Trouble Brewing in Kenya's Tea Sector

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Filling the pot spoils the tea

Global tea production now exceeds demand, and prices have dropped. Between 2003 and 2012, global trade in tea increased by about 26 percent while global production increased almost 48 percent. Throughout this period, prices at Kenya’s Mombasa auction climbed steadily, increasing almost 100 percent from $1.62/kg in 2003 to $3.18/kg in 2012. But then, starting in 2013, prices fell 20 percent and then a further 14 percent in 2014.

The Mombasa Tea Auction is the second largest black tea auction in the world after Colombo, with offerings from at least 10 different countries as far afield as Madagascar, Zimbabwe, and the Democratic Republic of Congo. Buyers representing over 50 countries are present at the auctions which take place on Tuesday and Wednesday of every week. Over 300,000 tonnes of tea were sold at the auction in 2011, a figure which grew to 400,339 tonnes in 2014.

The auction, which is the destination for 75 percent of all Kenyan tea, saw a consistent oversupply of product for several years leading up to the drop in price. In 2012, monthly sales ranged between 18,600 and 34,800 tonnes, and between 2,000 and 5,000 tonnes of this remained unsold each month. The following year there was a global tea surplus of 130,000 tonnes. Even in the wake of the price drop, Kenyan production reached new heights. The first months of 2013 and 2014 saw greater production than at any point in the previous 10 years.

Farmers reach their boiling point

As a result of the price drop, more and more Kenyan farmers are contemplating tearing up their tea bushes and replanting their land with less volatile crops. Such an action is particularly drastic in the world of tea cultivation, as tea bushes take 7 years to become fully mature.

The margins are minimal and the effort is massive, as laborers manually pluck leaves during every hour of daylight. The Kenyan Tea Development Authority (KTDA) guarantees farmers a minimum price for each kilogram, and adds to that an additional bonus that is determined by global prices. In the 2013-2014 season, farmers received $0.35 per kilogram, compared to $0.55 in 2011-2012.

On a broader scale, the wealth generated by the industry is more thinly spread than ten years ago: most of the production growth came from more farmers adopting tea production, rather than from existing farmers expanding their areas under cultivation.

About 60 percent of Kenyan tea is produced by smallholders. Smallholders operate under the Kenya Tea Development Authority (KTDA), which since 2000 has been operated as a private company with at least 562,000 smallholders acting as shareholders. After tea is plucked, it is transported to a processing factory, of which the KTDA operates 65 nationwide.

At the factories, tea is withered, sifted, exposed to Cut, Tear, Curl (CTC) processes, fermented, dried, and sent for auction at Mombasa. The KTDA sells the tea on behalf of the smallholders at the auction, giving them a guaranteed price upon delivery at the factory and then awarding bonuses based on the final sale price.

The cost of production has steadily increased over the past decade, largely due to the higher cost of labor and energy. These increased costs were not a major issue when prices were favorable, but the cost of production now outpaces revenues across Kenya and East Africa. Kenya’s tea profits fell by 31 percent in the first half of 2014, but most firms were able to break even. This compared somewhat favorably to other East African producers such as Tanzania where none of the country’s 16 tea estates were able to break even, or Uganda where only 3 out of 30 estates managed to avoid losses.

Why would Kenya, East Africa, and other international producers have grown themselves into unprofitability? They were caught in a tea bubble.

Tea bubbles

For the first 12 years of the century, the tea industry enjoyed ideal conditions and tea producers rode the rising tide, increasing production to maximize revenues. Many emerging markets around the world grew impressively in the early 2000s, allowing for greater expenditure on luxuries and imports.

GDP per capita in Russia, the world’s largest tea importer, grew by 1000 percent between 1999 and 2012, rising from $1,393 to $14,090 while the Russian ruble strengthened by 19 percent between 2003 and 2008. Other top importers such as Pakistan, Iraq, and particularly Egypt—whose currency improved by 10 percent during the same period—also enjoyed increasing levels of wealth.

In the early 2000s, tea demand grew rapidly, and producers responded by increasing production from 3.65 million tonnes to 4.26 million tonnes, and the area dedicated to tea cultivation from 2.69 million hectares to 3.03 million hectares.

During this period when consumption outpaced supply, Kenya, the world’s largest exporter at the time, was experiencing drought-like conditions which cut national production by more than 15 percent between 2007 and 2009.

Once ideal growing conditions returned in 2010, Kenya’s production increased by 18 percent, and Sri Lanka’s by 13 percent. These were the 2 greatest factors in global output jumping by more than 167,000 tonnes that year. Tea production had reached a historical peak, spurred by growing demand as the economies of major tea drinking countries improved. This growth, however, proved to be limited. The following year, in 2011, despite an increase in the area harvested and the fact that much of Kenyan tea is irrigated, tea production declined as a result of a particularly strong La Niña event that brought severe drought to the East African region as a whole.

Some of the world’s top 10 importers of tea include Russia, Pakistan, Egypt, and Iran. Egypt, which is the destination for roughly 20 percent of all Kenyan tea has undergone years of political upheaval with several regime changes. The Chairman of the East African Tea Traders Association cited Egyptian unrest as a primary reason for low prices that Kenyan tea has experienced. Pakistan, Afghanistan, Sudan, Russia, and Yemen are also top 10 destinations for Kenyan tea, many of whom have experienced recent political and/or economic uncertainty.

The competition’s pot

Kenya’s main competitor in tea production and exports is Sri Lanka, while China and India are also both major producers. Sri Lanka—Kenya’s main tea competitor—is home to the Colombo Tea Auction, the only black tea auction larger than Mombasa’s. The country consistently vies with Kenya as the world’s top tea exporter (both export much more than runners-up China and India) and Sri Lanka historically received higher prices for its product than Kenya. At the start of 2014, following the global crash of tea prices, only tea sold through Colombo maintained a price point similar to previous years. 

The country tempered its reaction to growing demand better than Kenya. Between 2003 and 2012, Sri Lanka increased its area dedicated to tea cultivation by 5.4% and production by 8.8%, compared to Kenya’s 45% increase in land area and 25.8% increase in production (this increase in land area was driven by more Kenyans, especially smallholders, taking up tea production). This may help to explain Sri Lanka’s ability to better weather the immediate storm of falling tea prices.

Sri Lankan tea, however, is not immune to market forces and the prices offered at the Colombo exchange began to drop in 2014. From January 2014 to January 2015, average prices at the auction fell 15%. 

The top 4 destinations for Sri Lankan tea in 2011 were Russia, Iran, Syria, and Iraq: a country list unfortunately filled with recent instability. In 2012, the EU and the US imposed sanctions against Iranian oil in condemnation of the country’s nuclear program, a move which greatly reduced Iran’s foreign purchasing power, and was worsened by the EU’s decision just months later to ban transactions with Iranian financial institutions. The Iranian Rial depreciated significantly as a result. Now, a similar situation seems to be unfolding in Russia, following the US and EU’s 2014 decision to impose sanctions on Russia following tensions around Ukraine. The situation in Iran and Russia—both major oil producers—has now taken a turn for the worse as oil prices now continue to tumble, and the earnings and purchasing power of both countries diminishes. 

Exports to Syria and Iraq are unlikely to recover anytime soon, as violent conflict continues to wreak havoc on the region. As demand at the Colombo Auction decreases, so will prices, and the effect will ripple across the global tea industry.

Reading the tea leaves

It is essential that all stakeholders grow more knowledgeable about the changing climate and its implications. Beyond obtaining access to seed varietals better equipped to withstand harsher climates, producers will also need to review the suitability of various crops and determine which have the ability to grow under a broader range of conditions.

Tea prices are unlikely to rebound anytime soon, as low oil prices, turmoil, and sanctions continue to affect the top global tea destinations. Producers everywhere are beginning to consider scaling back total production, while simultaneously identifying new potential markets for their goods.

While tea producers across the globe eagerly wait for tea prices to rise, there are a few actions Kenya could take. The first is to better insulate itself from the instability of international markets. About 95 percent of all Kenyan tea is for export, making it unusually exposed to global price fluctuations. If more tea were consumed domestically, farmers would have a more accessible outlet for their goods.

There are currently 40 different taxes, levies, and charges placed along Kenya’s tea value chain, including a 16 percent value-added (VAT) tax. The VAT, by forcing Kenyan tea prices upward, limits domestic tea consumption and its removal would have a favorable impact on consumption. The greatest increase in Kenyan tea consumption in the past half-decade occurred last year, when the price of tea dropped dramatically. Beyond this, the VAT is a hindrance to value-adding processors. Domestic tea packers are not permitted to acquire tea through the Mombasa auction, but must buy directly from factories or buyers which exposes them to the 16 percent VAT. If these packers then export their product, they can apply for a refund, but these are often not rewarded. If the packaged tea is sold domestically, it suffers the full 16 percent tax rate.

A long list of taxes are applied to Kenyan tea exports, minimizing their competitiveness. All tea has a 1 percent tax levied on it at the point of export, tea companies are charged 30 percent of all profits, and tea bound for Pakistan has an additional 0.5 percent tax added. Sri Lanka also levies some taxes on tea exports, but here the taxes are applied to bulk exports, in order to encourage value-added industry. As the world struggles to sell its surplus tea, Kenya needs to make efforts to make its product as appealing as possible.

The limited growth environment for value-added players restricts the profits that Kenya can make abroad. Currently, much of Kenyan tea is packaged in destination countries and then resold at a higher margin. By deferring the packaging process to foreign agents, Kenya not only misses out on the extra profits that result from producing a finished product, but also misses out on potential branding potential. Kenyan tea sold abroad is often blended with poorer quality tea sourced elsewhere. Sri Lanka, which has a stronger focus on value-added processes, earns 64 percent more per tonne of tea exported than does Kenya.

Even if tea prices return to their previously high levels, an improved tax regime and greater domestic consumption would have continued benefits for Kenyan tea producers. Then maybe more Kenyan consumers, like their British counterparts, would be able to enjoy the carefree benefits of a nice relaxing cup of tea.

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