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An exploration of commodity income stabilization options for coffee farmers - page 44 / 47

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issued in the 19th century by the Confederate States of America), and has been expanding in recent years. Currently, they are being used to finance a range of tree crops in Australia and Chile. 33

Other mixed products

Price risk management can be incorporated into many other offerings. For example, a large aluminium refinery could buy fire insurance wherein its deductible is a direct function of energy and aluminium prices: if there is a large fire and a pay-out is to come from the insurance company, if energy prices are high and aluminium prices low (and thus, the refinery’s cash flows are under pressure), the deductible is low; and when its profit margin is high, its deductible is high. Such fire insurance fits better the needs of the refinery than the traditional contracts with a fixed deductible, and thus give better value for the money. Or another insurance example: one could try to develop revenue insurance (still in its infancy in developed countries, and requiring large subsidies to elicit potential buyers’ interest).

While one conceptually could envisage similar complex instruments for coffee producers— and it may be possible to incorporate some of such instruments in government support packages for the coffee sector—we are likely to be still far from a possible implementation. One mixed product that may be feasible though (although still untried) is that warehouse operators offer those storing coffee the choice between taking the coffee back, or (before a certain period) just leave it with the warehouse operator and receive a pre-agreed price. This is similar to one of the programs used in the U.S. (for sugar) to give growers a minimum support price (called a “loan rate”). Warehouse keepers can manage their risks by buying call options, and they can include the related premiums into their warehousing charges. If this is considered a socially beneficial operation, governments could subsidize the option premiums.

Conclusion: What instruments are most feasible for farmers and their associations?

A wide range of instruments for risk transfer is available on the market, and all have been developed to meet the legitimate business needs of certain enterprises. There is no reason to assume that under all circumstances there is only one instrument which is best for everyone. All instruments have their benefits and drawbacks.

In the case of options, the principal drawback is the upfront cost. In the case of futures, they are difficult to use when there is both output and price uncertainty: one cannot use futures for uncertain production (and the same applies to over-the-counter strategies such as collars or participating options). Moreover, futures have large “contingent cash requirements”: those using them need ready access to cash.

From a practical perspective, it would seem advisable to use option-based strategies as a starting point for farmers’ associations—probably through the over-the-counter market or embedded in physical or financial transactions. Once such associations have built up skills and have strengthened their links with banks, instruments that are more difficult to deal in, from a cash flow, operational and managerial perspective, can be considered.

How can governments of coffee-exporting countries use market-based instruments to manage price risk?

33 See for a discussion UNCTAD, New sources of commodity sector finance: innovative ways of tapping into the capital market, June 2006.

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