Cutting against the grain
It's classic market economics: a crisis in grain supply coupled with soaring global demand is giving the spirits industry a headache. Tom Bruce-Gardyne reports
27 August, 2008
Back in the early days of making spirits, the price and availability of grain was the critical factor facing any distiller. In Scotland, for example, the size of the local harvest had a direct effect on how much whisky was produced at the local distillery - whether legally or not. Whenever the harvest failed, the government of the time was apt to ban distilling altogether to try and preserve what little grain there was for food. As the spirits industry came of age, the link between raw ingredient and finished product grew further and further apart, as grain became a globally traded commodity. If the UK wheat used to produce Gordon's gin or Smirnoff vodka was in short supply , then brand owner Diageo would simply look abroad.
That dynamic has not changed, of course, but the age-old bond between the land and the drink made from it has recently been brought back into focus - following the dramatic rise of grain prices. "If you are making alcohol from cereal, around 60 per cent of the manufacturing cost is the raw materials," says David Ward, general secretary of the Neutral Alcohol Producers Association in the UK.
The impact on the distiller depends on the type of spirit, the type of grain - be it wheat, maize or barley - and, crucially, the price at which the particular spirit is sold. Clearly the retail price of a premium brand of vodka - such as Absolut - has far more to do with tax, retail margin and marketing spend, than the cost of the winter wheat used to produce it. There is also the factor of age to consider - whether it is a white spirit sold virtually hot from the still or a dark spirit like Scotch that has to be matured for a minimum of three years. That said, Scotland's whisky distillers will still have to try to cover the unforeseen price increases in the grain bought this year with the Scotch being sold now.
Of course, next year's harvest could be back to normal, but no one is really expecting grain prices to fall back to where they were three years ago. Given increased demand from many sources - from biofuel to cattle feed - it seems spirits are already caught up in the general food inflation trend that has affected everything from Mexican tortillas to Chinese pork. Growing biofuels has stirred up a debate on the ethics of ethanol and whether it is right to use food for fuel.
Distillers could switch production methods from, say, wheat to sugar beet in the case of white spirits. As the EU Commission confirmed last year, vodka can be made from any "ethyl alcohol of agricultural origin". Yet Ward predicts no change. "People who have made gin and vodka from grain will continue to do so because they don't want to change either the real or perceived quality of their product."
The principal grain for bourbon enjoyed an "excellent harvest with good yields and the total acreage under grain the highest it has been in the US for many, many years ", according to Max Shapira, chief executive of the Heaven Hill Distilleries in Kentucky. Despite this, the price of maize has risen by around 60 per cent from US$2.25 to US$3.50 a bushel (56lb or 25.4kg) in the space of a year. According to Shapira that equates to a 20-30 cents rise in the cost of a proof gallon and about the same increase on the retail price of a US$10 bottle of bourbon. For those brands forced over this important price point, the impact will clearly be greater than the 2-3 per cent increase would suggest. As ever, the extent to which any increase is absorbed before reaching the end consumer depends on who holds the balance of power between supplier and retailer.
The price hike is down to a whole new market for US maize - namely biofuels. Until recently, the US government's willingness to promote the production of ethanol to blend with gasoline ebbed and flowed according to the political calendar. At election times it would be trumpeted as a sop to farmers in the corn belt, only to die away once the votes had been gathered in. Now with concerns over fuel security - of wanting to limit reliance on unstable and unsavoury regimes in the Middle East - coupled with a desire to limit carbon emissions, it is right back on the agenda. Especially now that the price of crude oil is sailing towards US$100 a barrel.
Tax breaks and subsidies have encouraged venture capital to flow out from Wall Street. In fact, there are now 129 distilleries making fuel-grade ethanol in the US, with another 80 under construction to meet ambitious government targets. The biofuel gold rush was sparked off by the 2005 energy law, which set a mandatory target to double the amount of ethanol mixed with gasoline to 7.5 billion gallons by 2012. The New York Times talks of farm prices being the highest in a generation and of "farmers making high-performance moonshine from amber fields of grain ". The newspaper even quoted one ethanol distillery in Minnesota making traditional moonshine, or rather a high-end brand of vodka, alongside several million gallons of transportation fuel.
Perhaps this is the logical conclusion of a business simply trying to extract maximum value from its production. Quite how consumers would react if they realised that the premium spirit in their vodka martini was also being used to power their 4x4 SUV, is unclear. It would certainly be a marketing challenge. When told of the Minnesota plant, Graham Bateman of the UK's Gin & Vodka Association, is unimpressed. "It would tend to backfire ," he says. "There isn't a single company in the UK who are trading in both - they are either producing ethanol or potable alcohol." And yet the giant US agribusiness Archer Daniels Midland has been doing it for years - not that it has come close thus far to producing its own brand of spirits.
But as Shapira says, the biofuel boom has now fuelled a glut. "The fact is, that while still huge, there are some cracks developing in the ethanol business here in the US as the price has gone down and squeezed margins substantially." As of late September the spot price for ethanol had fallen 30 per cent since May. Back in Europe, US maize is not really an option for distillers - at least those pledged not to use GM crops. An alternative would be French maize, but here too, prices have risen steeply . This is partly because they track the US market, but mainly because of the weather causing a 15 per cent reduction in this year's harvest compared to 2006.
Extreme weather pushed world wheat prices to their highest levels in more than a decade. According to the UK's Home-Grown Cereals Authority , there has been a movement of US$205 a tonne in just over six months to reach a peak of US$390 in early September. At the time of writing, it had fallen back a little to around US$330. The first warning signs came just over a year ago with news of serious drought in Australia. Forecasts from this major exporter have grown progressively worse since, and Ward says latest estimates are now 50 per cent down on normal.
Population growth and increased affluence have ramped up the global demand for wheat, as has the demand from the biofuels industry - though the HGCA believes this has been overplayed by the media. As a result, stocks were already tight when this year's harvest in Europe came in short, both in quantity and quality. Provisional estimates by DEFRA put wheat yields in Britain at 7.3 tonnes per h a , the lowest since 2001. The fact this was only 9 per cent below average hardly mattered since prices are global, meaning UK distillers were paying double whether they wanted their wheat home-grown or from elsewhere.
Scotland's distillers habitually buy their grain for malt whisky on the forward market, making up the difference on the spot market according to need.
For the HGCA, the problem this year has been that farmers tended to fix the price early. When the latest harvest came in short, prices shot up, causing quite a number to default on their contracts. Maltsters found themselves in the unenviable position of having to buy very expensive barley to meet demand. At the time of writing, the price of barley was still at a record high of US$450 per tonne delivered from the farm. This represents a 150 per cent increase on two years ago.
----=== World commodity prices 2003-7 ===CBOT* maize US$/t CBOT wheat US$/t W CE** barley US$/t
2003-4 102.20 135.75 198.47
2004-5 83.12 115.41 151.84
2005-6 86.41 125.58 142.55
2006-7 133.06 170.84 186.12
Source: HGCA *Chicago Board of Trade **Winnipeg Commodity Exchange. Average representative prices Jul 1-Jun 30