Coffee futures soar as Brazil cuts harvest hopes

Coffee futures soared after Brazil slashed its estimate for its drought-hit coffee crop, saying its harvest will, for the first time since the 1990s, fall for two successive years – and may fall for a third.

Arabica coffee for July delivery jumped to 197.75 cents a pound in New York before easing back to close at 196.80 cents a pound, a gain of 6.8%, rising back above the contract's 10-day and 50-day moving averages.

In London, robusta coffee for July closed 2.3% higher at $2,138 a tonne, ending back above its 10-, 20-day and 50-day moving averages.

While futures rose in early deals - helped by a forecast by analyst Judy Ganes-Chase to Agrimoney.com of a rise in arabica prices to 300 cents a pound - the rally gained pace after Brazil's official Conab crop bureau cut its estimate for domestic production to 44.57m bags.

"The somewhat-oversold arabica market was looking for a bullish input, and Conab provided it," said Citigroup analyst Sterling Smith.

The downgrade, from a forecast in January of a harvest of 46.53m-50.15m bags, leaves the country - for which 2014 is an "on" year in its cycle of higher and lower production years – looking at a drop of 9.3% in output.

Not since 1995 has Brazil recorded a second successive drop in coffee production.

'Serious damage'

Conab attributed the drop in production primarily to the "severe drought recorded in early 2014" in much of Brazil, as well as  heavy tree pruning by farmers, who viewed the low coffee prices last year as a reason to take a production pause and invigorate plantations.

The main arabica coffee growing state of Minas Gerais took the brunt of the downgrade, with the harvest pegged at 22.99m bags, well below a previous estimate of 25.88m-27.40m bags.

Rains in December were followed by a "long and severe drought during the first quarter of 2014, throughout the state", Conab said, adding that the lack of rain and high temperatures caused "serious damage" to crops coming at the crop-filling stage "that defines size, weight and bean quality".

Although "moderate" rains had returned in March, the amount was not viewed as sufficient to reverse the water deficit or crop losses, although it had enabled applications of fertilizers, which rely on moisture for being taken into plants.

Better for robusta

However, output declines in some other states were far less severe, with the forecasts for production in Bahia and Sao Paulo falling within the range of Conab estimates in January, if at the lower end.

The crop in Espirito Santo, Brazil's top robusta growing state, was pegged at 12.21m bags, at the upper end of the initial estimate range of 11.41m-12.61m bags.

The state's robusta crop was seen rising by 13.9% year on year to 9.35m bags, helped by "favourable climatic conditions, especially in the northern region of the state".

In fact, Espirito Santo crops "have potential for greater production", although the lower and volatile prices for much of the season "have led many producers to decrease fertilizer applications".

Prospects for 2015

Conab also highlighted the damage done by drought to arabica potential for next year, in stunting the growth of new vegetation on which the 2015 crop will be borne.

The lack of rainfall had "possibly compromised 2015 crop production", with low vegetative growth "found in much of the coffee crop".

"Next year's harvest will at best be stable with this crop, but could be less," said Janio Zeferino, director of coffee at Brazil's agriculture ministry, echoing the warning earlier from Ms Ganes-Chase.

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Brazil's woes mean coffee rally has much further to go

If the jump of more than 60% in arabica coffee prices so far this year seems extreme, well, you ain't seen nothing yet.

At least, so says Judith Ganes-Chase, a long-time soft commodities analyst who warns that however bad Brazil's harvest prospects for this harvest may look, 2015's are even worse.

"It is a definite" that coffee output from Brazil, the world's top producing country, will fall again next year, she says.

"There is no way for coffee trees to make up for growth" that they have lost to the drought in Brazil's coffee belt earlier this year.

The impact on prices will be to send them above 300 cents a pound, meaning a tripling so in values from their levels at the start of the year, and implying further upside of more than 60% for patient investors – or roasters slow to hedge their coverage.

"You would certainly think so. And the sooner it comes, the healthier it will be for the market, as it will allow roasters to ration supplies, and farmers to make adjustments to increase the quality and quantity of production.

"Higher price now will avoid a panic situation setting in later."

Big inventories?

Her level of anxiety over coffee supplies contrasts with the healthy estimates that many analysts have for the level of world inventories of the bean heading into Brazil's drought, so in theory cushioning the impact of crop losses.

The US Department of Agriculture estimates world coffee stocks at the close of 2013-14 at 36.3m bags.

Macquarie has forecast stocks at well above 60m bags.

And at the 9.3m bags at which the USDA staff in Brasilia estimates Brazil's stocks alone, the highest in nine years, there would appear to be plenty of coffee to spare to make up for drought damage.

Quality question

Not so fast, says Ms Ganes-Chase.

"Just because there are so many bags of coffee, does not mean there is adequate supply."

Assuming flat Brazilian exports in 2014-15, at some 32-33m tonnes, and domestic consumption of 20m-21m tonnes, the country looks like eating deep into these inventories, if the USDA's production estimate of 49.5m bags for this year is right.

(There are many estimates lower than that - Brazil's Conab bureau is expected to reveal one of them later on Thursday - although Ms Ganes-Chase cautions against mixing numbers from different commentators, who may use varying assumptions and crop years.)

The numbers imply a drop to 6m bags in Brazil's inventories, which may not prove itself the cushion it appears for foreign importers, given that stocks often comprise lower quality beans.

"About 20% of Brazil's crop is not of export quality anyway, so assuming that is represented in the stocks, that is 1.8m bags."

And of the rest of inventories, "what is left is usually the coffee that producers could not sell," she told Agrimoney.com.

"People buying are expecting a certain level of coffee quality – they are not going to get it."

Fate already sealed

And this is before getting into 2015-16 production prospects.

The reason the harvest will fall next year - however much rain falls, or fertilizer farmers apply – is that the tree growth needed to bear the flowers this year, for the cherries next year, has already been severely stunted.

Instead of 12-15 flower-bearing nodes that trees would typically have grown during the first three months of the year, they have grown 6-9 nodes, Ms Ganes-Chase says.

"It is too late now for any more growth - we are heading into the Brazilian winter. And that means that however perfect the weather is from now on, the damage is done.

"The crop has that much less potential."

Size is important

So Brazil's stocks would appear, on paper, to be heading for a further decline of at least a further 3m bags, from inventories whose quality will likely be worsened by the removal this season of the better supplies, with replacement from a 2014 crop which looks likely to struggle on taste as well as quantity.

"Beans or malformed or a lot lighter than usual, if they are there in the cherries at all.

"From what we are hearing, it is taking instead of about 600 beans to make a [60kg] bag, it is taking 1,100, which means the quality of that coffee will be pretty bad."

The maths suggest that Brazil's coffee inventories look like heading towards the 3m-bag mark which alarmed markets three years ago, sending New York coffee futures above 300 cents a pound.

'Multi-year problem'

Still, Brazil may be the largest coffee producer, but it is not the only one. Can't supplies in other countries fill the void?

"There is not that much stuff out there to make up for Brazil's shortfall," Ms Ganes-Chase says.

While Vietnam, the second-ranked coffee producer, did have a large harvest this year, its extra supplies have been offset by poor production in Indonesia.

And as for the recovery in Colombia, the second-bigger grower of arabica beans, she flagged a decline in production last month, the first year-on-year drop since 2012, which has raised questions over the country's ability to maintain its output recovery.

"This is a multi-year problem," she says.

And one of historic proportions too.

"In all my 30 years of covering commodities, I have not seen anything like this before."