Coffee Prices Head for a Bounce as Production Falls

Coffee production, concentrated in just a handful of countries around the world, is feeling the squeeze of increasingly erratic weather patterns.

Colombia, Vietnam, and parts of Brazil—among other coffee producers from Africa to Asia—have had dry weather since late last year, and in some instances the worst drought in decades, largely thanks to the weather phenomenon known as El Niño, which causes ocean temperatures to rise and upends weather patterns around the world. Although El Niño is expected to peter out in the first half of this year, the damage to coffee crops is just beginning to be quantified.

This has boosted investors’ expectations that 2016 will bring a lower bean supply and probably push coffee futures prices higher.

“All these weather issues have created uncertainty and more variability about where production will be this season and next,” independent consultant Judy Ganes-Chase wrote in a February note. “But it also shows the increased vulnerability in the marketplace because of production becoming highly concentrated in the hands of a few countries.”

Tumbling currencies in producer nations, especially industry giant Brazil, have sent prices reeling in the past 12 months. Weaker local currencies encourage growers to flood the market with beans because they make more when they repatriate their dollar-denominated sales. Arabica coffee on ICE Futures U.S. is down 25% for the year to date, ending Friday at $1.21 a pound, while robusta coffee on ICE Futures Europe has fallen 26%, ending Friday at $1,400 a metric ton. Still, traders and analysts are calling for prices, especially those of the more depressed robusta, to recover in the next few months.

Brazil is the world’s top producer of arabica, which is prized for its mild flavor and often used in gourmet blends, and the No. 2 producer of robusta, which has a more bitter taste and is typically used in instant blends. Vietnam is the top producer of robusta, while Colombia is the No. 2 arabica grower. These three countries make up about 60% of global coffee production.

SPECIALTY ARABICA COFFEES—often used to give flavor to blends of beans from multiple origins that would otherwise be one-note or bland—account for one of every two cups in the U.S. That has compelled retailers to dive deeper into places like Africa, bringing on board growers in riskier markets such as South Sudan, Burundi, and the Democratic Republic of the Congo. Demand for specialty coffee in Europe is also on the rise, traders say.

As a result, specialty coffee now accounts for nearly 30% of African coffee production, up from less than 15% three years ago, according to the African Fine Coffees Association. But coffee production on the continent—which includes the third-largest arabica grower, Ethiopia—still accounts for only about 10% of the international market. World Coffee Research, a nonprofit group, predicts Brazil will lose 50% of its coffee-producing land by 2050, whereas Africa will lose just 15% to 20%. “It shows that Africa is getting that increasing competitive advantage relative to other producing countries,” said Timothy Schilling, executive director of the group, at an industry conference in Tanzania last month.

And though 2050 is still a few decades off, this year could prove to be a preview of seasons to come, which means more upward pressure on coffee prices until levels are reached that stoke production in markets like Africa. 

Khoa Le

Source: barrons.com