By
Josephine Mason
November 21, 2012
NEW YORK,
Nov 21 (Reuters) - A combination of short memories and old coffee has fueled an
unprecedented sell-off in benchmark arabica futures
this week, as changes made two years ago to the age and quality of beans
deliverable against the ICE Futures contract
finally come into effect.
On
Tuesday, the day before the first notice day for December coffee futures, that contract plunged over 5 percent
and its discount versus March beans flared out to almost 9 cents per lb, the
largest in 18 years, as traders who were long the contract rushed to dump it
rather than roll into the next month. Rolling would mean selling the discounted
spot and buying March at a big premium.
While the
spot prices recovered slightly on Wednesday, the big discount to March remained
in place at 8.4 cents.
A major
reason for the selling of December is because new rules come into effect with
the March contract, which will hike the discounts for beans stored longer than
two years and considered past their prime, allow the delivery of Brazilian beans
against the board and add fees for delivering material out of warehouses.
The
massive swing in the spreads to adjust for the new penalties will only be
temporary, lasting until the December contract expires on Dec. 18 and the March
contract becomes the front month, but it is roiling the market at a tumultuous
time.
March
prices hover near 2-1/2-year lows close to $1.5 per lb as the market continues
to struggle with growing supplies and lackluster demand.
"I
think some longs may have got their fingers caught in the door here and
overstayed their welcome. They waited too long to liquidate and were forced to
liquidate in a dying contract during a holiday," said Sterling Smith,
futures specialist for Citigroup.
At the
time of the 2010 announcement, ICE's decision to accept Brazilian beans grabbed
the headlines as it ended a decade-long debate over whether beans from world's
top coffee grower would be of high enough quality for the board.
But hikes
in age penalties have had a much larger impact, catching some investors by
surprise as nearby spreads widened to account for the new pricing policy.
"The
change in the discount schedule was significant enough that it is really what
forced the spread to go wider," said a U.S. physical merchant.
"By
the time you factor in (the additional costs and new discounts), it gets for a
nasty surprise for somebody who didn't pay attention to the change."
SURPRISE
DISCOUNTS
ICE first
announced plans to introduce the changes on Dec. 10, 2010 to address criticism
that beans were sitting in storage for too long and becoming too old to make
decent coffee.
With
months to go, the exchange issued a notice on Oct. 8 to remind the market of
the upcoming amendment, but some longs were still caught off guard.
In
essence, the exchange has accelerated the price penalty for stock older than
720 days. For instance, the new policy will deduct 100 points - or 1 cent per
lb - for the first 30 days after beans have been certified for two years,
rather than 75 points - or 0.75 cent - now. The deductions increase the longer
the beans are stored.
In other
changes, Brazilian beans will be deliverable against the board for the first
time, at a discount of 900 points, and a rebate on loading out fees for those
receiving beans from warehouses will be introduced.
DISCOUNTS
The first
signs the market was adjusting to the new penalty and loading-out rates emerged
on Sept. 18 when the December-March spread soared from almost zero to 3.9
cents, its widest since the end of 2011.
The
spread remained in a narrow 4- to 6-cent range until Tuesday when it jumped to
8.7 cents. Traders held off buying from desperate longs until they secured a
8.7-cent discount to March to cover the cost of carrying stock into the new
contract.
That 8.7
cents, traders calculated, would cover the new age penalties and loading out
costs.
A second
U.S. merchant said he had paid as much as 12.75 cents under the March price on
Tuesday.
"If
I tender that lot in March, I'll get penalized with a different age discount
schedule," he said explaining the reason for the huge spread.
"The
spread had to go to where the financial carry was, which accounted for age
discounts, so the financial carry for first couple of lots was a 900-point
discount."
Few
expect big inflows of Brazilian beans immediately given the steep discount set
by the exchange, but the market may have to deal with that possibility if
demand weakens further and global output continues to rise, traders said.
For now
though, the longs were facing a tough roll into the March contract, with many
expected to be casting a fresh glance at the ICE rule book over the U.S.
Thanksgiving holiday.
"Not
all market participants are as knowledgeable as others and that causes days
like (Tuesday). This is something where you were caught long and that's quite a
rarity in commodities," said the first merchant.
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(Reporting by Josephine Mason; Editing by Bob Burgdorfer)