Coffee futures flirt with 13-year high on crop troubles

Retail price hikes lag, but supermarket prices could rise up to 10%

A previous version of this story incorrectly characterized Monday's settlement for coffee futures as the highest since September 1997. The story has been corrected.

SAN FRANCISCO (MarketWatch) -- Arabica coffee futures came off a nearly 13-year high on Monday, but traders say tight supplies are likely to keep prices of the better-quality bean elevated.

Coffee prices have increased 34% this year as recent crops from Colombia and countries in Central America were dogged by poor weather. Concerns about Brazil's upcoming crop also pulled in buyers.

Reuters

As prices soar in the futures markets, U.S. coffee producers have been bracing for higher coffee purchase costs. Some have already increased their prices.

Demand for coffee, however, is generally seen as impervious to higher prices -- coffee drinkers usually only change their purchasing habits if prices rise significantly.

Coffee for December delivery, the most active contract, declined 2 cents, or 1%, to settle at $1.83 a pound on ICE Futures U.S. on Monday. Earlier, they rose to an intraday high of $1.89 a pound.

They settled at $1.85 a pound on Friday, the highest settlement since September 1997. Coffee prices hit a record in May 1997, when prices hit $3.18 a pound.

A small exchange-traded note that tracks coffee futures, the iPath Dow Jones UBS Coffee Subindex Total Return ETN /quotes/comstock/13*!jo/quotes/nls/jo (JO 46.93, -2.62, -5.29%) , by Friday had topped Morningstar's list of best-performing exchange-traded fund, excluding leveraged ETFs, over the past three months. Read ETF Investing blog on coffee futures.

"I do think coffee has a very, very good chance of hitting $2 a pound," said Sterling Smith, an analyst with Country Hedging Inc. in St. Paul, Minn.

Supplies from Colombia are still tight, and it's not clear whether the Brazilian crop can lessen concerns about the precarious supply situation overall, he said.

Moreover, coffee is a cyclical crop, and even-year crops are usually smaller than odd-year crops, he added.

Prices gained earlier Monday as traders worried about Tropical Storm Danielle bringing more rain to Mexico and Central America. But Danielle, likely to be upgraded to a hurricane later on the week, is expected to miss most of the key coffee-growing regions in Mexico and nearby.

Richer brew

Americans don't seem to worry about paying more for coffee, Smith said. Demand cools as prices rise in most commodity markets, but coffee consumption only gets hit if prices increase "a great deal," he added.

He estimated that prices would have to run up to $3 per pound to cause Americans to stop buying as much coffee or start migrating to cheaper brands.

Higher prices already are a reality. J.M. Smucker /quotes/comstock/13*!sjm/quotes/nls/sjm (SJM 59.23, -0.57, -0.95%) , best known for its namesake jams, boosted retail prices by 9% for its Folgers, Dunkin' Donuts and Millstone coffee brands this month. This followed a 4% increase in May.

Kraft Foods (KFT 29.25, +0.10, +0.33%) raised prices for its Maxwell House ground coffee by 30 cents and instant coffee by 2.5 cents, on average. Sara Lee (SLE 14.65, -0.10, -0.65%) said it was raising prices but didn't specify the brands, which include Douwe Egberts and Senseo.

"We expect to see specialty coffee roasters begin raising prices later this year, as lower-priced coffee inventory is cycled," said Mitchell Pinheiro, analyst at Janney Capital Markets. "Retail coffee prices generally move in step with green coffee."

At the onset, rising commodity prices squeeze coffee producers more than the retail customer.

According to the USDA, a 10-cent increase in green-coffee bean prices, on average, trickles down to a 2-cent increase in both manufacturer and retail prices. But if the increase persists through several periods, prices rise about cent-for-cent with the commodity.

Senior market analyst Bill Patterson, with Mintel International Group, sees coffee price tags at supermarkets going up 9% to 10%.

"Whatever is going on at Kraft and Smucker, I'd be really surprised if the food service won't be forced to raise prices as well," he said. "They made the decision knowing others will follow."

Starbucks /quotes/comstock/15*!sbux/quotes/nls/sbux (SBUX 22.99, -0.69, -2.91%) said Aug. 17 it would swallow 4 cents a share in additional commodity costs in fiscal 2011, primarily due to higher coffee prices. The coffee chain noted that its purchase costs aren't necessarily linked to the commodities market because of its contracts with growers around the world.

In its Aug. 2 quarterly regulatory filing, Starbucks said it had committed to purchase an estimated $285 million of green coffee under price-to-be-fixed contracts as of June 27. Starbucks sells its premium bagged coffee at its own stores and at supermarkets, where it recently started to make an even bigger push with its Via instant coffee packets.

Retail chain and foodservice distributor Peet's Coffee & Tea (PEET 35.34, +0.32, +0.91%) said Aug. 3 it has no plans to raise coffee prices this year. At supermarkets, its packaged coffee sells at a 10% premium to other specialty coffees.

But CEO Patrick O'Dea did say Peet's would consider price increases if coffee-future prices sustain a run-up in price over the next six to nine months.

For 2010, Peet's said its coffee purchase costs will be up 2%. In January, the company had expected coffee costs to decline 1%. This price swing will "put about $1 million of cost pressures" on the balance sheet starting in the third quarter, the company has said.

Caribou Coffee Co. (CBOU 9.54, -0.02, -0.21%) said Aug. 4 it fixes the price of its green coffee contracts 12 months in advance and was able to buy coffee at costs lower than current market prices. The coffee chain said it has enough inventory through March 2011.

Rain blamed for tighter supplies

Like the recent rally in wheat prices, coffee's recent surge has stemmed from poor crop production.

Excessive rains and a cyclical rejuvenation of coffee plants have cut into Colombia's crop, which has been about 30% smaller than usual.

Colombia is the world's second largest coffee producer after Brazil, which produces about half of the world's Arabica coffee beans, the most sought-after and highest quality type of beans.

Robusta beans, mostly harvested in Asia, usually go to production of instant coffee or into cheaper coffee blends.

Concerns that Brazil is about to face dry conditions also contributed to the recent price increases.

Brazil had its own problems with last year's crop, affected by rain, said Marcio Bernardo, an analyst with Newedge USA. But even if the drought comes, coffee is a hardy plant that can tolerate some dry conditions and rains later in the season usually don't affect it, he said.

Fundamentals don't quite justify the latest price run-up, but then again the coffee market, like other commodities, is awash with speculative money making it difficult to predict where prices will go, Bernardo said.

Demand for coffee is increasing globally, Country Hedge's Smith said.

For years, Brazil grew most of the world's coffee but Brazilians, although heavy coffee drinkers, had only a passing interest in the choicest beans, which would end up exported.

That has changed as more Brazilians can afford coffee and more people have become more particular about their coffee. This trend could lead to continued higher prices in the long term as more of the best Arabica bean stays in Brazil, Smith said.

Claudia Assis is a San Francisco-based reporter for MarketWatch. Matt Andrejczak is a reporter for MarketWatch in San Francisco. Cynthia Lin is a MarketWatch reporter based in New York.