In our last blog, we presented 5 reasons why we are headed for a hop crisis. Today, let’s explore the solution.
Bank support is dwindling. A grower friend of mine is having trouble getting financing from his bank as we speak! He has hop contracts for almost everything he plans to grow … still problems. The bank tells him they’re not comfortable with the level of risk. Merchants have financed some steps are unlikely to finance the next step of expansion. There are few financing options that allow for a rapid increase in production capacity. Venture capital and private equity would be other options that could enable a quick expansion. Some of those guys read this blog. Unfortunately, even with the current market, hops don’t provide the type of returns that attract most professional investors. They’re more likely to invest in breweries.
So why does everybody think there so much risk? This market looks like a no brainer for people from the outside looking in. It is anything but simple. Enduring a risky high priced spot market during a shortage is one thing. Deals come and go quickly. You’re in, you’re out … badda bing, badda boom! It’s a spot market so you’re only gambling with the chips that are on the table. Usually, the buyer has his money on the table and ready to buy when you’re buying the hops. A high-priced contract market based on brewery projections for growth and farms that are stretched to the limit, on the other hand, that lasts for years. That is another game all together. Sure, there are profits built into the prices at both the merchant and grower levels. Those potential profits represent only a fraction of the potential losses though if the market falls apart. For that reason, some people are getting a little nervous at the speed of the expansion as we approach this next very expensive step of expansion.
To A Mouse
But, Mousie, thou art no thy lane [you aren’t alone]
In proving foresight may be vain:
The best laid schemes o’ mice an’ men
Gang aft a-gley, [often go awry]
An’ lea’e us nought but grief an’ pain,
For promised joy.
– Robert Burns 1786
As with the mouse’s nest in the poem above, the problem comes and the house of cards falls apart if the grand plans for the future are not realized. For that reason, some are cautious. The length of the market and the risk involved creates chronic risk, the type the hop industry has not seen before. Rather than a card game, it’s like playing Russian roulette over and over and over again. The longer you play, the more likely that something can go wrong.
Without banks that are willing to finance growth, the next step in the evolution of this high stakes game is very likely forward payments. If growth and infrastructure expenses continue, risk will continue to grow as the industry falls deeper and deeper into debt. That debt is only repaid when everybody down the line fulfills their obligations. Some people certainly won’t have an appetite for so much risk and will take only the risk with which they are comfortable. That risk needs to be minimized for the industry to continue to grow as a whole. The safest way to do that is to transfer that risk to its source, hence the idea of forward payments. Forward payments are just what they sound like, payments prior to receiving the product. Any people 35 or older out there might remember when stores used to put something on layaway. Forward payments are like a layaway program and will curb the temptation by brewers to buy hops speculatively on growth about which they are not certain. There is some of that going on right now. In addition to reducing risk, forward payments for hops inject stability into the system so the brewer can be sure he will receive his hops. Mother Nature can still turn the table over and mess up everybody’s cards, but that can happen with agriculture at any given moment. In the worst-case scenario, if a crop was severely short, a farmer might have to return some of the money to the merchant, who might have to return some to the brewer, but that’s as bad as it gets.
Forward payments could be structured as follows:
Payment of a 1% signing fee at the time of signing the contract,
Pay 33% of the contract value in the spring before the harvest,
Pay 33% of the contract value in the summer just prior to harvest, and
Pay the balance of the contract value by November 1st, after harvest.
I guarantee you … right now, after reading those 5 lines above, EVERY hop grower and EVERY hop merchant out there is thinking what a relief that would be, but how unlikely it is to happen. See how happy Kevin Spacey and Helen Hunt are in the picture above. Obviously forward payments makes you feel good too … so there’s that too. Many brewers say they care about the hops they purchase and want to support the industry. This would be a concrete way to demonstrate their concern for the sustainability of the hop industry and make a difference. Sure, it can just be that nobody has asked for forward payments yet, which is why nobody is paying this way. Maybe it’s an idea that will take some time to digest. It’s not all about money either. The closer relationship that would develop from this payment system would increase communication and stability as hop growers, merchants, brewers and beer drinkers will all be in the same boat. It would create a type of partnership between growers, merchants, brewers … and the beer drinkers. In that way, it’s a bit like crowd sourcing for the hops used by a brewery, but with an immediate deliverable to the end customer, the beer they’re drinking. That’s better than the promise of something down the road that may or may not materialize such as on Kickstarter. Granted, all of this seems like a pretty big leap from where we are today, but every idea must start somewhere.
Complicating things is that it all needs to happen very quickly given that the hop industry is quickly approaching a cliff. Continuing down our current path does not mean the end of hops as we know them of course. That would be ridiculous. There are other ways for the industry to grow, but they involve drastically higher hop prices and more extreme sharper turns down the road.
If brewers want to continue to receive a secure supply of hops as the craft market passes 20% of the U.S. beer market by 2020 forward payments or something very similar will be necessary. Unless some other source of money steps in like venture capital or private equity, banks are the only option at the moment for the scale of financing necessary at the moment. Remember that $1 billion dollars I mentioned the hop industry would invest by 2020? Conservatively, the U.S. hop industry spent $200 million for the growth in 2015. We’re well on our way and the expensive part hasn’t even started yet. Another $500 million must be spent in the next 2-3 years by hop growers to keep pace with the craft industry.
The reward for this shift in the payment schedule will be lower prices than are available on the regular market and, of course, guaranteed supply. In the old days, merchants used to advance growers money in the spring and prior to harvest. In the apple industry, packing houses give advances prior to harvest. Today, merchants financing farms where banks will not take the risk is happening. That’s not enough! Some merchants are getting low hop prices in exchange for that financing, making interest from the grower on the money borrowed … and a wider margin from the brewer at the same time. While that’s a great way for a merchant to make a side investment in the hop industry, it’s not a sustainable solution. It adds even more risk into the equation and puts both merchant and grower at risk. That’s a strategy that could work indefinitely if the industry was stable, but not at the current levels of growth. Not even the wealthiest hop merchant can finance 8-9 new hop farms at $20 million each. That’s how many new farms we need each year for the next few years.
ONE WAY OR ANOTHER
Brewers will pay the price to sustain the growth in the hop industry one way or another. They can choose to pay as they go, or they can pay all at once. I know that sounds harsh, but the money only flows from one source and that’s the way it always happens. Some will choose the former. Others will choose the latter. Who can say which is more correct? I suppose that depends on where you sit. Chances are though that if you don’t like $15-20 per pound of hops for the next 5-7 years, you really won’t like the idea of $100 per pound for those same hops for a year or two. It’s harder to make such high prices cash flow. Somebody has to take the next step. It would be nice if that step was one that reduced risk instead of increasing it.
It all starts at the beer drinker. Are consumers willing to pay 5-10% more for a glass of beer to finance the expansion of the hop industry? Honestly, I have no idea, but that’s all it would take to finance the necessary expansion. Can brewers collect that extra money and pass it along? I’m sure that can happen. If not, we better get used to drinking less hoppy beers, and forget about that whole craft revolution thing.