Thursday, March 1, 2012

Green Coffee Buying

By traditional reckoning, this has been a disastrous year for me as a coffee buyer. I have been consistently wrong on my price fixing against the market. As I look today the "C" market, the place on the commodities market where mild Arabica coffee contracts are traded, the price closed at $2.05. The coffee we received on contract in December was booked at $2.63 at a time when coffee prices were peaking out at $3.00.

Now, I realize that our image of a coffee buyer is a carefully constructed fiction of a world travelling explorer on an Indiana Jones style quest for God in a Cup. Look at virtually any coffee roaster's website and somewhere you will find a story of their intrepid Coffee Buyer out in the deep coffee lands choosing the rarest and most exclusive coffee beans. Usually there are some pictures of said explorer standing next to some green shrubs wearing their requisite coffee buyer garb of Dockers Khakis and an Ex-Officio travel vest. Never mind that they are on a sponsored mass group tour in Costa Rica.

Indeed, whenever I identify myself as a Coffee Buyer invariably the first question I am asked is if I get to go to all the places we get coffee from. This question always tends to pose a problem in answering. It would be easy to say, why yes, I have travelled around the world on coffee expeditions; and feed into the common misperception. Depending on the situation, however, I try to explain the travel in a more nuanced way. The fact is, in my experience, I have rarely bought coffee on one of these trips, so to suggest that I am travelling around the world buying coffee misses the point.

The value of travelling to coffee growing communities, and I believe it is invaluable, lies in a better understanding both of the environmental and social conditions that coffee is grown. While, as I said above, I have rarely bought coffee on these trips, I have decided not to buy coffee from particular suppliers based on what I have experienced. In one case it was due to very large differences of opinion on growing techniques, in this case the use of herbicides and mechanical pruning/harvesting methods that clearly wrought environmental damage. In another case it was less obvious, hard to articulate beyond to say that something seemed off on the farm and I felt more comfortable working with another farm that exhibited more of the values of relationship that I share. These are important reasons for visiting the places you do business with, not the least that they are a reflection of what you represent.

More often, though, I visit a coffee growing community that I have developed a buying relationship to express my gratitude for their hard work and persistence. Growing coffee is largely a thankless occupation populated by some of the most marginalized people. The typical coffee farmer, especially a small coffee farmer, never meets the people who ultimately buy their product. At worse, they are taken advantage of by local coffee buyers, "coyotes", who would cheat them; at best, they meet with an exporting firm or maybe an importing firm who tend to keep compliments to a minimum and instead voice a steady drumbeat of better quality. Maybe this is due to a rationale that if they were to compliment the quality the price would go up, and from an exporter's perspective just a couple of pennies difference in price can have a huge impact on their bottom line. Especially when you are competing on the commodities market.

What I want to accomplish, though, is a long term relationship with our coffee producing partners. When all is said and done, I am a pretty lazy coffee buyer; I would rather have a consistent source of reliable quality than to go searching for it every year. And experience has shown that coffee producers are much more likely to offer a higher quality lot to a long term buyer than some gringo that flies in boasting how much money they are willing to spend. While there are those who always want something different, I prefer having coffees that can be relied on each year. This is particularly true when it comes to something really important like an espresso blend. And this is where we come back to the traditional concept of a coffee buyer.

Historically, a coffee buyers job was to ensure that the brand's coffee blend flavor profile did not change. It is a difficult task to maintain blend consistency with imputs that are in varying degrees of flux, not just year to year but within the year itself. Much easier to simply throw a bunch of ingredients together and call whatever the result is good. But to maintain a blend consistency requires fair amount of perseverance. Perhaps this is why some roasters have abandoned the idea completely and opted for "seasonal" espresso blends.

By and large, with the exception of a screw up from our supplier, which to their credit they promptly corrected, our espresso blend profile has remained constant. Its in the realm of the other aspect of a traditional coffee buyer's job that has been the disaster: forecasting the price.

And here is where things get a bit tricky. For most of our coffees I try to forecast how much we will expect to use until the next crop and the price is set according to what the market is that day, plus whatever "differential" premium is set for that coffee. Differentials are determined by the exporting agent based on, well, any body's guess really, but largely around an additional value a particular coffee may have. It used to be that Differentials were quite small, five or ten cents, plus or minus the market based on perceived quality and supply. Today, Differential premiums can be quite large, sometimes as much as the market price itself, since there has been a real decline in availability of top quality coffee.

Now, in the case of the espresso blend we have some other options. Since I generally know how much coffee we will use over the course of the year I can book that coffee without setting a price. Maybe I think the prices are artificially high and that the market will cool off at a later date. Or, perhaps I think the exact opposite, that coffee prices are set to go up, I could book out even a year's worth of coffee based on the market price. I could do the same with the differential. So here's my options: I can book the coffee price and differential to be fixed; I could set the price and not the differential, or the differential and not the price; or I could book the coffee price and differential at an agreed price set for up to a year.

Normally I book our espresso blend coffees in the fall of the year for the next year. The year before last the prediction when I booked the coffees was that the market was a little overpriced and would probably come down about ten cents. Supply was a bit of a concern so I went ahead booked the differential but left the price to be fixed later. Then, the coffee prices began to climb. And Climb. And Climb. We started off around $1.70 and by years end had passed $2.50. This was unprecedented. Moreover, the price continued to climb throughout the new year and there was much talk of it topping $3.00.

The reasons for this dramatic volatility in the market stems from a number of factors. Some of it is due to the concentration of coffee production to just four main countries supplying the majority of coffee. Last year saw serious crop shortages in two of the four. IMF and World Bank policies have virtually destroyed the coffee industry in most African nations and many nations are dealing with the effects of climate change, Coupled with the fact that warehouse inventory stocks have seen a steady decline to historically low levels due to supply consistently lagging consumption and one would conclude that the higher prices are here to stay. However, the combination of algorithmic trading and too few people with too much money makes the commodities market operate simply as a casino. I could see a report that the Brazil crop is larger than average and the price goes up. Now we are seeing reports of diminished supply and the price goes down. The price no longer reflects supply and demand, or any fundamental market conditions. Prices are determined largely by emotionally charged speculation fueled by computer frenzied automated buys.

The idea behind fixing prices on a forward delivery contract is to have a sort of insurance policy on your price through the year. Mostly what you want to do is to hedge yourself to an overall average price so you can set prices for the year. One thing people hate is to have the price change, well, change upwards anyway. A Coffee Buyer can set forward delivery contract prices against future months. In this way, the price paid throughout the year is averaged. This works great in normal times, but these are not normal times.

So now we have coffee coming in that is far above market price. I would have been better off never fixing the price at all and letting the price be determined when we took delivery. But to do so would make setting our prices impossible. We would never know what our cost of goods would be from delivery to delivery. Currently, forward delivery contracts against September are about $2.10, far below what we are paying now. The question now is am I willing to gamble? If history is any guide, I'm a terrible gambler.