May 26, 2011 8:46 am

Starbucks decries speculators as coffee prices spike

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But retailers’ own hedging helps lift futures

Coming to a coffee shop near you: a heart-stopping increase in prices.

Arabica coffee futures have more than doubled over the past year, and now retailers are hiking prices. Starbucks became the latest on Wednesday, announcing a 17 per cent increase in the price of its packaged coffee, while JM Smucker, owner of Folger and Dunkin’ Donuts coffee brands, has raised prices 38 per cent since last May.

But the cause of the spike in coffee prices is the subject of a heated war of words. In the blue corner are the “evil speculators”. In the red corner: Starbucks.

Howard Schultz, Starbucks chief executive, has landed a few early blows, lashing out at “hedge funds, index funds and other ways to manipulate the market”.

“In our view, [the increase in prices] is the result of extreme speculation and not a result of normal market forces. We do not believe this is sustainable,” he said late last year.

It’s undeniable that investors/speculators have been active in the coffee futures markets in the past year. But it’s not at all clear how responsible they are for the move in prices, which has seen high-quality arabica coffee rise 125 per cent to a 33-year high of more than $3 a pound.

According to positioning data from the US Commodity Futures Trading Commission, speculators piled into the New York-based arabica futures market in June 2010, moving from a more or less neutral position to a net long position – a bet on higher prices – of 42,902 contracts in mid-August. At the same time, prices rose 35 per cent to $1.80 a pound, having spent most of the previous five years in a range of $1-$1.50.

Since then, however, speculative bets on higher coffee prices have actually fallen. The net long position most recently stood at 20,538 contracts – half of August’s peak level. And the price has risen a further 47 per cent over that period.

If speculators haven’t been the main driving force behind the coffee rally after its initial jump in June-August, what has?

Ironically enough, one culprit may be Starbucks itself. With the prospect of higher coffee prices on the horizon, the company has sought to hedge as much of its price exposure as possible.

“As the coffee prices began to escalate as we moved through December, we took the decision to remove that risk from this year, we think the responsible decision, and lock our pricing,” Troy Alstead, CFO, said in late January discussing the company’s quarterly results.

Sensible though it may be, the move to lock in prices for longer effectively involves buying coffee futures, and so puts upward pressure on prices.

Traders say a rush from coffee roasters such as Starbucks to hedge is one factor that has put wind in the sails of the coffee rally. Before last June, roasters typically hedged 2-3 months ahead of its needs, according to traders. In January, Starbucks said it was fully hedged through to the end of September – ie eight months ahead. In April, the company said it was covered until almost the end of the calendar year.

Of course, there is also the small matter of the influence of supply and demand fundamentals on prices. Global stocks of coffee are at their lowest in five decades; the crop in Brazil, the largest producer, looks likely to come in lower than initial expectations; and demand is growing strongly, especially in emerging markets.

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