Climate change is a threat to the global wine industry — there is not much disagreement about this fact. But what are the specific risks to the wine product chain and what are wine businesses doing about them?

Climate Change Risk: Timely Idea?

This is a complicated question if only because the wine product chain has so many links that are vulnerable to climate change’s direct and indirect effects. One way to begin to answer the question, I proposed in last week’s Wine Economist column, is to focus on the concept of material risk. Climate change is not just an abstract threat to wine, it poses a threat to the material operations of wine firms, which are required, therefore, to disclose and analyze them for the benefit of current and potential investors.

I didn’t come up with this idea myself. As I noted last week, I was inspired by Robert Swaak’s comments at the Porto Climate Change and Wine summit. And I was interested to see climate change and material risk featured in articles in both the Wall Street Journal and the Economist newspaper reporting on Biden administration investment disclosure policy.

And now the Financial Times reports that the European Central Bank is undertaking a climate change stress test to determine the risks that European banks need to take into account in their operations. Climate change risk (and the use of risk disclosure to stimulate action) is an idea that is in the air just now. Let’s see what we can learn from it.

I’ve chosen four quite different firms in different parts of the wine business to discuss here.  This analysis is not especially deep or sophisticated, but hopefully it tells us something about how these businesses think about climate change and perhaps how wine businesses in general see these risks.

Constellation Brands

I start with Constellation Brands because it is a very large publicly-traded company, which therefore has many investors who will look closely at its analysis of risk. Constellation is an important wine and spirits producer, but it derives much of its income from Mexican beer imports and has cannabis interests, too, and each business is subject to a number of significant risks. Constellation identifies four categories of risk: operational risk, strategic risk, financial risk, and “other risks,” which includes risk stemming from the fact that the company has a dual share class structure and is effectively controlled by the Sands family.

Seven pages of the report are devoted to the operational risks (pandemics are risk #1 in the 2020 report) and each risk receives relatively detailed analysis. Climate change is next to last on the list, with discussion focusing on risks to wine supply (through the impact of climate change on vineyard production, for example), and the potential costs of environmental regulatory compliance.

My key take-away form the Constellation annual report is perspective. Climate change is a business risk and environmental advocates would like it to be the top priority. But, in practice, there are a great many risks and, although climate change is taken seriously, it must necessarily compete with other risks for attention and resources.

Treasury Wine Estates

Treasury Wine Estates is a large multinational wine business with substantial assets in Australia and the United States and key markets in China, the UK, the US and around the world. Its Penfolds brand is iconic. It published both a summary Annual Report in 2020 and a supplementary Sustainability Report,  so clearly the importance of environmental issues isrecognized. I focused on the main annual report for this summary.

TWE’s annual report identifies 12 categories of material risk. Changing geopolitical risks is #7 on the list, but I suspect that it is close to the top of the minds of the company’s leaders right now. Political friction between China and TWE’s home country Australia resulted in high Chinese “anti-dumping” tariffs on Aussie wine imports and the collapse of TWE’s #1 export market. Treasury is working on a re-structuring plan and shifting focus, at least for now, to other export markets. That, my friends, is an example of how a seemingly low-probability material risk can strike suddenly and with major impact.

Climate is listed as the #1 material risk, which is described as

The impacts of climate change may lead to adverse effects on business operations and performance.
Restrictions on access to and/or an increase in the cost of water and energy, and the inability of
third-party suppliers to adapt to and mitigate against climate change, could impact on TWE’s ability to effectively source grapes and wine for production.

In addition, governmental actions to reduce the impacts of climate change, for example packaging
waste and emission reduction targets may also impact  TWE’s cost base.

The report lists a number of mitigation strategies.  Treasury’s report suggests that its management recognizes both the direct and indirect impacts of climate on their business and, like Constellation, also anticipate changing regulatory environments as governments address climate change issues. Much more detail is provided in the Sustainability Report.

Tesco

Tesco, the big British supermarket chain, is an incredibly important link in the global wine product chain. Indeed, in my book Wine Wars I list its headquarters on Delamare Road in Cheshunt, Hertfordshire as the center of the wine universe if we think in terms of retail sales. But wine is just one of many products and services that Tesco sells.

The annual report presents what it describes as “a robust approach to risk, ” with a long list of risks, each assessed according to movement (increasing, decreasing risk) and key controls and mitigating factors. Going through the list, I began to worry when I didn’t see a category for climate change. Then I turned to page 20 and discovered that climate is so important to Tesco that it has its own special risk task force.

In addition to general climate risks, Tesco seems to be undertaking specific studies of key product categories and risk areas, which makes sense. Wine is not one of the focus areas in the current report, but it is interesting to look closely at what’s there. Some UK stores and distribution centers, for example, are at risk from flooding due to climate change. And supplies of produce from outside the UK are threatened by climate effects in the countries of origin. South Africa, Egypt, Spain, and Peru are noted as particular concerns.

The supply chains for protein (beef, chicken, etc.) are concerns, too. But there are also demand-side impacts. Tesco expects that climate concerns will shift consumers to plant-based proteins that have less environmental impact than animal-based foods, so building those supply chains and anticipating demand is on the agenda. Very interesting.

Amorim

My final case study is Amorim, the world’s largest producer of cork closures. Amorim is well known for its commitment to sustainability, so I was sure that climate change would factor into its business plan.

Amorim categorizes its business risks as short-term and long-term potential threats. In the short time frame, anything that can affect its two main markets — the world wine industry and the construction sector — will have major impact on the business. The list of things that Amorim must worry about is thus nearly endless.

Long run risks include foreign exchange shifts, competition from alternative closures, and of course the environment.  The cork forests in Southern Europe and Northern Africa that supply Amorin’s raw materials are environmentally significant for their ability to take carbon out of the system and lock it away. As climate concerns intensify, the report suggests, the value of the forests for this purpose will grow.

But, ironically, the cork forests that help mitigate climate change are also threatened by it, which gives the need to address climate issues a particular urgency both for Amorim and, I think, for wine more generally.

More Questions than Answers

The question is what are the climate change risks to the wine industry and how are wine businesses responding. Inevitably this brief study has uncovered more questions than answers, in part because of its inherent limitations. I’ve looked at just four firms, examined their material climate change risks through the lens of annual reports, and of course only had space for fairly superficial summaries here.

Critical readers would have been suspicious of definitive answers or broad conclusions in the context of these limitations. That said, the actual complexity of the problem starts to show through as you read the reports. And the urgency shows through, too.

Given the Biden administration’s new SEC climate change material risk emphasis and the ECB’s climate change stress test program, I think we can expect climate disclosures to be taken even more seriously soon. Much too soon for a victory lap, but good news for wine and the environment nonetheless.

It is difficult to over-state the potential impact of climate change on the global wine sector. Recently, I was part of a panel on this topic. My task was to get a handle on how climate change is likely to impact the business side of wine. I developed an analytical framework to consider this question based on the concept of material risk. I wasn’t able to develop my ideas fully during the brief webinar, so I will do so in this space over the next two weeks.

Unpacking the Wine Product Chain

How will climate change impact the wine business? This is a hard question because the wine product chain is global and complicated and because climate impacts can be foreseen at all the product chain links.

One approach — and a good one — is therefore to develop a taxonomy of effects.  Start with nurseries and vineyards (an obvious climate impact point) and move to the cellar, where water availability is key, then through logistics — getting necessary inputs into production process and the final goods to market — and then distribution, sales, and final consumption. Climate change is a factor, either directly or indirectly, at each and every stage.

This is already pretty complicated, but we need to consider direct effects, financial effects, and regulatory responses and their costs. Indirect effects and what we might think of as counter-party impacts add more complexity.  No wonder the Porto Climate Chain conference featured speakers on so many elements of wine production, distribution, and sales. You can’t really address climate change and wine without taking a broad, deep perspective.

Many of the Porto participants were justifiably proud of their contribution to addressing climate change, but in my remarks I challenged them to do more. You need to own your product chain, I said, and take responsibility for whole process. If not you, who?

A Material Risk Approach

Stephen Rannekleiv of Rabobank and Robert Swaak of PwC joined me on that Porto panel and each made an important contribution. Rannekleiv, as he often does, focused on concrete steps that his bank,  its clients,. and other groups were taking to address climate change issues. Swaak, who is now CEO of another big Dutch bank, ABN AMRO, made an important point about climate change risk.

Because the climate change impacts discussed above are complex and uncertain, they are properly considered business risks. Businesses confront lots of risks in their operations, some more tangible than others, and they are expected to reveal and analyze them so that investors understand the business implications.

Confession: reading what firms have to say about risk in their annual reports is one of my guilty pleasures (along with reading really really negative wine reviews). Often the risk analysis is hidden in the back pages of annual reports, almost always in fine print. But it is always there because regulators are serious about requiring businesses to reveal to investors the risks that they are taking. You cannot evaluate risks and return if you don’t know the risk.

I like to think of these risk disclosure statements as being like the fine print you are given when you get a new prescription drug. Do you worry about possible side-effects? If so, be careful about reading drug disclosure statements because it can make imagination go all out of control. Lots of bad things can happen, although the probabilities are low enough relative to the benefits to justify a drug’s regulatory approval.

Swaak’s point in Porto was not just that climate change poses risks, it was that these are material risks — risks that can affect the material operations of the firm — which is a more serious category that requires deeper consideration and fuller disclosure. Swaak hoped that that this status would encourage firms to take climate change more seriously because they would be accountable to their investors for this actions or inactions.

As the Wall Street Journal reported yesterday, the Biden administration’s Securities and Exchange Commission is poised to require the firms its regulations cover to make their climate-change disclosures more comprehensive. The era when climate change risks could be over-looked may be coming to and end.

The Risky Business of Wine

Swaak’s Porto insight made me realize that one way to assess the likely effects of climate change would be to view them through the lens of material risk. Analysis of the material risk sections of corporate annual reports is one way to learn what climate change risks businesses see ahead of them and perhaps also what they are doing to prepare for them. At the very least it is a way to see if climate change is taken seriously.

I admit that this is not deep analysis. The firms might be myopic and not see climate change risks clearly. And there may be differences in the priorities listed in the report and those reflected in their actions. Getting values, priorities, and actions aligned is a universal problem, not limited to just corporations or to climate change.

As an article in the current Economist newspaper suggests, disclosure won’t by itself solve climate problems, but the requirement is at least an incentive to move away from climate-damaging practices and investments. With this in mind,  I made a quick study of four wine sector firms which I had hoped to discuss in that webinar. The four are

(1) Constellation Brands, a very large beverage alcohol company and at one time the world’s largest wine maker.

(2) Treasury Wine Estates, a firm with global interests and product chains.

(3) Tesco, the largest wine retailer and so a key product chain link.

(4) Amorim, the largest cork closure producer, known for its sustainability commitment.

What did my analysis reveal? Come back next week to find out.

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Videos of the Porto Climate Change conference presentations mentioned above are available. Click on these links for presentations by Mike Veseth, Stephen Rannekleiv, and Robert Swaak.