Feb 14 / Laleska Moda

Demand raises concerns as Arabica reaches new highs

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  • Arabica coffee futures continued to test new highs this week, with the March/25 contract exceeding 435 c/lb and the May/25 contract approaching 430 c/lb. Over the last three weeks, futures have hit 15 consecutive record highs.

  • In addition to concerns over Brazilian supply in 25/26, the rise in operating costs on the NY Exchange was a major factor in pushing prices higher throughout the week.

  • On the other hand, the rise in futures is not fully reflected in the physical market, which could indicate that demand is weakening. In Brazil, for example, the basis for Arabica coffee has fallen sharply in recent days.

  • The 17/18 Brazilian fine cup differential has also shown no sign of reaction in recent weeks, having risen sharply at the start of the year. Most washed Arabica differentials have also shown signs of weakness.

Demand raises concerns as Arabica reaches new highs

Arabica coffee futures continued their upward trend this week, with the March/25 contract breaking through the 430 c/lb mark. The highest for the week was 438.9 c/lb on Thursday, with the May/25 contract also approaching 430 c/lb on the same day. In the last three weeks, futures have hit 15 consecutive record highs and are already over 20% for the year. With the rise in Arabica, Robusta has also received support, albeit less intense, leading to an increase in arbitrage between the two.

Part of the increase in contracts reflects concerns about demand, particularly given the expectation of a smaller 25/26 Brazilian Arabica crop (see our estimates), the high farmer selling rate of the 24/25 Brazilian season and low global stocks. Moreover, with coffee prices at the highest levels in recent years, producers around the world are well-capitalized and in no hurry to sell their beans. On the other hand, this week's rampant movement reflected the increase in operating costs on the New York Stock Exchange.

With the rally in prices this week, the ICE raised initial margins on contracts, adding to the costs. For the May/25 contract the increase was around 10%, which represents a significant increase in traders' operating costs. It's interesting to note that Wednesday also saw the March/25 options expire, with an increase in open interest in the May/25 contract, which is now the most heavily traded.

LN Robusta, (USD/mt) NY Arabica and Arbirage (c/lb)

Source: Refinitiv 

While many still hold short positions, rising costs during price increases may eventually force traders with smaller or more limited credit lines to liquidate their positions. This also leads to the futures contracts buying back, resulting in high market volatility and the price support on ICE that we have seen recently.

Another important factor to note is that in addition to the increase in initial margin, the current spread between contracts has also required more capital from traders due to the strong advance of the shorter contracts. While the spread between the March/25 and May/25 contracts is around 13 c/lb, for the March/25-July/25 contract it is over 24 c/lb, meaning that to roll over a position the trader would have to pay this amount (in addition to the initial margin), making it more expensive to trade on the exchange.

Mach-May Spread (c/lb)

Source: Refinitiv

March-July Spread (c/lb)

Source: Refinitiv

On the other hand, the recent rise in prices has reinforced the view of a possible negative impact on demand. In the Brazilian domestic market, for example, although prices have risen in recent weeks, the basis for type 6 Arabica Good Cup and 600 def fell sharply in February. Although this movement also reflects the depreciation of the dollar against the real, the fall in the basis indicates that the increases in futures prices are not being fully passed on to the domestic market.

Brazil: Arabica Good Cup type 6 Basis (c/lb)

Source: Safras & Mercado, Hedgepoint

Brazil: Arabica 600 def Basis (c/lb)

Source: Safras & Mercado, Hedgepoint

In general, Arabica coffee differentials in other origins have also shown less strength since the beginning of February. In Brazil, the 17/18 fine cup differential has been flat in recent days, while in Honduras differentials are approaching level. Despite the ongoing harvest in Central America and Colombia, the weaker differentials are also a warning sign for demand.

With high prices and higher operating costs, roasters are expected to raise prices to the final consumer. In Brazil, even three of the largest roasters have already signaled a significant price increase by the end of March and further adjustments may be made given the recent record highs. This scenario is likely to be repeated around the world: Nestle announced this week that it will have to raise coffee prices globally by more than expected. This scenario has increased expectations of a possible negative impact on consumption.

Arabica Differential (c/lb)

Source: Refinitiv 

In Summary

Arabica coffee futures continue to break consecutive records on the NY Stock Exchange. In addition to the supply-side factors mentioned in previous analyses, the move since the end of January also reflects rising operating costs on the ICE. High spreads and an increase in initial margin are causing traders with limited credit to liquidate their short positions and subsequently repurchase them, inflating the market.

As futures rise, expectations of a negative impact on coffee demand this year are increasing. In the Brazilian physical market, prices have failed to keep pace with the rise in futures, while global Arabica differentials have shown weakness. As operating and raw material costs rise, it is likely that consumer prices will also increase in the coming months, potentially crushing demand this year.

Weekly Report — Coffee

Written by Laleska Moda

laleska.moda@hedgepointglobal.com

Reviewed by Lívea Coda
livea.coda@hedgepointglobal.com
www.hedgepointglobal.com

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