5 Reasons Why The Next Hop Crisis is Coming & How to Avoid it: Part 1

Last weekend, while at dinner with some hop friends, an interesting scenario came up during conversation. Granted, it’s partly hypothetical at this point, but the possibility should concern every brewer in the world.

WHAT IF?

The question was this … “What if, due to the risk involved with expanding quickly, growers and merchants let their own appetite for risk drive the pace of growth instead of letting the demand from the market dictate the pace … and what if those two things are not aligned?”  What??  That’s crazy!!!  Right???  Hop prices are going up.  Why wouldn’t everybody grab the new business? Isn’t it the American way, or capitalism, or greed … or something inherently in people that makes us naturally crave more, or for a better life for our children … or something like that?  Why would anybody in their right mind not take full advantage of the current market?

It’s not as crazy as it might seem on the surface to envision a situation where the market enters a perpetual state of shortage of necessary varieties.  It comes down to a question of RISK … Who is willing to take it, how much, when and what will it cost to for growers and merchants to be compensated adequately for taking that risk. Everybody has a certain risk/reward tolerance level. The next step of development in the hop industry is about finding the comfort level for the two powerhouses of the global hop industry, the American and German hop growers, so they make the investments necessary to expand.  Everybody from brewers to beer drinkers should care about this next step as it affects hop availability in the future.

In case you think I’m heading down some hypothetical rat hole exploring this line of thought, there already exist concrete examples of the appetite for risk affecting supply in our hop world. The reason our Czech grower friends seem unwilling to plant more hops is reason #1 why we’re headed for a hop crisis.

They are not confident in the longevity of this market.

What they want, it seems, are 10-year contracts at sustainable prices before they’ll consider expanding acreage.  Some of the Czech merchants are starting to get what they wished for but only after 2 years of near zero availability on the market.  We recently learned that some volumes of Czech hops are now contracted until 2025! Even with these new contracts, there are no grand plans for acreage expansion, although some excess capacity remains.

Another example I like to mention from time to time concerns our hop friends from New Zealand and is the reason #2 we’re headed for a hop crisis.

They won’t get too excited and ramp up for just one popular variety.

They seem to be relatively content with their current level of production. I have to admit, I thought that was crazy when I first heard it (no offense Doug Donelan). Since then, I’ve come around. Now, I understand exactly what they’re talking about. What would they like before they increase acreage?  They want customers interested in their entire basket of varieties, not just one. That makes sense! You wouldn’t marry somebody just because they think you have a nice smile. Similarly, you can’t build a new farm for one popular variety that people may or may not like in a couple years. Whose to say three years from now preferences won’t change yet again? People’s tastes change pretty quickly these days.  Do you even remember “What Does The Fox Say?”  New varieties can take 5-10 years to develop. With a market that prefers new flavors, can you blame growers for being cautious about assuming risk? So, if you want Nelsons, you better also start liking Dr. Rudi, Motueka and a few other New Zealand varieties.

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35 MILLION BARRELS

There was a statistic floating around the CBC that there are roughly 35 million barrels of beer production capacity in the US.  There are roughly 22 million barrels produced now. At the current growth rate, they proclaimed that entire capacity should be used within the next 3 years.  If that much more beer will be produced in that short of time, American growers need 12000-13000 more acres by crop 2017.  That’s a LOT of new farms … inconceivable you might say. If I had to guess, I’d say there are 3-4 new farms in the works for 2015. They are the talk of the industry because nobody else can afford to think about doing that yet despite the fact that prices have risen quite a bit in the past few years. To keep pace with that level of demand, we should be already know of plans for 8-9 new farms going in for 2015 with enough extra financial capacity and plans on the books to do it again for 2016 and again in 2017.  The fact that that growth is not there represents a risk for brewers.  The hops they think will be there might not actually be produced. Then, of course, there’s the inherent threat of water and Mother Nature.  It is agriculture after all, not a Apple iPhone factory in China.

Brewers assume that hops will be there when they need them. They assume the main variable is price. Sure, hops may cost more, but they’ll be there if you pay the price. Sure, higher rewards make everybody more willing to take risks. The rate at which prices are increasing has been enough for growers and merchants to assume the necessary risks the past couple years.  A more serious level of expansion is upon us in the next 12 months and with it comes more risk. There’s a need for higher prices or greater stability to make people willing to assume the risk associated with the next step.  Do you remember the blog where I mentioned that between then and 2020?  I claimed American hop growers would need to invest $1 billion? I still stand by that number, but the spending necessary in the next 3 years are the cause for reason #3 we’re headed for a crisis.

In the next 2-3 years, the U.S. industry must spend over $500 million.

If they don’t spend this kind of money on infrastructure, brewers will need to adjust their expectations and their recipes. An actual hop shortage, a time when there may not be enough hops to brew all the beer that needs to be brewed, may soon be upon us.

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TEAM AMERICA

OK, Czech and New Zealand are just two extreme examples, you say. Surely, it can’t be that in the good ole US of A though, where cash is king and where people eat risk for breakfast, that growers are reluctant to take advantage of an opportunity to expand.  There may still be more appetite for risk in the U.S. than in Europe, but even American growers are starting to reach limits, which is reason #4 why we’re headed for a crisis.

Some of those limits are being imposed upon them due to a lack of money available.

To brewers paying more now for hops now than in recent memory, that may seem hard to believe.  For growers in other countries who covet the American prices they only dream about, that must seem ridiculous.  Hops are profitable now to be sure at current prices.  If there was no growth necessary, every grower would probably have a new truck. The growth, however, is eating up all that profit and more. The current profits are not enough to finance the growth necessary to meet the current demand.

The supply chain is only as strong as its weakest link.  It seems hard to imagine, but there are also growers delaying expansion. Those may, at the end of the day, be the strong ones.  They have acres they can plant in 2015, but don’t. Instead, some are waiting until 2016 when, they say, prices will be higher.  When I first heard that, I thought, “Those greedy bastards! They just want more money”.  Maybe you’re thinking the same thing now. That’s not the whole story though. Sure, some growers are just greedy bastards, there’s no denying that. You can’t throw them all in that group though.  Some want to expand, and can’t find ways to finance it. That’s a bigger problem than you’d imagine. Others are waiting because they don’t want to stretch the farm and their finances too thin.

All that needs to happen now to continue the growth is for everybody’s financial projections to materialize in the real world. Can everybody deliver on the promises they’ve made? More farms today are like a house of cards on a creaky table hoping there are no storms on the horizon. Costs to expand are fixed. Plans for expansion in the future require commitments today. Today’s profits are committed toward tomorrow’s expansion. If somehow, the current step doesn’t happen as planned, it’s impossible for next steps to happen at all. All of this means, more than normal, that there is no room for a misstep in the 2015 crop. Talk about risk!! Pull out one card and the rest of the house of cards tumbles. Loads of risk on the farm translates to loads of risk for everybody.

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As hops get more expensive, the bets that merchants place and the consequences on those bets failing increases together with price.  As the risk of them losing everything grows and the reward relative to the size of the bets placed gets smaller, those bets become less attractive. As the situation gets more extreme, will some merchants lose their incentive to participate so aggressively to supply the market? Of course, all these bets are “calculated risks”, but at the end of the day they’re still bets.  At some point, without higher priced long-term contracts, there is less incentive for a merchant to ante up for every hand that is dealt at the table. I’m not saying they’ll sit out the entire game, but they may decide not to play a hand or two. The risk/reward ratio is a factor.  There is one sure fire way to fix the problem with expansion that plagues the industry today. We’ll get into that in Part 2 of Why The Next 5 Reasons Why The Next Hop Crisis May be Coming & How to Avoid it next week. Hint: It doesn’t involve shortage-style prices or contracts that last until forever.

Wait a minute … I promised 5 reasons and that’s only 4.  Reason #5 we’re heading for a crisis, which proves that these reasons are in no particular order (if you were wondering) is simple:

World alpha acid inventories are decreasing quickly, but demand is not.

OK … maybe you’re into craft and you don’t care so much about alpha. Start caring! Hops are hops and when there’s an alpha shortage even a Cluster with 5% alpha that is available when others aren’t becomes the sexiest variety around.  The alpha market is cyclical and the stars are lining up again.  I won’t get into that in too much detail unless you want me to. Send me an email at blog at demackinnon.com if you’d like to read about that.

STAY TUNED FOR PART 2: