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Currency exchange risks in the wine industry can be mitigated by using forward exchange contracts and other FX risk management tools

How Currency Exchange Risks Help Shape the International Wine IndustryARTICLE

By Bill Camarda

Many wine aficionados know the ancient Latin saying, “in vino veritas”: in wine, there is truth. But perhaps another phrase is of more immediate practical concern: in wine, there is currency risk. Wine businesses often engage in complex mixtures of importation and exportation. Each faces its own unique set of foreign exchange risks and challenges. Currency shifts can have both negative and positive impacts, and market volatility can make the risks difficult to manage.

U.K. Wine Sellers and the Challenges of a Weaker Currency

Consider a fairly simple case. From late June to late October 2016, the exchange rate of sterling dropped from approximately US$1.47 per pound to US$1.23, and from roughly 1.31 euros to 1.10, making it the world’s worst performing currency during that timeframe.1 In the wake of the pound’s decline, one Burgundy winemaker said, “We can easily see our Burgundy wines being priced out of what the market can bear,” adding that if the new exchange rates were “the new normal, it is hard to see a way forward for our U.K. business.”2

The Jancis Robinson website, namesake site of the popular U.K. wine critic, reported that some wine importers had anticipated the risk through hedging instruments that temporarily “softened the blow,” but this was only a short-term solution.3 Indeed, by December 2016, distributors were reporting that they could no longer protect customers against FX-related price increases in future orders.4

Other Side of the Coin: The Strong USD

The other side of the U.K.’s recent experience: the U.S. dollar’s relative strength. All else equal – though all else is never quite equal – U.S. consumers have benefited from downward pressure on foreign wine prices. So, too, of course, U.S. importers might find their dollars purchasing more wine.

This also applies to U.S. wineries’ large-scale purchases of bulk wine, often used in private label brands, to provide ingredients for blended wines or to supplement inadequate local harvests. According to Sid Patel, CEO and Founder of Beverage Trade Network, U.S. wineries import bulk wines primarily from Argentina, Chile and Canada, though opportunities are growing for Eurozone exporters.5 Foreign exchange rates can sometimes become a factor in choosing sources and suppliers.6

Importantly, “French oak barrels are considered a vital input for the finest wines, and comprise a very large portion of wine production costs,” according to a working paper by Eric N. Sims and Sarah Quintanar of the American Association of Wine Economists.7 The paper notes these barrels are priced in euros, placing U.K. and U.S. wineries at the mercy of fluctuations in the euro-GBP and euro-USD exchange rates, respectively. Some wineries may be in a position to manage this FX risk with hedging instruments. (For those without appropriate foreign exchange expertise, Sims and Quintanar recommend taking advantage of early purchase discounts wherever possible.)

Of course, a strong dollar has a downside for U.S. wineries: they face greater challenges in exporting their products. “When the exchange rate goes from 1.3 to 1.05 for the euro,” said one CEO, “yes, that is a big deal. We have actually had to discount to maintain our momentum in a lot of countries. We do not import enough to offset that.”8 Adding to domestic U.S. vintners’ woes, consumers may find foreign wines more attractive than they would in a weak-dollar environment.9

Wine Industry Foreign Exchange Risks in Australia

Australia’s wine exports began soaring in 1986 when Americans discovered that exchange rates made high-quality Australian wines a bargain. But the Australian dollar began rising in 2001, and within a decade, a “perfect storm of shocks” associated with currency, climate, and the global financial crisis led to a collapse in Australian wine imports to the U.S. that the industry is only now recovering from.10,11

As Australia’s example shows, foreign exchange risks often amplify other trends, multiplying those other risks’ impact. For example, while market research firm Technavio predicts only modest price increases in wine imported to the U.K. in 2017, it says these increases could be exacerbated by new tariffs arising from the U.K.’s forthcoming departure from the EU.12So, too, as California wineries manage the challenges of a strong dollar, The Wine Economist warns that they also face rising labor costs associated with toughening immigration policy,13 and Fortune magazine notes growing competition for labor from newly legal marijuana harvesters.14

Many factors affect the extent to which suppliers can “pass through” costs associated with FX risks to their customers. For example, sellers’ leverage may vary by the quality and price of the wine involved.15 And, of course, prices are impacted by factors unrelated to currency. These include weather issues, such as El Niño rains that “wreaked havoc” on Chile’s 2016 grape harvest;16 climate change effects;17 changing patterns of consumer taste (such as growing demand for higher-priced wines, a.k.a., “premiumization”);18 growth in new markets such as China;19 and increased supplementary demand from wine investment funds.”20

Protecting Against Currency Shifts in a Low-Margin Business

Even so, exchange rate shifts can have powerful impacts, especially because many companies in the wine industry operate on narrow margins. For example, South African wine producers’ average 2016 profits were less than 1 percent; according to VinPro, “44 percent are operating at break-even and 40 percent are making a loss.”21 VinSight, which specializes in software solutions for the wine industry, suggests several ways companies can use to protect themselves from foreign exchange risks:22

  • Establish a foreign currency bank account that can be used to make purchases at a time of the company’s choosing;
  • Buy currency in advance of when large purchases are expected;
  • Write contract clauses that agree on what the parties will do if exchange rates move dramatically;
  • Use FX hedging strategies including forward contracts; currency options; and currency market orders that aren’t fulfilled unless FX rates reach a pre-specified level.

The Takeaway

Winemakers and wine sellers, operating in an industry with narrow margins, must pay close attention to international currency shifts. Many can benefit from using forward exchange contracts and other FX risk management tools.

Bill Camarda - The Author

The Author

Bill Camarda

Bill Camarda is a professional writer with more than 30 years’ experience focusing on business and technology. He is author or co-author of 19 books on information technology and has written for clients including American Express Private Bank, Ernst & Young, Financial Times Knowledge and IBM..

Sources

1.“Pound sterling falls to six-year low against the euro,” The Independent; http://www.independent.co.uk/news/business/news/pound-value-sterling-drops-euro-dollar-currency-exchange-rate-latest-low-a7366001.html
2.“Brexit for Wine Lovers Updated,” Jancis Robinson, http://www.jancisrobinson.com/articles/brexit-for-wine-lovers-updated
3.Ibid.
4.“Wine prices set to increase as Brexit sends sterling lower,” CNBC; http://www.cnbc.com/2016/12/16/wine-prices-set-to-increase-as-brexit-sends-sterling-lower.html
5.“An Insider’s Guide to the US Bulk Wine Market,” Meininger’s Wine Business International; https://www.meininger.de/en/wine-business-international/insiders-guide-us-bulk-wine-market
6.“How Much Has the Strong Dollar Affected U.S. Wine Imports?” The Wine Economist; https://wineeconomist.com/2016/02/02/how-has-the-strong-dollar-affected-the-u-s-wine-market/
7.Analyzing Barrel Purchasing Decisions on Winery Costs, American Association of Wine Economists Working Paper No. 212;http://www.wine-economics.org/aawe/wp-content/uploads/2017/03/AAWE_WP212.pdf
8.“What Wine Industry Leaders Think Is Important for the Future,” University of California Davis; http://gsm.ucdavis.edu/sites/main/files/file-attachments/winesymposium2015ucdavisgsm_1.pdf
9.“Introduction to Wine Trade Weighted Exchange Rates,” UC Davis Agricultural Issues Center; http://aic.ucdavis.edu/publications/CAWGGabrielyan.pdf
10.“Exchange Rate Lessons from Australia’s Wine Boom and Bust,” The Wine Economist; https://wineeconomist.com/2015/03/24/kym-anderson/
11.“Has Australian Wine Recovered in the U.S.?” Wine Australia; https://www.wineaustralia.com/au/what-s-happening/stories-of-australian-wine/february-2017/has-australian-wine-recovered-in-the-us
12. “How will Brexit affect the wine industry in the UK and the EU in 2017?” Technavio; https://www.technavio.com/blog/how-will-brexit-affect-wine-industry-uk-and-eu-2017
13.“Unravelling Global Politics & the Vineyard Mechanization Imperative,” The Wine Economist; https://wineeconomist.com/2017/01/31/mechanization/
14.“Marijuana and Labor Shortages are Giving the Wine Industry a Headache,” Fortune; http://fortune.com/2017/01/24/wine-industry-marijuana-labor/
15.Quality, Trade, and Exchange Rate Pass-Through, International Monetary Fund Working Paper; https://www.imf.org/external/pubs/ft/wp/2014/wp1442.pdf
16.“El Niño wreaks havoc on 2016 Chile harvest,” The Drinks Business; https://www.thedrinksbusiness.com/2016/07/el-nino-wreaks-havoc-on-2016-chile-harvest/
17.“The Impact of Climate Change on Viticulture and Wine Quality,” Journal of Wine Economics; http://www.wine-economics.org/aawe/wp-content/uploads/2016/06/Vol11-Issue01-The-Impact-of-Climate-Change-on-Viticulture-and-Wine-Quality.pdf
18.“Fragmentation, premiumization impacts global wine industry,” Western Farm Press; http://www.westernfarmpress.com/grapes/fragmentation-premiumization-impacts-global-wine-industry
19.“China to become world’s 2nd biggest wine market by 2020,” China Chamber of Commerce in the Netherlands; https://www.dccchina.org/2017/03/china-to-become-worlds-2nd-biggest-wine-market-by-2020/
20.Macroeconomic Determinants of Wine Prices, American Association of Wine Economists Working Paper No. 202; http://www.westernfarmpress.com/grapes/fragmentation-premiumization-impacts-global-wine-industry
21.“South Africa Wine Industry: Serious Problems, Lofty Goals, Progress Update,” The Wine Economist; https://wineeconomist.com/2017/02/14/rsa-wine/
22.“Managing Exchange Rate Fluctuations,” Vinsight; https://www.vinsight.net/app-features/managing-exchange-rate-fluctuations

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