Middle Africa Briefing Note | Soft Commodities | Coffee

23 October 2014

Ethiopia: Coffee sector performs below potential Highlights 

Ethiopia is Sub-Saharan Africa’s leading coffee producer, with output of 373,940 MT of Arabica coffee in 2013, the equivalent of 51% of East Africa’s coffee output.

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Strong local consumption of coffee accounts for around half of national output, which constrains the volume of beans available for export each season.

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The marketing of Ethiopia’s coffee output has undergone a transformation with the creation of the Ethiopia Commodity Exchange (ECX), through which 85% of beans are sold.

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Ethiopian exports have been prone to fluctuation as a result of periodic falls in output, volatile international prices, and the pressures of supplying the domestic market.

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The leading offtakers of Ethiopian coffee exports are Germany, with a 21.4% market share, Saudi Arabia (17%), the USA (11.3%) and Japan (11%) in 2013.

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Ethiopia could position itself as a low-cost Arabica naturals producer, but it faces constraints, notably an inefficient supply chain and the low productivity of smallholder coffee farmers.

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The specialty segment is also being constrained by the ECX’s dominance of coffee marketing.

Ethiopia is Sub-Saharan Africa’s largest coffee producer Ethiopia is Sub-Saharan Africa’s leading producer of Arabica coffee, commanding an important share of the world speciality coffee market. Arabica coffee is believed to have originated in Ethiopia, and coffee remains central to the culture. Although Ethiopia has diversified into other crops in recent years, notably horticultural goods and oilseeds, coffee remains the country’s most significant commodity export. Africa’s coffee production is focused on East Africa, which accounts for around two thirds of the continent’s total output. Within East Africa, Ethiopia is the key producer, accounting for 51% of African output (Chart 2), well above its competitors, Uganda (31%), Tanzania (8%) and Kenya (5%). This reflects the tremendous growth in Ethiopian coffee output—following liberalisation of the sector—which increased by 139% in the decade from 2004 to 2013, from 126,188 MT to 373,940 MT in 2012 (Chart 1). However, Ethiopian output has been prone to fluctuations over the last five years. Output reached record highs in 2010-11, thanks to good weather and high international prices, but subsequently slipped back, reflecting drier weather and the natural peaks and troughs in coffee’s production cycle. Chart 1: Coffee production in East Africa, 000s MT

Chart 2: % share of production

700

600 500

5%

2% 3%

8%

400 51%

300 31%

200 100 0

2004

2005

2006

2007

Ethiopia

2008

Uganda

2009

2010

Tanzania

2011

2012 Kenya

2013 Burundi

Rwanda

Sources: FAOSTAT, Ecobank Research.

Ethiopia’s coffee sector is largely made up of smallholder farmers who account for 95% of output. Their holdings, estimated at 528,751 ha, are mainly found in Oromia and the Southern Nations, Nationalities and People Regions (SNNPR) in the south of the country. All farms that are smaller SEE ANALYST(S) CERTIFICATION(S) AND IMPORTANT DISCLAIMERS & DISCLOSURES ON LAST PAGE Ecobank Research | [email protected] | Twitter: @EcobankResearch

Middle Africa Briefing Note | Soft Commodities | Coffee

23 October 2014

than 5 ha are designated smallholder farms, and average plot sizes do not exceed 2 ha. Green coffee yields remain stubbornly low, at just 300kg/ha, equal to a third of Colombia’s yield of 900kg/ha and a quarter of Costa Rica’s yield of 1.2MT/ha. Ethiopia’s remaining 5% of output is produced by plantations, which average more than 50 ha in planted area, and which have been privatised by the government in recent years. Ethiopia produces high quality Arabica coffee, which is native to the country’s highlands. The country’s Arabica varieties, of which Sidamo, Yirgachefee and Harar are the best known globally, are renowned for their diverse flavours and acidity. This makes Ethiopian beans highly sought after in the bulk and specialty markets, and enables them to command a premium on the New York terminal market. The majority of Ethiopia’s coffee is sun-dried (naturals), representing 70% of total output, while the remaining 30% is washed. Although Ethiopia is primarily a provider of high quality bulk coffees—roasters use Ethiopian beans as low-cost substitutes for Brazilian Arabicas in blends—the country has also attracted strong interest from roasters in its single-origin, specialty coffees, which are grown at high elevations.

Strong domestic consumption can put pressure on supply Ethiopia is unique in being the only coffee-producer in Africa to consume a large proportion of its own output. Coffee plays an integral role in Ethiopian culture, and the country accounts for 70% of total coffee consumption in Middle Africa. Ethiopian consumption typically accounts for half of national output, but this can fluctuate, for example in 2008 when it dipped to a low of 34% (Chart 3). Changes in consumption reflect several factors, including rising international prices which make it more attractive to export coffee than sell it locally, and government incentives to reserve a majority of output for exports in order to capture hard currency. Conversely, illegal flows of beans to the domestic market tend to spike when international prices fall, as farmers and akrabis (local suppliers) get higher local prices, driving a thriving black market. Chart 3: Ethiopian production and consumption of coffee, 000s MT

400 350

300 250

200 150

100 50 0 2008

2009

2010

Production

2011

2012

2 013

Consumption

Sources: FAOSTAT, Ecobank Research.

The ECX has transformed coffee marketing The marketing of Ethiopia’s coffee output has undergone a transformation in the last six years with the setting up of the Ethiopia Commodity Exchange (ECX) in 2008. The ECX is the dominant marketing platform through which 85% of production is sold to local and international markets. However, many aspects of Ethiopia’s coffee value chain have remained unchanged. Farmers sell coffee cherries to cooperatives and akrabis that own dry mills and washing stations. The dried and washed beans are then delivered to ECX warehouses for grading and storage until they are sold by farmers or akrabis to buyers via the exchange. Akrabis are responsible for marketing between 80% and 90% of Ethiopian coffee and they are an invaluable source of information on

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Middle Africa Briefing Note | Soft Commodities | Coffee

23 October 2014

coffee provenance. However, cooperatives and plantations are the only two permitted channels for the procurement of single-origin coffee, which is of great importance to specialty roasters. The exchange uses an outcry system—sellers (farmers and akrabis) and buyers meet in the trading pit to negotiate prices and volumes—and sellers are paid within 48 hours from buyers’ cash accounts via the exchange’s clearing house. The warehouse receipt is then transferred to the buyer who will pick up the supply from one of nine regional warehouses. Despite several false starts, the Ethiopian government still intends to implement electronic trading, although it is unclear when this will happen. All ECX coffee prices are based on ICE “C” Arabica prices and include origin differentials, which enables farmers to consistently earn 60% of the export price, thanks to the provision of terminals displaying ECX prices in coffee producing areas. As the guarantor of coffee quality – which, along with lack of supply, was a critical problem for buyers under the old auction system – the ECX is responsible for grading and assigning regions to lots once they have been disposed at warehouses. Coffee is graded according to physical requirements—such as 11.5% moisture levels and screen size—which account for 40% of the grade, and sensory qualities, such as cleanliness, acidity, body and flavour, which account for the balance. ECX cuppers use the US-based Coffee Quality System’s Q system to assign export grades, which run from 1-9, with Q1 and Q2 for specialty coffees, and a 1-5 scale for local grades. All high-quality and washed coffees are destined for export, while low grade beans are allocated to the domestic market.

Roughly half of Ethiopia’s production is exported Ethiopia is one of Africa’s leading coffee exporters, vying with Uganda to be the continent’s top exporter. However, Ethiopian exports have been prone to fluctuation as a result of periodic falls in output, volatile international prices, and the pressures of supplying the domestic market. In 2009 exports slumped to a low of 133,992 MT—as a result of low international demand during the global financial recession—before surging by 48% over the next two years to an all-time high of 198,706 MT in 2013. Export earnings have also fluctuated, reflecting swings in international coffee prices. Export earnings fell to a low of US$376mn in 2009 before rebounding to a record high of US$841.6mn in 2011, thanks to high international prices that year, before declining steadily over the following three seasons (Chart 4). Chart 4: Ethiopia’s coffee exports, US$ millions 900 800 700 600 500 400 300 200

100 2007/08

2008/09

2009/10

2010/11

2011/12

2012/13

2013/14

Sources: ECEA, Ecobank Research.

The leading export destination for Ethiopia’s coffee is Germany, which commanded 21.4% of the export market share in 2013 (Chart 6), followed by Saudi Arabia (17%), the USA (11.3%) and Japan (11%). Given these countries’ importance as offtakers of Ethiopian coffee, the largest coffee traders in Ethiopia are Volcafe (ED&F Man), Neumann, Mondelez, Mitsubishi and Marubeni. Two factors dominate these coffee flows: first, roasters, who are large buyers of Brazilian naturals, will often substitute Ethiopian beans in their blends in order to save costs; and second, long-standing consumer preference for Ethiopian speciality varieties. Saudi Arabia is the largest Ecobank Research | [email protected] | Twitter: @EcobankResearch

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Middle Africa Briefing Note | Soft Commodities | Coffee

23 October 2014

offtaker of Harar coffee and its consumers are willingly to pay high premiums to secure it, as they prefer these beans for their low caffeine quantity, acidity and moka flavor. The export segment is highly fragmented, with the five largest players together holding just a 25% market share in 2012/13 (Chart 5). The remaining 192 exporters control the other 75% of the market. Horra Trading is the market leader, exporting 18,447 MT of coffee in 2012/13 and holding a 9% market share. It is trailed by Abba Hawa Trading and Kemal Abdella International, which both command 5% market shares. Chart 5: Market share of exporters, 2012/13

Chart 6: Major offtakers, 2013

Horra Trading

9% 5% 5% 4% 4%

Abba Hawa Trading Kemal Abdella

Germany 22% 31%

USA Japan 17%

Mullege 8%

73%

Saudi Arabia

GMT Industrial

Belgium

Other 11%

11%

Other Sources: ECEA, Ecobank Research.

The sector has strong potential, but faces challenges Ethiopia has the potential to position itself in the international coffee market as a low-cost supplier of Natural Arabica coffees, which are ideal substitutes if production in Central and South America falls shortly (most recently owing to the leaf rust outbreak). However, Ethiopia’s coffee sector is facing serious constraints that are limiting its growth. The supply chain remains highly inefficient, with reduces farmers’ share of the export price and limits their ability to reinvest in their plots. Ethiopia’s Natural Arabicas have the highest sourcing costs in East Africa, around 40% of the average 2012/13 international price of US$1.29/lb, limiting the farmers’ share to 60% of the export price. This compares with 70% for Kenya’s Washed Arabicas and 72% for Uganda’s Natural Arabicas. Following the withdrawal of the Ethiopian government from actively managing coffee production, the vast majority of smallholders lack the means to raise yields or add value. One solution would be to establish innovative partnerships with offtakers, and a feasibility study is underway on the creation of washing stations that are jointly owned by cooperatives and roasters. Marketing could also be bolstered by boosting the resources of the ECX to expand its warehousing, invest in its technological infrastructure and improve the transparency of grading.

The lucrative specialty segment is being squeezed Despite the benefits it has brought to Ethiopia’s coffee sector, the ECX’s creation has created obstacles for the development of the high-value specialty coffee segment. Given that the ECX is the principal marketing platform, most of Ethiopia’s coffee is sold as bulk, with only 5% sold as specialty. As specialty only represents 2% of international coffee flows, the government is incentivised to privilege bulk over specialty. This has led to complaints from specialty roasters about the difficulty of accessing single-origin beans in Ethiopia, which are now only available via unions or plantations. Specialty roasters have also raised concerns that ECX grading is opaque, which leads to the disqualification of many potential specialty coffees. Increased flexibility in marketing rules would also allow Ethiopia to increase its share of the world specialty coffee segment; currently Ethiopia and Kenya have an estimated 12% market share.

Ethiopia stands to benefit from Brazil’s woes Despite the constraints facing the sector, and the volatility that has affected its output and exports in recent years, the outlook for Ethiopia’s coffee sector is bright. The country stands to benefit from dry weather in Brazil, which is expected to substantially reduce the volume of Brazilian Arabica beans on the world market. In response, international Arabica prices have continued to rally, surging to over 200 US cents/lb in October, a three-year high, and industry Ecobank Research | [email protected] | Twitter: @EcobankResearch

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Middle Africa Briefing Note | Soft Commodities | Coffee

23 October 2014

experts expect this upward trend will continue into 2014/15. The Ethiopian Coffee Exporters Association (ECEA) has forecast that 2014/15 coffee export earnings will increase by 25%, to US$900mn, based on ECX prices at US$2/lb. Production is also forecast to reach 500,000 MT for 2014/15, with around half of this total being exported, representing a 31% increase over the 191,000 MT exported in 2013/14. Rising production has largely been attributed to an increase in the area planted with coffee, buoyed by the acquisition last year of 22,114 ha of government-owned coffee plantations by Saudi-Ethiopian businessman Mohammed al-Amoudi’s Horizon Plantations. The company plans to invest US$500mn in increasing coffee output at its Limmu and Bebeka coffee farms, which cover a total area of 18,000 ha. However, these investments will only bear fruit after coffee trees reach steady production levels in three to five years time. Coupled with the persistent challenges facing smallholder producers, this could result in a slower increase in production than the government has targeted.

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Middle Africa Briefing Note | Soft Commodities | Coffee

23 October 2014

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