The Caffeine Crash

Ingmar Empson

April 19th, 2019

For those complaining about the price of their morning coffee, it may come as a welcome reprieve to hear the global cost of coffee beans has fallen through the floor. However, to the farmers whose livelihood is directly tied to the delicate balance of supply and demand governing this volatile market, the collapse in price of Arabica and Robusta beans has been devastating. In the past year, many have been forced to abandon or sell coffee plantations owned and operated by families for generations as profit margins in this competitive market have continued to collapse. In this briefing, I will seek to understand the market forces which have dropped prices and whether there is a rebound in sight.


 This dramatic decline in the price of coffee can best be understood by examining the global benchmark on coffee prices above. ICE Coffee C Futures represents the majority play by institutional investors and global corporations in the coffee market, citing contract series ranging in variable month contract intervals from March through December. They trade in 37,500-pound lot sizes, prompting delivery at several ports around the globe, thus pricing in physical delivery of exchange-grade green beans (pre-roasted). Priced in cents, the above chart represents the May 2019 settlement future and demonstrates the full collapse of nearly half-value in the past two years. Ranging out through volume-liquidity requirements to July 2021, futures show a demonstrated forecasted rise but charts cannot price in a break above the $1 mark until at least the end of 2019. The December 2019 settlements are currently trading at 98.4.


In my analysis, I have defined four market-defining factors to be examined to establish a forecastive outlook on Arabica and Robusta beans. The first is the not-priced-in effects of these low market valuations given current break-even costs of farmers in Brazil, the world’s largest coffee bean exporter at ~25% of global production. The second is the note that, like many commodities originating in ‘coffee belt’ nations, the majority of coffee in global markets trades in dollars. The recent meltdown of the Brazilian Real relative to a strengthening USD in a turbulent Brazilian political environment has driven a glut of unloaded produce onto markets which may continue in the future. This volatile political landscape marks the third factor. The fourth factor is the macro-meteorological instability associated with changing climate conditions which will continue to increase volatility in markets directly tied to seasonal predictability.



In our comprehensive analysis, the first fundamental factor to understand is the 1-3 year result of historic low prices on farm production of coffee beans. For the majority of growers, margins between gross profit and a total net loss for the production of coffee beans remain tight, especially as consolidation has remained an extended process globally. For most producers, list prices of between $1.20 and $1.50 are required simply to hit the breakeven mark. Demonstrated in the current state of the futures market, not only are these numbers not currently available, but they are not forecasted for at least the next 12-48 months by current market sentiment. This proves problematic from a production standpoint given the typical agro profile of growers. With a significant portion of bean growth constrained by limited local production, the majority of farmers have little cushion to absorb multi-year losses. There is already evidence that this is weighing on growers, with many abandoning farms altogether. This rate of abandonment will increase over the next 2 years as those currently loading up on debt to finance operations may begin to miss payments if price inflation remains stagnant. Ultimately, this decline in production will drive prices higher due to lack of supply. However, this effect will be delayed through the typical bean production timeline and possibly further extended based on the number of farmers capable of obtaining financing options to help through this period of extended lows.


To further understand factors weighing in on the coffee bean market, it is important to grasp the importance of dollar-denomination in coffee contracts traded around the world. With 25% of all the world’s coffee beans originating in Brazil, the related value of the Brazilian Real versus the dollar is incredibly important.

As shown above, we have seen a consistent breakdown in the relative value of the BRL versus the USD over the past year. This is due to a number of factors. The first has been the rise in U.S. interest rates which have put significant downward pressure on EM currencies around the globe. Although it appears rate hikes have taken a pause and there is a possibility of a break in the cost of dollar financing in 2020, the impacts have been significant. Additionally, the election of Brazilian President Bolsonaro has resulted in a political crisis which continues to rock currency markets tied to the BRL. With a series of controversial upcoming proposals and a demonstrated unwillingness to work with others in the political arena, Brazil looks set to continue its trend towards political instability throughout 2019 and into the start of the next decade. With the lowest approval rating of any Brazilian president at the 100-day mark, Bolsonaro will continue to plague Brazil’s ability to attract FDI and will mar its currency’s relative strength.

The result of this currency weakness has been unloading by suppliers of beans onto international markets. Because of a stronger dollar rate, cash won abroad in USD translates well into currency at home. The result has been a market glut as product, regardless of forward supply budgeting expectations, has been dumped onto global markets, driving the price down further. This advantage seeking behavior has, in turn, kickstarted a poisonous cycle. Now producers of beans who initially looked to sell standard quantities of beans while saving some for the next year have been forced to clear inventory. This is because prices have become so low that financing their operations through typical gross sales quantities has become a challenge.


Making the situation worse for those relying on standard price setting is the resulting volatility of bean production stemming from meteorological shifts in climate, most importantly rainfall. 2018 marked one of the biggest bumper crops in Brazil’s growing history. In the fiscal year, 62 million 60kg bags of beans originating in Brazil were exported and sold.

 More rainfall combined with optimum humidity and temperature levels has enabled the trees to produce record levels of beans. This has led to even more supply on the market. Typically following such a massive year, the trees require 1-2 years to build and store energy before another huge haul. However, since the start of 2019 conditions have continued to remain at perfect levels. With steady rains forecasted for the duration of the next few months, analysts predict a drop from 62 million bags to ~52 million. This is a relatively small decrease after such a productive year. Further amplifying the effects of this supply boost, Bolsonaro has introduced legislation to roll back environmental and zoning protections, possibly opening the door to increased industry consolidation. This altered cyclicality stemming from abnormal climate impacts and a deregulatory political climate paints a near term picture of unnecessary supply.


In this analysis, four core factors have been identified which will shape the coffee bean market in the next three years: the role of small suppliers and breakeven costs, relative weakness in the BRL relative to the USD, a volatile political climate, and historic patterns of meteorological shifting as a result of climate change. Combining these factors with healthy demand growth of around 2-2.5% for coffee beans, a dynamic forecast emerges. In the next 12-18 months, I assign a 65% probability ICE Coffee C Futures land between 90-120. There is a 25% probability they land between 75-90 and a 10% probability they crash through 75. Looking from 18-36 months. I see a rebound in prices as dwindling suppliers cut out over a longer time horizon and the possibility for a strengthened BRL come into play. I ascribe a 25% probability of ICE Coffee C Futures trading from 100-120, a 50% probability of trading between 120-145 and a 25% probability of breaking up through 145. Investors interested in making a coffee play can also trade the iPath Pure Beta Coffee ETN or the Bloomberg Coffee Subindex Total Return ETN.