Grain farmers often talk about export and import parity* when considering price hedging strategies, but in the wine industry these are terms that are almost unheard of. Why is that? The reasons for this among other include that the South African wine industry has been in structural oversupply (produced a surplus crop in 8 out of the last 10 years) over the past decade and with the local market stagnant for a large part of this period, was largely reliant on exports to ensure a shift in inventories and to stimulate cash flow. These exports, specifically bulk wine, were done on an export parity basis.
Recent projections by Sawis and VinPro, however, indicate that import parity could soon become part of our daily vocabulary as the industry production curve declines and stock levels reduce. The key drivers for this include:
- Projections indicate that total area under vineyards can reduce with 5 000 hectares to 90 000 in 2021 with subsequent total crop projected at 1,3 million tons or 100,000 tons lower than in 2016.
- Significant profitability of other agricultural crops such as citrus, pecan nuts and fruit that compete for land and water with subsequent acceleration in uprooting of vineyard hectares. These crops often provide returns exceeding 10% on investment with wine grapes on average at 2%.
- Ageing of our vineyard area, with 29,7% of our white wine vineyards exceeding 20 years and a large component of our red vines soon older than 20 years and infected with leaf roll.
- Local wine market growth of 8% year on year or 30 million litres since end 2015 and exceeding 400 million litres by end 2016. It is expected that the momentum on volume growth will continue in 2017 although at a slower rate.
- Export market showing recovery – especially the past 2 months with volume and value growth – total market 430 million litres.
What is the relevance of the above and why does it matter? Well for the first time in a decade the SA wine industry seem to reach the optimal point of liquidity on supply and demand regarding stock levels and the projections indicate short supply in certain categories over the medium term – especially white wine. This is where the wine producer and winery will have to get into the “grain mode” and do some calculations, because suddenly in a short supply environment, price should move closer to import parity.
It is well known that wine differs in quality and cultivar classes, which does complicate calculations, but the question to ask is: what is the landed price per litre of B-grade wine in the Western Cape? Two scenarios were done on wine from the EU, at 25 cent and 35 euro cent per litre (see table below). The import parity answer at current exchange is R6,44 and R7,97 per litre respectively, which is 30%-50% higher than current price levels. This price level should theoretically become the new “floor price” in a short supply market with wineries to use this as part of their key marketing decisions across the value chain. Cognisance should however be taken of the relatively high price elasticity for wine, especially in the local market, where an overnight increase in retail selling price can lead to a more stagnant demand – especially for medium and standard priced wines. This is where wine businesses will have to embrace the principles of the Wise BrandSA strategic framework to grow sustainable value.
The Chinese word for crisis is composed of two Chinese characters respectively signifying “danger” and “opportunity”. Perhaps it is time that we calculate and talk more about the above opportunities that will arise from this perceived crisis.
*Import parity price (IPP) – the value of a unit of product bought from a foreign country, valued at a geographic location of interest in the importing country.
Export parity price (XPP) – the value of a product sold at a specific location in a foreign country, but valued from a specific location in the exporting country.