AUSTRALIA SUPPLY: Up and downunder

Trying to balance supply with demand is putting Australia’s wineries in a spin. One minute they’re facing an enormous surplus, then widespread drought threatens to produce a deficit. Penny Boothman reports

If the global wine industry was a funfair, it’s my guess that France would be the carousel, (traditional, reliable, but nice); California would be the bouncy castle, (always entertaining, even for grown-ups); the UK retail trade would be the hall of mirrors and goldfish in plastic bags would be on BOGOF. Australia? Australia would be the rollercoaster.

Gross generalisations aside, Australia screamed onto the international scene some 20 years ago, and has been suffering the nauseating ups and downs of supply and demand ever since. At first there isn’t enough wine to go around, then there’s more wine than they know what to do with, and if some predictions are correct things could be swinging back the other way before too long. For the last couple of years the Australian industry has been splashing around in quite a lake of wine, but where did this surplus come from, and how much surplus wine is there really now?

For the last year Australia has been up in arms and down in spirits over a glut of 900 million litres (a mere drop in the ocean of 2.8 billion litres that was distilled in Europe in 2005). However, a recent reworking of the figures by the Australian Wine and Brandy Corporation has placed a new, apparently conservative, estimate of the surplus at around 450m litres. This time last year, the AWBC was predicting a return to supply and demand balance by 2009-10, but it now expects the lake to be drained as soon as 2008. And when you consider that the equivalent of 2.5m bottles of wine now leave Australia every day, this doesn’t seem like such an outlandish proposition.

Feeling the pinch
Following an export-driven planting boom in the late 1990s, three bumper harvests in 2003, ‘04 and ‘05 sent stock levels skyward, and unit prices through the floor. Consumers are happy and retailers are rubbing their hands with glee, but the production side has been feeling the pinch. Many winemakers still had wineries full of wine at the beginning of the 2006 vintage, and so the bulk-wine market was flooded with unprecedented quantities of quality wine.

Just as California had the Two-Buck Chuck, the Australian domestic market is now awash with “cleanskin” wines – unbranded and mostly even unlabelled bottles, selling for as little as A$11.95 for a case of six bottles of Chardonnay. A particularly unfortunate part of this phenomenon is that the bottles come with (usually erroneous) whispers that the cheap plonk you’re drinking actually hails from a rather fine winery. Katnook Estate recently settled out of court with The Australian Salvage Wine Company, which was selling a Cabernet Sauvignon cleanskin for $12 and labelling it as the award-winning 2002 Katnook Coonawarra Cabernet Sauvignon, which retails for A$46.

There will always be plenty of wine at the cheaper end of the scale and, by definition almost, never quite enough of the landmark wines at the top of the ladder. However, a good deal of the surplus is unfortunately coming from cooler climate, higher-quality regions, which are of course more costly to cultivate. Grape prices have been falling across the board, and if the cool-climate growers have been dropping their asking price, how much lower can those already at the bottom of the price scale really go? Government aid is sought, and denied. Government advice is given instead; remove vineyard, mothball vines, do not prune vines, do not pick fruit, because no-one’s going to want to buy it.

Freak frosts
But then nature intervenes. Growers who took one on the chin from the government and mothballed a portion of their vineyard were then knocked out by a quick one-two from mother nature: freak frost incidents, and a seemingly unbreakable drought. Unseasonably severe frosts over much of Victoria and South Australia at the end of October and the first half of November have lain waste to as much as 60% of production in some areas, with many vineyard owners losing their entire crop. The Yarra Valley was decimated overnight when temperatures suddenly plunged to -3.6C. The Victorian Wine Industry Association has estimated revenue losses of A$39m for the State’s wine industry. Production has also been seriously curtailed in South Australia with the Coonawarra losing more than 50% of its crop and the Barossa Valley, among other regions, also badly affected.

As catastrophic as these frosts are, they were isolated incidents. A more serious natural disaster is waiting in the wings; drought. In the worst drought in a generation, irrigation allowances have been cut across the country, with the vast Riverland growing region receiving 60% of its normal water allowance, and one grower in Victoria reportedly expecting just 27%. Water can be bought on the open market, but prices of A$400-A$500 a megalitre (compared to the normal A$30-A$40) are out of reach for many.

Some commentators have been celebrating the fact that The Big Dry is going to evaporate the wine glut, but when nature’s in control, how easy is it going to be to turn the tap back on once the surplus has diminished? The real danger of the drought is long term. This year there may be just enough irrigation water to go round, next year there may or may not. And the year after that?

The real crux of the matter is finding a balance between supply and demand, which is easier said than done in a cyclical industry where new plantings take several years to come on stream, and the uncertainties of the weather can strike at any time. The future of the Australian industry could indeed be about not having enough wine, rather than having too much. The 2007 harvest is already forecast to be 25% down on last year, at an estimated 1.5m tonnes, with some putting it as low as 1.2m tonnes. 2008 will be similarly – or more severely – drought-affected, save for miracle rains next winter.

When times get tough in any market, belts get tightened, and consolidation has been a significant feature of the Australian industry over the last year. Smaller producers have been struggling since the oversupply situation began, but there are smoke signals coming from the bigger players in the industry which perhaps tell the true story of things to come. Larger companies have been reducing fixed costs by streamlining production operations. Constellation, for example, quickly jettisoned Western Australian Goundrey Wines and Amberley Estate, acquired through their Vincor merger earlier this year.

Cancelling contracts

McGuigan is unpopular with some grape growers again this year as “market disruption” clauses written into their contracts allowed them to suspend or cancel grape supply contracts with 160 Riverland and Murray Valley growers for the 2007 vintage. This time the company has given growers enough notice to make alternative arrangements, but a similar move just two months before the 2006 harvest began threatened them with legal action. And understandably so, as at the same time McGuigan had released a positive spin statement to shareholders saying that stocks were in balance and they had
plenty of room for the ‘06 vintage wines.

Foster’s has recently done some serious streamlining of its production and packing facilities, selling installations including the Seppeltsfield winery and the Penfolds’ white wine production facilities in the Barossa. It is also divesting itself of its wine clubs and services business, and is preparing to sell the large VinPac contract bottling business in South Australia.

Liberating assets is one thing, but there are other ways of staying in the black when times get tough. “There are a couple of overall points that describe the mechanics behind our wine business model profitability,” explains Troy Hey, manager external communications, Foster’s Group Ltd. Foster’s use supply management and demand forecasting to control assets and stock levels, and keep everything running at “best cost” efficiency.

“A focus on sustained brand investment, (between 8-10% of revenue) creates a pool of funds behind such global brands as Wolf Blass, Lindeman’s, Penfolds and Rosemount that drives these brands, which together return the bulk of group wine earnings,” says Hey. Meanwhile, “Product strategy ensures forward grape, wine and spirit commitments deliver profitable products, and provides a financial plan for each of our products – i.e. there is no product cross-subsidisation, each product must be profitable in its own right.”

Even when a couple of lighter harvests do come in, producers large and small will still be wearing the financial scars of recent difficult years. This is not an instant bounce-back situation. Winemakers are still crunching numbers, and waiting to see what the real outcome of the 2007 vintage will be, but the dynamics of the entire Australian industry have changed in the last few months.

It would be interesting to see Australian supply and demand reaching equilibrium; give them the chance to diversify, explore their regional proposal for premium wines, shake out the ranks a bit. With exports to the US storming ahead, and the Asian market just cracking open, producers are very aware – indeed hopeful – that demand is going to increase, and are standing by to up their supply once more. If they can.

You see, you may think you want the ride to stop, but you won’t necessarily be able to get off.

© db January 2007