Risk Management Workshop

Objectives
 To understand the main risks that threaten the results of the coffee export business
 To provide up-to-date information about the global supply and demand of coffee and
the tendencies of the niche and differentiated coffee markets
 To understand the specifics of handling sales in the Fairtrade market
 To understand how the futures market operates and how to fix prices
 To provide strategies and practical tools to mitigate commercial risks
 To understand our successes, our mistakes and the experiences of other organisations
 To provide the tools necessary to develop a harvest plan and for the definition of
gathering strategies, marketing and price fixation
 Terminologies
Hedging is a trading operation that allows a person to transform a less acceptable risk into
a more acceptable one. This is done by engaging in an offsetting operation in the same
commodity under roughly the same terms as the original transaction that created the risk.
Niche markets combines a set of conditions that enable a single species or a single
product to thrive within the greater ecological or commercial environment. Two main
factors determine whether coffee can find a niche market: quality and availability. 

Derivatives is a financial instrument whose value is derived from the value of one or more
basic variables called bases (underlying asset can be equity, commodity, forex or any other
asset)
Forward Contracts: is an agreement to buy or sell an asset(physical) on a specified date for a
specified price. There is an agreement to buy or sell the underlying asset and the transaction takes
place on a predetermined future date and price.
 
Future Contracts: is effectively a forward contract which is standardized(paper) in nature and is
exchange traded. Future contracts remove the lacunas of forward contracts as they are not exposed
to counterparty risk and are also much more liquid.
Forward markets are used to contract for the physical delivery of a commodity. By contrast, futures
markets are 'paper' markets used for hedging price risks or for speculation rather than for negotiating
the actual delivery of goods
 
Option Contracts: is a contract which gives one party the right to buy or sell the underlying asset
on a future date at a pre-determined price and other party has the obligation to sell/buy the
underlying asset at a pre-determined price.
 Price risks
There are no businesses without risk; it’s not about eliminating risks but about
identifying and limiting them to a level that doesn’t affect the continuity of the business

First we need to understand the dynamics of the market & how the price is formed:
supply and demand, technical movements and speculation

We to need to have strategies and tools to control the basic components of the business:
costs, cash flow, inventories, etc.

Physical risk management strategies should always be at the core, the use of hedging is
complementary and requires a more sophisticated management
 Price risks
The coffee price has the following components:

The international market reference price; mainly the New York futures price for
Arabica and the London one for Robusta

The quality/origin differentials

The local market price for procuring the coffee

The exchange rate – the conversion of the sales price in dollars into the local currency
for purchases

 We analyse it from the producer perspective, but taking into consideration the
position of the buyer
 Risk: International Price
The international price for Arabica is mainly based on the New York futures market
price (NYC)
Supply and demand influence the price, but also speculation, politics and economic
conditions, the weather in producer countries, etc.
When formulating the harvest plan one needs to consider the short and long term
trends and possible scenarios
For price fixing of sales contracts during harvest times, an analysis of the technical
and the speculative movements are more important for the price setting in the short
term
The futures market is very volatile and can fluctuate by up to 20 cents per day
 Risk: International Price

 In summary, the risks of the international price are:

 Procuring and not selling at the same time = being “long”; if the market price drops,
one loses

 Selling without procuring at the same time = being “short”; if the market price rises,
one loses
 We are not interested here in whether one is physically short or long, but in when one
buys or sells (that is, when the coffee price is fixed)
 The short or long position indicates exposure to the price risk; due to price fluctuations
the risk increases over time
 Cooperatives are usually long; waiting for a better price
45,000
International Price and Positions 180
40,000
170
35,000
30,000 160
25,000
150
20,000
15,000 140
10,000
130
5,000
0 120

Accumulated procurement Accumulated fixations

Accumulated contracts NY"C"
 International Price: Volatility
350.00

300.00

250.00

200.00

150.00

100.00

50.00

0.00
1973 1978 1983 1988 1993 1998 2003 2008 2013
 Risks: Differentials
 Differentials reflect the supply and demand of a certain origin and the quality in
relation to the exchange market price: premium or discount
 References to differentials serve as a guide, but in the end it’s about a negotiation
between the buyer and seller
 The origin, quality, consistency/history and local price (replacement value) all
influence
 Can vary according to the market and the shipping month
 The differential can also be a correction against speculative movements in the futures
market
 The differentials generally fluctuate less than the futures market price, but not always
 Risks: Differentials
 In principle, it’s the same problem as with the international futures market price:

 Buying when the differentials are high and then selling when they are low

 Conversely, selling when the differentials are low and then buying when they
are high

One difference in relation with the futures market price is that there are no hedging
tools to protect us against the risks associated with differentials; there are however
management strategies, like averaging sales prices at different times and in different
markets
 Risks: Differentials
+100.0

+75.0

+50.0

+25.0

+0.0

-25.0
oct.-08 oct.-09 oct.-10 oct.-11 oct.-12 oct.-13 oct.-14 oct.-15 oct.-16 oct.-17

Colombia Excelso Guatemala SHB Honduras HG Santos 2/3

 Risks: Local Market
 Is affected by the futures market, but it has it’s own supply and demand dynamics. A strong local
competition usually translates into high prices and a low competition generally results in low
prices

 The structure of the sector (competition), contextual factors (time, transport, strikes, etc.), as well
as politics and the condition of the infrastructure and services

 The local price can be higher than the global price, e.g. when exporters are ‘short’ (oversold,
especially at the end of the season, or when there is not a lot of coffee) or due to commercial
strategies and the speculation of competitors

Hedging protects against price fluctuations on the futures market, but not against opposing
tendencies in the local market
 Risks: Local Market

150
Nicaragua 09/10 NY vs mercado local
145
140
135
130
125
120
115
110
105
100
NY Plaza
95
oct-09 nov-09 dic-09 ene-10 feb-10
 Risks: Fairtrade Market
 In principle the FT Price is the market price plus a premium and it has a guaranteed minimum
price. FT has grown and has its own dynamics of supply and demand

 Prices below the standard undermine the use of the FT premium and the minimum price as a
main risk management strategy, especially for conventional coffee; organic coffee has an
additional premium

 Contracts are needed in order to access finance and this puts pressure on accepting
unfavourable conditions

 It’s more complicated for the buyer to guarantee the price without being at risk when the
market is close to the minimum, for which reason price fixing is being conditioned (e.g. stop
loss clauses that are high risk before the harvest)
 Risks: Fairtrade Market
 Some buyers don't operate on the futures market, but they introduce conditions that can
increase the risks for POs depending upon the market conditions (only fixing 1 month before
shipment, fixing against an average price of the past few months, etc.)

 Forward sales with a fixed price are high risk; if the market price goes up, the coop can’t
deliver or makes a loss

 Many organisations have limited experience, they speculate (without knowing), frequent
defaults on contracts

 Late shipments are common, they increase the costs and the risks

 The paradox: high prices are good for the producers but are difficult to manage for coops and
for buyers
 Risks: Producers
 Even though they are owned by the producers, cooperatives also buy and sell =
commercial risk

 A classic problem is the transfer of ownership and who assumes the risk, because
producers are both owners and suppliers

 Producers’ attitude towards risks taking and the level of loyalty to their
organisation; a speculative attitude and selling to the competition are common

 The “lottery effect” in price fixing when volumes are low: it takes a long time to
procure 1 lot, while prices fluctuate

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 Risks: Producers
 Many organisations’ internal culture and dynamics are very different to that of
the market (2 speeds, 2 worlds) e.g. members have to be consulted on market
related issues that require immediate decisions

 In general cooperatives are at a disadvantage vs. their competitors: human

resources, scale, costs, services, infrastructure, access to credit, etc.; therefore
they face higher risks in each of these aspects

 Coops are more limited in buying and selling, due to internal and external rules
and regulations (e.g. FT and organic)

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Thank you