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Why are Coffee Prices Soaring Worldwide? What's the Outlook for Indian Coffee Stocks?

Editor, TRANSFIN.
Jan 14, 2022 9:34 AM 6 min read
Editorial

The global coffee market continues to be in a state of constant flux.

Last year, COVID-19 and the supply chain crisis drove coffee prices to multi-year highs and threatened acute shortages. This trend has spilled over into the new year, with prices rallying across markets.

In fact, both Arabica and Robusta coffee futures posted gains upwards of +70% through 2021, well ahead of other major crop commodities like corn (+25%), sugar (+23%), wheat (+22%), soybeans (+4%), and cocoa (-5%). And this even as the broader market has swung from a surplus to a deficit of 5.2 million bags.

Coupled with the remaking of supply chains that is currently underway, these factors are giving a fillip to coffee stocks in India, with expectations rising that the country may succeed in filling the Brazil-sized void that seems to be up for grabs.

The full picture, however, is a little more complicated…

Firstly, Why Are Coffee Prices Shooting Up?

Besides the general state of disarray of the supply chain, a lot of the coffee inflation has to do with what’s happening in Brazil, the largest producer of the commodity.

Since 2021, the South American nation has been suffering all extremes of the climate crisis. Last year, it endured its worst drought in nearly a century. Around July, some parts of the equatorial country also saw the strongest frosts in decades, with temperatures dipping below 0°C in some places. And last month, it witnessed unnaturally heavy rainfall, with some places already receiving more rain than they do in an entire year. To top it all, Brazil saw one of the worst coronavirus outbreaks in the world.

There are also macro trends, which are expected to elevate coffee prices in the long run.

One relates to the climate crisis itself. Global heating leads to erratic weather patterns and warmer temperatures, both of which are disastrous for coffee cultivation, which is a notoriously delicate process. By 2050, nearly half of the current coffee-growing regions could become inhospitable for coffee plants. This is already happening. In Columbia, the Zona Cafetera region has warmed by 1.2°C since 1980. This has forced farmers to move higher up the mountains to find cooler pastures for the plant, leaving low-lying plantations to either produce low-quality beans or die out completely.

Two, the make-up of the global coffee industry itself. Until 1989, prices were relatively stable despite fluctuating outputs. This was largely due to the International Coffee Agreement (ICA), which acted like an OPEC for coffee-exporting nations. In 1989, ICA broke down over disagreements about its export quota system. In the years that followed, coffee prices went into free-fall and were primarily market- and output-driven. Arguably, this was to the detriment of small-scale coffee farmers i.e., the ones with land holdings of less than five hectares (60% of all coffee grown comes from such farmers).

With the absence of a consensus-driven price-stabilisation regime, many small-scale farmers moved onto more lucrative crops or sold their lands to larger producers. This gradual consolidation of the coffee market alongwith the exodus of small plantations does not bode well as international demand continues to surge.

 

Taking Stock of the Situation

During October and November (the first months of the 2021-22 coffee season), shipments from Brazil fell -31% even as exports from Latin America (mainly Guatemala and Honduras) and Asia (mainly India) climbed +30%.

Does this mean the coffee hierarchy is up for grabs, and does India (the sixth-largest producer and fifth-largest exporter of the bean) have a chance to inch up the ranks?

Why are Coffee Prices Soaring Worldwide? What's the Outlook for Indian Coffee Stocks?The rally in coffee stocks points to bullish sentiment among investors. Two of the biggest players in the sector, CCL Products and Tata Coffee, are up c. +66% and +90% YoY.

Indian coffee shares have been on a roll lately, riding on the back of (1) rising prices, (2) the coffee market’s pivot away from Brazil, and (3) supply bottlenecks that constrained Vietnam, the second-largest producer, last year.

However, the fine print calls for cautious optimism at best.

For starters, Brazil is down but not out. Its domestic coffee supply chains remain robust and on the path to recovery. And interestingly, the heavy rainfall that has flooded many of its coffee plantations may help it boost output in 2023 + fields at higher altitudes have escaped the worst of the inclement weather and are thus expected to be back in business at the earliest.

Second, erratic weather is hurting coffee-growers in India too. Key regions Chikkamagaluru, Kodagu and Hassan received +84%, +81% and +57% excess rainfall during the post-monsoon harvest period last year. This followed a broad rainfall deficit during the actual monsoon season (-18%, -23% and -16% respectively).

Third, it’s important to remember that the Indian coffee market is (1) relatively small, (2) heavily concentrated, and (3) overwhelmingly export-oriented. Two-thirds of Indian coffee is grown only in Karnataka, and over three-fourths of Indian coffee is exported. Domestic demand, while growing, remains relatively muted as Indians are a predominantly tea-drinking people. The overall market is expected to grow to only $2bn by 2025 from $1.5bn in 2020 (for context, the global coffee market is worth more than $100bn). As such, broadly speaking, Indian coffee companies supply only 4% of global demand.

Fourth, there are natural obstacles. Coffee grows best in medium-altitude places in tropical countries. It’s a stubborn plant, considering that it requires narrow temperature ranges, warm days, cool nights, a specific amount of rainfall, and a months-long dry season. Moreover, the average Indian soil is not conducive for coffee plants (which is why it’s mainly grown in a few belts in the South), unlike Vietnam or Ethiopia, which have large tracts of favourable volcanic soil. As such, many of the factors that determine the Indian coffee industry’s prospects are beyond human control, really. (Vertical farming, hydroponics, aquaponics or aeroponics may be possible solutions, but that’s a different topic altogether!)

 

Brewing Success

Presently, major coffee firms seem to see opportunity for some expansion to other countries, but they largely expect the geographical mix to "more or less [remain] the same way it used to be", to quote CCL's MD during the company's Q1FY22 earnings call.

Speaking of coffee firms, not all Indian ones are the same. Some, like CCL, are exclusively processors i.e., they don't own any coffee plantations of their own. Instead, they buy the raw materials from India and abroad (mainly Vietnam and Ethiopia) and process the beans, working with a cost-plus business model that arguably protects them from price fluctuations. Others, like Tata Coffee, also have backwards integration i.e., they own actual plantations, which makes them more susceptible to price and monsoon vacillations.

 

A Toast To Tomorrow

Whether the ongoing coffee bull run in Indian markets will last long is debatable. What is less contentious is the worsening coffee crisis. By all accounts, the ubiquitous drink is slated to become costlier - and sourer. (The crisis is particularly acute for Arabica coffee, which is sweeter than Robusta.)

FYI: 60-70% of global coffee production is Arabica, which is popularly sourced from Mexico, Ethiopia and Columbia. Robusta mainly comes from West Africa and Southeast Asia. Some producers - like India, Indonesia and Brazil - grow both varieties.

Either way, expecting India to ascend the coffee ranks in the near-term is easier said than done. The last time there was a similar rally, which was in 2020, Indian exporters missed the bus.

But even as India takes on Brazilian coffee, let’s hope we enjoy better luck than when we tried to take on Brazilian sugar!

FIN.
 

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