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August 03, 2009

Is Ethiopian Commodity Exchange good for coffee growers?

by Wondwossen Mezlekia

The Ethiopian Commodity Exchange (ECX) was established with the ambitious goal of eliminating food shortages and hunger in Ethiopia by creating an efficient marketing system for agricultural commodities. Barely two months after its launch, the highly praised exchange platform found itself caught in the midst of the complex global coffee trade, an undertaking that is entirely different and farther from its original vision of "revolutionizing" the inefficient domestic commodity market.

In August 2008, the government enacted a new law that forces the trading of all of the country's coffees through ECX and ECX welcomed the decision. Since then, the government confiscated stocks of coffee from exporters and revoked licenses, filled in the vacuum with the Ethiopian Grain Trade Enterprise (EGTE), and sold specialty coffees at commodity grade coffee prices.

Following its first rough encounter, ECX is now engaged in talks with specialty coffee buyers and faced with challenges of winning the hearts and minds of traders locally. But the effect of ECX on coffee growers is yet to be noticed.

This article attempts to reveal the pitfalls of trading coffee through ECX and its impact on small-scale farmers.

As has now become apparent, ECX was not ready to accommodate trading operations of a complex global commodity when it embarked on coffee export. This partly explains why ECX has run into problems as soon as it started its coffee trade.

ECX was initially established to create a trading platform for domestic agricultural commodities, mainly grain. The ECX was created with primary purposes of eliminating the archaic marketing system whose inefficiency, according to ECX's founder, Eleni Gebre-Medhin, is in part responsible for the recurring food shortages and hunger in parts of Ethiopia, and increasing the value of the domestic grain.

Dr. Eleni described her vision in June 2007 at TED Talk as: "Ethiopia's domestic market is about $1 billion of value and we feel over the next five years, if Ethiopia can capture even 40%, just 40% of the domestic market and add jut 25% value to that market, the value of the market doubles. ECX, moreover, can become a trading platform for the Pan-African market in agricultural commodity. Ethiopia's agricultural market is 30% higher than South Africa's grain production; and, in fact, Ethiopia is the second largest maize producer in Africa."

This ambition is founded on plausible assumptions about domestic grain trade but it did not take into consideration the state of coffee trade. Because the market system was designed to bring about changes in the grains trade – not in the coffee sector – ECX ended up further complicating the problems facing coffee growers when it suddenly decided to take on coffee trade.

By requiring 100% of coffee trade be conducted through ECX, the government eliminated direct trades. The government says that was necessary in order to improve the sector and prices. This is frivolous. Unlike grains, coffee trade is characterized by unregulated supply, market monopoly by a few multinational companies, and stiff competition between producing countries.

Coffee is a global commodity. It is the world’s second most traded commodity next to oil with its prices determined at the New York exchange market. The trade is largely controlled by the world's biggest coffee buyers. Five multinational companies, NestlĂ©, Philip Morris, Procter and Gamble, Sara Lee, and Kraft Foods buy about 70% of the world’s coffee and play pivotal roles in setting world coffee prices. Coffee-growing nations do not have a say in this unregulated global market.

To mitigate the burden, other coffee growing countries are resorting to creating differentiations and to find a place in the specialty niche market. The direct trade relationship with specialty coffee buyers gives these nations a relative stability, premium prices, and incentives to increasing quality standards.

ECX, on the other hand, adopted a strategy of forced bulk trading through a warehouse receipt system and eliminated direct trade. Still, it hopes to improve prices and the sector. The global coffee industry is increasingly moving towards greater transparency of coffee origins and differentiation but the ECX system is heading in the opposite direction.

Ethiopia is naturally endowed with the variety of coffees demanded by the specialty coffee buyers. The fine quality of its coffees and the distinctive features of the sector, including its genetic resources, abundance of wild coffee trees, and organic coffee production, earned Ethiopia a unique place in the global coffee marketplace. Ironically, instead of capitalizing on these unique attributes, ECX aims at bundling all of the coffees into commodity grades.

One possible explanation for this absurd strategy is ECX's underestimation of the importance of specialty grade coffees. “The “specialty-plus” market segment is only 3.7% of the total coffees exported, with the remainder to be considered as commodity coffee," says ECX in its whitepaper titled 'What is in a Bean?' This unsubstantiated analysis has led ECX to a mistaken conclusion, thus its decision to neglect the specialty market and focus on aggregate coffee production.

ECX's estimation is flawed and can be proved wrong by the following cursory appraisal of empirical evidence. In 2008, Starbucks, the world's largest specialty coffee buyer, bought 192,500 tons of specialty coffee, of which 5-10% (the company’s official numbers always fall within this range) was directly sourced from East Africa. (The major coffee growers in East Africa are Ethiopia, Kenya, Tanzania, and Rwanda.)

Since Ethiopia is the largest exporter of specialty coffee in Africa, and, given Starbucks' long history of close relationship with coffee growers in the country, it is reasonable to assume around 3% of Starbucks' purchase (or about 60% of its East African purchase) comes from Ethiopia. Meaning, around 5,775 tons of Starbucks’ 2008 purchases is practically from Ethiopia.

Since Ethiopia’s export during that year was 170,888 tons, Starbucks’ purchase only represents 3.4% of Ethiopia’s export. So, if at least 3.4% of Ethiopia's specialty grade was directly sold to Starbucks, one can imagine how the number can easily jump to a range of upper teens to twenties when the quantity that Starbucks bought through Germany (Starbucks buys most of its coffee from Germany which is also one of Ethiopia's major export markets) and the coffees directly sold to other small buyers through direct trade.

It is thus extraordinary that ECX diminishes the roles of specialty coffee in Ethiopia. Furthermore, it is unbelievable that ECX failed to see the fact that specialty coffees drive the global coffee trade. Marketing experts agree that the prestigious coffees such as Sidama, Yirgacheffe, and Harar serve marketers as ingredient brands.

The prominent Oxford Professor Douglas Holt defines ingredient brands as: “brands that are used as one component “ingredient” of another branded product or service. Gore waterproof fabric and Intel computer chips are classic examples." Dr. Holt argues, “Consumers view the ingredient’s inclusion as a distinctive and valuable addition to the offer. The ingredient is revealed to end-consumers through some sort of distinctive mark (name, logo, etc.) so that the inclusion of the ingredient increases the perceived value of the offering."

By undermining the roles played by specialty coffees to promote the sale of Ethiopia's aggregate coffee export, ECX's bulk trading system poses a threat to commoditizing some of the distinct coffees in the world. Farmers that grow some these finest beans expect their produce to fetch them a price better than that of the run-of-the-mill beans. The lack of incentive for their hard work may have adverse effect on the country's specialty coffee production. As quality deteriorates, the country’s prestigious brands water down as well.

When responding to criticism about its position on direct trade, ECX cites as an example the cooperatives and commercial farms that are directly selling specialty coffee outside of the ECX system. This is true but the problem is, by allowing selected group of growers to have access to the specialty market, ECX leaves out the smallholder families that are not organized in cooperatives. This practice deprives farmers of the privilege of establishing business relationship with external buyers.

In addition, the current ECX system also subjects small-scale farmers to a potential market monopoly by a few exporters. Farmers are not represented in the ECX Board of Directors, a body that currently comprises three major coffee exporters, including Berhane Hailu, General Manager of EGTE, and seven government officials. This degree of power imbalance puts farmers at a disadvantage.

Coffee trade under current ECX system is far from being a level playing field. It is difficult to imagine a marketplace that is fair to farmers in a setting where the government owned enterprise, EGTE, working to maximize profit and ensure uninterrupted inflow of foreign exchange also directs ECX. As far as small-scale coffee growers are concerned, ECX has so far not been “fair, independent, and free.”

If ECX were to be of any benefit to the poor farmers, it should create an environment where the bulk trading system functions alongside a direct trading system for specialty coffees and other certifications such as bird-friendly, forest, and organic coffees. This is a lifeline for many smallholder farmers and that is where they have comparative advantage over competitors.

Ethiopian Review

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