Rise in Coffee Prices
Great for Farmers, Tough on Co-Ops
by David Griswold
photographs courtesy of Sustainable Harvest

Coffee farmer by Gavin Johnson, courtesy of Sustainable Harvest.

During winter and spring of the 2005 harvest, a dilemma surfaced in rural areas of Central America and Mexico. Fair-trade cooperative managers found it increasingly difficult to get members to deliver coffee to their own organizations at fair-trade prices. The co-op managers were holding contracts that were set months before at fixed fair-trade prices of $1.26 per pound, but now the world coffee price was higher. Growers were seeing some of the highest prices paid in five years, and the temptation was great to sell their coffee to the highest local bidder, instead of delivering it as promised to their own co-ops.
   In most cases, the co-op's leaders were able to convince farmers to deliver coffee, but often based on arguments of loyalty, as the fair-trade fixed price was now lower than the premium prices being offered by local middlemen. It was not the model that the founders of fair-trade coffee pricing had envisioned when they created the program.
   "It's worth noting that we were pleased to see prices rise in late 2004," says Christopher Himes, TransFair USA's Director of Certification and Finance. "This price rise, in conjunction with the impact fair trade was already having, increased the income and living standards of coffee farmers around the world. The most challenging thing during this time for TransFair USA was the speed with which the local differentials-not the commodity market-rose in Indonesia. They quickly skyrocketed to 80 cents or higher, making the market value of farmers' coffee higher than that of some of the forward fixed fair-trade contracts."

Co-op members tend to coffee beans on a drying patio.

Reasons for the Rise
The rise in 2005 in the world coffee market price was due to a number of factors. There was an increase in worldwide consumption, a reduction of coffee stocks held in warehouses in both producing and consuming countries and a downturn in harvest yields in larger coffee-producing nations like Brazil. The coffee futures market, or "C" market, had become a hotbed of speculation because of wild price fluctuations that could result in large profit-taking opportunities. Speculators such as commodity investment funds bring liquidity (capital) to the coffee futures market. But they also add such a volume of activity that the futures price of coffee can be distorted from the actual supply-and-demand equilibrium price.
   2005 also saw a dramatic drop in yields in Central America and Mexico. This was the result of several factors. Farmers had neglected coffee plant yields due to four years of low prices. Erratic weather patterns at critical stages of the growing season had stifled the growth of coffee cherries in many places. Rains had come either too late or too early, and across Central America and Mexico, the volume was down roughly 20 percent to 25 percent.
   The steep increase in world coffee prices and the reduction in yield created ideal conditions for a coffee-buying frenzy in numerous places, which hurt the ability of co-ops to collect their members' coffee. According to farmer adviser Jeronimo Bolen of the Guatemala group Manos Campesinos, the high price of coffee had a big impact on the farmers' thinking.
   "A typical Guatemalan small-scale coffee farmer has a yearly income of about $1,500, so it is understandable that when the "C" market goes up they want to try [for something extra]," says Bolen. "The bottom line is basically that the temptation for an individual farmer is pretty high to sell his coffee to the local middlemen when prices are good. At that moment, the farmer isn't thinking at all about what's going to happen within a few years, when prices [will] probably drop again."
   The pressure on fair-trade co-op leaders to get coffee from members was most challenging in growing areas where international recognition has created the strongest demand, such as Guatemala's Lake Atitlan or Costa Rica's Tarrazu region. The premium prices paid for coffee, including fair-trade coffee, were extremely high. According to fair-trade co-op leaders, as well as fair-trade roasters and importers, many farmer co-op organizations faced challenges in securing their members' coffees to fulfill fair-trade contracts.
   "The most challenging aspect for me as an importer, with the rise in prices, has been balancing the fair-trade co-ops' desire to reap a windfall from this short-term futures market spike while at the same time protecting roasters from unfair manipulation after they have agreed to long-term contracts at fair-trade prices, or higher," says Alan Odom, a coffee trader with InterAmerican Coffee. "Relationships have become strained in many cases."

Growers deliver coffee to the co-op in Lake Atitlan, Guatemala.

Pricing Coffee in the Fair-Trade System
In the fair-trade coffee system, growers must join democratically run cooperatives that also must be on a list of the Fair Trade Labeling Organization (FLO), a European nongovernmental group that certifies co-ops. Growers are paid a minimum base price for their coffee crop, which currently is $1.21 per pound for conventional coffee, plus a fair-trade premium of five cents per pound, for a total price to the co-op of $1.26 per pound.
   Organic coffee farmer co-ops receive an additional 20-cent premium per pound on top of the $1.21 per pound base price. This minimum fair-trade price covers the costs of coffee production and provides a decent standard of living for farmers and their families. The premium is used by cooperatives to fund projects for the community or the business, as well as social and environmental projects. When the market is below the $1.21 base price, this system works well for co-ops and farmers, but when it rises above $1.21 per pound, farmers thrive but business becomes very complicated for the co-op organization.
   Trying to stay on top of changing local premiums can be difficult for both roasters and importers. These local prices are hard to verify because they often are based on hearsay, with the exception being when governments play the role of regulating local coffee prices in places like Costa Rica and Ethiopia.
   "In high prices, the fair-trade price must be the five-cent premium plus the local premium, which is different in every country," explains Alvaro Gomez, the leader of the Costa Rica co-op consortium COOCAFE. "Costa Rica has premiums that are very high, and ICAFE [the national coffee board of Costa Rica] does not permit any exporter, including co-op exporters, to sell coffee at prices lower than the lowest average price paid by exporters for that period. So if the going premium for Costa Rica is higher than the fair-trade amount of a five-cent premium, the difference has to be covered by the contract price."
   Some members of the trade believe serious modifications need to be made to the model. "TransFair and FLO need to better understand traditional coffee trading processes," says Odom. "The pricing system needs to be fine-tuned. It needs to match fluctuations in market conditions with fair-trade minimum prices to protect and benefit both producers and roasters."
   Gomez adds, "It is a complicated problem because when the market rises considerably to the minimum fair-trade price, the grower organization loses its competitiveness and its capacity to collect coffee for two reasons: a) the producer is better informed about the price and the price rise, and b) the competition increases in an aggressive fashion. As a consequence, the roaster risks not having the coffee delivered for a lack of physical coffee, and the co-op as an organization is at a disadvantage in trying to match price."

Willie Foote, director of Ecological Finance, speaks to growers in Oaxaca, Mexico, October 2004.

Grower Co-ops Outbid
Co-ops have found that in rising markets, multinational export houses are often able to access more cash at lower rates of interest than the growers' cooperative organizations are able to do. Co-ops struggle to provide local prices to their own members that match those offered by the private houses, not only because they lack access to credit lines, but in a market at double the previous year's value, the financing they may have had in place only buys half the coffee.
   "Unlike the private houses, small-scale family farmers who build commercially viable businesses simply don't meet the traditional requirements to access credit from local financial institutions," says Willie Foote, Executive Director of Ecologic Finance, one of the few U.S. banks willing to finance small-scale farmer cooperatives. "Being too large for microcredit agencies and too small to be considered "bankable" by commercial banks, farmer co-ops are stuck in a no-man's land where they cannot borrow the money they need to grow their businesses, invest in new equipment or merely survive the cash-less gap between planting and harvest time."
   Under Foote, Ecologic Finance loans some $8 million annually to small producer groups, and Foote remains optimistic about the upside potential for specialty coffee if lenders continue supporting the co-ops: "The power of creative pre-financing is that everyone wins. Small family farmers get the price they deserve; importers get a reliable supply of high-quality specialty coffee; and the world benefits because these communities thrive by using environmental farming practices."
   No matter how short-sighted it may seem on the part of growers, it is difficult for co-ops to get coffee from members if the co-op price is not matching local offers.

Technical advisor for Guatemala’s Manos Campesinos, Jeronimo Bolen (right), with associate Carlos Reynosa in Lake Atitlan region.

   "We have spoken to co-op leaders, members of Manos Campesinos," says Bolen. "They said literally, 'We know we are going to get less money from Manos Campesinos than [a local coffee middleman who buys for private export houses] might pay us at a certain moment.' But they also remember the benefit they've had in the last four years. They're going to fulfill our part of the commitment, no matter what," says Bolen. "But at the same time, we have communities [from which] we have had difficulties getting the volumes we contracted. For us, it means Manos Campesinos has to put up more money to buy their coffee. But that's something that not every grower organization can do. That's why this year, defaults have been high in Guatemala."
   One co-op leader in Mexico recalls driving his truck to the village warehouse where members of his coffee cooperative bring exportable bags of coffee in coffee parchment. He was planning to take the coffee to the dry mill for processing, but there was no coffee awaiting him. Local leaders explained that members had not been delivering coffee to the collection center. Then, conditions changed due to a combination of a drop in the world coffee price and exhortations by the co-op to get members to deliver. Slowly, over several weeks, the missing coffee bags began appearing, and the fixed fair-trade contract was fulfilled.
   According to TransFair USA's Himes, there was some confusion on the part of fair-trade sellers and buyers. "It's evident that, in some cases, there was a misunderstanding regarding the dynamism of fair-trade pricing," he explains. "Some buyers and sellers did not know that it was completely within the producers' right to fix a contract; they thought all fair-trade contracts automatically moved with the market. After years of the market price remaining far below the fair-trade floor price, most actors were happy to fix fair-trade contracts at the minimum price. This put a small minority of contracts under pressure, as cooperatives' farmers could get higher prices from local middlemen than from their co-ops. This situation has stabilized, but it was sobering for many people. As a result, buyers and sellers are much more mindful of what needs to be done to secure future fair-trade supply chains."

What Happened to the "Fair" Price?
For some buyers, it seemed paradoxical that for the previous four years, the growers found that selling coffee at a f.o.b. price of $1.26 per pound (or $1.41 per pound for organic) was considered "fair," and now in a rising market, those prices no longer were seen as such.
   "For us, there really [were] no defaults, there were co-ops that wanted more money, and we had to react to it by paying more money," says Mark Inman, co-founder of Taylor Maid, an organic and fair-trade coffee roaster based in Northern California. "But really, the message I would send to the growers is that the co-op is not an unemployment agency or a charity. Farmers cannot go in and out of them, go in only when there's a low market and they're broke, and leave them when there is a high market and they have the potential for doing better. Co-ops are there for growers as a type of management structure. That means you have to be there during good times and bad times. And if they can't adhere to that, then the co-op system truly has a weakness."

The 2005 harvest has tested the strength of coffee farmer co-ops and their contracts with buyers.

Getting Growers to Deliver to Their Organizations
From a producer's point of view, notes Bolen, the minimum $1.26 price was fair in relation to the market price at that time. "When analyzing the price structure, and knowing that the cost to put one pound of coffee f.o.b. on a ship bound for the U.S. costs about 85 cents to 90 cents per pound, the difference is only about 36 cents to 41 cents in margin to the grower," he explains. "However, this is not profit for the producer because he has to use this money to feed his family, buy clothes, pay the doctor. That's why I always say the fair-trade price is just about that: a minimum. So when the "C" goes up, every producer, whether big or small, tries to get the extra cents because this is where a producer might get a small profit."
   Some suggest it is odd that with the fair-trade model, when prices go up the farmer does better, but often at the expense of the farmer's own co-op organization. "Given the [price] spike, it would be logical to conclude that farmer cooperatives-the foundation of the fair-trade system-would benefit from increased revenue," explains Rink Dickinson, co-Executive Director of Equal Exchange, a pioneer roaster of fair-trade coffee in the U.S. "But this is not the case. Ironically, when prices in the coffee market rise, the pressure on small farmer cooperatives actually increases, resulting in a weakening of the fair-trade system."
   To rectify the situation, coffee industry and fair-trade advocates will continue to look for solutions to price fair-trade coffees in a way that allows farmers to enjoy the benefits of rising prices, but not at the expense of their co-op organization or the roasters who support them. Innovative thinking on both sides of the coffee chain needs to occur to protect the integrity of the model.
   Himes says everyone must learn from the lessons of 2005 to make things better in the future. "We will reiterate to our cooperatives (and our importers) that they must honor their contracts in order to remain in good standing with Fair Trade and with their longtime commercial partners. We will coach cooperatives to resist selling forward at a fixed price [for] coffee that they have not yet received from their members. We will work with importers, lenders and nongovernment organizations to coach producers on risk management. Eventually, we'd like to see cooperatives achieve a level of financial literacy that would enable them to hedge their positions."
   Inman suggests that the long-term solution for farmers is to stay loyal to their co-op organizations and to focus on maintaining coffee relationships. "The challenge to the co-op is that they have to somehow create a culture of loyalty," says Inman. "Because a higher market can be much more destructive to the co-op movement and the small farmer movement than very low market, because nothing is more vulnerable than a small farmer out on their own without the umbrella of protection of the co-op. This price situation is extremely destructive to the fair trade co-op movement. The theoretical hope by the big guys is that it will erode co-ops or create a lack of trust to where roasters will start to look away from co-ops as a viable option, and only at large estates, which I hope will not happen."