If you’re angry that Wall Street speculators have been driving up the price you pay for gasoline, these same big financial investors now are pushing up the price of your cup of joe.
Grocery shoppers have seen whopping increases this year in the price of a can of ordinary coffee, whether it’s a generic store brand or better-known ones such as Folgers and Maxwell House. Since spring, coffee has been selling at $7 to $8 a can in many parts of the country, or about twice the price of a gallon of gas.
The retail price of coffee in July was up 20.7 percent over the same month last year, according to the Bureau of Labor Statistics, which tracks changes in grocery store prices. Big coffee marketers have trimmed prices a bit for consumers in recent weeks, but the price of contracts for future delivery of coffee continues to rise unabated.
Coffee-industry veterans blame financial speculators. They say they’re taking advantage of global supply hiccups to drive up coffee prices by adding volatility to the trading of contracts for future delivery of coffee. It’s not as debilitating to family income as high crude oil prices, but the phenomenon is the same.
“It’s definitely not purely supply and demand; it’s way too volatile,” said Shawn Hamilton, the vice president of operations and a veteran coffee buyer for Java City in Sacramento, Calif., a national wholesaler of coffee and a midsize regional coffee roaster.
Experts say that global consumption of coffee is up, particularly in China and coffee-producing Brazil. There’s also been a weather-related dip in production from coffee-rich Colombia. These underlying supply-and-demand factors do justify higher coffee prices, just not this high.
The hiccup in production and rising demand set the stage for Wall Street speculators – many of them big hedge funds that invest for the ultra-wealthy – to flood into commodities markets and speculate on contracts for future delivery of coffee.
The net result distorts the price of coffee. The price of a futures contract for 37,500 pounds of coffee rose by more than 40 percent last year, and has gone up by more than 57 percent this year through Aug. 19.
“It’s not a true coffee market anymore, where the laws of supply and demand hold forth,” said Danell Seda, a trader for Walker Coffee Trading in Houston, an importer of green coffee beans that supplies the specialty coffee market.
Howard Schultz, the CEO of Starbucks, complained in March that he had no trouble obtaining coffee beans – there’s no supply shortage – and that speculators were to blame for soaring coffee bean prices on commodity exchanges, which had reached $2.96 a pound, their highest levels in 34 years, though not when adjusted for inflation. The company didn’t make an executive available for this story.
Just a few months earlier – in a letter Dec. 14 to members of the Commodity Futures Trading Commission – the chief procurement officer for Dunkin Donuts, Ed O’Rourke, called for a curb on financial speculators.
Something as simple as a good cup of coffee at a fair price is under threat today because of intense pressure by hedge funds and other speculators,” he wrote.
At least one CFTC commissioner now agrees.
“Speculators have influenced coffee prices in commodity markets in a way that isn’t consistent with the fundamentals of supply and demand,” Bart Chilton said. He’s prodded fellow CFTC members to find a way to rein in excess speculation in coffee and other commodities.
The National Coffee Association – the industry’s trade group – has come to no conclusion about volatile prices.
“Some people think the hedge funds are more to blame; others think it’s supply and demand or the weather,” spokesman Joe DeRupo said. “Everyone has their own hypothesis.”
Another high-level CFTC official, requesting anonymity in order to speak freely on a sensitive issue, acknowledged that the agency is unable to decipher how much coffee futures trading is being done by speculators versus those who are legitimately hedging against price shifts.
“It’s not clear to us what they’re doing,” the regulator acknowledged, noting that the line between producer and investor is blurrier than ever. “There is no denying that there are more different players entering the market. There’s debate in public, and perhaps on the commission, on the cause and effect.”
What’s not in dispute is that from June 2010 through last December, coffee leapt from about $1.35 a pound on commodity exchanges to around $2.17, an increase of 61 percent in six months. It only got worse from there, peaking above $3 last spring.
Big coffee retailers such as Kraft Foods, which owns the Maxwell House brand, quickly passed on the rising costs; in March it raised the retail price of coffee 22 percent. That was its fourth price hike in less than a year. A Kraft spokeswoman declined to comment.
Producers raise their prices based not on what they paid for their coffee, but rather on what price they must pay to replace it. This down-the-road price is determined by the futures market, where contracts for future delivery of coffee are traded.
In its most recent report, for the quarter that ended on Jan. 31, J.M. Smucker Co., which markets Folgers, reported a strong 19 percent increase in profits from its coffee division. Retail “coffee price increases taken during the year more than offset higher green coffee costs,” the company said.
J.M. Smucker and Kraft have dropped their prices in recent weeks, but they remain unusually high.
Also telling is the volume of trading in the coffee futures market.
During the first week of August 1995, slightly more than 46,000 coffee futures contracts were traded. In 2001, the first year after investment rules were relaxed and Wall Street money poured into commodities markets, the number rose to almost 76,000 contracts a week. During the first week of August 2008, the month the U.S. financial system began a near-meltdown, 196,805 contracts were traded – actually down from a record 284,000 contracts traded in early March that year.
This all points to the entry of financial players who never intend to take delivery of coffee. Some are Wall Street banks and hedge funds; others are so-called “massive passives,” big institutional investors such as pension funds that bet on rising prices.
The Federal Reserve’s actions this year to encourage investment in anything other than Treasury bonds drove some of the money into commodities investment.
“Commodities have become one of the ‘interesting’ homes for that money to operate in,” said Ric Rhinehart, the executive director of the Specialty Coffee Association of America.
Futures markets were designed as risk-management tools, in which producers or users of oil, wheat, coffee or other commodities could hedge against shifts in price. Today, financial investors appear to be crowding out end-users of commodities, in many markets outnumbering them two or threefold.
Critics argue that this influx of money – a lot of it involving algorithmic high-frequency trades triggered by small price shifts – at best distorts the market’s legitimate price discovery process and at worst renders it meaningless.
“I think you hit the really big issue there, and everybody who works in a commodity market of any kind needs to be concerned that the fundamentals of the physical trade have a less relative degree of influence than they’ve ever had,” Rhinehart said, referring to the disconnect between futures prices and supply-and-demand fundamentals.
There’s no shortage of coffee. The International Coffee Organization, an intergovernmental global body of coffee importing and exporting nations that’s based in London, reported in July that global production was up 8.1 percent to a record 133.3 million bags for the 2010-11 coffee year, which runs from October through September. Exports during the first nine months of that coffee year were also at record levels, up 16 percent.
But there’s an increasingly tight balance between supply and demand, which does tend to push up prices.
“Consumption has been growing steadily in the world, somewhere between 2 percent to 2.5 percent per year, and production has been growing at a slower rate, about 1.5 percent. Production has not been keeping up with demand,” Jose Sette, a Brazilian who heads the International Coffee Organization, said in an interview, adding that inventories of coffee are at historic lows.
Coffee was in a bust cycle from 2001 to 2006, he said. Many farmers were forced out of a crop that takes three years from planting to harvest. Additionally, three successive years of poor crops hit Colombia – one of the world’s leading suppliers – with production almost halved and still well off peak levels today.
Also, since the U.S. financial crisis began in late 2008, the dollar’s value has weakened. That’s led coffee growers in Brazil, Colombia and elsewhere to demand a higher price for coffee beans, since a dollar now buys less in their economies.
“All of these factors came together last year, and from May onwards prices really started to take off,” Sette said. He predicts that volatile prices will fall back. “Now the market is more or less well supplied, but these underlying factors of production growing slower than demand are still there.”
That leaves room for fears of potential supply problems, and fear is like whiskey to speculators. Sette acknowledges that they’re a problem, although he thinks they’re less of a threat over time.
“Definitely we have seen a lot of inflow of speculative funds, if you want to call them that, into all commodity markets, not just coffee. That is a fact of life,” he said. But he cautioned that “the fundamentals do prevail in the medium and long term.”
Short term, however, everything points to continued volatility in global coffee markets, and thus rising costs for a cup of joe.