1) Concentrated production
There are two main commercially grown types of coffee beans: Arabica, which accounts for 70% of the world’s coffee, and the Robusta bean which is far cheaper and easier to grow. The largest producer of coffee is Brazil accounting for about one-third of global production and about half of the worlds arabica output. The second major producer is Vietnam, accounting for just under 19% of global output and around half of robusta production. This concentrated output means that supply disruptions in one or both of these countries can have a significant impact on the price of coffee.
2) Substitution to cheaper beans
The robusta bean is far cheaper and easier to grow than arabica, but it has a bitter taste compared with the more expensive bean. This usually means that the price of robusta is much lower than the higher quality arabica bean. However, whenever the price spread between the two beans becomes very large then coffee manufacturing companies may start to substitute more of the cheaper bean into their blend. The incentive to do this is greatest when consumer demand is at its weakest.
3) The price of substitute products
Although many of us would say that caffeine is an essential first thing in the morning, if not all through the day there is more than one way to get it. Until recently the only substitute products was tea but now caffeine rich energy drinks are competing with coffee for attention.
4) The weather
Coffee is a tropical commodity. This makes it more susceptible to tropical weather events like El Niño. The timing of El Niño can have a big impact on whether the impact is positive or negative to supply. The warm weather that El Niño brings in June to August aids the arabica coffee harvest as the crop solidifies and warmer weather protects against the spread of the roya fungus (which thrives in wetter conditions). However, drier El Niño weather in December to February may have negative impacts on the next arabica crop, helping to support coffee prices as the event continues.
La Roya, or leaf rust is a deadly fungal disease rust has plagued farmers for more than a century. When a tree gets infected by it, its leaves produce a brown, thin powder when scratched, pretty much like iron rust. The disease decolours the bush’s leaves from a bright green to a brownish yellow. In the end, the tree loses all its leaves, as well as its ability to produce beans.
If left unattended, the disease can have dramatic consequences. In the late 19th Century, Sri Lanka, the Philippines, and other countries in Southeast Asia were the major exporters of coffee in the world. In a matter of decades, the disease meant they practically stopped growing it.
6) Flowering cycle
Brazilian coffee growing has traditionally followed a cycle of huge biennial swings, with an “on” year of large production followed by an “off” year of low output for arabica. However, these fluctuations have diminshed over time.
The expansion of coffee plantations in the northern areas of Brazil, which are less prone to frosts, has mitigated damage from cold weather. Meanwhile increased use of irrigation has minimised crop losses due to droughts while also helped coffee trees to recover faster from the stress of bearing a large crop. Finally, better fertilisation has also helped plants recover after bean production while plant breeding has led to more drought resistant trees.
7) Currency movements
Given Brazil’s position as the dominant producer of arabica coffee its exchange rate can have a significant impact on the price of coffee. A decline in the value of the Brazilian currency, the real increases the incentive for Brazilian farmers to increase output for export while at the same time reducing their production costs.
As with all commodities, low levels of stocks indicate strong demand, weak supply or a combination of the two. In addition, low stocks provide very little in the way of a buffer in case of disruption to future harvests.
The split of inventories between exporting and importing nations is viewed as an indicator of coffee price potential. It indicates the level of urgency, and willingness to pay up by importers.
9) Emerging market demand
Growing demand in emerging nations as per capita incomes rise – consumption of coffee in China has doubled in the last five years. Even in countries like Vietnam that are net exporters of coffee but have traditionally been tea drinkers there is a switch towards more coffee consumption.
Coffee like many other commodities is traded on futures exchanges. Although futures markets serve a valuable function by transferring risk from those who do not want it onto those that are able and willing to take it one there is a risk that at least for short periods of time the price doesn’t reflect the underlying fundamentals.
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