The coffee arbitrage between New York and London
Historically, bull markets for coffee start in New York. Usually they arise after weather problems in Brazil. When the difference between New York Arabica and London Robusta prices widens considerably, coffee roasters take notice and shift their demand from Arabica to Robusta coffee. The smallest arbitrage on a weekly basis was in December 1994 when it was 3.82 cents. Robusta prices moved for about a nanosecond higher than Arabica. At that time, Vietnam first started growing more coffee. Mostly when the arbitrage had tightened, it was because coffee prices had fallen, rather than reaction to a bull market and demand. The arbitrage has eased and demand has again shifted to more Robusta use following the same pattern after a price increase in Arabica. The difference is that this time the move has been inexorable as weather problems have persisted. Vietnam produced a smaller crop last season and the current harvest has been disappointing. This is probably due to a reduced fertilizer use when costs were high. Vietnamese farmers have also been reluctant to sell too early, as they want prices to keep rising. Other cash crops, such as durian, have given them the ability to hold back sales. What compounds the problem is that Brazil had unusual weather already in November with record high temperatures where the damage from it is starting to be seen, raising doubts about the size of the 2024/2025 Arabica and Robusta harvests that otherwise had the potential to be huge. Fixed differences prevent coffee from being certified in both New York and London, but also create a likelihood of coffee being withdrawn. Increased risks in the Red Sea of delivery delays add another factor of uncertainty. All these factors have helped to light this fire under the market, leading to coffee prices rise again.
What is an arbitrage?
Arbitrage is the simultaneous buying and selling of the same or similar asset in different markets to take advantage of small differences in the asset’s quoted price. It exploits short-term variations in the price of identical or similar financial instruments in different markets or in different forms. Arbitrage exists as a result of market inefficiencies, and it both exploits these inefficiencies and resolves them.
