Prices On Coffee Market

But before you bet the house on coffee prices, it might be prudent to take a look at the current supply situation in coffee and how coffee is priced. While we believe coffee prices could see a slight increase in 2007, we feel rallies will be limited. The public's belief that a bull market is imminent, however, could create some excellent profit opportunities for astute call sellers.

If one can focus on these big picture numbers and tune out the daily "noise," one can compare them to supply and demand of past years and their corresponding price levels. This may not tell us exactly where the market is going to go. But it can give one a fairly clear idea of where the market most likely will not go. And as option sellers, that is all we need.

While coffee is grown in many countries across the globe, Brazil is the world's largest producer and exporter of coffee by far, responsible for approximately 1/3 of the world's total coffee production in any given year and accounts for the majority of the higher quality arabica coffee traded at the NYBOT. Thus developments in the Brazilian crop have a substantial impact on coffee futures prices at the NYBOT.

The bulls are pointing to 2007's expected 31.5 million bag Brazilian crop as reason enough to buy coffee now. After all, it is a substantial decrease from last year's massive 48 million bag harvest and some analysts expect Brazilian coffee exports to drop as much as 10% in 2007 as a result.

While this may be true, this viewpoint does not take into account the excessive supplies in storage left over from the 2006 harvest. The South American coffee harvest typically wraps up in October. Most of this coffee is still sitting in Brazilian warehouses looking for a home. But Brazil is becoming much more active in exporting at current price levels.

In December, coffee exports from Brazil were up 26.4% over last year at the same time. The bulk of these supplies will be hitting the world market over the next 2-3 months which should keep a lid on runaway coffee prices in the near term.

This also assumes that 31.5 million bags of coffee is an accurate estimate. The Brazilian government is infamous for understating coffee production as lower expected supply can help support price. Some private forecasts have the crop yielding as much as 36 million bags this year.

Bulls also point to an expected production deficit in 2007 - as though the word itself implies "running out" of coffee. Nothing could be further from the truth. The world production/consumption figure merely measures that year's total world production vs. total consumption for the year.

In 2007, the world is expected to produce 117 million (60kg) bags of coffee while consuming 121 million bags. True, this is a deficit of 4 million bags. However, this figure does not take into account all the coffee in storage across the globe. In addition, the bulls may not consider that 2006 saw a production surplus of nearly 6 million bags.

In addition to last year's burdensome supplies, the market has at least partially already priced the expected production decline in 2007. Coffee prices started climbing in late 2006 around the time the first private estimates for the 2007 crop were made public.

Indeed, coffee prices have climbed nearly 30% since September of 2006. This is the primary reason that exporters have become so active as of late. Prices have reached a level that producers deem attractive enough to begin unloading product in earnest. In short, it is what they consider a fair price. Producers and roasters of coffee beans across the globe are well aware of expected supply figures for next year.

We are not necessarily bearish on coffee prices over the next 3-4 months. However, in selling options, one does not have to decide where prices will necessarily go - only where prices will not go. And while it is possible that coffee prices could rise 10-15 cents from current levels by mid-2007, we feel it unlikely prices can climb much higher than that.

The mild production deficit of 2005 produced only moderate price increases (prices topped out at $1.37 per pound) and coffee has not traded above $1.40 since the freeze scares of the late 90's (it is currently early summer in Brazil).

It is our contention that rallies in coffee will be met with strong producer selling in the coming months and that call sellers are now presented with an opportunity to sell call premium at 50-60 even 80 cents above current price levels.

Coffee closed on Friday at $1.20 per pound at the NYBOT.