The “Other” Certified Coffee: Understanding Recent Rule Changes to the Intercontinental Exchange | 25, Issue 21
Commodity market analyst JUDY GANES explains the Intercontinental Exchange grading process and considers how recent changes to this practice, which results in exchange-certified coffee and impacts levels of “certified stock,” are likely to impact C market dynamics.
Sometime in the mid-aughts, at one of my first Expo events, I overheard a green coffee buyer proclaim that the Specialty Coffee Association (of America, then) should “abolish the C market,” and a couple of other buyers agreed with them. I didn’t know much about the C market—other than the fact that it was “low”—and I was afraid to ask that group to clue me in, so I kept quiet. Over the next few years, I took a green coffee buying class, read a bunch of articles online, paid attention to daily price fluctuations, and asked questions of producer organizations and traders. I came to understand how many coffee buyers and sellers use “the C” (as the commodity futures market is colloquially known) to manage risk, and as a green buyer, I even eventually negotiated and hedged contracts benchmarked to the C. During that time, I discovered that while figures like the cost of production and the distribution of value are critical metrics for helping buyers and sellers agree on the value of a particular specialty coffee, the C plays a role in the decision-making of buyers and sellers—especially sellers—of all sizes.
All along, on some level, I was aware that, despite my experience as a buyer, there was a lot I still didn’t understand about the C market—maybe the “theory” versus the “practice.” Many specialty coffee professionals have no interest in commodity futures market theory, which is understandable. It is possible to have a rewarding career in specialty coffee without going anywhere near C market theory—just like it’s possible to ignore the history of espresso or the lifecycle of the coffee plant—but even just a little bit of it can shed light on complex questions like why certain countries’ coffees are more popular now than they were ten years ago and what the forecast of a strong El Nino weather pattern in the Pacific Ocean has to do with the National Agricultural Export Board’s cherry price in landlocked Rwanda.
When it comes to theory, Judy Ganes could give a master class: she has been informing and offering perspective on market dynamics to the coffee industry for more than 40 years. In this article, she unpacks the term “certified,” with an emphasis on the grading of coffee done by the Intercontinental Exchange (ICE) and recent changes to their rules about which coffees can be submitted for this process. Along the way, Ganes introduces and defines trading terms that may be unfamiliar even to long-time industry insiders (backwardation, anyone?) but promise to enrich the reader’s understanding of how the physical and futures markets for coffee are meant to work.
Note that I said meant to work—I don’t know anyone who would argue that the C market always works well, or that it works equally well for all value chain actors. When I became a green coffee buyer and negotiated differential-based contracts, I reflected on the call for abolition I had heard years before and tried to reconcile the dream of a different system with the real risks of coffee production, processing, trading, and shipping. My conclusion, for now at least, is that specialty coffee is fortunate to have choices when it comes to contracts: fixed price, long term, differential, and hedged (to name a few). Making coffee better is complex, so we would be wise to use all the tools at our disposal and commit to life-long learning.
KIM ELENA IONESCU
Chief Sustainability and Knowledge Development Officer
When we think “certified coffee,” sustainability certifications—logos proudly displayed on the packaging of roasted coffee—probably come to mind first, but a different kind of certified coffee plays an even more important role in coffee pricing.
When consumers think about purchasing a bag of “certified coffee,” they are most likely thinking about sustainability certifications—these link their purchase of the product to a better environment, better conditions for the coffee grower, and perhaps better quality for the premium price they are willing to pay. These kinds of sustainability certificates identify the coffee as coming from farms where the producers uphold certain standards on their entire farm, typically involving measures of best practices for the environment and responsibility in assuring this, which involves inspections, rigorous paperwork, and verification that the farm meets the standards relevant to the sustainability certification.
However, the use of the word “certified” also applies to coffee that passed grading standards required to be physically delivered against a commodities market like the Intercontinental Exchange (ICE, or “the Exchange”) New York Washed Arabica coffee (“C”) Futures contract, which serves as “the world benchmark for a base grade Arabica coffee”,[1] or ICE Futures Europe’s London Robusta Coffee Futures, which benchmarks the pricing of “physical Robusta coffee.”[2] These ICE products deal specifically in “futures contracts,” a binding legal contract where the coffee buyer (known as “the owner” of the contract) has the right to take delivery of the specified amount of physical coffee covered by the contract from the seller (who is then legally obligated to make the delivery on a certain date in the future for an agreed price). However, less than 2% of all futures contracts result in actual delivery: most are “closed” before the date specified, which eliminates both parties’ obligations to deliver or take delivery of (i.e., pay the contracted price for) the coffee in the futures contract.
There are two interrelated prices to keep in mind when talking about the dynamics of exchange markets: “future prices,” as set and determined by the futures contracts on the market, and “spot prices,” the price of a commodity if you were to buy it right now and take immediate delivery of the tangible product (“on the spot,” with cash, or via the “physical market”).[3] The fluctuations in the futures price are a reflection of shifts in the underlying physical market price, taking into consideration supply and demand expectations. In other words, a coffee futures market is a form of price discovery and considered a benchmark or proxy for the underlying physical market price for Arabica or Robusta coffee. The futures market also allows commercial traders to manage their economic risk in the physical market by hedging, which is taking the opposite position in the underlying futures contracts with gains or losses in the physical market offset by losses or gains in the futures positions. This helps to “lock in” the current market price and eliminate the risk from adverse changes in price before they make or take delivery of physical coffee they have contracted with a known counterparty.[4]
Each of these commodity futures markets has their own standards or criteria (i.e., color, size, defects, and more) against which coffee is graded, and if the coffee passes this grading, it is deemed “certified” and stored in designated areas of a similarly certified warehouse that is approved by the relevant exchange. Only coffee that is certified as passing the grading procedure is permitted to be used to satisfy delivery requirements against the futures contract. For example, Washed Arabica coffees certified by the New York exchange may be held in their exchange-licensed warehouses in the ports of New York, Virginia, New Orleans, Houston, and Miami within the United States, but may also be held by the ports of Bremen/Hamburg (Germany), Antwerp (Belgium), and Barcelona (Spain).[5]
Of course, there can be coffee from the same country of origin and of similar or higher quality that is not stored in a certified warehouse—but if the coffee did not go through this formal procedure, it does not count towards “certified coffee stock,” even if it could pass without question. Futures contracts, after all, are specifically for “commodities,” a basic good that is interchangeable with other goods of the same type.[6] Non-certified stock cannot therefore be used to satisfy delivery against a “short” futures position, where delivery is obligated if held until the contract expiration date. This is in comparison to a “long” futures position, where the buyer could seek to take delivery of the coffee, forcing a seller to deliver. In a hedged position, the “short” cash contract (someone does not yet own the coffee but needs to buy now or in the future) is offset by going “long,” or purchasing a futures position further away in time.
Certified Stocks and Market Dynamics
Traders in the market pay close attention to extreme fluctuations in the availability of exchange-certified stock: If the availability is deemed ample, meaning stocks seem to be growing, then the price for a nearby contract (delivery sooner rather than later) will be more depressed or lower priced than a contract or coffee deliverable further into the future. When availability of exchange-certified stocks seems to be depleting, then the price of coffee for nearby delivery will start to increase at a faster rate than coffee for delivery at a later point in time. This typically raises concern: if a buyer wanted to seek delivery under the terms of the futures contract, there may not be sufficient certified stock in warehouse to meet this obligation. The seller would be required to find sufficient coffee to meet their obligation to deliver, or the seller could buy back the futures position to fill the gap between what they have and what they must deliver, generally at a more expensive price than that for which they originally sold it (trading at a loss).
Additionally, when there is plentiful supply of exchange-certified coffee, the price spread from the nearest delivery month through the more distant contract months represents the cost of storing the physical coffee during this period. In market terms, this is described as “in contango” or trading “at normal carry.” These charges include the warehouse costs, moving the coffee in or out of storage, interest rates, insurance, and even the “time value of money.”[7] However, when the market perceives there is a shortfall or tightness in the availability of certified stock, the market spreads or the price from one delivery contract month to the next inverts, which is called “backwardation.” This means the contract price no longer accounts for the costs of “normal carry” (i.e., those costs of holding the coffee over time), but instead reflects concerns about tightness, where the demand in the short term may exceed the supply. The higher prices for those contracts in closer months will lead to more sellers delivering their coffee to the exchange, which requires it to pass grading to be certified, drawing out more supply and increasing the availability of certified stock. In other words, those with coffee to sell will want to sell more as soon as they can, to receive the better price now being offered.
Differentials: Where the Futures Market and Physical Market Interact
As noted, coffee traders become very sensitive to shifts in the price spreads between the different contract months relative to the supply of exchange-certified coffee stocks, but they are also paying close attention to the relationship between fluctuations in the physical market’s spot price and that in the futures contract price. Under ordinary circumstances, the spot and the futures price move in tandem with each other, but not in perfect unison—with the resulting differences between these two prices known as “differentials.” If spot prices of a specific origin or grade are trading at a premium to the futures price, this is a “positive differential” (or, in more general market terms outside of coffee, a “positive basis”); if spot prices are at a discount to the futures price, this is a “negative differential” (or “negative basis”).
Differentials are not static: they are rather dynamic, strengthening or weakening depending on the supply of a particular coffee (also known as a “growth”). For example: if the Colombian differentials were exceptionally strong (i.e., significantly positive or “firm”), buyers may choose to purchase coffee from another origin that is not as expensively priced (with a lower or “weaker” differential). This would boost demand for the other origin, helping to raise the spot price of that coffee, too. Conversely, if Brazilian coffee is in large oversupply and the differentials for this coffee weaken (i.e., they are in decline or negative), Brazilian coffee would become competitively priced in the physical market, leading to increased buying of Brazilian coffee over other origins. The physical market differentials also influence the futures market and willingness of traders to grade coffee for placement in certified stock or opt to take delivery against long futures positions. If the spot price is stronger than the futures price, it would be more economical for someone that needs to purchase physical coffee (like a roaster) to take a delivery from an exchange, if a coffee that would meet their quality requirements is in stock, rather than purchase it on the physical market. Similarly, a seller would be less inclined to deliver coffee to an exchange, as they could fetch a better price in the physical market.
Changing Rules, Changing Dynamics
Just in case there weren’t enough variables impacting market dynamics, there is another piece to the puzzle to consider, particularly when focused on the New York Washed Arabica Futures market (or “C market”). In the early 2000s, producers faced with very weak prices decided to focus on improving the quality of their coffee rather than on their quantity, as an oversupply of coffee has the tendency to depress prices further. The growing specialty industry, and roasters in particular, were willing to pay higher differentials because the C market price of base grade coffee was so cheap. This had two effects: first, very little coffee would be exchange-certified and held as certified stock, and second, it made certified stock very attractively priced, as it could be purchased without a positive differential. In recent years, the trend of very little coffee being delivered for exchange-certification, combined with buyers purchasing more and more coffee from certified stocks, further reduced the amount of certified stock available. In the fourth quarter of 2023, Arabica certified stocks slumped to their lowest level since 1999. The C market reacted to this by moving into backwardation, signaling the concern about the limited deliverable supplies—but there wasn’t a corresponding tightness (low supply, high demand) in the physical market. Differentials for most origins were getting weaker (spot prices were dropping at a faster rate relative to the futures contract). This was also influenced by the trade not wanting to finance carrying large inventories in a high-interest-rate environment, where there is uncertainty about demand. This could run the risk that the market structure could suddenly shift, leaving them holding high-priced coffee in a declining market. And now, with another twist, we seem to be entering a phase where our perceptions of what it means to have “ample” and “depleted” certified stock—and all the implications they have on C market dynamics—are shifting. Coffee, unlike wine, does not improve with age; the Exchange has always imposed penalties for coffee that sits in warehouse for an extended period of time. These age-related penalties start to accrue after 120 days and accelerate with the passage of more months held as certified stock. When a buyer takes a delivery of coffee that has been warehoused for along time, the price is discounted by any age-related penalties that have accumulated. (In some cases, penalties have accumulated to US$0.20, which is substantial.) These age-related discounts would make a coffee very competitively priced if a roaster was able to use this aged coffee in a commercial blend, but this is not the only way coffee with these penalties has been traded.
Historically, some traders have taken the delivery of an aged coffee—receiving the discounted price—but rather than using it in the commercial market (i.e., as a blend component), have tried to have the same coffee re-graded as exchange-certified for delivery against a new futures contract. If the coffee passed grading and was reaccepted as certified stock, it was the equivalent of setting the odometer back to zero on a used car: the coffee would be worth the current market price and no age-related discount would be applied, effectively earning the trader a profit worth the value of the original discount. The Exchange had previously tried to discourage this practice by introducing a new rule to the contract terms where coffee that is graded cannot have any hint of aging in the cup.[8] Previously, all grading was based on physical inspection for defects, color, and bean size—not taste. This rule amendment created an added risk that coffee sitting in stock long enough to accrue an age-related penalty might not pass grading again. However, many did. (In 2023, about 60% of the coffee graded passed.[9])
While this benefited traders that were able to re-grade coffee and “reset” the time clock, those that took delivery of these coffees were not pleased: they were not only paying an inflated price for a coffee that had previously had discounts applied, but in some cases, the coffee was very old (one story quotes an anonymous roaster as receiving five-year-old coffee).[10] To stop this practice—rather than only discourage it—the Exchange has again changed the rules, this time outright making it impossible to recertify any previously certified coffee from November 2023 onwards.
As coffee only accrues these age-related penalties if it is kept in an Exchange warehouse as certified stock, it is not advantageous to certify coffee for the Exchange unless one of two conditions is met: (a) it is required by a bank for collateral, or (b) the market price spreads or differentials make it more attractive to have their coffee graded as exchange-certified (i.e., a seller can achieve more by grading their coffee to be held in an Exchange warehouse for futures contracts rather than selling it on the physical market). Otherwise, the costs to exchange-certify coffee and the loss in value from age penalties mean there is less incentive for a seller to deliver coffee for the exchange as certified stock or for a buyer to take a delivery, rather than close the existing contract or swap it for a new one. This new rule change could lead to greater confidence that buyers will receive the true value of the certified stock delivered. As a result, the amount of certified stock has been slowly increasing since the rule change went into effect in November 2023.
New Year, New Rule
At the time of writing, the Intercontinental Exchange has announced yet another rule change which could further impact these dynamics. Differentials (the physical market premiums over futures prices) firm not only when supplies of a particular origin become tighter, but also when there are improvements in the quality of coffee from an origin over time. To account for this, the Intercontinental Exchange has standard country premiums and discounts that are applied when a trader makes or takes delivery of a contract: for example, Brazilian coffee has a 600-point (US$0.06) discount and Colombian a 400-point (US$0.04) premium. If the physical market premium is strong relative to the futures market premium, there is little incentive to deliver the coffee to the Exchange as certified stock—a seller can earn more for their coffee on the physical market than on the futures market. This is one of the reasons why, in recent years, very little coffee has been certified: differentials in the physical market have been stronger than these country premium adjustments. In other words, the futures market has not been at “tenderable parity” or a price that is attractive to grade coffee, unless it was older past crops. In early January 2024, the Exchange announced it would seek regulatory approval to increase some of the country premiums to bring the futures market into better alignment with physical market prices on a more consistent basis.
Approved unanimously on January 26, this could help to remove one of the recent barriers to have more coffee certified for delivery and prevent the market from inverting (moving into “backwardation”) unless there was an extreme market tightness, rather than only a shortfall in certified stock—and help to resolve some of the price disparity between cash and futures. ◇
JUDY GANES is the Founder and President of J Ganes Consulting, LLC, where she applies her extensive experience as a commodities and futures analyst to provide insights to food and agricultural industries.
References
[1] Intercontinental Exchange: Coffee C Futures, https://www.ice.com/products/15/Coffee-CFutures.
[2] Intercontinental Exchange: Robusta Coffee Futures, https://www.ice.com/products/37089079/Robusta-Coffee-Futures.
[3] “Contango Meaning, Why It Happens, and Backwardation,” Investopedia Economics, https://
www.investopedia.com/terms/c/contango.asp.
[4] For a concrete example of how hedging works, see Janina Grab’s feature in Issue 7 of 25, https://sca.coffee/sca-news/25-magazine/issue-7/english/can-we-tame-the-c-market.
[5] ICE: Coffee C Futures.
[6] “What is a Commodity and Understanding Its Role in the Stock Market,” Investopedia Economics,
https://www.investopedia.com/terms/c/commodity.asp.
[7] The “time value of money” is a core financial principle based on the idea that money you have in hand now is worth more than the same amount of money in the future. This is because the money you have now could be invested and earn more between now and then.
[8] ICE Futures US, Inc., Coffee “C” Rules, amended by the Board April 15, 2009; effective April 24, 2009, https://www.ice.com/publicdocs/rulebooks/futures_us/8_Coffee.pdf.
[9] Marcelo Teixeira for Reuters, “ICE Rejects 41% of Coffee in New Round, New Lots Arrive,” NASDAQ News and Insights Online (published December 5, 2023), https://www.nasdaq.com/articles/icerejects-41-of-coffee-in-new-grading-round-newlots-arrive.
[10] Marcelo Teixerira, “ICE Ends Controversial Re-Grading of Old Coffees at Exchange Warehouses,” Reuters Online (published September 29, 2023), https://www.reuters.com/article/idUSKBN30Z20V/.
We hope you are as excited as we are about the release of 25, Issue 21. This issue of 25 is made possible with the contributions of specialty coffee businesses who support the activities of the Specialty Coffee Association through its underwriting and sponsorship programs. Learn more about our underwriters here.