PRICE RISK MANAGEMENT IN COFFEE – ADVANTAGES OF COMMODITY EXCHANGES
MR. SANDEEP SINGH MAHARA* AND DR. RAJASHEKHAR KARJAGI**
*PROJECT TRAINEE, MANAGE, HYDERABAD AND **ASSISTANT MANAGER – CONSULTANCY, MCX INDIA LTD, MUMBAI
Coffee generates sizable export revenues in the coffee producing countries like Ethiopia, Vietnam and Columbia etc. One of the unique features of coffee trade is that the major coffee consuming countries are not active in coffee production of coffee. The maximum coffee intake is in USA, UK, Brazil, Germany, Italy, and France. Apart from Brazil, other growers are not consuming even 25 per cent of their produce. This disparity gives rise to enormous international exposure to this commodity, hence making it lucrative to trade it on one hand and bringing high volatility on the other hand.
Coffee cultivation in India is confined to the southern states of India such as, Karnataka, Kerala and Tamil Nadu. Karnataka accounts for a little more than 50 per cent of the total country’s production. In 1990”s coffee entered into a new phase of free market in India. Quality and price became the factors driving Coffee in the free traded commodity unlike that of wheat, rice etc. Around 7 million tones of coffee is being shipped to various destination worldwide annually. The estimated value of annual exports is 10 billion dollars.
Indian coffee production during 2005-06 was 274000 MT, out of which contribution Arabica is 94000 MT and that of Robusta is 180000 MT. India’s contribution to the total exports was 213143 MT with a value of Rs.115845 lakh. Italy, Russia and Germany are the major export destination. Such is the dependence on the exports, that more than 75 per cent of the domestic produce is shipped to the foreign land. India is a price taker in coffee, since Indian traders are referring to the prices of international exchanges like NYBOT and LIFFE for Arabica and Robusta respectively. The Indian players have to hedge their price risk on foreign exchanges in order to deal with the fluctuations in international prices. But in order to do that they are exposed to currency risk, which in the recent past have shown a lot of volatility. Hence there is a need to manage the price risk where in commodity exchanges play a vital role in minimizing the price risk.
We acknowledge that coffee trade is associated with many types of risk e.g. Production risk, price risk, credit risk etc. To manage the production risk the coffee farmers have to take the insurance or to trade in weather derivative. Of these instruments insurance the fact that information regarding the land records, cropping patterns are not in tune to actual field data, thus the insurance companies are circumspect to enter into this field. The weather derivatives are yet to be launched in the commodity exchanges in India. So there is less likelihood of farmers managing the production risk at this stage.
Another risk which the coffee producers and traders face is the price risk. India is among the top six coffee producing countries, yet it does not have any influence in setting the coffee prices. India have to take the prices which set on LIFFE and NYBOT for Robusta and Arabica respectively. The price risk can be covered by taking the suitable hedge position on the Future Exchanges. This market based instrument (future contract) allows the hedgers to protect themselves from adverse movement o prices, thus reducing their price exposure in the volatile market. Indian exchanges have another added advantage over NYBOT and LIFFE is that of trading in Indian currency. This mitigates the currency exchange rate risk, which in recent times become a headache for the exporters. Moreover the proximity of Indian exchange makes the delivery process easy for domestic traders. The delivery locations are in production hubs of coffee.
The grades of coffee traded on exchange are universally accepted by the rosters and traders. Further the quality standards which the exchange adheres to, is acceptable worldwide. Any grade which is accepted by the future exchanges carries the quality certification from the national level certification agencies. Thus the exchange traded coffee is geared to give appreciable returns the stakeholders by minimizing the price risk.
MR. SANDEEP SINGH MAHARA* AND DR. RAJASHEKHAR KARJAGI**
*PROJECT TRAINEE, MANAGE, HYDERABAD AND **ASSISTANT MANAGER – CONSULTANCY, MCX INDIA LTD, MUMBAI
Coffee generates sizable export revenues in the coffee producing countries like Ethiopia, Vietnam and Columbia etc. One of the unique features of coffee trade is that the major coffee consuming countries are not active in coffee production of coffee. The maximum coffee intake is in USA, UK, Brazil, Germany, Italy, and France. Apart from Brazil, other growers are not consuming even 25 per cent of their produce. This disparity gives rise to enormous international exposure to this commodity, hence making it lucrative to trade it on one hand and bringing high volatility on the other hand.
Coffee cultivation in India is confined to the southern states of India such as, Karnataka, Kerala and Tamil Nadu. Karnataka accounts for a little more than 50 per cent of the total country’s production. In 1990”s coffee entered into a new phase of free market in India. Quality and price became the factors driving Coffee in the free traded commodity unlike that of wheat, rice etc. Around 7 million tones of coffee is being shipped to various destination worldwide annually. The estimated value of annual exports is 10 billion dollars.
Indian coffee production during 2005-06 was 274000 MT, out of which contribution Arabica is 94000 MT and that of Robusta is 180000 MT. India’s contribution to the total exports was 213143 MT with a value of Rs.115845 lakh. Italy, Russia and Germany are the major export destination. Such is the dependence on the exports, that more than 75 per cent of the domestic produce is shipped to the foreign land. India is a price taker in coffee, since Indian traders are referring to the prices of international exchanges like NYBOT and LIFFE for Arabica and Robusta respectively. The Indian players have to hedge their price risk on foreign exchanges in order to deal with the fluctuations in international prices. But in order to do that they are exposed to currency risk, which in the recent past have shown a lot of volatility. Hence there is a need to manage the price risk where in commodity exchanges play a vital role in minimizing the price risk.
We acknowledge that coffee trade is associated with many types of risk e.g. Production risk, price risk, credit risk etc. To manage the production risk the coffee farmers have to take the insurance or to trade in weather derivative. Of these instruments insurance the fact that information regarding the land records, cropping patterns are not in tune to actual field data, thus the insurance companies are circumspect to enter into this field. The weather derivatives are yet to be launched in the commodity exchanges in India. So there is less likelihood of farmers managing the production risk at this stage.
Another risk which the coffee producers and traders face is the price risk. India is among the top six coffee producing countries, yet it does not have any influence in setting the coffee prices. India have to take the prices which set on LIFFE and NYBOT for Robusta and Arabica respectively. The price risk can be covered by taking the suitable hedge position on the Future Exchanges. This market based instrument (future contract) allows the hedgers to protect themselves from adverse movement o prices, thus reducing their price exposure in the volatile market. Indian exchanges have another added advantage over NYBOT and LIFFE is that of trading in Indian currency. This mitigates the currency exchange rate risk, which in recent times become a headache for the exporters. Moreover the proximity of Indian exchange makes the delivery process easy for domestic traders. The delivery locations are in production hubs of coffee.
The grades of coffee traded on exchange are universally accepted by the rosters and traders. Further the quality standards which the exchange adheres to, is acceptable worldwide. Any grade which is accepted by the future exchanges carries the quality certification from the national level certification agencies. Thus the exchange traded coffee is geared to give appreciable returns the stakeholders by minimizing the price risk.
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