Coffee Memo | Rob Answers Questions from the Mailbag Ep. 9
Episode Summary
We opened up the mailbag so Rob could answer questions about The Exchange (not us...the Intercontinental one), the inverted market, certified stocks and more.
Episode Notes
- The Intercontinental Exchange is analogous to a bank, making money from fees, services, and interest.
- Only certain countries can tender coffee to the exchange, some at the C price ("at par"), some at a premium, and some at a discount.
- There are Exchange licensed warehouses in several U.S. cities and four cities in Europe. Some of these warehouse also come at a premium or a discount.
- Buyers do not get to choose what coffee they will receive when they buy coffee from The Exchange.
- High prices incentivize coffee being tenders to the exchange to become certified stock.
MIKE FERGUSON: Welcome to Coffee Memo with Rob Stephen, a podcast where we talk about coffee industry news and current affairs. This is episode nine and we're opening up the mailbag because there are questions and hopefully Rob has some answers. Speaking of questions, if you have one or two or six, you can always email us at theexchange@covoya.com.
So Rob, this is a first, but it won't be the last time that we're back to follow up on a topic because we have questions. Questions about our last episode, which was certified stocks. So you have the questions. I'll listen to the answers.
ROB STEPHEN: And you can decide if my answer is...
MIKE: I will score them on a scale of 1 to 10.
ROB: I like this because otherwise I'd just get more questions. And we'll be in a recursive question loop. So yes, I was very excited to, to receive questions on the last episode, A, because it means people are listening and B, because it means people are interested. I have them here and I would love to provide even more clarity on this because a lot of these questions spoke to the basic structure of how the market works, which is an itch I would just love to scratch. So, a lot of these questions had to do with how The Exchange works. So I want to talk about that, even though it's sort of lower on my list here. I want to talk about what is The Exchange. So first of all, The Exchange has an unfortunate name, which is ICE. It's the International Continental Exchange. It is a global marketplace for coffee. But instead of trading shares in companies, it trades commodities, coffee, cocoa, sugar, cotton. And so for coffee, the ICE runs the Coffee C contract, which is a benchmark futures contract for Arabica coffee. So, it's where the market comes to do price discovery and hedge against price movements.
Who is ICE, right? It's a public company. It's listed on the New York Stock Exchange and it owns multiple exchanges including the New York Stock Exchange. So, it's a very large company that is in the business of exchanges. It acquired the New York Board of Trade in 2007, which was where the C contract was before that. So, it's a very big company but it plays a very public role in setting the rules, hosting the contracts, and maintaining transparency in the coffee market. So, what I found out from these questions was that a lot of people are under the impression that the way that the ICE or ICE makes money is by when the price goes up. They get to keep some of it. And that is not how it works. So, what I think we should think about here is how the ICE really does make money, right? And so they make it in a variety of ways, none of which really have to do with the price being really high or being really low.
MIKE: It has to do with price moving?
ROB: Sometimes, so it has to do with how much people use it. Okay, so it's a pay-for-service kind of thing. So, number one is trading fees. Okay, so every time a trader buys or sells a futures contract, they pay a transaction fee, right? So, just think of it like a bank. Yeah, a lot of commercial banking has fees. That's why bankers usually take you to lunch if you're the CFO of a company is because you're doing a lot of fees. You're doing a lot of money in and out and they charge you for that and they're small but they add up if you do a lot of transactions. So a company like ours, we've got origins all over the world, we've got trading desks all over the world, we're buying and selling futures all day long. There's a fee for us, so we're good customer, That sort of thing. There's also clearing fees. So, when you're basically paying for risk, so the more money you have tied up in margins and things like that, there's a fee on that as well. They are a very big purveyor of data. So, they make a lot of money selling market data. Right. real-time feeds, market feeds are a big money-maker for them. And historical market data, you can get some of it from the website, but they actually have a lot of really intricate stuff that you could pay for. They charge you to be a member. If you want to actually have unfiltered straight-in access to The Exchange, you have to buy what they call a clearing membership which gives you that access and it's not cheap.
MIKE: Like Trading Places?
ROB: Exactly, right? Yeah, so brokers clearing firms, other financial entities, right and then the platform itself, the technology services, they own those. They license those and they make a lot of money licensing those and the connectivity to it. There are actually firms that do like speculative trading, algorithmic trading, and it's not just for coffee, I'm talking about all the different exchanges. They'll actually move their offices as close as possible so that there's less nanoseconds of data going back and forth between the things.
MIKE: That's nuts.
ROB: And then the last thing is they do hold your money for margin calls and they make interest on that money, which they get to keep. Right? So that's a six item list. None of them said the price went up. We got to keep some of it. Right. So, if you're looking for a reason to hate The Exchange, it's the same reason you would hate your bank. Yeah. Which is they hold money, they do things with money, and they charge you for that.
MIKE: Yeah, we were just talking before we started the recording about how some of us in specialty coffee have remained intentionally ignorant of some things because the C market was our favorite bad guy. We would like to blame things on the C market, but the more I learn about it, the more I can't dislike it.
ROB: Right. And it's sort of like, hate the financial system, but I love being able to tap my phone at the store. It's exactly that.
So the next question that would follow is, what do they do? And they do three sort of, vital things for the industry. They host the futures contract. So, we are all buying and selling futures contracts as part of the trade. The contract is their sort of intellectual property. And the place where they go, it's an exchange. It's like an auction house, right? There is one place to go. It's not like I have many places that I can go to sell them. I have one place. they own that forum. They do what was the focus of the episode, which was they provide reporting on and keep track of certified stocks, which they set the rules up for and everything like that. And then they facilitate delivery. They have a whole department. It's basically a logistics department, which is helping coffee go in and out of those warehouses, right. So those are the three main things that The Exchange does. So I think now we've got a basis to sort of say, what are we dealing with here? What is The Exchange? Why does The Exchange and certified stocks sort of intersect with each other? That's what they are.
So that leads me to a place where I can talk about other questions that we had. So a lot of people wanted to know about, I guess I made a reference to there were different origins that had premiums and discounts and that you could put them in different warehouses. So I'm going to sort of read a little chart here. And these are the deliverable origins to The Exchange. So these are the places that you can put coffee into The Exchange where those coffees could come from: Mexico, El Salvador, Guatemala, Costa Rica, Nicaragua, Kenya, Papua New Guinea. Panama, Tanzania, Uganda, Honduras, Peru, Colombia, Burundi, Rwanda, Venezuela, India, Dominican Republic, Ecuador, and Brazil.
MIKE: Those aren't examples, that's the entire list?
ROB: That's the entire list now, Mexico, Salvador, Guatemala, Costa Rica, Nicaragua, Kenya, Papua New Guinea, Panama, Tanzania, Uganda, Honduras and Peru, their pricing is whatever the C market is. They call that “at par.” There's no premium and there's no discount. Columbia has a 400 point which is four cents premium. Burundi, Rwanda, Venezuela and India have a 100 point or one cent discount. Dominican Republic and Ecuador have a 400 point or four cent discount and Brazil has a 600 point discount or six cents.
But they're changing the rules and starting with the March 2026 futures contract, Guatemala is going to be at a 500 point premium and Colombia, Costa Rica and Kenya are going to be at a 1000 point or 10 cent premium. So, starting with the March ‘26 futures contract, Colombia, Costa Rica and Kenya will be highly incentivized to deliver to The Exchange.
MIKE: We are coming up on that, right?
ROB: As a matter of fact, first notice day is next week. Then the delivery locations, which are exchange licensed warehouses in the ports of New York, Virginia, New Orleans, Houston, Miami, Bremen and Hamburg, Antwerp, and Barcelona.
MIKE: And again, that's it.
ROB: That's the whole list, right? So, there's not just one warehouse in those ports. There's many licensed exchange warehouses in those ports. For example, in New York, there's tons of them,
MIKE: Right. So we're talking ports, not buildings.
ROB: Right. And then just as there were coffee origins that were at a premium or a discount, there are ports that are a premium or a discount.
MIKE: Oh, really?
ROB: Yeah. So, New York and Virginia are at par. So, there's no premium, no discount. New Orleans, Miami, and Houston are half a cent discount. Bremen, Hamburg, Antwerp, and Barcelona are discounts of 1 and a quarter cent.
MIKE: Why?
ROB: So I'm in theory here. I don't have an actual answer. But my sense of it is twofold. One is that this was originally a very American-centric exchange. It was the New York exchange. And so there is a discount for putting coffee in New York because it's randomized. When you take delivery, you might end up taking it from Europe, even though you're in the US. So, there was a discount because you're going to have to pay to get it over.
The other one that is a little more practical is that in Antwerp, you don't pay the loading-in fees when you tender the coffee. You pay it on the way out. So when you take coffee from Antwerp, you're going to get an extra bill. So, they discount the price for it a little bit. So, that's a lot, right? Luckily, everyone has a rewind button so they can go back. That is how The Exchange works, what the different origins can go in, how much they're worth relative to the C price. And then where you can deliver them to or take them from and if there's any financial ramifications from that. That was a lot, but right there, that's trading 101. Now you know how The Exchange works.
The question that sort of followed from that was, if I take coffee from The Exchange, do I get to pick? And the answer is no.
MIKE: No, you… just the volume.
ROB: You will get 42,500 pounds worth of coffee. That is the end of it.
MIKE: Not even, I mean not even the age of the coffee?
ROB: Nothing.
MIKE: As long as it's still passing, it's being graded out.
ROB: That is, it is the ultimate definition of the word commodity. There is no differentiation made between once it's certified to go in, you get what you get.
MIKE: So if you're one of those roasters that are buying that coffee, obviously you're huge. I mean, are you happy and sad?
ROB: Well, I mean, if you get one of these origins that has a discount, if you're a price-driven player, you might be happy about that. I think if you're really trying to get a really high-quality product and you're taking delivery from The Exchange, you're sad, right? Because you're at your last resort, which as we said last time was usually not good things happen when you're at the last resort.
MIKE: And they know, I mean they know before the truck shows up. I just keep imagining this roaster opening up the truck and going, oh damn.
ROB: Yeah, no, there's a whole... Remember how I said they have a facilitation of moving this coffee in and out? There's a department, it's called ECOPs, it's some acronym for the program that they have, and they will actually let you know, you'll get a notice from them, this is what you're getting, and this is what it is.
MIKE: It's just hard not to imagine some commercial roaster out there going, I was hoping for a Nic.
ROB: That's a specialty mindset.
MIKE: I know, it's almost impossible to readjust my thinking.
ROB: Yep. One question was, how does the inverted market incentivize tenders? I made mention that because of the inverted market, it can tend to draw coffees to The Exchange. Right. I think what's missing in that question is the word ‘now.’ What the market wants is coffee now. I need it yesterday. That's why prices are going up. Stocks are dropping. What will fix this? Coffee now. And coffee, therefore, is worth more now than it is in the future. So, that's what drives the inversion. Coffee now, is 20 cents more valuable to the exchange than it is in March.
MIKE: Warehouse stocks going up, is there a tipping point where the inversion goes away?
ROB: As you switch from one contract to the next, the week before first notice day, the spread is very variable. It's a very dangerous time to be exposed to it. It could go down to two cents, it could explode to 40 cents. Nobody knows. So, you sort of want to get out when you are at a place where you can absorb the impact of it. But if you are sitting at origin with stocks, if I ship it and it gets tendered and cleared before first notice day, I will make 20 cents more than I will the day after first notice day. So, I should ship it now. So, that is what drives the inversion, is trying to get coffee into the stocks as soon as possible.
MIKE: Very basic terms you're looking down the road and you're looking at lower prices in the future of course you're incentivized to get the coffee.
ROB: Exactly. I want to sell at the highest price that I can. I don't want to hold it any more than I have to, and I don't want to pay interest on it. I don't want to have even the security issues of holding coffee. I want to deliver it. I want to get it out of my hands. I want to get paid for it. And if I ship it now, I'll get paid more than if I ship it later. So that is the market being efficient, basically saying to all the participants in the market, we're trying to get coffee into the warehouses, and we are offering a huge premium if you ship it now. So that's what an... we're back to a few episodes ago, but that's how an inversion fulfills its market function.
Someone said, which I thought at first I didn't understand the question and then I appreciate the question a lot, what value do certified stocks have in general? There's the intangible value of it being a visible indicator of supply, but the value that they have is whatever your futures contract is worth.
MIKE: The liquidity.
ROB: But if you have a futures contract at 3.80 and the market rises to 4.50, your coffee is still 3.80. So, some could say it's worth 3.80, some could say it's worth 70 cent discount. It is about timing and price discovery as much as anything else. So you get the physical benefit of getting the coffee, assuming it's something that you can use. But you also get the opportunity to minimize your exposure to price volatility. So it's worth a lot if you do it right. What you don't want to do is end up in that situation where you say, as long as future at a bad price, I forgot about it. And now I have this coffee. That's the worst situation to be in, which is why, again, importers in general become very sort of twitchy about first notice day because nobody wants to get coffee that they don't want to get.
I think I have one more question here and that is, this is a good question. So, for any coffees entering The Exchange warehouses in the United States, are these bonded warehouses and coffees not being tariffed until it's delivered or is it tariffed on arrival? If it's tariffed on arrival, does The Exchange pay that, et cetera, et cetera?
MIKE: That's a great question.
ROB: That is a great question. And the answer is yes, they go into bonded warehouses. So The Exchange warehouses are bonded. So tariffs are not paid on the way in. So if a tariff is in effect, you'll pay it on the way out when you take delivery. But if it sat there and then tariffs were suddenly to go away, even though it was subject to tariff on the day came in, no tariff would be paid.
MIKE: Right, 400,000 bags right now, so not a lot of people are into that strategy.
ROB: Yeah, not a lot of people can be able to take advantage of that. And I have no way of knowing which lots arrived when there was no tariff. The other thing is because of that little thing I said about Antwerp where you don't pay the loading charges on the way in, 90% of stocks are in Antwerp.
MIKE: Really?
ROB: Really. So of that 400,000 bags, 90% of them are in Antwerp. There are very, very, very little stocks in the United States. So that's just the way it is.
MIKE: And why is it, we already talked about this, but remind me, why is there?
ROB: It’s a lower cost structure for those who are tendering.
MIKE: Yeah. And is that a business decision on Antwerps?
ROB: Yes. Just like Delaware hosting corporations. Let's just make it as easy and cost-free as possible. will drive people to put coffee in our warehouse.
MIKE: This is our niche in this game.
ROB: And then there was a follow-up question that had to do with EUDR, all the coffees that are getting shipped ahead of EUDR implementation. Do they get held in exchange warehouses? And what about the ones that are not EUDR-certified that are still there after the EUDR deadline? Which is a great question. And there is a answer that is not very satisfying, which is that there's a concept in these warehouses called transition stocks. You will be informed about whether you're getting a transition stock or not when you take delivery. And my understanding of it is that then you, that particular lot you can get a pass on because if it came in without EUDR before the deadline, you can get a sort of pass to use it even though that rule might be in flux. So, nobody'd make a business decision based on that answer, but my understanding is that currently it's a little less tight than the industry would like it to be.
MIKE: Okay, and speaking of EUDR, where are we?
ROB: In the Waffle House, I've seen so many different emails about different proposals that are talking about, still about postponement or about delays for certain aspects of the industry. Crazy. I don't know the answer.
MIKE: So, no certainty either way
ROB: Nope. And as we have always talked about, lack of certainty…
MIKE: …is not helpful.
ROB: Not helpful and creates volatility. People pay for risk and they pay for mitigating risk and when you're very volatile, cost of things goes up.
I think I've answered all the questions that I got. I'm super grateful for getting them and I would love to do this on the regular. I'd love to answer questions about the things I explained so that I can really feel like everybody got everything out of it.
MIKE: That was great. Our first questions episode.
ROB: And special thanks to Angela Greenhagen, who works here in our office, who gave me a few of these. And I appreciate them very much. Thanks, Mike.
