Coffee Risks Squeezing Starbucks, Funds on Supply

Date: Tuesday, February 17, 2009
Author: Shruti Date Singh, Bloomberg.com

An unexpected coffee rally sparked by dwindling supplies risks squeezing Starbucks Corp., Kraft Foods Inc. and hedge funds betting on a decline.

Demand may exceed output by 8 million 60-kilogram bags in the coming year -- almost what Germany consumes -- and exporter stockpiles are the lowest since 1965, the International Coffee Organization said. Arabica coffee futures may jump 25 percent this year after falling for the first time since 2001 as output drops in Brazil and Colombia, the Western Hemisphere’s top two growers, Goldman Sachs Group Inc. said Feb. 9.

“We see coffee prices increasing in 2009,” Sandra Bachofer, who helps manage $1.2 billion for Zug, Switzerland- based Tiberius Group, said yesterday in a telephone interview. “We expect coffee to be one of the most promising commodities in 2009.”

Expectations for a rebound show what happens when speculator-driven futures markets collide with real-world supply and demand. The rally would drive up costs for Seattle-based Starbucks and Kraft Foods’s Maxwell House, while enriching growers and increasing export revenue in countries such as Vietnam and Brazil.

While Fortis Bank says the recession may stall demand and keep prices in check, coffee is up 2.3 percent this year at $1.1465 a pound on ICE Futures U.S.. Contracts for December delivery indicate the rally will continue.

Price Forecasts

Judith Ganes-Chase, a former Merrill Lynch & Co. analyst who runs a consulting firm in Katonah, New York, said coffee may rise as much as 52 percent to $1.70 by June 30. Morgan Stanley forecast an average of $1.41 in the year starting Oct. 1, and Goldman Sachs predicted $1.40 in the next 12 months.

Starbucks, the world’s largest coffee chain, said Jan. 28 it expects “unfavorable” coffee costs in the year ending Sept. 30 to erode the benefit of lower dairy prices. The company said its cost of first-quarter sales rose 2.9 percentage points from a year earlier, partly because of higher coffee expenses.

“We are confident that we have the coffee we need and that increased premiums in specific countries will have little or no effect on our existing or future contracts,” Stacey Krum, a Starbucks spokeswoman, said in an e-mail.

The company usually has supply commitments for a year to 18 months into the future, so the impact of changing coffee costs may take that long to show up in financial results, said Jeffrey Farmer, an analyst with Jefferies & Co. in Boston, who rates the shares a “hold.”

Maxwell House

Northfield, Illinois-based Kraft, the world’s second-largest food company, raised Maxwell House coffee prices twice in early 2008 as bean costs jumped, followed by three reductions. No price changes were made this year, spokeswoman Bridget MacConnell said.

Higher prices may hurt hedge funds and other large speculators who sold 19,379 futures contracts valued at more than $864 million as of Feb. 10, based on the May delivery contract, in a bet that prices would fall, data from the Commodity Futures Trading Commission show.

Coffee fell 14 percent in the fourth quarter on the ICE exchange even as the premium for Colombian beans over the most- active New York futures jumped 54 percent, reflecting demand at a time when investors fled commodity markets. Open interest, or the number of outstanding contracts, fell almost 10 percent.

“Coffee fell victim to massive fund liquidation” last year, said Roland Veit, chairman of importer Paragon Coffee Trading Co. in White Plains, New York. “The coffee market was driven too low for non-fundamental reasons.” Buyers in the physical market “started to ignore” futures that didn’t reflect supply and demand, he said.

Commodity Rally

Investors stocked up on commodity futures early last year, hoping to profit from rising demand for food, feed and fuel. A weakening dollar made raw materials priced in the currency more appealing for overseas buyers and as an inflation hedge.

The number of outstanding coffee futures in New York reached a record 204,360 contracts on Feb. 15, 2008. At 37,500 pounds per contract, that’s equal to almost half of all the coffee consumed globally last year. The surge in speculator holdings helped push the price to a 10-year high of $1.719 a pound on Feb. 29, 2008.

Then the credit crisis and the recession erased optimism about commodity demand and sparked a rush by investors to sell assets. From October through December, hedge funds and other large speculators were betting coffee prices would drop as the Standard & Poor’s 500 Index posted the biggest quarterly decline since 1987. The Reuters/Jefferies CRB Index of 19 commodities, after reaching a record high July 3, plunged 36 percent last year, the most in more than five decades.

Colombia Premium

By December, coffee reached a two-year low and open interest had fallen 39 percent from its record.

Tighter supplies are pushing up the cost of coffee from Colombia, where a growers group on Jan. 26 reported 2008 production dropped 9 percent to 11.5 million bags. The decline means export shipments “may arrive late” to some buyers, said Jorge Lozano, head of the Association of Colombian Exporters.

Colombian beans, embodied by the image of sombrero-clad Juan Valdez and his mule, cost 27.42 cents more than the price of most-active New York futures on Feb. 13. The premium reached 28.85 cents on Feb. 4, the highest since at least 2001.

Similar premiums were reported for Costa Rican and Guatemalan beans, according to a Feb. 6 report from analyst F.O. Licht of Ratzeburg, Germany.

Stockpiles in warehouses monitored by ICE Futures U.S. on Feb. 12 reached the lowest since July 2007. Stockpiles held by shippers fell 32 percent from a year earlier to 17.26 million bags on Oct. 1, partly because consumption in coffee-exporting countries jumped 37 percent in the past decade, ICO data show.

Production Deficit

The financial crisis also may contribute to reduced output, according to Tiberius Group’s Bachofer.

“Coffee is very labor intensive and requires lots of fertilizer,” she said. “Financial credit is not as available as before. This may lead to lower inputs in these two areas. The reduced fertilizer input will mainly have an impact on the marketing year 2010-2011.”

Global demand may reach 130 million bags, exceeding supply by 6 million to 8 million bags in the year that starts Oct. 1, said Nestor Osorio, the ICO’s executive director. Brazil estimates its harvest will drop as much as 20 percent to 36.9 million bags this year as trees enter the smaller phase of a two- year crop cycle.

“It’s a very tight market,” Osorio said in a telephone interview from London. “The supply will be in deficit. There are no reasons to believe prices could come down.”

To contact the reporter on this story: Shruti Date Singh in Chicago at ssingh28@bloomberg.net.