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Wednesday, 18 September, 2002, 09:55 GMT 10:55 UK
Why cheap beans don't make cheap coffee

World coffee prices are at their lowest level for 30 years, having fallen by 50% in three years. And yet, coffee prices remain high in shops and cafes. BBC News Online explains why.

Why are world coffee prices low?

World coffee prices are low because there is an oversupply of coffee, the world's second most valuable commodity after oil.

Many coffee growers across the developing world have produced too much coffee which they have simultaneously released into the world market.

The global supply is estimated to be about 8% above demand, according to Oxfam.

This has depressed world prices.

Why have the coffee exporters flooded the market?

Coffee producing countries used to control the supply and the price of coffee, in accordance with the International Coffee Agreement.

But in 1989, coffee exporting states failed to agree on quotas.

This happened partly because countries that never used to produce coffee begun to grow the crop, thus adding to an already mature market.

Subsequently, many countries flooded the market with reserve coffee that had previously been held back to keep world prices high.

At the same time, consumers' demand for coffee fell in many parts of the world, in part due to competition from other drinks.

So world coffee prices halved and have remained volatile ever since.

Was this break-up of the coffee-makers' cartel good news for coffee drinkers?

Not immediately: It took four years for the supermarkets to slash the price of coffee, and then only by 20%.

And when prices bounced back in 1994, up 50%, the retail price rose immediately and stayed high despite another fall in world prices in 1995.

Are the supermarkets ripping off consumers?

If only it was that simple.

From bush to supermarket, some coffee beans can change hands as many as 150 times.

Most coffee farmers sell their coffee beans to local coffee dealers who will transport and store the coffee beans until they sell it on, sometimes to other dealers.

The processing and handling of green, or raw, coffee adds 50% to its price, according to estimates by the Fairtrade Foundation which works for a better deal for coffee producers.

Much of this goes towards paying for transport, storage and handling costs.

Then, as part of the exporting process, freight and insurance will add about 10% before an importer takes over.

So what happens after the coffee arrives in the UK?

The importer, which is usually a major trading company, will then incur port and customs charges before the coffee moves to a large coffee roasting company.

In the UK, where many people prefer instant coffee, the coffee beans go through a costly spray-drying or freeze-drying process.

Alternatively, the coffee is roasted and ground to make filter coffee.

Only then will the coffee tins and jars be filled, labelled and transported to the supermarket shelves or to the coffee shops.

Along this long chain, everybody will take a cut of the profit.

But why are coffee prices in the supermarkets and cafes stable while world coffee prices fluctuate?

Many of the expenses incurred - for example taxes, customs charges and wage costs to coffee roasters - are fixed.

The fixed costs account for a large proportion of the price paid by consumers in the UK, while the fluctuating world price for coffee is but a small part of the total.

In addition, the big coffee processors, like for example Kraft, Sara Lee, Procter & Gamble and Nestle, will hedge their risks using financial futures contracts, and this will stabilise the prices they pay for green coffee.

So what are the reasons for the fluctuation in world coffee prices?

When the supply of coffee is great, the world price of coffee falls, sometimes to levels below the actual cost of growing coffee.

Many farmers then go out of business, or they stop growing coffee to grow something else instead.

Consequently, the world supply of coffee falls, and prices rise again.

Once again, this makes it worthwhile for farmers to produce coffee instead of other crops.

As they do so, the supply rises and prices fall again.

In other words, coffee is a cyclical crop.

Are there other factors that influence the level of world coffee production?

Sometimes storms, a late frost, crop disease, war, exchange rate fluctuations or other unpredictable events can force coffee farmers out of business.

While at other times, centralised political decisions to produce more or less will affect output levels.

Small farmers are often encouraged to grow more coffee by governments eager to boost their exports earnings.

These governments are sometimes encouraged by the International Monetary Fund and the World Bank to produce more.

Is this bad advice?

Seen in isolation, it is probably good advice.

But if many countries and many farmers are advised to produce more when coffee prices are high, the end result is invariably a slump in world coffee prices caused by a dramatic oversupply of coffee on the world market.

Coffee traders in the financial markets are also often blamed for causing the world coffee price to fluctuate by placing speculative and sometimes market-moving bets on tomorrow's prices in the financial futures market.

What are the consequences for coffee producers?

Many countries rely heavily on their coffee exports as a source of foreign currency.

Coffee can make up about three-quarters of some countries' exports earnings.

Between seven and ten million farmers make a living from growing coffee.

Many of them are working on small farms which are unable to cope with downturns and too weak to take advantage of the good times.

See also:

18 Sep 02 | Business
18 Sep 02 | Asia-Pacific
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