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Dec 4, 2020


The news that China is going to impose huge new tariffs against Australian wine is the news none of us needed to have to close out 2020. The degree of shock registering throughout the industry provides the first clue – that, once again, we aren’t prepared for the future. But, with any loss of this magnitude – China consumes 25% of the wine we produce – we have to ask how and why it happened. To understand this, we need to understand the last crisis in the Australian wine industry – the glut of the oughties.

The post-millennium glut was a predictable outcome of massive overinvestment in the wine sector in the late 90’s and early oughties resulting from accelerated tax depreciation for new wine grape vine plantings. This policy was the result of wine industry leaders of the day lobbying for these tax breaks in a belief that Australia could be the biggest and best wine producer on earth. These same leaders, despite turning out to be hopelessly naïve, have continued to inform and drive industry policy ever since. What we have today is a recipe for disaster designed in the 1990’s for a 1980’s problem. 

From 2005 to 2015, Australia suffered massive twin hits of wine oversupply and a tumbling reputation for quality worldwide while wine inventories cleared and the industry unprofitably “adjusted.” What a lot of folks missed in this ten-year period was that this outcome was neither biggest or best in any positive sense. And, because a) everyone in the industry was in on the original scam (in so many ways) and b) most people just can’t say “I stuffed up”, we never identified a suitable new national strategy or new people to lead. Nor did industry stop listening to those who flogged this nonsense in the first place. 

Industry appeals for the government to assist in an adjustment process were justifiably rebuffed at the time. As an aside, Simon Birmingham has been on both sides of this divide; first as the man in Canberra for the Winemakers Federation and now as Trade Minister during this China row.

In the last five years, the entire sector has bounced back to something like parity due to a huge increase in demand from China in a strategy long championed by folks like Warren “Wazza” Randall of Seppeltsfield Wines. Almost alone, Randall saw that the scale of the opportunity China presented was our last best hope of a large market where we could sell above average value wine after our “biggest and best” strategy had wrecked our opportunity for a fine wine reputation in the USA and UK. Randall devoted enormous resources in China selling the Australian fine wine proposition. For many, his success was our success. 

I’ve often observed that the people who understand the wine market best are grape growers. All news, good or bad, is felt by them immediately. Only growers think in decades and generations. Winemakers think in vintages while public companies and marketers think in quarters.  As Australia’s largest private grower of high-value grapes, “Wazza” understood that prices would never increase until net demand exceeded net supply and that only China held the promise to absorb that much wine in the near to medium term. 

The result since 2015 has been something like parity in supply and demand. This is an incredible turnaround that deserves full credit. This strategy was always two things: 1) necessary over the long term and 2) risky over any time frame. While the Free Trade Agreement signed a few years ago seemed to neutralise a lot of risks and lower barriers, the destabilisation of the USA China relationship since 2016 has created risks that have revealed deeper cracks in the Australia China relationship than most were aware of. This will take a lot of time to stabilise, if ever, and is largely out of Australia’s control.

The best part of the China trade has been that it has involved both huge quantities and two to four times the prices paid by other large markets. Almost too good to be true. On the corporate front in China, Treasury Wine Estates has been the volume leader leveraging Penfold’s Grange as a calling card to open many doors. 

TWE has now announced that they are withdrawing from China to divert elsewhere and that they would be reducing Australian grape intake starting immediately. While trade policy will change in a year or five, the market will remember that we didn’t hang on through the tough times. How bad will we look if trade policy does an abrupt about-face in six months? We’ll look like Good Time Charlies, not a serious industry or nation. This is an under-appreciated risk.

What this “shock” event has revealed about our national wine industry is that absolutely everything has to be going right – a growing world market, China booming, low-ish currency, no “too big” vintages, some bad vintages overseas, FTA’s, etc – for supply and demand to be in balance. Prices for grapes have only started rising across the market for the past few vintages and for many are still below prices paid well over a decade ago.  In inland regions, more than 90% of growers are still losing money.

What the last few years have shown is that our default trading context – the WTO, TPP and FTA’s framework built over the last decades – is coming apart at the seams. We can’t bet on export growth anymore to solve our problems. And, these matters are largely out of our hands despite our best efforts. 

There is less irrigation water available in most places and or higher prices than in the past, as well as hotter, shorter vintages that don’t allow for capital invested in wineries to be used as efficiently. The oversupply of winery capacity resulting from the millennial building boom has temporarily masked the shorter vintage problem but this trend seems set to continue with climate change.

This failure to think inter-generationally is, perhaps, the most under-appreciated risk right now both for those winemakers who sell to China and the entire Australian wine industry. Fifteen years of wishful thinking that nearly (almost) got us ahead isn’t a strategy.

As an industry, we need to either pray things go back to normal quickly or we need to discuss existential questions sooner rather than later. Because it is very unlikely that: 

   1.  the Chinese will revolt over Australian wine and demand tariffs be lifted
   2.  either the Chinese or Australian government changes its current position  
   3.  the USA China rivalry settles down any time soon

The core issue we have to grasp as an industry is that no one has ever chosen between “biggest” and “best” for the Australian wine sector. And, aside from the Randalls of the world, no one in a position of leadership has publicly proposed serious alternatives to either or both of these options. 

The policy implications of serious change are significant. However, the cultural change required is, in the wine context anyhow, practically “un-Australian”. Meaning, the consensus-driven style of Australia’s governing bodies and institutions – always billed as a strength – is poorly suited to the hard decisions required. If you are a leader who has something to say, now is your moment to risk getting kicked off the old boys’ club Christmas card list. It’s not that bad, I promise.

A few points for those who don’t know the industry intimately: 

   1.  Australia exports about twice what it consumes domestically so is effectively dependent on foreign demand and currency fluctuations to remain profitable.
   2.  Exports are not taxed while domestic sales attract 41.9% (inc. GST) tax on sales over $500,000 for wineries.
   3.  The peak industry body, Australian Grape and Wine, operates on a principle (not written) of Board unanimity and hand selects its Board members that represent less than 20% of winemakers but 90% of production. In other words, the industry’s least change adept / most risk-averse members controls industry policy.
   4.  The federal corporation that oversees the industry, Wine Australia, has a Board of hand-picked Directors recommended by a “third party” (usually an industry grandee well past their use-by-date) from a slate of self-nominated applicants. This means very little innovative thinking or real change is tolerated. And that is before the first meeting opens for business. 
   5.  National wine grape supply is overwhelmingly grown using scarce river water. Those with permanent water entitlements get nearly free water to grow huge crops of largely unprofitable grapes. While few make money, the cost of change is higher than incrementally losing their capital as long as water is nearly free.
   6.  Export prices for Australian wine at wholesale are between $1-$2 per litre in most of the world but around $5 per litre to China. As a reference, the shiraz we grow in McLaren Vale is worth around $8 per litre on the vine (before picking costs, winemaking, oak barrels, packaging and distribution costs) are taken into account. From our perspective, $5 per litre exports are only a win relative to $1-2 exports.
   7.  Using the above inputs and outputs, our shiraz uses Australia’s scarcest resource, water, to create close to 100 times the product value of the same water input in a wine grape crop grown in an inland region. 
   8.  Most winery operating margins lost in the last decade or so have ended up in the ColesWorth duopoly’s pockets (a duopsony for the pedantic) on a nearly penny for penny basis.

Seemingly, there are only two ways to look at this. Some would argue that as a high cost producing country, the only way Australian wine is competitive is at lower price points from fruit grown in inland regions grown for export markets ($1-$2 per litre). This is a razor-thin margin business with exacerbated water and currency risk that does not create a huge number of jobs and is successfully dominated by Casella’s Yellow Tail brand, particularly in the USA. Their brand focus and enormous scale make this possible. On the other hand, when the Australian dollar was at historic highs, even their business looked wobbly for a while.

The other way to look at it is that high-value wines use far less water, employ disproportionately more people, are in climatically less risky regions and are better able to withstand currency and demand variations over time because of the high dollar margins ($5-$100 per litre). In either case, large companies dominate the market for the purchase of wine grapes (in market parlance, wineries are “price makers” while growers are “price takers” due to the perishability of grapes) in respective wine grape growing regions and have monopoly-type price-setting power due to their sheer scale. 

The brand “Australian Wine” is hopelessly out of focus as a result of serving both of these fiefdoms. What has seemingly escaped everyone is that this either-or analysis needn’t be the case and that major structural change is necessary if we are to sustainably continue. Finally, government involvement is required – sooner or later depending on the path chosen.

As mentioned, China is not the problem we face. We face many challenges and need integrated thinking and strategy to re-platform the industry for generations. Industry has taken a one-by-one approach to problem-solving that, when it has accomplished anything, can only be viewed as a “kick it down the road” strategy.

The wine industry regularly defends itself as “special” when making arguments about, health, taxation, tourism, regional economic development, etc. And the truth is that wine is different, even special, in that we do support regional economies better than most rural industries and because we only produce once per year. We are not like beer or spirits that can be produced any time of year, anywhere, with ingredients available year-round and using capital equipment year-round. 

The other truth is that we produce an addictive product that performs identically to beer and spirits (for people who consume for inebriation purposes) that does not deserve preferential treatment on the basis of consumption pattern. There is nothing “special” about cask wine or bottled wine under, say, $10. When you realize that 41.9% of that price is for tax, you realize wine can be made as cheaply as bottled water or soft drinks. Not special at all in this respect.

If the wine industry insists on being treated differently from beer and spirits on matters of tax, we need to be honest about what else makes wine special. As usually mentioned, wine is enjoyed as the beverage of choice to celebrate life’s moments and is enjoyed more responsibly by its customers. This is not only because of price but because it is deeply etched in our souls, cultures, religions and even at a genetic level as some research suggests. (Humans grew brains faster by eating over ripe fruit that gave us a huge caloric advantage over other species and a buzz as a kicker). This is no small thing. 

When you consider that our rivers are already running dry, the temperature is dramatically increasing, the medical establishment and other lobbies (including beer and spirits) want to make wine more expensive and that we do not produce essential food with our resources, at some point, we will lose the moral authority to argue that our “special” case is a net positive for society.

What we need to consider is using this latest crisis as a lever to shift the entire industry onto a more sustainable path for producers, the health of society and the preservation of our resources. These interests can all be served simultaneously by changing the way the industry is taxed. And, the industry can choose a better path by driving that process rather than having it imposed from without by a changing social or natural climate.

The latest long-term strategy (Strategy 2050) doesn’t even scratch the surface of addressing all of these challenges in an integrated way – it is just a repositioned, un-stress-tested, don’t startle the horses re-print of what got us into this mess in the first place. How far the consensus is from reality is proven by one announcement from Beijing. 

Here, then, is a list of proposals that could achieve all of the above:

   1.  A volumetric tax that broke even with the current ad valorem tax at around $15 per bottle. (Keep in mind, we would still be also required to pay an ad valorem tax (GST) on top of a volumetric tax as we do now on ad valorem so it would not be a pure volumetric tax). The current “un-bonded” system would remain. 
   2.  This tax could be phased in in three steps over a five-to-six-year period to allow time for adjustments. 
   3.  Government offers to buy grape growing properties (only available to those with full permanent water rights) on a reverse Dutch auction basis using a multiple of the water rights value as a “floor” price so that owners can sell in dignity provided they grub out vines and plant native biodiverse flora over the property. The goal should be to retire maximum permanent water rights per hectare.
   4.  Remaining growers would be encouraged to voluntarily re-plant or graft some of their holdings to varieties more climatically suitable than Chardonnay, Shiraz and Cabernet. Think Nero d’Avola, Grenache, Touriga Nacional, Mataro, Fiano, Vermentino, Arinto, Greco, Albarino, etc. This could be achieved through a temporary loan scheme underwritten by governments or by contracts with wineries. Diversity, sustainability and less water demand will result.
   5.  The government agrees to fix the volumetric rate rather than indexing it and indemnifies winemakers from lawsuits and legislation designed to harm it by medical, health, trade and consumer groups.
   6.  Labelling to be within 0.5% alcohol by volume as with other major producing countries. 
   7.  No company should be allowed to have more than 20% market share in the national market or more than 30% share of purchasing in any wine region by law administered by the ACCC. This will require some company reorganisation but will also allow companies to become large enough to take on export markets seriously and not unduly dominate local markets for production or consumption. Further, it will encourage export growth without harming current large exporters in the domestic market (bar the 20% rule). It will also reduce the Balkanisation of supply that harms growers.
   8.  Some form of incentive for producers who make physical investments in all of the sectors required for the long-term success of the industry and regions – growing, production and tourism. I know this makes “virtual” producers cranky but they do not contribute to regional economies in the same way as people who make capital investments do – be it in consumption, employment and housing patterns. We need to remember that societies have economies, not the other way around.
   9.  Grocers need to be prohibited from owning wine production, packaging and distribution businesses. Their 80% share of wine retail is bad enough.
   10.  No one over 65 should be on any industry Boards. Please leave the next generation to make their own mistakes. Boards should be both more inclusive to women and minorities as well as chosen more democratically. Maximum starting ages for new Board members should be 55 or less (don’t worry, I’m nearly 58).

While there is something to annoy everyone in this list (promoting more government involvement and more market competition – crazy, huh? Proof enough of its worthiness for consideration IMHO), these proposals present lots of small losses, changes and opportunities for different companies and regions but none are necessarily fatal to any. Cheap producers will still be able to export but will be harmed in the local market. More expensive producers will be able to reduce prices and be more competitive, particularly in the $20-$40 per bottle segment. Innovation, consumer choice and quality will explode. 

Net employment will grow as higher value producers grow (high-value wine employment is a much higher portion of revenue than low-value wine). “Stranded” growers will be able to quit or retire with dignity and their holdings eliminated from national supply. Those that don’t sell or adjust risk failing but they already have that risk. Permanent water will be saved benefitting the rivers and the environment (hopefully). Ideally, land left without water will be required to be returned to restore native vegetation that will provide bio-diversity benefits for those who remain.

The big loser will be folks who buy wine because it is cheaper or equal to beer or spirits. This is no bad thing. And, for Aunt Mabel on a pension who enjoys her “one glass with dinner”, maybe the government will re-visit the aged pension or her rellies will help out. As an industry, we should not be viewed as part of the problem or one of the causes of the problem, of disadvantage in Australia. Let the beer and spirits industry answer for that instead. That would make our industry special.

I’m sure there are variations on the above schema that could work. Peak bodies need to be advocating for a “grand bargain” to address the long-term triple bottom line for the industry. Any other solution will be incomplete and set the foundation for yet another crisis. 

We need to operate from a gross wine grape production base probably 15-25% lower than at present for the profitability and survival of all remaining participants. Failure to do so will be to bleed all industry participants as occurred between 2005-2015. As an industry, we do not have the resilience to survive that again with our current balance sheets. And, the poorer we get, collectively and individually, the greater the justifiable pressure to continue to sell our assets to foreign interests – like the Chinese – will be. 

Governments can be slow, but they aren’t stupid. If peak bodies do not pro-actively respond soon with a plan for the long-term viability of the industry, governments will see their failure as an industry unable to help itself and will step in of their own accord and on their own terms. (This is when government use the term “market failure” without a trace of irony despite them regulating the industry). Then, god knows what will happen but we can be sure it won’t be great – just look at the dairy industry, or the live export business, or the grain export business, etc. 

This is not a “steady as she goes”, “she’ll be right”, “softly, softly”, or “sheet it home” moment in wine industry history. Nor is it a time to bravely say “let the market take care of it.” Government policy is part of how we got here. It will need to be part of how we get somewhere better.

It is time to implement a lead, follow or get out of the way standard at every industry body. The visionaries who are willing to take risks, and take an activist, sustainable intergenerational view on policy, are our best bets, not the folks who have been doing the same things the same way hoping for different results. That’s the definition of insanity.

Source. Blogger. Dudley Brown. 01.12.2020