Updated: Aug 29
After the Brazil frost of 2021, prices skyrocketed and certified inventory dropped from well over 2 million bags to less than 500,000 bags. The lowest levels in decades. This sparked a persistent calendar spread inversion in the futures market, topping out at an almost unheard of +12c over. Now, 2 years later, the calendar spreads have come back out of the inversion and there is talk that new certified stocks may be on the horizon. How can we know this? The answer lies within the concept of Tenderable Parity.
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In this article we will define tenderable parity, talk about why it matters and how to calculate tenderable parity.
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Why Tenderable Parity Matters
Tenderable Parity is a core concept for any seasoned commodity trader, roaster or analyst, and it is inextricably linked with certified inventory. You can read more about certified inventory and its importance in a well-functioning futures market here, but suffice to say that certified inventory is what keeps the price of the futures equivalent to the price of actual coffee. In essence, Tenderable Parity is a calculation that determines the breakeven price for tendering coffee at the exchange.
In other words, if you want to buy coffee in origin, ship it to an exchange warehouse, get it certified, sell it on the futures market and tender it, then tenderable parity is the minimum purchase price to break even. If coffee prices are more expensive than tenderable parity, then it does not make sense to certify coffee and we are unlikely to see large amounts of new certified coffee (with some important exceptions below).
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In those cases (where physical coffee is more expensive than tenderable parity), traders would rather purchase coffee and sell it to roasters at higher prices.
Since roasters actually need the coffee for their businesses, tenderable parity usually occurs in periods of abundant supply. Although there can be exceptions to this.
Beyond direct profit incentives, other factors come into play as well. For example, there might be instances where it's more cost-effective to tender coffee rather than roll it. Additionally, exporters and trade houses may opt for certification to enable financing, as banks love certified coffee. Certified coffee represents liquid collateral to banks, so they more readily provide capital to the owners of it.
There is also the possibility that large trade houses may certify coffee to impact calendar spreads. Inversions are expensive to holders of short hedges, so traders may decide to show the market that there are plenty of certified stocks available as an option for dealing with expensive rolls.
III. How to Calculate Tenderable Parity
The calculation of tenderable parity is relatively straightforward, but one of the key components is not visible to lay people. The calculation includes the purchase price (the “diff” at origin), expenses associated with transporting the coffee to an exchange-designated warehouse (“freight” costs, these are only available to traders who receive quotes from logistics companies and understand the costs), plus the cost incurred during the certification process. Other factors include insurance/financing costs, and notably, the premium or discount applied by the exchange for the specific origin.
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As an example, consider a hypothetical scenario where we calculate the tenderable parity for a Colombian coffee. Let’s say that the coffee costs +10c for a tenderable quality, the freight costs 7c from Cartagena to NY, the exchange premium is +4c, the certification/insurance/financing fees are 1c, and the ex-warehouse fees are 2c.
Tenderable parity would be 1 + 2 + 7 – 4 = 6c. So you would have to buy coffee at –6c or less to hit breakeven to tender to the exchange. Since the coffee costs +10c, it would not be anywhere near tenderable parity, it is 16c away from being profitable! In this case, no one would tender Colombian coffee for profit reasons. However, if there was a glut of coffee and Colombians were trading at –5c (an admittedly unlikely price), then we would likely see a lot of Colombian coffees submitted for certification.
Those of us following the coffee market and the calendar spreads understand the importance of following the certified inventory, and Tenderable Parity is essential for understanding and predicting how the certified inventory will change. And it is this forward thinking that provides a critical edge for traders, analysts and roasters trying to comprehend market trends, and make informed trades in a volatile market.
Want to know more? Read our white paper for premium clients on the current status of tenderable parity and how this is likely to play out for the market Here.]
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