How do exchange rate fluctuations affect coffee prices?
Last week a coffee farmer got $3.00/lb, and they were happy, but today the price of coffee is $3.15/lb and they are disappointed. Why? There are many reasons that can contribute to this, but a very common one is currency fluctuations. The price producers get for their coffee depends not only on the volatile global coffee market but also on exchange rates. Let’s take a look at how these affect the real value of what coffee producers earn.
What is the price of exchange-traded coffee?
The majority of the world’s coffee is handled as a commodity. These are generally commodities that are assumed to have the same value across the board. This means that higher quality crops from one country will be traded alongside lower quality coffee from another, but treated as the same and cost the same. The center of coffee trade is based at the Intercontinental Exchange (ICE), located in New York. Here, the price of coffee, known as the C-price, is determined in US dollars (USD). Specialty coffees are generally sold at higher prices, but they are still affected by the changes in the C-price. Often the price paid is the C-price plus a quality premium. However, the commodity market does not follow simple rules. Prices are relative and constantly changing. Coffee is not only bought by people working in the coffee industry, but also by traders who are only interested in making money by buying and selling shares on the commodity market. This speculation can drastically affect the C-price, as it artificially distorts supply and demand. How and to what extent speculation does so often depends on how attractively coffee compares to other commodities traded that day. If other commodities look more attractive, less traders are likely to speculate on coffee; conversely, if other commodities look less attractive, more traders are likely to speculate on coffee. In theory, commodity prices should be a simple reflection of supply and demand. The supply of coffee could be reduced by bad weather, pests, conflict and so on, which would increase prices. In contrast, if there is a lot of supply or poor demand, prices should fall. In 2019, the C price reached its lowest point in a decade. While there are various factors that resulted in this, one notable cause is the oversupply of coffee from Brazil.
How exchange rates affect the price coffee producers receive
The C-price is set in US dollars, which means that the price negotiated for coffee, even if it is specialty coffee. However, with notable exceptions such as El Salvador and Ecuador, most producing countries have their own currency. This means that exchange rates also affect how much producers get for their coffee. And just like the C-price, exchange rates also always fluctuate. As with commodity prices, exchange rates fluctuate based on supply and demand. Demand is determined by expectations of national economic strengths and weaknesses. If it is perceived as weak, demand and value will fall. If it is perceived as strong, demand and value will increase. The value of the USD, along with all other currencies, is therefore constantly changing. In turn, this directly affects the real value of the money paid for the coffee. The value of the dollar can also cause fluctuations in the C-price. Otávio Sandrin, Commercial Coordinator at O’Coffee Brazilian Estates in Brazil, said: “If the US dollar is too high, the C-price usually drops to compensate for the final price.”
Who is most affected by exchange rate fluctuations?
Tim Heinze, director of Sucafina PNG and founder of Yunnan Coffee Traders and Huskee Co, says the impact of currency fluctuations will be different depending on the role the coffee producer plays. “If the coffee producer is an exporter, currency fluctuations will absolutely affect them, “ he says. When the exchange from USD to the local currency happens, if the local currency is weak, exporters get equal or higher returns. But if the dollar is weak, the exchange rate will lead to lower returns. Coffee producers who are not exporters, such as smallholders, will not experience the effects of the exchange rate in the same way. Instead, smaller producers will sell their coffee cherries or beans locally, which does not involve the exchange of different currencies. Tim says,“they should get paid when they either sell the product to a dry mill and/or exporter or if they have an agreed price when handing over the product.” However, producers at this level will be affected by the value of the C-price, which will cause the local prices paid at mills or cooperatives to fluctuate. It is not only producers and exporters in producing countries that are affected by these exchange rates. Importers of green coffee will be affected due to fluctuating exchange rates and local prices, especially those not based in the US. Tim tells me: “This also depends on the size of the company, but when one buys green in USD (especially if their home country’s currency is different), they also have to buy USD for this transaction.”
How else do exchange rates affect producers?
While payments to coffee producers are made in USD, all other payments are made in local currency. This is where problems can arise. From labor and tools to facilities and machinery, there are many steps in coffee production that require equipment and resources. Their prices can also be affected by the exchange rate. Otávio, who is based in Brazil, tells me how a weak Brazilian real means leading to higher prices for coffee; however, it comes at a cost. Otávio says, “in Brazil we import about 80% of our inputs (raw material and fertilizer). If we have a weak Brazilian real, of course our costs are affected. “ If the local currency is weak, this results in the import of production inputs being very expensive. This in turn can reduce profitability. In Brazil in 2015, the Brazilian real reached a record low of just R$ 4.0665 to the US dollar. Although the value of the currency fell, this meant better prices for coffee producers. But the weak currency also increased the cost of agricultural inputs, many of which are imported into the country. The exchange rate drove the price of fertilizer up by 50% throughout 2015, which in turn reduced the profitability of coffee farms. With currency fluctuations, every high is a low. Higher prices do not come without extra baggage.
How can coffee producers protect themselves from exchange rate fluctuations?
The effects of exchange rates are not specific to a particular country. Instead, exchange rates affect all coffee producers around the world, but especially producers who are large enough to export, but not large enough to access the futures market. Larger producers can access the futures market. Through hedging, they can make future contracts that allow buyers and sellers to sign contracts at the current price of coffee, protecting it from fluctuating prices when it is paid later. ICE requires producers to produce at least 37,550 pounds to access this market, resulting in many small producers being excluded. Deals with private exporters are also an option for larger producers. Tim, founder of Yunnan Coffee Traders explains a scheme they tested in Yunnan, China which involved buying 30 MT of coffee from a wet mill at an agreed price, on a three-year contract. Tim tells me: “While we had to put in some parameters if the market crashed or if it skyrocketed, we found that the wet mill was getting about 30% above local market prices for each year we did it… being able to negotiate long-term contracts with the roasters who also agreed to a fixed price over three years.” Such larger deals may not be available to smaller producers. However, joining other coffee producers in cooperatives, for example, may be an option. Larger groups of coffee producers can benefit from creating large dollar amounts for local currency exchanges. While this does not protect against fluctuations in exchange rates, it can ensure a better deal. When discussing coffee prices, it is important to remember that the C-price is never as simple as it sounds. There are so many different factors that influence the price of coffee, from the prices of other commodities to how weak or strong a local currency is. And in turn, this affects how profitable a price really is for a coffee farmer.
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