[OPE-L:7411] coffee prices

From: Rakesh Bhandari (rakeshb@stanford.edu)
Date: Mon Jul 08 2002 - 09:17:18 EDT

WSJ, July 8, 2002
An Oversupply of Coffee Beans
Deepens Latin America's Woes


LA DALIA, Nicaragua -- Antonio Luna thought he had seen the worst life had
to offer during the 1980s, when his village in Nicaragua's coffee-rich
northern highlands sat in the crossfire of a guerrilla war between
U.S.-backed "contra" rebels and the Marxist Sandinista government.

That was before this May, when his family's home became a plastic tarp
pitched along the roadside here. Huddled with about 3,000 other unemployed
coffee pickers, Mr. Luna is a hungry refugee from a potentially more
devastating conflict than any he has known before: a global brawl over the
$55 billion coffee market. The fight has left the world awash in java and
has driven inflation-adjusted prices for beans to their lowest levels in
more than a century.

"We've had no work since February and are here begging for our lives," says
Mr. Luna, a listless 33-year-old, surrounded by a group of visibly
malnourished, unshod children. They are living on wild bananas and the
charity of passersby. "At least during the war there was food," he says.

In lush coffee-growing regions from Central America to Africa, the collapse
of world coffee prices is contributing to societal meltdowns affecting an
estimated 125 million people. In former Cold War proxy battlefields such as
Nicaragua, the result is a combustible brew of unemployment, hunger and
migration. In countries such as Uganda and Burundi, which get 70% of their
export earnings from coffee, the severe price drop has blunted benefits
from international debt relief.

The oversupply of beans driving the crisis won't ease quickly because so
many small growers see few alternative crops that are profitable and legal.

In the U.S. and the rest of the developed world, the price of coffee on
supermarket shelves has fallen -- but considerably less than the price paid
to growers. That translates into record sales and profits for some of the
corporations that process and market coffee, according to industry
officials. Four giants -- Procter & Gamble Co., Philip Morris Cos.'s Kraft
Foods Inc., Sara Lee Corp. and Nestle SA of Switzerland -- control about
40% of the world's coffee. They buy it in bulk and then roast, grind and
blend it into brands such as Kraft's Maxwell House and P&G's Folgers.

Illegal Migration

The low bean prices fueling corporate profits are "causing entire rural
communities to disappear and forcing desperate peasants into everything
from crime and illicit crops to illegal migration," says Nestor Osorio, a
Colombian who heads the International Coffee Organization in London, which
represents producing nations. He predicts more tragedies like that which
befell 14 out-of-work coffee pickers from Mexico's Veracruz state. They
died of dehydration in Arizona in May 2001 while trying to cross the
Sonoran desert to a new life in the U.S.

Until the 1990s, the desire for international security made propping up
coffee prices a crucial instrument of U.S. foreign policy toward places
such as Nicaragua, where coffee supports more than 40% of the rural labor
force. The world's most-traded commodity after oil, coffee was seen during
World War II as key to thwarting the spread of fascism among German
immigrants in countries such as Guatemala. During the Cold War, coffee
wasn't only a morning pick-me-up but a bulwark against Communism.

At the time of the 1962 Cuban missile crisis, Sen. Hubert H. Humphrey told
Congress that ensuring healthy coffee prices for Latin American campesinos
"is a matter of life and death. ... Castroism will spread like a plague
through Latin America unless something is done about the prices of raw
materials produced there."

Fall of the Wall

That year, 66 coffee-importing and -exporting countries created the
International Coffee Agreement. The deal imposed strict limits on each
exporting nation. Actively promoted by the U.S., the world's largest coffee
consumer, the agreement artificially propped up prices for nearly three
decades. But when the Berlin Wall collapsed in 1989, so did the coffee deal.

In its place arose a new ideology of free trade, championed by the U.S.
Many producing nations ended coffee-buying and stockpiling programs that
controlled supply. That enabled Procter & Gamble, Nestle and other large
foreign buyers to purchase directly from relatively small growers, giving
the buyers more muscle to negotiate favorable prices. The result:
free-for-all coffee exports and a production boom that continues to
generate more beans than the world needs.

Brazil and Vietnam, which emerged as a coffee-growing giant in the last
five years, have flooded the market in a battle for dominance. That has
left the global market with an annual coffee excess of almost two billion

At the end of the 1980s, coffee-exporting nations received about $10
billion of a $30 billion annual retail market. Today, the total market has
nearly doubled, but with big buyers able to play growers against each
other, exporting countries receive less than $6 billion, according to the
International Coffee Organization.

Coffee prices on New York's Coffee, Sugar and Cocoa Exchange -- which
provides the industry with its benchmark for beans -- currently hover
around 50 cents a pound, down more than 80% from their brief peak of $3.15
in May 1997. But production costs in Central America are about 80 cents a
pound. That adds up to insolvency for many farmers.

"On my farm, I usually have about 100 permanent workers, but now I have
just 20," says Jose Angel Buitrago, who has grown coffee in Matagalpa,
Nicaragua, for 30 years. "I'm out of money, and in the next few weeks I'll
have to let them go, too. They'll end up on the highway begging for food."
When they have work, coffee pickers earn less than $2 a day in most of
Central America. Mr. Buitrago is lucky to have held out this long.
Neighboring farmers have already abandoned the business, leaving their land
overgrown with weeds.

The social impact on countries still emerging from the debt crises and wars
of the 1980s and 1990s is profound. In Central America and Mexico -- where
some of the world's highest-quality coffee is grown -- the World Bank
estimates that 600,000 permanent and temporary coffee workers have lost
their jobs in the past two years alone. Relief agencies estimate more than
1.5 million peasants in the region lack food.

In Guatemala, where a 36-year civil war with rural guerrillas ended in
1996, relief workers say about 6,000 children of out-of-work field hands
face starvation -- a situation exacerbated by a fierce drought. U.S.
government officials say struggling coffee growers in Colombia who had
resisted the drug trade are now turning to heroin poppies for a living.

The collapse of coffee prices has been a boon for the big companies that
process the beans and sell the final product. While prices paid to growers
have tumbled more than 80% since 1997, average retail prices for ground
roast coffee in U.S. cities have fallen only 27%, according to the U.S.
Bureau of Labor Statistics. Accordingly, the price differential between
international wholesale and U.S. supermarket prices ballooned to $2.54 in
May, compared with $1.50 five years ago.

Increasingly, big corporate buyers are substituting less expensive
"robusta" coffee from Vietnam and Brazil for the higher-quality "arabica"
variety commonly grown on the cloud-wreathed mountain slopes of Central
America. "Up to 75% of a typical can of coffee is now made up of the cheap
stuff, which they then cut with Central American or Colombian [arabica]
beans so your coffee doesn't taste like a shoe," says Eric Poncon, director
in Nicaragua of ECOM Group. ECOM, a major coffee trader and unit of
Brazil's Esteve SA, does business with Kraft and the other big coffee sellers.

Some of the industry's leaders have taken note of the widening gap between
the haves and have-nots. In March, Howard Schultz, chairman of Starbucks
Corp., urged fellow coffee executives in a speech at the National Coffee
Association's annual meeting to "share the blanket" of prosperity with
growers. The Swiss Coffee Federation has called for an "ethical coffee tax"
of more than one cent per pound to be invested in community programs in the
developing world -- a proposal the industry hasn't rushed to embrace.

Paying a Premium

Human-rights advocates and others in the so-called fair-trade movement have
pressured big companies to pay coffee prices that will sustain poorer
growers. Some upscale coffeehouse chains, including Starbucks, now pay a
premium for quality coffee. But bigger buyers typically don't.

Rather than pay above-market prices for coffee, says P&G spokeswoman Tonia
Hyatt, the maker of Folgers prefers to provide community aid. She says the
company's offices in Mexico, Brazil and Venezuela contributed a combined
$10 million last year for things such as community health centers and
schools. "We care very much and want everyone in coffee to have a
sustainable business along the whole line," she says.

Kraft, Sara Lee and Nestle say they, too, go out of their way to help small
growers. Sara Lee says it tries to buy at least 10% of its coffee from
small planters and cooperatives. Nestle buys 13% directly from farmers,
"ensuring that they receive the full value of their crop," says spokesman
Francois-Xavier Perroud. But he adds that increasing demand for coffee "is
the best way to ensure a long-term future for the farmers." Kraft has
helped educate Peruvian growers, among other programs, but it, too,
believes that its "most important contribution" is to promote demand, says
spokeswoman Patricia J. Riso.

Coffee consumption in the U.S. is growing by about 1% a year, but that
offers no panacea. Per capita consumption in the U.S. is about 20 gallons a
year, down from about 37 gallons in 1970.

Sara Lee's coffee-and-tea division had sales of $2.9 billion last year and
income "after accounting for non-recurring items" of $495 million -- its
best financial results in at least five years, says spokesman Joost J. den
Haan. P&G'S coffee business, with about $1 billion in annual sales, had "a
record year" in 2001, according to the company's annual report. P&G
declines to comment on coffee profitability, as do Nestle and Kraft. But
Nestle did say that coffee sales by volume hit a record in 2001.

To farmer Buenaventura Gutierrez, sitting in the dusty headquarters of the
Nicaraguan Coffee Growers Union in downtown Jinotega, corporate talk of
sustaining small planters sounds hollow. "In two or three years, most of
our industry will be gone," he predicts. "This is dangerous because we are
still coming out of a revolutionary, guerrilla environment in this part of

No one believes Nicaraguans are inclined to take up arms again. But the
coffee crisis is complicating a fragile political situation and eroding
confidence in the free market.

Coffee-related protests and the restructuring of coffee debt have become
daily thorns in the side of the new administration of Nicaraguan President
Enrique Bolanos. In the impoverished countryside, frustration is keeping
alive the political hopes of former President Arnoldo Aleman and former
Sandinista leader Daniel Ortega.

The rehabilitation of coffee fields after the devastation of war and
Sandinista mismanagement was a pillar of the government of Violeta
Chamorro, who defeated Mr. Ortega at the polls in 1990. "We all just wanted
to forget politics and get back to work," recalls coffee grower Miguel
Gomez, a former Sandinista official.

Loan Programs

In the 1990s, some plantation owners who hadn't been in the coffee business
took advantage of loan programs offered by the government and a regional
development bank. "Though coffee has been in Nicaragua for well over a
century, a lot of the businesses are relatively new, with very small
capital bases and lots of debt," says Julio Solorzano, a coffee grower and
special adviser to the Ministry of Agriculture.

The borrowing continued through the mid-1990s as frosts affecting Brazil's
huge crop helped boost international prices temporarily. By 2000,
Nicaragua's 32,000 farms had boosted coffee crops back to 1979 levels. But
by then, falling prices had rendered grower debt, estimated at $100
million, more difficult to pay off. While the cash-strapped government is
trying to help growers postpone repayment of some of what they owe, there
is little money to help starving field hands, officials say.

Mr. Solorzano, one of the struggling growers, struck a deal with his
remaining workers: They get paid two weeks salary for every three weeks
they actually work. His employees, rather than lose their jobs, agreed to
let him try and make up the difference at some point in the future.

Other farmers talk of switching crops. They are discouraged, however, by
the experience of farmers who have grown peanuts and sesame. Those growers
now find themselves on the verge of bankruptcy after trying to compete
against U.S. farmers receiving generous subsidies from Washington.

With a lack of competitive alternative crops, "the only viable
diversification alternative for workers is mass migration," says Mr.
Poncon, the coffee trader. An estimated 400,000 Nicaraguans now live in
Costa Rica, many of them recent arrivals. They scrounge for work in
competition with Costa Ricans unhappy to be their hosts.

The coffee crisis has prompted some fanciful proposed solutions. In Mexico,
state oil company Petroleos Mexicanos has been looking at the possibility
of using excess coffee to absorb oil spills. Other ideas include using
coffee as animal feed and as fuel. International charity Oxfam has
suggested a mass destruction program funded by a windfall tax on the big
international companies -- an approach the companies reject.

The answer for a handful of Nicaragua's best-run farms is selling to the
so-called specialty coffee market, which pays a premium for top-quality
branded coffee. But this niche market is small -- about $100 million a year
-- and the high-end brands have a hard time winning supermarket shelf space
when pitted against powerful marketers such as Procter & Gamble.

The U.S. National Coffee Association is hoping to stimulate more
consumption by focusing "on more scientific research on the health benefits
of coffee," says Robert F. Nelson, the trade group's president. "There's a
lot of bad science out there," he says.

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