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Last week a customer with some hop contracts asked us to lower his prices. He is happy with the quality and he said his volumes are OK. He was disappointed because he can find some of those varieties on the spot market today for less. It is common for prices to differ from year to year. Unfortunately, we cannot rewrite contracts every time prices on the spot market change. We have corresponding contracts with farmers for those hops. Farmers expect to be paid.
Would any brewer be OK if the company with which they contracted hops wanted to increase prices for their contracted hops because spot market were suddenly higher? Obviously, that’s such a ridiculous question no merchant or farmer would expect a brewer to consider it. That’s not how contracts work. In that situation, we would expect any brewer to say, “No way! … I have a contract for those hops at this price and that’s what I expect to pay!” The respect for contracts should be just as strong when the market moves against you as when it moves in your favor. Hop contracts are about so much more than just price and quantity. The trust inherent in contracts is the foundation upon which the hop industry is built.
Let’s imagine a world without hop contracts for a minute. It would work, but it would be different from the world we know today. A 100% spot hop market would be chaotic and inefficient. First of all, hops would only be grown in Washington and Idaho State. Those are the only places in the world where a farmer can plant hops and get a decent yield the first year. After all, who would plant hops that take three years to produce a crop without a contract? Three years is the norm everywhere in the world except for Idaho and Washington State. Goodbye centuries of European hop tradition. Regardless of where they’re located, how would a hop farmer know what to plant without a contract or what it would sell for when it is produced? It would be anybody’s best guess.
A completely spot hop market would fluctuate wildly from year to year. There would be more hoarding when prices increase and more dumping when surplus hops are produced. In short, there would be more gambling. Very likely, brewers would clamor for a more efficient system. Without contracts, brewers would pay for their hops in full in the spring before the crop is produced to assure the farmer the crop is sold. Without money in advance for hops, why should the farmer grow them? Without contracts, to guarantee stable beer production, brewers would also likely purchase more hops than they need. After all, who knows if they’ll be there next year.
In a completely spot market, farmers would produce the varieties that return the most money every year. Maybe farmers would even take a year or two off if brewers weren’t paying enough in a given year. There would be very little stability from one year to the next. Every year would be a new adventure. You see … farmers only know which varieties to plant from the contracts they receive. The contract length reveals the importance of that variety to future production. Price, on the spot market or in a contract is the only indication whether the market for a variety is over or under supplied. The contract is important for all those things, but hop contracts provide even more value than that.
American farmers typically receive financing for their farms. Banks don’t finance farms and merchants for fun. They want to make money. To fulfill hop contracts with craft brewers, the American hop industry today is hundreds of millions of dollars in debt. Brewers must now make good on those contracts or they risk destroying the hop industry. Banks need to see contracts that show what the crop will be worth and how much they can expect to receive. Contracts represent the earning potential, which gives the bank the confidence to lend money to farmers and merchants. The payment terms of the contracts create expectations for cash flow. Financing would be the responsibility of the brewer in an entirely spot market.
If brewers contract for their needs properly, they ensure their ability to produce beer. They reduce their risk. Brewers are easily distracted when prices on the spot market are low and forget about the value of the security they have guaranteed with their hop contracts. The security of supply has value. Brewers pay nothing for it under the current system because signing hop contracts costs nothing until it comes time to purchase the hops. It’s like an insurance policy. We all carry insurance to protect against the chance of bad things affecting our businesses. Contracts provide the same security.
There’s nothing like a shortage of hops to reinforce the value of hop contracts. In a shortage, those who have contracts get their hops at the contracted prices. Those without contracts, if they get hops at all, will pay top dollar. Hops can get very expensive during the frenzy of a shortage. Most craft brewers in the business today haven’t had the pleasure of experiencing a hop shortage … yet. That time may come sooner than they expect. The system of contracting hops is far from perfect, but it’s more efficient than any other system that exists. Does anybody really want a system in which price trumps everything else? Brewers should be careful what they wish for …