In the future, in hindsight, the 12 months between now and November 2018 will go down as the most significant time in the industry’s recent history. The next 12 months will likely determine the next 12 years for the hop industry. You’re probably thinking that’s a pretty bold statement and maybe even a little bit exaggerated … but it’s true. If you want to learn why, read on.
Brewers are beginning to realize that there is an alpha shortage. Unlike in 2007, when alpha prices tripled on the second day of the three-day Brau trade show in Nurnberg, the 2017 alpha market is playing out in slow motion, although they have doubled since pre-harvest price levels. If you’re not in the market for alpha hops, you might not even feel anything has changed. That’s because it’s all happening behind closed doors. It’s not a cabal of conspiracy-minded insiders secretly controlling the price. That would be exciting, but the hop industry isn’t so organized. By the luck of the calendar, this year we all assembled in Munich for Drinktec in September rather than in Nurnberg for Brau in November. That simple fact is one reason we do not see a frenzied rush for alpha and prices spiking.
Drinktec is a fun event to attend, but for the hop world it is not very useful due to the timing. Drinktec happens in September, so harvest and yields are only unfolding. It was clear the European drought of 2017 took a toll on the German crop, but nobody knew yet in September what prices or volumes they could offer. Only a few insiders took a risk and used their knowledge to buy remaining stocks from farmers who could not yet see the bigger picture. Nobody could say with any certainty in mid September how short the German crop would be. The result was that at the Drinktec merchants took a lot of orders from brewers and promised to get back with them later when they knew what was available. That dialogue is still happening today and playing out.
But wait, wasn’t this supposed to be an article looking ahead to 2018? Why are we lingering on something that happened in September? I’m getting to that part now … but first a little more backstory. With the surge in demand for American aroma varieties over the past 8 years, American hop farmers rushed to plant all the aroma hops they could. Acreage doubled. This created a deficit for alpha hops to which the German growers responded. Today, German growers produce more alpha hops than aroma hops while the situation in the U.S. is exactly the opposite. That is exactly the opposite of the way things were 10 years ago, during the previous alpha shortage. That is one reason why the market may be more volatile in the future than it has been in the past. I’ll get into the specifics of that more in a later blog. For now, let’s just focus on the next 12 months.
What do we know?
- We know the hop market is fragmented and each of these fragments act independently of one another.
- We know that there is a surplus of many American aroma varieties. Brewers are over contracted. They are having trouble getting out of those contracts. That has caused a massive amount of hops trying to find their way to a buyer through new and established channels. The result is that there are more people playing hop merchant today than ever in history.
- We know that aroma acreage will increase yet again in 2018, meaning that the problem with American aroma supply will worsen before it improves.
- We know that over 1/3 of the supply of American aroma varieties consists of proprietary varieties. The burden of management of that oversupply falls upon the owners of those varieties if they wish to maintain future pricing of their proprietary varieties at current levels.
- We know that due to German emphasis on planting alpha varieties in recent years there is a deficit of German aroma varieties. German farmers would be happy to plant more of these varieties. At the moment, they will not do it for less than their cost of production. Brewers who buy these hops are accustomed to those markets being in oversupply and therefore do not wish to pay the prices currently being requested by farmers. The deficit of these varieties, therefore, will likely continue for the foreseeable future.
- We know that the worldwide alpha surplus is gone. There is currently an annual deficit in the production of established high alpha producing varieties. The German drought exaggerated the effects of this deficit causing a price surge. The worldwide alpha balance is slightly negative relative to anticipated demand for the next year.
- We know American growers will search for something to plant in acres they must remove due to over production caused by excessive brewer contracting.
The alpha market today is near a point of equilibrium. While that sounds positive, it creates instability. With the lack of clear signals of surplus or shortage, some farmers may interpret the current situation as an opportunity to plant additional alpha varieties. Farmers may try to take advantage of what they think is an opportunity to profit. They may think they are the only ones with this idea. History has shown us that farmers rush into a market that does not yet exist to grab an opportunity they perceive may exist in the future.
What we don’t know is much more relevant to what will happen during the next year. If you’re still reading this blog, you’re probably hardcore into hops, which means this next part will appeal to you.
- We don’t know what the 2018 crop will yield. That is obvious, but it is more relevant today because of the lack of a surplus in two distinct hop markets, German aromas and world alpha. Uncertainty as to the supply from the 2018 harvest means that the market will be tight until such time as it becomes obvious what the new crop will yield. Since that cannot be known until August in Europe, we have some tense months ahead that may present many opportunities. A normal crop will alleviate any fears of shortage. A short crop again in 2018 will send the prices of many varieties skyrocketing.
- We don’t know what American farmers will do in response to surpluses in some aroma varieties. If they idle acreage of some aroma varieties, they will give time for demand to grow to meet the current production capacity.
- We don’t know if American farmers will plant high alpha hops without forward contracts in response to current alpha pricing levels. Without forward contracts available for American alpha hops, this would be a purely speculative gamble. That sort of thing has happened in the past. The combination of additional alpha hops from the U.S. together with a normal German crop would be catastrophic.
That’s a lot of information to digest. In short, the alpha market is short right now because not enough alpha acreage is in the ground. The German aroma market is tight right now due to the drought. The American aroma market is in surplus. That surplus is mostly contracted to breweries, which can be as much as a year behind in paying for those hops. That delay places the additional burden of long-term financing on the hop industry. Farmers would likely remove the unnecessary acreage, were it not for the contracts in place. The American aroma supply problem will likely continue to worsen before it improves. Much of that problem is privately held due to the popularity of proprietary varieties. The financial burden will be on those companies. If American growers shift back into high alpha hop varieties in 2018 in an attempt to maintain acreage while fixing the aroma supply situation, they will create oversupply in the alpha market.
The situation is complicated. The shift of alpha varieties to Germany created a situation that is inherently instable. German hop yields depend on the weather, which is unpredictable. Less than 20% of German hop acreage is under drip irrigation. Unlike American farmers in the Pacific Northwest who are focused on the bottom line, when German farmers plant hops, they intend to leave them there for generations. German farmers will not likely remove their alpha hops anytime soon. A German merchant friend of mine once told me, “German farmers can live without money, but they cannot live without hops”. American farmers could inject much-needed stability into the alpha market with their more predictable yields. Unfortunately, with the current production capacity in Germany there is no need to encourage production of additional alpha from the U.S. Any American surge in alpha production will ultimately suppress alpha prices for the better part of the next decade causing the vicious hop cycle to repeat itself, once again.
Banks lent the American hop industry hundreds of millions of dollars during the past 7-8 years. In doing so, they have facilitated their ability to outpace the growth of the fastest growing beer market in the history of man. Banks also now have the ability to manage the market so as to minimize the chaos. They must first realize that difficult decisions in the short-term will reduce the likelihood of massive losses in the future. To make those difficult decisions, they first must know the questions to ask and where to search for the answers. It would take somebody who knows the industry inside and out, like yours truly, to show bankers where to look.