Oil's Lower-for-Longer Mantra Has Spilled Into the Coffee Market

(Bloomberg) -- To the delight of bearish investors and dismay of growers, the lower-for-longer mantra that’s dominated oil has just spilled into coffee.

While global production is forecast to fall short of consumption next season, the shortage will be too small to offset the current surplus, according to Hannah Rizki, head of coffee research at Volcafe, one of the world’s top coffee traders. That means prices, which on Tuesday hit a more than 12-year low, probably will be stuck in a lower range for longer, said Rodrigo Costa, the U.S.-based director at Brazilian shipper Comexim.

Just like oil producers, which have faced depressed prices since OPEC began locking horns with shale producers in 2014, arabica-coffee growers will have to adapt. Top supplier Brazil keeps churning out more beans, helped by currency devaluation, at a time when higher-cost producers like Colombia, Costa Rica and Peru are struggling after prices sank below $1 a pound.

"A key factor is the 2018-19 season had such a substantial surplus, driven mainly by Brazil’s record arabica crop, that it essentially outweighs the upcoming 2019-20 deficit," Rizki said in an interview at the National Coffee Association’s conference in Atlanta last week.

Oil's Lower-for-Longer Mantra Has Spilled Into the Coffee Market

The global coffee market will face a shortage of 3 million bags in the 2019-20 season that starts in October in most countries, forecasts Volcafe, the coffee unit of ED&F Man Holdings Ltd. That follows a surplus of more than 10 million bags expected for the current season. Swiss trader Sucafina expects a shortfall of 2 million bags in 2019-20 after a surplus of 5 million to 6 million bags this season. A bag of coffee weighs 60 kilograms (132 pounds).

Such a small surplus will at best reduce stockpiles accumulated in the past year by a third, Comexim’s Costa said in a separate interview in Atlanta.

To make matters worse, Brazil has been the shale producer of coffee. A weaker real has meant years of high local prices, which allowed Brazilian farmers to invest more, leading to better yields, while favorable weather helped boost production.

Traders are already looking at a potential record of as much as 70 million bags for 2020-21, which would return the global market to a surplus similar to this season’s levels, Costa said.

"Is there potential for prices to rise? In principle, no," he said. "I don’t think the market falls much more than 90 cents. Now it will take time for it to breach the $1.10 a pound if nothing changes."

Oil's Lower-for-Longer Mantra Has Spilled Into the Coffee Market

It’s not all bad news for growers. Coffee demand remains healthy, growing at about 2 percent a year and bumper shipments from Brazil and Vietnam are being absorbed by the market, according to Sucafina. Output will start feeling the weight of lower prices from next season, especially in countries that produce mild arabica coffee beans, Volcafe’s Rizki said.

"Brazil and Vietnam have been shipping record volumes, but that’s only half of the story, as we are not seeing corresponding stock builds in destination markets," David Behrends, head of trading and partner at Sucafina, said in an interview in Atlanta. "That’s a sign demand is stronger than expected or roasters are filling the pipeline. I suspect it is a bit of both.”

Speculators have also been holding bearish arabica bets for almost two years, a factor that could quickly turn should an unexpected weather event hurt output.

Low prices have prompted producers from Colombia to Peru and Costa Rica to create the World Coffee Producers Forum to try to tackle the issue. Farmers are also facing increased pressure from buyers as some roasters have changed buying patterns to include longer payment terms, said Roberto Velez, president of the Colombian Coffee Growers Federation.

Everyday that prices stay below $1, forward production potential is being cut. If prices stay at current levels, global production potential could fall by 2 million bags in 2019-20 and by 4 million bags in 2020-21, Sucafina estimates.

“Prices are sending a clear signal to the farmer to not invest but it will be a slow burn,” Behrends said.

©2019 Bloomberg L.P.