Who Sets Hop Prices … and How?
Networks, Propaganda … and Collusion? Plus … a few words on the 2022 Market
Rising Costs ≠ Rising Prices
Some people claim the price of American hops has something to do with the cost to produce them. That’s not true. That’s not to say the cost of production has not increased, especially in 2022. It’s hard to find anything today for which the price has not increased this year. But who decides how much that should affect the price of hops? In Germany, some farmers have contracted out their alpha hops at 35 Euros per kilogram of alpha until 2030. That was a questionable decision before the rapidly rising German inflation of the past year (Figure 1). It looks even worse today.
Figure 1: Germany Consumer Price Indices 2018-2022[1]
Today, rapidly increasing costs threaten the existence of the farmers who signed those contracts. That’s not just in Germany. Hop farmers across Europe find themselves in this position. Will the large hop merchants default to the knee-jerk reaction and tell these farmers “a contract is a contract” and gamble on whether those farmers survive? The problem is that brewers, many of whom demand contract renegotiations when prices decrease have no interest in renegotiating contracts when prices increase. Under these circumstances, they will be the first to proclaim, “We have a contract!” and threaten to sue. So it happens that despite the fact that costs associated with producing hops around Europe have risen dramatically during the past year, prices may not increase as a result. It’s a double standard as old as the practice for contracting hops. The longer the term of the contract, the higher the risk that contract will not be fulfilled as written due to changing market forces. I’ve been burned by contracts many times. It’s one of the reasons I’m happy to be a recovering hop merchant.
That is also one of the reasons why I question the value of contracts as I did in an earlier article, The Con in Hop Contracts. In that article, I discussed how contracts and hop prices are about fear and opportunity. This year epitomizes the case for sustainable prices. American farmers like to use this term because it is a politically correct way to say they want more money. For nearly 10 years, they have made double or triple the revenue of their European counterparts all the while complaining they don’t make enough money.
But this article is about the prices at which those contracted sales happen? How are prices determined? Who decides what a variety is going to sell for today or tomorrow … or five years from now for that matter? Is there a central committee with a five-year plan? Why is the price for any given variety higher or lower than last year? The answers might surprise you.
First, let’s dispel the myth of a causal relationship between the cost of production and hop prices. That’s not how hop prices work. Hop prices are reactive. In a seller’s market, where a slight deficit or equilibrium exists, each farmer’s cost of production (They’re all different) acts as a self-imposed price floor[2] beneath which he does not want to sell his hops … unless he must. In a seller’s market, the brewers’ fear of scarcity keeps them content with the idea of paying prices above this floor. The challenge for more than a century has been to create a system in which a slight deficit or equilibrium can be created year after year. American farmers’ fierce independence, distrust of one another and self-interest caused their previous efforts to fail.
If farmers could create the belief among brewers that a deficit, which could lead to a shortage, was always right around the corner, they could name their price and get it. Proprietary varieties enable their owners to do just that. They can adjust the supply available to the market by removing surplus product. No American farmer wants to see his hops go to the landfill though. So, instead of destroying those surplus aroma hops, they extract them … hence the surplus of alpha acid on the market today[3]. That keeps aroma variety prices high at the expense of the alpha market.
Since 2010, U.S. proprietary variety acreage has been growing rapidly. Since 2017, it has represented a majority of U.S. acreage. Along with those increase came the ability to affect the price for public varieties as well. The owners of proprietary varieties are farmers and/or merchants. They can manage acreage to influence prices, keeping them favorable for the farmer. The challenge is to find the point where brewers might complain about high prices, but do not revolt or look for alternatives. Brewers’ belief that they need specific proprietary brands to succeed in the craft market ties them to a variety. Once that decision is made, they have no choice but to pay double or triple the price for which most European varieties may be purchased. I discussed in my previous article Are You Overpaying for American Hops? if you would like to read more about that. Despite the premium they receive, American farmers claim they barely survive from one year to the next. In an upcoming October article, I’ll explain how that can be.
To be sure, the cost of production of hops has risen. My point is not that the cost of production has not increased. That would be foolish. I am suggesting, rather, that the cost of production is not what typically determines the price.
An Irrational Market
Before the era of proprietary varieties when the decision making process regarding acreage was centralized into the hands of a few individuals, farmers were quick to increase acreage in response to increasing prices. They marketed what they produced rather than producing for the market. Price was irrelevant. Production changes did not coincide with changes in price (Figure 2).
Figure 2: U.S. Hop Production and Season Average Prices
Due to the cost involved, hop farmers are reluctant to remove infrastructure. They are slow to reduce production in response to decreasing prices (i.e., the Delayed Surplus Response or DSR[4]). The DSR happens in response to surplus production and results in still greater surplus production until the market sends such an overwhelming signal that acreage reductions can no longer be avoided. The cause of the DSR is both financial and emotional.
1) Financially speaking, once long-term fixed infrastructural assets (think trellis and picking machines) are in place, farmers can only reduce production so much before they become inefficient and cannot compete with their neighbors. Because farmers in the PNW farm such massive monocrops, this minimum number is rather large relative to producers in other countries. Many of their assets serve no other function. When demand decreases, hop farmers are backed into a financial corner.
2) Emotionally speaking, most farmers inherited or bought their farms from a relative. Many are emotionally attached to the farm and the idea of being a hop farmer. From my experience, it appears to be a large part of their self-image. They are not just people who produce hops. They are hop farmers. What is a hop farmer without a hop farm? That’s not a Zen paradox through for you to gain enlightenment. It’s a practical question to demonstrate how the farmer can be backed into an emotional corner during challenging times.
In theory, the cost of production matters in a seller’s market when people are competing against one another when demand exceeds supply. The irrationality arises when supply exceeds demand. Being financially and emotionally cornered, a farmer’s sold ahead position relative to his ideal sold ahead position, age, or perception of the future might affect his decisions on acreage and price.
“In theory there is no difference between theory and practice, while in practice there is.”
- Benjamin Brewster, The Yale Literary Magazine, 1882
In 2003, prices were at the lowest point since World War II (Figure 2). During the Federal Marketing Order hearings in Yakima Washington[5], one farmer (who today is a co-owner in a variety development entity) testified that he produces more acres of hops so he can lose less per pound. On the surface, that appears to be the epitome of irrationality. I would suggest the opposite. I suppose he had simply reframed the game … from one of short-term profit maximization to one of long-term industry domination. The small Oregon farmer whose testimony followed garnered laughter from all those in attendance when he admitted, “I don’t even know what that means.” When referring to the previous testimony. He was still playing the old game.
“What it means” is the farmer with the lowest cost of production loses less in the bad times than his competitor. He will be more likely to survive the downturn. The key takeaway from the first farmer’s statement is that by his own admission he will not stop producing hops based just because hop prices are low. A hop farm exists to produce hops. That is what it will do, regardless of price.
The royalties from proprietary varieties have enabled several farms to be very well capitalized. Farms without royalty revenue are at the mercy of the owners of the proprietary varieties they produce. They are most vulnerable and will be among the first to fall when proprietary varieties begin to lose their appeal and acreage must be reduced. This spring in the June Acreage Strung for Harvest report article I wrote, I discussed this effect. Individual farms still naively market themselves as producers, but their identity is as relevant as the company that assembles your iPhone in Asia. Many have not realized the change in their status yet. They will in the future.
Network
Since hops are traded over the counter[6] instead of on an exchange, there is no uniform price for hops like there is for crude oil, wheat, or gold. Every deal is unique. Every deal is negotiated between a farmer and a merchant. Every deal might find its own price based on the quantity exchanging hands, the terms of the agreement, the relationship between the parties and many other variables.
During the growing season and most days in between, farmers in the growing regions of the Pacific Northwest (PNW) have meetings almost every day. These meetings are between farmers, farmers meeting with merchants or merchants meeting with merchants (although the latter category occurs less frequently than the other two). They meet for breakfasts, lunches, coffees, dinners, or drinks after work to chat. During these meetings they discuss the following topics:
1) The local weather,
2) Weather in hop growing regions in other parts of the world if they’re having problems and might mean a short crop there,
3) Any exciting topics in the news,
4) Who is planting, harvesting, or building new yards,
5) What kind of pest or disease problems they’re having in their fields,
6) What kinds of problems they’ve noticed in their neighbors’ fields (Provided that the neighbor in question is not present),
7) Increasing costs,
8) How hard it is to find labor (for spring work or harvest is approaching),
9) Recent news of any sales … this sort of conversation may be sanitized depending on the strength of the relationship between the parties involved so no revealing details are revealed. An example of such a conversation might be:
Farmer Bob, “Did you hear about that big sale of Cascades to a brewer yesterday?”
Farmer Jim, “Really, what’d they sell for?”
Farmer Bob, “Don’t tell anybody, but I heard they went for about $6.50 a pound.”
Farmer Jim, “That’s a pretty good price. How big was the deal?”
Farmer Bob, “I heard it was pretty big, more than 20,000 pounds.” (Bob might also add the name of the merchant or the brewer involved depending on how well he knows Jim and how sensitive the information).
Most significant from these topics are the discussions regarding sales. This may seem trivial since the information might be sanitized. They are anything but trivial. Mobile phones, email, and social media, makes the network global. While it may seem like people gossiping, the information exchanged is valuable … when it’s true. Propaganda, misinformation, and lies can spread through the network knowingly, or unwittingly and can also affect the market. This price discovery process applies primarily to public varieties and proprietary varieties that are not strictly controlled. The most popular proprietary varieties are managed and prices to farmers are often set rather than negotiated.
Proprietary varieties are a brilliant strategy for the hop industry. There is little loyalty between brewers and merchants or between merchants and farmers. Loyalty lies with the variety or type of product purchased. Not only do they enable the creation of perpetual deficits by taking planting decisions away from the farmer, but they also lock the buyer in a specific supply chain. I believe the main purpose of proprietary varieties is not to create wonderful flavors for the good of the brewing industry. That’s a means to an end and great marketing. Their primary purpose, in my opinion, is to create competitive advantages for the merchant and farming entities in which their owners have a financial interest. By doing that, proprietary varieties impose loyalty to a single-source supplier (or distribution chain) upon the brewer. Once the brewer is locked in, the merchant can name their price … and they do.
Collusion
The constant exchange of information and the resulting adjustments to prices that takes place is a good example of a certain type of collusion, tacit collusion. Tacit collusion is also referred to as conscious parallelism[7]. Although it is considered by some to be controversial[8], it is not the type of collusion people envision when they hear the word, (where industry titans get together in wood paneled rooms to smoke cigars and conspire about price fixing). Conscious parallelism, on the other hand, is when competing companies react to a change in price by a competitor so rapidly and similarly that it appears to be the result of a conspiracy. Conscious parallelism is common in oligopolies and can create the appearance of explicit collusion to outside observers that assume the worst. With tacit collusion / conscious parallelism, however, there is no formal agreement and no coordination between the parties involved. It just looks that way.
Conscious parallelism is how hop prices are set. I’ve seen it in action. It all starts with the conversations between our fictious farmers, Bob and Jim from above, and the merchants that they work with. In that scenario, one relevant entity from the industry acts on information they believe will affect the market. They change their price strategy to reflect their new beliefs. News of that change spreads rapidly through the industry. Competitors act in kind, some based on their own analysis, others just following the leader assuming they know what they are doing. This is very different from explicit collusion (i.e., where two or more parties coordinate anti-competitive behavior). That would be illegal. There are other instances that may look anti-competitive, but that are not. The Capper-Volstead Act of 1922, for example, allows farmers to meet and discuss prices[9]. What is confusing to me is that there are people in the U.S. industry who wear more than one hat due to their ownership in various entities. Those people might be a farmer, a merchant and an owner of a company that creates proprietary varieties all at once. I have often wondered if their farmer hat applies to all their conversations regardless. If you have any insight into that, I’d love to hear your thoughts. You can message me on LinkedIn or Instagram.
In the early 1980’s, Anheuser-Busch filed a lawsuit against several merchants claiming anti-competitive behavior[10]. That, in turn, led to a civil suit by the Department of Justice. No evidence of guilt was found to justify the accusations, and the matter was settled[11]. The same system for price discovery I described above has existed for decades. Perhaps it was conscious parallelism and the way prices in the 1980’s moved in unison so rapidly that caused Anheuser-Busch to believe there was explicit collusion, or perhaps the lawyers at Anheuser-Busch were simply trying to set legal precedent. Regardless, their efforts did not ultimately change the price discovery system.
As a recovering hop merchant, explicit collusion among U.S. merchants is difficult to imagine. Sadly, my experience has been that most American merchants and many hop farmers would rather see their competitors fail so they can increase their market share. Schadenfreude (pleasure at somebody else’s misfortune) combines two simple words in typical German fashion to create a word with an outstanding meaning[12]. It thrives in the U.S. hop industry, however, than among German merchants and farmers. As I was researching this article, I ran across an equally creative German word, glüksschmerz (pain at another person’s good fortune). I’ve not heard this used in the wild, but it also seems ideally suited to describe the U.S. hop industry.
For more years than I care to remember, I have heard American farmers hoping for and toasting to a crop failure in Germany. Perhaps that’s all changed now that proprietary varieties dominate their market. American proprietary brands do not directly compete with European varieties so there is little reason for such competitiveness. Old habits die hard, however. I suspect schadenfreude and glüksschmerz are still alive and well among American farmers.
Observations
There are some great people in the hop industry around the world. Being at the Drinktec in Munich this week has been a wonderful reminder! Along the way, several people said to me something akin to, “… but you’re not making any money from these articles”. I didn’t immediately have an answer other than I enjoy writing, which is true. After some thought though, I realize that sharing what I have learned is one of the ways I hope to give back to the community from which I’ve learned so much. I enjoy putting my time and effort into these articles. Hearing that people whose opinion I respect have enjoyed reading what I have written is the best gift ever.
If you’ve made it this far … Thank you very much for your time and thank you for reading!
I would like to ask one thing … if you enjoyed what you read here and think it was worth your time, perhaps you could share it with somebody who might also find some value in these articles.
One More Thing: A few Words on the 2022 Market
Rather than send a separate article and annoy some of you with more emails than you care to read, here is a supplement regarding the 2022 Market:
There are some who believe that this year’s prices will increase due to the disastrous European crop. I doubt that will happen. I could be wrong. The USDA reported on March 1, 2022, that there were 196 million pounds (88,905 MT) of hops in storage in the U.S.[13] That’s just the United States! In April, The International Hop Growers Convention (IHGC) estimated production for 2022 to be 126.3 metric tons (278.5 million pounds)[14]. Last month, BarthHaas® predicted an 18% decrease in yields from a normal crop in Germany with similar or larger decreases in neighboring European countries[15].
I’ve spent a few days at the Drinktec this week. German farmers are reporting losses of 30% or more in the aroma varieties while the popular Czech Saaz variety is down approximately 50%. It has also been raining quite a bit this week, which brings into question the quality of the crop that will be harvested. That said, this morning I saw some beautiful German Herkules being harvested. It is easy (in my opinion) to imagine the European crop will be at least 15,000 - 20,000 metric tons (33 - 44 million pounds) lower than that IHGC April estimate[16]. That would put the world crop at approximately 106,000-111,000 metric tons (233.6 - 244.7 million pounds).
My point with all these statistics is simply that the United States, which has 39% of the world’s hop acreage[17] had the equivalent of 70% of the anticipated 2022 crop back in the spring. If the rest of the world had even one third the amount the U.S. at the time, there is likely at least an extra year’s worth of hops in storage today. Sometime in the next week to 10 days, the USDA September 1 hop stocks figure will be released. When it is available, you’ll be able to find it here. If prior trend regarding U.S. inventory levels holds (i.e., slowing rate of withdrawal), the report is likely to show that 140-145 million pounds (63,500 – 65,700 MT) of hops were in storage in the U.S. as of September 1st (prior to the 2022 harvest). If you pay attention to only one statistic to gauge the direction of the market, it should be the September 1 hop stocks figure. I’ll explain why in another article. The U.S. will produce over 100 million pounds (45,300 MT) in 2022. The quarter of a billion pounds ( 113,400 MT) of hops that will be in storage in the U.S. at the end of September will be a new record, although not one to celebrate. This year’s shortage will help to clean out some old inventories. They may not be the exact varieties the breweries want. I anticipate is there will be no meaningful or lasting increase in prices as a result of the deficit production from the 2022 European crop. Merchants will work hard to remove concerns quietly one-on-one behind the scenes by making deals on existing inventory.
[1] https://www.destatis.de/EN/Themes/Economy/Prices/Consumer-Price-Index/_node.html
[2] https://corporatefinanceinstitute.com/resources/knowledge/economics/price-floor/
[3] https://www.barthhaas.com/en/downloads/berichte-broschueren
[4] https://www.agriculturejournals.cz/web/agricecon.htm?type=article&id=156_2022-AGRICECON
[5] https://www.govinfo.gov/app/details/FR-2003-07-28/03-19127
[6] https://www.investopedia.com/terms/o/otc.asp
[7] https://stats.oecd.org/glossary/detail.asp?ID=3159
[8]https://www.law.cornell.edu/wex/conscious_parallelism#:~:text=Conscious%20parallelism%20refers%20to%20businesses,colluding%20or%20communicating%20with%20competitors.&text=Businesses%20in%20very%20competitive%20markets,in%20order%20to%20stay%20profitable.
[9] https://www.rd.usda.gov/files/cir35.pdf
[10] https://casetext.com/case/in-re-hops-antitrust-litigation-2
[11] https://www.washingtonpost.com/archive/business/1986/08/11/anheuser-busch-sues-hops-dealers/6a00264d-433f-4c0e-838c-e6ab45163f3c/
[12] https://www.merriam-webster.com/dictionary/schadenfreude
[13]https://www.nass.usda.gov/Statistics_by_State/Regional_Office/Northwest/includes/Publications/Hops/2022/hops0322.pdf
[14] http://www.hmelj-giz.si/ihgc/doc/2022_APR_IHGC_EC_Report_Summary.pdf
[15] https://www.barthhaas.com/fileadmin/user_upload/downloads/barth-berichte-broschueren/marktberichte/barthhaas-hop-report-august-2022-en.pdf
[16] My estimate.
[17] http://www.hmelj-giz.si/ihgc/doc/2022_APR_IHGC_EC_Report_Summary.pdf