• QA 227
    Why and how to deliver coffee from origin to the London Liffe futures market?
    How does physical coffee move from growers to roasters through the Liffe futures market? We understand little physical coffee is delivered but yet there are millions of bags of Liffe certified coffee stored in (European) warehouses. Do these coffees not become very old? Would we be able to deliver coffee to Liffe? If so, how?
    Asked by:
    Exporter - Indonesia

    Exporters can deliver physical coffee to the futures markets of London and New York. However, the procedure is quite cumbersome. *

    The primary function of a futures market is to divert risk by transferring it from one party to another at a price. The possibility of physical delivery to or from a futures market ensures a solid relationship with the underlying commodity but futures are neither meant to be nor are they a preferred delivery system for green or physical coffee to roasters. The main reason is that coffees from multiple origins can be delivered. This means roasters will never know in advance from which origin a delivery will come as the allocation of parcels is a function of the Exchange Clearing House. Roasters also often wish to approve the quality themselves before taking delivery.

    Why then is so much green coffee certified for delivery against the futures markets of London and New York?

    The reasons are mostly financial. Coffee stocks are nearly always financed through bank lending. Banks need to know these stocks are of acceptable quality - certification confirms this. Furthermore, as a last resort, certification opens the way for such stocks to be tendered against the futures market. For example if the borrower defaults. Hedging of unsold stocks is another reason. Q&A 117 in the Q&A Archive provides more detail on this and other reasons why stocks are certified.

    Certified stocks form part of the supply pipeline to the mainstream roasters. Whereas stocks rise and fall in response to supply and demand in the market there is a constant flow of incoming and outgoing coffee from the warehouses. This creates a form of turnaround and although it may happen that some coffees remain stored for long periods and become old, this is not always so.

    Exporters wishing to supply physical coffee to a futures market need  intermediaries - direct delivery is impossible. Coffee has to be shipped from origin, on arrival it has to be warehoused, sampled, graded and certified before it can be tendered through an intermediary who not only is entitled to do so but who also holds open short futures positions for the account of the exporter against which the deliveries could be made. Shipments have to be timed to ensure the goods arrive ahead of the tendering window, meaning longer financing. If certification fails the exporter is sitting with unsold coffee in a foreign warehouse. Worse, the exporter will also sit with unfulfilled futures contracts and as a result may lose money on both sides of the deal. Finally, how easy it would be to obtain financing for this kind of operation also remains to be seen - frankly, in most cases it would be rather unlikely…

    In conclusion: delivery to futures markets direct from origin is possible but with difficulty and involving considerable risk. There may be occasional market situations where such transactions could make sense but this would be the exception and certainly not the rule! We would therefore advise great caution.

    * Chapter 8 of the Guide deals with futures markets, their functions and systems.  Chapter 9 describes how the trade uses futures markets.

    Posted 25 July 2009

    Related chapter(s):
    Related Q & A:
    Q&A 017, 042, 115, 117