16 February 2022, Jos Algra
Differentials in the 1990s
When I was exporting coffee from Mexico in the first half of the 1990s, I was selling a Prime Washed PW coffee at -8 to -12, Extra Prima Washed EPW at 2 cents more and the best HG / SHG at level to +4. There was very little organic coffee and I had to guess at what price it could sell, usually +15/+20, sometimes up to +25, a good premium compared to conventional coffees. The Fairtrade market was just beginning and most of the time coffee sold at the minimum price, 121 cents at that time, including the premium, because the price in New York was between 50 and 100 cents most of the time. The exception was 1994, when the Arabica price spiked to 247 cents, due to frost in Brazil.
In the second half of the 1990s, when I was selling coffee from Mexican and Peruvian organizations as a broker, the differentials moved more or less at the same levels, between -10 and +2, as can be seen in the graph. The supply of organic coffee grew, Peru became the second producing country after Mexico and fetched the differentials between +15 and +30+.
If we compare it with the current differentials, as we showed in the first table in the previous blog The differential — Part 1, with all Washed Arabica at a positive differential, the difference is abysmal, for example Mexico HG +29/+30 and Peru Grade 1 +16 /+24 and all. To understand this great change, we must analyse the structural changes in the coffee industry in the last 20 years.
The growth of specialty coffee and the division of the market
After the second world war, when the coffee industry and consumption recovered, the standard blends of arabica and Robusta from different origins dominated. Later roasters began to change their blends to lower costs and increase profits. This was influenced by the black frost in Brazil in 1975, after which the price reached its maximum historical level of 340 cents. The quality of the coffee was reduced gradually so that the consumer would not notice it. This was partially compensated by better roasting techniques and the treatment of low-quality Robusta with steam, to increase acidity and to be able to increase the percentage in the blends.
It started in the United States and soon Europe followed. The graphs below illustrate how in the European Union in the last 25–30 years Naturals from Brazil and Robusta from Vietnam have displaced the Colombia Milds and Other Milds and how the cup profile has changed. Brazil produced an average of 30 million bags 30 years ago, now 60–70 million. Vietnam grew from 1 million in 1990 to 30 million bags today. Together they represent 55% of world production.
As a reaction, the specialty coffee movement was born, first in the United States and then spread to the rest of the world. Initially it was a relatively marginal niche, run by small roasters and specialty coffee shops. The coffee market began to divide: Brazil and Vietnam increasingly dominate the market for standard qualities, large volumes, low prices, modest growth in consumption. At the other extreme are the niche markets for high quality coffees, almost exclusively washed Arabicas, with a limited volume, but with rapid growth.
At some point in the transition from the third wave to the fourth wave (if there is one, in a future blog more on waves) the big roasters started to get interested and the volume started to grow. Companies like Starbucks with its coffee shops, Nespresso and Keurig with their pods, demand millions of bags of Washed Arabica.
The supply of these coffees has stagnated since the 1980s at around 40 million bags. Production costs are relatively high and cannot compete with natural arabicas from Brazil and Robusta from Vietnam. growing demand for these coffees drives up the price.
Brazil largely dictates the price on the New York futures market, so the limited supply of Washed Arabica is expressed through the differentials or high fixed prices, that is, well above the New York benchmark, starting with the most appreciated qualities. Gradually discounts become premiums for most Washed Arabica.
In the previous blog The differential — Part 1, it was explained how in 2008 the drop in Colombian production, from an average of 12 to 8 million bags, triggered the differentials in Colombia and in the other countries in a chain reaction. It took Colombia 4–5 years to recover the level of production and it was not until 2011, when the price in New York touched almost 300 cents, that the differentials returned to their previous level.
The differentiation between qualities and origins
Within the group of Washed Arabica there is also a growing division between the different origins and qualities. For example, at the beginning of 2007 a Costa Rica SHB had a differential of +12/+16 and a Honduras HG was at -3/-6, a difference of 15–20 cents. That gap between both coffees widened to more than 100 cents at some point and currently Costa Rica SHB is trading at +80/+83 and Honduras HG at +20/+22, a difference of about 60 cents. Honduras SHG, which has a cup similar to Costa Rica SHB, is currently trading between +25 and +35.
Costa Rica SHB is a highly appreciated coffee, but supply is very limited. In the 1990s Costa Rica produced about 2.5 million bags, currently 1 million less. In recent years, with the New York price in the 90–120 cent range, a lot of Costa Rica SHB was selling at a minimum of 200–220 cents or a +100/+110 differential, similar to a Kenya AB FAQ trading between +90 and +190 in the last 2 years.
Honduras, by contrast, produced some 2 million bags 30 years ago, a volume that has grown rapidly in the last decade to 7.6 million bags in 2017/18; last harvest produced 6.5 million.
To open a market for millions of extra bags, Honduras has to be very competitive, even against the Naturals from Brazil, which is sold at a discount. Improving quality and creating prestige in the market is an effort that takes time and money, but it seems that it is being achieved, judging by the premium that is now paid for Honduran coffee.
The differentials mentioned are standards grades according to the national quality standards. Certain specific origins in the countries and brands of the merchants have higher differentials, such as SHB from Guatemala Huehuetenango and Costa Rica Tarrazu that are now 3–5 cents more.
The price range between Washed Arabica from different areas of Ethiopia, such as Yergacheffe, Sidamo and Limu, is much wider, but many times traders do not reflect this on their offer sheets, so as not to show the competition how they are selling. The price is given only at the request of interested buyers.
Note that differentials on offer sheets do not necessarily reflect reality. It is common to reflect relatively high differentials as a price indicator and if you show interest in buying coffee, they send you a list with lower differentials.
The impact of COVID-19: read supply and demand
By reading the differentials well, one can better understand the relationship between supply and demand for the different origins and grades of coffee.
When the COVID-19 pandemic started 2 years ago there was a lot of concern among buyers about the supply of coffee, especially for Washed Arabica the stock levels in consuming countries were low, and differentials soared. Curiously, they have remained firm even after July 2021, when the price in New York shot up due to the frosts in Brazil, indicating that the supply-demand relationship remains tight.
Thus, the differential for Colombia Excelso rose from +33/+34 to around +50 and lately above +60. The differential of Honduras HG went from +6/+7 to a band of +18/+28, it fell to +14/+15 in October-December, when the export volume doubled with mainly coffees left over from the last harvest, but recently it is trading above +20 again.
This trend in differentials for Washed Arabica is even better understood when compared to differentials for Naturals from Brazil. The differential for Brazil 2/3 17/18 Fine Cup, which is one of the best standard grades among Naturals, went up from -7 to +2/+3, but for Brazil 3/4 14/16 Good Cup it remained at the same level of -8/-14.
With the start of the bumper crop 2020/21 in April-May 2020, the differentials started to go down, Brazil 2/3 17/18 FC went down to -17 and Brazil 3/4 14/16 CC to -27. In the 2020/21 season, Brazil produced a record volume of almost 70 million bags (50 million Arabica, 20 million Robusta), exported 45.7 million and even displaced Honduras as the main origin in the certified stocks of the New York futures market.
In the 2021/22 harvest, production fell to about 52 million bags, Arabica dropped 18 million due to the drought, and the differentials rose again to -10, respectively -15/-20 the above-mentioned grades. The production potential in the 2022/23 season, which starts in April-May, was affected by the drought and frost last year, reducing the volume by about 10 million bags to about 60 million bags and we see that the differentials are rising more in the last few weeks.
Much specialty coffee is sold at a fixed price, prices well above the New York futures market. With the differentials shooting up and the New York price above 200 cents and even 250 cents at this time, this situation has changed. Many sellers have returned to selling at differential, but which one? Some buyers get upset, because for years they have paid a high price that covers the costs and provides a margin to the producer and now suddenly they have to pay much more. According to a special edition of the Specialty Coffee Transaction Guide on the impact of COVID-19, the percentage of coffees sold at a differential grew 53.6%. Previously, more than 75% of specialty coffees were sold at a fixed price. By the way, they have just published the new edition of the Specialty Coffee Transaction Guide.
In a next blog more on prices for specialty coffees. If you have any question or comment, or if you would like to suggest a particular topic, please push the icon below and leave a message.
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