Analysis: Coffee roasters stick with less costly robusta

NEW YORK (Reuters) - Coffee roasters quietly pulled off a financial feat last year that went unnoticed by most customers: Adding a higher proportion of cheaper, lower-grade robusta to their grounds as the price of top-notch arabica beans surged.

As new data reveals the surprising extent of that substitution, which appears to have been far more widespread than experts had thought possible, the industry faces a vexing question: As the price premium for arabica beans returns to historically normal levels, will roasters switch back?

The short answer seems to be no.

The "swing" in demand was surprisingly decisive and swift. U.S. robusta imports rose by almost 80 percent in the first quarter of this year versus a year ago, while arabica fell by close to a third, International Coffee Organization data shows, likely reflecting purchases made during last year's rally.

"What we're realizing is that everybody underestimated the amount of demand in robusta because everybody thought ... that there was just a (certain) amount of robusta people could add to their blends," said Ernesto Alvarez, chief executive of U.S.-based coffee merchant COEX Coffee International.

Part of the increase in robusta demand can be explained by changing tastes as some U.S. consumers sought out lower-priced brands due to soaring prices. Lower-cost makes Folgers, owned by U.S. roasters J.M. Smucker, and Kraft Foods' Maxwell House both won market share last year, research shows.

The data are beginning to provide some credibility to widespread market speculation that some U.S. roasters have raised the robusta content to a higher level in their top-secret blends than many thought - in effect sacrificing quality in order to keep their profit margins.

The trend started last year, with U.S. robusta purchases from Brazil, the world's second-biggest robusta grower, tripling to 813,000 60-kg bags in 2011. While the total was still much less than the 5.84 million bags of arabica brought into the country, the rate of growth outpaced the premium grade's 3-percent rise year-on-year, ICO data showed. (Graphic: http://link.reuters.com/qub28s)

Now, however, market forces have reversed. The arabica premium has shrunk by almost 70 percent from its 2011 high of nearly $1.90 per lb to around 60 cents, making it far less financially advantageous to buy the lower-quality blends.

Experts say roasters have likely reached the limit of how far they can push the fine balance between robusta and arabica in their blends, but they may be able to maintain that ratio if it is economic and there is no consumer backlash.

"If the consumer has accepted the product well, and it's selling well, I don't see them going back to a higher arabica content, unless something's triggering it," said Carlos DeAldecoa, president of Maximus Coffee Group in Houston, which roasts coffee for 11 roasters, buys green coffee, and processes instant and decaffeinated coffees.

Smucker declined to comment on any changes in its green coffee purchases for proprietary reasons. Kraft said it could not share specifics about its blends.

ROBUST ROBUSTA DEMAND

Not all roasters can introduce lower quality beans to their blends. Those with premium taste and aroma profiles may not have the flexibility to use robusta beans, which typically have a less appealing taste described as earthy and bitter.

But those that can dabble according to price and bean availability - typically the national retail brands sold in supermarkets - set their sights on robusta beans in 2011 to help lower the cost of their brewed blends as arabica prices soared.

A steep and steady 11-month rally more than doubled the ICE benchmark arabica coffee futures price, lifting the market above $3 per lb to a 34-year high in May 2011 and pushing the arabica premium over robusta futures to nearly $1.90 per lb. (Graphic: http://link.reuters.com/bat58s)

"We're certainly seeing a change in the blends to include a higher percentage of robusta than they did in the past," said DeAldecoa.

Victor Garcez, chief executive of Italian-based Cafeco, which steams robusta beans on behalf of roasters to improve their quality, says demand for steamed robustas doubling at Cofaco's Vietnamese facility during the coffee rally as roasters tried to squeeze more out of lower-quality beans.

Massimo Zanetti USA, a mid-sized roaster that makes brands including Chock full o'Nuts and Hills Bros., was one of the only companies to discuss the blending issue publicly.

In November, it said it had increased its robusta usage by over a quarter year-to-date in order to reduce the impact of soaring Arabica prices and keep its retail prices as low as possible.

Arabica futures have since dropped nearly 50 percent to two-year lows at $1.561 per lb on Thursday, while Liffe robusta futures rallied on surging demand to an 8-1/2-month high at $2,269 per tonne at the end of May. They have since eased back to around $2,100.

Meanwhile, Liffe certified arabica stocks in Europe have seen an uninterrupted decline for 10 straight months, falling nearly 60 percent since mid-July 2011, indicating firm demand.

PRICE VS PALATE

So far many consumers have been more sensitive to prices than their palates, drinking less premium coffee or buying cheaper brands last year as coffee companies hiked prices multiple times, according to Garima Goel Lal, beverage analyst for consumer analyst Mintel, in Ithaca, New York.

Those who cut prices in response to the falling futures market won market share. Folgers' share retail volume climbed to 21.6 percent in 2011 from 19.7 pct in 2010 and Maxwell House rose to 10.5 percent from 10 percent in 2010, Euromonitor International data showed.

"If they didn't see any impact on their consumer from a quality standpoint, they might not change it because ultimately their total blend cost is going to be lower than it was years ago," DeAldoca said, speaking in general terms.

And without any resistance to the new blends, there is little incentive for roasters which have aided their profit margins with the new brew to switch back.

Some traders have taken steps preparing for the change to be long term.

COEX, which trades 3-1/2 million 60-kg bags annually, recently opened offices in Vietnam, the world's biggest grower of robusta, and Holland, strategically located for West African imports, to source robusta beans.

"We used to be an arabica house completely. Five, six years ago we traded no robustas. Now it's 40 percent of what we do," said Alvarez.

(Reporting By Marcy Nicholson; Editing by Josephine Mason and David Gregorio)

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