This year we saw the #coffeemarket ICE-NY certified inventory reach the lowest level in over 20+ years and with prices well above tenderable parity for the foreseeable future, it looked like there was no end in sight.
Yet, over the last two months we have seen the certified inventory more than double from well under 400 thousand bags to over 800 thousand, with another 227k bags awaiting grading. How did this happen when Brazilian semi-washed, the cheapest tenderable coffee, has differentials trading at the highs?
The answer, (and this is purely conjecture on our part) is that there are blends of washed/unwashed coffee being certified. This is controversial if true, and not something that we had anticipated. Its often acknowledged that past crop coffee could be certified, but naturals (unwashed coffee) have not historically been a major concern.
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If true, the reason its controversial to certify blends of naturals comes from the wording of the ice grading guidelines. The wording states that the coffee to be certified should be free of unwashed and aged flavors, but doesn't explicitly forbid blending unwashed and aged coffee if the taste is ok.
Regardless of the controversy and the source of the coffee, it is clear that the certified inventory crisis has ended, and the implications for the coffee market are game-changing.
Certified inventory is the fundamental supply for any futures market and has impacts on both flat price and the calendar spread structure of the commodity market. Since a coffee future is essentially interchangeable for a lot of certified coffee, the makeup of that certified inventory is essential for the pricing of #coffeefutures.
Originally the Coffee “C” Market only accepted Central American washed or “mild” coffees. The “C” in “'C' market" referred to "Central American". Gradually this extended to other origins as well but was always a mild, washed Arabica coffee contract until 2013 when the ICE exchange amended its rules to allow Brazilian semi-washed coffees.
This move was itself somewhat controversial, as Brazil is the largest total producer of coffee (Arabica + Robusta) and the largest producer of Arabica Coffee in the world. There was some fear that they would swamp the exchange with cheap Brazilian coffee and thus change the value of the “C” Contract.
This never really materialized because not much was certified until 2020, when a large Brazilian crop made semi-washed cheap. Therefore, the large buildup of stocks in 2020 made the KC contract a semi-washed Brazil contract.
With the double deficits in 2021 and 2022, Arabica prices rallied with differentials and freight costs incentivized the draw down in certs. Although freight prices and KC prices have since collapsed, differentials stayed above the board and so it seemed unlikely that coffees would be certified.
However, we started to see new coffees certified which at first, we thought were likely "recerts." In other words, someone took existing coffees that had already been certified and resubmitted them to avoid aging penalties. However, this continued far beyond the quantities that we would have expected from recerts and so we need to consider new sources.
The possibilities are basically two: cheapest fresh crop coffees (semi-washed Brazils), certified to serve as collateral for obtaining financing, or some other coffees submitted at economically viable rates.
The only economically viable coffees are either past-crop coffees or natural coffees. Both of these would not pass grading on their own, but it is possible that high quality past-crop or natural coffee could be blended with fresh semi-washed coffee and have a decent flavor in the cup.
Impact and What to Expect Going Forward
The impact on the market has been direct.
The once-formidable inversion has collapsed in the calendar spreads and even flirted with full carry as the December contract went off the board. Flat prices also collapsed with the market dropping below 200c and not looking back.
The impact on futures prices is meaningful not just from a supply perspective, but also potentially from a quality perspective.
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The certified inventory used to represent central American washed coffees and so the terminal prices would have reflected the value of those coffees. However, if the market is now accepting blended semi-washed and natural Brazil's, then the futures prices will have to reflect this new reality.
Going forward, we should see certs continnue to replenish. Diffs have been firm lately as the terminal market has come off and this might disincentivize new Brazilian coffees from being certified, however, we still have 227k bags of pending stocks in the meantime.
The market won't be focused on the pending stocks for long though. We have the next Brazilian crop coming with some major tradehouses projecting large increases for the Arabica crop. This would put new downward pressure on Brazil diffs and only incentivize more coffee to be certified.
The pending volume is consistently being added to, currently at an average of 5k bags per day, at this rate we should see certs nearing 1m bags in a couple of months.
The main hobgoblin that could spoil the certs party and turn this scenario around would be if decerts resume at a strong rate. This is certainly possible. Despite the optimism on certified inventory, if the volume of 226k total pending, stocks runs out without replenishment, there could be another period of stagnation or decline in certs.
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However we don't see a steep decline as probable, physical prices are off the highs (see below), and with KC trading at ~160c and freight back to 2019 levels, there's a lot less of an incentive to consume certs. Additionally, the October harvests have brought a new round of fresh mild coffees which will satisfy much of the demand, and with the new pending's coming in, we estimate continued certs increase, although at a slower rate than today.
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Dear Ryan, the answer (also purely conjecture on my part) is that during 2022 much of the certified coffee was utilized by commercials not only to satisfy demand, but also to take some “risky plays in the physical market”, trying to buy low (taking delivery) and then trying to sell high (resubmitting them to make delivery): “recerts”.
Look at the pattern of the daily flow of the cert stocks figures but the pending figures as well, you'll see that about 250.000 bags were resubmitted on late August taking advantage of the rally likely making a profit on most of that play (as the average price was about $2.20), but then you will see that about 500.000 bags were resubmitted on…