March’s interview with Sustainable Harvest’s® Director of Trade Jorge Cuevas touched on the rising pressure on both the producer and roaster sides of the supply chain, and how to minimize risk in a rapidly changing coffee market. This latest interview with Jorge explores the current market state and reviews lessons learned in the Central American harvest season that can be applied to the South American harvest.
1. What are the market expectations in the short to medium term?
In May we saw the market reach three dollars and it was a very scary time for everyone – we just didn’t know where it would stop. There were too many long positions pushing the market up, along with investment funds urging the market even higher. The market was clearly overbought. This, combined with the fears over Greece’s debt situation and the resulting potential financial bailout, adjusted the market downwards, and we saw coffee prices drop to the 2.40s. We now see the market correcting itself.
We’re currently in the Brazil frost season. From June 15th to July 15th, the coffee market is on high alert to any changes in Brazil’s weather that could result in a frost that harms the Brazil crop. This is a very volatile period – if there is a frost, the market shoots up, but if the frost never arrives, the market steadily drops. After July 15th, the market should stabilize as the frost risk dissipates.
2. What did we learn from the past harvest?
During the Mexican and Central American harvest that is wrapping up, we learned that no one can forecast the market’s movement. The market was surging upwards in May and then in June it crashed back down. Playing the guessing game didn’t work. What we did find is that it’s important to have discipline in this market, especially with price fixations. We learned that you have to put limits in place so you don’t gamble with your coffee prices. If I’m buying coffee as a cooperative from the members and the market is at 2.50, the moment that I have collected half my contract’s coffee, I have to protect that price. I need to say, “I’d like to put a stop loss at 2.50”, so if the market collapses underneath me, I’ve protected the 2.50 range at which I bought a large quantity of coffee. But if the market goes up, I’m still protected and I have the possibility to fix at a higher range when the whole container load of coffee is collected.
It’s important that we don’t say “Fix my contract at 2.65 and let me know when the market gets there”, because perhaps it never will. We have to get accustomed to putting high and low limits and working in disciplined ranges. A cooperative wants its competitive advantage to be the differential it can offer to farmers. They can’t rely on skill or an inherent ability to read the market – no one can do this. Co-ops shouldn’t acquire unnecessary risk, especially because the differentials that fair trade, organic, and specialty grade bring should give co-ops peace of mind as they collect coffee from members.
3. How can we protect a price level?
What happens when cooperatives are hesitant to fix their price because they think that the market might have reached its low? Even setting a stop loss price is unsettling because then it locks in that low level. The solution here is to not panic – put a stop loss to protect a minimum price, execute the price fix, and then buy a Call option. Buying an option on a futures contract gives the buyer the opportunity, not the obligation, to achieve a higher price for his coffee if the market prices go above the price specified in the option. If the market is really at its floor and is headed back up, buying an option is a form of insurance. Say we buy an option with coverage starting at 2.70. This means that when the market reaches 2.70 and continues higher, the market begins to pay out the difference. In this way, we remove the fear of inaction in a seemingly low market.
Our goal is for producers to collect coffee and fix, collect and fix, not to speculate. Options are novel in that they give producers a second opportunity. If a fix really was relatively low because the market came back, there is still a chance to participate in the market’s highs. This limits your risk, and the only thing left to do is watch the market. If it keeps falling, the call option won’t have much value. But because you have your fix, you’re still covered price-wise and have a better ability to keep buying coffee from farmers.
4. What are your thoughts on the roaster side?
For roasters, we have to look at the situation from the opposite angle. We came from a horrible market in the 3.00s. There were people who had to fix at 2.90 or 3.00because they didn’t know in the moment if the market would continue rising and we had people saying “I just want to control my costs”. Now that we’re back down in the 2.50s, roasters should be active and we’ve seen lately that they have been. It’s time to fix now, because relatively speaking we’re 50 cents lower than two months ago. This is a big advantage. Remember, what counts are averages – you’re not trying to game the market, but merely to come out with good average prices. If you’re a roaster, you probably have coffee fixed in the 2.80s and 2.90s, and now that the market is in the 2.50s, fixing lowers your overall average price. You effectively lessen the pressure, if even a little, to raise prices on your customers. Participate actively in the market and protect yourself, especially against any market jumps due to Brazil’s weather.