Odd Lots - Why the Price of Coffee Beans Soared in the Last Year

Episode Date: January 6, 2022

Agricultural commodities have generally surged in price over the last year. One commodity that's gone particularly wild is the coffee bean. Arabica beans — those at the premium end — are up about 100% since January 2021. So what's going on? Well, part of it is the generalized inflation, but like many other ags, weather has a lot to do with it. To start, bad weather in Brazil has had a negative impact on supply. On this episode of the podcast, we speak with Ryan Delany, a longtime player in the space and founder of the Coffee Trading Academy, to understand how this market works, and what's driven the huge price swing.See omnystudio.com/listener for privacy information.

Thanks for listening to Odd Lots. Follow the show on Amazon Music for more future episodes or just ask, Alexa, play the Odd Lots podcast on Amazon Music. Hello and welcome to another episode of the Odd Lots podcast. I'm Joe Wisenthall. And I'm Tracy Allaway. Tracy, we've talked a lot about various stresses and price increases that we've seen throughout the economy. But one of the themes, I guess I would say is, and we've joked about it, is we talk about a lot of stuff that's very much in the world. the background, things that are sort of like disconnected or mediated by several steps from the end consumer. Wait, Joe, can you explain that?

We talk a lot, you know, like we recently talked about the increased price of pallets, right? Right. And then it's gone up a lot. But most people don't experience the increased price of wooden pallets or even the increased price of a shipping container in their day-to-day life. Oh, I see. Well, I don't know.

I guess the cost gets passed on eventually, right? But yes, you're right. We're not like purchasing containers once a month in the same way that we are purchasing consumer goods and things like food and stuff like that. Yeah, exactly right. That's all I mean, which is that a lot of these things are things you wouldn't necessarily see yourself, even lumber, which we've talked a lot about on the show. You might not necessarily see.

We've talked a lot about grain, which people see, but in many ways that match. manifests itself in the form of higher meat prices or dairy prices for consumers. So a lot of these things, they seem to be like sort of like background factors that eventually feed through. Yeah. But on the other hand, since we're basically talking about inflation now, there are some price increases out there that are very much in front of consumers right now. Primarily food, right?

I did a deep dive into mayonnaise. and that was up like something like 8%. And everyone has an opinion on food inflation and what's going on. And it really seems to, I guess, touch a nerve with people. Yeah. Food inflation, in particular, gasoline, probably the other one is that people, that really touches a nerve. But food for sure.

And everyone has a theory. And everyone's trying to figure out, is this a macro thing that it's something about the money supply or fiscal that's pushing the price of everything up? But with food, you also have this other debt. dynamic of weather and other idiosyncratic factors. Anyway, I'm very excited because we're going to be talking about another consumable good that is highly emotional for people. That's highly relevant to a lot of people. And that is the price of coffee. Right. So truly something that a lot of people would consume on a daily basis. So the price of coffee has dramatically surged over the past

year or so. And I guess the question is how much of that price increase is actually being passed on to consumers. And here, I have to confess, I really have no familiarity with the coffee market at all. So I'm very, very curious to learn how purchasing actually works, how hedging works, and how the coffee sort of gets from the farmers all the way to Starbucks or, you know, a can in the grocery store. I am very excited about learning all of that as well. So we have the perfect guest. We are going to be speaking with Ryan Delaney.

He is the founder and chief analyst at Coffee Trading Academy. He has a career of coffee trading, both the spot, physical markets, futures, and so forth. And he trains companies. He gives them analysis and research on how the coffee market is doing. So we're going to learn everything about how this commodity market works. Hopefully, Ryan, thank you so much for joining us. Yeah, thanks for having me. Why do you actually just give us the very brief overview of why are we talking to you?

What is your expertise in the coffee market? How do you know it? That's a good question. I got no idea why you guys are talking about. So I've been in the coffee industry for about a dozen years, but come up with my entire sort of commodity experience is in coffee. So to give you, you know, the 30-second version of my background here. I started out with one of the large multinationals in their rotational program that is one of the top traders of coffee. So I worked and lived in origin in India and in Uganda, sort of buying coffee locally, processing it, and then exporting it to consumers.

And then I came back to the U.S. and traded coffee, physical coffee there for a little while before I transitioned to our company's hedge fund. A lot of these large multinational commodity firms have hedge funds to sort of capitalize on their informational edge. So I was the coffee and cocoa analyst and trader for our hedge fund. And, you know, one thing you'll hear a lot in the coffee industry, the more you talk to coffee people is how much there's coffee guys, there's coffee gals. You know, we refer to ourselves as coffee people. It's very much a tight-knit community. So I missed that interaction, you know.

So I actually transitioned to the sell side from the hedge fund and from the prop book I was trading. And from there, that was actually very interesting because I was advising clients on managing their price risk, their coffee price risk, across the supply chain. So that meant producers and exporters, trade houses and traders, speculators, but also roasters and consumers. So I kind of really got a crash course in price risk management for coffee. And that led me to starting this firm that I work in now, where I provide research and training to people who have a stake in the price and coffee. So first of all, it's really fascinating to think that a company like Nestle might have a hedge fund nestled inside of it, trading coffee futures.

And I definitely want to ask more about that. But before we do, I have a very basic question. And I was just thinking of it when I said in the intro, you know, the price of coffee has surged. If we say the price of coffee is at a 10-year high, what are we actually talking about? Like, what is the benchmark bean? Because I know there are obviously different types. But like, what's the bean equivalent of the, I guess, the 10-year, you? U.S. Treasury. Okay. I love that question. The being equivalent of the U.S. Treasury.

Yeah. Well, if you can put it in financial terms. Yeah. So the coffee futures market, effectively known as the C market, is the primary benchmark for the price of coffee. As you kind of alluded to, there are two major types of coffee. There's Arabica, which is what we trade on the sea market. And then there's Robusta, which is what is traded on the London. market. Now, the Arabica market is traded in cents per pound, and the robust market is traded in dollars per metric ton. But the Arabica market is the larger, more volatile and more exciting market. So that also attracts a lot more of the speculative interest. But those are the two main markets that we're trading. And of course, there's, you know, a spot market. There's a cash market

that's incredibly varied because coffee has really exploded in the last 20 years into this, this idea of specialty coffee and fine coffee. So there's a whole, you know, secondary market out there, much like there is for wine, right? There's probably a benchmark price for wine, but there's also a huge variety on the, you know, on the low and the high end. So quick question, are these other futures that are traded? Are they cash settled futures? Or are they physical? delivery futures? They are physical delivery and that is an essential part of the, you know, keeping these futures honest. So there really is a connection, you know, between the futures prices and the physical. And that, you know, that's done through the certified stocks. It's particularly

relevant because the exchange has set very steep aging penalties. And that exists for a very very important reason, and that's to facilitate that cash convergence, right? We don't want the certified stocks to just be a sort of a theoretical financial asset. At the end of the day, someone needs to take that coffee out of the warehouse and drink it, right? So they put heavy aging penalties on that to incentivize consumers to de-stock certified inventory and consume it. So could we dive into that a little bit more? Because I was reading that, people, traders are using more futures than normal right now because they're worried they might not be able to get enough stockpiles on the physical, the spot market. So they're worried

there won't be enough to actually take delivery of. Can you just explain how that process typically works and how much of trading is divided between spot and futures and sort of forward hedging versus buying right now? Because I imagine, again, a company, like Starbucks or Nestle, which needs huge amounts of coffee every year, is probably hedging its exposure very far in advance. Yeah. So it really depends because there is a variety of size in the consuming side and on the export side as well. Right. So there is a threshold that you need of production or consumption to make hedging in the futures market relevant and useful. So for context, a single futures contract of Arabica is 37,500 pounds. So if you're just a small mom and pop

roaster, you're probably not going to be hedging, you know, on the futures market. In terms of adding coverage, this is, as you kind of mentioned, something for the bigger traders or the bigger consumers to deal with. They have a pretty, you know, clear system. They have a methodology to how they're acquiring coffee in general. And that is a combination of physical contracts and futures contracts. If you're a large company like Nestle or Folgers or whoever, you have a network of suppliers and you will put out sort of bounties. You'll say, hey, who wants to sell me coffee?

Give me your best bids or offers, rather. And they will send out proposals to those big companies. I don't want to get too into at the moment the nuance of differential contracts and price-to-be-fixed contracts. But essentially, if you're a company like Nestle, you need to – there is a spread, right? There is a premium or a discount to buying specific physical qualities of coffee to the futures contract. So there's two different kind of risks that they need to manage. But there is also a general larger correlation. So if you're a company that does size that needs that physical of coffee, you have the option of either buying that physical, making a physical contract with a producer or an exporter to buy that coffee, or if you don't have a good deal, if there's not a good offer to you or you're not sure exactly which qualities you want to buy, you could buy futures, right?

So you could just buy, you know, as much of the physical that you need in futures contracts and hold that as a hedge until you are prepared to sell those out and buy your physicals. The news doesn't stop on the weekends. Context changes constantly. And now Bloomberg is the place to stay on top of it all. Hi, I'm David Gurra. Join us every Saturday and Sunday for the new Bloomberg this weekend. I'm Christina Ruffini.

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quality coffee, which is actually very good at Bloomberg, by the way. We have really good coffee. But anyway, can you just talk like, okay, there's a farmer in Uganda or India. Can you just real quickly like the whole supply chain from farmer to mouth? Oh, sure I can. The coffee industry is really divided into, or let me put it this way, the farmer, are primarily divided into Brazil and everybody else. Now, historically, coffee is produced.

It's a small holder production. It's done on small farms and small estates. And that has geographical underpinnings because coffee is what we call high-grown. So it's grown in the mountains, and it's tropical. So it's really only possible to grow coffee in tropical mountains. And that doesn't facilitate itself well to big megafarms. And so that kind of has this sort of smallholder farmer implication. The exception to that is Brazil, which has these very large plateaus.

So they are able to grow large amounts of coffee, and indeed they're the world's largest producer of coffee, and mechanize it at the same time. So they're the exception where they have these large farms and sort of the mass production of the, the farming of coffee. So you're going to have exporters now who are generally multinationals, but there's also local exporters as well, who are positioned in all of these key origins, these key producing origins. And they'll have buying centers spread out throughout the coffee farming regions. And much like, you know, grain elevators or whatever in the U.S. and other countries,

the farmers will have relationships with those buyers and they'll know the prices and they will deliver they will harvest the coffee themselves and then they will deliver it to the exporters. The processing of coffee is actually kind of nuanced as well and there's two primary ways of processing coffee. So the coffee bean itself, like that brown bean that you see in the bag when you buy that bag, that starts out as a green bean. inside of a ripe cherry, right? Like a red cherry, a piece of fruit. So the two ways of processing that and getting that bean to the roaster is either what we call

it the natural process, which means that the farmer picks those cherries. They spread them out on a patio to dry, and they dry over that bean like a kind of like a raisin, like a hard raisin. And you can actually pick those up and shake them and hear a little rattle inside when they're ready. or they have the washed process. And with the wash process, you're picking that ripe cherry and you are putting it through a wet mill. And that sort of has kind of like, remember, you know, the log shoot ride in Disney World where you're, you know, you get in the log and it goes down. Sure, yeah.

Thing of water. It's sort of like that. And so your bean goes through this chute of water and goes through kind of like a cheese grater type of device, which pulps that cherry off. it and then brings your washed green bean at the end, out the other side. So those are your two primary ways of getting that bean to the exporter. And the exporter will convert either of those methods into a processed green bean that they will sell to the consumer. Now, the big issue that you guys have probably been talking about with others and that everyone is talking about in general is supply chain issues, right? So right now, there is a big issue.

especially in Brazil, but all over the world, and Asia, Vietnam, with getting containers and getting ships there to actually get that coffee to the people who need it. And this has been affecting the price and the supply and demand issues because now destination markets have had to draw down inventories and consume locally coffee that normally would have been imported in. Now, once that gets into the destination market and that importer has that coffee, they will sell it to the roasters. And those can be large roasters like the various groups that roast Duncan Donuts coffee or small roasters or mom and pop shops. And when that roaster gets those bags of green beans, then they will put it in their roasting machines and they will come up with blends of coffee.

And then it's delivered to the coffee shops. All right. So maybe this is a good place to explain exactly what is driving the price of coffee higher. And I know you mentioned supply chain issues, but it seems like, well, with most things that seem to be experiencing a shortage or some degree of scarcity recently, it seems like it's a combination of factors. Absolutely. And it's really been, you know, what do you call it, a perfect storm, you know, a confluence of events here.

I am a fundamental trader at heart. That's kind of how I was raised and what I believe drives markets in general is supply and demand and fundamentals. And this has been a fundamental story. So coffee is a biannual crop. So it, meaning that the coffee is a tree crop, unlike row crops that you're planting with, you know, corn or wheat or cotton or whatever. So you have a tree that produces fruit. And so what happens is the tree usually produces a lot of fruit one year, and then the next year it sort of has to recover and rests. And so it will have less fruit the next year.

And that's sort of the general biennual cycle of coffee. So you tend to have an on year and an off year. So we had a very big on year in 2020, where there was a surplus and abundance of coffee. And then for 2021, we were expecting to have an off year. and that was normal. But it actually was exacerbated a bit more than that due to droughts in Brazil that affected the coffee crop on sort of two ends. Now, again, coffee is a tree crop.

So the way that the fruit comes onto the tree is in sort of two phases. You will have the branch growth the year prior to the coffee crop. And so you will have what we call new growth on the end of the branch of the branch, coffee tree and then the following season you will get flowering and fruit on that new growth. So what we had was we had a drought that stunted that new growth and made less room for coffee cherries. And then we had also a drought during that blooming season, during the flowering season where those would grow into new fruits. So that had kind of a double whammy on already a down year for coffee.

Now, just to make things even more interesting, we also had the worst frost that we've seen in Brazil in 25 years. And so even though we had this bad crop that we were like, okay, this is a bad crop, there's a deficit, but we had an on year of the year prior, that's normal. So, you know, the market needed to rally and all that was well and good. But at the same time, we had this frost. that essentially killed a lot of the new growth now on the tree that we were expecting for our next on crop, our next on cycle.

So that turned out to be an absolute disaster. And that was just back in July. And so we were waiting until the flowering, which starts in sort of October, November, and to see how bad things were. And we had a decent flowering, so we thought things were going to be okay. But it turned out that what we call the setting was subpar. So what happens is the branch grows these flowers, and then those become pollinated and turn into fruits. They set into a bean. But much less of those flowers turned into juvenile beans than expected.

So now we have a massive deficit in the current year that we're already in, and the bumper crop that we were looking to save this deficit, to solve the deficit, has now been severely compromised by frost. So that's the supply and demand issue, but we had other factors as well that went into that. You know, we've been talking a lot about inflation, right? That's been certainly a factor. And we saw that coffee largely rallied into dollar weakness, you know, last the earlier part of this year, along with many other commodities. And it's really kind of never looked back. You know, people are always, it's like people hear these supply side explanations and weather in particular. And I feel like it's almost unsatisfying to them.

And what you said is like totally makes sense. But they're like, yeah, but sure, certainly there might. must be like some big macro story. And you mentioned the dollar a little bit. I'm curious if there's any sort of demand element. And I'm thinking specifically in two ways. Like one is A, has there been any change in overall volume demand? But B, did the shift in particularly the developed world in say Europe, or really all over the world from offices where people obviously consume a lot of coffee to to working from home, did that change coffee buying behavior at all in terms of what kind of coffee people drink? And did that have any sort of ripple effects on the overall market?

Yeah, absolutely. And, you know, there's a reason that we look at the supply side over the demand side, I think, at least in coffee. And that's because the supply side is volatile and the demand side is relatively static. So I always teach in my classes that, you know, coffee has inelastic demand and it also has inelastic supply generally. And that's why it's so volatile because because it's a tree crop, you can't just plant more if prices are high. You have to plant that crop in several years earlier. And so this exacerbates moves on either side. So, you know, prices are high. You plant a bunch of new trees. And then three years later, you start getting the supply from that point. So then you can get a massive oversupply at that point. But to

To your point about demand, the initial reaction back in when COVID first became, people first realized that COVID was going to be here to stay and was going to be a problem was a sell-off. The initial reaction was this is going to destroy demand. Now, that was true. And I'll tell you why in a second. But before I do, in general, coffee has very inelastic demand. And that's because if you're walking down the street and someone is like, hey, coffee, free coffee. You might say, oh, great, I'll take a cup of coffee, right? And then you walk a few more feet and someone says, hey, free coffee. You'd say, no, thanks. I already have one. Right. You drink one or two cups of coffee a day or whatever.

Whatever it is that you drink, whether the price is $10 or $1, right? That's just, it's very, there's not a lot of substitutions for it. You're not like, oh, should I have a Coke or should I have a coffee? You have your coffees, you know, a set amount of them no matter what. Now, where the demand does have some wiggle room and some play, one of the major ones is an out-of-home consumption. When Starbucks charges you $10 for a latte or whatever it is, then you might, if times or tough, you might say, I can't afford that.

I'm just going to buy the Cafe Bustello at the local bodega, and that's how I'm going to have my coffee. So the overall demand tends not to move that much, but you might shift. where you're buying it. And when we had COVID and the lockdowns, that created an intense shift from out-of-home consumption, where the business of coffee shops was all but destroyed, to grocery store, where that was suddenly where, or Amazon or whatever, you know, digital subscriptions. And that was really the model now where people had to consume their coffee. But more than that, the other sort of hidden demand that was destroyed was the sort of social demand for coffee.

You mentioned office coffee, right? So whereas normally you would have had to go to the office and you make a brew of pot of coffee and then you brew a second pot of coffee and if no one drinks it, you dump it down the drain, right? Or you go to a wedding and they might brew a couple of big vats of coffee and then they dump down the drain what people don't consume. So all of these sort of of out-of-home events or industry events, right? You know, people stopped going to industry events for a while. So all of that demand from catering and from coffee shops was pretty much destroyed. So what happens when coffee prices go a lot higher? Like, A, how are the costs actually absorbed or passed on? And then B, do you see a lot of people maybe switching from high-quality

coffee beans like arabica to something cheaper to try to offset that price increase? Oh yeah, absolutely. So you see, you definitely see switching. Like I mentioned, total demand doesn't tend to change that much, but you definitely see switching from different varieties. The COVID really hurt the specialty coffee business. That has been something that have been growing tremendously for the last 20 years, as I mentioned. You know, there was a large group of people who enjoyed going to these specialty coffee shops and using a chemics or, you know, a special pourover type of delivery system and drinking these single origin fine coffees. That all kind of went away and a lot of that was lost.

But more generally, if you're talking about large price increases and how are you switching? Well, you have the switch in both destination markets and in origin. So in origin, the producing countries tend to drink locally and consume the cheaper qualities of coffee and export the higher qualities that are more valuable. So in Brazil, for example, they produce both Arabica and Robusta. So with the high prices of Arabica, what you'll see is that the local consumption will shift towards Robusta and they will export. less robusta and more arabica. So we'll see that shift there. But also on the consumption side,

there's plenty of companies and businesses that do 100% Arabica. And so they can't really shift that split, although they will shift to cheaper versions of Arabica if they need to. But many companies just put out like a breakfast blend or, you know, their French roast or whatever. And they don't specify where that coffee is coming from. And so then they're really selling more of a flavor profile. And then it's just a matter of optimizing cost versus flavor when prices are expensive.

Is the Arabica Robusta spread? Like, is that a thing you trade? Yeah, for sure. So there is the, we call it the ARB, even though it's not really an arbitrage. There's sort of two different products. But that's what we call the ARB. So the ARB tends to have a nice little range when things are calm. You know, maybe something like 40 to 60 cents or something like that would be the typical Arabica arbitrage.

But when Arabica goes nuts, that ARBT tends to just sort of disappear and just become the price of Arabica. Because Arabica tends to outpace robustness so steeply that it ceases to have that sort of range bound nature. and just tends to have, I don't know how into options you are, but it tends to have a same delta as a rabbit go. So is trading coffee, you know, given all that volatility that you just laid out and given these different spreads between different types of coffee bean, is trading coffee fun and lucrative? Should we all be going into the coffee trading business? All become coffee people.

You might have to take a couple of courses first at the coffee trading academy, but, No, they say it's not true, it's a myth, but they say that coffee is the second most traded commodity in the world for exactly that reason. It's because it is fun. I love the coffee business. It's very interesting. If you travel to do crop tours, you're going to sort of interesting and exciting places to learn about it. But from a lucrative, speculative point of view, there is volatility in coffee. And volatility. is how you make or in many cases lose money, right? But you need that volatility to be able to trade. So what we call the tourist's interest in coffee is heavy. There's a lot of people who are not necessarily coffee people, don't necessarily have a coffee background, but like to trade coffee, both sort of technical analysts

and sort of amateur or armchair fundamental traders. And there's plenty of good ones too. There's plenty of people who are just sort of part-time specs who make money and coffee. Interestingly enough, I only got into Twitter for my business, but in the Twitter sphere, the financial Twitter sphere, there is a lot of heated discussion on the coffee market and what's going on there. You can get the news whenever you want it with Bloomberg News Now. I'm Amy Morris. And I'm Karen Moscow here to tell you about our new on-demand news report, delivered right to your podcast.

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Get the reporting and the context from Bloomberg's 3,000 journalists and analysts we're all over the world. Listen to the latest from Bloomberg News Now on Apple, Spotify, or anywhere you listen. Something I'm curious about is like, okay, we've talked about Arabic on Rubusta, but I think there's other types of coffee. And I'm sort of curious, like, you know, more specialized beans or like Kona. I was in Hawaii and I had Kona coffee there. And then I know also like fairly traded coffee, which I imagine has something of a different market structure.

Let's say like I want to sell in volume Kona coffee in New York. Can I predictably use the futures markets for say Arabica as a hedge as a hedging instrument, even if my end need isn't Arabica? Like is there enough relationship generally between the price where these instruments will be of use to me, regardless of whether I'm actually selling arabica. Well, that's a great question. And, you know, the unfortunate answer is that it depends, right? So, 99% of coffee is either Arabica or Robusta.

Okay. There is a tiny proportion of coffee that is some sort of ancillary species like Liberica, which is sort of a much larger coffee tree. And I've only ever seen that once. And that was people used them sort of to border their plantations. So they just kind of created a sort of a tree border around their plantation that also produced a little bit of coffee. But they're not efficient and they don't produce good tasting coffee. So almost all of it is arabica or robusta.

Now, where you see the specialization is really an origin. So it's really, if you're talking about kona coffee, You're talking about Arabica that's produced in Kona. That's produced there. And other people, like you might, I personally always buy 100% Colombian. That's my personal coffee that I really like. And the secret before you, you doesn't have to be expensive Colombian coffee. If you can just go buy the can of 100% Colombian, it's usually going to be pretty decent.

So most Arabica coffees have a good correlation with. with the futures market. Now, each will have a differential based on how in demand, really, that origin is versus the overall market. Because the futures market is really made up of a basket of what we call milds, so those would be washed coffees. So the futures market that we look at is sort of like an average of Arabicas, right, of a certain group of arabicas.

If you look at Colombians, they tend to be, say, you know, 10 or 20 cents more than that. Right now, they're more like 55 or 60 cents more just because of supply and demand issues. If you look at something like Kona coffee, you have almost zero correlation with the futures market because that is such a tiny area of production and such a highly sought after coffee that it's always going to be like $4 or $5 per pound. I'm just making that number up. So even if the futures market is rallying heavily, that price tends to be sticky. Same with Kenyan coffee. Kenyon coffees are often like 100 cents more than the futures market.

So for those sort of very outlier specialty coffees, it's probably not going to make a lot of sense to use a futures market to hedge it. But for the bulk of coffees, for say the 80, 20 or the 90% it definitely would make sense. Can we go back to something you said in the very beginning about large multinationals having hedge funds that profit off of the information flow? And it kind of reminded me of, I guess, Goldman Sachs pre-Vulker rule, sort of pre-financial crisis, where it could have a very lucrative internal trading desk that,

traded for its own account. And it used its sort of position in the market, looking at the flow, going through it to help it make trading decisions. Is that sort of what's going on here with coffee? I would differentiate, first of all, between, say, a consuming company and a trading company. Okay. This is somewhat of an arbitrary distinction because no matter who's trading coffee, you're, and this is something I was taught from day one as a trader, is you're always speculating, right? If you don't buy, you're speculating that that's, you know, a good decision. If you, if you're buying now, then you're essentially bullish. If you're selling more than, than you're buying, then you're bearish, right? So no matter who you are in the supply chain,

you're always speculating somehow in your interaction with the futures market. So if you are an exporter, for example. Exporters will trade sort of a prop book, usually. They, you know, different companies have different rules on internally for managing their price risk. But, you know, let's say you're just a normal local exporter. You buy coffee locally and then you sell it for export. So what they would normally do if they're a differential trader is they would buy coffee locally and local currency from the farmers and the producers. And then they would immediately sell futures against that in the futures market. And that would create a differential position. So they would have, say the current futures price is $2 and they're buying coffee at $2.30

cents per pound. So they buy coffee locally at $2.30 cents per pound. They sell a future against it at $2 per pound. So they would have, they would be buying coffee for 30 cents over and they've locked in that differential, right? Then when they export that coffee, they sell it to another company and maybe that company buys it for 32 cents over the market, right? And then they would lift their hedge and sell that coffee to that company. Now, if that exporter is smart and they know that prices are going to rally, they know that, let's say you're a Brazilian exporter, and you know you need to buy coffee for your business, and you know that the crop is going to be small this year and the market's going to go nuts, then maybe you would buy futures ahead of time so that when you're

ready to buy physical, you can sell out those futures and make some profit. Or maybe you wouldn't hedge it right away. Maybe you would buy that physical from the farmers. And then rather than just immediately turning around and selling futures against it to lock in your hedge, you might wait for it to rally another five or ten cents and then lock in your hedge. So that's how they're going to be sort of speculating in that market. And the consumers are going to do the same thing on their side. It's sort of the opposite. They'll be buying or selling futures or options to protect their books and protect their hedges in different ways.

But the trade themselves sometimes have a hedge fund that's either, or a prop desk that's either part of the company itself or sort of shares a parent company and share information but have sort of Chinese walls and separations. And so they are straight up, you know, I don't want to say gambling, but, you know, speculating without a physical position in those markets. That honestly makes a lot of sense and I think is good for the market because they have insights into what the supply and demand is going to be. And so it is better for the market, if we know there's going to be a shortage for the market to start rallying now and repricing to what the proper price of coffee should be, to the levels that are going to incentivize production.

You want that to happen as soon as possible. And the opposite is true on the other side, right? When coffee is vastly oversupplied, you need to push the prices down to a point that's going to disincentivize production. You know, we talk about, okay, the price of these commodity coffee futures, right? roughly having doubled in the last year. How volatile is the end price of, say, you know, like, I let's say I buy coffee at Starbucks, or actually I typically buy coffee at Dunkin' Donuts when I buy a cup out there.

Like, how much is the bean in that price versus, you know, all the other things like the labor of staff at Dunkin' Donuts and so forth? It's a great question, and it's always a little bit controversial because coffee is one of the most socially conscious commodities out there. I think just by nature of the consumer. I mean, historically, they say that coffee houses created the Enlightenment back in the 17th century. Before that, everyone went to the pub. Once people started making coffee houses, they were sober enough to actually sit up and talk and think with each other.

So that tradition has carried on to today where if you have coffee houses, the consumer of coffee tends to be sort of conscientious. And they tend to care about where their beans come from. That's not true entirely. It's not true across the board. Some people just wake up and they want their cup of coffee and that's fine. But that sort of culture has spilled over into the demand side. You mentioned fair trade coffee before. That's something that basically came out of this coffee culture and this desire to ensure that there is sort of equitable treatment of farmers and everything. Because of that demand for it, that is spilled into the trade. So the trade has to facilitate sustainable practices. Something that was pioneered in the coffee industry is what we call certified coffee, which is where you have fair trade or rainforest alliance or Oots or whatever, where you have to actually certify that these certain practices are being met, you know, in order to sell your coffee in that way.

So to answer your question, so that's why it's a little bit controversial, because when we look at the price of coffee versus what you have in a coffee shop, and I just saw an infographic about this the other day that was put out by the Financial Times, then it's pretty depressing because you say for a cup of coffee that costs, say, $5, maybe about 20 cents of that is going to the grower. I don't think that that's necessarily inappropriate because a lot of the costs are heavier on the shop side. For example, if you offer free milk with your coffee,

that often has almost the same price as a commodity to coffee. So that's going to be one portion of your costs. The rent for your coffee shop is going to be something like nine times your cost to buy the coffee beans. If you have staff, that's going to be something like six times the cost of your coffee beans, right? Then you have taxes, right? That's four times the cost of those coffee beans. So you have all of these different costs that really are built into the price of that cup of coffee, which feels unfair, you know, in a lot of ways to that, to that grower. And, you know, there's a lot of people who have dedicated their lives to ensuring that the grower gets more of that.

And, you know, I think that's a very, that's a very popular industry in the coffee world is facilitating that. But I think what really sort of irks people about it is that it feels. like a cup of coffee is almost like a direct commodity, right? It feels like, oh, you know, if you buy an orange in the store, like most of the price for that orange should go to the grower of the orange, right? Same thing if you buy a cup of coffee, you feel like it's coffee. It shouldn't, you know, require anything but money to the grower. But it really requires a whole lot of capital aside from that, that initial bean. That a bean is part of it. But you have to On top of, you know, once that bean just gets sent to the exporter, then you have a huge capital

equipment cost to process it, right? All of those wet mills and dry mills we mentioned, those are big intensive machinery. Then you have to process and transport it, right? We've all seen the prices. If you looked at the Baltic Dry Index or something, you've seen the prices of shipping, how much of that goes into it. Once it comes to the destination market, the roaster has a huge amounts of costs. energy costs and capital equipment costs to turn that green bean into a brown bean. And then once it

gets to the shop, right, that shop owner has to pay their staff. They have to pay health insurance. They have to pay taxes. So there is really a whole unseen sort of supply chain of costs that go into that. Yeah. It sounds a bit like oil, right? Where there's a huge outlay for capital and exploration, and then, of course, you have the refining process and all of that actually goes into the cost of the end product. Ryan, I want to ask you the obvious question here, which is how long would we expect these high prices to persist? And I ask because lots of people seem to be suggesting that this is going to be a longer term issue, but we're actually recording this episode on the day that the U.S. Department of Agriculture just released its latest coffee report,

which is a thing that I didn't know existed. And the department just increased its estimate for world coffee output. So coffee prices are falling, at least for today. So I guess the question is, is this a turning point? Or would you expect price pressures to be with us for some time? So I would, I'm a fundamentalist. And the reason that coffee price, are high, I believe, are because of supply and demand issues. And we are in the midst of those supply and demand issues now. Historically, if you look at the price of coffee on a 50-year chart or 100-year chart or something, you'll see that it looks almost like an EKG, right? You know, like that machine that goes beep in the hospital. You have these spikes, then it comes down

and rests for a minute. And then it has a spike, and it comes down and rests for a minute. And it tends to do that between $1 and $3. So $250 is. is as my boss, or 225, as my old boss used to say at the hedge fund, it's kind of half pregnant. It's not really, hasn't really hit that full $3. This is a major problem mark that we typically expect from coffee. Now, I don't know if it's going to actually go there or not. Maybe we've solved the supply issues already. But it doesn't seem like that.

It seems more like, and the USDA is great for things like corn and wheat and, especially those U.S. centric markets. It's not, the people in the coffee world don't pay a ton of attention to it. It's not, it's not necessarily market moving. But if you look to the people in the know right now, it's all about revising down Brazil estimates for this coming crop. And that's really what it's all about. We're in the deficit market right now.

That's for sure. Now, the question is, will 22 be balanced, a little bit of a surplus, or a deficit. And there are some people saying that it's going to be a massive deficit. They're kind of outliers. I think the consensus is more for a modest deficit, a moderate deficit, which is no small thing on the back of a big deficit, right, especially when you were expecting a surplus after that. So that tightness should in theory continue into the next deficit year. But the real estimates, so right now, we're in the... the cycle of Brazil where the flowering has happened, the setting has happened, but the beans are

really too small to really be able to get an accurate count and gauge yet of what that crop's going to be. But in January, we should be able to get a more accurate count. We'll start to see the real estimates coming out as to what that crop will be, and that's largely going to determine the direction, the price of coffee. Ryan, thank you so much for coming on Oddlots. I just learned a ton about coffee and really appreciate you joining us. My pleasure. Yeah, thanks for having me. Thanks so much, Ryan. That was great. Thank you so much, Ryan. Tracy, you know, I know people get frustrated a little bit about all these sort of like weather and idiosyncratic explanations because they think like, oh, surely it must be all about the Fed or inflation or something like that.

But it really does feel like coffee, especially as he described in the beginning, like, yeah, it's really about like a bunch of weird weather stuff and a lot of it, particularly in Brazil. Yeah. I mean, it does seem like we've had these events where a confluence of different factors come together to create, as Ryan said, the perfect storm for a lot of commodity prices recently. But I guess on the other hand, you might expect that to happen, given that we've just had a global pandemic, which has really upended the way we do things normally. Right. A pandemic isn't technically a storm, but if you, you know, you don't have to, you don't have to extend that. metaphor or that analogy like too widely to say like how we could use the term perfect storm and have it encompass that. Of course, as Ryan pointed out, you know, there's energy prices go into coffee. He mentioned the Baltic Dry Index and shipping. So all of these things getting

jostled or whacked at once. Yeah, like of course, like it's going to happen even in coffee at the, you know, in the middle or, you know, the later stages, hopefully of a pandemic. whackflation strikes again. Actually, there's one thing, I'm bummed I didn't ask Ryan this, but I wanted to ask how much of the buying that we've seen over the past year that's helping to push up prices, how much of that is people buying in order to pad their inventories just in case they can't get coffee beans in the future? Because again, this is an issue that we see in lots of different commodities, this bullwip effect, where businesses, people find it difficult to balance their ordering with actual demand. And so you get

these big swings in inventory and then a big swing in the price as well. So I'm curious whether or not that's coming into play. But I guess I'll have to DM Ryan on coffee Twitter. Yeah, we can write a follow up blog post on that for the blog. But yeah, I mean, you know, as you pointed out, like everyone in the industry more or less has some reason to have a prop book on the side, or as you put it, like everyone is also kind of speculating as well. And so if there are these concerns, I thought that was really interesting about actually the lack of sensitivity on the supply side for tree-grown crops versus other kinds of crops. So obviously, you know, we talked about, you know, you talk about like corn and rice and soy.

And if it looks like the price is surging, then a farmer could say, oh, I'm just going to like reallocate more of my, my acreage next year to soy or corn or whatever it is. That's a really interesting distinction that I had never thought about, that that's inherently impossible with a tree grown crop that is going to have a minimum, like, say, like two or three year cycle before that tree bears fruit. And it would be kind of interesting. Like, I hadn't thought about that at all. But, you know, like, watching the next two years, now I'm going to like, oh, do about the sort of like the supply sensitivity to crops or two. any commodity in which there is that longer, longer lead time on the supply zone.

Definitely. Joe, what's the, what's the best coffee that you've ever had? Oh, good question. It is probably just like at a 7-Eleven or a Dunkin Donuts somewhere in a styrofoam cup. Like to me, you know, like on a road trip, a big cup, like a really big cup of coffee, sort of just like hits the spot. What about you? What you probably have, knowing you, you probably have like some very specific bean that you seek out when you're in some city. No, no, no, no.

I'm not like, I'm not a coffee snob. I like plain black coffee as well. But I would say probably the best coffee I've ever had was in Vietnam. I had one of those egg cream coffees that has like an egg mixed into it. That was so good. You are a chocolate snob, though, right? No, not really. I am an equal opportunity chocolate consumer. I like all the chocolate, like from, from Hershey's all the way up to the very fancy stuff. All right. Well, anyway, plenty more to talk about. We'll have Ryan back on next year to talk about what happens if supply and demand normalized. And we'll be watching those January bean reports from Brazil.

Yeah. All right. Shall we leave it there? Let's leave it there. All right. This has been another episode of the Odd Thoughts podcast. I'm Tracy Allaway. You can follow me on Twitter at Tracy Allaway. And I'm Jill Wisenthal. You can follow me on Twitter at The Stallwart. Follow our guest on Twitter, Ryan Delaney. He's at Coffee Ninja Ryan. Follow our producer, Laura Carlson. She's at Laura M. Carlson. Follow the Bloomberg head of podcast, Francesca Levy, at Francesca Today. And check out all of our podcasts at Bloomberg under the handle at podcast. Thanks for listening. I'm Francine Lacquhar, an award-winning journalist, and I've got a new podcast, Leaders with Francien Laquois from Bloomberg Podcasts. I've interviewed everyone from Heads of State to fashion icons about the news of the moment.

But I've always been curious, who are these people as leaders? I don't think there's one right way to be a leader. Make decisions. A poor decision is always better than no decision. Listen to new episodes every other Monday. Follow leaders with Francine Lacroix wherever you get your podcasts.