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A Technical Guide for Wine Producers
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Analysing possible future scenarios: Introducing a tool for strategic decision making
Sanri Reynolds, Western Cape Department of Agriculture and Dr Jan Lombard, Department of Agricultural Economics, University of Stellenbosch
Wine businesses operate in a fast moving and constant changing environment. Anticipating potential changes and being informed on the possible impact of these changes provide businesses with a competitive edge to survive in a highly competitive market. To assist in this, Winetech, among others, has funded a project for the development of a system of models simulating the wine sector in South Africa. The models, developed by the Bureau for Food and Agricultural Policy (BFAP, website: www.bfap.co.za), should be used in analysing different possible scenarios and used by decision makers as one of the tools in the strategic decision making process.
The BFAP models simulate future trends and levels of prices, production, consumption and trade, as well as farm profitability in different wine grape producing regions. The projections are based on historical relationships between variables, perceptions of market structures and price formation and also future expectations. Table 2 and Figures 1 to 4 show the so-called baseline simulations for the wine industry. These simulations do not constitute a forecast, but rather a benchmark of what could happen under a certain set of assumptions. The baseline assumes that all current policies, international and domestic, will prevail. The baseline also assumes normal weather patterns and do not take into account the possible impact of climate change. Finally, the baseline projections are based on important macro-economic assumptions. Selected assumptions which proved to be crucial in driving the agricultural industry are presented in Table 1. Other variables taken into account includes the US dollar/Euro exchange rate, volumes and prices of other wine producing countries, input costs, domestic interest rates and prices of alternative products.
Table 1: Macro-economic assumptions for baseline projections (Click table to enlarge)
Based on these assumptions and following the decline in prices over the past four to five years, total vines in production is projected to increase marginally in 2007, decline in 2008 up to 2012, before it recovers to some extent in 2013 and 2014. Wine production is projected to follow a similar trend. On the demand side, exports are projected to resume its upward trend in 2007 and to continue this increasing trend over the baseline period. Domestic demand for wine is also projected to increase over the baseline period. The increase in demand and decline in supply is projected to put upward pressure on drinking wine prices, as well as prices of rebate wine and distilling wine and grape juice. Wine stocks are projected to increase over the next two to three years, where after it is projected to decline over the remainder of the baseline period.
Table 2: Baseline projections (Click table to enlarge)
Figures 1 and 2 present the baseline projections for vines in production and grape prices for selected red and white varieties. Note that the prices are constant 2000 prices, i.e., the prices are adjusted for inflation. The prices of red wine grape varieties are projected to turn upwards in 2007 and 2008 and will remain on this upward trend until 2011 for Cabernet Sauvignon and Merlot and 2013 for Pinotage and Shiraz. Thereafter prices are projected to come under pressure as supply increases. Note that prices of red varieties are projected not to reach the same price levels as before. The price of Chardonnay grapes is projected to stabilise over the next two years, strengthen from 2010 to 2012 and then level off as supply increases. The price of Sauvignon Blanc grapes are projected to follow a similar trend, though the turning points are a few years later. The tendency to plant reactive to price trends and the resultant commodity cycle are evident in the graphs.
How will these price projections for different varieties impact on the profitability (in nominal terms) of wine grape farms in the various regions of South Africa? The possible effect of these price projections is simulated stochastically for representative wine grape farms in the different VinPro regions, and the average net farm income for one such region is illustrated in Figure 3. One way of presenting the possible effect of price risk on profitability, is illustrated in Figure 4 where the probability of various levels of projected net farm incomes are listed. Other performance measures like gross margin, net cash farm income, cash farm profit, ending cash surplus and net worth can also be simulated for a wine grape farm consisting of up to twelve grape varieties of three blocks each with variable age distributions of the vineyards.
However, as mentioned before, the environment is changing constantly and there are inherent uncertainties around policies, weather, financial markets, etc. For this reason, it is important to analyse different future scenarios. What if the exchange rate does not depreciate over time or what if the South African economy does not experience growth of between 4% and 6% per annum over the next seven years? For illustrative purposes, consider the possible impact should the exchange rate remain at R7,47/USD over the baseline period. How will this impact on supply, demand and prices and how will it impact on farm profitability?
Model results show that by 2014 exports will decline by almost 22% relative to the baseline; the decline in demand will push prices down with the real good wine price at R2.61/litre (constant 2000 prices), 11% below the baseline price (see Figure 5). Domestic consumption is expected to increase slightly, due to the lower prices. The impact on prices of red wine grape varieties is projected to exceed that of white wine grapes (see Figure 6), reflecting that prices of red wine grapes are more sensitive to changes in export demand than prices of white wine grapes. Finally, area under vines will decline the most in the Paarl region and least in the Robertson area (not shown in the figures).
The impact of the above mentioned exchange rate scenario on a representative wine grape farm in three VinPro regions is illustrated in Figure 7. Farm 2 in Figure 7 is the same representative farm as in Figure 3 and the effect of the exchange rate scenario is clear. The prices of different varieties in the different regions, as well as the relative composition of varieties and the age distribution of different vineyards will impact differently on the profitability and the effect that the exchange rate scenario will have on a specific representative farm.
The BFAP sector and farm level models of the wine grape industry give quantitative analyses and projections of how various policy options and a range of macro-economic variables can affect the supply of wine grapes and wine, as well as the demand for wine. The models are designed to address some of the most pressing information needs facing agri-businesses, farmers and policy makers. This management tool is available for evaluating strategic planning scenarios at various levels of decision making by different role players in the wine industry.
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