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July 20, 2011

Coffee Prices Lingering Near Record Highs

FreshCoffeeAnalyst Insight by Brian Morgan.

Arabica coffee prices hit a 34 year high in early May 2011, a culmination of several factors including increased global demand, higher oil prices, and lower than average coffee yields due to adverse weather patterns in some parts of the world.

Colombia, the world's larger producer of arabica coffee, is still recovering from a 2009 crop year that saw the smallest harvest in more than three decades. Brazil, the world's largest overall coffee producer, is expected to see the largest off-year crop on record in 2011, though the full effect on supply will likely not be felt until the 2012/13 harvest.

According to the International Coffee Organization (ICO), the 2010/11 crop year began with coffee stocks at the lowest levels seen since ICO began taking records in 1965. Total coffee prices began to fall somewhat in May and were down 5% in June, but are still up from the same period in 2010 and are likely to remain well above US$1 per pound until depleted stocks are rebuilt.

Price spike could last for years

In addition to the delay in Brazil's biennial harvest cycle, other factors could lead to a more prolonged period of higher coffee prices, even as growers take steps to capitalise on coffee's higher profitability. Investments made now typically take two to three years for the trees to mature enough to achieve a resulting increase in output, meaning supply will likely lag the continued increase in demand.

Farmers have tended towards exclusive supply agreements with global manufacturers in recent years and with this has come increased education about proper maintenance and fertilizer use. This kind of focus on maximizing production in Colombia, for example, could lead to an extra 1.5-2 bags per hectare, or a 10% supply increase nationwide, according to Colombia's coffee federation.

But in the meantime existing supply contracts from before the current phase of price increases are ending, and manufacturers have engaged in several rounds of retail price hikes in 2010 and through early 2011. JM Smucker announced an 11% retail price increase in May 2011 on its Folgers and Dunkin Donuts coffees, following a 10% increase in February, a 9% increase in August 2010, and a 4% increase in May 2010.

Typically other major producers follow suit soon after one price increase is announced, including in this case Starbucks, which refrained from a major increase on coffee sold in its stores in the US in 2010 but instituted a 17% rise in prices on 12 July.

Demand remains among consumers

Despite the ever increasing prices of coffee, consumer purchasing of coffee for at home use has not seen any significant slowdown. According to ICO figures, global coffee consumption reached 134 million 60 kg bags in 2010, while coffee output for 2010/11 was expected to reach only 133 million bags.

Producers voice concerns

This impending increase in supply has led producers like Illycaffe to caution that cycles of over and undersupply could be in store over the longer term, adding to coffee price volatility. A similar cycle was observed in 1998, with subsequent supply flooding the market in 2001 and leading to nearly a decade of lowered prices and reduced profitability until oil prices drove major commodities higher in 2008.

Coffee manufacturers will need to ensure they are differentiating through product innovation and quality, loyalty programs, and efforts to enhance convenience if they hope to justify these recent added costs of purchase.

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