The crisis that can destroy the hop industry

The March 1 Hop Stocks report collected by the United States Department of Agriculture National Agricultural Statistical Service (USDA NASS) is typically not fully appreciated by anybody and therefore only given a cursory glance. In 2017, however, this is very likely the most significant report you will read until harvest numbers are released. Hidden in the numbers is evidence of a trend, which, if it continues, will turn into a crisis of massive proportions with the potential to forever change and even destroy the hop industry as we know it today. Let’s take a deeper look.

Figure 1: The data from the most recent March 1Hop Stocks report

Figure 2: A graph of the 2007-2017 March 1 Hop Stocks data:

Less than a decade ago, brewers held more stocks than growers and merchants combined. That all changed in 2009 with the growth in popularity of the craft beer industry. Craft brewers clearly love their hops and they don’t mind contracting for them either. At first, that trend seemed to be great news for hop growers everywhere. Unfortunately, the way craft brewers are expressing their love lately has shifted the burden of financing the crop for an additional year before being paid. Some financing is traditionally built into hop prices, but not that much. Two things are troubling about the current trend:

  1. The gap of stocks and who is holding them is widening in the direction of growers and merchants, and
  2. The cost of and risk associated with that gap is growing.  

A quick look back in history reveals the scope of the problem. In March, 2007, growers and merchants held 40% of total stocks. Based on the season average price for the 2007 crop year of $2.99 per pound as reported by the USDA NASS, inventory held by growers and merchants in March 2007 represented approximately $83 million at a time when the entire industry production was valued at just under $180 million. 

Figure 3: A representation of the 2007-2017 March 1 Hop Stock data expressed in percentage of ownership of those stocks.

Fast forward to the most recent hop stocks report from March, 2017. Today, growers and merchants hold 200% more inventory than brewers, which equates to over a year’s worth of inventory. The season average price for 2016 was $5.72 per pound of hops. The increased price compounds the problem facing the industry by drastically increasing the risk associated with holding inventory. The total inventory held by growers and merchants today represents $600 million dollars. That’s represents a 722% increase in the value of stocks growers and merchants finance over the past 10 years alone. You can find the season average price data and do the math for yourself at the Hop Growers of America homepage

Hopefully you can see by now that the USDA March 1 Hop Stocks Reports is much more than a benign report that shows who is storing the inventory regardless of ownership. Typically, inventory does not sit long in the grower or merchant warehouse if the brewer needs it and has paid for it. Some does, but that’s the exception rather than the rule. Therefore, we can infer from the data not only who is storing the hops, but who needs it, who owns it … and more importantly who has not paid for it

Prices for hops surged over the past decade. Today, the USDA estimates the crop is worth roughly $500 million. According to the Brewers Association, the value of the craft beer industry in 2015 by contrast is $22.3 Billion. The natural question that arises in my mind is … Why is the industry worth $500 million financing the industry that generates over 40 times more revenue?  Something has to change or this will come to a bad end.

Hop prices increased to pay for investments in infrastructure incurred as the hop industry quickly ramped up in response to increased demand by craft brewers. Today’s prices do no cover the added responsibility of providing soft financing for brewers. It seems brewers are using growers and merchants as bankers of last resort. The current risk/reward ratio is not high enough for the hop industry to also act as banker. That is one reason we will see little interest in the short term by growers or brewers to soften prices. If the trend of financing continues, prices in the future will increase. Only once the ratio of stocks returns to a more balanced level, or if bankruptcies are imminent, will prices begin to soften.

Some brewers see the surge in hop stocks and hope prices will crash soon. They don’t understand the consequences of what they are wishing for. Hop prices crashing today will cause chaos in the hop industry. It would lead to countless hop farms going out of business. Say goodbye to creative new varieties. Sustainable business practices will take a back seat. Many of the features craft brewers say they appreciate about the industry today will disappear. Those go away when the money to pay for them goes away. Growers too should realize the seriousness of the situation. They cannot act without impunity. Ultimately neither they nor their neighbors will get paid if they continue to plant additional hops in the current environment. Ironically, it could be the craft brewers’ love for hops and their willingness to contract them that causes a catastrophic failure in the hop industry. 

 

How to know the weakest hop companies from the strong ones

Now is the time of year when hop growers and merchants are digging roots and planting new hop fields. The past few years brought with them the longest running bull market in the hop industry. That market created strengths and weaknesses in a lot of companies. Unfortunately, that type of money facilitates a lot of careless mistakes and can hide fatal flaws. Brewers, merchants and growers were all shocked when the increase in craft beer sales slowed so drastically in 2016. Most people anticipated the market would continue on its run through 2020 or longer. Many planned accordingly. Obviously, that was not the case. It was confirmation bias at its finest. If you’re a brewer or a hop merchant, of course you want to know which companies will be around for the long term, and which won’t … but how can you know?

 

If everyone thinks one way, it’s likely to be wrong.

     – Jim Rogers

 

The abrupt slowdown of craft sales slowed the flow of money into the hop industry. That caused a wave of contract renegotiations with merchants, but very few at the grower level. Through it all, the worst pain most growers felt was not being able to sell their spot hops. Despite the fact that the talk in the industry is about the craft slowdown, some hop companies are still expanding. They claim their plans are already in motion and cannot be stopped. Expanding in the face of a drastic slowdown … That doesn’t make any sense … or does it? Actually, it makes perfect sense. It’s a tell! You might think the strong companies are expanding because it takes capital to expand or because there is strong demand. The truth is counterintuitive. The companies expanding “because they have to” are very likely the weakest companies. They lack the financial strength to do anything but chase growth and sales on their books. They lack options. Growth looks great on paper and investors expect to see that. 

I am sure you are thinking to yourself … “The craft market is still growing, albeit at a slower rate. There’s got to be some legitimate demand out there for new hops?” That’s true. Based on the rate of payment and deliveries to breweries in 2016, however, the overall market appears to be extremely well supplied from the 2016 crop. The USDA collects statistics on hop stocks. They are collecting them now, in fact. The report will likely depict an increase in brewer and merchant stocks over last year. Statistically, that is how the slowdown manifests itself. Still, there are no reports of growers removing acreage. We expect a net increase in production in 2017 over crop year 2016. That is a net increase that is very likely not necessary. So why is it happening?

Strong merchants and growers are pausing now to see what comes next. The industry is nearing a tipping point and they realize it. There’s no incentive to get caught heading in the wrong direction unless you don’t have anything to lose. The weakest companies, on the other hand, aren’t concerned with the long-term effects of their decisions. If they don’t get through the short-term, there is no long-term for them. They lack options. For sure, they can get lucky and survive the next year or two.

Sometimes, the difference between surplus and shortage can be just one bad crop away. That’s the case in 2017. The weakest players can capitalize on that misfortune and potentially make a fortune … or not if there’s a bumper crop. It’s pretty rough when your best chance of making money in your chosen field comes only after a crop failure.

Is a great shakeout coming?

Last week, CNBC published an article about Boston Beer and the coming great shakeout of the craft industry. It may feel like a great shakeout to the corporate craft breweries at the top of the heap, like Boston Beer. They and the largest craft breweries enjoyed hockey stick growth the past 6-7 years. Today, they more closely resemble the corporate brewers against which they rebelled than our stereotypical image of a craft brewer. That growth slowed last year and continues to slow. Large corporate craft breweries are hardly local anymore. Many aspire to sell to stores around the U.S. Some are busy chasing global distribution.

The insatiable desire for growth is creating battles between corporate craft brewers and multinational brewers for control of shelf space and distribution. Neither group wants to stay in their lane. The craft beer industry probably won’t suffer much from that struggle. It will just be a question of who profits from it. Will the corporation worth hundreds of millions of dollars produce your craft beer, or will it be the corporation worth $186 billion? That struggle attracts a lot of attention. The irony of the situation appears to be lost. There’s another shakeout coming, one that will bring with it even more dire consequences.

If hop acreage growth continues on the current trajectory, there is a shakeout coming in the hop industry. How can that possibly be more important than the shakeout in craft beer? I’m glad you asked! Consider this … Last week, I ran into a Yakima hop grower I don’t normally see. He’s a brilliant guy and has done well over the years. We started talking about the trend of small hop farms starting across the country. He was concerned. We both agreed that they serve a purpose in their local markets but that they don’t understand how bad things can get in the market. Then, he emphasized, “Once they saturate their local markets and start selling outside of their area, they’re playing in my sandbox. If they want to do that, they better be ready to sell Cascades for $2.00 per pound.” 

Nobody wants to sell any hops for $2.00 per pound. Nobody makes money at those prices. Hop growers in the Pacific Northwest are prepared to go to the mattresses to protect their family businesses. If you own a small hop farm anywhere around the country, you should keep that in mind. Many PNW hop growers believe they can survive because they can always produce for less. That is their goto strategy. That doesn’t mean they are looking forward to it.

During the years from 2000-2005, PNW hop growers routinely sold hops far below their cost of production to drive out their competition, which at that time was other PNW hop growers. They are ready to use their size and economies of scale against the smaller farmers if necessary. It sounds like a crazy strategy, but it works. It challenges the resolve of the weaker player and to the victor goes the spoils … such as they are. For small hop farms that think this is a bluff … It’s not just hops. Even Amazon.com used the same strategy against diapers.com a few years ago.

To all the brewers excited by the thought of hops for $2.00 per pound … that should be the last thing you hope for. When prices sink below the cost of production everybody cuts corners, quality is a forgotten concept, farms go out of business, and the number of varieties available decreases. In short, you will get what you pay for.

 

 

American Hop Farmer Strategy “If there’s a bad crop …”

The strategy most often discussed at American hop conventions about a dozen years ago was how “Maybe next year things will be better” or how “if there’s a bad crop in Germany everything will be fine” (no offense ever intended to the German growers of course). Weak prices and a dire outlook for the future introduced plenty of humility to the hop industry. It used to be that without a fire in a kiln or a warehouse, there wasn’t enough money on the farm to pay for new equipment. I remember jokes like, “I tell my guys if the kiln catches fire to drive all the hop trucks right up next to it.” Back then, normal prices often didn’t even cover the cash cost of production. There were few people under the age of 40 in the industry. The industry was growing old and dying. 

In today’s world, everything has changed. Strong pricing the past few years has helped finance a renovation of much of the industry’s equipment. All that new investment brought along with it huge increases in capacity. It brought home a younger generation. In some cases, the pride and arrogance is off the charts. Some of them seem to think they invented hops or something. Much of the humility is gone except for those who lived through the bad times. You can tell they’re happy at the turn of fortune. It’s clear that memories of how bad things can be are just under the surface. I imagine they view the opportunities in the industry with some skepticism … and rightly so.

What hasn’t changed with all the ups and downs over the years is the American hop industry’s penchant for gluttony and the seeming inability to find a happy place. Maybe that’s just an American thing? Other countries’ hop industries seem to be relatively content when they’re making good money. When Doug Donelan of the New Zealand Hops Limited stated their strategy at an IHGC that New Zealand, that growers were content with their current levels of production, it shocked the rest of the participants. It was as if with such blasphemous statements he had just cursed the baby Jesus and the Virgin Mary in one go. Others scoffed at what they perceived to be a naïve position. They claimed those Kiwis were missing out on an opportunity of a lifetime.

I have to admit my Americanness made me wonder why they wouldn’t go for the brass ring. They seemed to have gotten it all right though. When is enough enough? Contentment?? American hop growers cannot seem to find the level at which they are content until they are looking at it in the rear view mirror. So long as there is an opportunity for growth, American hop growers will chase it. The money in today’s industry has emboldened them on that quest.

The more things change the more they stay the same. Since the last harvest I started to hear, “If there’s a bad crop everything will be just fine” again. That sounds oddly familiar. Everything is just wonderful in the industry today … isn’t it? A strategy based on somebody else’s misfortune does not sound like a good one. I believe there are cracks that lie just beneath the surface. If we scrape too much away, I imagine we will discover that what seemed like cracks in the ice are enormous crevasses.

Despite the recent upward trend, the hop market remains a fragile thing. If the industry had a strategy to responsibly manage production, as the New Zealand growers have done so well, perhaps there would be less cause for concern. Even those organizations in the U.S. that do resemble New Zealand Hops Limited aren’t showing any restraint. Unfortunately, there seems to be no plan, no strategy, no leader, no controls, no warnings and no consideration for the consequences of over supplying the market. So, we all continue forward on this roller coaster ride at full speed not knowing where the tracks may lead.

Does anybody have a better mousetrap?

In the search for their unique selling point, a better mousetrap if you will, hop growers and merchants all think they’re a little bit smarter and do things a little bit better than their competitors. That’s probably just the nature of business.

The majority of the people in the boat are surviving and that’s all they really want to do. That becomes difficult when nobody will act together because they quite literally hate one another.

Right now, for example, there’s enough hop acreage to cover the increased needs of brewers for 2017. Nevertheless, I hear reasoning like, “Why should I idle acreage if he’s going to plant?” and “My contracts are with better brewers than that other guy.” And “Our expansion is already in motion”.

In America today, everybody thinks they are special. If everybody is special, then by the meaning of the word, nobody is really special. The hop industry, high on the attention of the past few years, thinks it cannot repeat the mistakes of the past. If they continue to plant hops that are not necessary, we can, and most likely will, see Cascades for $2.00 per pound again. Thankfully, we are not at that point today. Everything is possible.

Hop growers and merchants never sing kumbaya together around campfires … ever. Sure, there are friendships in the industry. There are alliances. There are silos of groups that have banded together. They think they have built a better mousetrap with their collective intelligence. That’s an illusion. Even within those groups, everybody is only out for him or herself.

         It would be great for everybody in the industry to remember that they are the mice and they are all at the mercy of the market. They are not the mousetrap builders no matter how much they convince themselves otherwise.

The Future of Hop Growing

Automation will likely permeate the future of hop growing, even up to the decision making level. Agriculture is a laboratory for AI and robotics just as every other industry. Autonomous tractors already exist, although they are not yet so common in the hop industry. Everyday we hear news from Silicon Valley about autonomous vehicles on the streets. Stories about autonomous vehicles are common today. They aren’t even newsworthy anymore. Autonomy on the farm is simpler than in a city due to the reduced number of variables to track.

 

“Most human beings have an almost infinite capacity for taking things for granted.”

     ― Aldous Huxley, Brave New World

 

Minimum wage in Washington State in 2016 was $9.47 per hour. Now, it is $11.00 per hour. That’s an increase of $1.53 (13.9%) since 5 weeks ago. By 2020, the proposed minimum wage in Washington State will be $13.50 per hour. Increasing the minimum wage is a highly politicized issue. Regardless of your political beliefs on minimum wage, we all must admit there are consequences to the increases. An increasing minimum wage has one unintended consequence that is coming at the wrong time. It makes robotics, the cost of which is decreasing with each passing year, a more viable option to replace nearly all minimum wage or low wage workers.

Automation will touch almost every job requiring manual labor done on a hop farm today, during the next decade, if not sooner. Minimum wage increases alone are not the impetus for the evolution of agriculture. They will, however, hasten the coming changes. Where does the automation end? Can AI replace farmers and the decisions they make? Can future AI make more accurate decisions than humans? That’s not possible today. The fields of robotics and AI, however, is developing at an exponential pace. The time when the owner of the farm simply has to simply approve the recommendations given to him or her by a machine and send out the drones is in the foreseeable future. When that happens, the limitations of a farm will change.

Case in point, the latest development in robotics by Boston Dynamics, a company labeled “X” by it’s parent company, Alphabet.

 

We are entering a brave new world.

 

Changing Market Signals

The growth of craft changed the signals that traditionally guided hop growers and merchants as to what the market needs. The changing market created confusing signals for when to buy, when to sell, when to plant and when to idle acreage. The talk among hop merchants these days is how big brewers contracted for too many hops. Another hot topic is how payments from brewers are severely delayed and shipments of hops are moving at a snails pace. In 2016, late payments and slow deliveries primarily impacted the merchants. They reshuffled inventory to smaller customers whenever possible. Nevertheless, contracted inventory is piling up in warehouses. Nobody knows the complete picture of how pervasive the over contracting is in the craft brewing industry. For the most part, breweries still want their contracted inventory. They just don’t need it as soon as they thought they would.

Slowing deliveries is typically a sign of surplus and a harbinger of bad things to come. Not so in today’s hop market. Strong hop prices prevail. Strong hop prices are traditionally a signal to the industry to plant more. The industry traditionally reads that to mean that a variety is short and more is needed. Not so in today’s hop market. Quite a few growers and at least one merchant continue to plant more hops. Of course, they say it’s all contracted. I wonder when they will get paid for those hops? That’s the real question! It seems the people planting are still responding to signals of an old hop market where strong prices equates to short supply and a contract has a specific value in time. Everything has changed.

The current market requires delicate adjustments, somewhere between full throttle and full stop. Today’s market, with thousands of players acting in what they perceive as their own best interests, is unprecedented in our lifetimes. It sends conflicting signals to a hop industry used to a much smaller customer base. In 2017, the market will send hop growers plenty of signals. Right now, most merchants will not buy aroma hops. That doesn’t mean the market is gone completely. Merchants hesitate to buy hops from growers because of the optimism it can create. The hop industry does not need more acreage to satisfy demand.

Ten years ago, the current level of surplus would have crashed the market and acreage would be coming out. Will that news reach the fields in time to stop the production of millions of pounds of unnecessary hops in 2017? That is, literally, the million-dollar question! Growers don’t need to remove acreage. They simply need to slow down and let the brewers catch up.

Opposite Roles

Happy National Opposite Day!! Yes, it’s today! I bet you didn’t even know there was such a day, did you? It seems the hop and brewing industry are ahead of the times. For at least the past 6 months, members of the hop and craft brewing industries are playing opposite roles. Here’s an example … Today, it makes more sense for merchants to buy hops from big craft brewers than it does to buy them from growers. Many of the largest craft brewers in the country have more hops than they need and are desperately trying to sell hops. On the other hand, some hop growers, despite the slowing growth of craft beer, are planting more hops this spring. Could there be a better example of a time when somebody did the opposite of what they should be doing?

Is the situation hopeless? Should we prepare for Hopageddon? No … all is not lost. There are still breweries that need hops. They didn’t participate in the hop orgy the big craft breweries enjoyed when they thought the party would go on forever. Just as with beer, there’s a hangover when you have too many hops. Anybody who buys or sells hops for a living knows exactly what I’m talking about. The big craft breweries feel the effects of that hangover today. Unfortunately, there is no pill to take to make the problem go away.

When one big brewery has “some extra hops” it can take 50 smaller breweries needing that same variety to fix the problem. That’s 50 times the effort, 50 times the time and 50 times the expense to sell those hops … a second time. Growers and merchants who prefer to sell to the big craft breweries are not prepared for that level of increased transactional cost (that’s what they call it). The big craft breweries’ problems, like their successes, are big and they messed up … bigly.

If you aren’t a brewer sitting on a mountain of inventory, you still should not want prices to crash. Do you know what happens when prices crash? Quality crashes. Sustainability crashes. The number of varieties crashes. Selection crashes. Hops can be very cheap, but that comes at a very expensive price. You don’t want that … Not even on National Opposite Day.

Convention: One big Party?

When I was director of Hop Growers of America, most brewers, or anybody for that matter, didn’t care much about convention. When attendance was greater than 150 people, it was a shock. Convention was a time when growers and industry members would get together to discuss industry issues, drink free beer and play dice together. The meetings, I’ll admit, were a bit on the gloomy side. You have to remember that unless there was a warehouse fire or an alpha shortage, prices were often below the cost of production. Discussions involved much head shaking and trying figure out how to curb over production. In short, it was a lot of inside baseball. Growers drank a lot every evening (that hasn’t changed) and coffee was the lifeblood of the morning meetings. You could usually count on serious and thought provoking discussions.

Fast-forward 10 years … Hop convention is a big party! Some hop growers truly feel like rock stars and have naturally succumbed to hubris. There were more brewers at convention this year than you could shake a stick at, with about 650 people in attendance. How could you not think you were king of the world with all that attention? One brewer with whom I had breakfast enjoyed his first convention. He commented how great it would be if there were even more brewers in attendance.

Brewers communicating with hop growers and merchants is ultimately a good thing. Is convention the right venue for that? All the focus on selling and developing relationships has pushed some discussions to the side. There are a lot of issues growers and merchants need to discuss without brewers present. Planners today organize meetings regarding new variety development, increased hop quality. Everything has a theme of sustainability. The talks about cost of production, market forces, managing supply and the alpha surplus/shortage are conspicuously absent. Of course, that type of talk isn’t any fun when times are good.

Maybe people don’t care to watch the pennies when the dollars are flowing in. Maybe they just want to live for the moment knowing they cannot avoid their nemesis anyway when it comes. Lack of discipline in the hop industry can lead to big problems. Let’s not forget … The industry never figured out a way to manage supply and demand. They have been fortunate they haven’t had to for the past 7 years.

Hop Farming: 6 things to consider when starting a hop farm today

1) You’re a little late to the party. Had you planned your new hop farm a few years ago, you might have had it paid for by now and you’d be enjoying this article from a different perspective. Today, there’s no need for new hop farms, or even new acreage. Anybody planting hops commercially today is missing the bigger picture and contributing to oversupply. For all you passionate small growers just getting started … No, I don’t just want to keep acreage out to keep prices high just so I can get rich. Hop merchants can make money if prices are high or low. It’s growers who will take it in the shorts if the price drops below the cost of production.

 

2) Quality and service matter, but they’re not the only things that matter! There are very few brewers who are loyal to a certain supplier regardless of whether or not the price is competitive. Cue defensive brewers who want to argue to the contrary! I’m not saying they don’t exist, but, in general, brewers buy hops the same way they buy milk. Think about it … you don’t look for a certain variety of milk, do you? Unfortunately, price plays way too important a role in the hop industry. That’s the fault of the industry itself (a topic for another post). Grow what you have sold instead of selling what you have grown.

 

3) The industry feels big today with all the attention, but everybody in it is still in a very small boat. You may lose. It may not be something you do that brings you down, but something somebody else does. That’s why you need to know what’s going on in the industry and understand what that means for you. Everybody rises and falls together with the tide. Come to think of it, that doesn’t just apply for the small hop grower.

 

4) Nobody owes you anything! Sometimes the idea of sustainability alone isn’t sustainable. If you’re a small local producer, that doesn’t mean your local brewers have to prefer your hops. I know of a larger brewer who was excited to support their local hop growers. They bought local hops at $17 per pound really just because they were local. They thought they were doing the right thing. Sounds like a great sustainable thing to do … right? Unfortunately, quality and consistency were all over the place. By supporting their local hop industry they were supporting the wrong behavior. Fast forward to today … the brewery is back to buying hops from the Pacific Northwest. Being local in and of itself won’t be enough.

 

5) You have to know your market and know your place in it. If you produce hops in Michigan, Montana or Florida, your hops aren’t local in Illinois. Once you go out of state, you lose that competitive advantage. You may have high quality hops, but your local advantage is gone. Once you go out of state … guess what … all of a sudden you’re competing with Pacific Northwest growers. If you’re going there, you better be ready for a fight. Those guys are the big league. They could care less if you go out of business. In fact, they might even enjoy it a little bit. That would justify their business model and there are some sadistic mofos in the industry.

 

6) There’s no room for idealism in the hop industry. It’s a cutthroat business. That means you might have to do things you didn’t consider doing when you started to make money. Maybe you only want to sell organic hops. You can try to specialize, but at the end of the day you have to do everything possible to survive. You can’t live on enthusiasm and you can’t eat hops.