Before we delve into what we're doing with coffee (besides drinking a lot of it), there are a few key things to note about the sector. The coffee market has undergone an interesting transformation over the last 20 years. In the major coffee
consuming countries, highly differentiated markets have emerged for gourmet and high quality coffee, distinct from the instant coffees that formerly dominated the global market.
Rather than simply drinking coffee, consumers are demanding Fair Trade, organic, or specialty coffees. In response, coffee companies are creating beverages with unique flavor profiles and sourcing coffees from particular regions and countries. It’s a trend that looks likely to continue. While the per capita consumption of general, undifferentiated coffees has stayed flat or shown slow growth over the last decade, specialty and certified coffees have demonstrated annual growth rates of between 5 to 12 percent in the U.S. The story is similar in Europe and in parts of Asia.
Along with more exacting standards for sourcing coffee comes additional procurement difficulties and risk. Consider this past year, which saw the Central American coffee growing region affected by a tree-killing leaf rust fungus (“roya”). Coffee roasters, exporters, and importers who depend on coffee varietals from El Salvador, Guatemala, Honduras, and Costa Rica will face tighter supplies and higher prices. And of course, the coffee growers themselves have little ability to manage physical risk and may suffer a loss of income.
As is the case with many identity-preserved and specialty crops, the existing methods of handling price risk are proving to be inadequate. Coffee has a liquid, actively traded futures market, but in the case of country-of-origin coffees, up to one-third of the value of the coffee is attributable to factors unique to the origination country rather than the broader commodity market (Figure 1, below).
Although the International Coffee Organization (ICO) and others collect prices on single country-of-origin coffees, the general sentiment is that prices need to be collected with more frequency and rigor in order to have the credibility and utility to effectively hedge against price fluctuations on a country-by-country basis. Whether it's a disease, labor shortages, or excessive moisture or drought, the coffee market is vulnerable to shocks that are regionally-based. Because of this, it's important to the industry to monitor and understand how specific country-of-origin differentials change in comparison to the average coffee price.
Figure 1: Country of Origin Differential Prices