ECX and its Effect on the Coffee Sector - Part II
For Part III, click here
The Effects of ECX on Specialty Coffee Exporters and Buyers
I think, the first year of trading coffee through ECX was marred by problems and confusion. While the efforts made by ECX to take on a crop of global importance shortly after its launch is admirable, the strategies it went by to integrate the trade were far from being flawless. From the outset, ECX declared that it aims at creating a national standard commodity coffee classification system; it eliminated direct trade and traceability; and enticed the government to controlling the value chain from farm gate to the border. These changes have had remarkable effects on coffee exporters, buyers, growers, and the coffee sector at large.
I. Homogeneous National Coffee Brand
For a country with millions of poor people, the temptation of utilizing the high paying fewer coffee brands to drive sales and increase the value of the country's overall coffee production is high. That very thought has played a role in ECX' decision to homogenize all coffees grown in the same region through a standard commodity classification system.
This is clearly stated in the whitepaper released in April 2009 by the ECX titled: What is in a Bean? ECX and the Specialty Coffee Market. It reads, "We take the strong view that a significant majority of Ethiopian coffees have the potential to be considered fine coffees, and can be sold in the domestic market as such, with appropriate certification. The ECX model not only promotes the specialty coffee segment but also do so in such a way as to benefit the small farmer as well."
The document does not indicate how ECX' new system will benefit the small farmers but it stands firm by the assumptions and subsequent conclusions.
"The recent policy decision to include trading of all coffees within the Exchange is based on the strategic thinking that the [following] set of assumptions [is] correct:
1) A significant majority of washed Sidama and Yirgachefe and unwashed Harar could be considered specialty-plus in that they are branded and trademarked and have the potential to meet the fine coffee standards;
2) A significant majority of all Ethiopian coffees have the potential to be considered organic and obtain certification;
3) A significant portion of unwashed coffee can be promoted as forest coffee and/or bird friendly."
Although these assumptions are based on indisputable facts, they are not exhaustive enough to justify the conclusions drawn by the ECX. The fact that Ethiopia has the potential to increase its coffee qualities to the standards preferred by the global Specialty coffee industry does not give good reason for an immediate homogenization and an automatic upgrade of the classes of the whole coffee production. Ethiopia's coffee cannot be sold as Specialty coffees only because the country wanted or decided to. In a buyers' market, such as in the global Specialty coffee trade, unfortunately, the final say is not that of producers' but the buyers'. Specialty coffee buyers and roasters decide which plot to invest in and which crop to buy.
The alternative is for the country to invest in quality, branding, and slick marketing of its products to set itself apart from the competition and convince buyers. That way, Ethiopia could create the demand and subsequently the market for the coffee brands it wishes to create. This is, however, a daunting task and an expensive venture for Ethiopia, the poorest country in the world. In the absence of these endeavors, countries like Ethiopia are bound to the terms of the global coffee trade, at least for the foreseeable future.
The measures taken by the government to force sell all coffees through the ECX platform and ECX' decision to standardize the coffee grades into a national brand while, in ECX' estimation, only about 3.7% of the country's coffee production qualifies to be branded as a Specialty coffee, may cost the nation dearly. The farmers that are already producing the finest coffees will be the immediate victims of the new system as they are forced to give up the premium prices they are paid by buyers for their exceptional produce. Because, as soon as their coffees are blended with other coffees grown in the same region (in order to boost up the wholesale price for good of the country), these farmers lose their entitlement to the premium status their produce commands. This is unfair to the poor farmers.
Unless the ECX system of trading coffee as a commodity is corrected promptly, in the long term, the strategy risks watering-down the nation's coffee brands. Such a strategy undermines the superior standards some of the brands earned over the years and the result will be commoditizing the country’s valuable crop.
II. No Direct Trade, No Traceability
Specialty coffee buyers and roasters are puzzled and in panic over the ECX system. The biggest issue for these buyers is the loss of transparency and traceability. They need assurances that the bundle they want is the bundle they will get. The new system does not allow direct trade for single-origin coffee because it promotes the traditional trade relations model where commodity coffee sales is brokered in bulk, thus no traceability. The new system basically lumps together bundles of coffees into a generic class-type-grade combo.
Independent millers who used to buy coffee from farmers, mill it, escort it through the former auction systems, and export it are no longer allowed to do so. They are now required to sell the beans to the ECX, where its origin is lost. The possibility of tracing a bag of coffee to its origins is eliminated in this process. The ECX promises a secure inventory management and a guaranteed warehouse receipts system that ensures "zero delivery default and reduces mixing of coffee origins" during the marketing process. But, as far as buyers are concerned, traceability is lost because there is no way of proving whether the plot they will receive is the one they wanted.
This is remarkable because while the global coffee industry is increasingly moving towards greater transparency of coffee origins, tracing back all the way to individual plots of land, the Ethiopian system is heading in the opposite direction.
III. Government's Hands in the Bag
The third effect on the exporters and farmers has to do with the government's intervention.
While it is good, though not a necessity, that the new exchange system replaced the auction centers with an electronic trading system, unfortunately, ECX also tempted the government to enter into the market as a major player. Some private businesses are now effectively locked out of the market and, in an unprecedented move, the government has emerged with a strong control over the coffee sector.
In what played out early this year as a reaction to some of the major exporters' hesitance to sell their coffee stocks at the prevailing prices if sold through the ECX, the government confiscated coffee beans from the exporters and also tasked the state owned profit-making enterprise called Ethiopian Grain Trade Enterprise (EGTE) with exporting coffee. This crack down on the exporters had a devastating impact on some roasters and their relationship with the country as the country failed to fulfill its contractual agreements during the last harvest season. Also, it raised the question of what else would the government do in the future.
The ECX is currently negotiating with representatives of the Specialty Coffee Association of America (SCAA) and others to resolve this one problem. In the mean time, as the next harvest season approaches, the EGTE appears to be very well positioned to claim the biggest market share in the country's coffee export.
Domestically, this level of engagement by the government in exporting beans produced by smallholder families is alarming because of the imbalance of power and the obvious conflicts of interest. The government has its influences in almost everything from policy making, distribution of farm inputs, capital, to the land. This is the farthest one can get away from a free market system.
All these affect farmers as their sales volume is directly dependent on the volume sold by exporters.
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Next post: Part III - Is ECX good for coffee growers? To read, click here
5 comments:
You are one steadfast Ethiopian. I admire your dedication and fair analyses. I follow your blog with earnst interest even when I don't agree with some of your attacks against the Ethiopian government. Write, brother, write!
Yours seems to be one of the few well-informed voices offering regular analysis on matters of the Ethiopian coffee sector. It's thus sad to see that there's so little traffic (judging by the number of comments) on your blog! Besides this analysis, all we come across are pieces by ECX itself, or else media articles, which however unfortunately often don't pass as analysis but rather he-said, she-said (or oftentimes just "she-said, she-said").
Your two-part blog entry is a great start in that direction. I would want to very much encourage you to take it further and make it into a small essay, which you could post on your blog and also circulate widely.
In the mean time, I have a few questions that arose from reading your 2-part piece, which I think would be quite easy to answer for you, since you're well versed on the issues:
1. Specialty vs Other Farmers: While specialty coffee farmers are clearly getting hurt by the ECX policies to blend specialty with other coffee, does this however result in a net benefit for all farmers (ie the number of farmers who gain is larger than the number who lose)? While this is perhaps best answered with proper empirical analysis, one can probably still wager an educated and reasonably well agued-for guess as to what the net effect is likely to be.
2. Exempting Specialty: If only 3.7% of the country's coffee (is this the % of physical coffee tonnage, or the % of coffee value in $?) is specialty, why didn't ECX exempt such coffee from having to be sold via the Exchange? If they did, a big chunk of their current headaches, with heavy complaints from specialty roasters, would go away.
3. Share of Specialty: Do you know if there's any independent figure on the share of specialty in Ethiopia's total coffee production? Can we be sure it's 3.7% E.g. does the SCAA have any data on this?
4. Grains on the ECX: Whatever happened to other grains? Has ECX altogether given up on trading cereals? Or have they temporarily stopped this because, in light of the soaring food prices and major food insecurity problems of the country, such trading has become a political liability for the ECX? I know you mostly blog on coffee, but am hoping you may still have some insights on this.
5. International Experience: Many of the arguments you marshalled against the approaches chosen by ECX on trading coffee would equally apply in other countries--if similar approaches were chosen there. More generally in fact, there's a question mark on whether coffee, the value of which to a great extent derives from differentiation, traceability, etc is a very different commodity from other crops such as cereals, which--after meeting core quality standards--are usually not sold as highly differentiated products on the international market. Thus the larger question is: Should coffee be at all sold through exchanges? So my question is: What's done in other coffee producing countries which have commodity exchanges? Do these countries leave out coffee from their exchange? Include coffee but handle in a very different way from ECX? Do the same thing as ECX?
Anon 1&2, thank you for your generous comments! Anonymous #2, your insightful questions shake up the crux of the matter. I'll try to respond briefly:
1. Specialty vs Other Farmers: I strongly doubt that blending and standardizing the coffees will have a positive domino effect on the coffee sector. This approach worked well in the 1970's for Colombia when they created the Juan Valdez brand but Ethiopia's situation is different and times have changed since. Today, prices for commodity coffees are determined at the NY "C" market; whatever price offered at ECX is tied to that of the NY "C" price. Besides, there is no meaningful marketing effort going on to promote Ethiopia's multiple coffee brands.
Given all these, blending may have an infinitesimal effect globally - smaller than a drop in the ocean (Ethiopia's coffee export accounts for around 2.4% of the global coffee trade by volume) because some lucky buyer somewhere in the globe may get the fine coffee beans for a price of the NY "C" price.
Otherwise, domestically, blending will most likely have a negative effect on quality production as it eliminates the incentive for producing the gourmet coffees. After all, the theory of "ripple effect" is inapplicable in Ethiopia's situation because any increase in the FOB price, if any, easily dissipates in the long value chain (from exporters to collectors) before it gets to the farmers. In Ethiopia, where over 95% of coffee is produced by smallholder families - families often plowing less than half a hectare of land and scattered over a vast mountainous regions that are not accessible by car, commodity exchange ends at the of collectors' posts. Farmers travel with a bag of cherries on their shoulders for as far as they humanly can and sell their produce to the collectors stationed at a point of their exhaustion. That is the farthest the farmers could go to bargain or to shop around. So, why bother to produce fine coffees?
2. Exempting Specialty: First, there is no available data on the volume of Specialty coffees traded, in part because the concept of "Specialty" itself is still evolving, and statistics is statistics in Ethiopia. Secondly, I don't agree with the 3.7% argument at all. The ECX' estimation is based on some absurd assumptions. It is so absurd that if ECX' assumptions and estimation of the percent share of Ethiopia's Specialty coffees were true and that same logic applies all over the world, then there would not have been enough Specialty coffee in the world to run a sixth of Starbucks' global stores. I believe, the major reasons why ECX has had to run into these problems are, to name a few, lack of knowledge about the Specialty market, the government's eagerness to control the sector in order to ensure an uninterrupted flow of foreign currency, arrogance.
3. Share of Specialty: See #2
4. Grains on the ECX: The grain trade through ECX is insignificant at the moment because a) ECX' limited resources are tied up in addressing the coffee issues, b) production has plummeted, c) traders are reluctant to give in to ECX due to lack of awareness and wariness of government's unpredictability.
5. International Experience: Coffee can be - and is being - traded in bulk exchanges but the exchange markets are tailored to the situations in each country. Markets function well where there is limited government intervention and strong arbitration systems. Ethiopia's experience along with the draconian laws & regulations will have little relevance to other countries, such as India and Brazil. That said, ECX may function better if the authorities approve of a mechanisms that accommodate both direct trade (Specialty) and bulk exchanges - as traders wish.
More to come in Part III. - Wondwossen Mezlekia
It is interesting to read issues and comments involving ECX. ECX initial objectives were to establish commodity exchange for the grain market excluding coffee trading. Now, ECX is primarily coffee trading with limited grain trading capacity. Coffee trading had a manual rigorous processes. Therefore, it was decided to exclude coffee at least in the initial phase of the project. Now, the decision has been reversed and implemented with government heavy handed involvement, does it mean ECX has lost its vision and mission as it was articulated two or three years ago? What led to these critical decisions? Who made these decisions and based on which facts?
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