* Margin calls too expensive for some importers, exporters
* Local Guatemala coffee buying near halt on high prices
* Colombian exporters may turn to fixed prices
A potentially devastating storm is brewing in the world's physical coffee market, where a double whammy is hitting the companies that get beans from the farm gate to the cafe table.
Soaring prices and higher margins have squeezed exporters and importers, forcing them either to take on more risk by abandoning hedges or to pony up hefty financing costs.
Coffee roasters such as U.S. trendsetter J.M. Smucker Co have had little choice but to raise list prices by about 10 percent in its most recent hike. For coffee lovers, the good news is Starbucks , the world's biggest coffee shop chain, is working to offset rising commodity costs with a flexible pricing policy.
Benchmark ICE arabica futures have more than doubled in the past nine months to 34-year highs. Coffee handlers also have been slammed by soaring margins -- the sum they must pay to maintain an open position on the exchange.
Margins surged by 150 percent in the six months to October 2010, massively increasing the cost of hedging coffee purchases in the futures market.
The financial squeeze has become unbearable in Guatemala, producer of high-quality arabica beans, where trade came to a standstill as exporters said they couldn't afford the common practice of hedging their purchases.
"Exporters said they cannot do it. They cannot pay the margins," said Ricardo Villanueva, head of Anacafe, the country's coffee growers association. [ID:nN09287653]
The sentiment was echoed by major exporters across the region. Exporters in Colombia, the top grower of washed arabica, may sell at fixed prices and avoid the futures market.
Traders in Brazil, the world's biggest supplier of coffee overall, are lifting hedges to avoid paying increasing margins as open losses mount.
While that has worked out well for now as prices continue rising, it leaves those that have not hedged their positions exposed to heavy losses if the rally -- which has already defied most expectations -- stumbles.
"Everyone is looking for a way to cover themselves without having to pay margin calls - one way is to buy options, or to buy puts -- you need to have some kind of protection," said a market expert for a large exporter in Mexico.
Coffee roasters have passed on a small percentage of the price hike sporadically since the rally began. Kraft
Foods raised prices for Maxwell House and Yuban by about 12 percent in December 2010. This followed an increase last August, along with Smucker's, who did not rule out another price hike in the first quarter of this year.
The financial pain of a margin squeeze is nothing new to commodity traders. The surge in oil and grain prices in 2008 brought a number of firms to the brink of collapse. But it is being felt more acutely now in the small, clubby physical coffee market, which until last year had been largely left out of the commodities boom. For the smaller, local exporters, the extra tens of thousands of dollars to maintain open positions can be a heavy burden.
"We're worried about the market continuing to go higher and having to maintain those positions on the exchange," said Ray Keane, with importers Balzak Bros and Co in South Carolina. "We're a lot more cognizant of what our positions might be."
MARGIN SQUEEZE
Fund buying initially fueled the price surge in June 2010, but tight supplies of quality beans have sustained it.
On Thursday, the benchmark May arabica futures contract was down 3.3 percent at $2.8520 per lb at 12:31 a.m. EST (1731 GMT). It corrected lower after soaring to the highest intraday level for the second position since 1977 at $2.9665 on Wednesday.
Using the futures market to hedge is a widespread practice across the coffee market, a safeguard in the event the futures market declines by the time their beans come to market. But as the market keeps moving still higher, those holding short positions must pay increasingly hefty margins. The exchange most recently raised the margin requirements for coffee futures in October, bringing the increase to 150 percent over six months to $4,500 per hedge contract.
Anyone holding a short position on the May contract in this time span, however, would have had to pay more than $24,000 in both margin requirements and open losses.
For instance Alexcafe, a Pereira-based large exporter that plans to export 220,000 bags of coffee this year, was paying $1,800 to hedge a lot of 250 sacks of 70-kg bags six months ago, according to Carlos Ariel Ciro, the firm's financial adviser. Today the same lot is hedged at a cost of $4,800.
MORE RISK
Some physical dealers have been able to offset their losses by taking long positions on the futures market. Some are opting to hedge less and take on more risk, liquidating short positions as the rally gathers steam.
"It got to a point to where they could either buy coffee or send money for margining, so they have lifted hedges all the way up and it has worked fairly well for them," a coffee trader for a large exporting company in Brazil told Reuters.
In Vietnam, the world's largest producer of robusta beans, used in instant coffee and as a cheaper blend alternative for brewed coffee, record domestic coffee prices have spooked exporters struggling to secure supply as farmers fail to honor contracts.
Exporters there have reduced their exposure to rising coffee prices this year by hedging on the futures market to avoid losses and to focus on physical trading. Robusta futures trading on Liffe have climbed 84 percent in the past nine months to a three-year high at $2,586 per tonne on Wednesday, basis May .
For large roasters in the United States or Europe, however, the risk of lifting hedges may be too big. Instead, some are simply holding off buying anything but their most immediate needs, dealers said. Ciro and another unnamed coffee exporter, said international brokers are buying what is "strictly necessary."
"You can't simply say, I've decided to lift the hedge when you've got hundreds of thousands of bags of coffee on the line. So you have to pay these margins," said Flavio Ribeiro, director at the Rio de Janeiro brokerage house Flavour Coffee.
In Guatemala, Gerardo de Leon the marketing director at Guatemala's cooperatives umbrella organization Fedecocagua said, the problem hindering sales in his country is more about tax credits rather than exporters not wanting to buy.
