“Finance drowns the real economy.”

This is a point from Laudato Si, Pope Francis’ recent encyclical on the environment and poverty.

This phrase accurately explains what’s happening in the coffee sector. The “real economy” of the coffee sector consists of: millions of farmers and farmworkers who produce the world’s coffee; millers and roasters who add value to coffee; honest traders and retailers; and coffee consumers around the world.

Surrounding this real economy is the finance sector, which is necessary for mobilizing capital, but has proven most adept at concentrating wealth for a relatively small group of people with the financial and economic power to exploit the coffee market.

While some of the worlds’ largest coffee companies and shrewd traders have generated massive profits over the past decade, most coffee farmers and farmworkers remain poor and increasingly vulnerable to market volatility and other threats.

A few recent reports highlight the current scandal of the coffee market:

First, on August 20, the international price for coffee (C-Price) dropped below $1 per pound, to the lowest price since 2006.

Second, Caravela published a report on the cost of producing coffee in five different countries. Based on this impressive analysis, production costs are in the range of $1.05 to $1.40 per pound, meaning coffee prices are below the cost of production. Coffee farmers are losing money.

Third, the Specialty Coffee Association recently re-published its report on farmworkers, which raises two critical points: Approximately 70 percent of the cost of coffee production is labor, and most coffee workers receive less than a living wage. The bottom line: Farmworkers are living in deep poverty and they will not escape poverty by harvesting coffee.

Combined, these reports expose a crisis in the coffee business: Coffee is not sustainable, and “specialty coffee” should not be confused with “sustainable coffee.”

The C-price is drowning the real coffee economy.

“Finance” for the coffee sector is reflected in the C-Price, (the Arabica C-Market price listed is taken from the International Coffee Exchange (ICE). And the C-price is deeply flawed. How do we know it is flawed? Because pegging coffee prices at the C-price creates scenarios that justify severe inequality in coffee value chains and perpetuates deep poverty in the coffeelands.

Historically, the C-price is extremely volatile. But for some in the finance sector, volatility and confusion mean opportunities for quick profits:

Global demand for coffee has been growing with increasing population and changing taste buds in Asia. Coffee supply is highly dependent on seasonality and growing conditions in producing nations. Therefore, the price of coffee tends to be highly volatile attracting traders, investors, and speculators who seek to take advantage of the commodity’s highly volatile price.

The C-price exacerbates volatility in the coffee market because it relies too much on speculation and is based on very short-term projections. The market overreacts to information, such as the weather in Brazil, because too many people involved in the coffee trade are trying to make a buck in the short term.

One reason short-term volatility of the C-price wreaks havoc on the “real economy” is because coffee is a perennial crop, which takes about 5 years to come to full maturity. For this reason, there is a long lag-time between price signals versus farmers’ abilities to alter production. Farmers can’t possibly react in a timely way to the C-price, and this exacerbates price volatility.

The C-price is drowning the real coffee economy because it significantly increases risk to farmers — and other actors at the production side of the supply chain. Farmers are assuming far more risk than anyone else in the industry.

Why no urgency?

The lack of urgency about the C-Price contrasts starkly with the reaction to the recent coffee leaf rust epidemic in Central America. In 2012, the supply of specialty coffee was severely threatened by leaf rust, and the industry reacted with dozens of conferences, funding for research, and many development projects designed to help farmers recover from this crisis.

In contrast, this year, the industry is slow to react because there is not an immediate threat to coffee supply. The threat is to the lives of millions of coffee farmers and farmworkers, but these people don’t have the power to organize conferences or change policies; they are at the mercy of the market, and the market shows no urgency for change.

Another explanation for the lack of urgency is that many powerful actors in the coffee industry see no crisis. As mentioned above, shrewd commodity traders profit from price volatility. Also, many powerful large coffee companies are not fundamentally bothered by changes in the C-price.

Consider this: The C-price for a pound of coffee has very little bearing on the cost to produce a cup of coffee in your favorite coffee shop. A small americano is about $2 plus taxes. What goes into this $2? When you dissect all costs involved in a cup of coffee (renting prime real estate, payroll, utilities, insurance, taxes, etc.), the cost of coffee beans is, in fact, negligible. This is one reason why the cost of a small coffee does not rise or fall with the C-price. Calculating the cost of coffee for capsules and pods leads to a very similar conclusion: The cost that farmers receive to produce a pound of coffee has very little influence on the retail price for packaged single-serve coffees.

The coffee industry does not react to the C-price because the most powerful actors in the industry don’t see a crisis.

No easy solutions

I am no expert on coffee markets, and I confess I dove into this issue naively looking for an easy fix. I live in El Salvador and work with coffee farmers and farmworkers so I see firsthand people slipping into deep poverty — desperate and hungry, their kids out of school because mothers don’t have the means or stability to send them there. I also know the potential of coffee to be a hero crop — to pull people out of poverty and protect natural resources — so seeing this potential eroded by market forces that are so unjust and stupid (no better word for it) sparks anger and indignation.

There are many companies and certification programs that work to circumvent the commodity market, but generally these efforts only affect a small portion of the coffee trade.

Over the past two months, I’ve reached out to experts to learn and bounce ideas. We’ve bantered about a minimum price for all coffee — to “break” the C-price, similar to the FT price; we’ve talked about regulations and insurance markets to stabilize production and price volatility; I have read many recent blogs, tweets and articles (including this piece in Daily Coffee News by Parker Townley, Ben Zwerling Baltrushes and Colleen Anunu. In the end, while I believe there are traders and powerful companies that profit from an unjust market,I understand there are no obvious, easy solutions. But there is an urgent need for real solutions.

One trader I trust a great deal suggested we initiate a conversation about this issue to explore the root causes of the C-price crisis and pursue viable solutions.

Following this pursuit, the next post will explore the idea for a new benchmark for coffee prices, and invite responses and recommendations from a few experts.