WORLD WINE GLUT

More and more wine is being produced (but not drunk) internationally. It is a particularly grim outlook for Europe, suggests Alex Dale – but the New World has no room for smugness

‘If all else fails, drink more!’ An adage for all desperation, it increasingly applies to the world’s over-producing wine industry.

In Europe, home of the oldest wine-producers and consumers, surplus production is nothing short of alarming. Despite a slight decline in the area under vine within the European Union (EU) in recent years, some scary realities lurk beneath the statistics. Let’s look at some of the facts.

Spain, with over 1 228 000 hectares under vine (a third more than France, three times the sum of all US vineyards), has traditionally had much lower yields per hectare than France or Italy. According to Harpers magazine, Spain currently produces about 31.6 million hectolitres of wine per annum, versus France’s 49.9 million hectolitres. The Spanish are about to change this disproportion. The introduction of irrigation, for example, in La Mancha (which counts for about half of Spain’s vineyards), coupled with other new practices, means that Spain stands to produce up to 300% higher yields than currently. Start drinking.

Just about every wine-making country produces more wine than it consumes. Spain, France, Italy and Portugal are certainly no exception – while domestic consumption is steadily declining. It is estimated that France and Italy alone will account for about two thirds of the rising European surplus over the next five years. Add to that France’s slipping market share in various key export markets such as the USA and the UK and the outlook appears bleak.

The EU has been subsidising the ‘restructuring’ of Europe’s vineyards. Handing-out colossal amounts of cash under the Common Agricultural Policy to transform vineyards that once produced aramon, ugni or macabeu into vast new bearers of chardonnay, sauvignon blanc, shiraz, cabernet sauvignon and merlot – in other words, exactly what the New World producers have focused on. A case of fighting fire with fire –or just hopefully jumping on a gravy train? As the saying goes, if you spot a bandwagon, you’re too late…. Meanwhile, it is estimated that a further 68 000 hectares will be subsidised for transformation this year alone (according to the official Journal of the EU, 6 September 2003). That’s about two thirds the size of all South African vineyards, in one go. Spain, Italy and France account for almost 85% of that. With fewer domestic and foreign consumers with each harvest, it would appear that with such ‘transformation’, these EU producers are simply clutching at straws.

Talking of straws, a relevant aside: in the domestic US market over the past two years or so, the Charles Straw brand (‘Two Buck Chuck’), selling at $1.99, has become a retail phenomenon. It has single-handedly modified wine-buying patterns in the USA, whilst soaking up vast volumes of California’s surplus production at a huge discount. It has also switched consumers back on to cheap US-grown wine and away from EU imports, which can no longer compete due to the strength of the euro and the all-too-convenient weakness of the dollar. Sadly, however, Two Buck Chuck has reportedly failed to generate new consumers, and has simply attracted established consumers who are ‘buying down’.

One measure of the EU policy-makers has seen a significant increase in the levels of distillation, even of supposedly better quality wine. With total EU stock levels hitting a 20-year high in 2002 (the equivalent of 1.74 billion nine-litre cases), according to Harpers (January 2004), France alone accounted for 35% of surplus stocks with about 610 million cases worth – which would require every French baby, child, adolescent, adult and pensioner to consume 100 cases per annum more than the annual 6.4 cases they already statistically drink in order to soak up the excess. Italy has a surplus 380 million cases, Spain 365 million, Germany 157 million and Portugal 139 million.

French woes

France’s consumption has declined steadily, from 100 litres per capita in the 1960s to 58 litres in the early 2000s. And the decline continues. That’s 42% of its domestic market (its biggest market) which has simply evaporated. Guillaume Willette, of the Burgundy Wine Association, was quoted by Agence France Presse in February 2004 as saying ‘Wine is part of our culture – and this is a debate about the place of wine in French society’. Protesting against draconian anti-alcohol advertising laws, French vignerons find themselves banished from advertising their wines in their own country. A Paris court ruled recently against the Interprofessional Office of Burgundy Wine, under the reviled Evin law, instructing it to halt an add campaign. Bordeaux producers were subsequently sued over a poster campaign saying ‘Let’s drink less, let’s drink better’.

A clampdown by police has also seen restaurant wine consumption plummet, adding to the sector’s difficulties. So-called ‘doggy-bottles’ have been introduced in restaurants to encourage customers to continue to order a bottle of wine, but to take home what they don’t drink….

French producers, justifiably, are feeling more and more cornered on the home front – let alone in the export markets, where the New World onslaught is taking the very baguette from their mouths. AOC Burgundy and Bordeaux export sales fell 7% and 8% respectively in 2003 alone. The value of vineyards in Bordeaux has fallen by 40% in 12 months and Le Monde reports that 1000 growers are on the brink of bankruptcy there. Jean-Luc Roche, chief wine buyer at France’s Leclerc supermarket chain, was recently quoted as saying: ‘Between 15 and 20% of AOC wines do not deserve to be classified as such. They are real pig-swill that continue to enjoy the label because no politician wants to take the responsibility of changing the rules.’ That’s got to hurt….

One of the worrying new indicators is that the proportion of surplus ‘up-market’ wines is steadily growing – aided, of course, by the EU-funded vineyard transformation. An expensive and classic deferral of a problem from one insolvent sector to a second, even more costly one. Amazing how politically inspired, bureaucratic intervention can add fuel to an already raging fire. In France, ‘quality wine’ hectarage has now surpassed that of ‘table wine’ for the first time. Between 1992 and 2001, according to ONIVINS, the quality wine vineyard (from finite regions of production) grew 12% to 488 000 hectares, whilst table wine hectarage shrank to 305 000 ha. With quality wine yields also on the increase, actual quality wine production now also regularly exceeds that of table wine in France.

The picture is not too dissimilar across the EU as a whole, and quality wine production is now within a little over 10% of catching-up with Table wine production. In other words, and despite the hugely expensive vineyard transformation process, the wine lake is simply moving up-market. In 2002, about 15 million bottles-worth of beaujolais (including top crus) was distilled, in order to manipulate the bulk market back to a healthy supply-demand ratio, with hoped-for firmer pricing. Again, with a declining number of consumers for its product, this could prove to be a simple prelude to even more dramatic measures, as growers are increasingly forced out of the sector and into ruin.

Australian contradictions

Contrast all of the above to the New World. It’s a very different picture there – though not all rosy. Structurally, at least, it is considered that there isn’t a production surplus in the New World. There may well be an emerging imbalance in availability of red wine over white wine, however.

Prior to the 2004 harvest, the Australian Bureau of Agriculture and Resource Economics estimated that Australian wine grape production would soar 28% to 1.81 million tonnes. Admittedly, this comes after a drought-reduced crop the previous year. Red wine grapes, however, are forecast to increase by a further 5% over the three years to 2006 (with shiraz the dominant variety), whilst white grapes, particularly chardonnay, are due to increase by 15% to more than 703 333 tonnes. By comparison, South Africa’s entire vineyard production equates to 1.24 million tonnes (including distilling wines, grape juice concentrate etc).

Australia is the powerhouse of the modern international wine industry. Having grown its exports from ten million cases as recently as 1992 to 58 million cases in 2003, Australia has raced to the number four spot on the export charts, behind Italy, France and Spain. With export growth last year of a further 12% (or six million more cases), Australia is fast closing the gap, and certainly faster than even the ambitious Aussies themselves had set out to do in their 2025 industry plan, introduced a decade or so ago.

Their simple ambition was to be the world’s No.1 exporter by 2025. However derided that may have been at the time, not least by the French, that sobering prospect now seems more plausible – and sooner than anticipated. As France loses market share in the US and the UK, Australia gobbles it up. In terms of value (as opposed to volume) of exports, 99% of Australia’s increase in 2003 was to the USA. For the first time the US even overtook the UK as Australia’s most valuable export market (though not yet in volume, where the UK imports 204 million litres to the USA’s 152 million). And let’s not forget, that was in a US market in a state of turmoil and economic downturn. Australia’s domestic market (breaching the 400-million litre level for the first time ever) is at record levels, even if prices and margins are under huge pressure, due in part to a slowdown in the domestic economy and a temporary over-supply of red wines. Per capita consumption in Australia showed modest growth to 20.6 litres in 2003 – that opposed to decline in its European rivals’ home markets.

The Australian industry, however, is not in the best of shape. With the strength of its currency, export margins have plummeted. The effect of a price war in the UK and domestic markets a year earlier left a couple of the major groups struggling to recover. Tarnished reputations, devalued brands and bruised egos caused them to swallow some humble pie, to redirect their businesses and to try to return to profitability. With a near duopoly in wine retail sales in Australia, the big chains have wielded the stick in what has been a buyers’ market over the past couple of years.

Discounting and stock dumping are causing some pretty tense market conditions. The Australian Wine and Brandy Corporation estimates that the average return on assets has slipped from 7.6% in 1997/98 to 4.2% in 2000/01. In the same period, returns on bearing vineyards declined from 14.7% to 4.8%. Up-to-date figures for 2002/03 are expected to show a further sharp decline – worsened by the impact of the economic slowdown, the rise in the Australian dollar and the impact of the drought in 2003.

Industry analysts point to the slowdown in plantings in Australia, in large part due to the declining profitability of the sector. This, amazingly, and when compared with Australia’s strong export growth, means a pending shortage of grapes within the next two or three years. With planting now increasing at a rate of only 3% and sales at over 10%, it’s simply a matter of time until the engine runs out of fuel. ‘We need more vineyards because we’re going to run out of grapes’, said Brian McGuigan, MD of McGuigan Simeon Wines, one of Australia’s top five groups. The rising Australian dollar is discouraging people from planting, when there is already a shortage in varieties such as chardonnay, sémillon and sauvignon blanc. With export sales showing no sign of slowing down, shortages can only become more acute. In a market where brand-owners’ profit margins are being squeezed away by currency movements, the double-whammy of having to pay premiums on dwindling supply availability will wreak havoc with profitability and even with viability.

Within Australia, conditions vary from one region to another. In Western Australia, for example, an over-supply of red wine has led to large volumes of wine stocks taking up tank space even as the 2004 harvest gets under way. With most plantings in the four years to June 2002 being of red varieties, the 165% increase of area under vine during that period has led to a large surplus of red wine. With the domestic market remaining relatively static for its wines, and with their production costs being higher than in other southern hemisphere countries, Western Australian producers are finding it tough to empty tanks prior to the harvest. Sarah Dent, CEO of the West Australian Wine Industry Association, says that some winemakers face financial ruin if markets are not found in time. ‘As a small to medium winery, it is very difficult to access international markets when you are competing with countries like Chile, Argentina and South Africa.’ As tanks of red wines go unsold, Sarah Dent observes that – conversely – there is a shortage of white grapes in Western Australia, and especially of chardonnay.

New Zealand and USA

In New Zealand a different picture is emerging. Winegrowers New Zealand said, ahead of the 2004 harvest, that grape production was estimated to soar from last year’s 76 000 tonnes to 150 000 to 170 000 tonnes this year. Even if the climate has reduced that figure somewhat since, the pattern in clear. With thousands of tonnes of grapes being produced speculatively and without being contracted to brand-owners, there is a huge structural overhang emerging. Some growers not finding a home for their crop would resort to making their own wines, only to then enter the costly, over-traded and depressed margin arena of bottled-wine sales. Auckland wine broker Wayne Thomas was recently quoted in the New Zealand Herald as saying: ‘I can understand the concerns of uncontracted growers. I can’t move anything. I am at my wits end.’ He added: ‘We produce very good white wine, but at a cost. And this is quite a bit higher than Chile, Argentina and South Africa.’

In California, even in the ‘immune’ North Coast, business is being severely squeezed by the economic doldrums, a surplus of all but the rarest of wines, domestic discount brands and value imports. The Australian wine phenomenon Yellow Tail has taken the US market by storm, sales soaring to well over five million cases in 2003 after only a few years in the market place.

The good news, however, is the increase in US wine consumption, up by 14 million cases in 2003 and expected to rise by about the same again this year (that compared with a decline in the EU’s domestic markets, don’t forget). As a result of the weak dollar, exports are now also rising significantly, and the market seems to have bottomed out. With vine removal, aggressive discounting of inventories, increased exports, and more expensive imports, stability is seemingly slowly returning to the industry. Bulk prices are stabilising, the amount of available bulk wine for sale, compared with a year or two back, has fallen substantially and there is a surge in demand for chardonnay – all signs of improved market conditions. An over-supply of cabernet sauvignon (as in Australia where in some areas growers are not even picking their crop) is expected, however, to continue for some while, depending on how many vines are removed and how quickly wine sales recover.

Many wineries have suffered badly over the past two years and an increase in the number of acquisitions and mergers is anticipated. Distress sales on a large scale are quite likely now, such as the purchase of De Loach Vineyards by the Boisset group last year. Capital-strong companies, having weathered the storm are now poised to find easy pickings at a huge discount. It’s a buyers market once again.

South Africa

Back in South Africa, we see a combination of the conditions elsewhere. The main features are:

Sue Birch, CEO of Wines of South Africa, was recently quoted in Business Day as saying: ‘Without margins to support our brands, we are going to battle to maintain market share’. She added: ‘It’s going to be survival of the fittest. There are too many players operating within the middle priced segment of the international market without the capital to invest in sustaining their brands.’

In summary

So how should one summarize this snap-shot of the world wine industry? The Australians and Californians appear to have the lesser of the evils to deal with, in that they have strong export growth, domestic market growth, a reduction of the oversupply situation and a strengthening general momentum – albeit with various serious challenges. South Africa’s export success is being totally eroded by the strong rand and we should expect some big casualties if the currency situation continues. Most producers are praying for a downturn in the value of the rand – without preparing a plan B…. New Zealand’s costs are too high to compete in the volume market and their production is becoming too large for them only to occupy a premium niche: an interesting crossroads for them. Europe, however, is slipping into a deep and seemingly terminal crisis. They are about to hit meltdown, but don’t seem to realise it. The crux is that the New World wine-producing regions are converting more and more consumers to drink their produce, whereas the Old World producers are haemorrhaging consumers daily. Disaster for them means, though, light at the end of the tunnel for New World producers. But unless even more consumers can be converted to wine across the planet, however, or unless global production is reduced substantially, that light might just be an oncoming train.

Remember: ‘If all else fails, drink more!