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Differentials Unpacked

A few years ago I wrote an article on variables that affect the price of coffee. It centred on: the New York Coffee Market; Differentials, and Foreign Exchange. I re-read it before this article and it holds up pretty well so I would recommend you check that out before reading on if you want a refresher (Variables that affect the price of coffee). That said, if you just want to discuss differentials, let’s crack on!

Most of the coffee traded in the world is impacted by the three variables mentioned above, even if they themselves are bought and sold on an outright basis, as everyone is using the New York Coffee Market and the associated differentials to form referential pricing. Outright pricing makes up a sizeable chunk of speciality coffee, but perhaps less than you might think, as many speciality coffees are indeed bought on a differential basis-especially if they are going in a container that has other coffee that is bought on a differential basis: sometimes it’s just not possible to buy a full container of expensive outright speciality coffee. If you can, hats off to you, as this is always the goal so we can send as much value back to origin as possible. Back to the topic in hand though. Unsure about what a differential is? Let’s define it. 

A differential, otherwise known as a “premium” or “diff” is a US c/lb figure that is plus or minus the New York Coffee Market. And yes, lots of coffee, especially commercial Brazil has minus differentials.

US denotes the currency and lb denotes the unit: US cents, per pound of coffee. 

If you are reading this you are likely a customer of ours so you are probably based in the UK or Europe (not all of you though!) so you may be thinking: “Pounds?”. The pounds in this instance are not British money but the imperial unit of measure: our friends’ across the pond’s version of kilos. Some of my customers will be familiar with the term I like to call the ‘magic number’ which is 0.04536. If you divide a US c/lb number by the magic number it takes you to US $/mt and then you can further divide by 1000 if you prefer kilos to tonnage. I took a segway there but we have defined a differential and clarified the units and currency they are presented in. 

What do diffs look like in practice though? Let’s take an example. If a Brazilian exporter is offering +60 c/lb for a single estate coffee, that means it’s the NYC price plus the diff. If the market is 185 c/lb and the diff is 60 c/lb, then that would be 245 c/lb if the coffee was purchased and ‘fixed’. As mentioned above, some commercial Brazils have minus differentials. This is because they are cheaper in value than single estate Brazils that cup higher and carry full traceability. If we take a commercial Santos as an example, if the diff is –10 c/lb, the market is 185 c/lb, and the coffee is fixed, the final price would be 175 c/lb. If you wanted to convert 175 US c/lb to a US $/kg price you can engage the magic number above. 

If we go beyond the magic though, who creates differentials, how are their prices set and why might they change? They are created by exporters at origin and their prices will be dictated by what is happening at the origin in question (supply/demand, political situation etc), and also what the NYC is doing. For example, if there is a drought in Brazil, and this affects the supply of coffee, differentials may increase to compensate. If there is a bumper crop in Brazil and there is loads of coffee available, differentials there will likely fall. If the NYC falls to very low levels, differentials across all origins may rise a bit to compensate for this. There are no set of rules for differentials however, exporters offering the same grade of coffee may offer very different differentials when compared to each other, especially if one feels their grade is superior. One exporters’ Honduras SHG can be very different to another’s, even though the same grade is written on the bags exported. 

Although diffs are of course linked to the movements of the coffee market, they can go to the beat of their own drum. They can go up when the market goes up, they can do down when the market goes down and they can also go down when the market goes up and vice versa: all the different scenarios will have a significant impact on the price of your coffee. Below is a table that illustrates some of these moves:

Taking Scenario 1 as a base, in Scenario 2 we see that when the NYC price fell, the diff stayed the same, resulting in a reduced total price. If the producer felt that the supply for their coffee was limited, they might choose to increase the diff as seen in S3. This brings the total price back to 245 c/lb despite the NYC price falling. In S4, we assume that the NYC Price rises again due to low yields in Brazil, and with limited supply around, producers have also chosen to increase diffs to maintain profitability, resulting in an increased total price of 300. The increase in the diff in S4 exacerbates the trend of the NYC Price rising.

As you can see, movements of differentials are important and can either: exacerbate a positive or negative market movement or compensate for a positive or negative market movement (if they move, as we saw above, they can remain constant when the Market Price is moving). 

Key takeaway? It’s not just the movements of the NYC that effect your FCA warehouse price, diffs have an impact too! As a roaster, it’s always a good idea to ask your account manager for their opinion on diffs and how they see them moving going forward, as they may be able to help you select a good time to contract forward or not.