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WASHINGTON — If you’re angry that Wall Street speculators have been driving up the price you pay for gasoline, these same big financial investors now are pushing up the price of your cup of joe.

Grocery shoppers have seen whopping increases this year in the price of a can of ordinary coffee, whether it’s a generic store brand or better-known ones such as Folgers and Maxwell House. Since spring, coffee has been selling at $7 to $8 a can in many parts of the country, or about twice the price of a gallon of gas.

The retail price of coffee in July was up 20.7 percent over the same month last year, according to the Bureau of Labor Statistics, which tracks changes in grocery store prices. Big coffee marketers have trimmed prices a bit for consumers in recent weeks, but the price of contracts for future delivery of coffee continues to rise unabated.

What gives?

Coffee-industry veterans blame financial speculators. They say they’re taking advantage of global supply hiccups to drive up coffee prices by adding volatility to the trading of contracts for future delivery of coffee. It’s not as debilitating to family income as high crude oil prices, but the phenomenon is the same.

“It’s definitely not purely supply and demand; it’s way too volatile,” said Shawn Hamilton, the vice president of operations and a veteran coffee buyer for Java City in Sacramento, Calif., a national wholesaler of coffee and a midsize regional coffee roaster.

Experts say that global consumption of coffee is up, particularly in China and coffee-producing Brazil. There’s also been a weather-related dip in production from coffee-rich Colombia. These underlying supply-and-demand factors do justify higher coffee prices, just not this high.

The hiccup in production and rising demand set the stage for Wall Street speculators — many of them big hedge funds that invest for the ultra-wealthy — to flood into commodities markets and speculate on contracts for future delivery of coffee.

The net result distorts the price of coffee. The price of a futures contract for 37,500 pounds of coffee rose by more than 40 percent last year, and has gone up by more than 57 percent this year through Aug. 19.

“It’s not a true coffee market anymore, where the laws of supply and demand hold forth,” said Danell Seda, a trader for Walker Coffee Trading in Houston, an importer of green coffee beans that supplies the specialty coffee market.

Howard Schultz, the CEO of Starbucks, complained in March that he had no trouble obtaining coffee beans — there’s no supply shortage — and that speculators were to blame for soaring coffee bean prices on commodity exchanges, which had reached $2.96 a pound, their highest levels in 34 years, though not when adjusted for inflation. The company didn’t make an executive available for this story.

Just a few months earlier — in a letter Dec. 14 to members of the Commodity Futures Trading Commission — the chief procurement officer for Dunkin Donuts, Ed O’Rourke, called for a curb on financial speculators.

“Something as simple as a good cup of coffee at a fair price is under threat today because of intense pressure by hedge funds and other speculators,” he wrote.

At least one CFTC commissioner now agrees.

“Speculators have influenced coffee prices in commodity markets in a way that isn’t consistent with the fundamentals of supply and demand,” Bart Chilton said. He’s prodded fellow CFTC members to find a way to rein in excess speculation in coffee and other commodities.

The National Coffee Association — the industry’s trade group — has come to no conclusion about volatile prices.

“Some people think the hedge funds are more to blame; others think it’s supply and demand or the weather,” spokesman Joe DeRupo said. “Everyone has their own hypothesis.”

Another high-level CFTC official, requesting anonymity in order to speak freely on a sensitive issue, acknowledged that the agency is unable to decipher how much coffee futures trading is being done by speculators versus those who are legitimately hedging against price shifts.

“It’s not clear to us what they’re doing,” the regulator acknowledged, noting that the line between producer and investor is blurrier than ever. “There is no denying that there are more different players entering the market. There’s debate in public, and perhaps on the commission, on the cause and effect.”

What’s not in dispute is that from June 2010 through last December, coffee leapt from about $1.35 a pound on commodity exchanges to around $2.17, an increase of 61 percent in six months. It only got worse from there, peaking above $3 last spring.

Big coffee retailers such as Kraft Foods, which owns the Maxwell House brand, quickly passed on the rising costs; in March it raised the retail price of coffee 22 percent. That was its fourth price hike in less than a year. A Kraft spokeswoman declined to comment.

Producers raise their prices based not on what they paid for their coffee, but rather on what price they must pay to replace it. This down-the-road price is determined by the futures market, where contracts for future delivery of coffee are traded.

In its most recent report, for the quarter that ended on Jan. 31, J.M. Smucker Co., which markets Folgers, reported a strong 19 percent increase in profits from its coffee division. Retail “coffee price increases taken during the year more than offset higher green coffee costs,” the company said.

J.M. Smucker and Kraft have dropped their prices in recent weeks, but they remain unusually high.

Also telling is the volume of trading in the coffee futures market.

During the first week of August 1995, slightly more than 46,000 coffee futures contracts were traded. In 2001, the first year after investment rules were relaxed and Wall Street money poured into commodities markets, the number rose to almost 76,000 contracts a week. During the first week of August 2008, the month the U.S. financial system began a near-meltdown, 196,805 contracts were traded — actually down from a record 284,000 contracts traded in early March that year.

This all points to the entry of financial players who never intend to take delivery of coffee. Some are Wall Street banks and hedge funds; others are so-called “massive passives,” big institutional investors such as pension funds that bet on rising prices.

The Federal Reserve’s actions this year to encourage investment in anything other than Treasury bonds drove some of the money into commodities investment.

“Commodities have become one of the ‘interesting’ homes for that money to operate in,” said Ric Rhinehart, the executive director of the Specialty Coffee Association of America.

Futures markets were designed as risk-management tools, in which producers or users of oil, wheat, coffee or other commodities could hedge against shifts in price. Today, financial investors appear to be crowding out end-users of commodities, in many markets outnumbering them two or threefold.

Critics argue that this influx of money — a lot of it involving algorithmic high-frequency trades triggered by small price shifts — at best distorts the market’s legitimate price discovery process and at worst renders it meaningless.

“I think you hit the really big issue there, and everybody who works in a commodity market of any kind needs to be concerned that the fundamentals of the physical trade have a less relative degree of influence than they’ve ever had,” Rhinehart said, referring to the disconnect between futures prices and supply-and-demand fundamentals.

There’s no shortage of coffee. The International Coffee Organization, an intergovernmental global body of coffee importing and exporting nations that’s based in London, reported in July that global production was up 8.1 percent to a record 133.3 million bags for the 2010-11 coffee year, which runs from October through September. Exports during the first nine months of that coffee year were also at record levels, up 16 percent.

But there’s an increasingly tight balance between supply and demand, which does tend to push up prices.

“Consumption has been growing steadily in the world, somewhere between 2 percent to 2.5 percent per year, and production has been growing at a slower rate, about 1.5 percent. Production has not been keeping up with demand,” Jose Sette, a Brazilian who heads the International Coffee Organization, said in an interview, adding that inventories of coffee are at historic lows.

Coffee was in a bust cycle from 2001 to 2006, he said. Many farmers were forced out of a crop that takes three years from planting to harvest. Additionally, three successive years of poor crops hit Colombia — one of the world’s leading suppliers — with production almost halved and still well off peak levels today.

Also, since the U.S. financial crisis began in late 2008, the dollar’s value has weakened. That’s led coffee growers in Brazil, Colombia and elsewhere to demand a higher price for coffee beans, since a dollar now buys less in their economies.

“All of these factors came together last year, and from May onwards prices really started to take off,” Sette said. He predicts that volatile prices will fall back. “Now the market is more or less well supplied, but these underlying factors of production growing slower than demand are still there.”

That leaves room for fears of potential supply problems, and fear is like whiskey to speculators. Sette acknowledges that they’re a problem, although he thinks they’re less of a threat over time.

“Definitely we have seen a lot of inflow of speculative funds, if you want to call them that, into all commodity markets, not just coffee. That is a fact of life,” he said. But he cautioned that “the fundamentals do prevail in the medium and long term.”

Short term, however, everything points to continued volatility in global coffee markets, and thus rising costs for a cup of joe.

Story Transcript

PAUL JAY, SENIOR EDITOR, TRNN: Welcome to The Real News Network. I’m Paul Jay in Washington. Well, we’ve all noticed the price of coffee has gone way up. And you might think it’s because there’s a lot more people drinking coffee or a lot less coffee beans in the world. Well, if that’s what you think, you don’t know the whole story. Now joining us to talk about the price of coffee and speculation is Kevin Hall. He’s the national economics correspondent for McClatchy Newspapers. Thanks for joining us, Kevin.


JAY: So what has your investigation found about the price of coffee?

HALL: Well, we found that there are a lot of similarities to what happened in the oil market: the perception of supply tightness (in fact, record supplies of coffee), and around this perception, suddenly a flood of new money into the futures market, or the market for contracts of delivery, future delivery of coffee. And that has influenced greatly both the physical price and what big marketers of coffee in the United States and elsewhere can charge for coffee.

JAY: So what examples have you found, or what’s the research?

HALL: Well, what we found is that from a period of about 2000 and forward, it corresponded with commodities across the range. You had a lot of this financial money, whether it’s institutional investors like pension funds, a lot of big hedge funds, beginning to pour into this market after the reforms of 2000 that allowed easier access into these commodities markets. You had a huge influx of this speculative money. And this money now is a dominant force in these markets, as end users who buy coffee because they need coffee as part of their product–whether it’s a food company that makes ice cream out of coffee, or big things of that sort. So I think what you had is a similar phenomenon to coffee, where you have a crowding out in these markets by financial players of the people–crowding out the people who used to dominate these markets.

JAY: So if you’re an actual coffee producer–I should say, like, a grinder, coffee distributor, and you’re buying coffee in the market and you want to lock in next year’s prices, you’re locking in at a price that’s been driven up by someone that already went long on the price.

HALL: Right. And I think where you had a settlement process, before now, that’s been pushed out. And it’s actually one of the things I found in the reporting is that even on the farm level, a lot of specialty coffee, organic coffee, environmentally friendly coffee is done through these cooperatives, and the cooperatives are now having problems because the middlemen who buy coffee are offering higher prices than what the cooperative had locked in for its delivery price. And some of the farmers, the campesinos in Latin America, are walking away from the cooperatives for higher prices. And coffee has a long history of boom and bust cycles, and it’s pretty easy to foresee when you have such a massive amount of planning tied to this price that you can foresee a bust cycle coming, and these farmers will no longer have the shelter of a cooperative as they lose that part of this business.

JAY: Does this also encourage a certain amount of hoarding? Like, if you’re growing coffee and you look out and you see six months or a year from now the price is going to be that much higher, why put it on the market now?

HALL: And there is some of that going on right now from the people that we talk to, and we talk to a pretty wide range of influential voices in the coffee sector. Because of this volatility in prices, people are deciding, on a daily basis, do I sell today? Do I sell a week from now? And this just adds to this perception of scarcity. There is a record amount of coffee being produced around the globe right now. Exports for the first nine months of the season–coffee has a season that goes from October to September. The first nine months of that season, for the 2011 season, are record-high exports, almost 16 percent up. So there is no shortage of coffee. There’s plenty being exported. What has gone down are the inventories of coffee. And there are some real supply-demand fundamentals that are in play–they’re not the driver, but for the speculation to happen, you have to have this sort of fundamental issue. And we had three consecutive bad years of crops in Colombia, which is a premier producer of high-quality coffee. And they’ve had low height crop yields three years in a row, still not back up to what have been the historical levels. And I think that’s given some market tightness in the premium type of coffee that comes to the United States, which is different than what gets sold everywhere around the world. And so that’s also kind of given–a factor. Another factor is the weakening dollar, and the producers of coffee now, much like oil, are saying, well, if the dollar is weakening, I need to have a higher payback, because in relative terms, my currency is stronger against the dollar; I need to be earning more.

JAY: Well, how do you parse out those factors from the speculative factors?

HALL: Well, it’s the same problem that you have with oil. It’s impossible to say it’s just this or just that. But everyone, from the executive director of the International Coffee Organization on down, acknowledges that speculation is putting a premium on it. And just like oil, most Wall Street watchers will acknowledge that this financial speculation has created a premium in the price of oil. The question is: how do you determine how much? And what do you do about it? In the case of oil, there are proposals out there to limit a percentage of the market. Position limits it’s called: no big trader can have more than 10 percent to influence the market. That’s a proposal. On the coffee side of things, you have to kind of look at who’s in these markets. It’s very hard to distinguish, as we looked on the data–and we took a deep dive into the Commodity Futures Trading Commission historical data, and it’s hard to differentiate, because of this nebulous terminology, who is an actual merchant/producer who is hedging their coffee purchases or production, versus the Wall Street players and the hedge funds, because a lot of the big coffee companies or the big agribusiness companies are both buyers, sellers, and broker-dealers who arrange the transactions. So it’s a really murky picture as [to] who’s in these markets.

JAY: And even the regulations that are being talked about for position limits–and they’re talking about a 10 percent limit to how much any one company can have in a particular commodity. But that seems to be, first of all, a regulation that’s being tied up by lobbyists and by the process itself, and it doesn’t seem like it will keep out straight speculative casino gamblers anyway, and I guess there’s lot of ways for them to come in and play at different position limits. So right now, if I’m right, there really is no regulation that looks serious, either–in the short term, at any rate.

HALL: Well, there are some proposals by some of the bigger critics of the current system who think that we should go back to a cap, where, you know, financial–strict financial players can have no more than 30 percent or some percentage of the market.

JAY: As a total group, pure bettors can’t have more than 30 percent.

HALL: As an aggregate. Exactly. The problem with the position limits as being considered is, while it’s helpful for one big player cornering the market, it misses the point about the lack of people who have skin in the game. In other words, we have paper barrels or paper bags of coffee versus the physical product that’s going to be delivered. You get this distortion. And these markets were supposed to be about hedging risk management: a company is going to hedge against a price shift in the future. These are about what they call price discovery: a buyer and a seller come upon, you know, a fair price. Well, if nobody’s ever going to take delivery of these things and there’s no real supply and demand signal being given–I think your news organization has done a good job focusing on these so-called high-frequency traders and, you know, these people who come in and out of the market on big algorithmic trades. Well, what does that have to do with price discovery? And so I think there’s a realization beginning to grow that people are seeing that this isn’t a market about things like price discovery and risk management. They’re forms of legalized gambling, high-stakes gambling, very technological gambling. And consumers and producers all around the world end up paying the price.

JAY: Yeah, I think that’s a very important point. I just want to emphasize that to say that no particular player can have more than 10 percent doesn’t solve the problem. You need an overall cap on how much of the hedged market can be taken up by pure speculation, as opposed to players that are actually going to take delivery and use the goods.

HALL: Right. Right. And even that gets to be a difficult definition, because particularly in coffee, where you have people who are playing all three ends of the trade–you have people who are hedging their production, but they also have a finance arm that is involved in the speculative part of it, and they may–if they’re big enough, they may act as a broker-dealer, in other words, they bring two parties together and do the transaction on behalf. So you get all these asymmetrical information flows if these markets really are supposed to be about discovering, coming to a fair price. And I think people are starting to–in the academic world are looking at this, and they’re reaching the conclusion that we can’t ferret out how much of this is responsible for the pricing. But I think a lot of that debate misses the point, which is–has been: it’s price discovery. It’s not how much of this adds to the price. Is this really price discovery, I think, is the fundamental question.

JAY: Thanks for joining us, Kevin.

HALL: Thanks for having me.

JAY: And thank you for joining us on The Real News Network.

End of Transcript

DISCLAIMER: Please note that transcripts for The Real News Network are typed from a recording of the program. TRNN cannot guarantee their complete accuracy.

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Kevin G. Hall, is the national economics correspondent for McClatchy Newspapers. Previously he served as Latin America correspondent. During his career he has reported from Mexico City, Saudi Arabia, Miami, Los Angeles and Washington, D.C., for the Journal of Commerce and United Press International. He speaks Spanish and Portuguese.