Bean Battle: Fight Over Coffee Futures Breaks Out

WSJ – By ANNA RAFF

Dissent is brewing in the coffee market.

Market participants say the benchmark futures contract for the arabica variety doesn’t reflect real-world prices, pointing to aging coffee beans counted in stockpiles but seen as unfit for the drinks and roasted beans widely consumed in North America.

This leaves big coffee distributors and cafe owners in a bind: With futures lagging the current market price of coffee, roasters are unable to adequately hedge their costs and compensate for sharp price swings.

This means surging prices for the beans will trickle down more quickly.

With successive crop failures in Colombia and Central America, the surge in cash prices has outpaced increases in the price of IntercontinentalExchange Inc.’s so-called “C” futures contract. Under normal conditions, cash and futures prices move in lock step, and any sharp divergences usually are corrected by market forces. The persistent gap between the cash and futures markets in coffee distorts the price signals that are supposed to encourage farmers to plant more in times of scarcity.

“The current market seems to be failing as essentially 100% of the described underlying commodity is trading at a premium to the market price,” according to a statement from the Specialty Coffee Association of America submitted to ICE. This and several other comments to a proposed change to the contract were reviewed by Dow Jones.

The trade group that counts Seattle coffee giant Starbucks Corp. among its members called the state of affairs “intolerable,” adding that such a situation encourages its members to avoid the futures market altogether.

“Currently, for several reasons, the ‘C’ does not now adequately reflect the value of fresh, washed coffee,” wrote William Cortner, a vice president with Folgers Coffee, a unit of J.M. Smucker Co., in a letter to ICE.

In the same letter, Mr. Cortner opposed the proposed change, which would permit Brazilian beans in the mix that can be certified by ICE and held in licensed warehouses, noting that the industry’s ability to hedge is “already heavily impaired.”

Many of those who responded to ICE’s May 3 request for comment came out in favor of including Brazil, saying the addition of the beans from the world’s No. 1 coffee grower would better balance supply and demand.

This chorus of complaints has emerged against the backdrop of soaring coffee prices and the heated debate surrounding Brazilian coffee. Many say that including Brazil and a certifiable “origin” would result in a contract that better reflects the mix of beans brewed in the U.S.

However, including lower-quality Brazilian beans would likely result in generally lower price levels for the “C” contract, cementing the divergence with more-desirable Colombian and Central American coffees.

ICE declined to comment on the responses to its proposal or on the quality of the beans given passing marks by its graders.

An advisory committee comprising coffee industry representatives met on Wednesday to discuss the proposal regarding Brazil’s beans, but it’s unclear if a vote was taken on the issue.

For most of 2008, the price for mild-flavored Colombian beans was a few cents a pound higher than the futures price. Starting in October 2008, the differential ballooned and averaged more than 80 cents above the “C” contract in May 2009, according to the International Coffee Organization.

It has remained elevated even with futures prices on ICE continuing to trade near 13-year highs, coming in at 72 cents in June of this year. Coffee for December delivery on Wednesday crept up by 0.2% to settle at $1.8615 a pound on ICE Futures U.S.

Starbucks last month reversed a decision to stand pat and said it would boost prices on some drinks. Other roasters have also raised prices.

As it ages, raw, washed coffee beans turn from green to yellow. While exchange rules require that coffee certified for delivery be “greenish,” there are no requirements pertaining to crop year.

It’s this nuance that has split the coffee trading community, with some insisting that old coffee, even if it’s stored well, shouldn’t be what underpins the “C” contract.

“The historical system clearly seems broken,” said Bert von Roemer, president of Serengeti Trading, a coffee importer based in Dripping Springs, Texas.

Over the past year, von Roemer said his firm bought and later rejected coffee that was unloaded at a warehouse in 2006 but had been recently certified. Later, Serengeti Trading submitted four-year-old coffee from Peru to the exchange for certification, and von Roemer said he was “shocked” when the coffee was given passing grades.

In a letter to ICE, Luis Genaro Munoz, chief executive of the National Federation of Coffee Growers of Colombia, wrote that the existence of so many bags of coffee in warehouses “can be attributed to a decline in the usefulness of the certified stock due to aging.”