Something about hop contracts you should know

Last Friday, we attended the International Hop Growers Convention (IHGC) in Freising, Germany. Representatives from hop producing countries around the world shared their expectations and estimates for the coming crop.  The meeting was a bit on the dry side until it came time for the American report. Most of the crowd was sitting quietly in a mix of awe and disbelief at the acreage figures before them. The statistics showed that the American growers planted an additional 8,000 acres! American aroma acreage increased by 38%!! To put that into perspective, most European hop producing countries do not even have that much acreage.

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When I asked the American representative at the IHGC, a friend of mine, what he thought of the numbers. He responded, “Well, it’s all contracted.” That reveals another problem. Contracts should be fixed in stone, reflect the actual demand, difficult to enter into, paid in a timely manner and never open to renegotiation. Nothing could be further from the truth. The hop industry is having a cash flow crisis caused by contracted brewer inventories sitting in storage awaiting payment. This should scare everybody. The hop industry needs a stable foundation on which to plan its future. Contracts should be that foundation. There is no cost to a brewery wishing to renegotiate its contracts so they enter into them easily and try to walk away from them when they want. To be fair, not all breweries do that, but a lot try. All too often, the merchants are too accommodating. After all, the brewers are the ones who pay for the hops. They’re the customers. The customer is always right isn’t he? Not always!

While there are some brilliant hop growers, many have no clue what is going on in the market because they’re not in the market every day. Some even base their business plans on coffee shop gossip and rumors. At the end of the day, forward contracts are the only guidance growers receive about what they must grow. Merchants have the advantage to see inventory and delivery flow and can best gauge how closely the contracts they have are related to actual demand. Although this seems obvious to any grower or merchant, many brewers may not realize this. Contracts serve many important functions. One big craft brewer, who subscribes to this blog, regularly contracts 10% more hops than they need. They’re contracting the most desirable varieties. They sell the excess hops back into the market when they know they don’t need them anymore. Those hops are all contracted every year.When everybody is acting responsibly, the grower grows a little extra to make sure he fulfills his contracts in full.  Those hops are all contracted. The dealer most likely contracts a little more to be sure they fulfill their contracts. The brewer probably also contracts a little more than they need to be sure to cover any growth. Are you starting to see the problem?

Let’s lighten up the mood a bit.  Below are the type of requests we regularly hear from brewers regarding their hop contracts and why they think they should be renegotiated. We thought it would be fun if we reversed the roles of the conversation (for the purposes of this blog) to see how the same things would sound if they came from the merchant to demonstrate the absurdity of the requests. The result is funny.How to read the comments below:The Brewer comments below are things we actually hear from brewers. The Merchant comments are how the same thing would sound coming from a merchant.

Brewer:  Prices on the spot market are lower than all my contracts now so we’d like to see what we can do about those contracts.

Merchant:  Prices are much higher on the spot market now so we don’t want to honor those contracts we signed with you anymore.

Brewer:  It seems we contracted more than we need so I’d like to make some adjustments to our contracts.Merchant:It seems we have some extra hops on hand so we’d like to increase the amounts in your contract to make up for our mistake.

Brewer:  We already have a few years worth of Cascades sitting in our cooler so we want to take a look at those contracts we have with you.

Merchant:  We bought too many Cascades for the next few years so we need to increase the amount of Cascades you’re buying.

Brewer:  I’d appreciate it if we could take a look at those contracts again. I can find the same thing from your competitors today at a lower price.

Merchant:  We’ve been talking with your competitors and we can get more money for those hops we sold you so we’d like to get out of those contracts.

Brewer:  We’d like to have 120 days to pay for our hops. That’s our standard and all your competitors are OK with that.

Merchant:  Happy 4th of July.  We’ll be shipping you your hops the first week of November but we need to be paid for them now. That’s our standard. We require that of everybody.

Brewer:  The market has changed. I can get those hops for less today. I’d like to see what we can do about those contracts.

Merchant:  The market has changed.  We can get more for those hops today.  We’d like to increase the prices in your contract.

Brewer:We’ve been busy putting in some new fermenters for our big expansion so we can make more beer. Unfortunately, we can’t afford to pay for our hops right now.

Merchant:  We just put in a new pellet mill and are kind of low on cash. We need to you buy some more hops to help us pay for that.

We are thankful for the brewers who contract responsibly, who understand the importance of the contracts they sign, and who pay their bills on time, which is about 80% of the brewers with whom we do business. Without your commitment to the hop industry, none of this would be possible. We would like to ask you to have a word with some of your brewer friends who fall in the 20% though. The hop industry is very fragile.They can break it. Higher prices could alleviate the problem, but I doubt anybody wants prices that are higher than they currently are. It costs a lot to put in new hop yards and warehouses. It also costs quite a bit to wait a year to get paid for hops that are contracted.

For the past few years, the craft market has absorbed all the “extra” hops that have been produced, but ‘sold’ doesn’t necessarily mean ‘paid for’. There are a LOT of hops piling up in warehouses around the world that have been contracted, but not paid for. The value of those hops is growing to a troublesome level … and it all is financed and accruing interest.Some brewers are well informed and have given great consideration to how many hops they need. They contract responsibly and understand that contracts are binding agreements. Others, based on their later renegotiation requests, seem to consult the magic eight ball and contract for what they hope will come true. Merchants and the growers need to take these contracts to the bank … literally. Banks view hop contracts as binding agreements.

Some brewers act as if hop contracts are like hotel reservations, Something that can be canceled a day prior to their arrival.No brewer likes to see cheap spot hop prices when they have expensive contract prices. Price is not the sole function of a hop contract. When some brewers see cheap spot prices, they want to cherry pick expensive hops out of their contracts or cancel them outright. A falling spot market price does not mean the investments made in the industry have been repaid. It’s just a reflection of the current supply/demand situation.

At this point, maybe not everybody in the industry remembers the 2007-08 hop shortage and the resulting price spike followed by the crash of 09. The past 5 years have been unique and represent an unprecedented time in hop history. Demand has grown more quickly than hop growers can accommodate. Hop growers are quickly catching up though. The fundamentals of the market have not changed just because everybody is drinking craft beer. The hop market is just as sensitive to over supply as it ever was. Proprietary varieties create silos that isolate information and mask the effects of the market as a whole from other participants. Brewer hoarding of them only makes the problem worse. This makes an already opaque market even more opaque if that is possible.Solutions1) Let’s be blunt. Money is the root of the hop problem. Money is the grease that keeps the wheels of the hop industry moving. The American hop industry is completely debt financed. The group that has the most power to effectively regulate the market, therefore, is the bank. The expansion and production all starts and ends with the banks. Bankers literally hold the keys to the future. In the U.S., they don’t see it as their responsibility to judge the merit of deals, and they’re not experts in the hop industry, but they have the capacity to do that if they choose. They could more tightly regulate the funds flowing to the industry and help growers and merchants manage their future. Something needs to be done before we reach a surplus situation because it will be impossible to fix it after.

When did Noah build the ark? Before the flood.

The consequences of not finding a proactive solution will be enormous. Nearly all those nice small local hop farms that have popped up around the United States will be gone. A lot of established farms in the Pacific Northwest will go bankrupt due to their debt burden. Some merchants who have bought long, but do not have corresponding sold positions could go out of business.  In short, the Hopocalypse, a complete restructuring of the industry.  Let’s hope craft beer demand does not slow too quickly and that that time is still several years away.
stop-hops Here’s a novel idea … everybody should grow and buy only what they need. If we assume brewer behavior remains the same, they can provide the buffer against shortage with the excess inventories they have been contracting. There are Force Majeure clauses written into every contract to protect growers and merchants if the supply side of the industry is short. There’s no reason for growers to produce extra or for merchants to have a reserve if the contracts do not reflect actual demand. They need to be concerned about the long game rather than the short game! Maybe it’s easier and less risky to just call up and say, “sorry, but the crop didn’t come in as expected.” This is a huge change in thinking from the norm today for most merchants and would shift the burden of risk from the grower and the merchant to the brewer. If you think this is just some tactic to try to maintain high prices so as to make more money, go back to the top and read this again. This is a call for responsible contracts and responsible production that reflects actual demand. Brewers should want that.long-game

Conclusion:Prices go up or down as the hop industry responds to demand represented by brewery contracts the best it can. Right now, the contract system does not accurately reflect actual demand based on beer sales due to a minority of the brewers who do not seem to understand the full function of the forward hop contract.  The current contract system and the way the hop industry responds to it is flawed. The market is very cyclical as a result. At this point, due to the growth in the craft beer world, only adjustments are necessary. On the demand side, brewers need to contract only for what they need. Nobody needs to cut anything yet. On the supply side, the hop industry needs to take its foot off the accelerator so it can better navigate the road ahead.