Up & Down: Supply vs. Demand Forces and the C

There are a few intricacies of the market that I believe have been overlooked by the specialty coffee industry at large as it grapples with the current conversation surrounding C market prices.

The role of speculators is often misunderstood and demonized, overlooking the liquidity that they add to the markets for all involved in the chain. There is also, I believe, a case to be made for more transparent messaging from roasters about the role of importers and traders as an important and necessary piece of the coffee supply chain.

Blaming speculators or trade practices is expedient, and perhaps too convenient, if you are a specialty roaster trying to market your coffee, and may explain some part of the price phenomenons the industry is experiencing, but it doesn’t get to the root of the problem of volatility and producer exposure.

Thus, I would like to briefly explore the place of supply and demand forces in the market and take a look at some of the ways these forces are manifested as volatility. This is an attempt to turn the focus away from speculation and onto what I deem to be the fundamental structural issue that smallholders face.

Supply vs. Demand

The basis for volatility and risk originates in the cash market. (Coffee Exporters Guide, 9.9.1.2)

There is a misconception in the specialty industry that volatility in the C is caused by speculation and the futures market. Yet the principle drivers of fluctuations in all markets are supply and demand. Price fluctuations can be exacerbated by other factors — for example, currency depreciation or heavy speculation — but these factors merely drive low prices lower or high prices higher. In short, if the 2018 Brazilian crop was predicted at 20 million bags we would be having a very different discussion.

High Demand + Low Supply = High Prices

Low Demand + High Supply = Low Prices

Demand > Supply = Prices Rise

Demand < Supply = Prices Fall

We see this in all aspects of our life. A new Iphone 6 is available now at a fraction of the costs of its first release. Why? Because the demand pressure has been lowered by the availability of subsequent models. At its core, the C is just a representation of this balance. This, then, is a market that is functioning as intended, even if the price provided is well below the costs of production.

This then begs the question of why the simple supply vs. demand balance in agriculture results in such volatility when compared with other markets.

Problems with Agricultural Supply and Demand Forces

There are a number of supply/demand issues that cause disruption and volatility the coffee market. These are generally true of agriculture, but some are particularly relevant for the intricacies of coffee production.

Supply is influenced by factors outside of the control of the producers

This can mean weather fluctuations, political instability or a whole host of other issues. An unseasonable frost can damage supply significantly and cause a spike in prices, and particularly good conditions in multiple regions can result in a glut that drives the market down.

Supply is fixed in the short term

As an agricultural product, the global coffee supply is relatively fixed on the yearly cycle. A farmer cannot simply anticipate a lower C price, pull up her crop two months before harvest and grow Cocoa that year instead. Supply is similarly unresponsive to temporary shortages as it typically takes three to five years to bring coffee crops to fruit. This means that micro adjustments to over and under supply indicators are not possible and negative trends are hard to reverse or stabilize in the short term.

Demand is inelastic

Generally speaking, coffee consumption is somewhat static. If coffee all the sudden becomes very cheap for consumers, people would not suddenly drink twenty cups a day to capitalize on this. Similarly, coffee buyers cannot switch to another equivalent product due to pressure from higher prices. They are forced to deal with strategies to offset them so they can continue to meet consumer demand, which prevents correction in the market. Inelastic demand means that the results of small fluctuations in supply are exacerbated into large movements in the market price.

What Does This Mean In Practice?

The end result of this is a dynamic in which farmers are left exposed by the hard economics of the market, and unable to adapt to downward, or upward, swings in price.

A good and well documented example of this is the C price from 1997 to 2011. The below analysis demonstrates the intricate way in which supply vs. demand forces interact over a longer period, and the struggles of the producers to anticipate and adapt:

Between 1997 to 2000, we see production rise from [90 million bags] to over [130 million bags]. In this period the price falls from about 130¢/lb to 60¢/lb.

However, from 2002 to 2010, we see a rise in both price and global production. After 2010, the growth in supply finally leads to a fall in price.

One factor may be that the rise in price in 2002 encouraged an increase in supply. When prices started to fall in 2011, the increased planting of coffee plants can’t be reversed so we see the continued increase in supply because of previous years planting.

This seemingly strange rise in both price and production can be explained by an increase in product demand. Emergent markets in China and India have significantly increased the global need for coffee, and continue to do so, and the increased consumption and spread of coffee shop culture in the West all lead to a contradictory state of increasing output and higher prices. This continued until the growth of supply outstripped demand, and the prices began to fall. Unfortunately, due to the fixed nature of the short term supply force, producers can’t respond to this, and so instead of a slight dip in production and a stable equilibrium, the price continues on its downward trajectory, driven by an increasing supply unable to adapt in time.

No Soundbite Explanation

The traditional roaster soundbite explanations of speculation and exploitation significantly underestimate the scale of the problem. The market and the balance of forces it embodies are representations of global pressures. The fact that there are challenges specific to agricultural markets does not undermine the ultimate validity of supply and demand forces on price: If there is an oversupply and prices are low then the market is representative.

We do not contend with a corrupt or broken system, but the negative social and human impact of a global economic system that is working properly. This makes it far more of a problem than many assume, and much more difficult to deal with.

From a hard economics perspective, a global price crash in times of oversupply — for example, our current state of a 2.58 million bag surplus — is both correct and fair. If there is too much product for the global demand then it will always receive a lower price. The issue that we face is that the inelasticity of demand and the fixed nature of supply leaves millions of smallholders unable to adapt and quite literally at risk of starvation in the fallout of major downward movements.

How we respond to these issues is vital to the future of a stable and sustainable coffee industry, and to the livelihoods of millions of people.