Coffee futures

Coffee futures:
the basics for coffee roasters

Coffee what? Coffee futures. Futures are predefined contracts that allow buyers and sellers to agree on a transaction price of a predetermined quantity of coffee at various points in the future. Even if you only buy the finest specialty coffees, a comprehensive understanding of the coffee futures market can help illustrate the mechanics of the coffee industry.

For the sake of this article, we will discuss the ICE (Intercontinental Exchange) NY arabica market, setting aside the London Robusta market. We’ll dissect the basics of coffee futures, so you won’t have any confusion over coffee futures in the near and foreseeable future. But first, are futures even relevant for you?

Are coffee futures relevant for coffee roasters?

The average specialty roaster probably isn’t trading coffee futures. However, having a fundamental understanding of the market is crucial. Knowing what is happening in the futures market is a great tool you can use to protect your small business.

Think of the futures price as a barometer for your decision making. Is the market down? Well, it probably means there is a decent amount of supply in the market. Does the market look like it’s heading up? Maybe think about booking coffee forward to protect your costs.

But take note, this is not trading advice. As a coffee importer, we just want to make you aware of the mechanics to make the decision that’s best for you. Now back to the inner workings of the market.

The Intercontinental Exchange

The Intercontinental Exchange (ICE) in New York is the center of the arabica trade. The current iteration of the market roots back to 1882, when traders established a more uniform market for price discovery and more importantly, risk management. At the ICE, buyers and sellers use the coffee futures market price to trade green coffee in USD/pound.

Here’s the ICE definition of the coffee futures market.

The Coffee C contract is the world benchmark for Arabica coffee. The contract prices physical delivery of exchange-grade green beans, from one of 20 countries of origin in a licensed warehouse to one of several ports in the U. S. and Europe, with stated premiums/discounts for ports and growths.

How to interpret coffee futures timeslots

Trading is outlined into 14 set time slots (deliver months) to choose from going forward into the future, as far out as 2.5 years. A contract is defined by the coffee symbol (KC), contract month letter (September is ‘U’), and delivery year. For example, a contract for September of 2021 would be KCU21. Because the ICE expresses price in USD per pound, you can easily convert to USD c/kg by multiplying the price by 2.2046. For instance, if today the price was trading at $123c/lb, this would be equal to $271c/Kg.

So what exactly drives the price change on the market?

The coffee market mechanisms that drive the price

At any given point you can see consecutive delivery points (time slots) are usually priced higher, in a forward curve. Since nobody knows the future, it’s open to speculation. External factors play a massive role in price fluctuation.

Think of:

  • The relationship between coffee producing country’s currencies and the US dollar.
  • Interest rates, since future value could be derived from buying and storing coffee for a long time to deliver at some point in the future.
  • As a risk asset, the global macroeconomic picture.
  • Levels of stocks in downstream warehouses.
  • Levels of stocks in origin warehouses.
  • Growth factors. How are the rains looking? Is there a change of frost? Are we on a cyclical on or off-year?

How differentials work in the coffee market

The vast majority of sellers and buyers trade commercial coffee on a differential basis. This is the cost adjustment to account for grade and quality. Buyers and sellers will agree on a price relative to the NY market price to trade coffee.

Colombia, for example, currently trades at a differential of +50c/lb (FOB basis) for generically traded Excelso EP10%. If NY is 123c/lb, that means buyers agree to pay 173c/lb if the seller and buyer fix the contract today. A very standard grade, for example, MTGB 14/16 GC from Brazil might be offered at NY–25c/lb, far cheaper at 98c/lb if fixed now.

After the buyer and seller agree to a differential price agreement, the speculating begins.

Speculating, hedging, and fixing prices

For example, an industrial coffee roaster might predict that the NY market will go down, so decide to fix the contract later. Or an exporter might think the opposite, so wait a while before fixing their sales price. As a trader, Trabocca facilitates this by offsetting this decision in the market with a hedge. This illustrates one use of the market – offsetting risk. Others however may want to take the risk.

A speculator might want to take a position, for whatever reason, and have exposure to the price fluctuation in either direction, making or losing money if they are right or wrong, then closing the contract before it expires, or rolling the position into future months.

When talking about the coffee market, you can’t ignore questions and concerns about the NY price being “too low”. This all depends on the origin.

The NY price is relative to origin

It’s a fact that the price isn’t too low for certain farms in Brazil that continue to plant. But for other countries in Central America for example, who sell their coffee for less than what it costs to produce in the hope for better times, it almost certainly is.

The role of consumers within an imperfect coffee market

Consumers everywhere need to ask themselves if they are willing to pay a little more for well-produced coffee with more interesting profiles. That one is easy for us to answer. If so, the differentials will continue to rise for these crops until seller and buyer find a better price. While this system for coffee pricing and trading works, it is an imperfect system where so many different crops, each with their own nuances, pegged to one market price.

The exception to coffee futures, Ethiopia

Of course, it would be remiss of us not to mention Ethiopia. Ever the unique origin, coffee is seldom offered by exporters on a differential basis in Ethiopia. The Ethiopian monetary system prohibits local exporters to hedge their risk by trading futures.

Instead, we see outright price offers, meaning the futures price has a limited impact on price discovery. Furthermore, specialty coffees in Ethiopia tend to be high above the standards of the grades tenderable to the NY exchange.

Need help with coffee futures? Reach out.

You’ve completed your brief tour through the coffee futures market. By now, you have a basic understanding of the coffee industry mechanics. Head over to the ICE for all market specifications and trade information. And if you need any help with coffee futures, our traders standby to assist. Just reach out here.

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