It Was Entirely Predictable

It seems like every year recently, straight after vintage there are all sorts of press reports that call for action to reduce the Australian wine surplus and this year was no exception. It seems every second wine story in the press is about the problem or proposed solutions, but first, it would help to understand the size of the problem.

Figures are like sausages, it depends who makes them, but no matter whose figures you believe, the sausages are bloody fat and the problem is massive. In the 2005 growing season, it was estimated that 270 million litres of wine were produced that were excess to requirements and joined the already huge stockpile of wine that was not needed. As the 2006 season was only a fraction less than the previous years production and demand was not that much greater, this years excess will be in excess of another 200 million litres of wine. The excess to requirements stock is somewhere over 750 million litres of wine; and that’s one heck of a hangover (bad pun intended) for the industry. But the problem is probably much bigger than that and the 750 million figure is conservative; according to this news item, Australian Wine and Brandy Corporation statistics forecast 60,000 tonnes of wine grapes being left unpicked in the 2006 vintage, and about 300,000 tonnes of grapes being sold well below the cost of production. The unpicked component would have added almost another 34 million litres (that’s 45 million bottles) to the stockpile. (The excess inventory number used by the industry is actually 950 million litres.)

There are two main reasons for this oversupply. By far the greatest was the tax incentive provided by the government, essentially they helped to fund the huge expansion in vineyard plantings and because of peoples’ greed (and stupidity,) the old established growers find they are competing in an over-crowded market place with Mr Johnnie Come-Lately. In many instances, the investors did not do their homework; if they had, they would have seen the oversupply problem coming. The second and lesser cause is the proliferation of hobbyist farmers over the past decade. In many cases, these growers buy a small property with vines and are not as concerned with the return on investment as much as the lifestyle associated with owning a property that includes grape vines.

The massive new planting over the past decade or so has lead to the huge over-supply of grapes. This in turn has caused the price to drop, but it’s not just the new growers who have recently entered the market who are suffering, the growers who have been doing it for decades are being hit just as badly. These seasoned, experienced growers, in many cases have been producing a high quality product in their own market segment, be it Riverland bulk producers, or old vine material from the Barossa. Unfortunately the quality of the fruit from some of the new plantings is not as good, either because the vines are still very young or the site selection/setup/clonal choice is not as good as other existing properties but the lower price paid for these grapes is helping to pull the whole market down.

In the prior article about this problem, it was pointed out that whilst the prices for fruit from all over the country were down, at least the bulk growers in Sunrasia and the Riverina were able to sell 92% of their output, unlike the growers from the premium areas; in fact it was estimated that 44% of the premium areas production from 2005 was not sold and formed part of the excess wine lake. To make matters even worse, a fair percentage of the wine from the premium areas wound up being sold off as bulk wine too. Production costs in the premium areas are also significantly more expensive than those experienced by the growers from the Sunrasia and Riverina, making the problem even more significant for the premium growers.

All the growers are suffering; it’s just a matter of how much pain is being experienced. The oversupply of grapes and hence finished wine has lead to increased competition in the local retail market too, especially in the below $15 a bottle category. There has been a huge increase in cleanskin availability with shops and e-tailers springing up who specialise in them. As you pull the pricing at the very bottom of the market down, it has a flow on effect and puts significant pricing pressure on much of the whole market, with only a small percentage of quality producers unaffected.  

This problem, which is very sizeable and won’t being going away in a hurry, is not unique to Australia; the French and Italians have their own oversupply problems too. In Australia’s case, much of it was caused by tax incentives and in the case of France and Italy, much of it has been fostered and encouraged by decades of farming subsidies paid by their own countries and then the EU. Whichever way you look at it, the government subsidies in both cases have lead to either an inefficient industry turning out uncompetitive products in the world market, or an industry that is not as profitable as it would have been, had the industry been standing on its own feet without government tax incentives.

In the case of the EU, there have been all sorts of ructions, protests, and plans but the EU is notoriously effective at subsidising inefficient farming practices, so wholesale change is unlikely. In the case of Australia, it’s hard to believe that it was only about 20 years ago that the government was paying growers to rip up their old vines due to the overproduction of grapes in the 1980’s. And then providing them with massive tax incentives in the 90’s to plant new ones.

The one thing this shows is that growing wine grapes is a cyclic business with good and bad times and that the bad times will be here for some time; either until production reduces or demand catches up. So what are the likely scenarios and solutions that will fix the problem? There are only two possible ways to look at this; either you fix the problem or you treat the symptoms.

The first solution would involve nature’s cooperation; it would take a couple of seasons of horrendous growing conditions with minimal output, but given the extent of the geographical coverage of our vineyards, that’s a very unlikely solution.

There have been numerous suggestions about what the grower, the industry as whole, or the government can do to fix the problem and as we shall see, some of them are harebrained and have as much chance of success as an ambit claim by workers for a 25 hour week with double the current weekly pay packet. However, some of them do have some merit, even if implementing them will be extraordinarily difficult.

One request by some segments of the wine industry suggested that the excess inventory should be processed as ethanol and the cost subsidised or borne by the government. The monumentally inefficient European growers floated this idea and in a typical “brain fart” fashion there were suggestions by the industry here to do the same thing. In a meeting with the industry recently, the federal Agriculture Minister Peter McGauran pointed out that “a litre of wine, now selling at an historic low of 35-40c, contains an average of just 120ml of ethanol, equivalent to $3.33 a litre when concentrated into fuel and a litre of ethanol from a grain-feed ethanol plant could be produced for 50 cents a litre.

The efficiency (sic) of this suggestion would mean that it would cost $2.83 a litre more to produce ethanol from wine than grain, so that means it would only cost the government somewhere between 2 and 2.5 billion dollars to bail out the growers. Yep; that’s a great idea, and had about as much chance of flying as I do; it’s a very expensive and inefficient way to treat the symptoms.

The next most popular suggestion addresses the cause and comes from growers who are calling for another government subsidised vine pull scheme. The industry is suggesting that enough vines are pulled to remove 200,000 -300,000 tonnes from the system; that equals between 20 and 30% of annual production. Remember, earlier in this article it was pointed out that the Riverina and Sunrasia regions that produce over 60% of the nations wine grapes, moved 92% of their inventory; the most significant problem was in the cooler premium growing regions where a whopping 44% of their production was excess to requirements.

The “brain surgeons” that have suggested the vine pull scheme have also suggested it should be aimed at warm to cooler climate areas, the same areas that produce premium wines; the sort of wines that offer diversity and quality, rather than generic, global wines of no varietal distinction that could have been produced almost anywhere in the world. This suggestion would go a long way to continue the race to the bottom end of the market, whilst decimating the long term potential of the premium end.

Considering that the government has just “funded” the establishment of these new vines, if they were stupid enough to subsidise a vine pull, the federal opposition would be drinking Champagne from now till the next election on the political mileage they would obtain. It makes almost as much political sense as the ethanol proposition.

There have also been calls for growers to walk away from their vines but this plan will not fly either as it did not receive the support of the industry that was expected to fund the proposal; now there is a surprise – not!

The next suggestion from some industry players suggests a massive grafting scheme where vineyards that are having trouble selling their crop should be encouraged to switch their vines to an alternative variety. Sounds like a good idea? In theory it might be good but it has about as much chance of fixing the problem as a bandaid has of stopping an arterial bleed. Can you imagine the industry converting 20% of its vines to other varieties; I can’t and if it did happen, the chances are there would still be an excess of grapes, it would just be an excess of different varieties.

Looking to the government to provide a complete solution just will not happen for a number of reasons. Firstly, the cost would be enormous, there is not enough political mileage in it; in the future other industries would also expect similar treatment when the going gets tough and finally, many of the growers have made their own beds and it’s up to the industry to solve its own problems. That does not mean the government can’t or won’t help, but it does mean that the industry has to take the lead in helping themselves and look to the government for support, not a complete solution.

So what can they do about it and what is likely to happen.

Selling vineyards in this market is not an easy proposition and many will try; a few will succeed but most will fail to sell; many small growers will either go broke or simply walk away from their vines and forget about them. How many? No one knows or can even guess but when the cost of production exceeds the income, not many will want to continue for long. This will have some effect over time.

Over the next few years, just like this year, a number of growers will not harvest their entire crop and will just plough the excess back into the earth. Not good for their bank balance, but why crop when it’s uneconomical to do so.

Some growers will in fact graft non-selling varieties to better economic choices but this will be a drop in the wine ocean.

As previously noted, the biggest problem is with the premium end of the market and that’s the area that needs the greatest attention. A mass vine-pull from the warm to cool climate areas is not the solution and will not happen, although less production would certainly help. The problem already exists and whilst the government may help with some funding, the industry has to realise the government is only likely to assist them if the industry is prepared to help themselves; the government won’t bail them out.

The excess production is already there in storage and will continue for some years and it will possibly even get worse in the next couple of years. As the government is not going to fund its removal and the industry can’t either, the best alternative is a long term fix. The best way of doing that is export. Sure the market is tough and crowded but according to this report, the industry works with a $12 million annual promotional budget which is clearly not enough to move the excess inventory. If the government was going to fund anything, funding ways of moving the inventory is the best possible use of funds.

No matter if the government is prepared to help or not, the industry has to find a way to get together to help itself. Depending on which way you look at it, it will either be an easy task, or very difficult one. Less than 100 producers produce over 90% of the output, so getting those companies to cooperate could be considered easy in comparison to getting the other 1900 producers who produce less than 10% of the output to play ball. As outlined in this article, the Australian premium segment is in trouble in the US and desperate action needs to be taken to turn that around; but there are other new and emerging markets with huge potential, like China, India and the rest of Asia: as a national identity, we are doing a very poor job of trying to get in on the ground floor and crack into these markets. If the industry can’t get together to help itself in a crisis, many people will be hurt badly.

Copyright © Ric Einstein 2006