The Continued Rise of Premium Coffee
in the U.S.: Will It De-Commoditize Coffee?
By Michael Vellucci
Coffee displays all the characteristics one associates with a true commodity: it is liquid, price transparent and
fungible. However, U.S. consumers have developed a more discerning palate when it comes to higher value,
specialty foods, and in keeping with this trend, upscale coffee has proliferated. As specialty coffee becomes
a larger part of overall U.S. consumption, what impact will it have on the broader coffee industry?
10 Brown Brothers Harriman | C O M M O D I T Y M A R K E T S U P D A T E
According to the International Coffee Organization, coffee consumption worldwide increased 1.4% in 2014. While this growth
rate may appear insignificant on its face, it must be viewed in
the context of a leveling off of consumption growth in developing markets that had been growing robustly over the past
decade: the law of large numbers at work.
Since 1990, the compound annual growth rate in global coffee
consumption has been roughly 2%, largely driven by increasing
purchasing power and changing tastes in emerging middle-class
economies.1 Against a backdrop of globalization, economic liberalization and the unfettered movement of international capital
over the past 25 years, emerging market economies in Latin
America, North Africa, Eastern Europe and non-Japan Asia have
witnessed a burgeoning middle class. As millions in developing nations have emerged from poverty, they have begun to
demand the previously unavailable trappings of a middle class
lifestyle. Coffee has been one of these creature comforts.
suggests that the bump in consumption owes to the ever-important U.S. consumer. U.S. coffee consumption increased 3.25%
year over year in 2013 and another 2.1% in 2014.4 According to
the National Coffee Association’s (NCA’s) 2015 “National Coffee
Drinking Trends” study, 59% of U.S. adults drink coffee daily,
which makes it the country’s favorite beverage, beating soda
by 20 percentage points.
U.S. Coffee Imports
3.1
3.0
Billion pounds
U.S. Coffee Drinkers Perk Up Global Consumption
2.9
2.8
2.7
2.6
2.5
2010
2011
2012
2013
2014
Source: International Trade Center.
U.S. Consumers’ Specialty Coffee Habit
In 2007, coffee demand from traditional consumer markets (primarily Europe and the U.S.) was roughly 5.1 million tons, vs.
about 4.3 million tons from nontraditional consumer markets. By
contrast, in 2011, demand from traditional markets was roughly
5.3 million tons, compared with approximately 5.0 million tons
from nontraditional markets (coffee-producing countries, teadrinking regions and so forth).2
Much of the U.S. coffee consumption increase owes to consumers’ growing appetite for specialty coffee. According to the
Specialty Coffee Association of America (SCAA), one of every
two cups of coffee consumed in the U.S. is considered specialty,
and according to the NCA, specialty coffee consumption rose
threefold between 2000 and 2015; 34% of adult coffee drinkers
reported drinking specialty coffee daily, up from 24% in 2010.
U.S. Adult Specialty Coffee Consumption
While the emerging markets helped to foster a global recovery
in the years immediately following the Great Recession, their
more recent middling economic performance amid collapsing
commodity prices and a strong U.S. dollar has taken its toll on
demand for discretionary consumer food products – and coffee
has been no exception. For example, in Brazil, the third-largest
coffee consumer behind the EU and U.S., consumption fell 1.5%
in 2013, the first year-over-year decrease since 2003 and only
the second since 1990.3
% drinking specialty coffee daily
40%
35%
30%
25%
20%
15%
10%
5%
0%
Perhaps an even more worrisome trend exists in the EU, no
stranger to recent economic woes, where coffee consumption
dropped 2.2% year over year in 2013 and was relatively flat in 2014.
The recent malaise in the world’s No. 1 and No. 3 consumers puts the 2014 global demand increase in sharp relief and
2000
2002
2004
2006
2008
2010
2012
2014
Source: National Coffee Association.
1
Source: International Coffee Organization (ICO).
2
Source: ICO.
3
S ource: ICO.
4
Source: ICO.
December 2015 11
Specialty Coffee Share of U.S. Consumption
% of total cups of coffee consumed
60%
50%
the proliferation of small coffee shops and their impact on consumption trends continue to drive demand for specialty coffee.
Defining Specialty Coffee
40%
30%
20%
10%
0%
2010
2011
2012
2013
2014
Source: National Coffee Association.
Those tortured few who follow the coffee markets have for
some time busied themselves fretting over whether the growth
in single-serve, in-home coffee brewing would eventually put
a crimp in U.S. coffee consumption. For many years, analysts
have theorized that the largest consumer of coffee has been the
kitchen sink, as most consumers once brewed a pot of coffee
only to drink a few cups. Single-serve coffee products such as
Nestlé’s Nespresso and Keurig Green Mountain’s pods, it was
thought, would result in less waste and thus decreased demand.
Consumption patterns, at least in the U.S., do not seem to lend
credence to this concern. Indeed, the single-serve revolution
seems to have begun to bring premium coffee from retail coffee shops into the home.
Specialty coffee comes in many different varieties, is sourced
from myriad origins and has a broad spectrum of flavor profiles.
It is also referred to by different names – such as gourmet, premium, artisan or third wave – that complicate data collection and
analysis. Though none of these appellations lend themselves
to a concrete definition, specialty coffee generally focuses on
higher-quality Arabica beans, lighter roasts, nuanced flavor profiles and greater attention to source and supply chain traceability.
Specialty coffee is a differentiated product, less commodity-like
and typically costs more to produce. Differentiation and value
derive from a variety of factors, including origin country, region,
estate/farm, agricultural variety or certifications from nongovernmental organizations such as the Rainforest Alliance and Fair
Trade International. Specialty coffee typically has one or more
of the following characteristics:
Even as premium coffee comes into the home, retail specialty
coffee shops continue to grow. According to the SCAA, the number of U.S. specialty coffee retailers increased more than tenfold
in 20 years, from 2,850 in 1993 to 29,300 in 2013. Of this total,
45% were chains or franchises, while 55% were independent,
defined as having three or fewer locations. National chains and
franchises such as Starbucks and Dunkin’ Donuts, both of which
buy high-quality coffee, need a consistent flavor profile across all
locations. These larger players cannot use small lots of specialty
coffee that differ in availability or flavor between locations. Instead,
• Grown using fair labor practices: Given the vagaries of
the futures market and influences on the price that may or
may not be driven by supply and demand fundamentals in
the short run, farmers may not generate enough cash to
pay their labor and maintain their crops. In theory, some of
the premium price of specialty coffee is intended to eventually trickle down to the farmers.
• S
ourced with a focus on crop sustainability: If commodity
crop prices plummet – as they did in the so-called “coffee crisis” of the early 2000s, when the nearby contract on the New
York futures exchange traded at below 50 cents per pound –
many farmers will choose to switch crops or abandon their
farms altogether. Given the premium value, specialty growers
can be somewhat insulated from price fluctuations.
[T]he number of U.S. specialty coffee retailers increased more than tenfold in
20 years, from 2,850 in 1993 to 29,300 in 2013.”
12 Brown Brothers Harriman | C O M M O D I T Y M A R K E T S U P D A T E
• Shipped with a transparent and traceable supply
chain: Commodity coffee is typically blended in large
batches from multiple producers, farms, regions and origins. Specialty coffee consumers increasingly want to have
a tie to a specific country, region, varietal or even farm.
Deal value peaked in 2013 at $8.55 billion, driven by JAB’s acquisition of 85% of Master Blenders. While the market has come
off its peak, it remains frothy. According to Dealogic, since the
beginning of 2015, there have been 50 coffee or coffee-related
mergers and acquisitions worth an aggregate $3 billion worldwide. Strategic buyers have represented 97% of the dollar value
of the deals in 2015, with a clear eye toward adding scale to the
higher margins associated with specialty coffee.
Dollar Value of Annual Global Coffee and
Coffee-Related M&A Deals
M&A Activity Brews in the Specialty Coffee Industry
It is clear that there is growing demand for higher-quality coffee and supply chain traceability and that there is a still opaque,
but starting to crystallize, sense of what constitutes “specialty.”
But what has been the dollar impact on the U.S. aggregate retail
coffee market? Over the past several decades, specialty coffee
has grown from a niche market into a multibillion dollar industry. According to a study by The Fletcher School of Law and
Diplomacy at Tufts University, specialty coffee industry sales
grew from $8 billion to $18 billion between 2001 and 2012. The
SCAA pegs the number somewhat higher. It estimates that the
retail value of the U.S. coffee market is $46 billion and that while
specialty coffee represents 51% of the volume, it accounts for
55% of the dollar value.
According to IBISWorld, profit margins and trading multiples in
coffee roasting and retailing are on an upswing worldwide, but
especially so in the U.S. because of the shift in consumer tastes
to higher-quality, more expensive coffee. Publicly listed beverage and retail snack companies currently trade for 31.5 times
earnings,5 and this trend has not been lost on larger, acquisitive
players in the coffee industry.
Joh. A. Benckiser GmbH (JAB) has been on a buying spree. The
company purchased California-based Peet’s Coffee & Tea and
Minnesota-based Caribou Coffee in 2012, D.E. Master Blenders
1753, which had been spun off from Sara Lee Corp., in 2013,
and Danish retail coffee shop chain Baresso Coffee in a deal
announced in July 2015. Mondelez International combined its
coffee business with D.E. Master Blenders to form a joint venture called Jacobs Douwe Egberts, which is a pure-play coffee
company with €5 billion in annual sales.
(in billion USD)
$9
$8
$7
$6
$5
$4
$3
$2
$1
$0
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
• P roduced with a focus on quality: When farmers
receive higher prices for their crops, they are more likely to
invest in husbandry and processing best practices, which
helps yield and quality of the final product.
Financial Sponsors
Strategic Investors
Source: National Coffee Association.
Specialty coffee roasters and retailers such as Stumptown
Coffee Roasters, Intelligentsia Coffee, Blue Bottle Coffee, La
Colombe Torrefaction and Toby’s Estate Coffee may serve as
a clue to the next wave of consolidation in the coffee industry.
JAB-owned Peet’s reached an agreement to buy Stumptown in
October 2015, though the purchase price has not yet been made
public. Stumptown was founded in 1999 with a single location
in Portland, Oregon, and grew to roughly a dozen retail locations
in Portland, Seattle, New York and Los Angeles under its previous owner, private equity shop TSG Consumer Partners. More
recently, Intelligentsia was sold to Peet’s. All of these trends
reflect a shift away from commodity coffee toward a specialized consumer product where consumers are willing to pay a
premium for differentiation – not unlike the wine market or craft
beer. Is coffee in the process of being de-commoditized?
5
Source: Bloomberg and BBH analysis.
December 2015 13
Nearby C Price and USD/BRL Rate
The Future of Coffee Futures
Most sales and purchases of Arabica coffee are made or hedged
using the coffee futures (C) contract on the Intercontinental
Exchange as a benchmark. While it’s too early to predict any
eventual outcome, specialty coffee producers, importers and
roasters/retailers are beginning to look for and find alternative
price discovery and hedging tools to manage their businesses.
Increased volatility in the benchmark and a divergence in price
between commodity coffee and specialty coffee have combined to diminish the utility of the C contract as a pricing and
risk management tool.
When asked what the stock market would do, J.P. Morgan
famously quipped, “It will fluctuate.” Nowhere is this truism
more apt than in commodity markets – and especially so in
coffee of late. Over the past three years, coffee has been the
second most volatile commodity on the Bloomberg Commodity
Index behind natural gas.6 Volatility in the coffee futures market
is driven by multiple factors, but two stand out: the weather in
and financial condition of Brazil, which produces roughly 40%
of the world’s coffee.
When concerns surfaced last year that a drought in Brazil would
crimp supply, the C price displayed tremendous volatility. The nearmonth futures contract began 2014 at $1.11 per pound, peaked at
$2.22 per pound in October and fell back to $1.67 per pound by
year-end. The effect on the relative value of the U.S. dollar (USD)
to the Brazilian real (BRL) is perhaps an even more stark and quantifiable comparison. The nearby chart displays the relationship
between the nearby C contract and the USD/BRL exchange rate.
Indeed, a regression of the C price against the value of one USD to
BRL finds that over the past five years, the USD to BRL exchange
rate displays a strong, positive correlation of nearly 65%.
Faced with volatility that is driven by exogenous factors, many
specialty coffee industry players are further chagrined by a debate
as to whether prices for premium coffees are diverging from and
increasingly uncorrelated to prices for commercial grade coffees.
A recent Emory University study found a significant positive
correlation between the futures price and the price of specialty coffee. The research compiled data from 361 contracts
between 2010 and 2014 covering coffee from 15 countries
350
1
300
1.5
250
2
200
2.5
150
3
100
3.5
50
0
Oct 2010
4
Oct 2011
Oct 2012
C Price (cents/lb.)
(left axis)
Oct 2013
Oct 2014
4.5
Oct 2015
USD/BRL
(right axis)
Source: National Coffee Association.
and 32 cooperative growers associations and found that every
$1.00 increase in the C price corresponded to a $1.09 rise in
the specialty price. However, 87% of the sales contracts examined used the C price as a pricing benchmark, which makes
the statistical logic seem circular.
Admittedly, as discussed, determining qualifiers for the designation “specialty” is far from an exact science, and data is
difficult to obtain. Nevertheless, several data points and comparisons are illustrative and could lend credence to an apparent
divergence in price. The SCAA began publishing the Specialty
Coffee Retail Price Index last year, and this new benchmark
increased 12.5% year over year in the second quarter of 2015,
compared with a 24% drop in the most actively traded C contract for the comparable period.
When examining data collected from several different origins
that focus on some combination of the attributes that designate
a specialty coffee, there seems to be a clear divergence in price
and lack of correlation. The following chart shows the weighted
average free on board7 (FOB) sales price per pound of several
different African specialty coffees. While there are only a few
data points in this new index, a regression of the price of the
specialty grade against the C price finds a correlation of 36%; a
correlation of less than 50% essentially means that the prices
move independently of one another.
6
Source: Financial Times, August 2015.
7
Free on board (FOB) sales price: the price a buyer pays at the port of embarkation.
14 Brown Brothers Harriman | C O M M O D I T Y M A R K E T S U P D A T E
Starting in the mid-1980s, U.S. consumers began to shift their
orange juice consumption from frozen concentrated brands to
premium freshly squeezed brands, a trend which continues to
drive down participation in the frozen concentrated orange juice
futures (FCOJ) market. We may be witnessing the beginning of
a de-commoditization process in which coffee is shifting from
a commodity product where price reigns supreme to a luxury
consumer product where quality, brand and story matter first,
with price a distant second.
C Price vs. African Specialty Coffee
3.5
3.0
USD/lb.
2.5
2.0
1.5
1.0
0.5
Weighted Average Sales Price/lb.
of African Specialty Coffee
Oct-15
Jul-15
Apr-15
Oct-14
Jan-15
Jul-14
Apr-14
Jan-14
Jul-13
Oct-13
Apr-13
Jan-13
Jul-12
Oct-12
Apr-12
Jan-12
0
Average C Price
FCOJ Futures Volumes
1000
Source: Westrock Coffee.
An examination of the relationship between the C price and
the premium to that price that several Latin American origins
command finds an even weaker correlation. The following chart
depicts the C price since 2007 and the weighted average premium differential to the C price from three Latin American
specialty coffee varieties, both shown in cents per pound. A
regression of the premium differentials against the C price finds
a correlation of 1.4%.
10%
5%
800
0%
600
-5%
400
-10%
-15%
200
-20%
0
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
(P)
Annual Volume ($000)
(left axis)
Year-over-year change
(right axis)
Source: Commodity Futures Trading Commission.
C Price vs. Latin American Specialty Coffee
50
45
40
35
30
25
20
15
10
5
0
300
250
200
150
100
50
C Price (cents/lb.)
(left axis)
Mar-15
Sep-14
Mar-14
Sep-13
Mar-13
Sep-12
Sep-11
Mar-12
Mar-11
Sep-10
Sep-09
Mar-10
Sep-08
Mar-09
Mar-08
Sep-07
Mar-07
0
Premium to C (cents/lb.)
(right axis)
Source: ED&F Man, Transparent Trade and the Specialty Coffee Association of America.
Faced with a volatile and less relevant benchmark – and changing consumer demands and tastes – physical players in the
specialty coffee market are seeking alternatives to the traditional
pricing and hedging model. While this has not yet decreased the
volume of contracts traded on the coffee futures exchange, it
is not beyond the realm of possibility, nor is it unprecedented.
Conclusion
As baby boomers’ consumption and purchasing power wanes
and as millennials’ demand and disposable income grows, specialty coffee’s consumption will likely continue in both nominal
and percentage terms, as the former’s tastes favor commercial
grades while the latter’s run toward specialty. While it is premature to suggest that coffee prices per se will decouple from
the futures price, it is clear that some of the higher value, specialty grades are increasingly less commodity-like, uncorrelated
to the futures market and price inelastic. Though these grades
remain a small percentage of the overall coffee market, their
volumes are on a steeply upward sloping trend. If this continues, pricing and hedging will continue to vex the supply chain
for some time to come.
Brown Brothers Harriman is a leading U.S.-based bank to the coffee industry
and finances a significant amount of the coffee imported into the U.S. annually. We have supported the green coffee trade for more than a century and
will continue to monitor and adapt with our clients as it continues to change.
December 2015 15
This publication is provided by Brown Brothers Harriman & Co. and its subsidiaries (“BBH”) to recipients, who are classified as Professional Clients or Eligible
Counterparties if in the European Economic Area (“EEA”), solely for informational purposes. This does not constitute legal, tax or investment advice and is not intended
as an offer to sell or a solicitation to buy securities or investment products. Any reference to tax matters is not intended to be used, and may not be used, for purposes
of avoiding penalties under the U.S. Internal Revenue Code or for promotion, marketing or recommendation to third parties. This information has been obtained from
sources believed to be reliable that are available upon request. This material does not comprise an offer of services. Any opinions expressed are subject to change
without notice. Unauthorized use or distribution without the prior written permission of BBH is prohibited. This publication is approved for distribution in member states
of the EEA by Brown Brothers Harriman Investor Services Limited, authorized and regulated by the Financial Conduct Authority (FCA). BBH is a service mark of Brown
Brothers Harriman & Co., registered in the United States and other countries.
© Brown Brothers Harriman & Co. 2015. All rights reserved. 2015.
PB-2017-06-07-1430