Producers and many others in much of the developing world are exposed to highly volatile commodity revenues. A range of methods have been tried to either reduce this exposure (for example, through compensatory schemes and production/export controls) or to better manage it (e.g., through stabilization funds or market-based risk management mechanisms). This paper, one of a series on this subject commissioned by the International Institute for Sustainable Development (IISD), focuses on market-based instruments. Rather than providing a broad, theoretical description (which is amply available from other sources, including international organizations such as FAO, UNCTAD and World Bank) it takes the case of one commodity—coffee—and looks at how market-based risk management can be used to improve coffee growers’ lives.
The focus is on farmers, not on governments or others active throughout the coffee value chain. The annex, which describes the principles and structures of the main market-based risk management instruments, does, however, contain a discussion of how some of these instruments could be used at the governmental level. Furthermore, the discussion is on market-based instruments to manage price risk, rather than volume risk (largely because the market for managing volume risks, in particular weather-related risks, is still in its infancy).
The coffee sector provides an interesting case study. Over the past decade, the share of coffee farmers in the price paid by consumers for their products has steadily eroded. In the late 1980s and early 1990s, the world retail value of coffee was around US$30 billion, and the export earnings of coffee-producing countries were US$10–12 billion. By 2002, coffee retail value had increased to US$80 billion, and the exporting countries’ share had declined to US$5.5 billion.2 While liberalization increased farmers’ share in the export value of their crop, the net effect was a considerable fall in their share of their crop’s retail value. This negative trend has not been compensated by the growing importance of local markets (with shorter supply chains) in many producing countries, and has happened despite the emergence of a whole range of fair trade and other schemes which aim to provide better rewards to the producer. One could think that this larger “buffer” between producer and consumer prices would help shield producers from price volatility—if supply or demand factors give reason for a re-alignment of prices, the burden should not fall predominantly on farmers as there should be much room in the margins made in the various parts of the supply chain. Unfortunately, despite the declining share of farmers in the final price of their produce, they still remain the ones who shoulder the bulk of the price risk—those further up in the chain generally manage to protect their margins.3
In this context, price risk management remains of crucial importance to farmers—and given the importance of the sector for the livelihoods of so many (an estimated 20–25 million coffee-producing households in some 85 countries, and many more indirectly dependent on
2 International Coffee Organization (ICO), Lessons from the world coffee crisis: a serious problem for sustainable development, June 2004.
3 The market power of the intermediaries is clear from price behaviour at various times of the economic cycle. “Studies have shown that when commodity prices rise, the higher price is quickly passed on to consumers. But when commodity prices fall, retail prices rarely follow suit. Since the early 1990s, for example, even as coffee prices have plummeted, the value of global retail sales of coffee has more than doubled. The share of those sales received by coffee-exporting countries fell from around 35 per cent to less than 10 per cent.” (FAO, The State of Agricultural Commodity Markets, 2004) See also David Hallam, “Falling commodity prices and industry responses: some lessons from the coffee crisis,” in FAO, Commodity market review 2003–2004.