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The world coffee market: a brief economic history.

Before 1989 the international coffee market was regulated under the International Coffee Agreement (ICA) that was supported by producing and importing countries. That year, the ICA ended and the coffee industry became a free market without any interventions. In a few coffee-producing countries some form of local regulation continued. Given the deep structural imbalance between supply and demand the free market forces had a hard job to do. Today, after 20 years of market correction the supply surplus has disappeared and the market is better balanced, although it remains very volatile. Part I of this two-part series describes the "great correction" in the coffee market and discusses the price paid by the coffee farmer. The data used are all from the London-based International Coffee Organization (ICO).

Coffee is the largest market among the tropical agricultural commodities where millions of small farmers are dependent on exports. Due to swings in production, stocks play an important role as a buffer. During the 1960s coffee was, together with other commodities such as sugar, rubber and cocoa, part of the postcolonial North-South trade dialogue. This dialogue also took place in international organizations such as the United Nations, UN Conference on Trade and Development (UNCTAD), Food and Agricultural Organization (FAO) and the World Trade Organization (WTO). International commodity markets were traditionally plagued by overproduction in the exporting countries, declining price trends, volatility in production and prices, and other market uncertainties. The North-South trade negotiations resulted in the creation of several commodity agreements with intervention mechanisms to stabilize the markets; among them the International Coffee Agreement (ICA) in 1963.

The International Coffee Organization (ICO), London, was responsible for the implementation of the ICA. It was a de facto cartel with about 70 exporting and consumer countries as members. The objective of the agreement was to stabilize the international coffee market and coffee prices. Through a system of export quota the ICO tried to keep the coffee prices within an agreed price corridor. When the coffee price threatened to fall under the price-floor, export quota was applied to reduce supply and support the price. In case the market price came close to the price ceiling, the quota was suspended.

Like the other commodity agreements the coffee agreement had its share of difficulties, suspensions and ups and downs. Nevertheless the results of the coffee agreement--price support and stabilization-- were in general more positive than for other commodity agreements. Ultimately the main objective--structural balance between supply and demand--was not realized.

In 1989, the ICA was discontinued because of failure to reach world supply reduction, financing problems due high stocks, and problems agreeing on market shares of coffee countries. Leaks in the quota system especially with non-ICO countries (free riders) caused market disturbances. An important political factor was the emergence of neo-liberalism as a dominant doctrine in trade relations and trade policy in Anglo-American countries and at IMF and World Bank. They wanted to keep the market free (non-intervention), to reduce trade restrictions and to let the efficient free-market forces do their job. This idea of de-regulation was not only applied internationally but also started to change the markets in many coffee countries. This left the coffee farmers also without local price- and market-protection.

The ICO, as an industry association, continued without the intervention mandate and it is still very useful as a forum and platform for its members--the coffee export-and import-countries and coffee companies. The ICO publishes market prices, statistics and initiates promotional activities for the coffee industry.

Growth of Supply and Demand

For the period after the ICA intervention stopped (1990-2011), a number of important indicators are shown in Graph 1 (Supply/Demand Balance).

Supply: The total supply of coffee for export consists of exportable production and the gross stocks available in the producing countries. Exportable production is the gross production minus the local consumption in the producing country. For the crop years 1990/93, the total supply of coffee stood at an average level of 129 million bags (60 kg each) per year. This included gross stocks of 55 million bags (43 percent). Supply substantially exceeded the import demand of about 74 million bags. That made the market unstable and ripe for a major correction. After a 20-year free-market correction, the total supply had actually decreased. However, the gross production grew with 33 million bags. Increased local consumption and the reduction of gross stocks brought the total net supply down from 129 million bags to an average annual level of 108 million bags for the period 2008/2011.

The increase in production was geographically very one-sided. New coffee exporter Vietnam, and the largest coffee country Brazil, accounted for 90 percent of the increase in production. Their share in the world production increased jointly to 49 per cent. Vietnam's export share increased from a mere 2 percent in 1993, to 17 percent in 2011. While these two countries increased their market share, other export countries lost market share. Colombia saw its export share falling from 14 percent, to 9 percent and it dropped to third place, and fifth today. These shifts in market share destabilized the coffee market and distressed the coffee sectors in vulnerable coffee countries.

Demand: Consumption in coffee-importing countries has a low price-and income elasticity and is therefore fairly stable. The annual consumption during 1990/93 was about 74 million bags and increased steadily and moderately to 96 million bags in 2011 (green line in Graph 1). In the last 10 years demand in industrialized countries increased 1 percent per year and in emerging markets with 4.5 percent per year. The red line represents the actual imports that closely follow the consumption trend.

Supply surplus: The green area in the graph is the surplus of total supply above the import demand. The surplus almost disappeared in 2011. According to the free-market doctrine, the market correction should have resulted in: a decrease ha coffee production through the price mechanism as inefficient high-cost producers are forced to leave the market and entry into the market is discouraged; and lower consumer-prices, which due to the correction, should have resulted in increased demand.

This is not what happened. Total world production did not fall, but increased. As demand is in-elastic, exports did not get an extra boost. The free market correction took far longer and it needed two coffee crises before supply and demand became balanced. A positive trend was the increase in local consumption in the coffee producing countries absorbing part of the production increases.

Effect on Price

Graph 2 (ICO indicator prices) reflects the effects on prices caused by the supply/demand imbalance in the period 1990-2011. For clarity and simplicity the pricing of one of the coffee sectors is chosen: the price of Arabica other milds. This grade of coffee accounts for 24 percent of the total coffee market and can be regarded as representative for the whole coffee market. It is produced in Latin- and Middle American countries and some countries in Africa (Ethiopia and Kenya).

The price in Graph 2 is the annual ICO indicator price that is expressed in USD cents per pound. It is the average, weighted spot-price in the ports of New York and Hamburg (called CIF price in the graph--Cost, Insurance and Freight). Market prices as such do not tell us much unless compared with other factors in the market such as the cost price of production. An approximate range (the red band) is given where the CIF price more or less covers the cost of production of Arabica other milds. Many factors influence the final cost price. This approximation is among others based on ICO- and Fair Trade production cost-data.

The graph shows that the coffee farmer has paid a high price for the long free-market correction. Market prices were regularly lower than cost-price level. The market has known two severe coffee crises. The farmers lost billions of dollars in revenues.

In 2011, the annual price of Arabica other milds reached an all time high of 271 USD cents/lb. During 2012, the price had fallen fast to an annual level of 186 USD cents/lb. This was still comfortably above cost-price levels, but it shows how volatile the price movements still are. The consumer had to absorb price increases, but this hardly depressed consumption.

Part 2 of the series will discuss haw the market correction directly hit the upstream sector, affecting the revenues of the coffee grower and the balance of trade account in the coffee exporting country

Pieter J. Koerts, has a Master of Economic Sciences and worked in an army managerial positions in the marketing, distribution and trading of energy products in Europe before recently retiring. He became interested in the economics of the coffee market and studied it for some time. He is based in Amsterdam, NL.
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Title Annotation:ECONOMIC OVERVIEW OF COFFEE--PART I
Comment:The world coffee market: a brief economic history.(ECONOMIC OVERVIEW OF COFFEE--PART I)
Author:Koerts, Pieter J.
Publication:Tea & Coffee Trade Journal
Date:Jun 1, 2013
Words:1463
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