Chinese Whispers and Australian Wine, Part Two

by Dudley Brown

The big question from Part 1 of this series is “why does Australia Grape and Wine mischaracterise Australia’s structural wine oversupply as being the effect of China’s tariffs?”

The effect of supply over time on our national inventory of wine is shown below (source Wine Australia):

Figure 4: Annual difference between production and sales (historical)

If we look back to 2015 – a period of relative supply and demand balance – and account for all the surpluses and shortages since, we end up with a surplus of 433 million litres over eight years. This amount allows for diminished inventories from 2017-2020 to be restocked and still leaves a huge number of which the China surplus only accounts for 25% of that number by volume. There is just no credible way to only blame China for our oversupply.

So why does the AGW want to make it seem it is all China’s fault? There are a few obvious answers that all pass the self-interest and CYA tests but, the questions that need answering are:

  1. Was AWG aware of these momentous and rapidly changing consumer preferences (both away from wine and towards higher value consumption) for Australian wine between 2018 and 2021 in China and the massive overproduction of wine by AGW member wineries in the period 2020 to 2022?
  2. If so, why weren’t they widely communicated?
  3. If they were not aware of these, why not?

It is hard to see how AGW can assert that it isn’t either incompetent or worse with respect to understanding these problems. They are either a peak body with access to all relevant information and the skills to interpret and disseminate it regularly or it isn’t.

The fact is that the Australian wine industry has been managing a structural oversupply of wine grapes for about twenty years. Whether through good luck and / or the Casella family’s business acumen, a massive oversupply hasn’t occurred to this degree before. Yellow Tail saved many inland grape growers from ruin for most of the last 20 years and built a $500m per year business doing so. This is the same 20 years that the AGW and Wine Australia have been “building demand” to consume the oversupply using taxpayer and levy payer’s money. The last three years demonstrate that they have clearly failed in that long term effort despite a one time $50m injection in the 2016.

The Pre-Budget Submissions (PBS) submitted as the AGW only go back to 2019. Before that the AGW was known as the Winemaker’s Federation. The difference in the two is that the AGW is now recognised as the peak body for growers and winemakers rather than just representing just winemakers. 

In all the “PBS’s”, the word “oversupply” is never used. But “demand growth” and “building demand” are repeated ad nauseam. If you read all of the annual AGW submissions and substitute “because of wine grape oversupply” everywhere they use “build demand” or “demand growth” in the future tense, you will quickly get a sense of how badly the market has been oversupplied, particularly with inexpensive grapes used to make bulk wine or “no place of origin” bottled wine. 

In the last thirty years, the oversupply of these lower value grapes and wines have progressively smashed Australia’s reputation for fine wine in almost every major growth market we’ve entered – particularly the U.K. in the 80’s and the USA in the 90’s and 00’s. While neither makes enough wine for itself and needs to import bulk wine, it’s a variation on Gresham’s Law with low quality wine driving out high quality.

Since 2008, on average, across all regions, all wine grapes have dropped in value from about $720 per tonne to about $600 (Wine Australia). While this 16% drop is a simplification, no broad category of wine grapes (red or white, cool or warm region) is higher than 2008 levels today. What is not a simplification is that inflation has increased 38% over that time leaving growers a total of 48% behind in average real prices received over the last 15 years per tonne of grapes sold. And, 2008 was not a high base to start from.

In the UK and the USA, our fine wine offering led the initial charge but ended up getting swamped by the cheap stuff in the market place. In reputational terms in the USA, “Australia” still equals “Yellow Tail” for all but a tiny segment of consumers. In China, it was a bit of each at the beginning but, as shown in Part 1, the Chinese quickly rejected our cheap stuff. Not coincidentally, Yellow Tail’s owners (the Casella family) have boasted publicly that because only 3% of their sales were in China, the tariffs haven’t really affected them.

Remember the $50 million one time boost to improve marketing Australian wine targeting the USA and Chinese markets? Despite a positive evaluation by Deloitte and Touche of the program published in May 2021, it is easy to pick apart now as it came after three years of undersupply / falling inventories, etc.

D&T weren’t cherry picking data like AGW, they just benefitted from good timing. It paints a rosy picture of premium wine income growth in China pre-tariffs, but also seems to have missed the collapsing volume demand by China in the preceding years as discussed in Part 1. On the other hand, there has been no good news in the USA (7% decline in volumes June 2016 – March 2023) and average price decreasing by 9% and 16% total inflation over the same period (Wine Australia) since the $50 million dollar package was announced. Again, China is not the problem here.

It is impossible to build up a surplus of 400+ million litres of wine in just two years like Australia did from 2020 without it being overwhelmingly from inland grapes. The problem with wine grapes is that their supply is “sticky”, they can’t be turned on and off like an annual crop. But, they can definitely be turned “up”.

Growers pursue a level of income to cover their costs and make an income. When grape prices drop due to excess supply, growers increase production to pursue a dollar amount of income thereby creating still more oversupply. Because the marginal cost of doing so is so low (generally just a bit more water and fertiliser), it is a low risk strategy with potentially high returns.

Wineries only defence to this is to put tonnage limits on growers which leads back to the problem of bottom feeders sucking up the leftovers at even lower prices. Given human nature as it is, the only mechanism to prevent this is to reduce acreage of vines commensurate, at least, with the area required to produce the oversupply.

For example, assume 1.7 million tonnes per annum is established as a total level of supply commensurate with demand while we have the capacity to produce 2.1 million tonnes (as in 2021). There should be a coordinated policy developed by industry and government to reduce grape producing capacity by 400,000 tonnes of those grapes in greatest oversupply. In this example, if the least profitable grades are able to be grown at 25 tonnes per hectare, we need to reduce our foot print by at least 16,000 of those hectares or about 11% of the total national grape growing area. If the historic productivity capacity of a vineyard is less, then more hectares will be required to be pulled.

This is simplistic math to illustrate a point but it is the starting point for the right conversation. One way to look at the best areas to remove vines is that many regions are capable of producing alternative crops and alternative uses of the land need to be considered as a baseline of land value assuming water rights are included. Meaning, can the grower switch to grazing, broad acre or other agricultural uses to obtain a better return? Not all regions are suited to these pursuits and may not be the best to eliminate supply from.

One pastoralist in southeast South Australia recently bought a significant area of vineyard that adjoined his land from a large wine company. He bought it because he thought the grazing value exceeded the vineyard’s income value. He is keeping a small portion of the vineyard for its A and B grade blocks and tearing the rest out (mostly C grade) for pasture. C grade isn’t bulk quality but it is made to lower price point wine. The point here is, nines pulled needn’t be all inland vines that need removing and any solution will involve a variety of approaches and situations.

A working rule of thumb I propose is that of bare land vs. vine value as a total of planted land value. In short, if the land value (including required irrigation supply) isn’t greater than the price of physically establishing a new vineyard on that land, that established land or region isn’t really “brand-able” and should be considered ripe for removals.

This observation is sure to make a lot of folks unhappy but the regions around the world where it is the value of land that establishes the value of the grapes are inherently “brand-able.” Think Napa, the Piedmont of Italy, Burgundy, Champagne, etc. In fact, the greater percentage of the total value being land value, the greater the resulting wine and regional brand value. As a rule of thumb, this holds up pretty well in the inverse as well. And, it maximises the areas to be considered as appropriate for vine removals.

A contrarian might say “what about Bordeaux?” Well, the French government believes it will be able to persuade growers to remove 9500 hectares or 10% of the regions’ vines for about $8500 (AUD) per hectare. If this formula were followed here, we could eliminate structural oversupply in the Australian wine industry for as little as $100 million. Considering that the AGW was asking the federal government for about $85 million this coming budget year to fund approaches with a long and spotty history of success, this seems like a long term solution to industry wide profitability that could be implemented quite quickly at a reasonable price.

However you slice it, as long as the 20-year surplus of primarily inland vines continues, the wine brand Australia and its possibly more valuable regional brands will continue to suffer. And, the levy and taxpayers money spent on “demand building” will continue to be wasted keeping the industry’s nose just at the water line rather than being profitable at all levels and having an improving international brand.

The problem that has to be solved is that there are too many vines bearing too much fruit grown with water that is far too cheap for the value of the end product to be a good deal for anyone except a few canny winemakers and traders. If we solve for that problem instead of the failed attempts of the past to deal with oversupply by “building demand”, we’ll be on the right track. Then we can talk about marketing programs that can pay real dividends for all levels of the industry.

End Part 2

Stay tuned for Part 3