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Market Q&A with Jorge Cuevas

Posted by Wynne McAuley on March 18, 2011 at 3:52 PM

An interview with Jorge Cuevas, Sustainable Harvest’s® Director of Trade

What are the pressures that roasters and growers are feeling in the current market situation?

The general feeling is one of uncertainty. Fund buying by market speculators is wreaking havoc on a daily basis. This is especially frustrating because the rise and fall of the market has no correlation with happenings in the physical coffee realm. In such a volatile situation, people are hesitant to make decisions.

The recent sharp rise in the market started in December during the contracting season for Central American coffees. This meant that roasters were waiting to sign contracts until the price fell off. Until this week, the C market had steadily risen upwards, reaching nearly three dollars.

Furthermore, producers had to set very high differentials to protect themselves against the rapidly rising C market. High differentials + high C market = stalled contracting process. Both roasters and producers were stuck in a position where they needed to buy/sell coffee but also needed to protect themselves against the high prices. A wrong decision at this point could affect profitability further down the road.

It was at this point that we really saw that we needed to work together with each part of the supply chain to find solutions.
What measures can coffee suppliers take to minimize risk in such a volatile market?

The important thing for suppliers is discipline. They shouldn’t try to play the market because it can move against them very quickly. The funds are building up their market position and that’s what is making the market go up and up. At some point, they will liquidate their position, causing a sharp drop in the market.

Keeping this in mind, the best strategy for producers is to be methodical. For example, fair trade cooperatives should collect their coffee from members, then fix that coffee’s contract. Collect coffee, fix. This methodical approach yields an average price value for each month, even though they may make more money some months than others. Waiting until producers have the physical goods to back up a contract minimizes risk by diversifying levels of potential loss if the market nosedives.

What can coffee roasters do to minimize risk and plan ahead?

The important thing for roasters is that they know their raw material costs to put a price to their finished product. We hear that roasters are raising prices and conveying to their customers that coffee is at an all time high, but first we heard it was a 9 year high, then an 11 year high, then a 13 year high, and now 16. How many times can a price increase be passed on before customers start to balk?

For roasters, they can minimize this cycle by fixing a contract immediately after receiving it. In this market, there is no such thing as a lowest possible price – it’s always higher as time progresses. Cost certainty is the next best thing. Fixing upon receipt of a contract provides certainty and in the current situation, avoids exposure to higher prices in the future. Even if the market does drop after fixing, it’s not a huge loss to the roaster because he will continue to buy coffee that will be at a lower price in the future.

In this way, we see that roasters act opposite of producers. Roasters fix the contracts quickly to know their cost, while producers fix slowly to know they can afford to collect coffee as the season progresses.

The hedge is the most basic market-based tool to allow roasters and producers to fix the price of their contracts when they see fit. A more sophisticated method for managing risk is options. For producers who want to fix early, a call option protects them against a rising market because the call option increases in value as the market rises. If the market goes down, the producer is still in good shape because he has locked in that original high price.

It’s the opposite for roasters – a put option increases in value as the market goes down. If prices severely drop, then a put option helps mitigate any of that potential loss from having locked in a higher price.

Either way, the important thing to remember is that any market strategy has to be tailored for a specific user. Many variables come into play. Sustainable Harvest® encourages producers and roasters to open the conversation with us because we have access to tools to help and we can bring in financial advisors to give advice on tricky situations.

How does Relationship Coffee work in these market conditions?

There is no better time to show the value of Relationship Coffee. Unfortunately the market, as volatile as it has been, leads us to believe that a buyer and a seller are in antagonistic positions. But we don’t actually see the best interests of the roaster and producer at odds with each other. If we work together – suppliers need liquidity and access to credit but they’re happy with their price levels, and roasters need coffee delivered on time and at the agreed upon price – then we can prevent a breakdown in the supply chain. Relationship Coffee is a way to provide certainty and regain control over a market that has been greatly affected by outsiders.

Topics: Coffee, Coffee Market, Risk Management