Reference no: EM133079011

Coffee CrisesAn unfair bean count?

The cultivating, processing and retailing of coffee is big business. It is the second most widely traded commodity after oil and approximately 3 billion cups are consumed worldwide on a daily basis. Global consumption in the coffee year^[ii]2019/20 is estimated to be around 10 million tons and the annual income of the whole sector exceeds $220 billion. Around 25 million farmers spread across 50 countries harvest coffee. The majority of these farms are small and family run

Brazil is by far the biggest producer and accounts for about a third of the market. A good or poor harvest in Brazil can have a significant impact on prices. Vietnam and Columbia are the second and third biggest producers respectively and, with Brazil, account for nearly 70 per cent of global production.  

The late 1990s and early 2000s marked something of a crisis for coffee producers. During this period the world supply of coffee rose relative to demand, causing a slump in the price. The graph below shows the trend in the average price of coffee (there are many varieties and prices) between 1996 and 2020. Having reached $1.80 per lb in May 1997 (an imperial pound (lb) is equivalent to 454 grammes), it then fell more or less continuously over the next five years, reaching around $0.44 in 2002: a fall of some 75 per cent.

Source: ICO statistics (International Coffee Organization)

Coffee production (bars) and spot prices (blue line)

During this period, the supply of coffee increased by around 3.6 per cent a year, outstripping the 1.5 per cent annual increase in demand. The growth in supply was largely caused by new plantings in Vietnam and Brazil. In 2002 world demand was estimated to be around 106 million bags, but production was over 120 million bags with a further 40 million bags held in stock.

The effect of the low price on many coffee growers, who are mainly to be found in some of the world's poorest countries, was catastrophic. Many farmers were driven into debt; others left the land and migrated to cities, worsening the often appalling conditions there; others switched to growing narcotic drugs, such as cocaine in Vietnam.

As we can see from the chart, the price of coffee recovered after 2004, peaking initially in July 2008 at $1.33 per lb, its highest level since July 1997. In part, this was due to farmers diversifying into other crops; in part, it was due to buoyant global demand, with the emergence of new coffee markets, such as China and Russia, and strong demand in coffee-producing countries themselves.

In 2008, however, a combination of good harvests and a recovery in the coffee prices caused supply to increase substantially. Although demand was still growing in developing countries, the onset of recession in developed countries was halting the growth in demand and, as a result, the world growth in supply outstripped the world growth in demand. By the end of 2008 the price had fallen back to $1.03 per lb. 

Coffee prices then soared in 2010, reaching over $2.30 by early 2011. These price rises were largely the result of poor harvests in Central America and Vietnam and were then driven further upwards by speculation. But then, with world growth stalling, and signs that the 2011/12 crop would be larger, coffee prices started falling again. By the end of 2013 prices were at a six-year low. 

However, in 2014 Brazil experienced its worst drought for a decade, and with a coffee fungus spreading through Central America, coffee prices once more soared. The price rose from $1.10 per lb in November 2013 to $1.71 in April 2014 - a 55 per cent increase in just five months. 

Although global demand for coffee increased quite strongly between 2015 and 2019, record harvests in Brazil and Vietnam put downward pressure on prices. In 2018, Brazil produced a record 62 million bags of coffee and the oversupply in the market was estimated to be 8 million bags, nearly 5 per cent of global output. 

The impact of Covid-19

The coronavirus crisis has had an impact on both the demand and the supply sides of the market. On the demand side there have been two short-terms effects working in opposite directions. Initially, sales in supermarkets grew rapidly because of panic buying by consumers. However, out-of-home consumption collapsed as numerous countries introduced lockdown measures, leading to the closure of coffee shops and restaurants. Given all the uncertainty, the volatility of prices increased in the first half of 2020 but the trend was upwards from February to May. This made coffee one of the top performing commodities during this period.

Going forward, sales at supermarkets are likely to decline as consumers start to run down their stockpiles of coffee, whereas out-of-home consumption will gradually increase as lockdown restrictions ease and restaurants/coffee-shops begin to re-open. Social distancing and consumer confidence will probably limit the growth of out-of-home consumption and many brokers predict that overall demand will fall in 2020.

If the pandemic causes a major global recession, then this will have a longer lasting impact on demand as household incomes fall. The income elasticity of demand for coffee will determine the magnitude of this impact and it is likely to differ between high- and low-income countries. Some customers may respond by purchasing similar quantities of coffee by switching to cheaper brands.  

On the supply side, output for 2019/20 is largely unaffected by the crisis as most of the harvest occurred before the pandemic. Social distancing and lower staff levels did, however, have a negative impact on the capacity of ports to process and export the coffee. There is greater uncertainty over the likely size of the 2020/21 harvest. Travel restrictions, social distancing and concerns over catching the illness may reduce the labour mobility of migrant/seasonal workers and disrupt the coffee-picking season.   

The retail price of coffee

You might be wondering why the price of a latte or an espresso in your favourite coffee shop does not follow the volatility in prices received by coffee growers. One reason is that the coffee beans determine only a small proportion of the price. Recent estimates^[iii] put this at just 10p for a £2.50 cup of coffee - the same as the milk. Factors such as the cost of staff (63p), shops/rent (88p) and cups/stirrers (18p) have a far greater impact on the price.  

But why has the price of coffee in supermarkets not more closely followed the wholesale price of coffee? Once again, the fluctuating price of coffee beans determines only a small part of the cost of coffee purchased from a retailer. Transport, storage, handling and port/custom costs are far more significant. Also, instant coffee has to go through a relatively expensive process of spray drying or freeze drying. 

Another contributing factor may be the actions of coffee roasters. This market has become increasingly dominated by a small number of businesses such as Nestlé, JAB Holdings and Lavazza. JAB Holdings purchased DE Master Blenders in 2013 and then merged this business with the coffee division of Mondelez International to establish Jacobs Douwe Egberts in 2015. These coffee roasting companies, with their significant market power, do not, in general, pass on the reduction in the price of coffee to producers but instead take advantage of the lower costs to increase their profits.

Read the case study and answer the following questions

Questions

1. What do you think caused the large increase in the price of coffee in 1997?

2. Use supply and demand diagrams to explain (a) the fall in coffee prices in the late 1990s and early 2000s, and in the period 2015 to 2019; (b) the increase in coffee prices from 2004 to 2011, and in 2014 and 2016; (c) the greater volatility in coffee price in early 2020.