Good morning Steve, and thanks for agreeing to talk with us. First, could you please tell me a little about yourself?
After studying Economics at the London School of Oriental and African Studies, I joined Rowntree’s as an economist in their cocoa buying office. In 1988 I moved to ED&F Man to become head of cocoa research. Three years later they merged their cocoa and coffee divisions and I took over as head of research of both. When ED&F Man bought Volcafé in 2004 I also became head of coffee research for Volcafé.
In 2006 I moved to the US to join the Ospraie hedge fund. I worked for them for four years before coming back to the UK to co-found Tropical Research Services. We provide research and data on the coffee, sugar and cocoa markets, including extensive field research.
What does the current S&D look like for coffee?
Arabica is interesting at the moment; there are a lot of similarities with 2009/10. That year there was a shortage of mild arabica and a surplus of Brazil naturals. Differentials for mild arabicas from Central America and Colombia widened significantly, certified arabica stocks declined and eventually the market rallied to 300 cents per pound to ration mild arabica usage. There wasn’t an overall shortage of coffee in the world, just a shortage of mild arabica. The New York C contract is a mild arabica contract.
We are in a similar situation now where the differentials for Colombia and Central America mild arabicas are increasing, certified stocks are falling, and we have a record Brazil crop of natural arabicas, rather than the semi-washed arabicas which could substitute for mild arabicas.
The big unknown is what impact Covid19 will have on demand. We are seeing the collapse of out of home consumption as restaurants and coffee bars close, and a big increase in at home consumption. This may lead to a shift away from mild arabica consumption towards naturals and robustas.
We are also heading for a major recession. In 2008 after the Great Recession, coffee consumption held up, the rate of growth slowed but people carried on drinking coffee. But in hard times, consumers tend to buy cheaper coffee, so again, Covid19 could lead to lower mild arabica consumption and higher naturals and robusta consumption, so we probably won’t see a price spike as high as in 2009/10, but if Covid19 does not resolve the mild arabica conundrum, prices will.
There is also a risk to the semi-washed harvest in Brazil from Covid19 measures on labour supply. The Brazilian government is trying to stop people moving across state borders and this may lead to a labour shortage. This could slow the harvest. You won’t lose any coffee as the harvest will just go on for longer, but you could see a fall in quality.
This is something we will be monitoring as the harvest progresses, and we have people in the field looking at how the harvest is progressing.
Any drop in semi-washed production could further tighten the mild arabica balance sheet, so there are a lot of moving parts at the moment.
Where does Vietnam fit into this?
The robusta market in London used to represent Vietnamese coffee, Vietnam being the world’s largest robusta producer. As most of the Brazilian robusta crop was consumed internally little was exported. Over the past few years Brazil has created a surplus of robusta – conilons – that was exported and is now sitting in Europe. There is very little demand for this in Europe.
Roasters don’t like them, and consumers don’t particularly like them either. What should happen is that the price differentials between Brazil conilons and Vietnam’s become so large that roasters would start blending in conilons.
There is however a problem in that the EU has just tightened up their rules on pesticide and herbicide residues, particularly glyphosate, in food. Brazilian growers use more glyphosate nearer the harvest than in other producing countries.
A lot of the conilons already in Europe no longer meet the tightened EU restrictions, and as a result no one in Europe wants the conilons. No one wants to take delivery of London. The calendar spreads are weak and the coffee continues to get carried forward. Meanwhile, the funds stay short, picking up the roll yield each time they roll forward.
Basically, the London robusta coffee futures contract is broken.
What’s going to happen to those conilons? Are they going to be burnt or dumped in the ocean?
Maybe they will be shipped to Russia, the US or Mexico. Robusta certified stocks have been coming down, so the market is slowly finding a solution.
Please tell me a little more about what is happening on the demand side?
The ICO did a study recently that showed a 95 percent correlation between GDP growth and coffee consumption growth. Because GDP going to take a big hit with Covid19, some people expect coffee consumption will collapse. I am not so convinced. There is also a very high correlation between coffee consumption and population growth, and population will continue to grow despite coronavirus.
In 2008 – the last time we had a decline in global GDP growth – the rate of coffee consumption growth slowed, but consumption still grew. This is in stark contrast to cocoa consumption, for instance, which showed a substantial decline. The difference is that cocoa is a luxury while coffee is – in many respects – a necessity.
During the last two years, prices have been low in dollar terms and consumption has grown by 3.5 percent per year. We expect that consumption growth this year will drop to 1-1.5 percent. If GDP growth takes a really big hit, the growth rate in global coffee consumption may fall to zero, but I don’t expect it to fall to below zero.
People who buy a cup of coffee on their way to work will now make it at home. The question is what sort of coffee they will buy from the supermarket. Will it be mild arabica or a blend of naturals and robustas? Possibly the latter.
How big will the shift be from mild arabicas? If there is no shift, then you have a potentially explosive situation for the arabica market. If the shift is big enough then we could just about get by.
We’re factoring all this in and we will review it as the year progresses, along with crop developments in the major producing countries.
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