How Global Events Affect Coffee Futures: From Supply Chain Shocks to Market Speculation

Coffee is a commodity that is frequently traded, and has an unpredictable price. As a commodity, coffee is used primarily to hedge against risk and to speculate on the futures market (i.e., trading in the expectation of earning a profit). Trading in coffee is done through futures contracts, which are contracts in which you lock in the price that you will pay for coffee at a future date.

The price of coffee fluctuates greatly, and in some weeks, it may rise by 8%. However, the following week, it may fall just as quickly. The fluctuations in coffee prices are not based on random chance but are primarily based on many different interrelated factors, such as the weather, disruption in shipping, and economic conditions. Many traders will find themselves blindsided by price changes that may occur because of any of these interrelated factors.

Understanding Coffee Futures: Core Concepts and Pricing Mechanics

Standard coffee futures contracts are created when a buyer agrees to purchase coffee from a seller at a specific price before an agreed future date. The two largest exchanges for trading coffee are ICE (Intercontinental Exchange) for Arabica coffee and the commodity exchanges for tracking Robusta coffee.

Arabica and Robusta are different species of coffee. Arabica is typically grown at higher elevations and has a smoother taste that commands higher pricing. Robusta is typically grown at lower elevations, is higher in caffeine, and has lower pricing. The vast majority of specialty coffee shops only use Arabica coffee beans, while instant coffee is almost exclusively made with Robusta coffee beans. The irony of the situation is that the supply chains, regions in which the different types of coffee are grown, and all other price drivers for Arabica and Robusta coffee are different, and therefore, coffee futures contracts for each coffee species are traded separately.

Supply Chain Shocks: How Logistics Disruptions Drive Coffee Futures Volatility

The coffee supply chain is deliberately designed to be delicate. The majority of the supply for coffee globally comes from three major producing countries-Brazil, Vietnam and Colombia-and the fact that so much coffee is produced in such a small area results in a very large ripple effect for any disruption in the coffee growing regions. 

Coffee has many choke points between the producer and consumer. Coffee must be harvested, processed, transported to a port, and then loaded onto a ship and shipped to its destination where it is unloaded and then distributed to roasters; at each step the coffee supply chain is exposed to risk. 

Climate Events & Natural Disasters: Extreme Weather as the Biggest Risk to Coffee Futures

The tools used to grow and process Asian Robusta (Robusta) are considerably susceptible to changes in climate. Arabica coffee trees grow optimally at elevations between 3000 - 6000 feet and between the temperatures of 60°F - 70°F. Yield and/or quality decreases dramatically once outside those ranges.

The occurrence of severe climatic events has direct. Severe weather events affect the markets of coffee futures using the following methods: Frost affects the death of coffee trees; Heat wave affects the ability of the plants to produce beans and decrease the quality; Drought reduces the yield of coffee; and Excessive rain creates Fungal disease - Root rot. Each weather event results in unique market response.

Currency Movements: Why the Brazilian Real (BRL) Drives Coffee Futures

The majority of pricing for coffee is based upon the currency exchange rate of the Brazilian Real against the U.S. dollar. As the Real declines relative to the dollar, Brazilian coffee is cheaper for buyers in other countries that are using stronger currencies. This results in more available supply of coffee globally; consequently, pricing for coffee futures decreases due to greater supplies. Conversely, when the Real appreciates relative to the dollar, Brazilian coffee becomes more expensive for foreign buyers, resulting in reduced quantity of available supply and higher prices for coffee futures.

The relationship between the Real and coffee futures has remained strong and stable since 2020. There exists a significant negative correlation between movements in the BRL/USD exchange rate with ICE Coffee C futures from 2020 through 2022. When the Real depreciated, coffee futures were generally declining; when the Real appreciated, coffee futures were typically surging.

Conclusion

Due to their interconnectedness, many factors influence the pricing of coffee futures globally, including the weather in Brazil, the shipping costs from Asia, the currency exchange rates from South America, the political environment in Colombia, and the ongoing market speculation in New York and London.

As a result, coffee traders track a number of different multi-factor signals, including: Weather conditions during frost; True Strength during harvesting; Futures trading positions (COT) extreme positioning; and Port Strike information. Each factor is important and missing one of the above signals will often result in missing a trade or ending up on the wrong side of one.

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