The Coffee Crisis is Coming

Dear Retail Investor,

Over 2.25 billion cups of coffee are consumed worldwide daily, making it one of the world’s most widely consumed

The US is the world’s largest consumer of coffee, at nearly 500 cups a day. In fact, the US consumed a total of 27,430,000 60 kg bags of coffee in 2019/2020.

If you look at the per capita consumption of coffee, the Netherlands is the world leader, coming in at 8.3 kg per capita (vs the US’ 3.5 kg per capita).

The point is, while more than 90% of the world’s coffee supply comes from developing countries, the top consumers of coffee are industrialized economies.

Because coffee can only grow in specific climates, the countries that consume the most coffee must import it from the places that can grow them naturally, such as Brazil, Colombia, and Vietnam.

Major Supply Setbacks vs Rising Demand

As you know, coffee and other commodities are priced based on supply vs demand. When supply outweighs demand, prices are lower. When supply can’t keep up with demand, prices rise.

Coffee stockpiles have recently sunk to a six-year low in the US, sending prices surging in recent months. Brazil, the world’s top producer of coffee, had a record coffee crop in 2020, but 2021 has seen it ravaged by COVID-induced supply chain problems and droughts.

The National Weather System (NWS) recently issued a water emergency alert for several of Brazil’s top coffee-producing states, calling the rainfall deficit in Brazil “severe”, and forecasting most of Brazil’s central region will receive little rainfall from July to August.

This drier than usual weather has led to a drop in output that is expected to shift the world balance to a deficit in the coming months.

Unfortunately this isn’t just a near-term problem. Marex Solutions said last week that beans collected from arabica coffee fields showed that yields are well below normal.

Marex also stated that low soil moisture could stunt the development of the 2022/ 2023 Brazil coffee crop.

And Brazil’s crop agency Conab projected that 2021 Brazil coffee production would fall -23% year over year, to a 4-year low of 48.8 m bags.

Meanwhile, the world’s second largest producer of coffee, Colombia, has seen coffee exports decline significantly in recent months, after protests broke out over the government’s new tax reform bill.

The Colombian National Federation of Coffee Growers said shipping companies had suspended bookings for coffee cargoes as protests caused road and port blockades.

The Shipping Crisis

Colombia and Brazil account for roughly 50% of the world’s coffee supply, combined. You might be thinking that coffee comes from more than just these two countries, and you’d be right.

In Latin America, coffee is grown for export by Mexico, Nicaragua, Costa Rica, Peru, Honduras, and Guatemala.

In Asia, it’s grown in Indonesia, Vietnam, Papua New Guinea, China, and Thailand. Coffee is also grown for export in some regions of Africa and India.

One problem – some of these countries are dealing with their own issues, including warmer than usual growing seasons, and a crop-ravaging fungus called Coffee Rust (which is currently causing problems in Mexico).

More importantly, the raw beans still need to be imported into North America and Europe, the world’s top coffee consumers. And a global shortage of shipping containers, which is forecast to last until 2022, has significantly disrupted the global food trade since the onset of the pandemic.

Coupled with the rising fuel prices, this has contributed to surging shipping costs – in some cases causing them to more than double.

Interestingly, China, which is the world’s most populous country, has one of the lowest coffee consumption rates.

However, coffee consumption rates in China are growing quickly at 30% per year compared to the rest of the world’s 2% per year, meaning that Chinese demand for the commodity is also rising and could increasingly impact global supplies in future.

What this Means for Retail Investors

Worried about your daily $6 latte rising to $10? Don’t panic – yet. Currently, coffee roasters have been able to draw on existing inventories rather than raise prices, but this is likely to change as supplies continue to dwindle.

Rising coffee prices could mean that the world has to scale back on daily coffee consumption, which has been rising steadily not just over the past decade, but also during the pandemic.

It could also mean bare shelves of coffee at the grocery store as people start hoarding coffee beans.

From an investment standpoint, coffee prices have already surged over the last few months. So what can you do?

While commodities trading isn’t for everyone, one way to play this trend would be to buy an ETN like the iPath Dow Jones-UBS Coffee Subindex Total Return ETN (JO).

An ETN (Exchange-Traded-Note) is different than an ETF because rather than holding stocks in the index it tracks, an ETN does not provide ownership of the securities to the investor. Instead, ETNs are senior, unsecured debt securities issued by a bank, that pay the returns of the index they track. The JO ETN for example tracks the Dow Jones coffee index by holding coffee futures contracts in the nearest month ahead.

An ETN pays investors once the fund matures based on the price of the asset or index. However, these are complex investment vehicles that require extensive due diligence on the underwriter involved. If the bank or institution backing the ETN suddenly goes bankrupt, investors can lose their initial investment.

ETNs are also not for everyone, and most retail investors tend to stay away from them as they are harder to grasp than ETFs – but they can also be more efficient than ETFs, and can, in some cases, offer certain tax advantages (in the US).

Note: this is NOT investment advice. You can learn about the advantages and disadvantages of ETNs vs ETFs here.

What about Coffee Stocks?

One thing you can be sure of is that major coffee roasters and distributors, as well as chains like Starbucks (NASDAQ: SBUX) and Dunkin Donuts (NASDAQ: DNKN) are well aware of rising coffee prices (to understand where the top coffee chains source their beans, check out this video from Business Insider).

Coffee roasters and wholesale distributors like Farmer Brothers (NASDAQ: FARM) and Coffee Holding Co (NASDAQ: JVA), whose stocks have both been on a tear over the past 6 months – still need to import their raw beans from other countries. So these companies could be facing a margin squeeze in the coming months or even years.

Meanwhile it’s safe to assume that coffee chains like Starbucks have limited choices in the face of a constrained coffee supply and rising prices – they can either eat the additional cost (not likely) or raise the price of their products – seeing that Starbucks already charges a pretty penny for a cup of plain old drip coffee, this doesn’t leave them much wiggle room.

It is likely that these chains, unless they can come up with some clever new marketing ploys (like offering their customers watered-down coffee as a “caffein-light” alternative or creating the mother of all breakfast sandwiches) will see a margin squeeze if and when coffee prices rise even higher.

Could the US Ever Become Coffee Independent?

There is also a chance that the US could  become a reliable source of coffee in the future.

Hawaii and California are the only climates in the US that are capable of producing coffee, but experimental coffee plantations are also cropping up in Georgia.

Hawaii in particular had a generous harvest in 2020, with cherry yield increasing 2.8% from the previous season. However being an island state, Hawaii doesn’t bypass the challenges currently faced by the global shipping industry.

In California, experimental coffee bean plantations have recently been cropping up beside avocado groves located in the region between San Diego and Santa Barbara. Although the conditions in California do not typically favor coffee, local farmers have created special irrigation systems to help them grow.

If these experimental coffee growing projects are increasingly successful, in time California could become a major supplier to the rest of the US, which currently imports 90% of its coffee beans.

However, California-grown coffee comes with a hefty price tag, with some selling for $50-$80 per 140 g bag!

What about coffee alternatives?

Well, there’s mushroom coffee, which quite frankly sounds gross and also isn’t exactly cheap (most of these blends also contain ground coffee). We’ve had an in-depth look at several small-cap companies that sell mushroom coffee products, and their financials and other key criteria didn’t look promising enough to post about (we’ll keep tracking them however).

Dear Retail will also be keeping an eye on energy drink companies, many of which rely on synthetic caffeine or alternative energy-boosting sources.

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