Friday, November 2, 2007

Beeronomics: Hops Prices and Futures Markets

In light of the recent surge in hops prices it seems reasonable to ask: what do big users of inputs that are prone to big price fluctuations (like crops) do to hedge against risk? They trade in futures markets. Futures markets are set up to facilitate transactions based on promising today to buy or sell a quantity of a commodity for a set price tomorrow. If price increase the buyers is better off, if they decrease the seller is better off, but everyone can be made better off by reducing risk. Undoubtedly big brewers like AB and SABMiller lock in prices for hops well in advance of delivery, but I imagine that small brewers like those we have in Oregon buy at least some of thier hops on spot-markets: markets where you pay the current price when you by and take delivery. This leaves these smaller breweries more prone to risk, which is ironic because it is likely that they are also less able to deal with large fluctuations. I imagine this is more true for the less used varieties upon which they rely heavily.

The only recourse, then, for a small brewery is to pass the increased production costs on to their customers in terms of high prices. It is likely that large brewers will not have to do so to the same extent due to these futures contracts. This means that small brewery beers may increase in price quite a bit while macro brews may not. Will this hurt the small brewery sales? Probably. Both though lower sales from the income effect, customers simply cannot afford to buy the same amount of beer with the higher prices, and the substitution effect, customers may shirt consumption to relatively cheaper beers. The first effect is probably pretty predictable, but the second effect raises a big question: how close are micro and macro brews in terms of consumer's tastes? Are they close substitutes, in which case micro breweries may have a lot to worry about, or are they hardly substitutes at all, in which case the micro breweries have a lot less to worry about? Beer enthusiasts hope that beer drinkers have become sophisticated enough to know that a Bud is not a good substitute for a Dead Guy, for example, but the answer remains to be seen.

Finally, one strategy that may be helpful for craft breweries going forward is to create a buyers cooperative in which they all commit to buying a certain amount of the particularly uncommon hops in advance and try to lock in prices for these hops on futures markets. This would help mitigate the risk, which is particularly dangerous for small breweries.

(Picture is from an 1892 New York Times article)


Jessica said...

What about the arguement that those who can afford to buy the micros in the first place don't have that much price elasticity to begin with? Or is that a lot of price elasticity? I don't remember but, what I'm alluding to is that perhaps the buyers of micros are at an income level where even a doubling of price will not reduce their purchases?

Patrick Emerson said...

Yes, that's quite right. Wealthier people tend to be less price sensitive (have lower elasticities) and so, to the extent that it is wealthier people who buy craft beer, there should be lower elasticity. What I don't know, but would be curious to find out is if it is the wealther drinkers who buy the craft beer? Anyone have any stats?