shipped and consumed more beans than were grown, but, with stocks now virtually exhausted, this state of affairs cannot continue.
Strengthening demand for food in China and other developing countries, coupled with the steady run down in stocks, has caused prices of soya, wheat, maize, beef, and many other agricultural commodities and foods to at least double in the past 12 months.
With most coffee fundamentals similar to those of other commodities, many analysts feel that the price of coffee must rise sharply in the near future as well.
Veteran grower Luis Hafers thinks that sentiment will change once the market assimilates the fact that the current harvest will prove to be less than 50 million bags, rather than the 55 million bags some analysts anticipated earlier. Moreover the following 2009/10 crop will inevitably be smaller than the current one. This will make it obvious that Brazil will no longer be able to export 30% of the total traded worldwide, with the result that prices will "explode" before the end of the year, says Hafers. Mr. Joachim Libanio, export manager of the Cooxupe co-operative in Varginia, Minas Gerais, now Brazil's second largest exporter, worries that because the price of fertilizer has doubled in the past year, farmers will use far less than is ideal this year. The main impact of this will only be felt in the 2010/11 crop, which is likely to be much smaller than if bushes were looked after properly.
In the past few years, Brazil has exported an average of about 27 million bags of green beans and soluble_ coffee, while domestic consumption, growing by between 4-5% a year, has now reached almost 18 million bags. If domestic demand continues strong, close to an extra million bags will be needed on the domestic market each year from now on. If Brazil is to maintain the 30% share of the amount of coffee traded worldwide each year, now increasing by at least 1.5% each year, another 700,000 bags on top of that will be needed each year. With no sign of the investments needed to accompany such a growth in demand, it seems more likely that output will continue to hover between 40 - 45 million bags, so Brazil's market share will slip. Grower Luis Hafers, says this does not worry him. His main concern is that growing coffee should be profitable.
The Ministry of Agriculture is so concerned that coffee prices have not risen along with those of virtually all other commodities, that it has set up a working party, chaired by Mr. Lima, to seek an explanation and see what can be done about it.
Mr. Hafers thinks an important reason why prices have hardly moved in the past 12 months is that most of the hedge funds which are now the leading investors in coffee, take a very short term view. They see that this year's (2008/09) crop is a large one, while coffee has continued to flow normally out of Brazil in the past few weeks. A. looming supply crisis has not been expected. Because most farmers do not have sufficient resources to withhold much coffee from the market, the flow will continue as normal during this year. Last year, many small farmers shared some of the $200 mln made available by the Treasury, in the "Pepro" subsidy scheme. However, largely because some co-operatives claimed more than the 300 bags maximum each member had a right to under the scheme, details of Pepro will have to be changed this year to prevent a repeat. As this will take time, it seems very unlikely that any Pepro funds will be available before September. Nevertheless many farmers have to repay their debts then, and so will have to sell beans to do so.
2009/10 output to drop sharply
If prices do not rise later this year as expected, many farmers will prune back heavily to allow bushes to rest, as well as cutting back on fertilizer. This tactic would mean the 2009/10 crop would be substantially smaller than the current one, rather than the 37 - 38 million bags many now anticipated for next year, weather permitting, that is.
Mainly because drought affected many growing areas towards the end of last year, this year's crop is unlikely to be the 55 mln bags hoped for earlier. Bushes have been well looked after in recent years, so rather than the 2009/10 crop being up to 30% smaller than the current one, often the difference between a large and a small crop, the annual variation is expected to be relatively small. As well as the price of fertilizer having risen, labour, previously responsible for about 25% of the cost of producing a bag, now forms closer to 30%. Manoel Correa of the Valorizacao trading company in Rio de Janeiro, notes that the average price of a bag of coffee has doubled since 1994, when a new currency, the Real, was introduced, causing prices to stabilize after years of inflation. However, the minimum wage, which determines the rate paid both to the 700,000 or so itinerant workers who harvest the beans and the 500,000 or so permanent workers on plantations, has increased six fold since then. The cost of diesel fuel, fertilizer, lime, electricity and many other inputs has risen four or five times in the same period, while social security charges have shot up as well.
While coffee used to be the only option for unskilled labour, the industry now has to compete with sugar cane, forestry, fruit picking, civil construction and others for manpower. Because coffee planters cannot pay as much as most others, the quality of workers and consequently their productivity, has declined. This helps to explain why harvesting is proceeding so slowly this year. With the cost of labour unlikely to fall, the only alternative is to mechanize. Many farmers are buying large machines suitable for flat plantations as well as portable ones for farms on hills.
Because the burning of standing sugar cane before it is cut causes severe pollution, manual cane cutters will have to be replaced by machine in about 20 years time. But some labour will always be needed to strip the bushes on very hilly land. Sugar cane, soya, maize and citrus, recently joined by rubber, all of which are planted on flat land, are now more profitable than coffee, as is raising beef and dairy cattle. As a result most coffee has had to retreat to land too steep for planting arable crops, where the use of machines is limited.
Mr. Hafers worries that growers are the only group in the industry anxious to see the price of beans rise. Exporters, who receive a proportion of the price of beans whatever it happens to be, are quite happy with the way things are. But the soluble industry wants beans to be cheap, and domestic roasters fear higher prices would push many companies into bankruptcy. Exporter Jorge Esteve, of the Esteve Irmaos trading house in Santos, notes that largely because of increased spending power of people in many developing countries, many important producing countries are consuming much more and the annual growth in the amount of beans consumed, until recently about 1.5% a year, is now closer to 2%.
Consumption in many developed countries is stagnating, with some consumers in the United States at least, moving down market. But while the share of the developed countries in the overall total consumed is slipping, the overall trend is positive. Anxious to see consumption in other producing countries grow by the 4 - 5% average seen in Brazil in the past 15 years, Carlos Brando's P & A Marketing company was contracted by the International Coffee Organisation to devise programmes aimed at pushing consumption up in other producing countries as well. The scheme has been adopted successfully in India, Colombia, Guatemala, Mexico and Costa Rica. Two other countries which for the time being Mr. Brando is not free to name, one of them in Asia and the other in Latin America, are expected to adopt the scheme soon. A few years ago, about 20% of all the coffee consumed worldwide was drunk in producing countries. However, with almost half the increase in consumption of the past few years concentrated in producing countries, this proportion is now closer to 25%. To be successful, all the various players in a producing country - growers, exporters, roasters, the soluble industry if there is one, and the government - have to be convinced that they will all benefit if consumption increases. Their interests may be contradictory. Roasters, for example, might worry that fewer beans could be available for them to sell abroad.
More robusta
The fact that the habit of coffee drinking is spreading to many countries where tea was previously the dominant beverage, also helps explain why the last few years has seen a steady increase in the amount of soluble coffee sold, and therefore the proportion of robusta coffee included in blends. Partly because 2007/08's Vietnamese crop has been relatively small, the price of robusta beans has now risen to the point where they cost only about 15% less than the average Arabica bean. The situation is similar to what it had been when the ICO's economic clauses were in force. The very wide price difference between robusta and Arabica, which began in the late 1980's and lasted about 15 years, is commonly attri buted to the meteoric rise in the amount of robusta grown in Vietnam. Because robusta beans were so much cheaper than Arabica for so long, roasters in many countries who had previously insisted that their blends would only include Arabica beans, started incorporating up to 40% of robusta beans. Procedures such as steaming have allowed the negative qualities of robusta beans, which have less flavour than Arabica ones and can have a smoky taste with a much higher caffeine content, to be disguised. The positive factors, which include the fact that robusta
beans contain more soluble solids than Arabica ones, so are therefore more attractive to the soluble industry and above all, that they are far cheaper to grow, have allowed the variety to gain ground.
Mr. Nathan Herszkowicz, chief executive of the Brazilian Association of Roasters and Grinders, Abic, says that while 25 bags will be harvested from the average hectare of plantation in Brazil this year, 100 or more bags of the Conillon type of robusta planted in Brazil can be picked from a hectare. This high productivity is further boosted as its name indicates, since robusta coffee is far less demanding than the delicate Arabica, with the result that it costs only about $60 to produce a 60 kg bag of Conillon. This is less than half as much as the $130 an average bag of Arabica now costs to produce in Brazil. But while a 60 kg bag of good quality Arabica sells for about US $160, bringing growers a profit of about $30 per bag, Conillon, which now sells for about $130 per bag, gives growers a profit of about $70. Because of the huge difference in profitability, it is no wonder that farmers planting Conillon in Espirito Santo state, where about 60% of the 10 million bags or so harvested each year are grown, are extending existing plantations, or irrigating them to get even higher yields. They are also expanding into the neighbouring state of Bahia, where the crop is replacing cocoa. Conillon bushes are also being planted on low lying land in the north of Minas Gerais State, while experimental plantations of the variety are also being laid down in Sao Paulo, Brazil's leading coffee producing state before being overtaken first by Parana and latterly by Minas Gerais, where bushes are at far less risk from frost. Manoel Correa of Valorizacao calculates that the each labourer in Brazil, where he reckons harvesting costs about $2.2 bln each year, is paid at least twice as much as one in Colombia. But Mr. Correa points out that because yields are much higher in Brazil than anywhere else, while the cost of logistics is substantially lower, high productivity more than compensates for the cost of labour being so much greater.
Soluble losing ground
Mr. Mauro Malta, executive director of the Association of Brazilian Soluble Producers, Abics, welcomes the fact that much more Conillon coffee, which forms up to 70% of the beans used in the typical soluble blend, is to be planted, even if it were to be some time before enough extra would be available to make a difference. But exports of Brazilian soluble are not keeping pace with the growth in demand. The continued rise in the value of the Real means that Brazilian soluble coffee has become steadily less competitive. In theory cheaper beans can be imported under a "drawback" regime, if they are to be re-exported once processed. This would allow products to incorporate beans from African countries, which consumers in countries such as Spain and France prefer, or beans from Vietnam, which are often cheaper. However, regulations require that a sanitary official must visit the country of origin of any beans, to ensure that there is no risk of a disease, not present in Brazil, being imported. This procedure takes at least two years to complete, so such imports have proved impossible. Another obstacle is that the soluble industry is not able to claw back various taxes paid where the product is made, which adds to costs.
In addition to problems in Brazil itself, the authorities in the EU, now the leading customer for Brazilian soluble, levy a 9% import duty on the Brazilian product.
They have refused to make any allowance for the fact that many of the EU's new members did not previously tax Brazilian soluble. On the other hand soluble from most Andean countries, oil-rich Venezuela now amongst them, can enter the EU tax free, as can soluble from African countries. To add insult to injury, says Mr. Malta, Brazil is importing more coffee, without restricting it in any way. The Illy company sources about 60% of the beans it processes in Brazil, where its products are sold for five or six times the price Illy pays for the 150,000 bags of beans it buys in the country each year. Starbucks, now opening outlets in many Brazilian shopping centres, also imports the blend it uses from the United States. The low profitability of Brazil's soluble industry, means companies have not been able to make the investments needed to keep pace with the steady increase in demand for better quality freeze dried soluble coffee. This is steadily gaining ground at the expense of the vacuum dried variety. Only three of the country's seven soluble processing plants make freeze dried coffee. Although this forms only
7.5% of the amount of soluble now shipped, it generates 11.5% of industry earnings.
Higher prices could push many small roasters to the wall
If growers are anxious for bean prices to rise, exporters, whose revenue derives from a small percentage of whatever the price happens to be, are basically neutral. However, the country's 1,220 roasters, who will between them process close to 18 million bags this year, have very mixed feelings about the prospect of paying more for their beans. Like the growers, roasters have seen their margins narrow steadily over the past 15 years. During that time the price of a bag of coffee has roughly doubled, but most of their other costs, notably labour and the price of utilities, have increased five or six times.
With demand growing by an average of 4.5% a year, close to a million bags have been added to sales each year for several years, resulting in economies of scale.
However, margins have been squeezed remorselessly, to the point where many roasters are close to insolvency. In recent years, most of the largest roasters, including companies owned by the Sara Lee and Straus Elite groups, as well as by long established firms such as Melitta, which previously only distributed their products in the more prosperous centre south of the country, have begun selling countrywide. In their turn, the largest roasters in the north east have begun distributing nationally too. These trends have intensified pressure on the hundreds of very small roasters, many of which are small family concerns distributing over a restricted area. In the search for wider margins, many of the largest concerns have introduced premium brands, including gourmet and single source blends, but despite fast growth, this segment still founis no more than 5% of the total, so cannot be the solution for all roasters.
The incomes of the lower paid have risen by more than those of the middle class in Brazil in recent years, so much of the extra coffee has been bought by low income families, who tend to buy cheaper blends. Although the Brazilian economy is still expected to grow this year, if not by the 5% of 2006 and last year, then by at least 4.5%, the increase in the amount of coffee sold, which peaked at virtually 5% last year, could end up being slightly less than 4% this year. Inflation is set to rise by about 6% in Brazil this year, while the price of basic foods, which form a high proportion, of the spending of the lower paid, has risen by much more than that, so coffee sales could slow. In these circumstances, the major rise in prices which the growers are pressing for could push many small roasters out of the market. They will not be able to pass on higher prices to consumers. Abic has been trying to find ways for small roasters to reach consumers by selling through other, smaller outlets, rather than the very large supermarket chains. The large stores have gradually increased their share of the total sold in recent years, but because space is limited, they display a very small number of better selling brands on their shelves. However, judging by the sales of coffee making machines and small roasters, which have been growing by more than 20% each year, both home and out of home sales continue buoyant in Brazil. Chains such as Starbucks, Dunkin Donuts, Nescafe and McDonalds, which first tested coffee in its outlets in Brazil before offering the beverage on a very large scale at outlets in the United States, continue to open new coffee shops in Brazil. Thus, whereas future growth of output may be restricted, domestic consumption seems to be headed for more growth down the road.
