Coffee Memo | Rob Talks Certified Coffee Stocks Ep. 8
Episode Summary
In this episode of Coffee Memo, Rob Stephen discusses the critical role of certified coffee stocks in the coffee market. He explains how these stocks function, their historical context, and their impact on current market dynamics. The conversation goes into the certification process, quality control, and the relationship between certified stocks and coffee prices. Rob also highlights coffee industry news and the challenges faced by producers and the supply chain, as well as the future outlook for coffee market trends, including coffee stocks and prices.
Episode Notes
- Certified coffee stocks are essential for market stability.
- The current level of certified stocks is alarmingly low.
- Market prices are influenced by the availability of certified stocks.
- Quality control is crucial in the certification process.
- Producers must find attractive prices to encourage shipping.
- The relationship between stocks and prices is a key indicator.
- Futures contracts play a significant role in market dynamics.
- Roasters are currently relying on certified stocks for supply.
- Understanding certified stocks helps predict coffee market trends.
- The future of coffee prices is uncertain without increased stock levels.
- Check out the ICE Coffee C Daily Stocks
MIKE FERGUSON: Welcome to Coffee Memo with Rob Stephen, a podcast where we talk about coffee industry news and current affairs. This is episode 8 and we're talking about certified coffee stocks or Coffee C Daily Warehouse stocks. You've heard about them, seen the words used here and there and probably have a general idea of what they are and why they are. In this episode, Rob fills in some of the details you may not know and explains the critical role certified stocks play in the coffee market.
So Rob, every episode, I feel like we're picking a puzzle piece off of a pile and then setting it down where it belongs. This inverted market goes over here next to working capital, sort of. And then we've got volatility or whatever. Last episode, Mike Nugent reminded us that even though we're in sort of chaotic environment, the weather is still a primary driver.
So, we've got all these pieces here. One of the pieces to the puzzle seems like it should be easiest to understand, and yet it's probably behind inverted market, the one I understand the least, and that's certified stocks. So, I hope you'll help us understand what they are, how they function historically, and what's happening now.
ROB STEPHEN: Yeah, no, you know, it's really funny. I talked to a few people in the office and I said, I was going to talk about certified stocks and everyone got this look on their face. Like I said, you know, does anyone want this rotten sandwich from the fridge? Like, okay. I don't want to talk about that. And it's funny because you know, you're right that there's so many different factors and certified stocks is always mentioned, but it's mentioned in this sort of thing. Like, well, stocks are really low. As in, and you should know what that means. Right. And so let's not take that for granted.
I think a good place to start is to just talk about what we mean when we say certified stocks. So, we understand that there's a C market, right, which is the futures price for Arabica coffee. Right. That's run by an exchange, the ICE exchange. Unfortunately named ICE exchange, ICE, Intercontinental Exchange. It is a, without getting really into the weeds about commodity markets and exchanges, an exchange is a place where you can buy and sell things. In order to buy and sell things, you have to have a seller and a buyer. And so, what the primary function of an exchange is to match sellers and buyers. But there are times where there isn't a willing or ready buyer or there isn't a willing or ready seller, when somebody wants to buy or sell. There isn't somebody on the opposite end. And so in that time or in that instance, The Exchange can act as the buyer or seller, either a first or last resort. They have coffee in a warehouse that is of a known type and quantity. Everything about it is sort of predictable. And you can say, I'll take that. Or I have that and I would like you to buy it. And the price is the price.
MIKE: And this is real, physical coffee right?
ROB: Absolutely, physical coffee. So, when we're talking about certified stocks, it's that. It's the reserves that The Exchange is holding in warehouses, in certain ports and in certain cities in Europe and in the United States that was bought from sellers, and sits there to eventually be sold to buyers. As a function of The Exchange. You can think of it like milk on the shelf in the grocery store, right? It is there to be sold and it was sold to the grocery store and it will be sold onward, right? That's how it works, right? And so, when I'm thinking about certified stocks, I have to think about why is the level where it is compared to where it has been in the past? If it's the reason if it's a visible indicator of reserves, this is how much coffee The Exchange has available for someone to buy. Is that the right amount? Is that a high number? Is that a really low number if it's a really high number or really low number, what does that mean? So the reason that we talk a lot about certified stocks right now is that they are at 15 year lows. So, in just before 2010, they were at almost 2.5 million bags spread across these warehouses. They've just fallen to just about 400,000 bags. Right now. Yeah. Which is terrifying to people who sort of follow this on the day to day, right? It doesn't mean much to people who like, that's a number, 400,000. 400,000 is almost empty.
MIKE: Yeah, which hasn't happened since ’96.
ROB: Right. That means that we've been talking all this time about how you think about the market and what's it going to take to get coffee in the right places. Well, when you've got enough coffee available for everyone to buy and everyone has the option to buy the coffees that they want to buy, the excess goes into The Exchanges. It's one way to look at it is it's sort of like the relief valve. If there's even more coffee, then people need to buy, The Exchange warehouses fill up. Right? So the opposite is true. If there's not enough coffee, The Exchange warehouses deplete.
MIKE: Yeah. Well, let's see, consumption has been outpacing production for four of the last six years. Is that where the coffee was?
ROB: That's mostly right and so then you take all these other factors that we've been talking about: tariffs EUDR, the inverted market which is making it very difficult for importers to hold stocks because it's so expensive and the working capital crisis, which is also making it hard for people to hold stocks Where is coffee sitting at a known quantity ready to go? In The Exchange warehouses. So that's why if you were a commercial roaster you would take delivery, right, right? And so that's what's been happening. And so there's been just this consistent, on a very regular cadence, drawdown of these stocks. And it can't go below zero, but it could get there. And so it just reminds the market every day. Every day, the people who watch this market, they come in and they say, stocks dropped again, dropped again, dropped again. Even more reminder that there's not enough coffee in the right place. Market trades up.
MIKE: Yeah, which has been happening for two, three years now. Yeah. mean, the stocks and prices parted ways. If you lay down a trend line on prices and a trend line on stocks, it's a fork in the road.
ROB: And we'll hopefully put a chart in the show notes. I have exactly that chart, right? And so you can see the direct correlation between C price and stocks. And there is an equilibrium. There's a place where they sort of, the relationship forms an X, right? Where the market feels that there's enough coffee, not too much, not too little, and the C price sort of equilibrates right in that middle spot there.
MIKE: And conversely, we had the opposite when prices were historically low in the early 2000s, were way down, low prices. We were bumping up at five million bags.
ROB: Yeah, and the warehouses, they had to put new warehouses online because they were all full, that sort of thing. And now you can play kickball in these warehouses.
MIKE: I think it's interesting, there is an anomaly, which I'm sure you noticed in your chart, that during COVID, we had stocks rising and prices rising at the exact same time for a very brief period.
ROB: Yeah. And again, you think about COVID, I mean, you had this sort of anomaly in consumption, right? Where it went to commercial coffee because that's the only place you could buy anything, was on the grocery store, right? So commercial coffee had their best year in decades because they were able to maximize their distribution channels. So that was a great year for commercial coffee. Remember when we say the C market, the C stands for commercial, right?
So, let's talk about what a certified stock is, right? So, a certified stock is a container of coffee that is delivered to The Exchange, but you can't just deliver any coffee. There's a list of countries that are allowed in The Exchange parlance they call them growths. Don't ask me why, but they call them growths. And the coffee has to meet a certain very specific and strict quality definition. Now, by quality definition, I don't mean that has to be of a very high quality. It just has to be a very consistent quality so that you are basically taking coffee and commodifying it, turning it into something that is, this is the same as that, is the same as that, is the same as that. It's the opposite of what makes specialty, specialty. In specialty, we're always looking for new and interesting and different. In commercial, you're looking for, I can use that and that or that and they'll all be the same. And so that's the utility of an exchange certified stock.
It also can't be anywhere. There are certain ports in the United States and there are certain ports in Europe that are allowed. They have a lot of historical context, but there's some on the West Coast, there's some on the East Coast. You have Antwerp and you have Hamburg in Europe. They can only be stored under certain conditions, so there's warehouses that are certified by The Exchange. So, you're getting it from a short number of origins at a very specific defect and cup quality and you're getting it in very specific places. And there is a list of, depending on the origin and depending on the location, of premiums or discounts to the C price. So, a Colombian coffee in New York is worth more than a Honduran coffee in Antwerp. And because you have to... the idea is that you would pay more to get it there and you would pay... the origin is valued more in the market.
MIKE: Colombia.
ROB: Right. So, the differential would be higher. So, the premium would be higher. But that's it. It's pretty simple. And sort of as an aside, so, I'm sure a lot of our listeners are Q graders or have thought about being Q graders. So the Q grader system is a very loving, yet carbon copy of the C grading system. And so, the original intent was that there would be a specialty exchange and coffees would need to have a score and a sort of description attached to them so that you would know what you were putting in or getting out of The Exchange. And so you would need people who could make that evaluation and apply it to that coffee and then any exchange participant would know what they were getting or what they were putting in and what it was worth. And so, there are C-graders. There are people who work in the grading room. And when people take a coffee that they want to sell to The Exchange, they deliver it to an exchange warehouse. They load it in, just like you would load in any other coffee coming in from origin. But it sits there, and they then do a process that's called tendering. And you tender a coffee to The Exchange. You put it in an exchange warehouse, you draw a sample, and you send it to The Exchange. And these graders, on a regular interval, come in and they evaluate the coffee against the commercial standard. And if it passes, which every mill knows how to do, then it is accepted by The Exchange and it is now available to be a certified stock. So, if you look on, again, another chart I hope to put in the show notes is every day, there's a list of what did we start with for bags in all the warehouses, the certified warehouses around the world, how much was taken out, and how much is pending grading.
And that pending grading is coffee that's been loaded in and hopes one day to make the baseball team. It's a pending evaluation, and if it passes, it will become, the certified stocks will go up. And if it fails, they won't go down, it's just they won't increase. And so you'll see past gradings and failed gradings as part of the stats. And if there's a lot of failed gradings, it's just people throwing stuff at the wall to see what sticks.
MIKE: Why- why does that happen?
ROB: So we're going to get into why you would tender coffee to The Exchange. Let me first talk about the flip side. So, if you're short futures, meaning that you have sold a futures contract on The Exchange, you can resolve that position by rolling out of it, or you can resolve that position by delivering coffee. And so, if you get to a day in the trading calendar called first notice day, which if you're a customer of ours or you're a customer of anyone who does price fixing, you'll hear that term come up a lot. You'll see it on contracts, FND or first notice day. You must fix by first notice day, right? Or sometimes earlier than first notice day because the people who have positions need a little time to get their position squared up.
The reason that nobody can be flexible on that and that everyone is such a cop about it is that if they don't have their positions exactly squared by first notice day, The Exchange can come to them and say, you owe me coffee or you have to take coffee, which nobody wants unless they want it. And so, we have five days a year, there's a first notice day because there's five contracts. And so we have five times of the year where that contract is approaching expiry and it's a fire drill. Every single time. I mean, it's an orderly and sort of nice fire drill, but it's a, hey, we have to get this resolved. It has to be to the decimal point. We have to get this right. And so therefore, all of our customers who have open positions have to resolve them so that we don't unwittingly or unwillingly become a participant in The Exchange's liquidity function, which is you are short of future, now you owe us coffee. Right?
Nobody, aside from having short futures that you don't resolve, The Exchange can't just go out and randomly take coffee from people. You have to want to deliver. So why would you want to put coffee into an exchange warehouse is a valid question. So let's say you're a producer or a co-op or an exporter and you have coffee. So you are long the physical. Meaning you have something that you need to sell, so you're long. That's a futures definition. And if you've hedged it, you now short a future, right? You have a thing to sell in order to hedge it, you sell a future. So now, what do you do? You look at what you could sell it for in the marketplace, right? I don't even want to make up numbers, let's just say that there's a number that you realize this is what the market will bear to sell this product. However, if you look at The Exchange and the C price plus or minus any premiums or discounts, minus the cost it would take you to get it to and load it into an exchange warehouse… If that is higher than what the market would pay you for the coffee, you will sell it to The Exchange all day long. Yeah. All right. And so that threshold, which is different for every producer in origin, is called tenderable parity. Now that's a phrase that I heard for years before I knew what it meant. And that's a big one for understanding how The Exchange works.
So, I'll go through that again. If you are holding coffee at origin and say you're like, wow, I really want to sell this at +10 and everyone is offering you -10, and you're like, I just think I can do better than that. And then you realize, well, I could get it to The Exchange for 10 cents and this origin, The Exchange will pay me another 5 cents because it's a value. Suddenly, I’m in the money, right? All day long, send it to The Exchange, right? And that's something that has happened opportunistically throughout the last 15 years. So when the market is sort of saying, there's too much coffee, I don't really want to pay you for that, The Exchange will buy it and you'll make money, right? And that's The Exchange saying, give me some liquidity, it's worth it for us, the trading community, to take your coffee, put it in the bank as a visible expression of supply. Right? Because remember, when coffee's in the right place, prices regulate. Coffee being where it's going to be consumed is the right place. So, I will pay you to send your coffee here so we can put it in the warehouse. Right?
When those times happen, the roasters say, great, I will deliver coffee. And what's happening right now, warehouses are emptying. So, prices are still not attractive enough on the market side for producers to say, I'll send you my coffee. So, what does that mean? It means prices need to go higher before coffee will work its way to The Exchange.
MIKE: Huh. it's not, logically I would think that when prices are high, the stocks are going down because they can get a better price in the open market.
ROB: If you're selling, if you're trying to sell coffee from, from origin, you would rather sell it to a roaster or to a trader or something like that. Right. And if they're a wash in choices and they're sort of like, well, you're not, you know, we can do better. Like, I still need to sell it. The Exchange is a ready buyer. And if it's above tenderable parity, it makes a lot of sense for you to do that.
And what kind of situation are we in now? We're in, we're in a situation where nobody has choices because there's so little spot inventory anywhere. Right? So, the market will pay for it. You know what mean? So, if roasters need coffee, they'll pay for it. So why would you sell it to The Exchange? You can make more money selling it to a roaster. Right? So that's the supply side. That's how coffee gets, becomes a certified stock. And it can sit there for a long, long time. Years. And there are periods where it has to pass again after a certain period of time, but in general, you could end up getting three, four, five year old coffee. As long as it still passes the sort of commercial grading standards, it'll still pass. Right?
So, let's flip to the other side. What does it take to deplete the stocks? How do you get coffee out of The Exchange? And so, to get coffee out of The Exchange, you basically have a long futures position where you bought the C market and instead of resolving your position, on first notice day, you just let it expire and you get coffee and you get coffee at the price of your futures contract. So, if you buy a futures contract at an attractive price and let it expire, you get a container of coffee at that price per pound. Amazing, right? It's amazing if you're a roaster that can just use interchangeable commercial-grade coffee. And so those roasters are very price-conscious. They are not willing to, or able to pass along the costs associated with tariffs, inverted market costs, extended costs of carry. So, they're having trouble buying in the spot market because spot coffee is so rare and so expensive. Where is there coffee they can get? In The Exchange. Just go take it out. No must, no fuss. They'll just deliver it to you, right? You'll pay for the delivery, but I mean, they'll just, off you go, right? And so the commercial roasters have been steadily drawing off of these stocks because it's the best option available to them. So sometimes The Exchange is the best buyer and sometimes The Exchange is the best seller. And when one of those are true, usually the market's going in one direction. And so right now The Exchange is a great seller of coffee to commercial roasters and they're taking advantage of that liquidity.
And again, you have to look at The Exchange almost like Vegas. Right? And not that it's about the gambling aspect of it, but imagine if a casino had more chips on the floor than they had money in the vault. Right? Then you could conceivably win big and they'd be like, we don't have the money to pay you. Right? It's the same thing with futures contracts. If they don't have enough coffee to back up their futures contracts, you could end up with a long future and be like, give me my coffee. And they'd go, there is none.
MIKE: But isn't that where we are now?
ROB: We're getting there, which is why prices are rising because that's how they attract coffee into The Exchange. I think that that relationship is really important for everyone to understand. The lower The Exchange certified stocks go, the more dangerous it is for the liquidity of the market. You have to have something behind those futures contracts to guarantee the liquidity of it because a futures contract is a promise. A promise to be able to buy coffee at a price. And if nobody else will sell you that coffee at that price, we will.
MIKE: What happens? I mean, we have hit zero stocks on paper.
ROB: Yeah, market ceases to function in any real way, right? And you basically have complete and total chaos. And so what the market ends up doing is really trying hard to keep that from happening. And that's why today we almost hit 4.25 again in the C market because the stocks continue to fall. Right? And tariffs aren't helping that. Inverted market isn't helping that. None of these, the cost of capital crisis is not helping that. EUDR is not helping that. None of these things are helping to bring coffee to the market. And so, we end up in this situation where, as you said at the beginning, we tick off all these different things to look at. I think of all of the things that a roaster can look at, the one that is most easy to get your arms around in terms of once you understand what it is, is stocks because it's a, the number went up or the number went down, right? And if the number went down, it means one thing. If the number went up, it typically means another, right? And so, a steadily falling stock gives you a bullish bent, right? The stocks are falling, prices must be going up over the long term. And they have been. Stocks have been falling steadily, price has been going up steadily. And so, as a roaster, you can look at that and go, in general, as these stocks continue to fall every day, which I can see through publicly available information, I should have an outlook that in general, prices will go up. Nothing is guaranteed. There's always anomalies. There's always... But in general, can... We heard Mike Nugent talk the other day about things revert to the mean. Right? The mean is that equilibrium between supply and demand where there's enough coffee for everybody, but not too much. And certified stocks are one of those equilibrium points. And it's easier to understand and not necessarily predict, but have a viewpoint on versus weather or versus government policy, which could just hit you like a hurricane out of nowhere, right?
MIKE: So, chicken and egg, which is going to change first?
ROB: My personal view, remember I've got my Red Sox hat on and not my Covoya hat on, but I think that until we see the warehouses start filling up again, prices have only one direction to go. But having said that, I think that we're approaching what could be called a tenderable parity place for certain producers. There are certain countries that might have enough coffee or might find the prices attractive to start shipping again. But things have to happen, right? They have to have the ability to get it into those warehouses.
MIKE: So these are coffees, that are countries that are having unusual years, like Indonesia.
ROB: Yeah, well, know, one of the biggest things to ever happen to the C market in our recent history was the listing of Brazil as a deliverable origin. For years and years and years, Brazil was not allowed as an exchange coffee, right? And so it was allowed into The Exchange. But the fact that we can't get Brazils into the US warehouses is a huge deal. Right? I mean, there would be two million bags available. Easy.
MIKE: Just like that?
ROB: Well, yeah, I mean not everybody wants them. Yeah, but if the market stayed at high long enough the warehouses would fill back up Yeah, I'm making a very oversimplification of how this all works. There's so many different things that could happen but a nice, easy indicator for looking at the market is where the certified stocks are they rising or falling? How quickly are they rising or falling? What does that mean for a long-term and sort of, medium-term outlook?
And if they're falling very fast, then that's a good indicator that not only is coffee where it needs to be, but there's no indication that it's going to come anytime soon. So, people are buying from the seller of last resort. Anytime you're doing anything, that's the last resort, it doesn't really speak to a good feelings. I think also, I just want to thank again, our guests from last week, Mike Nugent. That was a big thrill for me.
MIKE: Yeah. That was a lot of fun.
ROB: Yeah. It was, I hope we can do that again sometime. I would ask everyone to write in, let us know what you'd like us to be talking about. Please review and rate our podcast.
MIKE: Do all the things.
ROB: Do all the things. Thanks, Mike.
