Starting the Price Risk Management Conversation re:Coffee

Coffee is the developing world's biggest trading commodity, with annual export quantity varying in the range of 4.8 to 5.4 million metric tons and export value varying in the range of US$ 5 to 12 billion over the period 1997 to 2005 (ICO, 2006). Coffee is almost entirely produced in developing countries and mostly consumed in the developed world. A key feature of the world coffee market has been the substantial short-term fluctuations in coffee prices, both at the level of international markets as well as markets relevant for coffee producers. This exposes producers to high levels of price risk.

The initiation of economic reforms in developing countries in the late 1980s resulted in countries liberalising their coffee sector by replacing state-controlled marketing systems with markets run by private agents. The reforms are expected to bring clear benefits to producers from introduction of more efficient markets, but they also give rise to new problems, the most important being that price risk is thrown back onto the local producers and intermediaries, who are ill equipped to deal with it. Price risk poses a greater problem for them because they lack market power, due to their sheer numbers and wide geographic spread, and have limited ability to hedge their risk exposure. Therefore, how to best manage the negative consequences of volatile markets for producers remains a key issue for governments and policy makers.

The increasing globalisation of commodity markets and the introduction of new information technology provide new opportunities for commodity producers and exporters in remote parts of the world to make efficient use of commodity-linked financial risk management instruments like futures and options for hedging their price risks.

The Fair Trade pricing structure sought to increase PRM by artificially elevating the price at $500 above the NYSE price for cocoa beans. Because this was an arbitrary measure, the elevated price effected supply and demand in the market by causing an artificially high demand where it did not actually exist. The following interview is with a coop investment company called Sustainable Harvest and looks at how training cooperatives to respond dynamically to price fluctuations creates overall better profits during boom and bust price cycles.