Towards supply / demand equilibrium

As seen in the Figure 2 above, up until 2006/07, wine production in Australia has consistently outstripped demand / sales. The continual oversupply led to a build-up of inventory, peaking at almost 2 billion litres in 2005/06³, and the highly publicised ‘wine glut’ which continued to hamper the industry’s profitability for years after.

Although the severe drought in 2007 helped to reduce inventory levels in the late 2000’s, a significant imbalance between supply and demand was still present. In 2009, after stating that “structural surpluses of grapes and wine are now so large that they are causing long-term damage to our industry”⁴, a group of key industry bodies announced the Wine Restructuring Action Agenda which identified an urgent need to reduce wine inventories and production capacity in order to rebalance supply and demand, and made recommendations on how best to achieve this⁵.

Since then, total vineyard area has significantly reduced, yields have been lowered, less wine has been produced and wine inventories have been drawn down to more a sustainable level. Couple this with a relatively consistent level of sales/demand since 2008 (which is now generally consistent with production levels) and the emerging Asian export markets and it appears as though the historical imbalance between supply and demand is now less significant than in previous years. Although surplus inventories still remain in 2016, rebalancing supply has helped average prices reach the highest level achieved across all varieties since 2009 (as shown in the 2016 Vintage Report), placing the industry in a much better financial position in 2016 than it has been in recent years⁶.

Importance of supply

Although supply is now generally consistent with demand on a total production basis across all Australian wine grapes, the situation can be drastically different when assessed on a by-region or by-variety basis. Furthermore, the supply situation can become even narrower when also taking into account specific grades of fruit particularly with respect to the supply situation for ‘premium’ fruit of a specific variety from a specific region.

For example, Barossa Shiraz continues to be one of the most highly sought after grapes in Australia (and one of the most in-demand varieties in the world!) and due to low yields in 2013 and 2014, Barossa Shiraz fruit was labelled by Austwine in 2015 as being in a state of undersupply⁷. This is a critical factor to consider for producers and wholesalers targeting a specific wine (whether that be by grade, variety or region), particularly those looking to cash in on the next wave of growth opportunities presented by Asian export markets. Now that the 2005/06 wine glut has been substantially reduced and new sources of demand continue to emerge, it will be critical for wine producers to secure adequate supply of their desired future varieties.

However, ensuring security of supply is never a straightforward task in the agricultural industry. One common approach towards achieving surety of supply is to enter into medium to long-term contracts with growers, a practice widely adopted by wine producers. Although such arrangements may assist in achieving surety of supply of a particular parcel of fruit, they can create other risks such as location specific seasonal or disease risks, variability of quality risk, contract pricing risk, and a reduced ability to adapt to the ever-changing preferences of the consumer.

With so much hype around unlocking new markets and creating additional demand for Australian wine, it will be critical for participants in all parts of the supply-chain (including bulk wine producers, wine makers and wine retailers) to ensure they have adequate supply arrangements to satisfy demand. Wine producers need to seriously consider that they may only be one low yielding vintage away from a situation of severe undersupply.

As an example, if weather conditions or disease were to impact an upcoming vintage in a similar way to what occurred in 2006/07, where total crush volume was down by 32%⁸ due to drought, producers would need to closely consider the impacts such a supply-shock could have on their business. A weakened level of supply will have an even greater impact on those producers who rely upon consistency of specifically chosen regional and/or varietal fruit where the supply/demand position is already much tighter than other parcels of fruit. In such circumstances:

• Would a small vintage affect the producer’s ability to satisfy pre-determined sales contracts? 
• If the producer cannot secure adequate supply to service these supply contracts, will this affect their ability to maintain their relationship and agreements with key distributors? 
• Furthermore, will the producer be forced to forge sales opportunities in new growth markets to focus on satisfying demand in existing markets? 
• If so, how will this affect the producer’s ability to continue to compete for market share in these markets?

In a typically highly demand driven market, it is critical that these supply side considerations are assessed by industry participants with as much scrutiny as the demand side. Those who do not may find their situation a lot more challenging if next year’s vintage is not as ‘sensational’ as we have seen in 2016.

Author

Jake Stacy
Senior Analyst
Financial Advisory and SA Wine Industry Group Member

References

¹ Wine Australia – Vintage Report 2016  
² All data taken from Vintage Report 2016
³ Wine Australia – Results of the 2015 Wine Production, Inventory and Domestic Sales Survey
⁴ Winemaker’s Federation of Australia – Wine industry must confront the reality of oversupply
⁵ Foundation for Alcohol Research and Education – The Wine Glut
⁶ Wine Australia – Wine facts, Supply and Demand Imbalances
⁷ Austwine - State of the Industry Report, as presented at the SA Winegrape Growers Summit 2015  
⁸ Data from 2005/06 – 2014/15: Wine Australia Results of the 2015 Wine Production, Inventory and Domestic Sales Survey