What Have We Learned About Price Risk Management?

(Editor’s note: This piece follows a five-part interview series on price risk management involving various parties within the coffee supply chain. See the links provided below for each of the interviews.)

What have we learned about price risk management (PRM) from this interview series?

We’ve had five very different discussions along the way — perspectives from the point of view of cooperatives, of exporters, of estates and of a leading broker of options and futures contracts. It was my hope that by getting diverse opinions on PRM, the most common and shared viewpoints would resonate.

I came into this process very much a PRM novice. I have a great understanding of the risks that farmers face in the field — the whims of a changing climate, El Niño, diseases — but on top of all of that, they face risks in the market, which I came to appreciate. From a farmer’s perspective, it is extremely hard to invest in mitigating risks on the production side — in new technologies to make your farm more productive, more efficient, with less impact on the environment — if you can’t protect yourself on price.

While I believed that farmers needed to find ways to ensure they got the best price they could get, could they minimize their risk without turning into speculators, with their eyes, and focus, always glued to the price ticker? I learned a lot along the way.

Five Interviews and an Intro: The Cliffs Notes

I introduced the series by talking about a World Bank report related to risk to access to finance that really started connecting dots for me, and by mentioning how I am very late to the PRM party.

In our first interview, Ed Canty brought up a number thought-provoking points. PRM is not an issue solely for cooperatives, but this is an industry-wide concern. Any institution or corporation that has invested or will invest in cooperatives (banks, NGOs) has their investment at risk if the cooperative is not addressing PRM. Having cooperatives go bankrupt or that are unable to fulfill contracts isn’t in anyone’s best interest.

Ed went further. He suggested that the cost and purchase of options needs to be included as part of the cost presented to the buyer, either bulked in as part of the quality/country differential, or presented separately as a PRM line item. Each organization will need to figure out how to broach this with its clients and how to best include this cost.

In the second interview, Raul brought us the perspective of a modern estate, which in this case happens to have a former commodities broker managing its price risk management strategy. He reminded us that when farmers miss out on price upswings, they can still take advantage of the higher price and fix prices for future harvests, allowing for planning and investment into the productive parts of the farm. While not all farmers are able to do this — it requires that a farmer to have enough trust and status with their exporter/cooperative to fix forward contracts — it represents a great example of a farmer using all the tools available to protect themselves.

Our third conversation was with Jorge Cuevas of green trader Sustainable Harvest, one of the first advocates for the use of PRM strategies for their cooperatives. In order to promote the use of the purchase of options, or price insurance, Sustainable Harvest has a model in which they front the money for the purchase of the insurance and then include the charge for it as a line item in the final cost to the roaster. They even use their own brokerage account to make it a painless experience for their client cooperatives.

We spoke to the Mercon group, who suggested that for the majority of individual farmers, especially smallholders, the priority should be understanding what production costs and using this as a basis to plan for the future. Amongst the pithy nuggets in the interview were: “Pricing at the right time and levels should be their (the farmers) primary focus” and “Don’t worry so much about what you didn’t get, but rather focus on what you have.” I think this line might really resonate with all of the parents out there, as well.

Finally, our last interview was with Albert Scalla, of Intl FC Stone, one of the leading financial services providers to the coffee sector. Albert reminded us of the basic macroeconomics that are keeping current coffee prices at or below the cost of production for many farmers. He told us of the different accounts that Intl FC Stone offers and ways that a farmer or cooperative could obtain price insurance and recounted how farmers protected themselves in recent moments of extreme volatility.

So to borrow my friend and colleague Michael’s trope to get us to simultaneously advance the discussion and close this post…

So What?

Advanced PRM strategies involve the use of complex financial tools that have high knowledge- and financial-barriers to entry. The use of these tools has provided financial benefits, or peace of mind, to many a cooperative and to many a roaster. Yet, given this complexity, these tools aren’t for everyone. Many farmers view price insurance as an additional cost, rather than as a service and they have a hard time paying upfront for the services. For these farmers and cooperatives who are not ready for this level of sophistication, there are much simpler PRM strategies that a farmer or a cooperative can put into place that provides some mitigation of price risk.

Yet there is a serious need for the use of these tools. At current prices, investing back into the farm just isn’t that attractive. How can a farmer sell their crop today to pay bills and debts, yet ensure that if the price goes up in a few months, they will not have lost their opportunity?

I see a serious vacuum here: While NGOs like CRS can help disseminate knowledge of PRM, we do not commercialize coffee. There is a need for providing tailored risk-management for cooperatives, involving assessment, strategizing and execution. I think this is a void could be ably filled by the private sector.

Every month, I learn about some new and great direct trade platforms coming online — Algrano, Café Internacional, Cropster. Where are the B Corps with a social mission to minimize risk exposure for cooperatives and small farmers? They could even use the Sustainable Harvest model and run it through their own brokerage account, charging fees to the cooperative, who could recoup some of the costs in their contracts with roasters? While it doesn’t sound as nearly as sexy as direct trade, there would be no shortage of clients.