The Cabernet Boom and Its Discontents

Our recent trip to the Napa Valley provokes two columns: this one about the Cabernet Sauvignon boom and next’s week’s about Zinfandel’s uncertain future.

>>><<<

What winegrape variety comes to mind when I say “Napa Valley …”? There are lots of possibilities. Chardonnay. Merlot. Sauvignon Blanc, of course! Hey, Larkmead makes a tasty Tocai Friuliano.

hqdefault

But I’ll bet that your “fill in the blank” answer was Cabernet Sauvignon and there are several good reasons for this. Cabernet is a noble grape and many of the world’s great wines are made from it or with it. American consumers are in love with this winegrape variety. Cabernet Sauvignon has recently overtaken Chardonnay as America’s #1 favorite.

Cabernet is #1

According to recent Nielsen data taken from the August 2018 issue of Wine Business Monthly, sales of Cab wines totaled more than $201 million in the most recent 4-week period, up 3.9% from the previous year. That compares with $190 million and 0.5% growth for Chardonnay, which has for years topped the league table.  Next in line but far behind, is Pinot Gris/Grigio ($96 million / 1.3% growth) and Pinot Noir ($82 million / 2.6%). The fastest-growing category is Rosé, as you might have guessed, with 67% growth on a relatively small $22 million sales base.

Consumers love Cabernet Sauvignon and growers love it, too, because they see it as a potential solution to the their financial squeeze. The costs of land, labor, equipment, and supplies keep rising, but the prices of many grape varieties have been stagnant, putting pressure on profits and, in some cases, generating rivers of red ink.

The Cabernet grape price premium can be substantial according to the 2017 California Grape Crush Report. Cabernet grapes fetched $700 per ton on average in Lodi, for example, compared with $552 for Merlot and Chardonnay. A ton of Cabernet sold for $2209 on average in Mendocino county, $2352 in Lake Country, and about $3000 in Sonoma County.

Premium Prices

Napa county topped the list with an average Cab price of $7,421 per ton. That average translates into a $70+ bottle price using the one-percent rule of thumb. And that’s the average. The very best Napa Cab grapes from exceptional sites sold for $10,000 per ton and more. Lesser Cab grapes sold for less, of course, but still generally for more than other grape varieties. Cab Rules.

And it’s not just a California thing. Cabernet is now the most-planted winegrape variety in Washington state, too, with 62,200 tons harvested in 2017 compated with #2 Chardonnay’s 39,300 tons.  The overall average price of Washington winegrapes was $1200 per ton, with Cabernet selling at a significant premium at $1500-$1600 per ton.

No wonder more and more Cabernet is being planted wherever it might possibly grow successfully. Jeff Bitter, recently appointed President of Allied Grape Growers, presented the results of the 2017 California Nursery Report at the Unified Wine & Grape Symposium meetings in January. Bottom line: Cabernet is big and getting bigger.

The Nursery Report provides insights about what grape varieties are being planted or grafted, which foretells shifts in winegrape production a few years from now when the vines are productive. The 2017 report showed that 72% of new vines were red varieties with only 28% white. Cabernet vines accounted for an incredible 37.4% of all new vines followed by 19.5% for Pinot Noir and 16.7% for Chardonnay.

Cab Pipeline is Full

If you combine Cabernet with other varieties that are often blended with it (such as Merlot, Malbec, Cabernet Franc, and Petit Verdot), they account for over 42 percent of all new California vines. I am not sure what the composition is of the vines they may have replaced, but I suspect the disproportionate emphasis on Cab and Cab blending grapes represents a significant net increase in future production.

Cabernet’s dominance is noteworthy, but the upward trend in Cab plantings is part of the long term trend that Benjamin Lewin MW described in his 2013 book Claret & Cabs: The Story of Cabernet Sauvignon. Zinfandel, not Cabernet, was the most-planted winegrape variety in the Napa Valley in the decades following Prohibition.

Zin was thought to  make the best Claret, according to Lewin, which of course is interesting because Claret is the name the British gave to Cab- and Merlot-based Bordeaux wines. Ridge made a “Claret”  in 1981, for example, from Zinfandel, Petite Sirah and Carignan and I’ll bet it was delicious!claret

Cabernet Sauvignon was a minor player on Napa’s wine scene, Lewin notes, although it made some historic wines including the great Beringer Cabs of the 1930s and the Beaulieu Georges de Latour Private Reserve wines that André Tchelistcheff made between 1938 and 1973.

The Napa Cab boom really picked up speed in the 1970s as new quality-driven wineries (think Robert Mondavi) focused on Cabernet. The Judgement of Paris in 1976 put Napa Cab firmly on the wine world’s radar.

No wonder new investment flooded into Napa Valley and Cabernet plantings expanded rapidly, both in Napa and California generally. Now the steady rise has accelerated, taking on some boom-time characteristics. The cycle of higher Cab prices, higher vineyard valuations, and increased Cabernet plantings continues.

Stein’s Law

Cycles and booms are a common characteristic of agricultural and financial markets, both of which I have studied. There are two things I have learned about the booms. First, they are driven by internal logic that seems bullet-proof from inside the cycle.  People (like me) who try to call turns often end up looking like Chicken Little fools. So don’t expect me to forecast a Cabernet bust!

The other thing I have learned is that Stein’s Law always applies in the long run. Named for the famous economist Herb Stein, Stein’s Law is says that if something cannot go on forever … it will end. And I think that Cabernet prices cannot go on going up forever (especially with new plantings on the rise) any more than housing prices could defy gravity forever a dozen years ago, no matter how how much rising prices might seem baked in the cake at any particular moment.

That doesn’t mean that the boom must inevitably be followed by a bust — there are many possible adjustment patterns as Kym Anderson’s analysis of Australia’s winegrape cycles shows. In the meantime, Cabernet is crowding out other grape varieties, including those Zinfandel vines that were once the pride of Napa Valley winemakers. That’s where we are going in the next column.

Sue and I came to the Napa Valley with Zinfandel on our minds. Circle back next week to find out what we learned.

>>><<<

The Boom Varietal image above comes from a 2011 Sky Pinnick documentary of the same name about Malbec, which is sort of the Cabernet Sauvignon of Argentina. I was pleased to be part of the cast for this award-winning film. The film talks about the rise of Malbec in Argentina and the understandable concern that the boom could go bust (Argentina has a history of boom and bust).

 

The American Wine Industry’s Achilles Heel: Labor

lodiI tell my friends that the wine business is a people business and it is really true. Relationships matter a lot in wine. One of the reasons that Sue and I so enjoy our work is the opportunity to meet and get to know so many wonderful people.

People are the wine industry’s strength, but they are also its Achilles heel and finding ways to adapt to a world with changing labor market conditions is perhaps wine’s greatest current challenge. We saw several aspects of the evolving labor crisis during a recent visit to the Napa Valley where I spoke at the California Association of Winegrape Growers’ (CAWG) summer conference.

Trouble in the Vineyards

We talked with a number of winegrowers who were understandably focused on their vineyards — how to get the hard work of winegrape farming done and the crop harvested efficiently in the current farm labor environment. Migrant labor policies are the main issue here and the impacts extend beyond winegrapes to virtually all California agriculture.

Farm labor generally means migrant labor, including a substantial proportion of undocumented workers. Current federal policy is decided unfavorable to the needs of farm employers and the progress is very slow to craft useful reforms.

Large-scale grape farming depends upon these workers, which is very risky because their work status and the policies that affect them are so uncertain. Mechanization — mechanical harvesting and also increasingly mechanical pruning — is the most direct response, which reduces labor uncertainty exposure even if it doesn’t eliminate the problem.

Matt Parker, the President of Silverado Investment Management Group, which farms 20,000 acres, told the CAWG audience about the strong mechanization dynamic driven by cost, uncertainty, and technical change. Mechanically-harvested grapes can be as good as hand-harvest grapes and are sometimes even better because an entire vineyard can be harvested quickly (and sometimes at night as in the photo above) with machines, whereas hand-harvest may take many days and grape quality can deteriorate.

Everyone we spoke with wanted to see the migrant worker situation resolved so that the cloud of uncertainty that hangs over their businesses and the lives of the workers might be lifted. But I didn’t hear many optimistic voices. Stay tuned.

Beyond the Vineyards

Harvest and vineyard workers are not the only labor market issue we found in Napa. A friend with talked with runs a business that is a major supplier of packaging products to the wine industry, with a large warehouse and light manufacturing facility south of the city. Labor was on his mind as he showed us around his operation.

Labor constraints limited the efficiency of the business, which was running one shift instead of the two or three that it could handle. Rising wages were a concern, of course, but availability was a bigger long term issue. Housing shortages and cost, transportation bottlenecks, and immigration policy all contributed to the uncertain availability of workers.

His solution was automation and his company is making major technology investments both to increase production flexibility and efficiency and to reduce exposure to labor cost and availability risk.

Truckloads of Trouble

One of the CAWG conference’s most interesting speakers was Yvonne Sams of G3 Trucking, a company that many vineyards and wineries rely upon to get grapes to the cellar quickly and at affordable cost during harvest.

“Do the math,” people say, and here is the stunning winegrape trucking math. California produces about 4 million tons of grapes in a typical year (if there is such a thing). That is equivalent to 170,000 truck loads of grapes over the harvest season, according to Sams, with about 2000 truck loads on peak harvest days. The typical load travels about 40 miles. That is a lot of trucks, highway miles, and driver shifts.

Everything about this process is closely monitored and some elements, such as driver cab-time and break periods, is tightly regulated. Driver regulation is about to get more strict, with the result that each driver will be able to manage fewer loads than in the past. Thus the current driver shortage will likely increase. Sams reported that one trucking company now advertises on television specifically targeting women, who are under-represented in the industry, in the hopes of expanding the potential driver pool.

What’s the solution? No one wants to see their grapes rotting in bins waiting for a truck and driver to appear! Sams reported a number of initiatives. More trailers, for example, could increase efficiency by reducing the time that drivers spend waiting to load and unload. Ideally the truck and driver would appear just as the trailer is filled and then drop it off at the other end, picking up a new load while the trailed waits to be unloaded.

We also heard the basic outline of what you might think of as an Uber for truckers, which would allow truckers with available time to more efficiently match up with waiting loads.

Finally there is Elon Musk’s favorite strategy — autonomous trucks (Musk’s would be electric, of course) that need no driver but do require pretty sophisticated software and, as we heard from a representative of Verizon, would benefit by the roll-out of 5G cellular systems.

Napa at the Forefront

Many U.S. industries are struggling to cope with labor issues today. Agriculture, including wine grapes, struggles a bit more because of the traditional labor-intensive model and the relatively short half-life of freshly-harvested goods compared with manufactured products.

Napa, because of its high housing costs and transportation bottlenecks, is particularly affected. Napa’s wealth insulates it a bit, I suppose, but also provides resources for technological labor-replacing systems. As these case studies show, there is no escaping the wine industry labor crisis because it is not one problem, but many, that all negatively impact production, cost, and profitability.

As I wrote in a 2017 column on vineyard labor issues

Are the machines coming to a vineyard near  you? No, they are probably  already there and, as vineyards — even those in iconic regions — are replanted or renewed, you can be sure that one factor that will be considered is the potential to maximize technological compatibility.

Hand work in the vineyards is not going to disappear and many wineries will continue to rely upon  their teams of highly-skilled vineyard workers for years to come. But what we are seeing is that the business model associated with vineyard labor is changing rapidly. Technology, economics and anti-globalization politics are all part of the dynamic.

>><<<

Thanks to Sue Veseth for the photo of workers and machines at a night harvest in Lodi.

 

 

 

Beyond Wine Boom & Bust: Taking a Closer Look at the SVB Report

svb-2018wine-thumbSilicon Valley Bank recently released their 2018 State of the Industry report on the U.S. wine market and if you haven’t read it you should. It is well researched, written, and argued. Most important, it will challenge your ideas about the U.S. wine industry and make you think.

Most of the media reaction to the report has focused on two “boom and bust” elements: the predictions that (1) the 20-year wine market expansion is coming to an end and (2) that the relentless rise in grape prices and vineyard valuations in Napa Valley will pause or plateau.

Both of these predictions are significant although, as the report notes, calling a “turn” in the market is inherently problematic and will be difficult to assess until a few years down the road. In the short term, for example, the report notes that the U.S. wine market should continue to grow in 2018, although at a slower pace. Value will grow faster than volume due to the “two track” U.S. market with growth in premium wine sales offsetting declining lower-shelf demand.

This Changes Everything?

Boom and bust make headlines, but there are two important points that the SVB report makes that I think should get more attention. The first is the fact that we are witnessing fundamental changes in the retail market environment. Not just retail wine market, retail everything (or just about). Who buys, when, where, and how, who consumes, when, where, why, and how. Even the way people pay is changing.  Amazon is one driving force in this environmental transformation, but only part of it.

This fact was driven home to me a few weeks ago when I read that the Swiss luxury group Richemont (controlled by South Africa’s Rupert family), announced plans to buy out Yoox Net-a-Porter,  an Italy-based  luxury “etailer.” Richemont’s brands include Cartier, Van Cleef & Arpels, Piaget, Vacheron Constantin, Jaeger-LeCoultre, IWC Schaffhausen, Panerai and Montblanc. High end stuff.

You might think that consumers would be willing to buy books and t-shirts online but that they would hesitate to throw down $5000 or more for jewelry or a watch without holding it in their hands. But you would be wrong, or so the Richemont folks believe. The idea kind of takes my breath away.

It’s a new world for wine as for other things, the SVB report suggests. And the patterns and practices that were successful in years gone by, including but not limited to bricks-and-mortar versus online sales, are not guaranteed to work in the future. Time to question and rethink.

income

Talking ‘Bout the Generations

A second interesting but possibly under-appreciated point that the SVB report raises concerns generational analysis of the wine market. Most of what you read about wine today frames the changing market demographics in terms of baby boomers versus millennials. But, as this figure from Statista.com suggests, there is a “missing middle” to this analysis. The figure shows 2016 median household income by age of householder.

Lost in the focus on rising younger, poorer millennials versus declining older, richer boomers is the Gen-X generation who are in their 40s now (more or less) and reaching their peak earning (and consuming) years. They are, SVB argues, an important but sometimes underappreciated market for wine. And, as a recent Wine Access study reveals, although Gen-X is a smaller cohort than boomers or millennials, they are willing and able to spend proportionately more on wine.

I think these are very useful insights, although I’m always a bit cautious regarding generational analysis. My years as a university professor taught me that the differences between generations are sometimes less important than diversity within them. Sometimes it is appropriate to generalize about a generation, but not always.

Take boomers, for example. The conventional wisdom is that baby boomers have driven the wine market growth — and this is true — but remember that most boomers don’t drink wine regularly and many don’t drink it (or any alcohol) at all.

The boomer wine boom is driven by a relatively small segment of this generational group. In a way, the boomer wine phenomenon is about a subgroup that is at least somewhat atypical of its cohort — and that difference is key.

The SVB report goes well beyond boom and bust to include these significant insights and many others, too. Highly recommended for anyone who wants to understand the American wine industry today and where it is headed.

>>><<<

Congratulations to Rob McMillan and his team for a thought-provoking report.

David Ricardo to Donald Trump: Global Wine Trade and Its Discontents

5788597-mWhen David Ricardo wanted to make the logic of his famous Theory of Comparative Advantage crystal clear he knew what example to choose: wine. It was obvious that Britain should import wine from Portugal in exchange for cloth rather than trying for vinous self-sufficiency. Any fool could see that!

Make Great Britain Great?

But wine wasn’t really the point of his example. He was more concerned about the Corn Laws, a set of trade barriers designed to choke off agricultural imports and promote higher prices for domestic grain (lining the pockets of rural landowners in the process). If Britain should trade cloth for wine, then why not trade cloth for wheat and other grains as well?

The wine story was good enough to convince Ricardo’s economist colleagues, but not so much those in parliament. The Corn Laws lasted from 1815 until 1846. Economic logic triumphed over vested interests in the long run, but the human cost of the trade barriers to urban workers and their families in terms of higher food costs and lower living standards was very high.

Britain really didn’t fulfill the promise of its Industrial Revolution until the Corn Laws were repealed. It is fair to speculate that Parliament could have acted to Make Great Britain Great much sooner if they had been guided by the economic logic of wine trade.

Wine is perhaps a good guide to British political economy today, too. Brexit, which was promoted as a way to Make Great Britain Great Again, seems to have instead made British families poorer even though the change in trade policies has not yet been enacted or even agreed.  Rising import prices and stagnant wages have squeezed consumer budgets for wine as for many other items (sound familiar?). Tesco, the upscale supermarket giant, is reportedly planning a discount chain of its own to compete with increasingly popular “hard discount” Aldi and Lidl stores.

Make American Wine Even Greater?

The wine trade has lessons for the United States, too. Or at least that was my takeaway from two speakers at the “State of the Industry” session at the recent Washington Winegrowers Convention and Trade Show. 

Glenn Proctor of The Ciatti Company presented a very interesting survey of global wine market conditions. There are only two big wine markets that are growing in terms of total consumption, Proctor said: China and the United States. The Chinese market is particularly attractive because of the large rising middle class and potential for further growth.  French wines are top of the import table in China, followed by Australia and Chile — two countries that have benefited from free trade agreements with China.

Indeed, China is now the #1 export market for Australian wine, accounting for 33 per cent of exports, ahead of the US (18%), UK (14%), Canada (7%), and Hong Kong (5%). The Chinese market has powered Australia’s resurgence as a global wine power and the free trade agreement is an important part of the story.

The United States? Well, the U.S. has no free trade agreement with China and President Trump pulled the U.S. out of the Trans-Pacific Partnership negotiations — which could have opened up Asian markets — on his first day in office. Partly as a result, I suppose, the U.S. ranks #6 on the China import list. Australia wine sales volumes are more than ten times the U.S. amount.

If recent import trends continue for a couple of years, U.S. sales to China may be surpassed by relatively tiny Georgia. Georgian wine sales to China have surged (up 45%) in part because of the Georgia-China free trade structure that went into effect at the beginning of the year. The U.S. wine industry is clearly handicapped in foreign markets where other producers have preferential access.

John Aguirre, President of the California Association of Winegrape Growers, also highlighted  the importance of trade agreements for the wine industry. President Trump has raised doubts about  U.S. – Korea free trade (the Korean market has lots of potential for U.S. wine) and launched negotiations to revise NAFTA. Since Canada is the largest export market for U.S. wines, it is essential that NAFTA maintain open cross-border access.

The wine industry would suffer if the NAFTA negotiation somehow collapse, although the negative impacts would obviously be less than agriculture generally and the automotive industry, both of which have become dependent on efficient trans-border industrial integration in order to compete with efficient producers in other parts of the world.

I am hopeful that the NAFTA negotiations will be successful at updating the treaty since there is so much at stake. But my confidence is shaken somewhat by President Trump’s actions to block new appointments to the World Trade Organization’s appeals body — the entity charged with enforcing the rules of the trade game.  This will make it more difficult for the U.S. wine industry to pursue its complaint against the British Columbia wine regulators concerning their discriminatory supermarket wine sales policy, which favors B.C. wines relative to imports in clear violation, in my view, of the WTO’s non-discrimination principle.

What’s the bottom line? If President Trump: wants to Make American Wine Even Greater, he might take a lesson from David Ricardo and re-think administration actions and policies regarding global trade agreements.

Economic Impact of California Wine Country Wildfires: Preliminary Analysis


wine-country-fireLike most of you I have been intently focused on the wildfires that have swept through the California North Coast wine region and their tragic human impact. It is difficult to accept that such loss of life and property is possible, but the fires and the winds that drive them have been relentless.

I started getting calls from reporters as soon as a wildfire emergency was declared and, like many others, I declined to comment on the economic impacts. Too soon to know, I said, and not the real story in any case. More important to tell the human story and help people come together and cope with loss.

Still Too Soon

It is still too soon to know the economic impacts. The fire danger continues and the fatality  and property damage reports are still coming in. But I have started to think about the nature of the potential losses to the wine industry. As Tom Wark wrote last week,  we need to think about what happens when the fires are finally out, even if that’s not the most important immediate concern.

Here is what I am thinking now. The direct impact of the wildfires on California wine will very unevenly distributed, because that’s how a wildfire works, but the indirect effects are likely to be even larger and widespread. It is important to get out the message that California wine is open for business.

Uneven Direct Impact

The North Coast region (Napa, Sonoma, Mendocino, and Lake counties) is very important in terms of the value of the wine it produces, but is dwarfed by Central Valley production in terms of volume. The huge quantities of California appellation wines that fill the nation’s retail shelves will not be much affected by the wildfires. This is important to realize since some press reports link the wildfires to the tight global wine market that has resulted from poor harvests in Europe this year, which risks giving a false impression about wine supplies in California.

While some North Coast vineyards and wineries lost everything, others suffered little or no direct damage to cellar, vineyard, or wine stocks. The floor of the Napa Valley, for example, is not much damaged so far. But that doesn’t mean that wineries without direct damage won’t suffer an economic loss.

Wine Tourism Losses

No way to put a dollar and cents  figure on the direct losses until individual assessments of winery destruction, vineyard damage, loss to stored wines, possible smoke taint issues, and so forth are made. But we can already see the indirect cost in one area: tourism.

napa1Wine tourism is incredibly important to Napa and Sonoma these days, both for the high-margin direct sales that wineries there increasingly rely upon to compensate for escalating grape costs and for the hospitality industry that has grown up to serve wine tourists.  The economic impact of wine tourism is very large for the region.

On a typical day in 2016, according to the latest Napa tourism economic impact study, there were almost 17,000 tourist in the Napa Valley who spend more than $5 million. These are not typical days and the income and jobs those numbers represent are nowhere to be seen for now.

The wildfires have obviously interrupted wine tourism even for wineries that are not directly affected by the fires and it is not clear how soon anything like a normal tourist flow will return. This is complicated by a number of factors including the perception that the whole region is badly burnt and therefore closed for business, damage to transportation and hospitality infrastructure, and problems for the workers who support both the wine and hospitality industries.

It’s a People Business

Many of the workers who live in the region are dealing with personal losses or are busy helping those in need. The hundreds of workers who live outside the local area and commute to jobs in Napa face obviously obvious obstacles, too. In the short term I am told that it is actually the shortage of staff more than the direct impacts of the fires that limits winery operations in many cases.

The bottom line is that while the direct damage from the firestorm is large but unevenly distributed, the indirect costs are likely to be even bigger and affect almost everyone in the region, wine people and non-wine folks, too.  It is not entirely clear what normal will look like when the smoke clears and it will take some time to find out. But, as Tom Wark writes, Napa Stands Strong (and Sonoma, too) and it is important to press ahead.

Renewal and Rebirth

The videos I have seen of  the fire damage bring to mind scenes of burning Napa vineyards that appear in a wonderful 1942 book by Alice Tisdale Hobart called The Cup and the Sword (which was made into a terrible 1959 film called This Earth is Mine starring Rock Hudson and Jean Simmons and set in Napa and Sonoma).

Hobart’s novel is about the resilience of the strong women and men who built the California wine industry and the vineyard fire signifies rebirth from the ashes because, with some effort and care, the sturdy vines in the novel do come back to life. It is an image to keep in mind today when recovery, rebuilding, and rebirth are on our minds once again.

 

How Will Brexit Impact World Wine Markets? A Dismal New Forecast

brexitMy remarks at the Unified Wine and Grape Symposium‘s “State of the Industry” session earlier this year focused on the uncertainty surrounding Brexit (Britain’s choice to exit the European Union) and the great potential it has to damage wine markets in both the UK and other countries.

I called Brexit a “known unknown” because we know (or should realize) that we really don’t know what Brexit will look like when the two-year exit process concludes or what its impact will be when the dust finally clears.

The exit negotiations will begin in earnest after the June 8 elections in the UK, which Prime Minister Theresa May and her Tory party are expected to win although perhaps not by as big a margin as originally conceived.

An Inconvenient Truth

One particular problem for the wine industry is that wine isn’t very important to the overall British economy (so don’t expect it to get much special attention in the trade negotiations), but the British market is extremely important to the global wine industry, both as a major importer and a bottling and distribution center.  The UK market is a top target for many wine exporters, including Australia, New Zealand, Chile, and even the United States.

Kym Anderson (University of Adelaide) and Glyn Wittwer (Victoria University, Melbourne) have taken a first stab at understanding what is at stake in a study that they released earlier this month titled “Will Brexit Harm UK and Global Wine Markets? (pdf). Anderson and Wittwer ran three Brexit scenarios through their econometric model of the global wine market and reported the results.  I encourage you to take the time to study their research.

Major Impact on Wine

Anderson and Wittwer’s conclusion, to cut to the chase, are that there would be substantial Brexit impact on UK wine imports:

In our ‘large’ Brexit scenario, as compared with the initial baseline scenario, the consumer price of wine in 2025 would be 22% higher in the UK in local currency terms (20% because of real depreciation of the pound, 4% because of the new tariffs on EU, Chilean and South African wines, and -2% because of slower UK income growth). The volume of UK wine consumption would be 28% lower (16% because of slower UK economic growth, 7% because of real depreciation of the pound, and 5% because of the new tariffs). Super-premium still wine sales would be the most affected, dropping by two-fifths, while sparkling and commercial wines would drop by a little less than a quarter.

The authors examine three Brexit scenarios, judging that the most likely general outcome (the “large” Brexit model) is that the UK would adopt the same tariff barriers as the EU27 in the short run and then work eventually to restore free trade arrangements with Chile and South Africa. This makes sense to me if for no other reason than that Britain lacks the time and staff necessary to negotiate Brexit and to work out its own detailed tariff regime and also to negotiate detailed free trade agreements to replace those that will be lost.

Losers and Winners?

Brexit will obviously have high costs for UK wine consumers and retailers and for the bottling and distribution industries as well. Who will suffer the most among countries that export wine to the UK?

Australia, New Zealand, and the US will have to deal with the negative income growth rate effects of Brexit and the exchange rate impacts, too, but won’t see an increase in tariff rates under the “large” Brexit scenario, since their exports to the UK are already subject to EU rates. They will gain a little form a more level playing field with respect to European wine producers in the UK market.

Chile and South Africa are more vulnerable to Brexit woes because they currently have preferential access to the EU (and thus British) market. Their wine exports to the UK will be subject to tariff at least until they can reach new free trade agreements.

European wine exports (France, Italy, Spain and others) previously had tariff-free access to the UK market and so will face new barriers to trade. But, as Anderson and Wittwer note, the likely tariff rate of 13 pence per liter is dwarfed by Britain’s domestic excise tax of nearly £3 per liter and 20% VAT.

No Rising Tide

Does anyone win in this analysis of Brexit? Well you would think that the small but growing UK wine industry would gain from the various hurdles that imported wine faces — and they will. But Brexit is also likely to make imported winemaking and vineyard equipment and supplies more expensive and restrict or increase the cost of migrant seasonal labor, so it is unclear if Brexit will be truly beneficial.

And of course the declining overall wine market is bad news — the opposite of the idea that a rising tide raises all ships, if you see what I mean.

The devil is in the details of scenario forecasts like this and we won’t really know what to expect until the May government announces its intentions (and even then we might not know because the government has developed a recent habit of reversing itself on economic policies and, of course, the final outcome depends on the EU negotiating stance, too). Until then, however, this forecast is a very good place to start your thinking.

This column is just a summary of the new research with a few thoughts of my own. I encourage you to read the Anderson-Wittwer paper and note your own thoughts and reactions in the Comments section below.

What Next? Wine Industry Mid-Year Report & Preliminary Brexit Analysis

economist-cover“What next? was the question I asked to open my report at the Unified Wine & Grape Symposium‘s “State of the Industry” session in January. Risk and uncertainty were my forecast for 2016.

Bernie, Donald, Zika, Brexit. Look out! Anything can happen, I told the audience, although I ended with a Frank Sinatra theme. It could be a “Very Good Year” if we can dodge the many potential hazards.

I wasn’t the only one who was worried. Four speakers in a session on wine industry investment were asked about their expectations for 2016. All four said that the prospects for the U.S. wine industry were bright … unless something happened to the economy.

Cautious Optimism?

We are halfway through the year and the cautious optimism expressed earlier seems justified. The U.S. remains one of the few large economies to be growing, for example, and unemployment rates are low. The June jobs report offered evidence of further recovery. But confidence in economic growth seems very fragile and the Federal Reserve has hesitated repeatedly to raise key interest rates.

One worrisome indicator is the yield curve, which tracks the difference between short- and long-term interest rates. The yield curve has become unusually flat recently, a pattern that is sometimes associated with economic slowdowns. A  recent Deutsche Bank analysis of the yield curve forecasts a 60% chance of a recession in the U.S. in the next 12 months. Yikes!

Interest rates around the world are so low (and sometimes even negative) that policy makers are worried. What if something goes wrong? How can we push interest rates even lower? Would it make any difference if we did? With fiscal policy handcuffed by political chaos in many countries and monetary policy seemingly out of ammunition, there is concern that a crisis in one country could easily spread to others.

What next? That’s still the right question, both in general and when it comes to wine. While the U.S. wine market continues to grow and attract the attention of international competitors, the Nielsen figures reported in the July 2016 issue of Wine Business Monthly suggest caution. Off-premise wine sales increased by a rate of just 1.1 percent overall in the four weeks ending April 23, 2016, indicating a possible deceleration of earlier more healthy growth.

Brexit’s Many Potential Impacts20160702_cuk400

The list of potential challenges and threats is very long but the U.K.’s vote to leave the European Union (a.k.a. Brexit) is at the top of most lists. What does Brexit mean to the wine business? The answer is that it is too soon to be sure, but here is a quick guide to what to look out for and the impact on wine.

The biggest impacts of Brexit to far have been political, with the heads of the Conservative Party and the nationalist UKIP group both resigning (for very different reasons) and Labour’s leader under sharp attack from his own members. Since British tax policy has been a significant burden on wine sales there in recent years, the uncertainty about the who will lead and where she (Theresa May will take over as Prime Minister in the next day or so) will want to go is significant for wine.

The partial political vacuum in England has seemingly increased the influence of Scotland’s talented leader Nicola Sturgeon, who suggests that Scotland might once again consider leaving the U.K. (a Scexit?) in order to remain closely linked to the E.U. Sturgeon has taken strong anti-alcohol positions, which could affect wine policy, although this is way down the list of things to worry about if Scotland breaks away and the U.K. breaks apart.

Financial markets react to news more quickly than the “real” economy and the rise of the U.S. dollar and fall of the British Pound are the most visible effects so far. The Pound has tumbled dramatically as the graph above show and some observers believe that it will continue its descent although this is far from certain.newfx

Short Run: Exchange Rate Effects

The falling Pound is important because, as this table of U.S. exports for the first quarter of 2016 from Wine by Numbers indicates, the U.K. has become a more important market for U.S. wine exports in recent years. The U.K. is second to Canada in U.S. bottled wine exports and first in the bulk wine market.

The falling Pound makes imports from the U.S. and other wine nations more expensive in the U.K. U.K. consumers are notoriously price sensitive, so the falling Pound could produce substantial wine demand impacts, especially if there is a U.K. recession, as many expect, due to falling investment (see below).

brexit

The exchange rate effect will hurt U.S. exports to the U.K., but the biggest impacts will be on other countries that rely upon the British market to a greater extent than we do. Australia, South Africa and of course European wine producers will take a bigger hit.

The problem is compounded by the fact that supermarkets are a critical sales vector in the U.K. and much of the food they sell is imported and will therefore be more costly to source. Supermarket margins are likely to be squeezed as they attempt to pass on higher costs to consumers with uncertain economic prospects.

Don’t be surprised if this puts pressure on foreign wine suppliers to cut their wholesale prices to British supermarket buyers and thus absorb some of the exchange rate impact. That is an incentive to develop alternative markets … such as the U.S. The margin wars are just getting started.

So the wine news is not very good in the U.K., where wine prices are likely to rise, incomes could fall, wine taxes may also increase, margins come under attack, and prohibitionist forces may be strengthened. Bad news for the British who drink wine and bad news for others including U.S. producers  who want to sell it to them.

Long Run: The Vultures Circle

But the biggest impacts are likely to be the long-term structural changes that will be required if and when Britain or England or whoever is left leaves the European Union and the single market. The U.K. is an important wine center both because of the large British domestic market and also because of its essentially unrestricted access to European markets and resources. It is too soon to know how this will change for wine, but it is instructive to watch other sectors to get a sense of the dynamic.

There is already concern about disinvestment in British steel and automobile manufacturing, for example, if resources are shifted into other E.U. zones. Much of British auto production is exported and would be disadvantaged if the U.K. loses its open access to E.U. markets. Voters in Sunderland may eventually rue their strong Brexit support if Nissan moves production (and some of the current 7000 factory jobs) away from its big plant there to new homes in the E.U. heartland.

And everyone in The City, London’s big financial center, is openly concerned, too. London residents voted overwhelmingly to remain in the E.U. in part because of their desire to protect The City’s economic standing (and their jobs), which would diminish if movements of capital and skilled workers to and from the continent were restricted.

Any major disruption in The City will have widespread impacts on wine, especially the on-premise trade but not limited to that. The vultures (in the form of European cities hungry for those high-paying finance jobs) have already started circling.

I am still cautiously optimistic for the U.S. wine economy and for Britain, too, but there are lots of risks to consider. That question — What Next? — still applies.