Cartels: price stability or fair-weather support?

Barely heard amid recent drug summit fanfare was Columbian President Virgilio Barco urging U.S. President George Bush to help revive the International Coffee Agreement. Barco's may be a forlorn hope.

As Stephen Platt, a Dean Witter senior analyst, says, "The success of commodity agreements

Of the active cartels, only the Organization of Petroleum Exporting Countries (OPEC) has had consistent price support success.

"The oil agreement prevents wide price fluctuations, narrows the range and volatility of the market," says Nauman Barakat of Shearson Lehman Hutton.

The only other groups left are the International Sugar Organization (ISO), the International Coffee Organization (ICO) and the International Cocoa Organization (ICCO).

The ISO gave up price management in 1968. The ICO and the ICCO have made on-again, off-again efforts for years. Now it's "off " for both.

Recent bargaining failures by ICO and ICCO members raise questions: * Is the price control function of cartels realistic? * Does it matter to traders that the cartels even exist? * Might other approaches do more?

Each cartel uses a different control device. OPEC members negotiate production quotas. The ICO uses a system of export quotas in which the cartel issues stamps to exporting countries and each importer is supposed to monitor compliance.

In the ICCO's buffer stock arrangement, the buffer stock manager, funded by member nations, buys cocoa as prices dip below agreed levels.

Methods differ, but the idea is the same. By regulating the flow of goods to market, the cartel supports prices. At least that's the theory.

In practice, their success is spotty-. Nations outside the agreement are 21 problem. Worse, recent ICCO talks failed to generate payments to the buffer stock fund. The last buffer stock purchase was in February 1988.

The breakdown of the coffee agreement is more complex. Among the major issues is the failure of the quotas to reflect changing demand.

Platt claims three major coffees vie for market share. African growers primarily produce "robusta." Most Brazilians grow "arabica." Columbia and other Central American nations produce "mild arabica." Consumer perceptions of the moment rank robustas lowest, while ranking fuller flavored, less bitter mild arabicas highest in quality.

Producers of the milder coffees want bigger quotas. Brazil, the largest producer, refuses to give up any of its quota. Negotiators, unable to overcome that standoff, suspended quotas altogether last July.

Commenting on the problematic nature of these agreements, Victor DeMayo, Coffee Sugar & Cocoa Exchange (CSCE) economist, says "commodity agreements work when the supply-demand balance is good, but if there's one problem, and most often it's on the supply side, prices go right through the quota limits."

In effect, that means agreements work best when the cartels need them least. If supply and demand balance, prices behave well for both sides. When they really need controls, the agreements tend not to work.

The most basic problem, though, is supply and demand. Group politics notwithstanding, cocoa has been in surplus each of the last six years.

With fewer members (all of them producers), OPEC has the advantage of fewer opinions to reconcile. Producers and consumers conflict on a basic level: Low prices are a danger for one, a blessing for the other.

Even so, agreement is not easy to come by. Barakat notes producers don't share the same interests. Saudi Arabia wants high prices, but Kuwait wants prices to stay at $18 a barrel.

Anyone with excess capacity," he adds, "can influence the market."

To Barakat, the coffee and cocoa cartels are not comparable to OPEC. In a sense, coffee and cocoa growers are victims of supply inelasticity.

To limit supply, oil producers can just shut down wells. The oil stays put until they restart the pumps.

Unless weather is a problem, coffee and cocoa growers can do little but limit inputs (fertilizers, insecticides, fungicides) to reduce their harvests. Still, the cocoa or coffee tree keeps growing, producing and needing care. As Platt says, those plants live for years. The only real way to curtail production is to destroy trees. Because a new tree takes several years to bear, that step is not taken lightly.

TO traders, the effectiveness of the cartels, or whether they even exist, is of little moment. Coffee charts cover periods with and without quotas. In either case, volatility figures indicate speculative opportunity aplenty, a view the price movements reinforce.

If workable quotas mean something to a nation like Columbia, one could argue the United States should use its good offices to that end. Coffee and cocoa are socially acceptable crops. Coca is not. Anything making an economy less dependent on coca, the logic runs, deserves support.

Not only are all coffee and cocoa producing countries "developing" nations, many depend on both crops.

Brazil, the biggest coffee producer, ranks second in raw cocoa exports. The Ivory Coast, first in cocoa, is fourth in coffee. Columbia, second in coffee, is ninth in cocoa. Of the top 15 cocoa producers (who accounted for 95% of the world's cocoa in 1988-89), 13 grow coffee (producing 65% of that crop) and eight rank in the top 15.

But Platt isn't sure reinstating the agreements is in the best interests of the coffee and cocoa producing countries or the consumers either.

"The production side is the source of the problems, but the agreements don't have constraints on production. Maybe direct aid is the best way," Platt says. That could "pump money into diversification."

To some extent, the markets and other events have already forced moves in that direction.

The Ivory Coast long kept support payments to cocoa farmers high, but International Monetary Fund (IMF) and World Bank pressure finally forced it to lower supports. It also cut its cocoa export tax, which last year brought in almost $250 million - for a struggling country, a hard choice.

It is even tougher since slumping markets and a government austerity program led to rioting in March that President Felix Houphouet-Boigny blames on multinational companies exploiting vulnerable commodity-based African economies.

Still, for Ivorians (and others), turmoil may spur useful choices.

"Young farmers in particular are slowly starting to concentrate on food crop production," Gill & Duffus says, "because they no longer feel cocoa cultivation offers the guaranteed income enjoyed by their forefathers."