Perspectives On Price Risk Management: What Coffee Farming Could Look Like

Coffee futures as of this writing.

If you wanted to make a prototype of what the future of coffee farming could look like, you’d make sure farmers had an entrepreneurial approach to farming coffee, that farmers understood and used the complex financial tools available to offset risk, and you’d imbue farmers with a sense of how to take advantage of opportunities when they presented themselves.

In other words, it might look a little like Raul Amador Somarriba.

Raul, 31, works a day job as the financial director of Grupo Invercasa, a privately held financial services company in Nicaragua that his family started. He also manages the price risk management for the two coffee estates in Jinotega and Matagalpa that his family owns. Raul cut his teeth managing the price risk management and purchasing options for the farm when he was 23, having just returned from the US, where he graduated from Penn State and subsequently worked for a few years trading commodity futures.

He was the perfect person to talk to about more advanced use of PRM.

(The following conversation with Raul was condensed, edited for clarity and translated from Spanglish.)

KK: Tell me a bit about the farms and how you started with PRM and trading futures.

RA: Well, the two farms are San Vicente, in Matagalpa and Isabela in Jinotega. They are organized like a small business. We have structures, policies in place, it’s pretty well organized. We’ve had the farms in the family since 1997, but we didn’t start hedging until I came back before the 2008/2009 harvest. At this time, coffee was slowly coming back from a serious price crisis and prices started to spike up. I took a decision and bought options. I had to convince the board that this was a fixed cost and something that needed to be budgeted every year for the business. In the 2010/11 harvest, the price was already pretty high and we hedged against the price going back down and didn’t get to participate in all of the upside when the price kept climbing and climbing. We felt bad, but we knew we could plan for the next coming years and used the price spike to fix our coffee for the next 2 years.

KK: That’s fantastic. Most folks would have been seriously upset that they missed out not getting a better price. You turned it into an opportunity.

RA: You have to be forward looking. You know what price you are selling at, so you don’t have the price risk. And what you can do with that is invest in the farm. You know what your fixed costs are, you manage your variable costs and you can invest in productivity.

KK: I think a big problem for many farmers and organizations is that they don’t know what their cost of production is and this limits their ability to effectively negotiate or to use PRM strategies. Do you mind sharing what it costs you to produce coffee?

RA: It’s about $1.10 a pound. When prices are this low (at the time of the interview, it was about $1.18), you focus on keeping your costs down.

KK: Do you guys export directly, or do you sell to someone locally? How does your options trading sit with your exporter?

RA: We sell primarily to CISA. (Author’s note: This is the local branch of the Mercon Group.) We use Intl FC Stone to trade options, which we do through a branch of an introducing broker that we opened here in Nicaragua. CISA is thrilled that we can do this on our own. We don’t have a lot of room to negotiate price with them since they are traders and they trade based on the global price. They do offer us opportunities to fix price and so when the price jumped up a few months ago, we took the opportunity to fix.

KK: Wait. You have your own futures trade desk? How did that happen? Have you ever thought of offering PRM services to other farms or cooperatives and buying options upon their behalf?

RA: That was the idea behind opening the desk — that eventually we’d be able to offer services to others. But there is a serious challenge here. Famers don’t want to put cash into an account to do their trading. They view it as a cost without benefit. Farmers are used to going to the banks and getting cash out as a loan in exchange for coffee later on. I think that this is a missed opportunity. Banks could add a bit more in the loan to finance the purchase of options.

KK: That’s a great idea. The bank lowers their risk of default and assures a minimum price for the coffee and the producer gets to fund his offsetting his risk. We should explore this a bit more and the idea that you could serve as a broker for other farms and cooperatives.

RA: Actually, we’re trying to get out of the coffee business. We’re looking at other businesses where there are more opportunities for aggregated value. Farmers are taking the most risk in this value chain. We’ve been paying workers the same 20 cordobas ($0.72) for a lata of coffee cherries for years. That’s not going to get people out of poverty. We can’t help the workers any more. We’re all at the bottom of the coffee food chain. We’re not making any real impact on Nicaragua paying workers that.

KK: I get that perspective. Farmers face a lot of risk and get rewarded with a price that is barely just above their cost of production. Hypothetically speaking, what’s the average price point where you’d reconsider selling the farm and staying in coffee?

RA: I think at about $2.00.

KK: I think at $2.00, you’d have a lot of farmers investing more in their farms and staying on the farm. This has been a really great discussion. Thanks for your time.

(Author’s note: Raul’s comment at the end unsettled me a bit. Here is a really sophisticated, young entrepreneur, making use of the most advanced financial tools to mitigate risk. Yet when he does the math, he and his family don’t see a future in coffee as viable option. The rewards aren’t concomitant to the risks faced. If some of the brightest coffee farmers don’t see a future in farming coffee, then the future of coffee isn’t so bright.)