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Global Demand Rises Despite Poor Harvests

Special Report from The Drinks Business

(United Kingdom) – Undersupply replaced a decade-long era of oversupply with autumn 2012’s harvest and the inevitable prices hikes will hurt the entry-level market. Meanwhile global demand continues to rise.

Tweets of the “OMG! We’re going to run out of wine!” variety greeted reports in the autumn of 2012 that grape harvests in the Northern Hemisphere had widely fulfilled predictions of shortfalls across a sweep of major wine-producing regions. This compounded earlier Southern Hemisphere shortfalls at a time when global consumption is growing. Without question, the headline figures made for sobering reading, especially after a decade or more of oversupply being the norm.

As 2012 European harvest volumes were confirmed, the International Organization of Vine and Wine (OIV) estimated that total global output had fallen from 264.2 million hectolitres in 2011 to 248.4m hl in 2012, representing the lowest level since 1975, when the body began tracking these figures.

Of the world’s best known regions, Burgundy was down 40 percent, Champagne down 25 percent and Rioja down 30 percent, to name but a few, with popular styles such as Pinot Grigio also significantly down. Meanwhile the output of entire countries such as France, down 19 percent (at a recent historical low), Italy, down 4 percent (this compared against two previous low vintages), and Spain, down 6 percent, conspired to produce an unsettling reminder that annual wine supply is predicated as much on climatic factors as man’s intervention.

Furthermore, while highlighting the reduction in vineyard area in many parts of the world, OIV projected a final global consumption for 2012 of between 235.7m and 249.4m hl, with a caveat that 30m hl of wine are absorbed by industrial usage. At a glance, this may appear to bring wine production more into balance with demand, but the situation is far more complex than these figures alone suggest.

The world, of course, isn’t about to run out of wine. But with hindsight, the fallout from 2012 could well prove to be the most visible marker of a fundamental shift that is occurring in the global balance of production and consumption – and this is potentially to the detriment of mature wine-drinking markets such as the UK.

“It’s going to be tough, especially at the entry level, because there isn’t a region in the world that has a massive surplus,” admits Dan Jago, Tesco’s group wine director, responsible for overall global wine strategy. “There is a lack of availability in Europe and the high- volume producing nations, with France, Italy and Spain down on volumes, and this is part of a cycle, as with any other [agricultural] commodity, where prices will fluctuate.”

ON THE RISE

Simon Thorpe MW, managing director of Negociants UK, highlights an impasse between cash-strapped consumers on the one hand and margin-squeezed producers on the other. He believes that those who have invested in secure, long- term wine supply, along with producers and brand owners that control their production and distribution, are best placed to weather the coming period.

“It is difficult to predict anything other than price rises [during 2013] across the wine category as harvests have fallen and inflationary pressures on agriculture and production continue,” comments Thorpe.

“The UK, although still a hugely important export market for many producing countries, does not operate in a bubble and while we see demand for wine slowing here there are emerging markets perfectly capable of taking up any demand deficit,” continues Thorpe. “For the first time in a long while global demand will exceed supply and the natural outcome of that economic equation is that prices will rise, which is bad news for the wine category overall given the lack of consumer disposable income and inflationary pressures.”

A key concern is that the UK, along with other economically fragile Western nations, risks an acceleration of an already established trend. Wine producers around the globe have become increasingly vocal about maintaining a minimal presence in the UK, while putting their resources, time and sales and marketing budgets into other, often emerging markets, that are delivering growth coupled with sustainable margin.

As Michael Cox, European director at Wines of Chile, points out: “The UK should have built price increases in during the economic good times before the downturn but, regrettably, the opportunity was missed and we may pay the price now.”

WORLD VIEW

It’s worth crunching a few more figures to highlight what is going on globally – and especially in the most keenly followed developing market of China – to help assess what this bargain basement approach means for countries such as the UK.

When Accolade Wines unveiled its Wine Nation report in late 2012 it predicted that the US and Asia would drive growth in global wine consumption by as much as 6% percent over the next four years. Focusing in on China, the report further predicted that 2012 per capita consumption of two glasses could increase to 1.5 to two bottles over the next two to three years.

“If this is the case, 1.2 billion extra bottles of wine will have to be found to satisfy demand,” concluded the report. Alongside this statement was an idiot- proof graphic highlighting global demand in three simple phrases: “supply down + demand up = pressure on price.”

ASC Wines, a leading mainland China importer and retailer, concurs that strong growth will continue, albeit suggesting more conservative figures than Accolade.

“There is no doubt the wine market in China will continue to grow and we anticipate by 1.5 to two times over the next five years, but it is very difficult to predict as China continues to develop rapidly,” says David Lucas, vice president of brand management and trade marketing at ASC Fine Wines.

China, of course, is only one of many increasingly thirsty emerging wine markets, which include the other BRIC countries, along with the Chinese diaspora and other nations throughout East Asia, plus African countries and the likes of Turkey, Mexico and Indonesia. Upwardly mobile professional and middle classes, for whom wine is a symbol of status and sophistication, are fast growing worldwide.

OECD figures from 2012 suggest a rise in the “global middle class” from around 1.8m to around 3.2bn by 2020. Put another way, an earlier OECD report (OECD Development Centre Working Paper 285) predicts a shrinking of North America’s share of middle class global purchasing power from 26 percent in 2009 to 10 percent in 2030, with Europe’s share dwindling from 38 percent to 20 percent over the same period, while Asia Pacific is set to grow from 23 percent to 59 percent.

These may be intelligent guestimates, but even allowing for a wide margin of error the inference is clear. Put very simply, Western buying power is diminishing at a time when there is increasing global thirst for limited supplies of wine (and not just the 2012 vintage). It’s against this backdrop that the future of the UK wine trade will play out.

What is also increasingly apparent – this especially pertinent as the 2012 shortfall plays out through 2013 – is that the number of countries or regions not just willing, but also financially able to step into the breach and plug a volume gap on multiples’ shelves has diminished significantly.

Few producers can now sustain the deals expected by UK consumers and make any margin.

ON THE SHELVES

In terms of winners and losers on the UK’s shelves, more ample harvests, coupled with an easing of exchange rates, may see countries such as South Africa and Chile gaining some ground, along with California, all of which have delivered reasonable volume vintages. But even here the major players point to inflationary domestic pressures that are continuing to impact on the cost of production.

Meanwhile, Australia’s UK- bound exports continue to suffer from the strong Australian dollar making exports to this traditional market less profitable than eagerly sought (and growing) share in new territories such as China.

“I don’t think anyone will walk away from the UK market at the moment and there are opportunities in the mid-to-longer term,” says Garreth Anderson, DGB managing director UK and Ireland. “But inflation in South Africa is very significant, so while currency has eased, perhaps throwing the quality value relationship in the wines into sharper relief, opportunities for sustainable growth are going to come at higher price points.”

Cox, speaking generically for Chile, takes a similar line, suggesting that while 2012 was modestly up in terms of volume, this came on the back of below- average harvests in the previous two years. “This has eased the situation, but there is still upward price pressure for bulk wine because of rising labor, transport and dry goods costs, while Chile is also realigning itself to greater production of premium wines,” he says.

Andrew Shaw, head of buying at Bibendum, predicted that on-shelf UK retail prices for the cheapest offerings from Spain, Italy and France will increase by 10 percent, ameliorated to a degree by an easing of the euro/sterling exchange rate, but tempered by a consumer that will bear very little in the way of price hikes. He also suggested that there will be an increase of “lookalike” brands replacing key lines such as Pinot Grigio (predicting a 20 percent fall in lower-end sales) and Rioja, where price increases on the back of shortages will force the cheaper offerings off the shelves.

“The New World will play an increasingly large part in entry-level products and the promotional mix. South Africa will fuel much of this business, and a return to Australia and Chile will feature to a lesser extent,” concludes Shaw.

In terms of the hardest hit categories, Jeremy Howard, Slurp CEO, highlights the following: “Sauvignon Blanc from New Zealand will probably see one of the highest relative price increases at around 18 percent across all varieties, and Burgundy has been widely predicted to rise as much as 30 percent in cost over the 2011 vintage, while Italian Pinot Grigio at a price point consumers expect is becoming an increasingly difficult proposition.”

FLIGHT TO QUALITY

Elsewhere, others have suggested that Europe’s recent rebound against the New World will continue in the UK, but this will be increasingly driven by higher- priced offerings rather than predicated primarily on low-priced volume.

Shaw’s colleague, Bibendum director Simon Farr, suggests that consumers will increasingly be forced to spend more, delivering a change of purchasing behavior, playing to the strengths of independent merchants’ lists and, at mid-to higher prices, Old World wines.

“Given that £5 no longer pays for any wine in the bottle and it’s only at £7 and above that anyone can really make any money down the supply line, the customer in this climate will not want some ‘Château Kiss-Me-Quick’ created in an office,” says Farr.

“Instead, in addition to quality and price, they will buy into other reassuring factors such as heritage, prestige and tradition, and in most instances this favors the Old World and the lists of independent merchants.”

UK importers such as Matt Douglas, managing director at Stevens Garnier, agree. “In part the Old World resurgence has been driven by the currency exchange rates making the New World wines significantly more expensive, along with the Australian production reduction, and this, combined with the ‘cleaning up’ and flavor profile changes from countries like Spain will ensure the Old World increase will be here for some time,” he says. “The movement back to the Old World is more structural, although it is susceptible to a sum of effects, which could change in a short period.”

Farr may also be correct in stating that independent merchants will fare better than their multiple rivals, although times are tough in this sector too, says Cambridge Wines managing director Hal Wilson. “With higher-than-inflation duty and price increases, as with all independents, we have had to reduce our cost base and margins have been squeezed, and if we push through 15 percent price increases, we are not going to sell wine,” he states.

“Prices are likely to rise across the board, but the real pressure will be on lower quality wines, so this may be more of a crisis for supermarkets. However, even retailers like Cambridge sell a majority of wines at the more modest prices so rises will have an impact on sales, but we can explain to customers why price rises are happening.” Perhaps a final word should go to Tesco’s Jago, who preaches a good line while presiding over a wine retail operation that many would suggest has helped deliver the bargain basement mentality of British wine buyers.

“Price is the biggest issue, especially with brands, in that few give much rationale as to why consumers should spend more,” says Jago. “The wine industry needs to look hard at how to convince consumers that wine should cost more than an entry-level price by giving them reasons to spend more money.”

On the back of the 2012 vintage, this seems an increasingly likely necessity for the health of the UK wine trade. Quality, not quantity, is clearly the message for the future. Otherwise we may all be tweeting “OMG!!”

Feature Findings:

  • As global demand exceeds supply, price rises will inevitably ensue, and it is likely that producers will focus on emerging markets at the expense of the UK.
  • Few producers can now sustain the deals expected by UK consumers and make any margin.
  • The likes of Chile, South Africa and California may gain ground on UK shelves, but growth opportunities come at higher price points.
  • Consumers will increasingly be forced to spend more, playing to the strengths of independent merchants and Old World wines.
  • Prices are likely to rise across the board, but the real pressure will be on lower quality wines, so this may be more of a crisis for supermarkets.

Insights and Predictions:

  • “For the first time in a long while global demand will exceed supply and the natural outcome of that economic equation is that prices will rise,” thinks Simon Thorpe, managing director, Negociants UK.
  • According to the OIV, estimated total global output fell from 264.2 million hectoliters in 2011 to 248.4m hl in 2012, representing the lowest level since figures were first collated in 1975.
  • Projected final global consumption for 2012 is between 235.7m and 249.4m hl, with 30m hl of this wine absorbed by industrial usage, says the OIV.
  • Accolade’s Trends Report 2012 predicts that the US and Asia will drive growth in global wine consumption by as much as 6% over the next four years.
  • China’s consumption is predicted to rise from two glasses of wine per capita to 1.5 bottles per capita in the next two to three years, meaning 1.2 billion extra bottles will be required to meet demand, adds Accolade’s report.
  • The “global middle class” will grow from around 1.8 million to around 3.2 billion by 2020, states the OECD.

SOURCE: The Drinks Business

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