Internal Consumption Strengthens Brazil’s Coffee Market Clout

By Marvin G. Perez

Brazil’s coffee growers are enjoying the best of times—almost.

With the country’s economy among the fastest-growing in the world and with demand for its agricultural crops on a tear, Brazilian coffee farmers could see further happy times, especially as global demand for their beans remains strong and world-wide weather woes are encouraging non-traditional buyers of premium coffee to turn to the South Americans to meet their supply needs. Soaring internal demand is also helping the country’s farmers, who can either sell to local industries or abroad, with foreign demand coming from other exporting countries as well as consuming nations.

However, not all growers are benefitting from the coffee price boom and there are labor and currency challenges confronting the sector.

According to local analysts, producers who improved the quality of their coffees over the last few years are enjoying the bonanza, but many are not, as the country’s high quality beans remains limited to about 8–10 percent of the total production. With 24-hour news and information available, farmers are savvy and know when to sell and when to hold back.

“Producers now know what’s happening in the market…they know the prices, they know the premiums, the contests,” says Celso Vegro, professor and researcher at the Sao Paulo-based Institute of Agricultural Economics, IEA.

Events like the Cup of Excellence competition and other local cupping challenges have enabled local producers and buyers to come together, allowing for a more transparent price- discovery mechanism, exposing many growers to the premium sector of the market.

This has put the South American giant in an enviable spot, one where farmers can’t get products to markets fast enough to satisfy the world’s appetite for its crops. Prices are rising and land values are increasing as well, a reflection of a global trend of shrinking arable land and population growth. The rising price of arable land might be one of the biggest factors, as Brazil is the world’s leading producer of sugarcane, orange juice and coffee, and ranks amongst top producers of cotton and soybeans, corn and other raw materials, all of which compete for land.

INTERNAL PRICES COMMAND PREMIUM OVER NEW YORK

In early February, internal coffee prices in Brazil briefly started trading at a premium over New York’s futures prices, when historically the opposite has been the case. That illustrates the tight relationship between demand and supply in the world’s largest coffee market.

On a continuation basis, Arabica coffee prices hit fresh 14-year highs in mid-February. That level represented 34-year highs for the second contract position at the ICE futures exchange in New York. And the evolution of crude oil prices, which are hovering $100/barrel amid the Mideast unrest. The fact that futures prices in Brazil briefly rose above New York’s raised some eyebrows among seasoned coffee traders, some of whom argue that the behavior of Brazilian growers has been “irresponsible” in some cases, as they appeared to have sold more than what they had. For others, producers simply have seen more demand for their beans than is actually estimated.

“The only logical conclusion is that Brazil is seriously oversold, which seems rather careless with a 57 million 60-kilo bag crop,” commented a trader with one of the world’s largest trade houses in New York.

Brazil’s 2010/11 crop was officially estimated at nearly 48 million bags, a figure challenged by seasoned traders, who argue that with the country exporting 33 million bags and consuming 19.4 million bags last year, production remains underestimated by the National Commodity Supply agency, Conab. But that would be oversimplification of what’s happening at the South American giant.

CONSUMPTION GROWING FAST  

World total coffee consumption in 2010 is estimated around 131 million bags compared to 130 million bags in 2009. Indeed, global consumption has increased from 104 million bags in 2001, or about 2.6 percent per year, while global production has alternated between a cycle of high output followed by a smaller one, and typically is the result of Brazil’s biennial Arabica crop output.

Brazil’s consumption alone jumped almost 50 percent from 2000–2010, and now represents close to 16 percent of the world’s total and 50 percent of the total consumption in exporting countries. Indeed, Brazil is expected to become the world’s largest coffee consumer, overtaking the U.S., over the next three years. Because of weather woes in other countries, mainly Central America and Colombia over the last two seasons, Brazil has also become a growing supplier of coffees to those regions. Data from the Brazilian Coffee Council shows exports to Central America increased 17 percent last year, illustrating its growing clout in the market. Colombia has also been buying coffee from Brazil and Peru, following three years of poor crops.

WORLD CONSUMPTION BOUNCING

Meanwhile, after being hit by the financial crisis of 2008, total global demand for coffee is also on the mend, while production has been restrained by weather problems, limited land available for crops and the vagaries of Brazil’s biennial nature of its arabica crop, which alternates between a low-production cycle followed by a high-one.
According to data from the International Coffee Organization, consumption in the five leading importing countries (France, Germany, Italy, Japan and the United States) bounced to 37.3 million bags during the period January to September 2010, as compared with 36.5 million bags for the same period the previous year.

Brazil’s consumption is expected to rise in 2011 to 20.3 million from 19.5 million bags last year, continuing a trend started more than 10 years ago, when sound economic policies kicked off the current economic boom, powered largely by its commodity export prowess. A smaller crop this year and inventories near all-time lows means there’s very little room for maneuvering should a weather event or any other development disrupt flows out of the world’s largest producer and exporter of the commodity.

PRODUCTION LAGS IN OTHER COUNTRIES  

Elsewhere, production is expected to be slightly lower in Vietnam, while significantly lower output is anticipated in Indonesia and several other exporting countries as a result of unfavorable weather conditions. Colombia will find it difficult to recover its former production level since many coffee trees have been affected by coffee leaf rust and access to appropriate treatment is limited by the high cost of inputs, noted the International Coffee Organization recently.

The situation is complicated by the fact that consumption is growing rapidly in Vietnam and Indonesia, numbers 2 and 3 in global production respectively, reducing the coffees available for international buyers. In 2009, consumption in Vietnam grew 18 percent to almost 1.2 million tons.

Market fundamentals continue to be favorable to the support of high price levels. “Adverse weather is still disrupting harvesting and transportation in many exporting countries and affecting short-term coffee supplies,” said the ICO executive director Jose Sette recently, adding however that better crops in Ethiopia and some other African countries led to an upward revision for world production in crop year 2010/11 to around 134.6 million bags from 122.8 million in 2009/10.

FEW CHALLENGES FOR BRAZIL AHEAD 

Although Brazil’s growers generated record coffee export income in 2010 at $5.3 billion, a stronger local currency has reduced total returns in local currency. The Brazilian Real has appreciated 38 percent over the last two years, the best performing currency amongst emerging markets. Meanwhile, rising minimum wages could slice into producers’ returns. The country’s monthly minimum wage rose 62 percent in Real terms under the administration of Luiz Inacio Lula da Silva.

Brazil’s President Dilma Rousseff’s administration has “deep concerns” over the strength of the real and rising wages and may take trade measures to protect domestic manufacturers, Trade Minister Fernando Pimentel said in early February. Rousseff has said she favors lifting wages an additional 6.8 percent this year to 545 reais ($327) using a formula set by the unions and Lula in 2006. Unions want a higher increase, which could wreak havoc for employers. As a result, inflation has reared its head there as elsewhere in Latin America. Ravaged by hyperinflation of more than 2,000 percent as recently as 1994, Brazil has also has become increasingly concerned that inflation will exceed 5.5 percent this year.

Marvin G. Perez is a business writer and consultant and has been covering world financial markets for almost 15 years. He has been a guest speaker at CNBC Business News Channel in New York and a frequent speaker at top world commodity conferences. His articles have appeared on Dow Jones Newswires, Barron’s, The Wall Street Journal and on online- based news outlets, including SugarNetwork and CoffeeNetwork. He can be reached at marvinperez@gmail.com and his comments on Twitter @coffeemarkets.

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