Sao Paulo, 18 March 2011

Speculators have pushed the price of coffee to an unjustifiably high level and could be setting the sector up for a cycle of boom and bust in the next few years, the head of Italy's illycaffe said on Thursday.

Chief Executive Andrea Illy, in Brazil for celebrations marking the gourmet roaster's 20-year presence in the world's top coffee grower, told Reuters that speculators had caused prices to depart from the range fundamentals would normally dictate.

"What worries me most is this resulting in an explosion in production, like happened in the last big rise in coffee in 1998. Three years later the world was flooded with coffee and that led to lower prices and a crisis in coffee," he said. Illy said the inflated price of coffee created problems for processors, which have struggled to obtain financing for the much larger amount of working capital they now need as a result, and said concluding sales with retailers was now more difficult.

"I don't like the situation on the market, the price is very high compared to what it should be. And this is due to speculation. It's negative for coffee," he said, singling out investment funds as an important driver of the rally.

He said he was in favor of regulators increasing market oversight to limit speculation-driven price spikes. Coffee prices have more than doubled in the space of nine months. New York arabica futures for May delivery rose 2.1 percent on Thursday to $2.7220 per lb. This time a year ago, prices were around $1.35 per lb.

Illy forecast Brazil's 2011/12 harvest at 45-47 million 60-kg bags, down from the last crop, which he estimated at 55 million bags, due to a biennial output dip. The government said last year's total was 48.1 million bags. The 2011 crop will start to be harvested in May.

The premium brand coffee supplier's estimate is typical of those given by local exporters who usually work with forecasts a few million bags above the official government estimate. The official estimate is for 41.9-44.7 million bags for this year.

Going by either party's forecast, the coming crop will be the highest ever output for an "off" year. Brazilian producers were seeking to raise output in response to the rise in prices, Illy said, but the market remained tightly supplied as new trees do not produce significant amounts of coffee before three years of age.

"Brazil's contribution isn't sufficient to keep a positive balance, so we are in a deficit," Illy said. He said global stocks were "very low" at about 20 percent of global consumption.

Illy, whose company sources half of its coffee requirements from Brazil, said the country could now be considered a world leader in the supply of gourmet coffees. Brazil is raising output of mild coffees and has striven to improve husbandry.

"Thanks to this, it compensates for the deficit in other countries like Colombia and Central America," he said. Colombia, the next largest arabica grower after Brazil, has had a run of smaller harvests in the last few years due to tree renewal and weather problems. Illy said output there was "recovering gradually".

Ends --

By Roberto Samora, Reuters - for Commodities Now