October 25, 2010, 8:11 pm
Filling the Gap Between Farm and Fair Trade
By DAVID BORNSTEIN

Fixes looks at solutions to social problems and why they work.

We’ve all seen the ads for fair trade coffee with the beautiful photos of villagers hand picking coffee cherries in exotic regions around the globe. Fair trade is one of those ideas that’s always in the air, but we don’t often consider what it means. What does it really take to connect rural producers in the developing world with consumers in wealthy countries – so that everybody benefits?
While the global market for natural goods is booming, millions of small producers who dream of accessing it are shut out.

Willy Foote is an American banker who has spent the past decade answering this question. In the early 1990s, Foote worked for Lehman Brothers doing corporate finance in Latin America, where he fell in love with the culture and learned to play dozens of revolutionary songs on guitar. In 1996, he left Lehman to pursue a business journalism fellowship in Mexico, and he and his wife spent two years traveling around the country in an old pickup truck, interviewing villagers. What he found was that the missing link between small producers in the developing world and middle-class consumers who like to buy their morning coffee at Starbucks is a special kind of banker. That’s why, in 1999, Foote founded Root Capital, a not-for-profit organization that helps environmentally sustainable grassroots businesses gain access to capital, skills and markets.

Of the 2.6 billion people who live on $2 a day or less, three quarters live in rural areas, and many are small producers – which is why the World Bank says agricultural businesses are the most effective vehicles to reduce global poverty. The problem is that their businesses, even when they form associations, are too small and risky to be served by banks and too big for Grameen Bank-style microfinance. To succeed, they typically need access to loans between $10,000 and $1 million. This is a banking no-man’s land – often called the “missing middle.” While the global market for natural goods is booming, millions of small producers who dream of accessing it are shut out. Every day, we hear politicians trumpet free-market solutions as a cure for economic ills, but few have worked out the messy details to make the slogans real – especially for people in the countryside.
Root Capital Rolando Lazo works with SOPPEXCCA, a coffee cooperative that receives loans from Root Capital.

That’s what Root Capital does. Consider the example of Rolando Lazo, a coffee producer who lives in the Jinotega region of Nicaragua, in the densely forested mountains about 100 miles northeast of Managua, where the country’s best coffee is grown. Jinotega was the location of some of the worst violence during Nicaragua’s civil war in the late 1970s. When Lazo was a boy, his parents were killed and he grew up in extreme poverty, often sleeping under trees. He eked out a living as a migrant farm worker, barely earning enough to cover his basic needs, let alone save for the future.

Today, Lazo and his family have a small plot of land and a house – plus electricity, TV and access to potable water. How did this happen?

Lazo joined a coffee farmers’ cooperative that linked up with a larger association of 19 cooperatives called SOPPEXCCA. Over the past six years, after struggling financially, the association received nine loans from Root Capital ranging from $70,000 to $450,000 to build an export business that would benefit all its members.

Most of the credit went to cover costs between the time when the association’s 700 farmers harvest their coffee and the payments come in from buyers. This ensured that farmers wouldn’t be forced to sell at fire-sale prices to middlemen. Some of the loans were extended to Lazo and others to buy their own land. And $280,000 was used to purchase a warehouse and a dry mill with machines for hulling, sorting and packing, which ensure consistent quality coffee. The investments reduced processing and transportation costs and allowed SOPPEXCCA to earn profits that would otherwise have gone to private millers.

As a result, SOPPEXCCA now sells much of its coffee at specialty-grade prices to retailers in Germany, Italy, Ireland, the Netherlands and the United States, where Peet’s Coffee carries its beans. According to the association, sales have increased from $531,000 in 2003 to $1.7 million this year.

While traveling through Mexico, Foote had met hundreds of farmers who had good products to sell. “I came across leaders wherever I went,” Foote said. But hardly any could get access to credit. Without opportunities, many resorted to illegal logging or slash-and-burn agriculture, practices that eroded the soil, destroyed biodiversity, and made their communities vulnerable to flooding – all of which deepened poverty.

One day Foote found himself in the Chimalapas jungle surrounded by 100 vanilla farmers in cowboy hats. The farmers had organized themselves and taken back their land from narco-ganaderos (narco-ranchers) who grew marijuana and poppies for the drug trade. ” ‘We’re organized now,’ ” Foote recalled a young leader declare. “‘We have our cooperative. We will find markets for our vanilla and we will make money!'”

They didn’t. The cooperative failed. Foote returned to the United States. He had planned to attend business school, but he never went. Instead, he started EcoLogic Finance (later renamed Root Capital). If farmers were courageous enough to resist the drug trade, he said, the least the world owed them was a decent shot at building honest businesses.

His timing was good. At the time, high profile companies like Starbucks, Whole Foods, and The Body Shop were looking to source more of their products from small producers, a trend that has accelerated – and will continue to accelerate the more customers pay attention to ethical and environmental considerations.

But a big bottleneck is the banking sector, which has yet to adjust its business practices to make markets work the way they could – and should. Only a quarter of the world’s bank branches are located in rural areas. “Nobody has figured out how to get commercial banks to focus on these rural markets,” said Foote. Even when they do, traditional banks are uncomfortable lending to people who lack hard collateral. The rural poor often have no land, buildings or legal titles. And government rural credit schemes have been riddled with corruption and waste.
Root Capital Maraba, a coffee cooperative in Rwanda, has been a Root Capital client since 2005.

Against this backdrop, Root Capital has lent $235 million to 305 rural businesses in 35 countries, with a 99 percent repayment rate, and it is poised to triple its annual lending by 2013. The businesses that Root Capital has financed – producers of such things as coffee, cocoa, nuts, cotton, fruit, timber and artisan goods -support 400,000 households, or well over a million people.

How has it achieved such success? Root Capital’s investment officers spend a third to half their time visiting clients, walking along dirt roads, discussing harvests, inquiring about whether farmers’ kids are attending school. Their intimate knowledge of their clients allows them to approve new loan applications in four to six weeks and renewals often in days. The organization raises money from investors at 2.5 percent interest – Starbucks is one of its biggest investors – and lends it out at 9.5 to 12 percent interest. This year, it expects to cover 73 percent of lending costs with interest income. Foote says the lending business will break even in three years.

Typically, in agricultural trade, small producers bear most of the risk while export companies and retailers reap most of the profits. What is most innovative about Root Capital is the way it has “derisked” an inherently risky business while shifting some of the profits from the big guys in the supply chain to the little guys. In addition to helping small producers add value, which boosts their revenues, the organization secures its loans by arranging fixed-price forward contracts from buyers. This insulates small farmers from the risk of price drops. And to further stabilize its borrowers, the organization works with companies like Green Mountain Coffee Roasters which provides grants to train leaders of rural associations in things like managing cash flow, account reconciliation, and financial decision making.

Root Capital also gets paid back directly from importers and retailers, rather than from its borrowers. “We think we have a very compelling risk mitigation strategy,” Foote said. “As long as product ships we get paid back. So we get very good at asking ‘Why wouldn’t product ship?'”

There are lots of reasons: droughts, frosts, labor strikes at port, civil wars. But that’s not usually what goes wrong in rural credit. What usually goes wrong is what caused the mortgage crisis in the United States: bankers make loans without getting to know their borrowers.

Root Capital can’t afford to make that mistake; it is trying to prove that rural producers represent a serious “asset class” for lenders. “If we lose a lot of money in the early days then the whole thing is over,” Foote said. So they have gotten good at finding bankers who are motivated to redeploy their skills to attack poverty. And they have no shortage of applicants.
Related More From Fixes

Root Capital is now expanding into new market segments – seed companies, agricultural processors, staple foods, like sorghum, beans, and maize, and high-nutrient foods like plumpy’nut. It is helping farmers invest in “leap frog” technologies like drip irrigation, which can multiply crop yields and efficiencies.

In the coming years, Foote plans to standardize Root Capital’s work – to turn it into a “plug and play business” so other lenders can adopt its model. Some of its borrowers have already “graduated” to mainstream banks, a mark of success. But Foote is not expecting commercial banks to dive in anytime soon. Rather, he envisions something similar to what occurred in micro-finance over the past 15 years.

“I think we’re going to see the catalyzing of an entirely new industry of specialized financial institutions that are 100 percent dedicated to this market,” he said. “Because it’s such a massive opportunity – and it’s so grossly underserved right now.”

David Bornstein is the author of “How to Change the World,” which has been published in 20 languages, and “The Price of a Dream: The Story of the Grameen Bank,” and is co-author of “Social Entrepreneurship: What Everyone Needs to Know.” He is the founder of dowser.org, a media site that reports on social innovation.

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Although crops from Brazil and Vietnam are likely to ease somewhat world coffee supply in the coming months, Arabica beans are seen staying on the tight side, and this will probably reduce stocks of certified beans at the ICE Futures US warehouses in the coming months and push up coffee prices, according to market participants.

The pace of decline of stocks at ICE may slow down a bit in the next three to four months, but the decline will resume soon after, commented Christian Wolthers, a market veteran with ample experience in the cash market and president and CEO of Wolthers America.

He said during a presentation at the National Coffee Association’s annual fall program on Tuesday in New York that with Brazil’s consumption expected to reach over 19.4 million bags this year and exports near 30 million bags, the country’s carryover stocks will be just 1 million bags by the end of MY 2010/11 next July.

The country started with zero carryover stocks this year and given that the country is bound to see a drop in production next year because of the biennial nature of the Arabica crop, internal demand and a strong currency will encourage producers to sell in the internal market and that’s likely to reduce exports out of the world’s largest exporter by next year.

He said that as Central America, Colombia and Brazil increase exports in the coming months, that may reduce the pace of decline of ICE stocks, but if differentials in the cash market continue at current levels, the inventories are poised to decline further next year as well.

He recalled that in 1996 as Brazil was recovering from a damaging frost, ICE stocks had fallen to 320 bags by that year (versus 1.8 million bags currently), taking world Arabica prices around $3 a pound by 1997. A similar situation could develop in the coming months, if Colombia does not see a clear recovery in production (which is doubted by trade) while Central America coffee production continues to see tough competition from other crops, clouding further the potential to refill stocks at ICE warehouses, which have fallen for 24 consecutive months.

He said that Brazil‘s area planted has continued to decline 1-2% annually for the last few year, and only improvements in productivity could push up production in that country a bit but other crops are competing as well for land and farmer resources. He noted that average productivity increased inBrazil over the few years to 18 bags per hectare from 13 bags earlier in the decade, and the country could take that to 25 bags (which is already achieved in some regions) but competition for land and resources from other crops is also tough there.

He estimates Brazil‘s crop this year at 50 million bags and next year could see a decline to 40 million bags, leaving the country with a deficit of 8 million bags for coffee by the end of MY 11/12 which could translate into lower exports out of the world’s top exporter.

Mr. Wolthers was speaking at a panel discussion over the future of the green coffee market. He was joined by John Meyer, vice-president of ADM Investor Services; Jon Stefenson, director of Marketing at Atlantic Coffee (USA) and Jonathan White, principal of White Coffee Corp. a roasting company based inLong Island, New York.

Mr. Wolthers concurred with other panelists that the coffee market this year saw the anomalous development of steady, firm demand over the summer months while ICE stocks kept falling, which led to the current market prices near 13-year highs that have spooked many in the industry.

Meantime, he said industry buyers have reduced the amount of coffee they buy beyond six months of inventories, mainly because the higher prices have reduced cash on hand and also amid uncertainty as to what’s going to happen withColombia.

Mr. Wolthers estimates world coffee output in 2010/11 at 134.7 million and consumption near 131.5 million, leaving a surplus of 2-3 million bags, which may not be enough to face the lower Brazilian output next year.

A strong Brazilian real may also discourage producers from selling above as internal prices stay strong, noted panelists.

Mr. Stefenson of Atlantic Coffee estimated the Brazilian crop at 55 million bags in 2010/11.

Mr. Stefenson defended the current certification process at ICE warehouses, which has been under fire in recent years for what participants call a “broken system” that allows re-certification of 2-3 year old coffees at ICE. He said that in some hot places likeHouston, stored coffee may lose some of its “greenish” required color, but in other places like New York and Hamburg coffee tends to stay in better shape, in part thanks to the cooler weather. He said that the ICE warehouses are the home of excess coffees, which has not been the case the last few years.

ICE Inclusion of Brazil‘s coffee still doubted

The panelists addressed the recent news that an advisory committee at ICE Futures US recommended the inclusion of Brazils washed and semi-washed Arabica coffees into the C contract.

Mr. Wolthers said that the measure faces tough opposition from ABIC, Brazil’s roaster association, whose members fear that they may have to pay more for their coffee if producers decide to take their coffee to ICE warehouses, where they would be paid higher prices. He insisted the initiative is “dead-on-arrival”, although he saw the merits of ICE hoping to stabilize the market, which has been on upward mode since early May, rattling industry users.

Two of the panelist suggested creating a new Brazil natural coffee contract, otherwise Brazil‘s lower quality coffees will over-flood the C market, depressing prices and reducing that market’s usefulness for industry to hedge costs.

Colombia Crop Still in Doubt

The panelists agreed that Colombia‘s main crop picked between Sep-Dec is still uncertain and they expressed concerns as to whether the country will be able to produce again 12-12.5 million bags of coffee as was the case few years ago. (As reported, the national Federation of Coffee Growers now estimates the 2010 output near 9.5 million bags below early estimates for 10-11 million bags and up from 7.8 million bags last year.)

Mr. White noted that given the recent prices, many of his clients have reduced their blend to replace the very expensive Colombian coffee component, and said that reduced promotion from the Colombian Federation for its 100% Colombian Coffee brand has also contributed to lower demand for Colombian coffees. But he said that could reverse if price differentials go down again to historical levels, something that could have happen next year if that country’s crop recovers significantly. He also expressed optimism that new sources of coffee will compensate somewhat falling production inColombia and some Central American countries. He mentioned China and Laos as possible sources of coffee.

Mr. Meyer of ADM Investors Services gave a wide range for Brazil‘s 2010/11 crop between 50-58 million bags but said that the real output is somewhere around 54 million bags. He said that although the market is unlikely to see a price jump to $3 a pound as was the case in 1997, if ICE certified coffee stocks continue their dramatic decline, prices will definitely climb above $2 a pound in the coming months.

ICE Dec Arabica coffee prices were recently up 4.75 cents at 190.35 cents, flirting with key resistance at 190.90 cents, which, if broken, could accelerate a move towards the 13-year high of 198.55 cents hit in August.

Reports are circulating today that Guilherme Braga, general director of Brazil’s Council of Coffee Exporters said that coffee prices could increase up to 13% up to $2.10 by April next year as Brazil harvests a smaller crop.

By Marvin G. Perez, email hidden; JavaScript is required

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.”