Coffee: The cost of a cup - Cincinnati News, FOX19-WXIX TV

Coffee: The cost of a cup

Updated: Jul 22, 2014 10:03 AM
© Christopher Robbins / Photodisc / Thinkstock © Christopher Robbins / Photodisc / Thinkstock


By Jesse Emspak

Coffee: Plenty of us swear by our daily caffeine fix. Coffee has to be one of the cheapest addictive substances in the world, and as an added bonus it doesn't give you cancer. At a food cart in New York, you can get an 8-ounce cup for a dollar or less.

That may change, though, as some long-term trends will likely push the price up for consumers. How much is anybody's guess, as it depends on several factors, only some of which growers can control.

How the Coffee Market Works

In the countries that produce coffee, such as Brazil (the single largest), Colombia or Indonesia, the beans are grown on mountain plantations. The coffee is packed into 60-kilogram (132-pound) bags and handed off to someone to transport it to the ports. At this point the coffee is a greenish bean.

The coffee is taken to the ports and shipped to the consumer country. The largest consumer is the U.S., with Europe in second place, but that's the EU taken as a bloc. The U.S. is number one among individual countries, importing some 27 million bags in 2013.

After that the coffee beans are roasted. Roasters buy the bulk coffee and bake in a margin to resell it to the companies that distribute it – which could mean big outfits such as Smucker's, which owns the Folgers brand, or big end-users such as Starbucks (SBUX).

The roasting companies' margins are pretty flexible but not infinitely so. That said, the margin there provides a cushion for those of us who buy coffee retail.

Dan Cox, owner and president of Coffee Enterprises, a consulting firm, noted that roasters will sometimes buy coffee at a certain price for several months at a time, but not too long in case the price drops. There's also an important role for the "middlemen" who export the coffee from the farm to the country where it's going. "Buying direct is a fraud," he said. "There's so much risk. You have to make sure the coffee is the same product you paid for, for instance."

That's the role those importers and shippers play. Cox said when he used to buy coffee for a major chain, he might go to the farm and agree on a price for a certain amount, but he would go to another company that would make sure the product was right and ship it to port.

A Price Breakdown

Cox gave the following breakdown for a pound bag of premium coffee, one that sells for $15 per pound (which is about the price for a pound of Equal Exchange whole-bean coffee on Amazon.com).

The retail store, he said, takes about $4. The roaster that "cooks" the coffee when it arrives in the U.S. takes in about $2. Transporting the roasted beans costs about $1.50. Meanwhile, in the roasting process about 15-20% of the coffee's weight is lost, as the moisture is removed from the green beans. Starbucks or Peet's, which use a dark roast, will lose 20-22%, while a bulk user such as Kraft Foods Group (KRFT) will lose less, about 15%. But that adds about $2.50 to the price. Another $1 goes into getting the coffee from a possibly remote farm to the point where it's exported, and one can add to that the $4 per pound for the raw beans. A major chain such as Starbucks might pay about $2-3 per pound on average, Cox said.

The situation is slightly different for the non-specialty coffees, the ones that come in cans and bulk containers. Those are usually blends of two species of coffee, coffea Arabica, which makes most higher-end brews, and coffea Robusta, which makes a poorer-tasting one. The latter is added to give Arabica extra bulk. Cox noted that the price of that won't move by more than a few cents at a time, and raising prices by $1 would indicate a worldwide shortage of coffee. Those brands tend to be sold with smaller margins, and customer loyalty isn't nearly as strong.

That's why it was a big news item this month (June) when Kraft Foods, Smucker's and Starbucks said they would raise the price of coffee. For a typical can of Maxwell House, owned by Kraft, that won't mean much more than a few cents. Starbucks, though, said some beverage prices would rise by up to 40 cents.

The driver is a drought in Brazil and a fungal disease in Central America. Brazil is the largest single producer of coffee for the mass market, while other nations produce it for coffee-bar chains such as Starbucks.

Supply and Demand

Coffee prices also depend almost entirely on supply rather than demand. Demand tends to be relatively inelastic and increases in a linear fashion, says Tom Copple, an economist at the International Coffee Organization. About the only exception to this is Germany, but the Germans are a relatively small consumer compared to the U.S., the fame of their coffee shops notwithstanding. (In fact, while a number of European nations beat the U.S. in coffee consumed per capita, the U.S. is far and away the biggest single market.)

It is possible for new producers to drastically affect the price of coffee. Cox said when Vietnam started making coffee in the mid 1990s, the country had no tradition of growing it at all – but now it is a major producer with about 20 percent of the world market. Vietnam was one factor in the price of coffee falling in the early 2000s enough to drive many Latin American producers from the business. An increase in the specialty-coffee market size reversed that trend, and since then Latin America has returned to a premier position.

The price on the coffee futures market is not always closely related to what the roasters pay or what the sale price is at the farm. The reason is that the futures price is a bet on the future supply and demand for coffee, and thus a bet on the price that a grower can demand. The prices in the real world tend to lag what the futures market shows, meaning that even though coffee as a commodity is a very volatile trading item, the price at the store or coffee shop stays relatively stable.

While it might seem that a major user like Starbucks could affect the price, it turns out not to be the case. Starbucks' policies could affect an individual farm or group of farms, but no one coffee consumer is large enough to move the needle on the commodity prices.

Longer-term, there's a more worrying trend: climate change. Coffee has some flexibility in where it can grow, but it isn't infinitely so. A big issue is the loss of land on which coffee can be grown as temperatures rise and rainfall patterns change. Many African countries may no longer be able to produce coffee at all. The production might move southward, but it is far from clear whether temperatures, rainfall and soil chemistry will be amenable to the plant.

And all this could raise the price of your daily cup of joe significantly. Assuming a linear relation between supply and price, a loss of half the available coffee cultivation area would mean that $3 latte at Starbucks would double.

But so far that hasn't happened, and work is being done to improve the coffee plant and create varieties that can grow in a wider climate range.

The Bottom Line

For investors, coffee will remain a wild ride. Meanwhile, there's every possibility that efforts to improve coffee plants will expand the area where coffee can be grown, even as climate change puts pressure on traditional regions. Since that's an uncertain process, it's likely coffee prices will rise over the long term, in a slow burn consumers aren't likely to notice as it will take years.

Originally posted on Investopedia.com


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