Why Your Hops May Cost $1 Billion more by 2020!

I’ve heard some criticism about a figure I mentioned in an earlier blog post  “Greedy Growers and Dirty Dealers” in which I said the investment necessary in the industry over the next 5 years could be as high as $1 billion if the growth in craft continues. When I was a student, I admit used to get in trouble for not showing my work on math tests even when the answers were correct. I would do the work in my head. So I’m not guilty of the same mistake here, over this article and the next, I’d like to show how you get to $1 billion.
I’m really only talking about the changes necessary in the Pacific Northwest (PNW) of the US. The trend of smaller hop farms around the US is nice and offers brewers fresh and local hops, but let’s be honest, there’s really no way they are going to keep up with the growth in the craft industry.  No offense to those guys. They’re doing a great job and they definitely fill a niche, but it’s only a niche.  The solution needs to come from growers who can keep pace with the scale of change happening today.    
Investing in infrastructure means different things to different growers. It depends in part how close they are to maxing out their picking capacity.  There are “little” investments that can be made, a million here to expand the kiln capacity, another few hundred thousand to add some extra dribble belts to speed things up a bit. Those are the “cheap” ways of adding picking capacity on the farm.  Those things are happening now and will happen in 2015. Those are baby steps though.  Baby steps alone aren’t going to get the job done.
The hop industry is facing big problems that need big solutions. As Americans, we like to do things BIG, and we thrive on instant gratification. The hop farms in the PNW satisfy both of those needs.  A new state of the art hop farm in the PNW can cost up to $6-10 million.  That farm would be able to pick as much as 1,000 acres the same year it’s planted, assuming the proper variety mix that took advantage of the entire picking season. That’s going to mean lots of Willamettes and Fuggles on the early end of harvest, lots of alpha varieties on the late end and lots of the really popular stuff in the middle.  It costs roughly $10,000 to establish a new acre and that land costs about $10,000 to purchase.  We’ll get into that in more detail in the next article.  So, for the 1,000 acres we mentioned above, that’s an obligation of $20 million for the land and trellis, another roughly $6-8 million for the picking facility.  All for a farm that can pick about 2.5 million pounds of hops assuming good yields on all the varieties, but probably less depending on the varieties planted. The alpha varieties really drive up that average.  All that, and we haven’t started farming yet. Let’s say an additional $9,000 – $12,000 per acre to actually grow those hops, which admittedly includes a good profit for the grower (nothing wrong with that) and you have roughly an extra $10 million.
Table 1: Cost for a new 1,000 acre hop farm
Expense Item
Cost in USD
Description & Notes
Land
$10 million
Purchase 1,000 acres @ $10,000/acre – Of course this can be financed if the grower has 20% to put down. The expense can be reduced and spread out if the land is leased … if the grower can find a neighbor who is willing to lease his land, None of this addresses the lack of available land due to the fact that other crops are also doing well right now.
Establishing Yards
$10 million
Establish a new hop yard on 1,000 acres @ roughly $10,000/acre
Facilities
$10 million
New state of the art picking machine, kiln, baling room, pellet mill (why bale all the hops when 95% of the industry uses pellets?) State of the art … remember.
Growing costs
$10 million / year
Of course, this is a recurring cost.
Total 1st year cost
$40 million
Of course, that’s investment just on the grower side of things.  The grower does a lot of work, but the work doesn’t stop there. The merchants have to store and process a majority of those hops. Raw hop storage isn’t cheap. One warehouse that can hold about 2 million pounds of hops can cost about $1.6 million. All those extra hops have to go somewhere! Then most of them will need to get processed.  That means pellet mills or extractors.  Those aren’t cheap either.  We can probably safely assume an extra $50 – 100 million in investment in infrastructure necessary by the merchants.
None of those numbers are exact, but they’re close enough for government work.  There is a lot of talk about the craft industry reaching 20% of US beer market share by 2020, 20 X 2020.  Whether it’s just a catchy tag line because of all the 20’s or if it’s a reality we don’t know.  If the craft industry keeps growing like it has, between now and 2020, it’ll make it. We care about hops here … So, what does 20 X 2020 mean for hops? 
Check out Table 2 just below this paragraph.  Any way you measure it, the demand for hops used in craft will more than double between now and 2020.  The Brewers Association figure of 1.5 pounds per barrel seems to be somewhat controversial depending on who you talk to.  We know from first hand accounts from our customers some brewers use 3 and even as many as 5 pounds of hops per barrel.  We think it’s worth considering what potentially higher usage looks like so we did the math also for an average of 2 and 3 pounds of hops per barrel.   
Table 2: Potential Hop Demand 2014 – 2020
1
Year
2014
2015
2016
2017
2018
2019
2020
Diff. 2014 & 2020
2
Market Share %*
10.00
11.66
13.32
14.98
16.64
18.30
20.00
+10%
3
Barrels of Craft
Produced (millions)**


18.00
20.99
24.47
28.53
33.27
38.79
45.23


+27.23
4
Pounds of hops  (millions) @ 1.5 pounds/barrel
27.60
32.18
37.52
43.75
51.02
59.48
69.36


+41.76
5
Pounds of hops  (millions) @ 2 pounds/barrel
36.80
42.91
50.03
58.34
68.02
79.31
92.48


+55.68
6
Pounds of hops  (millions) @ 3 pounds/barrel
55.20
64.36
75.05
87.51
102.03
118.97
138.72


+83.52

**  The market share numbers were then used to create corresponding production figures for craft beer during the same period.*  To calculate market share in line 2, we simply used a steady annual rise in market share between the current 2014 market share and the anticipated 20% by 2020.
Table 2:  Analysis of Table 2
Pounds of hops/barrel of beer
Diff. in Potential Usage between 2014 & 2020
New farms necessary @ 2 million pounds/farm
Total cost of infrastructure at $30 million per new farm
1.5
+41.76
20.88
$626,400,000
2.0
+55.68
27.84
$835,200,000
3.0
+83.52
41.76
$1,252,800,000

Table 2 shows a range of potential investment necessary by 2020 depending upon the circumstances, $626 million to $1.25 billion dollars.  Of course banks aren’t going to lend 100% of the money.  On new picking machines, they may lend only 50% of the cost because that’s a single use piece of equipment. You can’t really blame them.  What’s a picking machine worth in a bad hop market?  Most of them still remember 2004 and 2005, when you couldn’t even give hops away.  Regardless of which total investment number you use, growers will most likely need to come up with at least 20% on their own.  That’s a huge number by itself.
Of course, there’s room to massage the numbers any way you like.  You can argue that all new hop farms won’t go to on-farm pelleting. You can argue that growers will lease land instead of buying it wherever possible.  That doesn’t eliminate the cost, but it cuts it down and spreads it out a bit.  On the other hand, you can argue $12,000 an acre is a reasonable return for the grower to expect and that number will increase in the future.  You can argue the price of poles, wire, fuel and labor will all increase between now and 2020.  Like with solar panels, one challenge with growing hops is that the facilities required for production take a long time to pay for themselves.  Unfortunately, unlike with solar panels that can count on the sun being there for another billion years or so, nobody knows how long the demand for craft beer will last.  We all hope the trend is like what we’ve seen in the wine industry, but … honestly … nobody knows.
In next week’s article, we’ll talk about what else the grower has to think about … and … how to avoid high hop prices.

Stay tuned for part 2

2 thoughts on “Why Your Hops May Cost $1 Billion more by 2020!

  1. Douglas MacKinnon says:

    Eljefe,

    You bring up some great points. Of course, I can't speak for any of the other merchants and what they might be thinking. They're welcome to comment here and speak for themselves, but I suspect they won't. More discussion whether for or against the things I write is good for everybody.

    To your point about merchants growing more hops … Merchants growing more acreage for their own sales does not fix the coming supply crisis as costs are legitimately rising across the board. It just changes who is incurring those costs. Those costs continue to rise.

    You mentioned IPOs. That brings to mind the need to begin searching for non-traditional ways of getting around the supply challenges that lie ahead. Brewer/merchant or brewer/grower partnerships, in whatever form they take, will most likely be a part of the landscape going forward. Just like Noah built the ark before the rains came, brewers must act before the hop supply crisis intensifies. The signs are all there for brewers to know what's coming with regards to hops.

    As for your point about $10/lb. hops … we'll see very shortly as harvest is underway. This is the time of year when everybody starts to realize there aren't enough hops. I can tell you demand continues to outpace supply. That combined with the crop not performing as hoped is creating a very tight supply. That $10 number is more realistic to people today than when I wrote the article to which you refer.

    It sounds like you are comfortable because you have contracts. That's what contracts are for! Brewers who have contracted with 47Hops are safe because we are sure to leave a reserve to buffer against short crops. I’d recommend brewers contracted with other merchants get written confirmation that they'll receive 100% of their contracted hops. I mention that because of all the horror stories I have heard from brewers who were also very confident … until they got the bad news.

    That leads to your point on hop contracts … Hop contracts must be honored. If a merchant makes a hop contract with a brewery, regardless of price, they should cover that contract on the grower side when it's signed. If they don't, they're gambling. That's not the type of merchant you want to work with. The changes in the market shouldn't affect previously contracted hop prices or availability if you're dealing with an honest merchant. That's not happening at some companies today. Unfortunately, we get calls every week from brewers who are told by other merchants they will not receive their contracted hops. Naturally, they panic. Fortunately, most of the time we are able to take care of them and get them the hops they need.

    People today want hoppy beer and are willing to pay for it. As long as that's the case, brewers will figure out ways to brew it. There are creative ways to change recipes to make that happen even given the coming hop supply crisis. I don't think we'll see the end of IPAs and DIPAs just because the price of hops increases. Ultimately, the price increases in a pint of beer brought about by the coming increases in hop prices will not likely be significant enough to stop the current craft beer trend.

    I'd like to believe the free market will take care of everybody too. I don't think the free market is a place of fairness and equity though. I believe it's a place where an equitable price can be discovered, but, like you mentioned, those who are established may have some advantages over those who aren't. People who not established, but who are creative will find a way to be competitive too. I'd like to think that's the strength of the craft beer revolution and of our country. The future I see coming is very unbalanced. There will be people who have aroma hops to work with and others who don't and have to make substitutions.

    As they say, necessity is the mother of invention. I believe people's creativity and ingenuity will be the great equalizer in the hop and craft beer industries going forward.

    Doug
    47Hops

  2. eljefe says:

    What are the chances, that Haas and Steiner take an even bigger interest in the farms themselves, thereby financing some of this reinvestment?
    Or some of the largest breweries?
    What's the chance that YCR/HU or smaller companies like Holingberry, 47Hops and Indie hops make IPOs thereby financing part of the reinvestment?

    And when 80+% of the harvest is contracted at an agreed upon price before a single row has been picked, what is that going to do to the price of spot hops and the potential profitability of opening a new Pale/IPA focused brewery?
    I can't believe that we will see average hop prices climbing above $10/lb. for spot hops anytime soon, but I can totally see a surge in style offerings that are less focused on hopping rates. That being said, those of us firmly in the game and well contracted are at such a monumental advantage to those just getting into it, it seems rather unfair…far be it from me to complain about advantages for my own company, just sayin.

    And what of the astronomical contracts of the nations top brewers making all sorts of IPAs and DIPAs? Some of these are purportedly 10 even 20 years out for prices that don't truly seem profitable for the hop industry? Can they be honored?

    Don't know that there are answers to any of these questions but there what immediately come to mind for me. I have to believe the free market will keep it equitable for all.

Comments are closed.