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Episode 9 - Albert Scalla on Market Volatility and Brazil's Frosts

Albert is a Senior Vice President of Trading at StoneX. Stone X is a financial services company and is among one of the largest commission commodity houses in the world. Albert’s expertise spans across commodity brokerage in the commodity futures markets.

What it's all about: Albert brings a wealth of financial knowledge into the coffee industry and has spent a lot of time educating coffee professionals around the world on futures trading and hedging in coffee. Enjoy as Albert gives an in-depth and easy to digest discussion on market volatility and the recent market affects from Brazil’s frosts.


Transcript

Nick (00:00:02):

Hey there. Thanks for listening to this episode of the coffee and technology podcast brought to you by Cropster. In this episode, we speak with Albert Scalla. Albert is a senior vice president of trading at Stone X Stone. X is a financial services company and is among one of the largest commission commodity trading houses in the world. Albert's expertise spans across commodity brokerage and the commodity futures markets. Albert brings a wealth of financial knowledge into the coffee industry and has spent a significant amount of time educating coffee professionals around the world on futures trading and hedging and coffee enjoy as Albert discusses market volatility and the recent market effects of Brazil's frosts. Albert, welcome to our podcast. It's super exciting to have you here. Me and Norbert have been itching to get this, this conversation with you started. So it's a, it's a pleasure to have you here.

Albert (00:00:49):

Well, thank you, Norbert and Nicholas, thank you for the mutation. Pleasure to join you. And it's always a pleasure and that's always part of our interest at the company at Stone X to assist in any way possible, especially what we're dealing with. The actual physical commodity, it's traders, it's a stakeholders in the entire commercial chain.

Nick (00:01:09):

Yeah, no, for sure. So just a really quick to maybe just get things started. If you can maybe give us a brief background of you know, who you are and your work at Stone X. I think that will set us up for what's going to be a really interesting conversation.

Albert (00:01:26):

My name is Albert Scalla. I'm now a senior vice-president of a trading here at Stone X Stone X today, one of the largest commission commodity houses. We've been growing quite fast for the past several, several years in the last two years. We've seen an explosion of our growth, which has hidden number 58 in the Fortune 100 companies. We hit a number 37 in the fastest growing companies, and we've grown from number 383 in the fortune global 500 to number one 90. And it's all been because of the explosion of what's happened over the last two years in market volatility, commodities, the stock market, the exchange rates personal investment finances. And it's all, all of this is tied into the volatility of prices of all commodities of all products from shipping to coffee prices. And it's been a slew of different things.

Albert (00:02:27):

And what I do, I'm a commodities broker, just like a stock broker, but our expertise are in the commodity, the futures markets. If you want to see the value of a share of I don't know, apple. So you go to the stock market and you see where Apple shares are trading. However, if you want to see where crude oil, if you want to see where soybean prices are trading or coffee prices, then you look at the futures exchanges and each exchange specializes in a commodity. And if you want to trade a coffee, you have to look at the New York Intercontinental exchange or the London Intercontinental exchange and see where Robusta coffee prices were trading and where New York arabica prices are trading. And my job in its basic form is to assist anyone from the tree to the cup, anyone in between to be able to transfer risk.

Albert (00:03:27):

So Nicholas let's say you're a producer well you've got price volatility, you've got risk. You know, you've got property, a harvest, a crop on the trees that you need to harvest. But you don't have harvest until November, but prices are attractive today, but your coffee is not ready until November. So you don't want to wait until November to harvest your crop and then ask, oh, where's the market. And now the market is much lower. So the futures exchange and a commodity broker like myself, what we do is assist producers like yourself to say, okay, prices are high. Now your crop doesn't come until into October, November. Okay. Let's take advantage of the futures exchange so I can secure my December prices. So you sell today for something you're going to deliver in three months. And that's a basic operation of a hedge. What happens if if I cannot deliver because of weather, right?

Albert (00:04:30):

So the mechanics is Nicholas saw the prices and they're attractive. So he sells today, December delivery coffee in the futures exchange, let's say the next month that he's got problems with the weather. And he doesn't seem that he's going to be able to harvest the attractive part of the futures exchange is that you're not locked into that price. Let's say next month you see that the production is going down. Nicholas can cancel that contract. They can eliminate, they can liquidate the contract. So he sold them, let's say at a dollar 80 and next month he sees that, you know, it's not coming in. He can come in, call his broker and say, you know what? I don't have the coffee coming liquidate. So he can, he sold it at a dollar 80. He just in a month sees where the price is. It may be lower.

Norbert (00:05:18):

It may be higher. He just liquidates contract 99 and a half percent of all the contracts traded in the exchange do not end up in delivery. And the physical delivery to the exchange. It is a mechanism for the producer, the roaster, the importer to protect the inventory until they make the delivery to their typical buyers. They don't deliver to the change. So Nicholas contracts with Norbert for coffee roasters. So Norbert fixes his price, whatever it's attractive, Nicholas protects. They both go into deliver to each other, but in the meantime, they park the risk via the futures, price exchange each change.

Norbert (00:06:04):

So, Albert who can participate?

Albert (00:06:06):

Anybody. Here's the limitation because it's not anybody. You do have limitations because you do need to have some financial backing. What does it take to open an account? It's just like, if you want to write a check, if you want to send a wire transfer, well, you need to have a futures account in order to hedge.

Albert (00:06:30):

So there's two basic types of accounts. What is a basic futures account? And really, there's no minimum to open that account. Anybody can use open it under the farm's name or under your personal name. You know, each individual has to be an individual farmer without having an actual company. You can open it under your individual name or a company name. And you do have to meet the margin requirements and collaterals that the exchange requires. So if you're a roaster or if you're a producer or anybody in between, if you want to buy a futures contract, which is 17 tons of Arabica, or 284 bags of 60 kilogram bags, 37,500 pounds, whichever way you want to look at it, the exchange requires today to put a collateral of $9,000.

Norbert (00:07:27):

And that's for buyers?

Albert (00:07:29):

That's for everybody. Yeah. So if you're buying, you're going to be buying a futures contract. If Nick was as a producer and he's going to be selling a futures contract, each participant for every contract, they need to put a collateral today of $9,000. The day that you liquidate the contract, the exchange returns the collateral to you. Okay. And the only thing that you have to maintain as well is let's say you're the roaster. You bought it at $1.80. If the market comes down to $1.75, you also have to put that difference in cash to the account. If you sold, if Nick sold it and the market goes up, Nick has to put the balance that difference. And that's the way that the exchange guarantees that every participant meets their obligations with what's called initial deposit, initial margin and the daily variance, whether it's up or down and at the end, anytime that the customer decides to get out of the contract, the exchange returns that initial deposit back to you. And the only thing that's left is where you bought it and where you sold.

Nick (00:08:41):

This is super interesting to me, just cause it's like so in college I took a money and banking class, and this is everything we talked about in the textbook, literally, but now it's interesting hearing it from you because it's coming now from an industry that I actually work in, which is even more fascinating. So it makes me feel like that class didn't go to waste. But let me, let me, let me ask you this. So what, I mean, let's just dive deep into it. What is the, like the level of accessibility of these accounts for, let's say producers or those in origin who are remote in the middle of nowhere and have very limited technological access you know, where does, for example, Stone X come in and say, yeah, these things are accessible to you.

Albert (00:09:25):

Well, we've come a long way into this. When I first started in this business 30 years ago, it was, you know, I think I was at the tail end of telex machines. Okay. So now it's pretty bad. Then we started getting these thing called faxes. All right. Pretty much obsolete. I still see whenever I do a banking or whatever they say, what's your fax number and go, do they still exist or floppy disc? Okay. That's another back in 1994, the last major frost, we didn't have iPhones. We didn't have people taking pictures on their iPhone, on the farms and sending via email, email barely started. So you can see the difference where we've come from 1994, the last major freeze to, you know, this year has major freeze today before by the time the sun was rising, everybody was flowing.

Albert (00:10:20):

Hundreds of pictures taken from the farm videos. Up to the second at the same thing has happened with the financial the access to the financial markets. Just we, we have you know, small producers in the Andes of south America. We have small producers in central America. It's hard to find someone without a smartphone nowadays. And you go to many of the farms up in the mountains in Peru and Colombia and Central America, Brazil, just about everybody has access to a smartphone or there's internet cafes. So the information today it's, you know, at another level what do you need to have the access to the markets? Basically you need to be able to have a bank account where you can send wire transfers because, you know, if you want to trade a futures, you need to have a bank account because you need to wire money to your account in the United States to London where the two main exchanges are.

Albert (00:11:24):

So the first thing the customer needs to do is open a futures accounts, with a commission house, and you want to look for a commission house that has a good reputation, and that has a team that specializes in the product that you will not trade. So, for example, if you are, if you're a corn farmer, you know, you want to go with a company that, you know, has some experience in the corn activities. Or if you're in coffee, you want to look for commission house, whether it's Stone X or anyone else that has a team that is dedicated to coffee, it has, can help you with all the intricacies of trading coffee, futures, options, and instructional products. You open an account, very similar to opening an account, a bank account. They're going to ask you the name, ID pictures. If it's a company they're going on to, you know, to see your financial statements or to see the corporate documents, the the articles of incorporation or each country has a different legal.

Albert (00:12:20):

So that's the limitation being, having to have a bank account that you can tell you wire money to Nicholas in California, or whatever that futures or commissioned houses and then be able to have access to funds because one futures contract today it's very close to $100,000, and you can control that futures contract with only $9,000, the deposit of about 7 to 9% and is, has gone up quite a bit before July 20th, it was $4,000, but what happened? We had a freeze market, exploded prices, went through the roof volatility when, so what is the exchange to whenever volatility gets really bad and risk goes up, they need to increase those deposits, make sure that everybody meets their obligations. If not, it would be today three, 4%, $4,000, which is not bad.

Norbert (00:13:18):

Can we dive into the freeze a little bit, because there's a lot of information there and it's a little bit controversial in some sense. So I would like to analyze it a little bit on different levels. So one, you just mentioned on the, on the pure data and information level, like what is really happening and how that does that translate into that? I would say hype or, or, or, you know, that, that that stress, maybe some people feel

Albert (00:13:51):

Well, you hit one of the words controversial, you mentioned that word and here, let me take you a little bit of history of coffee and logistics, supply, and demand numbers. I'm a big critic of it. Did you see my presentation always criticize because we're a very coffee, we're a very large business globally in terms of volume, in terms of value, in terms of, you know, how many countries we are produced, how many countries we consume, it's huge or logistical our supply and demand numbers are pretty, pretty concerned. We do not have proper transparency. So you go back to the question, you know, the, the volatility, the transparency, the and the problem is that we don't know yet exactly how much we produce on a regular year, nor do we know how much we consume on a regular year. And it's very difficult to find out what our stocks are in a year.

Albert (00:14:56):

There's a lot of controversial. There's a lot of misinformation we were lacking. For example, if you go to corn the, the USD publishes core numbers every single month, the USA in coffee publishes the coffee production number once a year. So that lack of information creates uncertainty, that uncertainty creates volatility, and that volatility means risks. And that's a problem we have in coffee. We have a huge amount of volatility. So for example, we have a total of 80 countries that produce coffee really, 60 are listed and really about 40 generate the coffee of which approximately 15 generate about 80, 90% of the coffee bottle. And there's a lot of misinformation out there. And what do a lot of the country governments publish as their production numbers that tend to send them low? Why is obviously you want to bring the price up. And then when you look at you know, consumption numbers, we really don't have reliable consumption numbers.

Albert (00:16:06):

Let me give you a little bit of some of the things that we always argue, and it'll go to your question. Well, how much did it get damaged? This freeze? Normally we spend months and months. The flowering, for example, in Brazil, happens between September 15 and October 15. Usually you get four or five flowerings right. That's going to be the flowering for the harvest that starts in April to July the next year. So we'll get the flowering, it'll go months, everybody putting out numbers, putting our numbers high, low, medium numbers, everywhere numbers everywhere. It'll take us months to figure out what is the harvest on a crop that has already flowered already growing already Granulating weeks away from harvest. We still don't know yet. The market wanted to know within 23 minutes of the freeze, how many bags to the bean were damaged or not harvest that still hasn't flowered.

Albert (00:17:05):

It was still hasn't shown any beans. And that's the problem, right? Direct to, to the question that you, you know, what is the the volatility? What is the, you know arguments out there? It's very complicated. So let's go to July 20th of, you know, a few weeks ago, coffee what affects all agricultural commodities are three things. The volatility of our cultural commodity come from weather, global macroeconomic conditions and supply and demand, how much you produce, how much you consume. What's leftover stocks in coffee. The big black Swan event is whether in Brazil, which is 40% of the world crop. So you can have either a freeze in the winter months, which is the opposite of the Northern hemisphere, that Southern hemisphere it's may June, July. And the second is drought, which is normally, historically has always been between September and October. That's when the rainy season comes and you need the rains at the right time and continuous rain to not only start the flowering, but also to hold the flower.

Albert (00:18:17):

As of 2014, we found out that there was a second drought events, possibly January and February, and that where the two big trouts, 2014 and Arabica 2015, and Robusta as they're called in Brazil. So everybody always bet on the freeze cause the freeze would hit you overnight. You will wake up. Brazil has been destroyed, the harvest market doubles or triples in price. Everybody's dream, the rest of the world. All the other producers dream come true, market prices, double or triple overnight. So we had a freeze around the 15th of the month, like very light. You know, you always get these cold fronts coming in. The first one was very light. The talk was about a hundred thousand bags, but then July 20th, we had another cold front coming in. I remember July 19th, the market fell 600.60 cents a bag, and it wasn't really showing much the cold front, but lo and behold, it really shocked everybody.

Albert (00:19:25):

Temperatures drop more than expected. As a matter of fact, that was knowing that many 14 cities in Brazil started snowing because of the high winds and the low humidity. It allowed for the, you know, the, the freeze that nobody was expecting and prices exploded. And then on the 28, 29, we had a third cold front that weather forecasters were saying that was going to be even worse than the week before. And the market just went through the roof. But what happened that third probable freeze never really materialized because humidity went through the roof and the winds come down. So that's a whole bunch of variables that can affect a freeze, whether it's temperature that two point humidity winds, you know, the whole thing. So the question is how much damage that had occurred, impossible to actually say what is our number? We have an agsteam and we're going to go again to really get an idea.

Albert (00:20:31):

You need to wait a little longer to see how the plants that the plantations responded to that aggressive cold. It takes several days, maybe a couple of weeks for the plan to talk to you. The initial numbers that keep going around is 165,000 to 275,000 hectares. Then you get to tell how much of what was the productivity of each Hector. So multiply that by whatever the number is. So we go from the ranges of the low ranges of 2 million bags, all the way to 10 million bags. And again, we go to that same uncertainty that we run every year and the normal production estimates, which this past year from the low to the high, it was almost 14 million back difference.

Norbert (00:21:21):

That's amazing. Oh, that, so you were mentioning the, like we are in the information age, well into the information age, not just sorry. We have all this connectivity, we have all the systems and it, it tells you that because 20 years ago I started working in Colombia on information systems for farmers. One of the, one of the stuff we were working on because we are focusing on small holder farmers was more like precision agriculture concepts and those, those things. So why is general, let's say national interest, for example, or some associations to actually put systems in place because in terms of software, that's out there. And I mean, crops has some of it, but not all of it, but I know that there's many other vendors who would be gladly equipping every farmer with a phone or with a, with an app. What, what is holding back?

Albert (00:22:17):

Well number one is money. Honestly, number one is money. For example, if you look at you know, the farming of a wheat or corn or soybeans as the farmer is harvesting the combine, the harvesting machine is telling you how many bushels per acre, your life harvesting, right? The information it's you know, then again, you're looking at the United States department of agriculture on the U S government behind Bush. Then in Brazil, you have pretty much the same in Argentina, huge in coffee, we have a deficiency. We, we just have a deficiency you know, the biggest producer in the world Brazil has the CONAB national production estimate of the government, which they tend to go low and everybody knows it. So if CONAB comes to them with a number no matter if it's lower or high, you know, the market shrugs it off.

Albert (00:23:16):

Why? Because of the history that they've had then you have Vietnam, then you have Indonesia. Indonesia has a lot of question marks on their production and inventory, not just in coffee, but I can call Quinn Palm oil. Several, you have to look at it. You have 10,000 islands. So is it a matter of that? There's not enough resources to, you know, conduct accurate numbers and you have Vietnam, the second producer in the world, you know, most of the coffee's also government controlled. So you see where I'm going. Sometimes the, you know, the question is, is the lack of ability to, to have a system in place? Is it money or is it, you know, massaging the numbers. And historically, if you go back 150 years of coffee and massaging the numbers tends to come up quite a bit and, you know, five, too many people that used to work at the old Brazilian the IBC the what's it called the Brazilian Institute of Coffee.

Albert (00:24:21):

And they said, oh, you know Nicholas, our head agronomist says it's 60 million. Let's put 58.9 million, it sounds better. You know, and that goes in coffee, whether you want to accept that or not. And then on top of that, you have consumption. You know, if we have tens of thousands of agronomers globally trying to count beans, and we're still getting it wrong. And you know, this year we had a difference of almost 8 million bags into the harvest. Well, who's counting how many cups you drink? There is no, I brought him. There is no institution. So we go by the disappearance are, which is okay, how much you produce, how much you import and export and how much stocks are left, whatever's missing is consumption. But if you don't know what production is, you don't have the stock numbers, your consumption numbers going to be wrong. So that is the bulk that we have. And that's one of the things that we're pushing mostly in the, just by, in every speech or event that we speak out is that the world of coffee needs to set up a different system in place.

Norbert (00:25:20):

You speak my soul and my mind. And of course, this is what we do, right. Technology and systems. Where do you think that investment could or should come from?

Albert (00:25:33):

The actual producing countries. You know, there's some big argument, okay. Who should do it be consuming countries or the producing countries? And what I'm telling now, the producing countries is that the producing countries need to take the lead to get the numbers, right. Not only to get the numbers right, but more importantly is to set up a consumption promotion system in place

Norbert (00:26:01):

In their own countries

Albert (00:26:03):

And especially globally. But you know, my last speech with ANACAFE, and I can share the the presentation with you, the biggest growth potential that we have globally for the benefit of coffee producers is in the own producing countries. That's where the biggest growth we can see. But, you know, if you look at many countries is produce and export it, get it out of here. Many of these countries have the best coffee in the world yet. They don't want to consume it, sell it, get it up. And the biggest growth that we can have in consumption is in producing countries.

Norbert (00:26:43):

There is a little bit a conflict here, as you said some countries might not be actually interested in, in measuring all, all the data or having those systems in place. How strong is that influence or is, or what, what would be an argument against it to say, well, get better data because you hedge better or you trade better, or you get a better position on the table. I don't know.

Albert (00:27:07):

It's much simpler than that. Let's say we go to a country, just make up a country, we'll go to a country and we'll say, okay, you know, we're got to do this first question is who's going to pay for it. Right. And then you say, well, you know, Nicholas, you're the producer. Why don't you I'm not going to put it in because it doesn't put it in. I'm not going to put it in. And nobody's going to say, well, if I'm worked, doesn't put it in one. And then we're going in a circle again, we're going to circle again. You know, for the last several years, there was a questionable call on the Brazil's CONAB that their numbers were just off. And they got to the point that they said, okay, well, there was unconfirmed reports that the CONAB contacted USDA to hire them a come and teach us, come and show us, how do you do this?

Albert (00:27:54):

You know, satellites, how do we, you know, talk about technology, we have technology. But the cost was $14 million you know, to, do the whole thing. But how big is coffee in terms of dollar? Yeah, 14 million is a lot, but how big is coffee? And then the politics there. Well, you know, if it would have paid for 10 million to the USDA, we can do it here locally, blah, blah, blah. And know the politics started getting holdings that's okay, next chapter. And then we keep going the same things that we see today. This is a repeat of 30 years ago. This is nothing different.

Norbert (00:28:27):

So we need to disrupt the system some somehow different, right, by getting directly to the farmers, for example, and, and in influencing or, or incentivizing them to come their own beans.

Albert (00:28:39):

And now it's the best opportunity. So you want to invest when there's money. You don't want to invest when the things is a $0.98 cents . a pound coffee your cost of production is a dollar 20. You barely trying to survive. You don't want to invest on things that times or bet because there is no money. Now we do have, for example, Brazil, the internal coffee prices in Brazil is I would say doubled the historic highs. Colombia's internal prices, very close to double historic highs. Most of the countries are enjoying historically high prices because of the currency devaluation, not because coffee isn't that high as a combination of New York prices, but more importantly, currency devaluation. So now there is money, especially for, you know, if you're in Colombia, there's good Colombian, in income right now to be able to invest in consumption, to be able to invest in, you know what? You mentioned, technology. This is the time when there's money. We need to invest for the future.

Nick (00:29:46):

Like what you've heard so far, this podcast is brought to you by Cropster a software solution that connects coffee professionals from origin to roasteries and cafes around the world. Whether you produce trade, roast, or brew coffee, crops, or products will help your business take that next step.

Norbert (00:30:00):

So those, those a great prices might not, not last forever. So they might go down at some point, what is the triggering event for that?

Albert (00:30:12):

Okay. So historically you just said, what happens if you go back 50 years? Whenever we have a freeze or a drought, yeah. We have the big spike in prices, prices explode, but they last very little up there. They don't last long. And immediately what happens? We have these massive price spikes, but if you're a producer, if you're a farmer, what do you do? Well, let me buy the neighbor's farm because now I'm making so much more money in coffee. Let me expand my production. Now I can put more fertilizer. Now I can invest more in husbandry. Now I can make this thing really produce. And then you also have, you know, Nicholas, who's a lawyer in XYZ com country say, Hey, I hear prices in coffee or historic highs. Let me invest in coffee production. So normally what happens when you have these massive price spikes, is that crops grow globally, explode.

Albert (00:31:10):

This is not this, you know, it's happened six times in the past 50 years. Now, the, your question is when does that happen? Look what happened? The last frost market went to $2 and 16 cents. We're trading at $1.80 today. That happened two weeks ago. If it goes down, it's not. So in two or three weeks, you can say that the market has lost almost 35 cents. Okay. And that's that? That's several a month. That's 15%, right? What is the next big thing that we need to watch as members of this coffee supply chain from the producer to the final roasters and coffee shops? We still don't know what the exact number is on damages from the frosts, our unofficial numbers, somewhere between four or 5 million bucks, but it's still, we still have to go out and do several trips. We'll I'm going to go personally with the team possibly end of October, right after the flowering, right after you start getting the flour, the following has happened and you start getting the baby beans started growing what they call being to get a better idea.

Albert (00:32:25):

The next thing we need to watch, and we are watching every day now. I don't know if Nicholas you're getting my messages. It's the rainfall we've gone already through two years of La Niña Last year, the reason our crop went down in Brazil, 20%, 22% was because last year, the world got hit with a pretty strong La Niña, which basically decimated crops across the globe from soybeans to soybean oil, to canola, to call sun Europe to Palm oil in Southeast Asia and coffee, because La Niña in the Americas brings high heat and drop. We had massive heat in the Midwest, in the United States that brought down tremendously, the soybean crop and the canola oil crops. And as well as in Brazil, droughts, everything went up, corn, soybeans sugar and coffee. We're going into another year with a high probability of La Niña.

Albert (00:33:29):

Still not confirmed. We're still watching the temperatures out in the Pacific. So if we get another bout of La Niña, well, what's going to happen. Are we going to get another drop in rainfall? And the important window that we need to watch is September 15th to October 15th, rain needs to come in during that period in order to spark the flowering, sustain the flowering and feed the new beans. And that's going to be the determining factor of, okay, what's next year's crop. Is it going to be good? Is it going to be high? It's going to be low. What's going to have, how much are we going to recover? Because next year is the high cycle of the Brazilian crop, right? So we had to watch that flowering and how the rates continue to come, because if they come flowers, sparks, and then we have drought, forget it it's over.

Norbert (00:34:19):

So there might be another price spike coming or not?

Albert (00:34:23):

Depending on the weather.

Norbert (00:34:25):

So you saying those, those effects last, quite short who can take advantage of it. So how does this translate to smaller, mid, mid size farmers? Can, can the actually sell at those high prices is just something we can participate or is this watered down because there's so many middleman and Middleburg and then

Albert (00:34:49):

Nope. For example, we have a lot of small farmers you know, certainly all the co-ops have the access to the commodity futures markets. They have access to the prices you can sell December. You can sell March of next year, may in coffee, you can hedge and fixed prices three years forward. Yeah. So if you're a farmer and many farmers, for example, in Brazil, but they do is they'll look at this year's harvest, but they'll also look at next year's harvest, right? Let me sell 40% of next year. And then the second year, you know, what are the price? Okay, let me sell 10%. So as a farmer, you can go 1, 2, 3 years out. I do a portion. So you can guarantee at least some of that price today, we have the prices, for example, it's, let's say Colombia $1.80, Then you have an extra 52 cents of differential.

Albert (00:35:44):

And then on top of that, you have a very high exchange rate. So internal coffee prices today are 1.7 million. This was burner loading. If you go to Brazil, you're talking 1100 Reals per bag. Those are, and the producer can, you know, hedge term. Now one problem, that's a risk. And the last six months with this tremendous price rally, is that there you do have concerns of defaults on behalf of the producer. That may be last February, you sold what you thought was the historic high price. And now it's even higher and said, you know what, Nicholas, I'm not going to deliver a copy at the price that we prearranged because I'm going to sell it to somebody else at a higher price, but you agree to deliver to Nicholas. I need to go those, you know hedges and he sold the coffee. So there's a supply situation right now with possible defaults. So what keeps you from doing really not much, you do have to meet your obligations, that if you sell that coffee, you need to meet the obligations, not you, the exchange will call you for the margin deposits. But everybody has access or can't have access.

Norbert (00:36:58):

So the reality is that those copes will benefit from those high prices because they're a part of that game or the system?

Albert (00:37:08):

Yeah. Well, the co-op works on behalf of the producers, right? The co-op has its members and the members, you know, the, the, the purpose of our cooperative agreement is that a few help many. So all the producers are part of this. Co-Op the co-op provides all the services that for example, multinational could, and it provides, you know hedging tools that can provide us selling other transport all the benefits that our cooperative agreement can provide all of its associates. Right.

Nick (00:37:45):

So I, I can imagine there's given that it's, this is like this is the financial world side of it. I'm I'm curious to know what some of the legal implications could be of, you know, a producer in Colombia, for example, doing, you know, hedging, a futures contract in the US or in London. Obviously that gets really complicated with international law and whatnot. Yeah. I'm just wondering what, what the, some of the legal implications could be there.

Albert (00:38:13):

Really, it's very simple. You're in Colombian producer or expert or any, any anyone out there you open your account and you call your broker and you look at December prices and December prices are attractive at $1.80 Then you, you know, you add your differential, which is another 52 cents, and you do your exchange rate so that you can book a tremendous income. Never seen it before. The implication if you directly, you know, hedging, you struggling to deliver your coffee to your fiscal buyer, they go always dealt with whether it's a multinational, exporter or whether it's a co-op, but you're hedging internally your, your risk with a market. the moment that you call your broker and you give instructions to sell one futures contract that day, the exchange requires you to post $9,000 collateral. And I think that's going to go down once the volatility goes by, then they're going to start bringing it down.

Albert (00:39:15):

So you post your margins and every day you have to post, you know, the market movement, whether it's against your, if it's in favor of gold deposit, let's say that the market moves and you can't send any more money tomorrow. The day after at that moment, the broker will call you and say, Nicholas, you need to, you know you have a margin call. You need to post the difference. No, I don't want to post anymore, or I don't want to send any more money. Well, then the exchange requires some broker and the customer that you need to get out, you need to liquidate your positions. So in the futures market is very simple. No, the, the futures market, the system, the financial system is measuring your financial situation day to day. If it's a physical, in other words, you don't go to the futures market.

Albert (00:40:01):

You go directly to, I dunno, some middleman or, or co-op whatever. And you got feedback in March that today you're going to deliver a coffee. And all of a sudden today you decide you're not to then there's a default. And then you go in with a local loss. You know, let's say you're in Mexico. Okay. So what is the Mexico? Because you have contracted privately in a commercial deal with the co-op in Mexico, that you're going to deliver at a certain price, and now you're not going to deliver, okay. What is the legal implications in Mexico? How do they fold that contract, that fiscal contract and the futures market is we measured day to day, but in a physical internally, you're not going to find out until 2, 3, 4 or five months. No sorry can't deliver.

Norbert (00:40:52):

Right? So I know some cases where they don't touch anything locally, they basically produce first. And then in that producing months or weeks, they already see a little bit closer how much they will have. And then they go actually to the local representatives or co ops, or you know, some of the big firms are directly on the ground or in Colombia, you have to the Colombian Coffee Federation, of course. And they all have prices in that, during that, that week. So how do those prices reflect what's going on on the hedging market right now? Let's say it is December. My friend down in Colombia, produces Nick in Colombia produces. And he says, well, I just produced 20 bags and I want to get, I want to get those fantastic prices. Will that be a reality or will that.

Albert (00:41:47):

Yeah, if the mark is still there and you know, what you just mentioned as the truth, you know, you know, the majority of coffee producers that don't hedge, correct. You know, you produce, okay, you Harvard, where's the price. I have the computer, it was the price. So when December comes around Nick will harvest and most likely, you know, he's got all the information, because like I said, all producers have smartphones. They, you know, they get a little text messages at some someone, Colombia you know, many other companies, whether it's a multinational company or co-ops, or the Federation, they'll send a little text message and say, you know, today's prices blah, blah, blah. Where does that price come from? You know, you have a, we're taking the, the example of Colombia, us, as you mentioned that you have all the private exporters', you have the Federation, you have the co-ops and they're all throwing prices all day long.

Albert (00:42:41):

Where does that price come from? Number one is that combination of where's New York. Where does Colombia differential traded today? And where is the exchange rate today? So based on that triangle and there's other costs because there's taxes, there's shipping from interior to the port, to the mill of this, a whole bunch of, but the three main are those three items and that triangle. So that combination, they put it on their Excel sheet and it will spit out. Okay. Today is 1.7 million pesos per 12.5 kg load of parchment coffee. And then what happens? Okay. Nick is a big multinational. So next, okay. Norbert is 1.70, okay I'm going to bid at 1.720, and then somebody else would go, okay, he's putting one point, so, okay, I'll do 1.7 30. So then you have the minimum price that formula throws. But then, you know, somebody, if, if it's a lot of demand, you know, the price goes up or down, but that's where the internal prices, whether it's Brazil, whether it's Colombia, where there's Mexico, Guatemala, those are the three main where's New York. Where's the differential or six.

Norbert (00:43:51):

And how does the hatch hatching come in here? So we've, if, as you say today, the price is two 20. But the farm gate price might be only one 50. So someone will offer coffee for $2.20.

Albert (00:44:10):

No, no. So you say that today, the price is $2.20.

Albert (00:44:19):

Okay. The the price today is now $1.50 today. The price is, you know, the exchange rate today is a $1.80. Then there's a physical differential for, you know, the origin let's say Colombia is plus 50. So whoever comes in to buy that coffee from the co-op or the producer will offer based on the, take $2.30. Okay. If Nicholas who's, the producer says, okay, Norbert, let's do it. Then Norbert has to turn around whatever the company turned around and call the broker, sell, sell one futures in New York for December. They're going to sell the differential physically with our buyer. And immediately they have to lock in the exchange rate for that delivery because, and they take three shorts. You have to sell the futures in New York to guarantee that price, they have to sell the differential with the buyer, and then they have to sell the dollars are going to be received, because if you don't have, if anything of those move and they move against you, yeah. It's going to hurt. Right? So whenever the producer brings the bags of coffee to the market and Norbert offers a XYZ price, Norbert has to take the hedge of meaning. You could not take that if you don't want to, you don't have to hedge, but what happens if the market collapses you're taking a big hit.

Norbert (00:45:50):

Right. It's a, it's a very intriguing and complex situation. In my opinion, I would like to learn of course, more just want to bring one kind of last example and then maybe move on a little bit about the topics. What if I can just wait? So basically I'm a producer puts things in storage and I wait until the price is right. Is that, is that an option? If like, as long as I have the financial means to sustain myself, which I know is not the case in many, in many farming communities.

Albert (00:46:21):

And then for example, Brazil is very common. You know, Brazil, bigger producers, you know, they'll harvest and not out of the harvest, they'll sell 80%, 20 asset investments savings. So that is very typical. You know, you hold back, some countries hold back. There's no holds back more. Now, for example, a lot of that depends on your financial situation of the producer. Can you hold, can you hold 20%? Do you have the financial capability of holding 20%? And you know, you can hold it, save it. Especially if you're in a economy where you have the evaluation, that's you have a product that's sold in dollars, right. And your currency and your vendor is devaluating. That's, you know, you make, you know, big big money is made in evaluations. If you holding a us dollar, but then again, you get into a situation that's called speculation. Right. So, okay, let me hold 20 30%. Let me hold half, because I think prices are going to go up. What if they fall right. That so that you get into speculative mode?

Norbert (00:47:25):

Well, and also so then that's a little bit of a seg way to specialty coffee, where we, most of our listeners, I think are interested, especially coffee doesn't well, coffee, doesn't get better by storing it. So we want the freshest crop on our tables and in our cups. How can we incentivize that with that hatching game or with that situation, is there, is there a, is there an incentive for farmers to, to sell as quickly as possible and for traders to release it as, as, as quickly as possible?

Albert (00:47:57):

Well, you just said the tracking on the, as coffee ages, you started losing premium, you started those human qualities, you started losing a what game, its premium price. And then the next question that you get in there, do we need to hedge specialty coffee? Everything traits are that differential. So everything trades let's say Arabica, you know, the base is New York, but then for example, Nicholas, maybe trading Guatemala, or I don't know, somebody else may be trading Kenya, AA, everything trades at a differential differential means difference of New York to your local market. So let's say that glass is a producer of Guatemala Antigua. The differential for that coffee is much higher. Differential means difference, difference from where, okay. The basis, New York, where is Antigua trading or where is Kenya, or for example, you may go to other coffees such as Brazil, which are a discount to New York.

Albert (00:49:01):

So everything's traded based on that differential. So let's say that I want to buy Antigua Guatemala, Antigua, okay. That producer can head, or the roaster can hedge the base, which is New York. And then they just lock the differential with the supplier. So all coffees are hedged. Now, here is the next question. You're probably going to ask fixed price coffees. Right? Right. So let's say I want to buy Peruvians a special, organic blah, blah, blah coffees from here there. No, just give me a fixed, but I don't want to talk differential or New York, whatever. Let's just say $3 a pound, right? So I want to buy $3, buy it. You're going to sell me $3 a pound today. When the market is a $1.80, it looks great price. What happens if we get an you and I on the producer in Peru and you're the buyer in California, and we agreed to $3.

Albert (00:49:58):

You're happy because you're the buyer of coffee in California. And I'm ecstatic just having the summer improve this organic coffee at $3 a we get, I'm going to deliver in December I promise. Now September 15, we get the rain's delayed, no rains, September 30th, October 10th, no rains, price explodes. And then we're at October 15th to October 30th and New York goes from a dollar 80 to $2.50 cents. This is hypothetical. Don't say that Albert said tt's going to go to two hypothetical situation. So now coffee is at $2. Well, when I sold you the coffee at $3, coffee was a 180. So what was the differential? $1.20, right? The difference now that the coffee is two 50, well, me as a producer, I don't want $2.50. I want $3.70 now. And I'll tell you Norbert. You know what I, you know, I can't, you have to pay me $3.70 because the market went up and he told me, but Albert, you promised $3. Then we have a contract with sorry, Norbert I can't deliver. Right. Doing coffees in a extremely volatile market that we live in, fixed price, very dangerous.

Norbert (00:51:16):

That's right, but it's, it does. It goes both ways, right? In a, in a market where the $3 is fantastic. I can take the deal and that might hold might be a good deal for the farmer for like two or three years, and then come year four and then the price switches. And then suddenly the, it appears to be a bad decision for the farmer, but it's, it's risk management ultimately, but we also sometimes explain it with like relationship coffee and direct trade to basically take the guesswork out as words like sustainable income or, or living income. And those, those things where we get closer to reality of the farmer and say, farm, I will always pay you what you need to to live plus plus of profit. And if that is just $3, I promised that independently, if price goes up or down, why is that? I mean, I know human nature is not ultimately like that, but it could be like that. So what, what you say about it is it like a hippy concept? It's like, oh yeah, this is great for, for that 0.7% or

Albert (00:52:24):

And it happens then because of the chart that we have in the industry, it's the prices have spiked so fast that everybody's concerned with those agreements that we made last year. Right? Of course now. So how do we fix it? Because we go, you went, you mentioned what's the hedging. So how do we fix it? Let's say, let's go back to the deal of the $3 of Peruvian organic. And you're the buyer in California before this whole mess of the drought or freeze or whatever. And you contracted with me Peru for the next two years. Okay. $3. Okay. We have our coffee's very susceptive to whether, you know, you can insurance ensure that price. Okay. So me as a producer, I'm making a great deal here. $3 a pound, coffee's a $1.80 a us consumer. You really want my coffee because I have a really special coffee that you need for your cup, for your roasting.

Albert (00:53:17):

That's right. There's something called insurance and the prices of coffee. And then financial markets, we call them options. So for example, as a producer, I can say, you know, I'm going to sell this gentleman, the coffee at $3. But if there's a freeze or a drought, I can insure myself. So I'm going to buy insurance at $3. So that if it goes to $5, I'm going to make a killing. And why do you buy insurance on a car? Because the first thing you do when you buy a car, that before you take it out of the dealership, you call your insurance agent, make sure it's fully insured because

Norbert (00:53:51):

It's a legal requirement,

Albert (00:53:53):

Well, not necessarily because

Norbert (00:53:56):

Yeah. Okay. So yeah. liability is legal requirement, but not in the car

Albert (00:54:00):

Yeah, but not in the car. You can just buy the car and walk out. Right. But if you have an accident, the moment you drive out and you have an accident, it's your equity, it's your loss, right? So what does everybody do? We buy insurance. And we have that already burned into our DNA, that whatever we have risk, we buy insurance question is why are we not doing it in coffee prices? And if my target needs to not do it, you know, if you're a roaster, if you're a producer, you can do your contracts and put a little insurance to guarantee that at worst case scenario, if there's an accident, you haven't priced insurance. So that we get it to the second instrument, which you can do the futures price, or you can do the options the insurance price. And many times we do, for example, those roasters that want to have that relationship coffee, that you mentioned, that sustainability and for the farmers and all that.

Albert (00:54:52):

And let's say coffee prices are a dollar. And you taught me to look out for, I'm gonna pay you $2 for the next 3 years. And you always have that risk that if prices explode, you may not get delivered. So what do you do? You put on insurance on a $2 coffee. So the worst case scenario and the very cheap when you're talking, those levels are away. It's very cheap. And you can guarantee for the worst case scenario, and you tell the producer to pay you $2. And if it goes too $4, I raised it to $4

Norbert (00:55:20):

Because of that insurance

Albert (00:55:22):

Because of the insurance. So there's a lot of things that we can do in terms of hedging, even if it's specialty, even if it's a fixed price that I'm going to pay you $4 a pound for forever and a day. There's always that question. And what do you do December 31st? When the insurance expires, you call your car insurance broker. Anytime we know you're even argued because they may raise prices, right? So January 1st, you renew automatically. We don't have that, you know, our DNA in the coffee world.

Norbert (00:55:55):

Okay. So there's a lot of education still, still needed. And I can see, and that's, that's part of why we are talking here and I appreciate your time and all your insights. This is really very valuable. And I feel like we will get some questions here from publishers and cause you know, I think there's a lot of people still intimidated, including me by financial financial markets and risks. And sometimes the answer is, oh, this is too, I will rather not engage in walkaway instead of doing something. So what is this something very where people and I got a feeling that the insurance might be the first step in, not, not the hedging. What, what is your, what is your take? Albert is if, if people buy or sell coffees, should the first think about insurance? Do not, not get over overwhelmed or is there, should they just talk to brokers and say, Hey, if you don't want to deal with that, it's like with the bank, you go to the bank, put your money there and they will find the deal for you. What, what, what is the advice?

Albert (00:57:00):

And you know, you've mentioned we brokers in the financial industry. We have, you know, we tend to complicate things and we tend to put very complex names to things now, but we've done in Stone X is try to get away from that. So for example, when we do certain, some of these strategies you know, the industry calls them really complex games. For example, one of the strategies we have is variable sales. All producers know how to do fixed sales, variable sales is where a producer sells. But if the market continues to go up, they can continue to increase their prices. The same with the roasters. Let's say I'm paying $1.80 for coffee. That's very high, our roaster combined fixed price and protect and do variable purchases. Okay. I bought a, I bought an insurance. If the collapses I'd never bought it up there, I can put it out.

Albert (00:57:54):

But in order to understand this whole world of hedging and financial things the best thing is to, you know, take costs. We used to do four or five times a year. We do hedging hedge shops and hedge of workshops for 10, because of the pandemic, this whole thing, we haven't been able to carry these on and online. These are very complex, three day 21 hour sessions. So it's very complex to do them online. But the first thing that we need to do is transmit these through, you know, simple workshops so that at least all the stakeholders can say, okay, there's something out there called hedging, and you can do this and you can do that. And if I need more information or let me call one of the brokers in the industry to get more explanation on it, but the way to do it, the way we've done with all of our clientele is through workshops, teaching simple concepts, little by little.

Norbert (00:58:49):

Right? So, and if a coffee roaster is committed to this, let's say the social good, knowing that there's certain certain costs at at origin and they want the guarantee the producer gets paid well, what is their, what is the elements. So they don't want to hedge down. Do you want to get to get into the negative betting? They just want to guarantee certain prices. It is that it's a possible, can that be done?

Albert (00:59:14):

Yeah. Yeah, sure. There's different ways of cutting the the cake. There's different ways of splitting the apple here, a producer can come in and say, okay, coffees and $1.80, my custom production, New York, let's say it's a dollar 30. Because I know I'm going to get paid 50 cents differential. Okay. But my base is a dollar 30 for New York. I can come in and buy insurance at a dollar 30, let's say for March next year, because it's so far away, it's going to be cheap. So if the market, all of a sudden collapses and goes to a dollar, well, I have this insurance that the exchange guarantees me a dollar 30, and I sold it to Nicholas exporting company at a 50 cent over premium. So I'm back to a dollar 80 with the markets at a dollar. So you can go simple or you can go more complex. The amount of instruments that the exchange provides and strategies are quite, quite deep, but at the very simple, you know, just like you buy the car insurance, you can have also buy price insurance in case.

Norbert (01:00:20):

So knowing that that farmer's always cash strapped if, if a roaster wants to do that for them. So let's say, Hey, I want to help my farmers. And I will pick up the insurance tab instead of possibility.

Albert (01:00:32):

And we do that every day. We do that everyday There's a lot of, for example, roasters that have, you know, the social programs relationships and okay, the farmer may not have the financial ability to do all this. Well. The who says, you know, I have the accounts, I have the systems. You tell me what you need. I know you don't sell me the coffee. So I'll provide you in the meantime from here until March, they deliver the company, provide you the tools for you to protect yourself. Cause I want you to do good. It says, if you do good, I'm going to get really good quality coffee.

Norbert (01:01:04):

Right? Right. Exactly. And for you Albert and your company, it's all the same. So whatever the market needs, you have to provide those, those tools and those instruments. There's no like either or, or a certain direction.

Albert (01:01:18):

No, we have a customers go directly from very small farmers in the producing countries, all the way to coffee shops at destination, and then anyone in between.

Norbert (01:01:29):

That's really powerful. I think that's extremely exciting. So that basically one of the messages can be, Hey, I'm roasters out there who want to do good and want to want to go that route, call out, but, and tell, tell him, tell him what you need and what you want and that what makes it happen. That's, that's fantastic. I'm excited.

Albert (01:01:49):

Excellent. Excellent. And then it's a lot more information at this time. If you want to do another podcast or, you know, again, a group of producers or roasters, I'll be more than happy to do that. I'm sure they're going to get a lot of benefit, especially now that so much, you know, volatility, uncertainty, things to try to figure out and understand yet.

Nick (01:02:08):

No, and this is nice because I think for a very, you know, your field of work is very complex and can be complicated, but you are able to simplify it for a lot of our listeners in a way, which is going to be massively beneficial. And honestly it probably will call for some followups. Yeah. Some good conversation. Yeah.

Norbert (01:02:26):

I got a great taste and I would like to continue.

Albert (01:02:29):

Yes, let's do it again. It's been fun.

Nick (01:02:32):

Yeah, absolutely. Thanks a lot. I really appreciate it.

Albert (01:02:36):

My pleasure. Thank you.

Nick (01:02:39):

Thanks for listening to this episode of the coffee and technology podcast brought to you by Cropster. If you enjoy what you heard, please subscribe or give us a follow on any of our channels to always get the latest episode. If you're interested in more educational content on all things, coffee and tech, be sure to head to cropster.com/learn or visit our YouTube channel. Cheers to more coffee.

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