Wine as an investment in the wake of globalization

Kym AndersonSchool of Economics, University of Adelaide,

Australiakym.anderson@adelaide.edu.au

Institute for Quantitative Investment Research Conference

Chateau la Couspaude, Bordeaux, 9 October 2008

Investment by whom?

Wine producers

Buyers of high-quality wines

Why is globalization relevant?

Global dominance of long-time European wine producers is decreasing

More challenges for those producersAnd more choices, lower prices, but

less familiarity, for wine buyers

Outline

Impact of globalization on returns to investing in grape and wine production

Information required by buyers to make sound investments in iconic wines for later consumption or resale

Are there proven ways for buyers to judge the future value of an iconic wine?

Dramatic changes on the supply side

Globalization of the world’s wine markets over the past 20 years

Changes in:Consumer demand (tastes, regulations)Production capabilityShare of production exportedGlobal export contributions by ‘Old World’ vs ‘New World’Firm size and concentration in the industry

Wine globalization is not new …

Winegrape cultivation began before 6000BC

•Spread west from Middle East from 2500BC

•Spread north from Mediterranean by 400AD

• Took another 1100 years before spreading to:–South America by 1500s–South Africa by 1655–Australia by 1788 (from Rio and Cape Town)–California and New Zealand by 1820

… but wine market globalization has accelerated hugely since the late 1980s

Most previous globalization was about technology transfer, leading to little long-distance trade growthBut since the late 1980s, share of volume of production exported has risen from <10% to almost 30%

even higher in value terms (>50%?)Europe’s share of world exports (excl. intra-EU) has fallen from >70% to <50%

Causing Jancis Robinson to include the G-word in OCW-3‘New World’ wineries have become far more export-oriented, focusing on premium (esp. low-end) bottled wine, initially exploiting retail regulation changes in UK

Australia in next slide is just one example

Growth of Aust. wine exports, 1970-06

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Sources: AWBC Export Approval Database, ABS Catalogue No 8504.0

Exports

Domestic sales

Other features of recent globalization of wine markets

Mergers/acquisitions of wineries, especially cross-border

In response to IT revolution, FDI reforms, and the wineries’ need to combat the supermarket revolution

Flying vignerons enjoying 2+ vintages/yearaccelerating 2-way int’l technology transfer

WTO-induced policy developmentsTax cuts (eg China, India); GI legal recognition

Parkerization of preferences

Divergent trends in tastesHalving of per capita wine consumption in Mediterranean Europe and Argentina since 1970sDoubling or more of per capita consumption in new markets in Europe (and Asia), and big rises too in UK (20lit/cap) and US (8.5lit/cap)Big switch from dominance of super premium and non-premium to dominance of bottled value-for-money, easy-drinking premium wine

Popular premium range is US$1 to $4/litre pre-tax wholesale, or US$5-10 per 750ml bottle retail

Declines in wine consumption per capita in traditional markets, 1970 to 2000 …

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1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000

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Italy

Spain

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Chile

… while per capita consumption keeps growing in emerging markets

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1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000

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Divergent trends in production tooWinegrape acreage expanded hugely in New World from late 1980s

Trebled in Australia, aiming at popular premium wineFive-fold increase in New Zealand, aiming at super premium sav blanc and then also pinot noir

Acreage is stagnant or declining in Old WorldEU regulation of its industry stifled adjustment, so was missing out on growth in popular wine niche

However, more-innovative producers in Europe are adapting/re-positioning to capture a part of the rapidly growing mid-range market, while cutting back on low-end non-premium wine

And are following Australia with generic advertising

Big variance in export prices (US$/lit)1995 2000 2005

France 3.66 3.11 4.71

Italy 1.11 1.22 2.34

US 1.67 1.89 1.78

Australia 2.60 2.77 3.03

NZ 3.44 4.02 6.46

Chile 1.41 2.11 2.10

Argentina 0.34 1.55 1.39

Rapid growth in New World’s share of global exports

Even including intra-EU trade, New World’s share has grown from

5% in 1990 to 11% in 1995, 19% in 2000, and 24% in 2005

New World wine export growth, 1990-2005

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Australia

Chile

USA

South Africa

Argentina

New Zealand

Firm concentration is accelerating …

But from a low base: wine was one of the least concentrated beverage industries as recently as 1998Since then, major consolidation among wine firms has been a striking characteristic of the new globalization

driven in part by the need to combat firm concentration at the distribution and retail ends of the value chain

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Softdrink

Spirit Tea Coffee Beer Wine

Source: Centre for International Economic Studies

Share of global sales by top 3 firms, 1998

Mergers/acquisitions are continually altering the rankings

2000 20061. E&J Gallo 1. Constellation + BRL

Hardy

2. LVMH 2. Beringer Blass + Southcorp

3. Constellation 3. LVMH

4. Allied Domecq 4. Pernot Ricard + Allied Dom.

5. The Wine Group 5. E&J Gallo

6 .Southcorp (incl R.) 6. Castel Freres

7. Beringer Blass 7. The Wine Group

11. Pernod Ricard

18. BRL Hardy 15. Concha Y Toro

The 15 top global wine firms, 2006

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Source: Rabobank, 2006

Great heterogeniety across countries in firm size of wineries and growers

National annual average winery output, in cases, varies from 5,000 (France) to 290,000 (Chile) per firmShare of 3 largest wine firms nationally varies from 6% (Italy) to 60-70% (US, Australia, New Zealand)Average vineyard size varies from 1.3ha (Italy) to 21-26ha in Aust, NZ and South Africa, and to 40ha in the US

Wine production by firms, 2005Prod’n

(million hl)‘000 cases

/winery% share of

3 largest firms

France 52 5 13

Italy 51 141 6

Spain 35 93 12

Germany 9 na 19

United States 23 131 61

Argentina 15 211 39

Australia 14 82 60

South Africa 8 165 38

Chile 8 293 34

New Zealand 1 22 70

Vineyard area per grapegrower, 2005

Area(‘000 ha)

ha/grower

France 877 7

Italy 795 1

Spain 1181 6

Germany 102 3

United States 213 40

Argentina 217 8

Australia 167 21

South Africa 100 23

Chile 114 14

New Zealand 21 26

B. Globalization prospectsover the next 20+ years

What to expect in terms of:

Taste and preference changesincluding the influence of marketing strategies and of Parker

Terroir and technology changesincluding climate change and R&D

Taxes and other regulationsincluding EU wine regulatory reforms, water policy reforms, excise tax changes

Taste changes

Slowdown in population growth in OECDBut ageing raises per capita consumption of high-quality wines

New markets emerging in AsiaWesternization of tastes in China and India

What roles for generic and brand marketing? For Parker and wine judges?

Terroir and technology changes

R&D strategies in different countriesScope for rapidly emerging markets (eg China and India) to self-supply?Will old markets rejuvenate (CEE/FSU)?Climate change

How will it affect grapegrowing conditions globally?How are R&D and plantings changing in various countries?

Impact of govt. regulationsProspective impacts of:

EU wine policy reformsSupermarket revolution, including in developing countriesIrrigation water policy/regulatory reforms

Will we see more convergence between Old and New World, where both regions export terroir-driven super-premium/iconic wines alongside affordable bottles of popular premium wines, while non-premium wines continue their demise?

Climate change: will it lead to this in Australia?

Climate change may cause a rise in average temperatures in grape growing regions

Rise of perhaps 2.5oC by 2050, if little mitigation in the interim Which means earlier grape harvesting, by perhaps 1 monthHence following a much hotter ripening period (>4oC by 2050 in Australia?)

Warmer temperatures alter grape quality

Growing-season temp has an inverted U-shaped relationship with winegrape quality and hence priceBut there’s a different optimal temperature for different varieties (Jones 2006)Hence even if temperature change was the same in each region, climate change will affect regions differentially because of differing varietal mixes

In New World, regions will alter their variety mixWhat about in Europe (given EU regulations)?

Climate change could affect winegrape quality also by:

More extreme weather eventsMore-frequent heatwaves, frosts, high winds, bushfireshence more variability of grape yields and quality

Less rainfall in growing season and greater variation between seasons (& more salinity)

hence lower water quality and higher water price

Increased incidence of pests and diseases=> more difficult to maintain vine balance

What about supplies of wine in competitor countries in the face of climate change?

More-temperate, less irrigation-dependent wine regions (maybe not Calif. or Southern Europe) will be less adversely affected than Aust, and some will benefit from temp. rise (see Jones et al. 2005 graphs below)

but may still be harmed by more extreme weather events

Climate in France, New Zealand

Region:Mean

Jan. temp.

Annual Rainfall

Midi, southern France 23.8 730

Bordeaux 19.5 890

Burgundy 19.5 740

Alsace 19.1 745

Marlborough, NZ 17.7 740

Nelson, NZ 17.0 1000

Climate, and regional shares (%) in Australia’s winegrape industry, 2006

Zone (MJT range):Wted

av. MJT

Wted av.

rain

Grape vol.

Vine area

Grape value

Very hot (23.0+ oC)

23.5 317 62 60 41

Hot (21.0–22.9 oC)

21.8 603 14 12 21

Warm (19.5–20.9 oC)

20.1 639 14 16 24

Cool (<19.5 oC)

19.1 933 3 3 7

Not classified na na 7 9 7TOTAL 22.6 426 100 100 100

Will rest of world’s wine regions become more or less competitive with climate change?

1950-1999 temperature changes (Jones et al. 2005):

Bordeaux: 1.76O Northern Calif: 1.23O

Champagne: 0.54O

But warmer may mean better there

Projected temp change in wine regions, 2000-2050 (from Jones et al. 2005)

Bordeaux: 2.3O Northern Calif: 2.2O

Rhine: 1.5O

Barossa: 2.0O

Warmer may mean better winegrapes in cool areas, but not in Australia’s hot areas

Regional average Australian winegrape price declines as January temperature rises

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All Varieties

Extent of red varietal winegrape price decline as Aust. MJT rises beyond 19oC

0200400600800

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Shiraz

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18 19 20 21 22 23 24 25 26Av Regional MJT (Celsius)

Cabernet Sauvignon

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18 19 20 21 22 23 24 25 26Av Regional MJT (Celsius)

Merlot

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18 19 20 21 22 23 24 25 26

Av Regional MJT (Celsius)

Pinot Noir

Extent of white varietal winegrape price decline as Aust. MJT rises beyond 19oC

0200400600800

1000120014001600180020002200

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18 19 20 21 22 23 24 25 26

Av Regional MJT (Celsius)

Chardonnay

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1000120014001600180020002200

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Semillon

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Sauvignon Blanc

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Av Regional MJT (Celsius)

Riesling

Possible adaptive responses by New World

Despite the crop being perennial, with large sunk costs, the wine industry has shown great agility and flexibility when unfettered by regulations

Big changes in Aust varietal mix since 1980

Shiraz

Chardonnay

Sultana

Cabernet Sauvignon

Merlot

Semillon50 000

100 000

150 000

200 000

250 000

300 000

350 000

400 000

450 000

500 000

.80

-81

.82

-83

.84

-85

.86

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Source: ABS Vineyard Survey

Aust. regions’ varietal specialization has changed a lot in six vintages, 2001-2006

Region i’s Varietal Intensity Index: Vim = fim/fm

where fim is the fraction of variety m in region i’s crush and fm is the fraction of that variety in the national crushAustralian examples of 2 red and 2 white varieties:

Aust. Varietal Intensity Index: Shiraz

00.20.4

0.60.8

11.2

1.41.6

1.82

McLaren V Barossa Clare

20012006

Aust. Varietal Intensity Index: Pinot Noir

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Tasmania Mornington Yarra

20012006

Aust. Varietal Intensity Index: Sav. Blanc

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Aust. Varietal Intensity Index: Semillon

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Australia’s wine regions are becoming more distinct also in terms of quality

Regional Quality Index: Ri = Pi/P

where Pi is the average price for region i and P is the national average winegrape price

Aust. Regional Quality Index, ’01 & ‘060

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Possible adaptive responses to climate change by the wine industry

Changes in viticultural and winemaking practices with known technologiesMore investment in R&D aimed at adaptationChanges in varietal mix in existing areasReduce vine area in very hot zones, move to cooler zonesMore investment in market development abroad

Can wine industry adapt better/faster in New World than in Old World?

New World has been less restricted by viticultural regulations than in EU and, partly because of that, has been more flexible, more adaptableBut EU is reforming its wine policies, and EU quality may rise/costs fall with climate changeSo New World will have to adapt faster, & from already high temperatures by global standards

R&D investments are gearing up

How can buyers make sound investments in fine wines in this

globalizing, climate-changing world?

Do wine critics influence prices?

Jones and Storchmann (AE, 2001); Hadj et al. (EJ, 2008): Parker points raise Bordeaux cru classes and en primeur pricesSchamel and Anderson (2003): Halliday points raise Aust and NZ wine prices

=> Dearer to buy high-scoring wines, but are they more enjoyable? And do high-scoring wines offer a higher return if stored?

Some answers from the latest (Spring 2008) issue of the Journal of Wine Economics

On wine enjoyment:Goldstein et al. find non-expert wine consumers get more enjoyment from less-expensive wines than show winesVeale and Quester find consumers judge wines more by price and country of origin than by trusting their own blind tasting

On returns from storing fine wine:Sanning et al. find Bordeaux wines gave 7-9% p.a. above average risk-adjusted returns (and low covariance with financial asset returns), 1996-2003

=> considerable under-investment in this asset class?

If wanting to invest in fine wines, how should one decide which to buy?

If for later resale, need to restrict choice to ones with a thick-enough secondary market?If for future own-consumption, choose less-popular labels, including from New World, at much lower prices (esp. if not status-conscious)In either case, choose vintages on the basis of a few econometrically estimated growing-season weather variables (more reliable than wine critics’ recommendations: eg 1989, ’90 vintages)

useful info, especially if/when climate change raises mean temperature and volatility of seasons

The example of BordeauxAshenfelter (Econ Jou, 2008) finds 90% of price variation in Bordeaux wine 20-30 years old is explained by vintage weather and vineyard/Chateau features (terroir, including climate)Wine age (to cover storage cost and increased scarcity) explains 20% of variation, while vintage (as captured by temperature and rainfall) explains 60%

dry Aug-Sept, warm growing season, preceded by wet winter, is ideal for Bordeaux

The example of AustraliaWood and Anderson (JWE 2006) find:

Age adds 2.2% p.a. to the price of Grange (c.f. 3% in Bordeaux)Growing season temperature helps Hill of Grace up to around 200 but then hurts (as does bigger diurnal temperature range)Rain prior to harvest hurts, rain in previous winter helps (though less than in Bordeaux, perhaps because irrigation can be used in Aust)

With higher temperatures from climate change, some Aust single-vineyard wines may become less attractive investments after optimal temp is reached

Some implicationsSome implicationsFor viticulturalists, results suggest climate variables can help with site selection, and in bargaining with winery over grape price each vintageFor winemakers, results suggest grape prices paid, and the release prices (or hold-back period) for wine, could be set in part by the season’s weather conditionsFor wine consumers/investors, weather provides a robust guide as to which vintages to avoid (especially for wines whose release or en primeur prices change little across vintages)

CautionsVine yield/ha and hence supply of a vineyard’s wine is determined by spring weather, while quality depends on weather later in the season

and greater supply means lower price, other things equal

Status also affects demand so, for those wanting to later consume, stay away from vintages status seekers want (e.g. 1982, vs 1989 or 1990 Bordeaux)Technologies are increasingly affecting quality, reducing the influence of terroir (Geraud and Ginsburgh, Economic Journal, 2008)

A few referencesAnderson, K., “Wine’s New World”, Foreign Policy 136: 47-54, May/June 2003 Anderson, K. (ed.), The World’s Wine Markets: Globalization at Work (Edward Elgar, London, 2004)Wittwer, G. and J. Rothfield, The Global Wine Statistical Compendium, 1961 to 2006 (AWBC, Adelaide, 2008), see www.awbc.com.au/winefacts Ashenfelter, O. “Predicting the Quality and Price of Bordeaux Wine”, Economic Journal 118: F174-F184, 2008Wood, D. and K. Anderson,“What Determines the Future Value of an Icon Wine? New Evidence from Australia”, Journal of Wine Economics 1(2): 141-61, Fall 2006

Thanks!

kym.anderson@adelaide.edu.au

www.adelaide.edu.au/cies/wine

www.wine-economics.org/journal