basic materials

Java gets the jitters

Coffee prices are spiking, and while some are blaming speculators, the real culprit is good old supply and demand.

(Photo: Tim Boyle/Getty Images)

There are few economic problems for which depraved “speculators” escape blame. But their notoriety might gain a much larger (and more irritable) audience if Starbucks has its way. The coffee chain recently hiked prices on bagged beans. It did this because coffee, often called the world’s second-most-valuable commodity after oil, has suddenly doubled in value. The International Coffee Organization’s composite indicator, which measures a variety of beans from prized Colombian milds to disparaged robustos, peaked May 3 at 247.63¢US per pound. That’s a 14-year high, and a twofold increase over the already elevated levels seen a year earlier. Starbucks executives publicly blamed this on hedge funds and other capital market miscreants, with CEO Howard Schultz claiming it “is the result of extreme speculation and not a result of normal market forces.”

While speculators are doubtlessly active in coffee, today’s pricey java likely owes more to a classic imbalance between supply and demand. Colombia, the world’s second-largest producer, is now enduring its fourth consecutive disappointing crop year. (Between 2001 and 2007, it consistently produced about 12 million bags a year, but then volumes dropped to around eight to nine million.) This was partly because low coffee prices prevailing during the past decade encouraged under-investment in infrastructure. “There was not a lot of maintenance done to roads,” says Sterling Smith, an analyst with commodity broker Country Hedging in Minnesota. “In terms of replacing sick or dying trees, none of that went on when coffee prices were depressed.” Compounding matters, the country endured unusually high rainfalls this year, including the wettest April on record. (Heavy rains knock ripe coffee cherries from trees, allowing them to rot.) Meanwhile, Vietnam has of late been wracked by drought. And it doesn’t help that Brazil, the largest producer, is in the off-year of a two-year cycle for arabica production.

Such challenges notwithstanding, global coffee production continues to grow. The problem is that it hasn’t kept pace with demand. Although traditional large importers like the U.S. and Europe continue to imbibe consistently, emerging nations like China and Vietnam are also gaining a taste for coffee as their people gain more disposable income. Most significant, Brazilians are getting high on their own supply. “Until recently, Brazil was not a big consumer,” observes Smith. “But as its economy has expanded, coffee consumption has gone up noticeably. That has taken coffee off the market that would otherwise be exported. That’s the single biggest factor driving prices up.”

So it’s no surprise producing nations now have the lowest inventories witnessed in decades. Kenrick Jordan, a senior economist at BMO Financial Group, agrees speculation likely contributed to recent volatility. “Speculation can affect prices perhaps for a short period of time,” he says. “But on a sustained basis, I don’t see it, unless they could actually find a way to accumulate the stocks and hoard. That’s not easy to do given the number of actors in the market.” By press time, coffee prices had retreated substantially from highs reached in early May. Yet they remain elevated, and Smith believes that dirt-cheap coffee seen during the past decade will not return anytime soon. If there is a silver lining, it is that today’s high prices should encourage more production, but unlike fast-growing crops like rice, wheat and soybeans, coffee grows on trees that take years to mature. “Prices may not retreat as quickly as might be the case for other commodities,” Jordan says. “Relief should come, but it will be slow.”