Hedging in coffee a strategy boost
July 29, 2014
Any assumption that most food and beverage manufacturers hedge their raw material ingredients has been called into question by developments in the coffee market in recent months. In response to violent fluctuations in green coffee prices, from just above $1 per pound to a peak near $3 and back to $1.79 currently, several of the leading producers of roasted coffee raised their prices, by a maximum of 10%, on brands sold through retail stores. While ingredient prices were cited as the reason for the pricing action, nothing was said about hedged positions. At the same time, companies that have openly acknowledged their practice of hedging raw bean requirements through futures and forward purchases for as much as a year ahead have held prices unchanged. Since retail prices are viewed as a highly sensitive factor affecting coffee demand, for both individual brands as well as for total consumption, the opinion that pricing differences stem from varied hedging policies has gained ground.
Food and beverage companies, not just in coffee but across the entire spectrum, do not customarily reveal hedging policies, if indeed they have one. The use of futures exchanges for this purpose is deeply embedded in industries like flour milling and even baking where wheat markets register wide swings. Since wheat flour users prefer forward coverage, say for 120 days, hedging the wheat component has been hugely important for a long time.
Corn refining and soybean crushing companies also certainly utilize futures markets. Coffee roasting is another industry where efficient and actively traded futures markets are available to provide hedging strategies or opportunities at fairly low cost, and it’s their use or lack of it that some blame for the varied consumer price impact occurring this year. Poultry processing, in spite of its position as supplier of the leading protein meat source for American consumers, has much the opposite situation because of the absence of a futures market that fairly reflects the complexity of forward poultry prices.
Coffee roasters without forward coverage might have been persuaded to resist hedging through futures based on the so-called “C” contract traded on ICE Futures, the former New York Board of Trade. While this contract stands as the benchmark for green beans of Arabica coffee, the type of bean preferred over Robusta, consumer demand has tended to focus increasingly on quality superior to the standard grade. International companies with brands that are successful globally or in individual countries have stepped up industrywide competition by emphasizing quality claims.
The ICE market reflects coffee originating from an amazing 19 countries in South America, Africa and Asia. Yes, Brazil is the major supplier, and it was concern about drought damage to that country’s coffee-growing trees that drove the earlier price climb.
On such an international market where unanticipated supply-demand, political and economic forces have the power to move prices of commodities like coffee, hedging at times may prove extremely difficult and even costly. This reminds of events many years ago, in the 1970s, when wheat markets faced sudden demand from the Former Soviet Union. As American export supplies were reduced, leading international traders sold large quantities of new crop wheat originating from Argentina where prices were controlled by the government but not yet declared for shipment some months later. As a hedge against this exposure, traders mostly purchased Chicago wheat futures. It was then that the U.S. government decided to impose a block on U.S. wheat exports to the F.S.U., causing Chicago futures to plummet and Argentina to raise its prices. The turn of events converted what seemed an obvious hedge into a punishingly expensive transaction.
After acknowledging mishaps like this, it is still apparent that food and beverage manufacturers have available to them first class hedging facilities. Futures exchanges provide an effective and low-cost system for covering essential raw material prices. Counting on consumer price adjustments, up or down, seems an unsatisfactory alternative.