Supply and Demand

There has been an interesting thread on David D’s K&L Spirits Blog recently regarding the much-talked-about boom/bust cycle in whisky. His opinion, based on comparisons to the continuously overinflated Bordeaux wine market, is that the whisky industry may have broken out of the boom/bust cycle and prices may be on a perpetual increasing trajectory. I’m certainly no expert – and David has a lot more insider knowledge and first-hand experience with the market than most anyone around – but as a customer I really want to believe that a bust is coming. What follows is half my opinion and half wishful thinking.

I like to think that the cause of the historically established whisky bubble/bust cycle is twofold. One, the law of supply and demand coupled with the lengthy aging process of whisky. Two, the capriciousness of public opinion and global taste trends.

First, supply and demand plays a funny role in scotch. Traditionally, because it costs a lot of money to produce spirit and, more importantly, age it (the costs of barrels, storage space, and taxes on aging whisky) distillery managers had to estimate the future demand for their whisky based on historical data in order to produce the “right” amount of new make. Also traditionally, distilleries always got this wrong. If nobody’s buying whisky right now, it hardly makes sense to push the stills to the max and cram the warehouse with barrels that are going to cost a lot *now* and then wait for some hypothetical future boom cycle to recoup those costs. Even when extra whisky is produced during a bust cycle, those excess barrels are generally sold off to blenders (at a price just high enough to keep the lights on), or to speculators in the independent bottling business. Distillation and aging are expensive, and potential future gains don’t pay today’s bills.

Conversely, when whisky is popular and mature barrels are flying off the racks, distilleries become flush with capital and begin to upgrade equipment, expand production, start research & development operations, implement wood management programs, increase efficiency, and generally make more new-make whisky to age. That’s where we are right now. There’s going to be a lot more whisky racked in warehouses and rickhouses in 10 years than there is now.

The nature of supply and demand means that IF demand decreases between now and the ten-or-so years it takes to mature all this new-make (or fails to increase proportionally to the increased production output), THEN the excess supply in ten years will drive prices down. So will demand decrease? That brings me to point number two.

Luxury spirits, like many other niche luxury industries, rely on trends. When you have young drinkers in Japan enjoying blended scotch highballs, American yuppies sipping and hoarding rare bourbons, and trendy European nightclubs serving Ardbeg cocktails, those brands all benefit, and this ripples out to attract people who want to understand and participate in the current hot trend. When the category is not so happening – like 20 years ago when scotch was an old man’s drink and bourbon meant Jim Beam and Jack Daniels – demand plummets.

It’s also worth noting that the high end of markets like whisky and wine are supported by the volume of the low end. There is a lot more Charles Shaw, Beringer, and Yellowtail sold globally each year than first-growth Bordeaux. There’s a whole lot more blending whisky and low-end bourbon sold than Talisker 25, Brora, and Pappy. IF the bottom were to fall out of one of those markets – consider today’s global demand for sherry for instance – the prices of the higher end products would likely have to change to reflect the sinking demand for the category as a whole.

Of course, today’s whisky companies are aware of all this and are doing their best to counteract the effect. By slowly eliminating age statements from the public’s perception of quality, they can begin selling whisky (perhaps vatted together with older stock) at a younger age and short-circuit the bust cycle. By advertising, holding tastings, and running promotions, they seek to instill a sense of brand loyalty in new drinkers that could support a coming bust. My opinion is that, at best, these are mitigating efforts that will help keep distilleries from shuttering when the bust comes, but are not going to free the industry from the cycle.

At some point five, ten, twenty years down the line, it will no longer be cool to drink whisky. Terroir artesian spring waters? Vintage sake? Gin cocktails? Who knows what will be next, but it will make all of those massive stocks of aging scotch look like more of a tax burden than a smart investment for the future. Who knows, if wine suffers the same perceived drop in trendiness… “Bordeaux? Please, that’s what my parents drink. I’m into craft ciders….” we could see a reversal in prices there, too. Remember that people said the housing market would increase forever, and that we’d broken out of the real estate cycle. My wallet and I are both hoping that today’s $1 house in Detroit is a harbinger for tomorrow’s $30 two-for-one sale on The Macallan “Ruby”.