Hey Melbourne, let’s talk about coffee.
Well that got your attention quickly, didn’t it?
Brazil, where one-third of the world’s coffee crops are grown, has experienced its worst drought in decades.
The bad news is that it looks like you might be paying more for your coffee in the near future, and potentially beyond. The good news is, of course, that this unfortunate occurrence has given us an excuse to talk about our favourite field of study and our favourite hot beverage in the same breath.
With the recent drought in Brazil, prices for Arabica coffee beans have skyrocketed. In commodities markets, coffee was trading at 196 cents/lb in April 2014. It was trading at around the 130 mark at the same time last year, and historical highs and lows occurred at 339.86 in April 1977 and 42.50 in October 2001 respectively. You can check out the Trading Economics website to learn more about historical prices for coffee.
What impact might movements in the commodity market have on the retail market for coffee? After all, that is what you, as a student who will be relying on caffeine to get through the next half of semester, really care about.
The short answer is, not much, in the short run at least.
Coffee prices are renowned for their stickiness. Late last year, there were cries that consumers were being ripped off when it came to their morning grind. The Sydney Morning Herald noted that although the price of coffee had been dropping for two years, this had not been passed on to consumers. At that time, warehouses were stocked with an abundance of coffee beans thanks to good rains and a good harvest. But retail prices were not budging. Bloomberg offered four explanations for this in the context of US prices: Firstly, large companies such as Starbucks hedge using futures markets, and thus do not benefit from temporary dips in the price. Secondly, the Brazilian government supports its farmers by buying beans at increased prices. Thirdly, consumers’ loss aversion mean that if retail coffee prices fell now and increased in the future when the price of beans eventually rose, consumers (and therefore retailers) would feel more pain than if prices just remained stable. Lastly, US retail prices had already decreased slightly earlier that year, which made it unlikely they would fall again.
It seems that this price stickiness works both ways. So, even though coffee prices are increasing in commodity markets, the trickle down to the retail market is slow. This, in part, has again to do with large firms either locking in the price of beans with suppliers or hedging in futures markets, forcing smaller retailers to toe the line. However, it also has to do with conditions in the retail market.
Gilkatho, maker of Jura coffee machines and Lazumba coffee, surveys Australian cafes annually, and has been keeping track of coffee prices in Australia since 2003. Gilkatho reports, unsurprisingly, that café owners are feeling squeezed with the rising cost of raw materials, but with their inventories of usually 8 to 10 months, most owners have not yet had to increase costs to consumers. Moreover, consumer sovereignty still makes its presence known in this market. The average price of coffee increased slightly in the last quarter of 2013, but has since come back down as consumers voted with their feet, according to managing director of Gilkatho, Wayne Fowler. So coffee shop owners are being restrained by how much their customers are willing to pay.
(As a side note, Gilkatho also reported that while Melbourne is still one of the cheaper states in which to consume coffee, coffee prices in Melbourne increased by more than any other state from 2010 to 2014, eek!)
In the longer term, a range of other factors need to be considered. Indeed, the Brazilian drought is being seen as an effect of climate change, and some are bracing themselves for the climate to have an even bigger impact on coffee crops in the future. Moreover, policies implemented in light of climate change will likely increase the cost of doing business, while the rapid expansion of a middle class acquiring a taste for coffee in developing nations like China and Brazil will affect the demand side. And eventually, even big firms will have to raise prices. These indicate that prices will be going nowhere but up.
Image: ‘A photo of a cup of coffee’ by Julius Schorzman (http://assembleme.com/), http://assembleme.com/blog/2009/4/8/featured-picture.html. Licence at https://creativecommons.org/licenses/by-sa/2.0/deed.en. (Licence denoted at https://commons.wikimedia.org/wiki/File:A_small_cup_of_coffee.JPG).