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J-F Lambert spent most of his career in international banking and trade finance, originally with Crédit Commercial de France, or CCF, and then with HSBC. He is now a consultant on trade and commodity finance and strategy for banks, companies and funds. He also teaches commodity market dynamics at Sciences Po in Paris and regularly lectures at the London Business School.

What has been the impact of the virus, lockdown and oil price war on financing for commodity traders?

As for any corporate or individuals, the challenges caused by the virus and the measures taken to ringfence its dire consequences are massive. With about half the world population in lockdown and most developed economy in a standstill, the shock is enormous.

What makes it even more challenging is that both supply and demand are affected, and that like in a low speed tsunami, the wave eventually reaches every shore.

In such a context, commodity trading faces three kinds of difficulty: a choc of demand, disruption on supply and, if the crisis lingers, increased counterparty risk. Whilst the volatility is high, these uncertainties prevent trading houses from taking full advantage of it.

In rough seas one needs a sturdy vessel. In terms of commodity trading, this means that only large trading houses can cope with the underlying risks: trading risks, liquidity risks in the face of margin calls or payment delays, and counterparty risks. Smaller players should err on caution: if they find themselves on the wrong side of the market, they may lack the financial muscle to absorb the shocks.

Are banks tightening their lending to traders?

Banks are tightening their exposures on every front. With regard to commodity trading, their reaction is to fly for quality, and be quite restrictive on everything else. This means that the ABCD+s will not be significantly challenged as they are able to communicate on their strategy, positions, liquidity and results with their mains banks almost daily if necessary.

Smaller players, unlike larger traders, often have slim liquidity and are often much less equipped to monitor their books and communicate effectively with the lenders. When this is the case, and in the current context, their banks will not be accommodative. In case of doubts or difficulty in assessing the market positions of their smaller customers, banks will not hesitate to reduce their lines.

Why would banks reduce lending to traders now if the traders are not directly exposed to lower prices? Don’t lower prices make things easier for traders as they need less capital?

Unlike producers and end users, traders are not in principle exposed to the flat price. So, in theory you are right. However, in real life things are somehow different. To ring fence the flat price risks, traders rely on hedges, whether on a book or deal basis. In the these volatile markets your hedging strategy is only as good as your ability to pay for margin calls. If you are not able to meet your margin calls, then your hedge vanishes and you are left exposed, potentially facing huge losses. Besides, if the logistical disruption on the supply side and potential counterparty defaults are significant, they could trigger losses both on the hedge and the trade.

For all these reasons banks will stick to robust traders (the large trading houses) and will certainly revisit their exposure to whichever company they might deem to be overstretched.

Have the risks of counterparty defaults increased and, if so, how?

The risk of counterpart default is rising as the crisis lingers. The world economy is in standstill. Oil demand has fallen 30 percent when it has been rising consistently for the past 30 years or so. China’s ability to rebound is a moot point. Europe and America face the biggest economic crisis since WW2. In this context, defaults are bound to happen. Hence the nervousness of banks. Hence the reluctance of insurers to underwrite new businesses.

Are some commodities more impacted than others?

All commodities are affected, whether on the supply side, demand side or both!

Banks have long recognized that commodity trading is a critical activity. Rather than taking a global decision to pull out of one sector or another, banks are taking a close look at their customers and will direct their support to the fittest and most resilient ones. With others the time is not ripe to stage pull-outs, but to endeavour to ring fence their exposure by capping, reducing their limits or strengthening security packages. Strategic decisions will come later.

Finally, is finance the Achilles Heel of the commodity trade – the most vulnerable point of the system?

So far money has not been the issue.  Huge and sudden imbalances between demand and supply, potential logistical disruptions and rising counterparty risks are at the root of the current difficulties for commodity players.

Having said that, the commodity trade relies on other people’s money, in other words: bank money. Unless your bankers are comfortable, you can’t trade. So, my humble advice to commodity traders is to be as transparent and forthcoming as possible with your financiers, whether in calm as well as (and even more so) in rough seas.

As a former banker I cannot emphasize this enough: doubt, misunderstanding and suspicion about a borrower’s business will inevitably lead to the severance of the relation. All the more when we are witnessing the biggest recession since 1929.

© Commodity Conversations® 2020

I interviewed Teddy Esteve, the CEO of ECOM Coffee, while he was on Coronavirus lockdown at his home in Mexico. I asked him what was his relationship to the founders of ECOM.

ECOM is a seventh-generation business that started in cotton in Barcelona, Spain, and I’m part of that seventh generation. There are still quite a few of us from that seventh generation involved in the business, from three branches of the family.

I see from your website that ECOM is the number one coffee miller in the world and the number two coffee trader in the world.

Our company started in coffee in 1959 in Brazil. When we started in Mexico, we had a different shareholder structure than the one in Brazil. Today we are one group under a united management with a fantastic understanding of each other, so we work very well together.

Having said that, our Brazilian operations are largely autonomous.  Our people there are excellent, and they know their job better than anyone. They have been in this business for ever, and they just get on with it.

How did the business develop in Central America?

The operation in Mexico had started a few years before I arrived.

ED&F Man had come to us and said, “Hey, you guys know Mexico and we know coffee, so let’s start a joint venture coffee operation in Mexico.” We set up Omnicafé, a 50-50 joint venture; it lost a bundle in the first year.

At the end of the first year, we went to EDF Man and said, “Listen, you guys know coffee, you keep the company.” But they said, “No, no, you know Mexico, you keep it.” In the end, we lost the fight and we kept it! That was 1981.

From then on, we built the business from the ground up. We grew by knowing the business inside out.  It’s a very big advantage when you don’t inherit a business.

Did the acquisition of Cargill Coffee in 2000 boost your business? 

Anyone that buys something from Cargill, well it’s a real “wow!”

We bought Cargill’s coffee operation after Neumann, Volcafé and probably some others turned it down. Cargill was keen to sell it, so we bought it on good terms. The purchase was an important one for us. They had a lot of inventory and Cargill is without doubt the best school there is for commodity trading. We still have excellent ex-Cargill colleagues working with us.

In 2013, you took over Armajaro’s coffee operations. Was that also a boost to your business?

We bought Armajaro for their cocoa business, and it has been the best thing that could ever have happened to our cocoa business. It was a very good deal.

For coffee, it was good in the sense that the purchase included Dorman’s in East Africa. Dorman has a very good operation in Kenya, Tanzania and Rwanda. Armajaro also had some good contracts on their books with roasters.

What is your trading style?

We are very different to our competitors. We are the least trader of the traders and we are the most merchants of the merchants. If you have a scale with a wine merchant at one end and a soybean trader at the other end, I see myself more as a wine merchant than as a soybean trader.

People ask me how they can make more money. By buying cheaper coffee? No, by selling more expensive coffee, not by buying cheaper!

Everyone knows the price of coffee today; they all have a cell phone and access to the internet. We strive to improve the price to the farmer and ourselves by differentiating the product; the more I pay the farmer, the better the supply chain. Cheap coffee does not fit our business model.

Why is the price of coffee so low – is it because Brazil and Vietnam are so efficient?

Brazil sets the price of robusta. Today if you take delivery of the futures market in London you will get only Conilon – Brazilian robusta. Not everyone wants Conilon, so if you have Conilon, the easiest place to go with it is the futures market. So, although Vietnam produces more robusta than Brazil, it is Brazil that sets the futures price because the futures represent Brazils.

Brazil also sets the price of arabica.

Brazil can see yields in excess of 60 bags per hectare versus 5 bags per hectare in Africa. So, Brazil obviously produces a lot at a very cheap price. If a country wants to compete with Brazil, they have to compete on something else other than price. They have to compete on quality. In the long run, nobody can compete with Brazil just on price.

Is the world of coffee pricing broken?

There are currently too many producers who can’t make a living out of coffee. So, yes, in that sense coffee pricing is broken, and it has been broken for a while.

Having said that, there are a lot of companies who pay farmers correctly, and they are not small companies. These are people who know that you cannot live by taking advantage of others.

Two last questions: What is your favourite coffee? And what’s your favourite brewing method?

My favourite coffee is from Kenya: Dorman’s Gourmet Special Reserve. Once you drink this, you can’t drink anything else. It’s like Petrus. If I started to drink Petrus I wouldn’t be able to drink anything else. That’s why I haven’t start drinking Petrus.

I use a French press.

Thank you, Teddy, for your time and input.

© Commodity Conversations ® 2020

This is a short extract of an interview that will be published in my upcoming book Merchants & Roasters – Conversations over Coffee

 

 

I recently chatted with Dave Behrends, the Founder and President of Farmer Connect. I asked him how it all started.

In 2017 I attended a coffee conference in Medellin Colombia. Professor Jeffrey Sachs, an economist from Columbia University, got up on stage and told the audience,

“Every day I go to a famous coffee shop and pay $1.95 for my medium sized black coffee, but how much of that $1.95 actually goes to farmers? The answer is five cents.”

The conference descended into chaos, with everyone arguing as to whether the coffee chain makes too much money, and why the farmers don’t make enough. But what was lost – and it was this that personally inspired me – was the second statement that Jeffrey Sachs made. He said,

“If as a consumer I was given the option to pay $2 for my coffee instead of $1.95, but I was sure that that the extra five cents would go back to the farmer, or back to the farmers’ community to either double their income or really significantly improve his livelihood, I would gladly pay that extra five cents.”

That was a light bulb moment for me. I realised that he was right. Consumers would be willing to pay a little bit more as long as they could trace that money flow back to farmers and their communities.

And has that vision now come to fruition?

Yes, it has. Farmer Connect currently offers three main components, or solutions: the first is Farmer ID, the second is an Enterprise Blockchain Solution; and the third is Thank My Farmer.

Farmer ID gives each farmer a self-sovereign digital identity that stores two types of credentials: one transactional and the other behavioural (in terms of sustainability). Having the transaction and the behaviour on the platform creates a trust score and a credit score that micro-finance institutions can use to determine the farmer’s credit worthiness.

In addition to the transactional and behavioural credentials, Farmer ID also has a link to digital wallets, bank accounts or other means of payment.

The Enterprise Blockchain Solution is the second component of the scheme. It records two types of data: prices paid at every stage along the supply chain, as well as what we call ‘the journey of the product’.

Thank My Farmer is the third component. It will allow a consumer to scan a QR code on his cup, or bag, of coffee and immediately see the journey that product has taken.

It will allow consumers to contribute to social projects in the farmer’s geography or to make a donation directly to the farmer who grew the coffee.

Do you think that consumers will use the Thank My Farmer app to tip a farmer in the same way that they would tip a barista?

I think there are consumers who will engage. The millennial and post-millennial generations may be a little bit more inclined to do so compared to older generations. Also, some countries have more of a tipping culture than others, so it could vary by geographies.

But we don’t want to limit it just to that. We’re speaking with brands who are saying that they want to give money to sustainability projects, and they want to allow their consumers to choose which project to support.

How will Farmer Connect increase farmer revenues?

Farmer Connect will enable consumers to engage in a new way with the supply chain and allow them to know that every cup they’re drinking is positively impacting the lives of the farmers who produce it. Once that happens, we believe that consumers will be willing to pay more for their coffee, and probably drink more.

This changes the game for everyone. Instead of fighting over whether the brand owner or the retailer make too much and the farmer make too little, we’re going to grow the whole pie. And as we grow that pie we will make sure that the farmers are getting a more than equitable share of it.

I believe that you are currently raising money.

Yes, we are going through a series A fundraising, looking to raise US $10 to 20 million, and we envision bringing in three to seven investors.

We’ve purposely gone out of our way to turn down Venture Capital and Private Equity money. Even if it means that we have a lower valuation we’ve put most of our focus on finding industry partners. We really believe that this should be done by the industry for the industry.

Dave, thank you for your time and explanations, and I wish you every success with the venture.

To see Dave’s latest blog on child labour click here.

© Commodity Conversations ® 2020

I met recently with Nicolas A. Tamari, the CEO of Sucafina. I asked him about the geographical spread of his business.

We are in the top five of global coffee traders. One out of every 20 cups of coffee drunk in the world comes from Sucafina. That is a big number, but we look more at profitability than at volume. We say that ‘volume is vanity, profit is sanity and cash flow is reality’. We look to be profitable, not to fight for market share.

We source about one third of our coffee from Africa, one third from the Americas, and one third from Asia. Historically we were more of a robusta based company, but in the last decade we’re now doing more arabica. The majority of our business is now arabica.

Our strategy in the next five years is to build in Asia in terms of both origination and destination. A couple of months back we acquired a specialty coffee merchant operating in Hong Kong, Australia and New Zealand. It used to be called MTC, which stood for Mountain Top Coffee, but has been rebranded as Sucafina Specialty.

Who owns Sucafina today?

The company today is owned by the family and by the management. We believe that commodity trading companies should be owned by the management. It’s a people business. We are about one thousand employees in total in the company.

We encourage key people to become shareholders. To become a shareholder, you have to have worked for the company for a minimum number of years, to share our values, and to contribute to the bottom line financially.

Why are coffee prices so low and do you see any relief for growers in the near future?

Prices are currently low because the Brazilian Real is low against the US dollar. Brazil is the largest producer and exporter of coffee, and the low Real gives producers there a reasonable return.

As you know in coffee, we have two exchanges: one in New York that trades arabica and one in London that trades robusta. They are two different qualities. To make an analogy, they are like red wine and white wine.

The contract specification for the New York contract is washed arabica. Brazil mainly produces natural Arabica, which means that the vast majority of Brazilian coffee cannot be tendered on the Exchange – even if it still trades on that Exchange.

It’s a little bit like the cotton anomaly of a decade or so ago. You remember how most of the cotton in the world cannot be tendered against the futures market. It has to be US origin.

We have a similar phenomenon in coffee now where most of the physical coffee trades against a market where it cannot be delivered. I believe that this technical situation in itself will lead to a rally in prices.

In addition, even with the Coronavirus I am confident that coffee consumption will keep growing in the decade to come.

So yes, I believe we will soon have a rally, and that the New York market will reflect the fundamental tightness in washed arabica coffee.

If the New York contract is washed arabica while Brazil produces only natural arabica, why doesn’t Brazil just wash the coffee and make it deliverable?

Less than 10 percent of Brazil’s arabica coffee can be washed in Brazil. That 10 percent can be delivered on the exchange. Traditionally – for the last hundred years or so – the Brazilians rarely washed their coffee. The majority do not currently have the infrastructure to wash it, and it would need substantial capex to build it.

Do the futures markets in London and New York work well?

Both are liquid. Both set prices correctly.

But as I mentioned, most of the coffee traded against the New York Exchange is not tenderable. This results in a de-correlation between physical and futures prices in terms of the basis, which we call the ‘differential’.

Historically differentials were not particularly volatile, except for Colombia in 2009 when we had a weather problem. Recently differentials have become more volatile leading to a total de-correlation between physical and futures.

Right now, we’re currently living with a scenario where washed arabica coffee is trading at the massive premium to the underlying futures. There is a shortage of washed arabica coffee, but an excess of natural arabica coffee.

So, what would stop someone taking delivery of New York and getting the washed coffee?

That’s what’s happening as we speak and that’s why I believe the market will rally.

Thank you, Nicolas, for your time and your insights.

© Commodity Conversations ®

This is a short extract of an interview that I plan to publish in full in my new book Merchants and Roasters – Conversations over Coffee – hopefully out at the end of this year.