Coffee prices have always been a source of uncertainty for all the agents of the value chain, especially small coffee farmers that have seen their livelihoods worsened every time prices drop. The most recent Consultative Forum on Coffee Finance took the subject of price volatility and increasing production costs as its main focus, seeing how the profitability of the market is on the decline. The following is a concise background on the current situation.
Background: The breakdown of the International Coffee Agreement, 1990s coffee prices crisis and the coffee leaf rust epidemic
In order to properly understand and accurately analyze the current situation of coffee growers worldwide, it is necessary to reach back to important events that shaped the coffee market we face nowadays.
First of all, it is important to recognize the impact that the breakdown of the International Coffee Agreement had in the coffee market. Since 1962, producing countries belonging to the pact reached agreements on how much each member would produce for the trading year, in a fashion not that different to what OPEC does for oil. Such an arrangement was made necessary by the high volatility of coffee prices. Through a constraint in supply, coffee producing countries experienced some of the most stable prices in coffee trading history.
However, by the late 1980s, the coffee market had changed in some very significant ways: on the producer side, non-traditional producing countries such as Vietnam and Indonesia, were pushing for a bigger quota, while Brazil was also experiencing bigger harvests and looking to expand its exports. On the consumer side, people were asking for better quality of coffee, favoring smooth Arabicas (such as the ones produce by Colombia and Central America) over coarse Robustas (the ones produced in Brazil and Vietnam). This setup was used by large interest groups mainly lead by the multinational roasting companies to lobby for a breakdown of the Coffee Agreement, with the intent of bringing the artificially high prices down through free market. In 1989, they finally succeeded, taking advantage of a reduction in Brazil coarse coffee quotas, which the Brazilians weren’t eager to approve.
The effect of the breakdown of the Coffee Agreement was mostly evident in the historically low prices of the late 1990s and the early 2000s. Under free market, supply increased in countries such as Brazil and Vietnam, bringing prices down from about $1.15 per lb. to about 50 cents per lb. A negative cycle ensued in which producers were either kicked out of the market or they lowered investment and thus productivity.
To make matters worse for coffee farmers, low investment (and a high reliance on productive but disease-susceptible varieties) left the productive stock susceptible to coffee leaf rust—coffee’s most dangerous disease. Coffee farmers plunged deeper into depression as a result.
Looking at it from an impartial point of view, this was just the correction of an imperfect market. However, the human cost was significant. It meant devastation for millions of small holders and chaos in developing countries whose national income rely heavily on coffee exports. To put this in perspective, Colombia experienced a full-fledged economic crisis, with real estate and financial bubbles bursting. Suddenly people couldn’t keep up with payments after revenues from the most relevant crop were cut down by a fourth.
The aftermath and current situation
The market has bounced back. Countries have adapted in different ways, but it is safe to say that the market we have today was fundamentally changed by the breakdown of the International Coffee Agreement. As predicted by basic microeconomic theory, profits tend to be small or zero in the long run for industries that have limited barriers to entry. This on top of the fact that coffee is a commodity with highly volatile prices, it is hard for a small producer to survive extended periods of low coffee prices.
Recently, Vinente Partida wrote about the findings of the 6th Consultative Forum on Coffee Finance.[1] In line with what has been the trend in recent post-coffee agreement breakdown, the prediction for profits in the coffee farming sector are low, mainly due to the high volatility in the prices of coffee and the increase of costs of production. There have even been years (2007/2008 and 2014/2015 harvest) when coffee growers were producing at a loss. A call for more innovative financial instruments for farmers of all sizes was made.
Two different approaches to the same problem
The best lesson learned by (some) coffee growers after the last coffee crisis was the need to distance themselves from commodity markets and bulk coffee transactions. Especially, amongst small and medium coffee growers, a desire to differentiate themselves and seek niches within the global coffee market was a maxim.
- Enacting barriers of entry through sustainability
The demand for sustainable coffee—Fair Trade, Organic, or any other combination of Good Agricultural Practices—has been increasing over the last couple of decades. Coffee growers have recognized this trend and used it as a differentiating feature of their produce. Seals such as FLO (Fair Trade), Organic (USDA Organic, JAS), UTZ, Rainforest Alliance have been designed to enact barriers of entry that both guarantee to the consumer that the product they are buying was grown following strict standards, and help producers obtain a higher margin for their coffee. Because this is effectively fractioning the market of coffee between sustainable (certified) coffees and non-certified coffees, different partial equilibriums can be found.
Figure 1. Hypothetical partial equilibrium in a fragmented market. Non-certified vs. certified sustainable coffee
Figure 1 shows a hypothetical case: The market for certified coffees might have a steeper demand and supply curves. In the hypothetical case illustrated above that means a lower quantity of it is traded but at a higher price. The barriers of entry ensure that producer who find themselves in the non-certified market cannot instantly transition into the certified one and bring down prices. Such barriers include: requirements for the hiring of labor (no slave or servile workers, children, equality of pay between sex, race and religion), requirements for the production technology (pest control, weed control) and requirements for the conservation of the environment (erosion, forest management). These obstacles ensure (at least in the short run) that a small number of suppliers have access to the market thus bringing prices up.
On the downside of this approach, it has been mentioned that the barriers of entry offer “protection” in the long run. This is because said barriers are not that difficult to surmount, meaning that non-certified farmer who see their peers do better off in the sustainable market, have a high incentive to do the transition and become certified, thus bringing the price down again. Evidence of this can already be seen in ending stocks for most seals, which means that demand isn´t growing as fast as supply.
- Enacting barriers of entry through quality
The setup for this approach is quite similar to the one that has just been visited. The need to differentiate the product and a consumer market that is receptive to it. Similar conditions of partial equilibrium can be seen as shown in Figure 1 with a smaller market and a higher price.
The key difference between both approaches arises from the nature of coffee production. If the barriers enacted through sustainability seal are somewhat easy to overcome, one can imagine barriers of entry through quality that can be much harder—even impossible—for potential competitors to overcome. That is because quality in coffee is a function of, and amongst many, environmental conditions (temperature, radiation, soil, water, etc.), agronomic management (fertilization, variety planted, pest control) harvesting and processing (ripe fruits, wet/dry process, roasting). As a consequence, different combinations of these factors yield different qualities of coffee. A coffee farmer who is able of standardizing his/her product and finds a consumer willing to pay for it, finds himself in an almost monopolistic position. This is not easy to emulate, because he/she only knows the right combination.
[1]*Article published at the International Coffee Organization Blog: https://icocoffeeorg.tumblr.com/post/150775120970/coffee-farmers-face-dangerously-low-profits. Author: Vicente Partida. Officerpartida@ico.org