Wine consumption is growing worldwide and particularly in the world’s new largest wine market, the U.S. Trouble is, shocks to the global economy and to the wine business in particular over the past several years along with tough growing seasons have dramatically limited the supply of grapes and wine sold in bulk to supply the thirst.
Hugh Reimers, executive vice president and chief operating officer at Jackson Family Wines with a background in winemaking in Australia, cautioned a recent gathering of wine industry professionals recently not to expect significant relief from shortages internationally.
“The grape supply is in balance globally,” he said at a Wine Industry Financial Roundtable hosted in Napa by accounting firm Moss Adams LLP in February. Jackson owns wineries and vineyards in coastal California and owns producers and imports wines from Italy, France, Chile and Australia.
But he noted that plantings worldwide have been minimal. Twenty percent of vines were nonbearing in 1999, compared to only 4 percent today, he said. Exacerbating the need for more supply, wine consumption is expected to grow from today’s 2.5 gallons per capita to 3.8 gallons in 2025, requiring more wine and grapes.
The Business Journal asked members of the 2012 Wine Industry Conference panel on grape and wine supply panel at the about some of the hotly discussed topics in the wine business in California. Panel members at the April 18 conference include Joe Ciatti of Zepponi & Company; Mark Couchman of Silverado Premium Properties; Jeffrey O’Neill of O’Neill Vintners & Distillers; Bill Pauli of Pauli Ranch Winery, Yakayo Wine Co. and current president of the California Association of Winegrape Growers; and Steve Smit of Constellation Wines U.S.
How are prices and availability of bulk wine and grapes affecting operations?
Jeffrey O’Neill: An industrywide shortage of inventory is affecting virtually everyone’s business. We have gone from a “cascading excess” to “will anyone notice if I put Bulgarian merlot in my Napa label.”
For the past five years, many brand owners have been pushing surplus inventory down to second- and third-tier labels. In less than 18 months, that surplus is gone, and vendors are now facing significantly higher prices and a grape supply that has not kept pace with industry growth.
Many of the second-tier labels that relied on surplus inventory will now have to seek sourcing from lower-cost districts or countries, or simply be discontinued.
The higher costs of grapes will ultimately be passed through to the consumer, but retailers will be resistant, particularly in their disbelief that the industry could have gone from a long position to a short position in a matter of 18 months. It is possible the increase in pricing could put a damper on the growth of California wines, only to be fulfilled by low-cost imports.
Bill Pauli: Growers are very cautious about signing new, or extended, contracts, not knowing where pricing per ton is going to peak.
The bulk wine market is more limited in Mendocino and Lake counties by supply — fewer wineries and appellations. In our case, we are seeing a strong appetite for reds led by cabernet sauvignon and merlot. No one has any zinfandel or pinot noir available. Pricing is $10.50-$14.00 a gallon on merlot and $12-$16 on cab. There are some exceptions, up and down, for very small lots, depending on quality.
Steve Smit: Certainly, the supply has tightened up. We’re taking opportunities where we can. We have solid products, and we’re in a fairly balanced situation. It’s very difficult to take [bottle] price [up], and our margins are being compressed. We’re looking at all supply opportunities for existing and new products coming out.
We buy [grape] products from all over California. We’re 80 percent grapes purchased and have always been so. We’ve been able to develop solid relationships with growers. It’s a partnership between winery and grower.
Joe Ciatti: It’s a natural happening in agricultural business cycles when there’s a supply of raw materials that’s really long, the market will use up the fruit available and not plant for quite a while.
People think a big crop will take us out of where we are today, but we need to plant. Wineries are trying to secure supply with long-term grape contracts, planting grapes or getting growers to plant for them. Strong wineries are trying to buy vineyards in the right places.
It’s a big change. It all happened in the last eight to nine months, and it will probably be here for six to eight years. It’s easy to say wineries have to raise casegoods prices. It is difficult to do that in practice, but in reality it will happen. I think that’s what a lot of wineries are doing in telling growers that they are taking grape prices up severely. There’s a lot of greed on both sides, with some stretching prices.
How much of the supply and pricing issue is determined by the target bottle price of a wine program?
Bill Pauli: Brand owners and wineries of small and mid-size, and negociants are working on very tight margins per case and are struggling to find bulk wine that allows for some margin per case. Do they blend down, if they can find bulk wine available? Do they look off shore? I suspect we will see some brands forced to do those things to maintain availability of product or raise prices to slow growth while waiting for the 2012 crop.
Some larger wineries with multiple brands may move to different product mixes while still maintaining overall case sales, shelf space, and distribution. Price points will be driven by competition and the economy along with consumer preference.
Bulk wine supply is challenging for certain select appellations for high-end red wines such as cabernet sauvignon, pinot noir and zinfandel. However, supply is not as much of an issue as is the price per gallon that the wineries are willing to pay.
For expanding or growing a brand, purchasing an existing brand or completing acquisitions in progress, finding grape or bulk-wine supply at “reasonable” prices for existing brand price points is a challenge.
Steve Smit: It’s fairly uniform across all pricing tiers. Certainly in the popular pricing segments and going all the way up to luxury tiers, there is a similar pattern in terms of wineries getting imbalanced in their inventories and seeing growth in volume sales. It’s a healthy thing. We’re growing.
Luxury tier less of factor in resulting bottle price?: true but I was talking availability of supply across tiers. Not as great as make it out to be unless in super luxury. Availability of supply is pretty uniform across all tiers. There’s not an excess of grapes for any particular product. Heath of demand is in our view pretty uniform across all tiers.
Joe Ciatti: It has an effect on everybody because the price is going up in every sector. But it has less impact on the high-end wines. Generally, any bottle price of $10 or below isn’t appellation-driven; it’s pretty much California appellation. If such a wine is appellation-driven, it will become California-sourced. Wines in $7 range will go overseas for supply.
Imports really affect wines $10 or below. We will see 30 percent to 40 percent of U.S. wine sales from imports instead of the 30 percent now. If a U.S. brand is appellation-driven and retailing for $12-$18 or more, consumers will pay more for the wines because they like the labels and won’t look for overseas brands.
The higher the price of the wine — really, for $30-$50 wines and above — the less the percentage of grape prices to the cost normally impacts the program. There’s a little more elasticity in the high end, and people can afford to pay more for grapes than for wines retailing in teens or below.
Some say there is a substantial amount of wine in winery tanks that will become available for sale in bulk, easing supply and price concerns. How true is that?
Jeffrey O’Neill: If there are large bulk suppliers holding big stashes of bulk inventories, they are clearly the smartest guys in the business. With bulk pricing up 30 percent to 50 percent, it is highly likely they would have already shown their hand.
Bill Pauli: Current supply and cost of grapes are a major part of bottle price and per-case costs. But all component costs, from winemaking to finished goods, are increasing. This impacts our margins. The marketplace — consumption — and the economy will determine final outcomes.
In a shorter timeframe, additional supplies will become available if bulk wine prices rise to unreasonable levels. It will be a tough call for wineries that need cash and profits in the short term but also are concerned about sales projections and growth to support their brands. Question is, will they be able to replace supply two to four years out and at what costs?
Steve Smit: There could be. Some, potentially, may be holding out on selling on the bulk market because they think the price will go higher, but that is a gamble.
Initial casts on 2012 cluster counts for vines [with shoots] that are out far enough to count is very positive. There was a sense of gloom and doom with the cool season last year that the crop would be small this year, but it looks good. We see that, particularly, in the Central Valley and Central Coast, where the vines are out farther.
Joe Ciatti: If people think there are two or three major producers hoarding wine, it’s wishful thinking. I don’t think that’s there.
In these types of constrained supply situations, people get carried away with pricing. People say they used to sell chardonnay for $10 a gallon and now they want $13, $16 or $18. Where’s the top? People are throwing things out there to see where top is.
For bulk Napa Valley cabernet sauvignon wine being marketed as high as $40 a gallon, if someone paid $5,000 a ton for very high-end grapes and factor in processing costs, you can get to that kind of price. Some producers with wine on the market will drop prices this year because it’s not selling.
On the casegoods side, many people now are saying they will not do a second label, control label or one for a store like Costco or BevMo. We will see a lot changes in how to adjust inventory. Smart producers should be raising prices now, if they have valuable wine in inventory from the 2009 through 2011 crops.
It’s been 12 years since this happened before, and a lot people in the business now have not seen this.
How could vineyard practices to prepare for a potentially large 2012 crop affect supply?
Jeffrey O’Neill: The industry could use a large 2012 crop. Two of the last three years were sizable crops, and we are not able to keep up with demand.
There is substantial planting going on, although right now it lags because of the availability of wood [nursery stock], but it appears the next two to three years will be tight on inventory.
However, a banker told me the other day, “There is not enough land in California to keep up with grape demand.” This, of course, is complete hogwash. It was proved wrong in the late ’70s, early ’90s and a surplus that is just subsiding in 2012. Growers will always find a way to grow more grapes.
Steve Smit: If anything, growers want to be sure they will have grapes to sell and will be more than happy to thin the crop, rather than not have enough. In all parts of California, including the North Coast, growers are leaving more wood [on the vine after pruning]. Our targets are in terms of quality, and that’s foremost in our minds. We want to ensure we get a decent crop, but quality parameters still need to be met.
Joe Ciatti: We will see some of that happen. I don’t think in quality areas wineries will give up quality for yields. There are a lot of wineries under grape contracts that didn’t want as many grapes in the last two to three years and had pretty tight restrictions on growers on what they would accept. Those restrictions will come off.
If a grower doesn’t have contract on a vineyard will see how much he can push envelope and how much can hang. Growers and wineries will work together first for quality then for as much as possible.
There’s definitely going to be more fruit hung. We must have new acreage or plantable acres coming in to change the meter at all. We’re not going to do it by hanging another ton of fruit per acre.
What’s the outlook for supply and demand of grapes and wine in the next few years?
Bill Pauli: A large crop — say, 3.9 million tons — would put things back in balance. But what is the longer-term outlook with continued growth in sales and the supply needed to sustain that growth? What is a realistic, longer-term, average yearly state grape tonnage? Regional supplies for coastal brands will be a concern, as a large percentage of new plantings will be concentrated in District 13 [Madera, Fresno, Alpine, Mono and Inyo counties and parts of Kings and Tulare counties].
Supplies in coastal regions will remain tight due to limited land availability and the high cost of development.
Steve Smit: As we’ve all heard there is a fairly large surge in plantings. There were some decent plantings last year in the Central Valley.
My gut feeling is that a lot plantings are in new ground, so that will help ease supply. But I see supply being tight for the next two to three years. There is need for zinfandel and cab. But are we coming into balance with merlot?
In North Coast, we have older vines that need to be replanted, so really that’s just keeping balance with what we have and so not much about growth in terms of tonnage.
Prices have come back to where they were three years ago just before recession. The market had been going in the positive direction, and I think coming back there.
Again, I don’t think we’re taking a lot of price on wine yet. The global picture complicates typical cycles we had in grape growing communities. Globalization, acceptance and tasting of wines around the world will have impact on the cyclicality of the wine business.
Joe Ciatti: We’re going to be basically short, as we are right now in California and in almost every variety. It is going to take replanting and new vineyards to really change it. There is land for planting grapes in outlying wine regions such as Lake and Mendocino counties and Clarksburg and certain areas of the Central Valley. In the Central Valley, they’re talking about planting, but there’s no rootstock left for 2012 and nurseries are gearing up for 2013. That’s good for growers, but they do not want to be so pricey that it will hurt sales of California wine.
Five years from now, some Harvard graduate will say the wine market is so strong the industry can never overplant, and just at that point we can guarantee there will be oversupply.
Values of vineyards have gone up dramatically, like grape prices have. Banks are more comfortable lending on bulk inventory and grape contracts with planting of vineyards. It’s a good time to be in the industry.
Kathe Guglielmetti of Moss Adams LLP contributed Hugh Reimers’ comments for this report.
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