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Report catalogues how coffee cartels have siphoned Sh28b from Kenyan farmers in 7 years

FINANCIAL STANDARD
By Paul Wafula | August 11th 2015
Farmers affiliated to Gachatha Farmers’ Cooperative Society in Tetu, Nyeri County sorts out dry coffee berries. PHOTO KIBATA KIHU/STANDARD.

NAIROBI: Cartels running the country’s coffee industry have siphoned at least Sh28 billion from farmers in the past seven years in an elaborate price manipulation scam, an insider report has found.

The audit report, The State of the Coffee Industry, seen by Business Beat and authored by a former managing director at a coffee company, indicates that farmers have been losing an average of Sh3 billion a year through a price manipulation syndicate at the Nairobi Coffee Exchange (NCE), where a coffee auction is held every Tuesday.

The author requested anonymity as it was not meant to be a public report and he did not want the ramifications that would follow his being seen as telling on his peers. Trade around coffee remains highly protected, and attempts to streamline it have in some cases been met with violence.

The report breaks down the grades of coffee bought from farmers from 2008 to date and computes the unrealised value to come up with the losses.

MAJOR LOSSES

For instance, in 2008, the report says, grade AA fetched an average of Sh19,300 ($193) per 50kg bag, but after computation, the actual price should have been at least Sh29,300 ($293), a difference of Sh10,000 ($100) per bag.

The following year, grade TT fetched Sh11,400 ($114) per bag against an intrinsic value of Sh17,300 ($173), handing farmers losses of about Sh59,000 ($59).

These figures have been converted using current exchange rates.

“From the above, the closest the market depicted the intrinsic value of Kenyan coffee was in the 2009-10 financial year. However, the previous and subsequent years saw major losses arising from our premium grades,” the report reads in part.

Another player in the coffee sector, who also spoke to Business Beat on condition of anonymity over the sensitivity of the issue, said big dealers collude before an auction to bid just above the reserve price for a certain coffee grade.

Our visit to the auction revealed that dealers send signals to one another on the benches or whistle openly to keep prices down.

“If one dealer surpasses what it is expected, you begin to hear whistles all over. Among themselves, they agree how much they will pay,” a dealer for one of the coffee-buying companies said.

Two weeks before an auction, coffee samples are sent to the sample room at the auction in Wakulima House, Nairobi. The dealers are then allowed to buy them in quantities of 200 grammes from each lot.

The samples are from a particular grade, with the number of bags available for sale stated in a catalogue, which is made available to marketers.

BIASED MARKET

The marketing agent then gives a reserve price, which is the minimum amount each coffee lot is expected to fetch. It is based on price levels at the New York Board of Trade (NYBOT) or Inter-Continental Exchange (ICE) on the Friday before a Tuesday auction.

This is where the main fraud begins.

Business Beat has learnt that some dealers will have access these reserve prices, which are supposed to be known only to the seller and management of the NCE, which conducts the auction.

It is understood that at this point, the dealers then strategise on how much more they will pay for each coffee lot.

“The NYBOT is a futures market and in no way determines the price based on the quality of Kenyan coffee. Most dealers sell short so they can only pay so much, with the knowledge of what they want to make and the impression they want to create for certain growers,” the report says.

“So the prices on certain catalogues will be bought at good prices, while others will fetch less, despite the fact that the cup qualities may be the same. Whereas it is believed that the auction is the best price deterministic mechanism, there are a number of factors that make it more of a biased market than it is believed.”

As a result, dealers who have mills and also double as marketing agents can buy premium coffee from the catalogues of sister marketing agents, and tend to shy away from other catalogues or bid low on them.

The participation on catalogues is, therefore, reduced in this way, setting up some coffee lots or counters for cheaper prices.

“While the ICE/NYBOT act as indicators against which Kenyan and world coffee is measured, coffee’s intrinsic value is determined by the origin and cup taste. Kenyan coffee is used for blending other low-quality coffee and is not used in its pure form, owing to the good acidity of a large portion of our production,” the author says.

The report notes that catalogues dating back to 1997 show that the pricing of coffee then was very good and the cost of production low, as the government subsidised extension services. Prices for inputs were also low.

“The pricing for the same coffee in Kenya is fetching between half and three-quarters of that price. The pertinent question then remains, does the pricing of our coffee take into consideration the basic fundamentals of inflation and subsequent increases in costs of production? Who bears this increase in production and how is that spread in the value chain across the world?”

LOW-GRADE COFFEE

Talk of price manipulation at the exchange is not new, but its effect on farmers has yet to be fully computed. The insider report, however, has helped add credence to an earlier tip that estimated that cartels were siphoning close to Sh5.5 billion annually from coffee farmers.

The losses are felt most severely by small-scale holders, who make up about 70 per cent of coffee producers, given that they lack the capacity to export directly to the international market.

And matters are made worse by the fact that they are experiencing one of the biggest price drops in the commodity in recent months.

Coffee prices at NCE have dipped 35 per cent this year, from a high of Sh26,700 ($267) for a 50kg bag on average in February, to Sh17,300 ($173) last week.

This is set to deny farmers the benefits of a weak shilling that would have seen them earn at least 14 per cent more on exchange gains alone.

Players have attributed the decline in local earnings to the fall in global coffee prices at the ICE that have contracted from about Sh23 ($0.228) per pound (0.45 kilogrammes) to Sh13 ($0.130).

And as the industry approaches the close of the main crop season, they argue, low-quality coffees are now dominating the market.

For instance, low-grade coffees increased from 7 per cent in February to 40 per cent in April before the coffee exchange went into recess.

Daniel Mbithi, the chief executive officer of the coffee auction, also attributed the poor prices to oversupply in the international markets and local low-quality coffee.

“There are two main reasons that explain what is happening in the market, one being that international coffee prices have been coming down. There has also been an oversupply in major coffee-producing countries like Brazil, Colombia and Vietnam,” he said in a phone interview.

“The coffee coming in the market is also from previous seasons, and we are yet to start receiving good quality coffee from the new season.”

Mr Mbithi added that he does not believe the prices are determined by anything other than the market forces of demand and supply, both at home and in international markets.

Critics have, however, raised concerns that falling international prices are providing a cover for the poor prices farmers are getting, particularly because the market does not always respect the natural forces of demand and supply.

Further, sources maintain that a lethal club of wealthy tycoons has perfected the art of suppressing coffee prices and will cut out any player who does not play by the rules.

“The key perspective would otherwise be to relate the physical market where Kenyan coffee is be sold, against what is being offered at the auction, taking into consideration factors like quality, supply and demand. The prices at which the coffee is bought overseas are generally much higher than what is offered at the auction,” Mr Benard Sitati, a player in the coffee market, said in an email interview.

 

“However, you will also note that the advent of the second window has not boosted farmers’ earning substantially, but marginally.”

The second window offers an alternative to the auction system by enabling farmers sell their produce to registered marketing agents for sale to overseas buyers. It had been expected to allow farmers to negotiate for better prices.

ECONOMIC INDICATORS

Coffee production in Kenya has contracted by over 60 per cent in the last three decades, as the crop gradually gives way to more profitable cash crops and property projects.

Industry data shows that crop production declined from a high of 128, 926 metric tonnes (MT) in the 1987-88 production season, to 40,000MT in 2010-11, the lowest in decades, before recovering slightly to 49,500MT last year.

The insider report suggests that if the production of coffee continues declining at current rates, coffee would stop being a significant export crop for the country within the next five to 10 years, following in the footsteps of cotton and pyrethrum.

The latest economic indicators published by the Kenya National Bureau of Statistics (KNBS) show that the quantity of coffee auctioned at the NCE declined 20 per cent from 3,714MT in April this year to 2,969MT in May. Over this period, average auction prices dropped from Sh310.44 per kilo to Sh289.09.

Further, the quantity of coffee exported contracted from 4,289MT in March to 3,948 MT in April, with earnings decreasing from Sh2 billion to Sh1.9 billion.

However, the Economic Survey shows that the total value of marketed coffee rose from Sh10.9 billion in 2013 to Sh16.6 billion last year.

According to the report, 60 per cent of the production is from small-scale farmers organised into 600 co-operative societies that have an estimated total membership of 700,000 members. The remaining 40 per cent comes from large-scale farmers and small estates.

The decline in the coffee industry — which is estimated to provide jobs for six million Kenyans directly and indirectly — follows a pattern similar to what led to the collapse of the pyrethrum and cotton sectors.

Kenya’s premium coffee is among the best in the world, making it a high-value target for marketing agencies. Multinationals have thrived out of Nairobi, selling Kenyan coffee to the world at a premium price.

But for decades, the same kind of poor policies that led to the collapse of the pyrethrum and cotton sectors have plagued the coffee industry.

INPUT FINANCING

The State of the Coffee Industry report notes that the sector began to suffer when it switched from the 1980 model that was farmer-centric, to a model driven by middlemen through an auction system. It says that amendments to the Coffee Act, though done with good intentions, have ended up hurting the industry.

In the 1980s, the report notes, there was significant input financing through various government initiatives, intensive extension services from the private and public sectors, and there was training on good farming practices through government training institutes.

There were also relatively better and commensurate returns from coffee farming, and the management of co-operative societies was more transparent and accountable.

The current state of the industry is thought to have been exacerbated by long-running governance issues at the Kenya Planters Cooperative Union (KPCU) and sector regulator Coffee Board of Kenya (CBK), as well as the high costs of production.

The withdrawal of government extension services and farmers’ training, as well as a lack of adequate input financing have also contributed to the sector’s woes.

Further, the fact that Kenya’s industry is yet to move into value addition has locked out farmers from realising billions of shillings from processing and packaging of coffee.

Though the country’s coffee accounts for one per cent of world coffee production, making the country a smaller player compared to Brazil and Vietnam, its coffee is a leader in terms of quality and has been used as a reference point in setting global quality standards.

But the industry’s future appears uncertain, and is worsened by conflicts of interest among players in the sector. For instance, some plantation growers market their own coffee. This makes it impossible to be impartial.

Mr Sitati additionally blamed the troubles in the coffee industry on low returns as a result of past debts, and high costs of borrowing.

“A poor legislative regime that empowers middlemen at the expense of farmers, and a lack of extension services at the farm level, which means that farmers continue producing coffee in their own crude way below the standards of those who have the knowledge, continues to hurt the industry,” he continued.

“Despite the liberalisation of coffee in 2001 with the opening of the second window for marketing, there has been very little encouragement for farmers to get good value for their produce.”

Sitati said that following various amendments, which he insisted were not consultative, to the Coffee Act in 2001, the initial predicate on which the Act was built has been eroded, and production continues to decrease.

“Having too many players licensed in the chain has occasioned this,” he said.

DIRECT SALES

Sitati argued that direct sales are done largely by established players who have distribution points across the world.

“Since the reasons for engaging in trade are purely commercial, we would be wrong to imagine they are at it to help farmers get better prices. The chains are the very same ones buying coffee at the auction, and they would not offer much more for the produce.”

The model adopted by Uganda, where smallholder coffee farmers can process their coffee at any licensed processor, can be replicated in Kenya. Studies have found that this arrangement has created healthy competition, a sense of complementarity among players, and increased efficiency across the board in Uganda.

Players are counting on the move by the Government to operationalise the Coffee Mark of Origin — which would popularise Kenyan coffee by identifying it in the world market — to turn around the dwindling fortunes of the sector.

The industry is also yet to feel the impact of the intervention of the counties in coffee marketing as prices continue to drop.

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