There was some excitement after a recent article in which Bart Watson from the Brewers Association referred to the hop supply ‘unsustainable’. This Brewbound article brought up some good points as did this piece by Stan Hieronymus. There are a few key points missing from the conversation I would like to add.
Surplus Challenges
I would like to start this article with the challenge about the hop surplus in 2023.
1) The current surplus is contracted proprietary varieties. Tracking contracted volumes over the years and updating them relative to production offers a good picture of surplus or deficit production (Figure 1). This is the first time that statistic has been published anywhere, but it is not difficult to calculate. Since approximately 70% of the U.S. crop is proprietary, we can read the graph below as an indication of proprietary supply versus demand.
Figure 1. U.S. Sold Ahead Position Forecasted and Actual for the Current Year 2014-2022.
Source: IHGC Country Reports[1]
Note: IHGC sold ahead positions are calculated based on anticipated yields for the year in which they are reported. Changes in yields affect the actual sold ahead position.
Despite massive surplus production, a distorted world view continued for six years after initial surplus signals first became apparent in 2016. By 2018, some brewers started noticing the ease with which they could find spot hops available, a clear sign of a developing surplus[2]. Louis Gimbel, CEO of Hopsteiner, told attendees at the 2018 Hop Growers of America (HGA) convention that the market was oversupplied[3]. Clear statements like that from the head of a hop dealer are rare. Farmers should have listened. Instead, they ignored his warning. They followed the money. Hop Breeding Company (HBC) varieties occupied 31.53% of U.S. hop acreage in 2018. They continued offering farmers lucrative contracts for several years. Farmers, blinded by confirmation bias and greed, believed the market was growing. Contracts are widely accepted among farmers as an indication of demand. All those contracts certainly meant the market was still growing. They ignored the obvious signs to the contrary (Figure 2).
Figure 2. U.S. September 1 Inventory Levels 1947-2022.
Source: USDA NASS Hop Stock Reports 1947-2022
According to USDA statistics, HBC variety acreage grew by 11,970 acres between 2018 and 2022 to 49.05% of U.S. acreage. In January 2023, at the HGA convention, Alex Barth, former CEO of John I. Haas and one of the three governors of the Hop Breeding Company, L.L.C.[4], shared his belief that a hop surplus of 40 million pounds (18,143.8 MT) existed. The industry, he said, needed to cut 10,000 acres (4,048 ha.)[5].
One of my first articles in 2022 was about the oversupply problem, “Massive Hop Inventory in the U.S.”. You can read that here. If you haven’t yet subscribed, please consider subscribing today.
2) The 2023 hop surplus resulted from contracts with thousands of craft breweries. Other surpluses predated the craft beer boom and involved macro brewers. The macros enjoyed an oligopsony and could dictate prices and terms due to their relative size and buying power[6]. Their market was different. Contracts designed for macro brewers are ineffective at meeting the needs of craft brewers.
3) Craft brewers don’t have decades of experience to help them forecast future demand. This results in a lot of contracts that are bad from the day they are signed[7]. A dealer’s size relative to the brewery combined with limited access to proprietary varieties bestows unprecedented power upon the dealer. The average small craft brewer in 2023 relies on the hop dealer more than the hop dealer relies on the brewer.
Surplus Problems
Previous surpluses were the result of too many contracts. There is often uncontracted inventory on the side. Unrestricted access to public varieties during previous surpluses enabled free market competition. Brewers found alternate sources of the varieties they wanted when prices were too high. Competition resulted in quicker corrections, greater price flexibility and contract renegotiations. With proprietary varieties, that changed. Brewers today can’t and won’t find the same proprietary variety from a competitor at a lower price. The absence of competition lessens the need for price flexibility and contract renegotiation. In theory, proprietary varieties could prevent surpluses That would require the discipline to deny contracts to brewers willing to sign them at any price.
“In theory, there is no difference between theory and practice. In practice, there is.”
- Richard Feynman
In the minds of hop farmers and dealers, the 2023 surplus is not likely an overproduction problem. I believe they will view it resulting from brewers contracting more hops than they needed. Technically, that’s true. To believe that though … We should forget about acreage increases and record 2020 and 2021 production levels despite dire predictions for the beer industry due to covid restrictions worldwide[8][9][10][11]. We would have to ignore misleading industry claims they planned to reduce acreage in response to Covid[12]. Brewers, dealers and farmers were all victims of long-term contracts. The inflexibility of contracts caused the surplus. All that is water under the bridge. The problem farmers or dealers have is that they have not been paid for the more than one billion dollars of product sitting in storage. The problem for brewers is that the hop industry is holding them liable for over one billion dollars in hops they don’t need. In the end, brewers will have to sell aging contracted hops at a loss to move them while they still have brewing value.
Contract Perspective
I believe farmers and dealers understand the fear they create when they threaten no hops without contracts. That’s a cynical view, perhaps, but it is based on two decades of experience in the industry. I’ve talked with salespeople who objectify their customers. They take advantage of and played on brewer fear to get contracts. “Nobody forced them to sign that contract” is something I’ve often heard over the years. While that is true, it reveals the insensitive and exploitative nature of the business. Knowing this, it seems disingenuous and insincere where I see words like “partner” used in reference to brewer customers. The primary goal of a dealer or a farmer is to sell hops at a profit. They are not all bad people, but a brewer’s relationship with them is never anything more than transactional.
“Trust but verify”
“Доверяй но проверяй”
- Russian proverb
The Contract Myth
The industry will never admit that contracts contribute to the recurring oversupply problem. They only say positive things about contracts on the record. The hop industry must uphold the contract system at all costs because it enables the financing of an industry that could not operate without borrowed money. You won’t read about that anywhere else. In 2017, Alex Barth then president of John I. Haas stated “I can’t stress enough the importance of contracts. It gives the industry direction.”[13]. While that is true, the direction it provides is not always correct. Also in 2017, Ryan Hopkins then national sales director at Yakima Chief Hops™ said, “There needs to be clarity in the supply chain”[14]. That too is correct, but contracts do not always provide that necessary clarity. They are not the panacea they are presented to be. The constant reinforcement of the positive aspects of contracting, however, while neglecting the negative is one very effective form propaganda.
When I was executive director of Hop Growers of America or during my decade as a hop dealer, I would have said something similar. Recurring business from an existing contract is a great business model. Long-term hop contracts are a cash cow. That, in addition to the financing they enable, is one reason they are so popular. The predictive value of a contract or the clarity they provide is a difficult argument to justify in 2023 given the imbalance in the market today resulting from contracts. Dealers and farmers cannot be blamed. Contracts cause as many problems as they solve. It would take superhuman restraint to resist signing profitable contracts with brewers when they will sign anything.
Brewers should never be so quick to sign contracts now or in the future. The hop industry has never had a chronic “undersupply” problem. A hop farm exists to produce hops. They will continue to produce hops, at some level … contracted or not … so long as they can sell them after harvest.
Surplus Financing
Banks use 100% of the value of every domestic contract combined with inventory value as collateral to finance a dealer. For U.S. bankers, contracts with entities in all but a few foreign countries have no value as collateral. Regardless of whether contracts are with domestic or foreign customers, when payments are delayed for a year or two (like now), that causes stress. Banks will likely offer larger lines of credit to make ends meet until the money from those contracts comes in. That’s a trap. Due to record high prices, the current surplus is a very expensive problem. If future prices decline below contracted prices, brewers will rebel and demand renegotiation en masse. Aging inventory that must make its way into the market has less brewing value after a few years even under ideal storage conditions. That will create alternatives and add downward pressure to prices. The bank has no interest in writing down the value of their collateral. Dealers and farmers have their backs against the wall. To maintain their lines of credit and to keep prices from falling, they will pressure brewers to fulfill their contracts.
Surplus Powers
What empowers sellers to do this in 2023? The concentrated ownership of proprietary varieties combined with their dominance of the U.S. market. There is nothing inherently bad about proprietary varieties. However, when one company can influence 50% of the largest hop producing region in the world, industry dynamics change. Craft brewers changed the balance of power in favor of hop dealers and farmers by purchasing disproportionate quantities of proprietary varieties since 2012.
Following is a chain of events that led to the current balance of power.
Short supplies of hops have always resulted in higher prices. That’s hoponomics 101. Prior to the existence of patented varieties, farmers were free to choose the varieties they produced. The varieties were public. Cyclical shortages and price surges occurred every 10-12 years. Prices between the price surges were abysmal. In the 20thcentury, American farmers enacted three Federal marketing orders to unify the industry and restrict the quantity of hops available. The most recent lasted from 1966-1985[15][16]. Greed led to its failure[17]. Between 2012 and 2022, variety patent owners were able to temporarily achieve those goals. They perpetuated the illusion of scarcity by limiting production via strict licensing agreements. That is their right as intellectual property (IP) owners[18]. The result was the prolonged illusion of scarcity that kept prices at record levels while supply increased and surplus contracted inventory developed[19].
Several owners of proprietary varieties enhanced the illusion of scarcity further by removing unsold aroma varieties from the market, extracting them and selling them as generic extract at significant discounts to their aroma market prices. This enabled them to maintain premium prices to craft brewers.
Fears of shortage created by a manufactured scarcity empowered dealers to demand long-term contracts. Without long-term contracts farmers said they would not produce.
Restricted competition through sales licensing agreements only with primary vendors in approved supply chains enabled sustained premium prices.
That brings us to where the market is today … a massive expensive surplus of unwanted contracted hops. The high value of expensive proprietary varieties combined with the slower rate of depletion since 2016 created a bubble worth over one billion dollars once processing and storage fees are considered. Interest on that inventory alone is $60 million every year. Nobody can afford to write that off so it must move into the market.
Restricted access to proprietary varieties force brewers to fulfill existing contracts before accessing new product. Brewers who abandon their contracts risk losing access to any varieties controlled by that dealer at best … and legal action at worst. With the HBC, whose popular varieties occupied 49.05% of U.S. hop acreage in 2022, brewers cannot afford to walk away from their contracts[20]. Common ownership between the HBC, John I. Haas and Yakima Chief Hops™[21] created a powerful duopoly for those HBC varieties. Brewers looking to escape the duopoly can move to more expensive secondary markets like Lupulin Exchange or other third parties that sell surplus inventories.
Three additional factors that affected the current balance of power:
Fear made it difficult for brewers to resist signing contracts for hops they think they need and may not get. They feared losing the opportunity to access those varieties.
Greed made it difficult for dealers and farmers to turn down opportunities to sign long-term contracts for high priced hops when some brewers wouldn’t take no for an answer.
U.S., bankers valued contracts with American breweries at their face value for collateral. The value of inventory in storage also played a role. It is often valued at either the contracted value, or the original purchase value plus any additional value added. Bankers have plausible deniability when contracts fail. They could demand information about contract renegotiation and failure rates and discount total contract value accordingly. The value of inventory for collateral could follow a similar method. I knew that information when I was a dealer. Nobody asked for it. Instead, they just reviewed spreadsheets with contract details and stopped by to take pictures of inventory each month. There are several bankers who read these articles. I’d love to hear your thoughts over a cup of coffee … off the record of course.
Surplus Forecast
During a recent presentation by dealers in Central Europe, one dealer estimated the U.S. will reduce production by 8,151 acres (3,300 ha.). That’s short of the 10,000 acres (4,048 ha.) allegedly needed to balance annual supply with annual demand. Although that will be an impressive acreage reduction if it happens. It does nothing to address the growing inventory in warehouses across the U.S., which I documented in my previous article, “The Truth Behind the Hop Surplus”.
The average yield between 2017 and 2021 for U.S. hops was 1,910 pounds per acre (2.14 MT/ha.)[22]. If farmers in Washington and Idaho plant no new proprietary or public acreage in 2023, that reduction will result in 98.6 million pounds (44,734 MT) produced on 51,634 acres (20,904 ha.). That will be an impressive reduction of 15.5 million pounds (7,030.7 MT) from the 2022 production capacity. That’s not enough. If demand remains unchanged in the next seven months, by September 1, 2023, the hop stocks report will show an increase of at least five million pounds (2,268 MT) to approximately 144 million pounds (65,318 MT) … +/- a couple million pounds. There is a good chance the surplus will be larger. Why? Somebody in Washington or Idaho will plant hops in 2023. As soon as the ground dries out, it will probably become more obvious. To anybody who has spent time in the industry, this is as certain as knowing the sun will rise each day in the east.
Surplus Prices
Craft brewers have been paying prices that set 70-year record highs (Figure 2). If they’re not content with that, or if they want some power during their negotiations with hop suppliers, they have the power to change that.
Figure 2. U.S. Season Average Prices Adjusted for Inflation Using the Consumer Price Index to 2022 USD with Standard Deviation Demarcation and Mean. 1948-2022.
Source: USDA NASS, Bureau of Labor Statistics
The surplus will not affect proprietary varieties the same as it did public varieties. If brewers don’t want to see hop prices double by 2030, they need to reintroduce competition back into the hop market. Continuing to chase proprietary varieties won’t do that. Under the status quo, prices will continue to increase for proprietary varieties from the newest crop, contracts will be strictly enforced, and brewers will have little ability to negotiate.
If anything is unsustainable about the hop industry, it is prices. The different rates at which U.S. and European hop prices increased over the past decade has created a value gap. American farmers and merchants have long had the perception that hops are such a small part of the total cost of brewing that it won’t matter if the price doubles. Average U.S. prices have tripled since I first heard that about 20 years ago. It seems they haven’t discovered where the boundary is. Craft brewers continue to raise that bar ever higher. This is all due to the perception that branded proprietary variety hops are more valuable than public varieties. Two hop companies have done a better job at perpetuating that myth by creating a brand image with which breweries want to associate. It’s a brilliant strategy because it leads to emotional purchase decisions and logic goes out the window. As the gap continues to widen, it will be more difficult to justify the premium prices associated with American proprietary varieties. At some point craft brewers are going to ask themselves is this proprietary variety really that much better than that public one. We have all made these decisions on a personal level. The video below does a great job explaining how this works. They may price themselves out of the market since experienced brewers can achieve similar results by combining flavors instead of relying solely upon a hop variety.
Whose Market Is It?
Living in Yakima and working with hops can be interesting. You never know who you will bump into going about your daily routine. I was once walking into Starbucks in Yakima when I bumped into a hop farmer. At the time, he was President of Hop Growers of America. That day, he was headed to the airport. He had been invited to speak to a group of Michigan hop growers. We talked for a bit. He seemed to me to be a little irritated about the trip. I clearly remember one thing he said that day, “They don’t have any idea how low we’ll go. We’ll sell for $2.00 a pound to keep those guys from stealing our market”.
Conclusion
From what I have experienced, that story above reflects the attitudes of many hop farmers in the Pacific Northwest. They are territorial. Many believe they inherited exclusive rights to the hop market together with their farms. Newcomers or outsiders have no right to participate. Like walls around a medieval city expensive barriers to entry keep potential invaders out of the market. Proprietary varieties raise those walls even higher. Today, without permission a farmer cannot produce the varieties most breweries want.
In recent months, farmers producing somebody else’s proprietary varieties discovered they had been used to develop market share for that variety. Between 2010 and 2015 dealers around the world suffered the same fate as their access to popular proprietary varieties was revoked. I can’t miss the parallels between the hop industry and Animal Farm by George Orwell. In a nutshell, the pigs on the farm rise to power and begin making the business decisions for the farm, which benefit the pigs more than anybody else. By the end of the book, the pigs transform into the very thing the animals sought to escape in the first place. If you haven’t read the book, check out the video below for a fun Thug Notes summary.
“All Animals are Equal, but Some Animals are More Equal Than Others”
- George Orwell, Animal Farm
Stress will build among American farmers as acreage continues to shrink. They self-censor to avoid the risk of losing future proprietary production rights altogether, but they have plenty of resources at their disposal if they choose to act. They will want to take action before permanently downsizing their farms. What is the value of a hop farm in a shrinking market when there are no hops to produce?
Production licensing agreements can be revoked on short notice with a letter when you’re no longer part of somebody’s plan. The same can happen with sales licensing agreements. I know. Until now, massive profits from selling high margin proprietary varieties silenced complaints and kept everybody playing together. Things are about to change.
The surplus represents an opportunity for craft brewers to escape the trap of constant contracts and high prices. Why would craft brewers contract during a surplus when you can buy perfectly good hops on the spot market? This surplus represents a chance for craft brewers to be more proactive and thoughtful about the way they buy hops. It represents an opportunity for craft brewers to realize that discounts on pellets or extract that are one or two years old represent an opportunity to save money without compromising. It represents an opportunity to prevent the world’s hop supply from becoming a monopoly.
There is a faction within the American hop industry that has long wanted to take over the industry. Through their purchases of proprietary varieties, craft brewers have helped that group progress toward that goal. While there are still options, brewers should be mindful of the consequence of their hop purchasing decisions. Monopolies drive up prices, increase inefficiency and loss[23]. If brewers don’t want a future where they struggle to pay their hop bill more than they already do, now is the time to act.
I would like to thank you for taking time to read this article. For the many of you who subscribed over the past month … THANK YOU! I hope you feel like you receive value from these articles. If you do, please pay that forward and share it with somebody who might also find it valuable. I know my articles are long and I appreciate your patience if you read even part of any of them. There is a good reason I write them the way I do. I will share that with subscribers a few months from now. If you’ve not already subscribed, please consider doing that now.
[1] http://www.hmelj-giz.si/ihgc/act.htm
[2] https://thebrewermagazine.com/working-hop-contracts/
[3] https://brewingindustryguide.com/rightsizing-the-hop-market/
[4] The other two governors of the company are Mike Smith and Steven Perrault. This information may be found by typing in Hop Breeding Company at the following URL. https://ccfs.sos.wa.gov/#/BusinessSearch
[5] https://www.hoptalk.live/post/too-many-hops-10000-acre-cut-needed-says-barth
[6] https://www.investopedia.com/terms/o/oligopsony.asp
[7] https://www.westword.com/restaurants/ska-brewing-uses-humor-to-turn-a-bad-hops-contract-into-a-beer-9381027
[8] https://www.spokesman.com/stories/2021/sep/07/hop-harvest-underway-in-the-yakima-valley-with-gro/
[9] https://www.brewersassociation.org/insights/impact-survey-shows-extreme-challenges/
[10] https://www.nass.usda.gov/Statistics_by_State/Washington/Publications/Hops/index.php
[11] https://www.idahofb.org/news-room/posts/covid-19-impacts-hop-production/
[12] https://www.yakimaherald.com/news/local/hop-growers-make-changes-adjust-acreage-in-response-to-covid-19-pandemic/article_64c56709-9fca-513f-8b59-73095458b508.html
[13] https://www.beeradvocate.com/articles/10408/the-cost-of-brewing-business/
[14] https://brewingindustryguide.com/forward-contracting-hops/
[15] https://www.ers.usda.gov/webdocs/publications/40612/50840_aer707.pdf?v=0
[16] https://www.latimes.com/archives/la-xpm-1985-07-03-fi-10355-story.html
[17] MacKinnon D., Pavlovič M. (2022): The delayed surplus response for hops related to market dynamics. Agric. Econ. – Czech, 68: 293–298. Available online at: https://www.agriculturejournals.cz/publicFiles/156_2022-AGRICECON.pdf
[18] https://www.uspto.gov/sites/default/files/documents/eligibility2019comments_f_morinville_05mar2019.pdf
[19] https://www.usahops.org/img/blog_pdf/435.pdf
[20] https://www.nass.usda.gov/Statistics_by_State/Washington/Publications/Hops/index.php
[21] The links between these three companies may be found on their respective web sites but are also available by typing the names of the companies into this URL. https://ccfs.sos.wa.gov/#/BusinessSearch
[22] I did not include the low yields of 2022 in the 5-year average because it was an anomaly and would have skewed the long-term average downward to a point where it would not skewed projections.
[23] https://www.minneapolisfed.org/article/2016/the-costs-of-monopoly-a-new-view