Sunday, July 15, 2012

Is There Really a Grape Shortage?


Women's Syncronized Swimming Team Drowns Trying
To Signal Help with their Legs

I thought I'd tip my lid to the upcoming Olympics in London and in this weeks edition of SVB on Wine, share a story and a revelation about market bubbles and tie that into an observation about year-end grape supply and grape market dynamics.

Let The Games Begin!

Somewhere early in the year 2000 my mother-in-law was moving things out of a vacation home in Mariposa CA. I volunteered my help, so together with a hired back from the Starving Students movers; a young man named Anthony, we started lumping furniture.

During the synchronized around the corner couch bending preliminaries, Anthony started sharing about his stock investments. Wait...what? Stock investments? Anthony couldn't have been much more than 21. This was going to be interesting. It turns out he was actually a student - a student taking a videotape course in "How To Retire Before You're Thirty" and was day trading.

Moving on to the speed hallway wall-scratching semifinals, he explained his trading philosophy, high growth Internet stock investments, stock picks, and how he had amassed a small fortune already doing it all with credit cards and margin debt. I started to wonder if I was missing out and being too cautious with my own investments?

At afternoon's end it was time for the balcony mattress dropping finals and after almost catching it and keeping it out of the dirt which would have received a very high mark from the judges had he managed, Anthony told me this was his final move and he would be retiring from competition. He was going to day-trade stocks from his home and be his own boss.

At the closing ceremonies, we rolled down the paneled rear door of the truck. I latched the door  putting a punctuation on the day's athletic competition and stood watching in pain as Anthony pulled away in a puff of dust and exhaust. A loud crash from the contents inside the truck was audible as Anthony dropped the rear tire off the curb breaking the axle and taking the overhead electrical wires down at the same time. Oh my gawd, I thought! .......Everyone is saying this is a new internet economy and there are new rules. Maybe I should be taking on more risk like him? ....... and then I wondered what broke inside the truck or if Anthony was electrocuted, but that's not important.

What is important is I had time to replay the day on my drive home, called my broker and cashed out of the market. With the Tech Crash hitting just weeks later, I had discovered a new technical indicator that would define my investing strategy from then on. I called it, "the Starving Students Bubble Indicator (SSBI):
"When a Starving Student gives you stock tips, get the hell out of the market because its overbought."
Hold on ....I'm getting to the wine part.

Back to Reality

Glenn Proctor, Ciatti Company
In early February of this year I was on a panel with an unnamed wine and grape broker and we were trading insights. We were both of the belief that the grape market was trending to a shortage, but the marketplace was still largely behaving and pricing grapes as if it were permanently long. Already having researched and presented our view that supply was narrowing in the prior year's State of the Industry Report, we believed after a couple of low yielding years the market for grapes and bulk was close to being in balance and was trending to shortage. We printed that prediction in this year's report. Since then, others have added to that chorus to the point where today our prediction of "an emerging shortage" has become in the press a panic and widespread grape shortage.

In the middle 1990's we saw a shortage. It wasn't uncommon for wineries to run out of wine in nine or ten months and distributors were making nice with all the small producers to have enough product to quench the thirst of the mid-life boomer populace. So acute was the problem, Mondavi started importing Chilean bulk wine to go into a new brand (I think it was called Morningstar if memory serves.)

SSBI Today

This week I was talking with a stranger; a visitor to wine country. We were at the Marriott bar having a quick dinner. Our visitor told me he was going to get into the wine business and he launched into his strategy, talking in hushed tones as if the ketchup bottle had a wire in it. "There aren't nearly enough grapes for the business today." he whispered. "I'm going pick up a distressed property that has 6 acres of grapes and a 3,500 sf home, and pay for half the mortgage by selling grapes at prices that will have to be higher for the next decade."

You probably recognize the guy's look if you're in the wine business: that star-struck far away glazed-over look in a wannabe winery owner's eyes? After hearing my naively confident friend lay out the plan, I flashed back to the Starving Student Bubble Indicator. Could this be it? Has it reached the point today where even wannabe experts and Starving Students know to a moral certainty that we are already in a full blown grape shortage? My SSBI light is officially flashing yellow.

SVB has been predicting the likelihood of a large harvest this year, based simply on the fact farmers will farm for yield in this kind of a market. So needing to get an update this past week, I decided to call around to get an early indicator on yield and harvest timing. The belief from almost all appellations is if the weather continues to cooperate, the harvest will be between large and perhaps even very large. Conditions thus far in the North Coast have been almost ideal, so the harvest could also produce one of those perfect alignments of a large crop AND good quality if major weather issues don't show up to spoil the party. Rain is always a concern but the consensus is harvest will be as much as a month earlier than last year in some appellations, making that less of a concern. As we get later in the season that extra hang time could embolden growers to hang just a little more fruit.

Late last week, the Gomberg Fredrikson report noted that imported wines were dramatically up this year but it was all in bulk wine. While imported bottled wines were down 3,000,000 cases, five months through May, bulk imports were up 167% or 12,000,000 equivalent cases. Those shipments come primarily from the following countries in declining order of shipments: Chile, Australia, Argentina, New Zealand, Italy and France. That bulk wine will go largely into lower priced bottles so I'll discount that point as it relates to the fine wine business for the present, but please bookmark that is a change from past short cycles; if you need generic chardonnay, you don't have to plant vines to find supply. The question simply is one of price.

I talked last week about the declining rate of growth in sales for fine wine business in SVB on Wine but lets extrapolate that data point against a large harvest as well and what do you get? The distinct possibility that the supply that we said was 'trending to shortage' early this year, might just be equalized for another season. Now its way too soon to firmly predict that since we are just starting verasion in the early ripening zones. There are still a lot of things that can happen to yield and cluster weights. Further, from a demand perspective there is still Q4, the big holiday season ahead of us that can turn either way. But with the fiscal cliff and the EU drama which could slow demand as more likely, versus an out of the blue growth ramp-up, placed against the greater likelihood of a larger harvest.... we just might see a grape and bulk market this winter and spring that doesn't behave like its short at all.

This harvest might have some unique gifts for the wine business that will change grape pricing and terms for contracts. That likelihood is increasing especially if we go back and include the dramatically higher level of imported bulk wine. That is a piece of the cycle that is new; the fact that when short, production wineries can just order up supply from offshore instead of planting. That should at a minimum make a betting man think twice before putting money down with conviction, banking on a true shortage at the end of the year.

Short term we have the Olympics to watch before harvest starts and I have tickets for the mattress dropping event this year. Long term, in answer to the title question: Yes there is still going to be a shortage either way in the fine wine business because of a lack of planting. The increased pricing we've seen in grapes isn't going to come crashing back like the stock market in 2000 either. Its not a bubble we are looking at. But if I were a grower or a vintner, this would be the time where I would hedge my harvest bets just a little for the medium term because there is a chance that demand softens given economic uncertainty, and a chance that supply expands in the last half of the year. The SSBI indicator is blinking yellow.

Let the games begin!

18 comments:

  1. Rob,

    I thought it really interesting (and supportive of your blog here) that the Bulk Report recently showed that average bulk pricing has stabilized and is no longer rising (in fact it fell for a couple of wines). Seems that all it took as reports of the possibility of a big harvest and that was enough to stop price increases.

    This too makes me think that the shortage is perhaps short lived.

    Adamm Lee
    Siduri Wines

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    1. Adam - Thanks for the note. Thus far several folks have chimed in directly saying the conclusion resonates with them. Its interesting to note that those with vineyard interests have suggested I might be overstating things and indeed things are and will be short, while wineries largely suggest the news of shortage is over-hyped and supply is fine. That's why I talk to people who have no vested interest in seeing a harvest large or small, but provide services to the wine business. I think it gives us a better perspective of reality. Of course discussion about a future event is not reality either, but my read of the tea levaves (grape leaves?) tell me some attention is required to the possibilities posed.

      Thanks for commenting.

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  2. Quite astute (or should I say astudent?).
    A chicken that cries the sky is falling has probably placed a short call on sky investments.

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    1. Good line. I'll have to remember that one.

      Taking contrarian views in investing will surely get you into trouble, but almost by definition, an efficient market will price in all information, and if everyone from Wall Street to Main Street has the same information, there is no pricing upside anymore. Maybe said another way, after a steep run up in grape and bulk wine prices since the beginning of the year, is there more likely?

      Thanks for the comments

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  3. Rob

    You always ask these hard questions! As we have mentioned a few times over the last five years, the world really is flat. To understand California Supply you really need to factor in the World Supply at the same time. Our world is too complicated today to just refer to the "Wheel" for your answers.
    There are a few questions to be answered that will take time to really understand where we sit regarding supply and demand. 1)How will consumers react to price increases in a muddled world economy?; 2)Can supplies from the world market fill spot needs in US demand?

    I think we saw many buyers begin the year will very short supplies and they were very aggressive in securing bulk wine and grapes to get them at or near their sales projections. This caused some steep price increases given the tight supply in California. Now given the crop looks above average, and some bulk has filled immediate needs wineries are digesting their activity from the first part of the year. They are trying to understand if they can pass pricing onto consumers and if they do how will that affect sales projections etc. So the lull we are feeling in our mind makes sense as we contemplate what we just ate.

    How the consumer responds will be the big question? And I think that is yet to be determind.

    We do not know the future - Wish we did! - but I think for growers and wineries there are some long term opportunities that have been available. Waiting for the highest or lowest price has never been a sound strategy. But laying down good business decisions over time based on a long term strategy will always be good business.

    I would think reality Rob is somewhere in the middle - supply being not as long and the wineries want to believe or not as short as growers hope.

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    1. Thanks for weighing in Glenn. I agree with your last line (and several other ones too), and that was the focus of the blog this week. Over time you get a sense for what the 'industry' is thinking. In the same way we believed the industry was behaving as if permanently long at one point, its now behaving as if there is a critical shortage and the reality is its somewhere in the middle.

      Also as to the traditional view of grape cycle, we do have to recognize especially as it relates to low priced wines and low priced grape sourcing, that offshore bulk wine is now an option instead of planting more vines. Competition from off-shore for higher priced bottled wines continues as well but clearly bulk juice for cheaper wine has a higher range of volatiity.

      Sorry to co-opt that picture off the web above. You are much more handsome in public.

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  4. Great article -- thanks for this! I run a small (5K annual case production) Central Coast Winery and although I admit to not looking at the fine print of the "grape shortage" reports, I still took these reports lightly as my assumption was that they were based on information obtained from large conglomerate wineries producing low-price point wines, large vineyards, bulk wine brokerages, bank reports, etc. etc. (I'm wondering if that assumption is lacking or correct?). As far as I can tell, wineries selling wines at super premium price points and higher are still sitting on accumulated inventories from previous vintages -- I know mine is. I intend -- and I get the same message from talking with others running similar sized wineries -- that if nothing else I will continue sale prices to move the through the inventory I have but also negotiate as low as I can on grape prices this year. I don't see grape prices increasing drastically in my market much anytime soon -- especially with good crop and great weather -- at least not until inventory depletions increase significantly. Perhaps the prediction of a shortage is at least a year early?

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    1. Thank you for commenting. To answer the one question directly, our analysis is from a representative cross section of the wine business. Our annual survey gets between 500-600 wineries responding annually but we also use internal data bases and interviews to get at the analysis of the wine business.

      I would suggest your winery might be a little out of the centre of the business. There is no question that most wineries have already moved through their slow moving wines. You can see that change just by observation when walking into Trader Joes. What used to be isles filled with boxes of West Coast wines with appellation designations as small as Santa Lucia Highlands and Willamette Valley, have since gone to North Coast and California appellations first, and now to a lot more foreign bottled wine versus a year ago.

      For someone with slow moving wine at this point in the recovery, this is the time where you would expect to see some higher degree of success than previous years ... at least that is what our client base of about 350 wine industry clients have shown us.

      Thanks again for the response. I really appreciate that you read this through. Its a fair amount of work putting something like this out each week and its nice to see that some people are reading it .... 2,400 people according to blogspot stats thus far today.

      Kind regards
      Rob

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  5. Hi

    We can not talk about "grape shortage" just analyzing 6 moths market behavior. We have to analyze at least five or ten years. Arounf the world the las 10 years garpe prices has been very low. Non country has planted and may like european have get off many vines. Even more China consumption has increased by 15% annualy the last 7 years. So probably the California 2012 crop comes larger, and distributors are reluctant to accept price increase. Howebver the trend is clear , we are in a new cycle of High grape prices, so the consumer must accept that. Last years entry level wine prices are no sense. Pobably in the next 6 years we will not see prices like USD 3.99 a bottle any more. It is just a matter of time !!!!!!!!!!!!!

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  6. Thanks for the comments Raimundo. I agree the analysis has to span decades and we have done that for the past 30 years. I also agree from all reports, world-wide wine is at the lowest supply point .... certainly relative to demand world-wide, at any point I can remember. The US market is trending to a shortage, but that ignores how much more available wine is out there as a commodity now versus 30 years ago. Imports can alter the supply balance still in lower priced wines.

    Where I'll disagree with you is the notion there wont be any USD $3.99 wines around. As long as there is a demand for that, it can be produced in a way that's drinkable, and there is dirt somewhere that can produce at an economic return grapes that can be used to make a $3.99 wine, we will have $3.99 wine. It is true that it's particularly difficult to do that in California given land prices and alternative uses for that land. But there is land that can produce that kind of wine still in the world at sufficient tonnage to make it worthwile for farmers. I'll bet you a $7.98 bottle we'll still find that $3.99 bottle next year and several years from now, as long as inflation stays under control.

    Thanks again for your thoughtful comments.

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  7. Raimundo

    You most certainly understand this market and how the world is reacting. I respect your opnion greatly. I completely agree we are in a trend of higher grape prices - and those prices had to get higher or otherwise more grapes would have been removed. As you mention , it is an important point to remember that prices have been at historical lows for a number of years. Prices had to come up at some point.

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    1. Glenn - what do you think about Raimundo's thoughts on $3.99 wines in the US. Do you think there are places in the world capable of supplying juice for a $3.99 USD wine in the future?

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  8. Rob:

    Raimundo makes some great points about the global grape supply and the need for grape prices to rise to encourage the redevelopment of acres and the planting of new acres. There are places in the world that will continue to be capable of supplying wine for a $3.99 per bottle retail in the US. It just may not be a varietal wine or of the quality level consumers have seen in the last few years.

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  9. Thanks for the comments Steve. We are in agreement I believe.

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  10. Rob
    if you see wine grape growers around the world , you will see that is feasibe to produce a 3.99 decent wine, but their financial health is not very good. This a matter to produce a 3.99 and to have a fair profit return.
    Until now buyers have had the power to buy cheaper and cheaper. Growers desperate to clean their cellars sell at any price. Even more since today at this price range wine is absolutelly a global market, buyers are changing from one country to another every year , depending on spot price. 2 years ago was chile, last year spain and today probably south africa. But in the long term it is not possible to keep 3.99 just over the oversupply or desperation of one country.
    Even more if you analyze what is behind a bottle of wne !!! 4 years to wait until first harvest. Then fight against weather conditions , and finally to produce a wine is not like to produce a bottle. Wine is something alive , so after all of this .... just 3.99 !!!! think about ........... just a matter of time to see the change

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  11. Thanks again for your comments Raimundo. I really appreciate your participation in the forum.

    I understand your perspective on a $3.99 priced wine and agree with you largely. You point out that growers haven't earned a fair economic return in many cases (Chile, Spain, S Africa export their oversupply of late).

    The reality is buyers who look for generic varietal wines don't care about appellation or country of origin. They just move around depending on the spot price. Consumers who drink that wine apparently don't care either or there wouldn't be a market. That's what a market is and that's the impact of the internet on shrinking the global marketplace.

    Mother Nature will give countries more or less wine every year. Exchange rates will also play a role in making a market work or not work. Planting will go through cycles as well and truly efficient market places will correct the imbalances.

    I believe there are probably few $3.99 wines out there that are really "good" today and I think that's your point. A grower deserves more than that for a 'good' wine. I don't know how those grapes for such a good wine could be sold profitably and truly, the wine probably isn't sold at a profit in many cases for that price point. To even get to 'good enough' quality, the wines have probably been so manipulated, any resemblance to the varietal is lost.

    But lets not overly criticize the producer who is working to find that wine in a world market. At least that juice was sold instead of sprayed over the ground. Some grower was willing to take a return on the harvest instead of getting stuck with grapes.

    I'm not opining on the way markets should react. Good wines should in a perfect world, be made from good grapes that paid fair and economic prices to the grower. The business isn't always that perfect.

    Thanks again for your comments and participation. We've had more than 3,000 people read the blog today and your comments are out there for people to consider. Please come back and contribute more of your thinking anytime. Your perspective is needed.

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  12. Update: @SVBWine - Getting more reports of some large yields on the North Coast from early returns. To soon to confirm a solid trend. Original Tweet: http://twitter.com/SVBWine/statuses/246318337947230211

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  13. Rob,
    Seems you could re-post for the 2013 harvest, no? :)

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