In the coffee industry, larger roasters generally have a greater capacity to manage price risk, but small and medium-sized roasters also have tools at their disposal.
Managing price risk might seem much more difficult for smaller roasters (who simply don’t have access to the same kind of tools and expertise), but that doesn’t mean they’re unable to do so.
To learn more about how coffee roasters can manage and minimise the impact of price risk, I spoke to some industry experts to learn more.
You might also like our article on how we can bridge the gap in coffee education.
What is price risk?
Whatever way roasters buy coffee, it is a fact of life that their costs will be affected in some capacity by the C market.
Usually, this is a direct correlation, as many roasters either pay the C market price or a differential (a specific number of cents above or below the C market price).
Kat Nolte Ferguson is a Specialty Managing Trader for Sucafina North America. She says: “By our estimations, 96% of all coffees sold in North America are determined by the C market at some point.”
While some roasters do buy coffee outright – at a fixed price determined between the roaster and the co-operative or producer – the vast majority of coffee is not bought outright, and is therefore tied to the C market.
Since the C market is driven by global supply and demand, the price of coffee can change significantly. This change can affect roasters in three ways:
- If the C price goes up, roasters may have to pay higher prices for spot coffees (available to ship immediately from the warehouse) and future coffees (contracted for delivery at a later date). Right now, since the market is so high, with little indication that it will fall significantly, most roasters have to pay high prices for coffee.
- If a roaster “locks in” a price at a specific C market level, they can lose money if the market changes. If the price goes down after a roaster secures a price, they’re left holding a more expensive contract than the current futures price.
- Finally, if a roaster signs a contract that doesn’t secure a specific market price (with the plan being to secure it later) and the price goes up, then they’re left with a contractual obligation to buy coffee at a higher price than they had expected.
For all of these scenarios and more, roasters can exercise something known as price risk mitigation. This encompasses a range of tactics that can help coffee roasters soften the impact of price changes.
Price risk mitigation for coffee roasters
For larger roasters, market-based mechanisms like hedging are the most common ways to mitigate price risk.
Hedging is where large coffee roasters buy stocks on the futures market at the time they lock in their contract price. Then, if the price of coffee on the market goes up, they can sell the stock they’ve purchased to offset the rising price.
Conversely, if the C market price goes down, they’ll take a hit on their futures stock, but will pay a lower cost for their coffee.
However, a single stock of coffee futures is an entire container of coffee (roughly 17,010kg or 37,500lbs). As such, this kind of investment isn’t something that many coffee roasters are able to make.
“Buying and selling futures for small to medium-sized roasters is not really feasible,” Kat explains. “This is because a single stock of futures is sometimes their entire annual volume.”
Ultimately, this means that the options for small to medium-sized roasters to hedge price risk are different from those available for larger brands.
#1: Know your market
Keeping an eye on the origin markets that are most important to your business can give you advance warning when markets are on the rise.
Al Liu is the Vice President of Coffee at Colectivo Coffee. He says: “Four years ago, the Sumatra market went crazy.
“Sumatra is our number-one origin; we basically need to have it all the time,” he adds. “So, when the internal market spiked and I heard that was happening, I snapped up all the spot and nearby FTO (Fair Trade and organic) lots that I could, especially from our producing partners.
“This allowed us to bulk up our inventory before the pricing really skyrocketed.”
By keeping an eye on movements at origin, Al was able to foresee the price changes that would come for Sumatran coffee in the near future, and get out in front of them.
For cases like those we’re experiencing in 2022 (when coffee prices are on the rise in general), a little advance warning can make a big difference, and enable you to purchase enough stock to “ride out” a price spike.
“You can find coffees that are good for you and do a lot of good for the farmer,” Kat explains.
Prices can rise for a variety of reasons, but buying coffee at lower prices doesn’t have to mean lower prices for farmers.
When prices rise at origin, it doesn’t necessarily mean that the producer is getting more money. Price increases can occur during other stages of export, because of transport or shipping costs.
Ultimately, roasters buying directly from co-operatives can help ensure a higher portion of the sale price goes back to the co-operative and ultimately, the producer. Beyond that, roasters also can share second payment and quality premiums to thank co-operatives and producers for their hard work.
#2: Maintain good relationships with importers
A good relationship with importers in your region can make a huge difference in knowing when to book, how much to book, and how to hedge costs.
Importers, especially those with contacts and sister companies at origin, keep their fingers on the market’s pulse so they can access insights that would otherwise be unavailable to roasters.
“Know your importing partners and work closely with them to understand what might happen in the market,” Kat says. “Understanding specific supply and demand pain points is super helpful.
“If you’re working with a well-informed importer, they may even be able to alert you to incoming supply shortages or surpluses from a specific origin. That could lead to an opportunity to forge a new relationship that’s beneficial for both you and the producers.”
Another thing that importers can help you with is hedging risk on the C market. As mentioned above, it’s difficult for smaller roasters to hedge prices by purchasing stock in the C market. But importers can aggregate smaller hedges from several customers and build hedging into smaller contracts on behalf of their roaster clients.
#3: Embrace flexibility
Being flexible about origins and lots, especially for blends, can be another way to offset price changes and keep costs affordable.
Al acknowledges that it’s easy to get stuck in the mindset that your blend needs to have specific origins and specific proportions.
However, he says: “If you can achieve the same cup profile using coffee that’s from an origin you haven’t used and it costs less, why wouldn’t you do it?”
“As a green buyer, it’s important for us to be flexible and look for new opportunities that already exist that we may not be aware of.”
#4: Link sales contracts to the market
If you have a wholesale business, make sure you can fix wholesale contracts and market prices for the same time period.
James Dargan is the Head of Asia Pacific Arabica for Sucafina. He says: “If your sales contract is fixed for one year and your purchase for three months, that’s a risk. You should look to match sale and purchase terms as closely as possible.”
One potential approach is to renegotiate wholesale contract lengths so they are shorter and match the length of time for which you fix prices. Another is to fix contract prices further out to match your wholesale contract lengths.
“Ultimately, your business and your sales will influence how far out you should fix your purchase side,” James says.
Another aspect of wholesale contracts to consider is currency.
If you’re operating outside the US and have wholesale contracts fixed in your local currency, you may want to consider using hedging techniques to offset potential currency changes.
This is worthwhile as most coffee is traded on the C market in US dollars. This means that currency and foreign exchange rate changes can affect the price you pay for coffee and thus, your overall profit. James notes that if you find this difficult, you can work with banks or importers to help hedge currency risk.
Making sure things stay good for you and good for the farmer
At a time when the C price is volatile, there are several ways for small to medium-sized roasters to mitigate price risk.
Furthermore, with strong supply chains, better prices for roasters don’t have to mean lower prices for farmers.
“Just because it’s a good deal for you doesn’t mean it’s ripping off the farmer,” Kat explains.
Coffee can be cheaper for the roaster for a number of reasons, so building positive relationships with suppliers can help you understand just how ethical your coffee is.
“A coffee can be cheaper because someone on the harvest side hedged a lot or because a bumper crop, such as those we see frequently in Burundi, drove the prices down,” Kat explains.
On the importer side, vertical integration can also reduce costs. For instance, Kat explains that Sucafina has washing stations in Uganda that work directly with farmers.
“This means that we’re able to provide affordable, high-quality naturals that can be substituted for more expensive Ethiopian naturals in blends.”
Another important benefit of vertically-integrated supply chains is the way in which they connect the roaster to the farmer.
“At Sucafina, we’re working to allow a window from the farmer to the roaster that can enable them to contribute to farmer livelihoods through second payments,” Kat says.
She adds that the company’s Farmgate Initiative is connecting roasters with specific projects that can significantly affect farmer livelihoods, as well as providing an option to deliver quality premiums directly to producing partners.
By leveraging these four tips, roasters can minimise their exposure to changes in the C market, and better insulate themselves from price risk as a result.
Ultimately, you will need to remember that the right technique for your business will depend entirely on its size and customers. However, whether it’s embracing flexibility, tweaking wholesale contracts, maintaining good importer relationships, or a combination of these three, it’s worth remembering that managing price risk isn’t something that only larger roasters can do.
Enjoyed this? Then read our article on the Chinese coffee supply chain.
Photo credits: Sucafina
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