What Drives Coffee Prices?

Joel Anderson |

“Do you have any idea what a cup of coffee cost in my day?”

Thus goes one of the standard curmudgeonly refrains against the culture of premium coffee that rose out of the 1990s, turning coffee from something cheap and simple to a gourmet beverage. And while you may yearn for the days when coffee was a nickel a cup, it’s clear that they’re not going to return any time soon.

But while the rise of Starbucks (SBUX) may seem like the biggest shift in the coffee economy since Bill Clinton took office, depending on one’s perspective, it’s dwarfed by Vietnam’s entry into the coffee market in 1994. It won’t surprise many people to know that Brazil is the leading producer of coffee in the world. But did you know that Vietnam’s number two with a bullet? The Southeast Asian nation, despite only being in the game for two decades, is producing 450 million more pounds of coffee a year than Ivory Coast (the number three producer in the world) and more than six times as much coffee as Colombia, a country known for its coffee.

If you weren’t aware that a significant portion of the coffee you drink was coming from Vietnam, don’t sweat it. Unless you’re a commodities trader, it’s entirely possible that this wasn’t on your radar. However, it does raise a pretty interesting question: why does your cup of coffee cost what it does?

Arabica vs. Robusta

There are two main varietals of coffee bean, and knowing the different between the two is essential to understanding the basic economics of coffee trading.

Arabica beans come from the coffea arabica plant. Arabica beans are generally held in much higher regard than other varietals, offering more flavor and better body. Robusta beans, from the coffea caephora plant, are typically viewed as being of inferior quality. However, robusta beans have a number of characteristics that make them attractive to coffee growers. The plants are hardier and less susceptible to pests and diseases, like the dreaded coffee leaf rust to which arabica plants are particularly vulnerable. They can also grow at lower altitudes and warmer temperatures.

And growing robusta beans isn’t without certain benefits for coffee drinkers, too. Robusta beans have 40-50 percent more caffeine than arabica beans, and the beans are more bitter, which can appeal to certain palettes. Top quality robusta seeds are used exclusively for Italian espresso because they produce a full-bodied taste and a better head of foam.

However, in the end, global tastes trend towards the arabica. Global coffee production is about 75 percent arabica, and robusta beans are most often used as a part of blends.

Coffee Producers

As stated above, the dominant coffee producing country in the world is Brazil. And by a pretty sizeable margin. With production reaching 5.6 billion pounds a year, it’s at nearly double the next biggest producer (Vietnam), and more than the next four biggest producers in the world (Vietnam, Ivory Coast, Indonesia, and Ethiopia) combined. Brazil’s crop is primarily arabica, and the country has long been the dominant coffee producer. While Vietnam’s rise has been rapid and recent, Brazil’s always been there at the top.

However, Vietnam’s rapid expansion of its coffee industry has resulted in a change in the coffee-producing landscape. Vietnam has actually been producing coffee since it was introduced by the French in 1857, but production was interrupted by the Vietnam War. Its resurrection in the mid-1990s (coffee production in Vietnam tripled between 1995 and 1999) was driven by the production of robusta beans.

Coffee remains a commodities market with many players, though. There are 22 counties producing more than 100 million pounds of coffee a year.

Different Markets for Specialty Coffee

One might wonder how, with so much coffee out there and so many different countries producing it, it can still wind up costing $5 a cup at Starbucks. Well, for starters, the fancy lattes at Starbucks are getting a pretty substantial mark-up over the price of their ingredients. But the coffee market is also more complicated than simply supply and demand.

Different countries and varietals are all coveted to different degrees by different coffee drinkers. The island of Jamaica may only produce 4 million pounds of coffee a year, but for those in the know, Jamaican Blue Mountain Coffee is some of the most highly prized coffee in the world. The gourmet coffee market is fundamentally different than the market at the whole, and that drives a fundamentally different market. Starbucks, for instance, purchases all of its coffee beans outside normal commodities exchanges, signing multi-year deals with growers that pay as much as twice what coffee is priced at on the open market. This is consistent with the specialty coffee market where beans are distinguished by quality and region. Coffee from Java, Kona, or Colombia can be sold at prices much higher than blends incorporating lower-quality beans from a variety of locations.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

Companies

Symbol Name Price Change % Volume
SBUX Starbucks Corporation 57.46 -0.04 -0.07 5,040,456
GDNDF Sokoman Iron Corp Ord 0.03 0.00 13.40 17,000

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