Background and International Coffee Organization

 

1. Introduction

The purpose of this report is to describe the current situation in the global coffee market, role of demand and supply in coffee market, as well as how demand and supply affect the price of coffee and to determine price volatility of coffee. This report illustrates two significant situations for coffee the last 13 years.

Coffee is one of the most popular drinks in the world, it has wonderful aroma, refined taste and strong tonic effect, and also it is considered as one of the most strategically important raw materials in the world trade (Nestle Coffee Report 2004). Today it is wonderful drinks accompanies business meetings, parties, restaurants and bars (Kjeldgaard Et al. 2011).

Activities of more than 25 million devoted to the cultivation, trade and production of coffee (Stanford Graduate School of Business 2004). In importance of coffee is second only to oil, giving livelihoods to millions of people (Vernadakis 2007). Foreign Agriculture Service/USDA (2012) accounts for 2012/2013 a record 151 million bags of 60 kg in the world. Of this, only Brazil supplies the world market 55, 9 million bags, Vietnam 25 million bags, other 70, 1 million bags (ibid).

 

2. Main Body

 

2.1 Background and International Coffee Organization

Stability of the price of coffee is highly dependent on the balance between supply and demand of coffee where demand shows the amount of product that the consumer is willing and able to buy at a certain price for a certain time (Sloman 2003). Demand and price are usually inversely related to each other, that is, if the price is lower, the demand will be high and vice versa (ibid). Imbalance between demand and supply often happened in the past in the international market. Weather effects, poor planning and faulty forecasts repeatedly led to a significant jump in price, for example, frost in July 1975 in Brazil has destroyed about 70% of the crop and most of the coffee trees, and its consequences affect until the end of 1976 in the form of the increase in the world coffee prices (International Cotton Advisory Committee 2011). Given the large impact of the production and trade of coffee on the world economy since the beginning of the XX century, to achieve long-term control of the market, international agreement in 1962, after lengthy negotiations, under the auspices of the UN in the UNCTAD (United Nations Conference on Trade and Development) of the International Coffee Agreement was subsequently signed and ratified the major producing countries and consumers of coffee (ibid). The agreement helps regulate the world coffee market and stabilize prices and meantime world prices of coffee producers must reimburse their costs of production, and for consumers to be acceptable (Vogelvang 1992). Optimal prices should maintain a high demand for coffee.

 

2. Why 2001/2002 years was critically period for coffee?

 

The coffee is taken into consideration like thriving industry in developed countries. However, on the one hand, the coffee industry rises every year, on the other hand, in countries where coffee is the most important component in economy and is received a large income, in this countries farmers who produce coffee and whole country’s economy periodically have difficulties (Duncan n.d.). The catastrophe period for farmers was in 2001-2002 years (ibid), decreasing price the last 11 years was dramatically and it can be seen in the Graph 1.

 

 

 

 

 

 

 

 

 

 

 

 

 

Graph 1- World Coffee Price

Source: author

Data from Index Mundi 2013(www.indexmundi.com)

The situation with low price in 2001/2002 years results of disproportion between the demand and supply, it can be seen in the Graph 2 that production of coffee was stability higher then demand for coffee. In theory, low price results of highest supply in the Figure 1 (Sloman 2000). Total production of coffee significant rose and in 2001/2002 was 126,968 thousand 60-kg bags, consumption 112,832 thousand 60 bags in Graph 2 (ibid). Coffee production has grown on average by 3.6%, but demand has increased by 1.5% (Integrated Workers' Union (CUT) and the National Confederation of Agricultural Workers (Contag) 2002). At the root of this coffee glut was the rapid expansion of production in Vietnam and Columbia and also new plantations in Brazil, Brazil produced above 37% and Columbia with Vietnam 18 % (ibid). All the changes in 2001/2002 can be observed in the Figure 1: supply significant increased, demand slightly, price went down and quantity of coffee rose.

 

 

Graph 2 – Coffee World Production, Consumption, Total Supply, Export and Import

Source: author

Data from Foreign Agricultural Service/USDA, December 2012

 

 

In other words, especially significant decreased income for those countries where coffee provides most (more than half in this case) of export earnings. Approximately 125 million people around the world survive on coffee production (Tejeda-Cruz and Sutherland 2004). However, Osorio (2002) claims that for farmers it is not easy to find alternative industry to change because of unstable and also low price. Therefore, consequences of this situation can be summed up in a few ways, but all this ways do not even cover the cost of production:

• In many African and Asian countries, coffee is part of cash crops, therefore people do not have enough money for education and healthcare;
• Low price for coffee affect on agricultural which to led decreasing cost for farmers and high level of unemployment;
• Because of that profit of many farmers depends on coffee, farmers have to out and change on alternative crops (ibid).  

As for as consumers is concerned, Hays (2009) states that in this case customers do not benefit from low prices from coffee, excessively low prices lead to lower quality An example is a farmer who usually pays harvesters to get through the coffee trees three times during the harvest season to pick the ripe cherries, and now sends them through once, picking unripe and overripe beans and ripe ones (Dave 2005).

 

3. Why price for coffee was high in 2011?

 

From the information given in the Graph 2, it can be noticed that coffee in the past four years have increased in value in 2011 because demand outstrips supply. It can be observed in the Graph 2 that coffee harvest in 2010 was only 72% compared to 2009, which was the fault of bad weather in Brazil and India, as well as fungus were found in coffee beans in the south-east of Brazil (Volcafe 2013). In south-east Brazil precipitation surprisingly increased by 20% (Haggar and Schepp 2012). In April 2011 price for coffee was beaten 10-year high, and the coffee was trading at 221.99 US cent per pound (see the Graph 1). Due to the low level of stocks, exports were sufficient to cover the demand in importing countries in the past few years (ibid). As the economic crisis in 2011, it did not significantly affect the volume of demand this situation was likely to persist in the medium term.

Global demand for coffee is really growing in the last 15 years, the demand in the world for coffee grew by 91% in 2010, Great Britain where a hot drink tea historically dominated in recent years has increased the consumption of coffee by 35% (Fairtrade foundation 2012). Coffee has also become fashionable in developing countries such as India and China (International Coffee Organisation 2012). Coffee is a product of agricultural, cultivation is possible in about 50 countries (ibid). Despite the growing demand, the crop meets twice a year, and the volume of the collection can not grow exponentially, which would support the global reserves. However, improved methods of cultivation have left their mark, and overall total production of exporting countries increases. Specialists note that the dynamics of the market makes coffee and what coffee crop harvested twice a year: from October to December and from April to June (Fajanes 2011). Therefore, the first successful harvest can temporarily lower the price of coffee, which was what happened in 2012, the world production of coffee and increased from 144,420 to 151,283 thousand 60-kg bags in the Figure 2. The popularity of coffee and the supply for coffee increase in the global market.

 

4. Difference between two kinds of coffee

 
There are two main botanical species of coffee trees, and, accordingly, the grains obtained from the fruit of the trees: Arabica and Robusta (Baffes, Lewin Varangis 2004). These two species have variously estimated up to 98% of the produced coffee, this volume is divided in the ratio of 70% - Arabica, 30% - Robusta (Privat et al. 2008). Robusta is usually considered less gourmet coffee, but it contains more caffeine and it is often used in espresso blends, which allows customers to achieve better and cheaper coffee foam mixture (ibid). OECD (2007) argues that in establishing the exchange prices for coffee beans one of the main criteria is the country of origin and botanical species of coffee. A kind of standard is Arabica, which is produced in Colombia, Kenya and Tanzania and also its price is calculated value of all other varieties (Ghoshray 2010). 
When was the peak of the price of coffee in April 2011 302,71 US cent per pound in the Graph 1, all varieties of Arabica prices have peaked this year due to lack of production, then the price of Arabica in September 2012 fell by 179, 6 Us cent per pound, it can be seen in the Graph 4 . Therefore, demand for others types of coffee have increased in recent years, such as the demand for coffee Robusta increased because the price of Arabica in 2011 was higher.

 

Graph 3 – World Production Arabica and Robusta

Source: author

Data from Foreign Agricultural Service/USDA, December 2012

Graph 4 – World Price for Arabica and Robusta

Source: author

Data from Index Mundi 2013(www.indexmundi.com).

 

5. How to set the price of coffee?

Prices are falling for instant coffee with a decrease in the price of coffee beans. In other words, the more moderate the volatility of instant coffee reflects greater stability of prices for this product as compared with the price of coffee beans. However, how it can be this happened if the beans are the main ingredient of instant coffee? This explanation is related to the concept of elasticity of demand. It is fact that the coffee is very sensitive to climate change, the offer of coffee in one year may differ significantly from the proposal in the other just because of the weather (International Trade Centre, February 2010). The extent to which how price and quantity are responding to these changes in supply, it can be easily understood from the table of supply and demand in the Figure 2. Part (a) shows an example of relatively elastic demand curve, the shift in the supply curve (from S1 to S2) results in only a slight increase in price, with P1 to P2. If demand is relatively inelastic, as shown in part (b) of the Figure 2, the same shift in the supply curve leads to a greater increase in price. Accordingly, changes in the price in part (a) and part (b) the figure is changing the amount of coffee to be bought and sold. It can be noticed that the greatest quantitative changes when demand is relatively more elastic. Different elasticity of demand implies that from the point of view of consumers that the natural and instant coffee are different products. 
  

P2 P2          P1 P1                                                                                                                  Q2 Q1                  Q2 Q1

P - Price; Q - Quantity; S - Supply; D – Demand;

Source: author

Figure 2 - Interdependence of changes in demand and prices for coffee 
   
 If there are two products, the cross-price elasticity of demand which is a positive value (the price for one of them grows, and demand for the other increases), in this case the goods are substitutes. Therefore, consumers are considered that the products are good substitutes for each other (for example, Coca-Cola and Pepsi-Cola), its must have a large positive value of the cross-elasticity of demand. It is important to note that a product that has many closed substitute, it has elastic (relatively flat) demand curve, because, as the price for it is growing, these substitutes are relatively cheap (Sloman and Sutcliffe 2001). Therefore, if for most buyers, there are more close substitutes for instant coffee, organic coffee than it can be explained the fluctuations in prices for organic coffee in the elasticity of demand. The existence of alternative beverages, such as tea or hot chocolate, may explain the apparent greater elasticity of demand for instant coffee. Therefore, if the majority of consumers believe that the tea is a good substitute for instant coffee, but a poor substitute for real coffee, it can be come to the conclusion that the demand for instant coffee more flexible. Thus, it is obvious that the price of coffee beans more volatile than the price of coffee, it can be explained using the concept of elasticity of demand.

3. Conclusion

 

In conclusion, because of coffee is grain (like raw material) and it is not staples (ECLAC/FAO/ICCA Newsletter 2011), coffee has great volatility and high liquidity in the future:

• if coffee is exchange goods takes into consideration, it will be subject to various speculations;
• stagnation of production;
• the quantity demanded exceeds supply;
• global warming;
• it is taken into account that coffee is traded on the stock exchange in dollars, a stronger dollar on the world market could lead to lower prices, despite the deficit (Lewin, Giovannucci and Varangis 2004).  

However, price for coffee back to trend in the last time. As regards demand for coffee, it moderate rises every year which gives chance to improve situation by 2020 (in the Graph 2) and to allow demand and supply will be more stability.

 

 

 

 

 

 

 

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