Daily Management Review

Drought in Brazil throws the coffee market into a panic


Coffee futures are rapidly becoming more expensive due to decline in production of the world's largest exporters and reducing stocks of grains. The best part of your morning may soon become more expensive, as coffee futures’ cost is climbing higher. Last year, Brazilian regions have been affected by drought, and the region is still experiencing water shortages. State of Espírito Santo, the main region growing robusta, hasn’t seen rain almost a month. Drought has become so severe that the government had to impose restrictions on use of river water for irrigation.

Investors fear that supply of coffee might fall. Price of Robusta, which is used primarily in production of instant coffee, has risen to almost four-year high at the London Mercantile Exchange. Arabica’s price has been affected, too. From the beginning of 2017, futures for the more fragrant cultivar showed the most significant growth among Bloomberg Commodity Index. Last week, hedge funds raised bets on the coffee market rally for the first time in two months.

Harish Sundaresh, portfolio manager and commodity analyst at investment group Loomis Sayles Alpha Strategies, says: "The bullish sentiment has so many reasons. We start the year with a very low level of stocks and rate of production in the main growing regions of coffee, Brazil and Vietnam, are expected to be lower."

As follows from report of the The U.S. Commodity Futures Trading Commission, a week from 3 to 10 January net long open positions in arabica coffee rose by 60% to 13,565 futures and options. This is the largest increase since June last year. Prices on the U.S. stock exchange ICE Futures last week jumped 4.5% to $ 1.493 per pound, which was the most significant growth since October. Robusta futures on the London Mercantile Exchange rose 2.9% last week.

Robusta crop in Brazil, which is the largest producer and exporter of coffee in the world, fell to the lowest level in the last ten years. Robusta futures showed 40% year-to-year jump, while Arabica has grown by 8.2%.

Demand for arabica is climbing higher, and coffee stocks, according to the ICE, have been falling for 13 consecutive quarters. This is the longest decline since 1995, when data first began to be recorded; stocks now are close to the lowest level since 2000.

Falling supplies lead to increase in retail prices. In the last week, J.M. Smucker Co. said it is going to raise prices for most of its coffee products in the United States. The company owns coffee brand Folgers, which for many years has been bestseller in the United States.

Although the drought has hit robusta-growing regions hard, weather was generally favorable for harvest of Arabica in Brazil. This fact can provide the coffee industry with a kind of safety net. The government estimates that farmers have collected a record harvest of Arabica beans during the current season. Citigroup Inc. last week raised its forecast of world production for the season by about 3 million bags to 148.2 million, and also noted good prospects for Colombia.

However, crop of coffee is subject to a two-year cycle, and most of Brazilian Arabica plantations enters its lower stage in May. Last week, research unit of the University of São Paulo published a report, according to which the crop in the next season can be reduced by as much as 30%.

At the same time, the summer heat can only exacerbate the drought, so apparently plantations of robusta are going to be affected. Since January 1, average daily maximum temperature in the growing areas for production of Espírito Santo was 32.9 Celsius degrees, says Olivia Nunez, meteorologist forecaster at SOMAR Meteorologia. It is almost 2 degrees above the historical average.

source: bloomberg.com

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