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

Craft Beer is a Trend, Not a Fad

There seems to be no shortage of articles proclaiming the growth in craft beer can’t continue.  People say it’s not going to last, that it’s a fad.  Recently, in a Bon Appetit article, Sam Calagione of Dogfish Head fame, even went so far as to say, “There’s a bloodbath coming” when referring to the competition the craft beer industry will face ahead. He was referring to the increase in the number of craft breweries and assuming that they’re all going to fight bitterly to the death in a winner-takes-all competition Roman gladiator style battle for market share. That is, after all, how brands like Budweiser, Coors and Miller became universally recognized so it’s no surprise that somebody out there thinks that.  Statements like that assume the future will resemble the past, which is never the case.
There may be a bloodbath among the big craft brewers as they lose their “localness” in their quest for greater and greater national market share. That represents something more akin to a mid-life crisis they still have yet to endure, not an industry wide bloodbath. Hopefully when that happens they don’t also begin to compromise quality in exchange for profits.  If they do, their beer will become a different product, and will no longer be in direct competition with the smaller more local craft brewery.  You can make a very good case that while their quality may not yet have changed they have already crossed that line. 
For 90% of the craft industry, it’s all about local.  The Internet and technology empowers local like never before.  It levels the playing field.  In a hold over from the pre-Internet world, which I am old enough to fondly remember, big companies outspend their competitors in the advertising world so their message is the only one in your face. Money has traditionally controlled message.  All that has changed. First, they’re putting their message where we’re not looking. Second because their message doesn’t jive with what people crave, sincere, local content. In today’s world, passion and hard work can get you in front of just as many eyeballs through social media. Who doesn’t like an underdog?  That’s the American dream after all. We like to see somebody start from nothing and make something of themselves.  We like to support those people.  You’re reading this blog, aren’t you? Thank you for that by the way!!  Craft brewers are full of passion and few of them are afraid of hard work. The world where pretty horses pulling wagons and animated bottles playing football against each other on TV may be cute, but it’s not enough to sell beer. That time is fading into the past. The big guys are only just starting to become aware they’re not driving the bus anymore. They’re still spending billions on ads we don’t care about.  What content is more important to you, some beer ad you see with horses and mountains on TV … if you even watch commercials anymore … or what 50 of your closest “friends” on Facebook or Twitter are posting about the new pub that just opened downtown?  Chances are the latter influences you more. Passionate content is the key. That’s the world in which we live.  Craft brewers are nothing if they’re not passionate.  You can see it in their bearded faces.  It’s no surprise in that world we are seeing the rise of Craft Beer and other local products.  We have access to the world’s information in our pocket. It offers plenty of stupid stuff like Miley Cyrus twerking or What Does the Fox Say, but it also offers local companies the ability to do an end run around the big guys.
An industry-wide bloodbath would be inevitable if every little craft brewer that starts in his garage had ambitions of becoming a behemoth multinational brewery.  Big guys would sell cheap. Little guys would go out of business. That scene has been played many times during the era of globalization. That world is changing. Sure, there are plenty of breweries that want to expand as fast and as far as possible, but not everybody wants to be a Dogfish Head or a Lagunitas. There are some that are happy to be like Central Coast Brewing in San Luis Obispo, California. They have a great local following and are content making people happy one pint at a time.  At the end of the day, that’s why craft beer is popular. There’s a story and some local flavor in the beer.
I’m reminded of something Doug Donelan from the New Zealand Hops Ltd. said in 2013 at the International Hop Growers Convention in Belgium.  When asked if New Zealand growers would be expanding production to meet the unbelievable demand for their varieties, he replied probably not because most of them are happy with the money they’re making now and working day and night for more money isn’t very attractive. I recently had a very similar conversation with a good friend of mine who is a hop grower in the Hallertau region of Germany. Because he runs a small family farm, which is the norm there, the thought of adding an extra 15-20 acres is not appealing despite the fact that he knows he could sell it all and make a good profit. The money is not worth the trade off of time, additional work, stress and risk it would require.  Hop growing, he said, is only part of my life.  I respect him for that. His beautiful 5-year old daughter will be better off in the long run for it too! 
I’d like to think there are people out there who put quality of life first and aren’t just chasing dollars despite the temptation. The solution to the problem in this case is not larger farms or bigger breweries, but more of them.  That’s why we’re seeing them pop up all over the US. Big breweries will undoubtedly get bigger, but there is plenty of room for more competition at the other end, locally. In the end, quality is important.  As long as there are plenty of small craft brewers producing quality craft beer, there will be a market for it.  There will be more hop growers and bigger hop farms producing for them too.  In a more competitive market, there will be no room for marginal quality.  If that’s the blood bath Sam was referring to, then we welcome it because everybody wins. Craft beer is not just about drinking beer.  The wine industry gets this.  Craft beer is about the experience of drinking craft beer, which is why there is room for thousands more small craft breweries in the years to come. 
In the 1960’s we put a man on the moon.  That took courage, foresight and the belief that we can do something seemingly impossible … just because we wanted to.  Captain Kirk and the crew boldly went where no man had gone before.  Sure that was just a TV show, but it embodied the spirit of challenge and conquest that was alive in America at the time. I don’t think that was just the Kennedy era.  I don’t think that adventurous spirit hasn’t died in today’s world of TSA checkpoints and the NSA following our every move.  Judging by the number of people willing to go all in and pursue their dreams of craft brewing, I think it’s alive and well.

Long live the hop revolution!

Why Hop Prices are Really Rising? Opening the Kimono.

We touched briefly on this in our previous post, Greedy Growers & Dirty Dealers  However, recently an interesting article by Eric Connor in USATODAY has been making the rounds among hopheads the past days on the Twittersphere.  It claims the rise in the cost of hops is responsible for the high prices of craft beer. The article touches on the surface of a very real problem within the industry, but doesn’t explore the deeper question of WHY prices are increasing. Although the title is a bit sensational and gives a little too much credit to hops for affecting beer prices, it’s a great excuse to dig in a little deeper into one of the most serious problems the industry today and ask WHY. 
In the article, Eric states, “In many cases, farmers don’t know how or what to plant in an uncertain market…”  That’s just not true! My guess is that Eric didn’t have the opportunity to talk to many farmers before writing the hop piece. Farmers are pretty good at responding to market signals by planting hops when prices are good, and to a lesser extent, removing hops when prices are bad. Growers are great at figuring out ways to produce more hops per acre when no restrictions are placed on them. Eric Connor probably did not … or more likely was not able … to look into the economics of hop or beer production. Perhaps he was not privy to what insiders know about the system. That’s not hard to believe. The industry is very closed to outsiders. It’s hard to find somebody who will answer the question WHY. Eric … Drop me an email. I’d be happy to share what I can with you. Just like in the Wizard of Oz, there is a man behind the curtain. There may be some smoke and mirrors too. 
Most proprietary varieties, although grown by many growers, are strictly controlled on both the production and sales sides. Sure, you may be able to get your favorite proprietary aroma variety through several merchants, but that’s all part of the illusion of a free and open supply chain. Like sand through an hourglass, most of those proprietary varieties, regardless of where they start and where they ultimately are sold, flow through one central control point. That is the most likely reason you can’t get your favorite variety today, or if you do, why it’s costing so much. It’s not because growers are demanding a fortune for them. According to several growers with whom I’ve spoken, they are actually not being offered enough to grow them in greater quantities. That’s strange with the market in its current state. Of course, those who sit in the center of control want to maintain the status quo. They’ll argue that everything is peachy. They won’t acknowledge publicly the waiting lists for hundreds of thousands of pounds they won’t be able to fill this year or next. That would mean their system isn’t working. They’re focused on retaining control so tightly that they don’t see the consequences. The problem with blaming a shortage of land or picking capacity is that money at the grower level, fixes all those problems. Land and machines can all be bought if money is available.
There is, of course, temptation to control something you’ve created. A monkey will get his hand caught in a trap because he won’t let go of the banana he wants. He is a victim of his own circumstance. As with the monkey, the solution to the problem of supply of proprietary hop varieties is simple. Of course, if you create a hop variety it’s your baby, but just like when your baby rides their bike for the first time without training wheels, at some point you have to let go and see if they can ride on their own. In this case, there’s not just a skinned knee at stake. That makes it even harder to let the banana go. Letting go though does not mean letting go of the returns on a well-developed breeding program. In fact, letting go means reducing the cynicism developing among brewers about new varieties, who currently think they don’t stand a chance of getting the existing varieties, not to mention any new varieties that may come unless they are somebody’s favorite brewer. Letting go means removing some very negative vibes circulating out there right now. Letting go also means increasing market share for the varieties while there is still demand.  Eeek eeek!
Those in control of managing the most popular aroma varieties seem to not be reading the tea leaves correctly. Perhaps, they are reluctant to believe that craft is a trend, not a fad!  Those who own the proprietary varieties and have done a great job at bringing them to market while they were in their infancy won’t shift gears now that the varieties have gained popularity. They don’t have a second play in their playbook. Now that that has happened, the next move should be to allow growers to buy the hop roots and pay royalties on strictly monitored production with heavy fines for non-reporting. That would allow growers to plant more and would quickly unlock the vast potential of those varieties, which, ironically, would very likely earn them even more money. 
Power is the great aphrodisiac 
– Henry A. Kissinger
Continued deficits in very popular and very unavailable, proprietary varieties lead brewers to conclude they must want the hops they can get instead of getting the hops they want. I’ve had conversations and signed contracts with brewers frustrated about this very topic. They’ll find the flavors some other way, like by adding actual citrus fruit to a brew or something even more off the wall. Craft brewers are a pretty creative bunch. Instead, the almighty Oz has chosen the path that any world dictator would admire and respect, one of tight central planning and control, but that doesn’t usually work out very well, as we’re seeing now. That’s why you have hops selling at prices up to $20 per pound right now … supply and demand are out of balance. The market doesn’t have to be that way.
The free market can control everything if allowed to and sends signals to those who can read them which way to move. Right now, the market is screaming, “give us some more of those damn proprietary aroma hops”. Although there have been acreage increases, they’re hardly what the market demanded. Somebody is not listening, or are they choosing not to listen? Hopefully that’s not the case. Maybe the ones in control use a cloudy crystal ball or a broken Quija board to figure out how many acres of those varieties to plant. It doesn’t seem they’re responding to market signals, which are clearly saying via extremely high prices on the secondary markets that there is a shortage of certain varieties. That inefficient structure could ultimately cause more harm than good to the industry, but hop growers seldom act in unison. They are more accustomed to building fences than bridges. 
What is a great variety worth if you can’t get it?  Nothing!  The ones who suffer most are the small or start-up craft brewers who are not the darlings of most of the long-established hop merchants. They prefer the bigger brewers because of the large volumes and easy deals they represent. The problem in the industry now is not a lack of great varieties. There are plenty of those. The problem in the industry now is being able to produce more of the great varieties we already have. All the while, breeding programs continue to efficiently churn out new amazing varieties every year further exacerbating the problem.
Nothing is ever black and white in this world. To be fair, the higher prices we’re seeing today are not exclusively the fault of one man behind the curtain. Although, just looking at the surface, it would be easy to say that’s the case, that’s giving him too much credit. Prices are increasing also because they’ve been kept too low for too long during times of surplus. Those $3 Cascades you hear about so often and may even remember were a result of big breweries strong-arming growers and merchants to sell for less during times of oversupply. When a hop merchant can sell Cascades at $3 per pound, nobody wins except the big brewer. Some merchants seem to enjoy doing that to get a customer for bragging rights … I still don’t get that, but to each his own. The grower loses money at those prices. An industry is not sustainable when price spikes every 10 years keep the industry alive and 8 years out of 10 prices are below the cost of production. That’s not good business. Since the early 90’s, NO grower has been able to grow Cascades at a price that allows the merchant to sell them for $3 per pound. The fact that they’ve regularly sold at that price until just recently proves how heavily things were stacked against the grower most of the time. Every pound of hops that sold for $3 was farmer and merchant equity going out the door. Prices are correcting to where they need to be now to maintain current acreage and finance necessary growth. While the hops may be even more expensive soon, that’s not a bad thing if hoppy beers are what you crave. Is it wrong for a business to want to survive? 
We’re not in Kansas anymore!  Growers, finally empowered by reasonable craft brewers who are willing to pay a sustainable price for their hops, have the courage to say NO to the terrible prices below the cost of production offered by the big brewers and, in turn, by some of the big hop dealers too. Craft brewers are expanding as quickly as possible to keep up with their demand by investing in new brewery equipment and everything else that comes along with growing a business. Every so often we read of millions borrowed or invested by one of the large craft brewers to expand. They deserve kudos for being able to figure out ways to expand in a growing market and keep up with cash flow. Hop growers are trying to do the same, but all we read are articles explaining how higher hop prices are bad for craft beer. Why the double standard?
Don’t get me wrong … I’m not an apologist for hop growers. Just like anywhere, there are some good ones, some bad ones and some ugly ones. People are people after all … as the song goes. Regardless, good, bad and ugly alike deserve to make enough of a profit to be able to keep up with the increasing demands for the crop they grow. That means they need to calculate for expansion, and … God forbid … profit. That’s sustainable … and it’s the right thing to do. If 47 Hops was an old school hop merchant, higher prices would actually be the last thing I should be calling for. For a merchant company, higher prices mean more money out of pocket to buy hops from growers, which means more risk. Your old school merchant might buy long on the grower side and sell on the spot market in an up market increasing his prices every year because that’s where the most profit could be made. Some guys are using that strategy right now. Higher prices are what is necessary and they are what is right in today’s market. The grower has to make enough to sustain his business and so does the merchant. For the record, 47Hops has bought on long-term contracts from the growers before it became the obvious thing to do and we sell on long-term contracts to the brewers. We’re interested in stability and getting our brewers through the even rougher times we foresee ahead instead of exploiting the weaknesses in the system. We used to get a lot of push back from brewers on 5-year contracts. We’ve been accused of trying to strong-arm people into contracts. When that happened, we shared with them our philosophy and what’s going on in the industry and then they understood WHY. There’s much less resistance to the idea today. 
Hop growers should be compensated for their hard work. Without them, there is no beer!  Do you really want to drink a beer knowing that with each sip you’re bringing a farm closer to bankruptcy?  That’s the pillar on which the multinational brewers have built their fortunes. They strived to get the lowest possible prices for ingredients so they can make more money for themselves and for their shareholders. Their empires were formed on the backs of broken farmers. They used their great power to get what they wanted. It doesn’t seem to be the mantra of most craft brewers now and hopefully it never will be. They have changed the dynamic of the hop market. In today’s market, that lowest possible price will be sustainable and it will include some profit for the grower and the merchant. 
LONG LIVE THE HOP REVOLUTION!!