Half-Pregnant
We are in a particularly awkward moment in #coffee, and the stakes are high for the direction of price. Already faced by two, back-to-back deficits, there are some good analysts out there who believe we are headed for a third deficit, and that could have severe consequences for price.
Coffee is in a precarious state “half-pregnant” (to quote a mentor of mine) with prices expensive, but not above 200c and the future is uncertain.
For my own view, I hold a not-very popular middle of the road view at this point.
Things don’t look not great, but don’t look deathly at the moment to me either. People disagree with me on both sides, but in this article I will try to present the case as I see it, and outline my view on price expectations for coffee.
In below we analyze the situation and show why our forecast is more stagnant than disaster.
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The 5 Coffee Markets
The Balance sheet in coffee is ambiguous (as it often is), because there is no publicly agreed on “truth”, which is why the market pays people like me to analyze the data.
Different players have different numbers, some showing surplus, others flat others deficit. Most agree that the outlook for coffee is disappointing, and problems are besetting coffee like plagues of locusts.
Despite this hyperbole, seems more like stagnation than disaster at the moment.
We are at a critical juncture now before the #Brazil and #Indonesia crops, and there is still widespread opinion about what will happen with those crops, and the implication will matter to the global market
Coffee is really 5 separate markets: Total Coffee, #Arabica, #Robusta, #Natural Arabicas, and #Washed Arabicas. To understand the impact on coffee prices, we need to understand each of these on their own, but also in relation to each other.
In this article, we are going to think about them hierarchically, and focus primarily on the top 3: total coffee, total #Arabica, and total #Robusta.
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Total Coffee
The Total Coffee #Supply and #Demand is going to be the key driver for both the Arabica and Robusta #futures markets. Think of it like “Beta” for the stock market. A rising tide lifts all boats, and a "Total Coffee" deficit tends to lift both markets.
Total Coffee is unambiguously coming off of two, back-to-back deficits, and the consensus is that those were meaningful deficits. The market agreed as coffee rallied accordingly to 260 back in 2022.
Going forward, the 23/24 balance sheet is right around the corner and there is less consensus.
Crop forecasts for the 2023/24 year originally showed decent, if not hefty surpluses but they have been dropping and now some major #tradehouses are forecasting a third year of deficit.
From here we have to consider the split more carefully into each variety.
Arabica
The Arabica futures market is technically, a washed Arabica market, which means that only washed certified coffees (controversies aside), can be exchanged for futures. However, washed arabicas do not drive the price for this market because there is fungibility between the coffees.
Older Washed Arabicas can often be replaced with natural arabicas by consumers and natural arabicas can often be replaced with Robustas. Hence, all 3 of these markets are connected to a degree.
Despite the interconnectivity, both the Arabica S&D as a whole, and the washed arabica (“milds”) S&D are key supplemental factors. We see these markets in modest deficits, but this is tough to pin down because of the aforementioned demand rotation. When Arabica prices are high, demand can shift to #naturals or robustas.
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Robusta
Since coffee prices have been historically high for years now, demand has likely shifted intensely to Robusta. Robusta is the coffee of last resort, since it is the cheapest, and so during periods of prolonged high prices, demand tends to settle here.
We show Robusta as being in modest surpluses for since 18/19 now, so we could have some decent stocks built up. However, we also have dramatically reduced our the Robusta surplus for this year and next, based on poorer crops in Uganda, Indonesia and Vietnam.
On top of this, some traders have Robusta in deficit due to the high demand for Robustas, this has propelled prices above $2200 /MT, significant number as it correlates to $1/lb, an important reference point for traders and is considered expensive for robusta.
Certs and Spreads
Both Arabica and Robusta have been inverted for some time now, on account of low certified inventory. Over the last few days, Robusta spreads have started to really take off, and are now ~50 over in the front months. The Arabica inversion is much more rare, and has been impressive and persistent, but is also far from the highs and looks to be moving closer to carry at present.
Arabica spreads are much harder to squeeze by one or two players, so the inversion there is more concerning (though as mentioned this is declining).
Robusta is more accustomed to fireworks, as the low inventory levels and high position limits make it easier for a few big traders to move the calendar spreads with their positions (position limits will be lowered by roughly half starting in November 2023).
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All of this sounds very bullish, and indeed, we have the market as being in peak bullishness at present.
That said, our constant refrain is that the market is foreard looking, and so prices are less concerned with what is happening, and more concerned with what “will”, or “may” happen.
Going Forward:
Going forward there are a few key factors that will be essential to watch for coffee pricing.
Summer Crops
First and foremost is Brazil. The Brazil crop is just around the corner and although the consensus is for a disappointing, on-cycle crop, there are 7 million bags spread between consensus estimates, and there is divergence of opinion on the Arabica/Robusta split.
Regardless, there will shortly be a large amount of Naturals and Robustas that will be available to sell very shortly. This hedge flow likely to provide an upper cap on the market, as I think producers will be happy with prices above 180c, and $2200/MT.
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We also have the April #Indonesian robusta crops. There are reports stating that this Robusta crop has been devastated by heavy rains, some saying as much as 18% down. Our view is probably closer to half of that based on interviews with #exporters, #analysts and #traders with close ties to the region. Regardless, this too will be a source of hedge flow.
Winter Crops
Once the May – Aug harvest period is complete, the world will be looking to the October crops, including Colombia, Central America and Vietnam.
Our view is that Vietnam will have a good but not great crop, they have been affected by fertilizer prices and crop rotations among other things. The Vietnamese will hold back their coffee for good prices, but if prices above $2200/MT that seems likely to attract good flow.
Colombia and Central America also have their own problems. Colombia also suffered from heavy rains over the last 2 years that decimated the crop there. It is not clear yet whether we will see a nice recovery in 23 or further problems.
Central America has had heavy rain too, but in this case Roya (or rust disease) is the problem to worry about. This could have a major impact on the production of washed coffees, the only coffee that can be certified for delivery in the Arabica futures market.
This is especially relevant in a year when exchange stocks are below 1 million bags. A problem in these regions could lead to further drawdown in certified inventory and a commensurate rally in calendar spreads.
24/25 Crop
Regardless of how the crop turns out in Central America. There will be some coffee and there will be #hedgeflow. More importantly, once these crops are complete, the 24/25 Brazil crop is right around the corner. It is very early days to make a call on the 24/25 crop, but in broad strokes we can say that the weather has been favorable to branch growth for that crop. If I had to guess, I would say that the odds favor a strong crop in Brazil (as is usually the case).
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If the Brazil crop looks good by January of February of Next year, I think it is reasonable to think that the market will have priced that in, which means a move lower.
But what does it all mean?
In sum, over the next year, I think there are problems in coffee, and so high prices between 150 and 200 are not unwarranted. Despite the problems there will be coffee, we will be getting large dumps of coffee in batches starting in May – Aug and then again Dec – Feb. Those two dumps will be a limiting factor keeping price from rising much higher unless there are new supply shocks or dramatic currency volatility.
I could also be wrong on the size of crops in any of the key origins. Those numbers matter and can shift the conception of fair value in either direction. Regardless, Brazil is acting as a bearish time bomb once again. The closer we get to the 24/25 crop in Brazil, the more it looks like prices will come down. There is potential for squeezes and rallies before then, but no one wants to be the last long.
With the rapid improvements in communications technology the market moves faster than ever, and prices in events further forward in the future. Given Brazil’s expanding super-power capicity in coffee, there is a real bearish bias. However, this also leads the way to complacency and consensus. These two together have a devastating effect on markets when supply shocks inevitably arise.
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