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Posted October 2008

New whine, old battles

Foster’s decline Being brewers, they should have known better. Mixing beer and wine is a bad idea. But, hey these were the days of Globalisation Mach I.  Anything seemed possible. You got a good story? The banks got the money. Almost a decade ago, Foster’s went out on a shopping spree. Chivvied on by low interest rates and high hopes, they hoped that buying into wine would propel them to the top of the pops. And pronto. Unfortunately, their story proved too fantastic to come true. As the era of easy-dosh-globalisation draws to a close, the Foster's Group still grapples with turning around their under-performing wine division.

For months now, Australia’s newspapers have shouted: “Water Crisis.” Or “Australia’s Epic Drought”. Or “Crime and Drought in Australia’s Murray River Basin”.  Readers not familiar with the situation could be forgiven for thinking that they are falling victim to the usual media hype: After all, “crime” and “crisis” seem to be the most popular catch words on Google that even level-headed publications feel prompted to resort to full-blown hyperbole in order to make themselves heard and read on the internet. Sadly, but truly, Australia’s drought has already reached a level of severity that does not require any more embellishment.    

Not that you would have noticed, though. Travelling 2,500 km from Australia’s red centre down to Adelaide in late August your correspondent saw lusciously green fields, ditches filled with water and cars covered in mud – which meant that rainfalls must have been plenty and frequent. However, this was towards the end of Australia’s winter season when temperatures in Adelaide barely rise above 12 degrees Celsius during the day and people never leave home without an umbrella or a hoodie.

If you walked through Adelaide’s leafy suburbs the symptoms of drought still would have been evident to expert gardeners only: To them the unusually small lemons that hung on trees or the droopy branches of an old avocado tree would have been tell-tale signs of water distress.  

As said, you could have been forgiven for thinking that Australia’s water crisis was not worth a story until you saw the mouth of the Murray River or rather what’s left of the Murray River when it reaches the ocean. The Murray River is part of the Murray-Darling Basin, a vast expanse of land that runs down the continent's eastern coast and covers the states of Queensland, New South Wales, Victoria and South Australia. The basin represents 14 percent of Australia’s land area. This is slightly larger than the Danube Basin but the average flow of the Danube is over 17 times that of the Murray River.

Even at the best of times, the Murray River is a very dry river. It flows through nationally and internationally-listed heritage areas such as the RAMSAR wetlands of the Lower Lakes and Coorong.  As well as sustaining important ecological communities, the Murray River also provides drinking water for over 3 million people, including Adelaide, and more than 40 percent of Australia's agricultural production.

 

Running dry

Australia's biggest river system is coming out of its fifth-driest winter in more than 115 years and the forecast is for more dry weather during spring. Where, under natural conditions, more than half the water that flowed into the river would flow right through to the Murray Mouth, that has now been reduced to a trickle.

Water inflows in the past two years were the lowest since records began. Water storages are just 20 percent full at a time when they should contain three times that volume.  

As if the drought were not enough, the over-use of water has left the Murray River’s bed exposed, producing a toxic chemical reaction that is spreading. Dramatic conditions call for dramatic actions. That’s why the authorities have dared to discuss openly a controversial option of flooding the areas most affected with seawater. The action is risky and unpopular, but it could help save an eco-system that would be dying otherwise. A weir would be constructed to prevent salt or acidic water contaminating Adelaide's drinking water supply.

You can blame Australia’s drought on global warming or the climate change. But there is no avoiding the other painful truth that too much water has been taken out of the system for irrigation. In fact, very little would grow in the Murray-Darling Basin were it not for irrigation. On average about 20 percent of the total water volume diverted is used for cotton production, 20 percent for rice, 25 percent for pasture and cereal crops, 25 percent for dairy and the remaining 10 percent for all horticulture (grapes, citrus, stone fruit etc) plus urban use.  

Interestingly, for once it is not the urban population that is accused of squandering Australia’s precious water on such sinful activities as hosing down cars and taking full baths because less than 4 percent of the water that is taken from the Murray River is used for urban or domestic use.

This is not to say that many of the more puritanical suggestions as to save water are beside the point. Even if Australia’s “worried –well” (read Middle Class) stopped washing their fruit with water before eating them that would save only one litre of the 3,000 litres of water that go into the food that they eat each day according to estimates by the International Water Management Institute, a research outfit based in Colombo, Sri Lanka. As the Economist newspaper argued recently, most people may drink a maximum of two litres of water a day. Still, they “eat” a staggering amount of 5,000 litres of water a day—especially if they eat lots of meat. 

Perhaps Australians, who have been more immediately affected by climate change than those of us who live in the northern hemisphere, have also become more sensitive to the water issue than we have. That does not mean that they have found a solution to the grim problem that the world is facing: coming to terms with a water shortage not a food shortage.

Water in Australia remains a complex and highly emotional issue, irrespective of the fact that Australians have moved beyond the fundamentalist battle between free market economists who regard water as a tradable commodity and their opponents who claim that water is a common good and free access to it a human right. Nonetheless, these irreconcilable standpoints still serve as a backdrop for many of the current debates and help explain the passionate involvement of the protagonists.

The controversy over water licenses illustrates this point. With water being scarce, the state of South Australia began issuing water licenses in the 1960s. Many of the farmers who got licenses in those days got them for free. The licenses went to farmers who just used to take water from the Murray River. That may have been the right thing to do. But was it just? Especially since these water entitlements considerably increased the value of their properties. If a farm was valued at AUD 2 million, the water licence alone would have been worth AUD 1 million. Consequently, if a farm had no water license it was worth a lot less.

Perhaps the South Australian government was shrewder than others and soon saw the error of their ways because they stopped issuing water licences in 1969. Other states went on giving out water licenses until the 1990s, when all the states in the Murray-Darling Basin were forced to agree on a cap as the system had turned unsustainable.

 

Agreeing to disagree

The Australian Constitution provides the individual states with responsibility for water resources in their state. Because of the situation with the Constitution, the states got together in 1902 (one year after the constitution was signed) to develop a cooperative approach to manage these cross-border resources.  This took 13 years and a Royal Commission but in 1915 the River Murray Water Commission was finally formed.

Under this agreement the water resources were shared by three states (New South Wales, Victoria and South Australia). These sharing rules have effectively been retained until the present day. Under the circumstances that prevailed until a few years ago, these rules have proven to be reasonably effective.

Unfortunately, Australians have had to learn to their distress that in a prolonged drought these rules do not provide for a conflict-free water allocation. Hence the Commonwealth Government has announced that they will take over responsibility for the management of the Murray-Darling Basin but this requires the states to delegate powers to the Commonwealth for the management of some water resources. As this would be tantamount to calling out a state of emergency – the national government is suitable reluctant.   

With the issuing of water licenses, farmers became aware of how intimately the price of water was bound to what they produced. Very few farmers could make do with the water they were entitled to, so a trade in water began. In a normal year in South Australia (but what is a normal year under conditions of scarcity?) a mega litre of water (that’s 10,000 hl) would trade for AUD 30 to AUD 80 plus delivery charges. However, last year farmers had to pay up to AUD 1,200 per mega litre. At the end of August this year, the price per mega litre stood at AUD 400.

Now consider this: if you grow cotton or rice, your yield is AUD 50 for each mega litre of water used. If you are a dairy farmer, your yield will be AUD 3 to AUD 5 per mega litre. However, if you are a grape grower your yield is AUD 500 to AUD 1,500 per mega litre of water. Be honest, wouldn’t you rather be a grape grower?

Actually, the answer is not as simple as that. Sometimes it’s even more economically feasible to grow nothing at all. Sell your water rights to the highest bidder and spend the rest of the year at the Costa del Sol nursing a cocktail. That’s what some farmers have been doing in the state of New South Wales. They sold their water entitlements to grape growers – and still made a hefty profit. But did this make them popular members of their communities? Err, no.

Farmers like to be opportunistic in their decision making. Rice and cotton are annual crops and allow for short-term choices. Grapes, on the other hand, require quite some investment and do not provide for immediate returns. There is a four year lag between planting and vineyards bearing. So when the New World wine boom took off in the early 1990s, the government had to devise a policy that would stimulate Australia’s wine exports.

Wine has been one of Australia's great export success stories. While drinkers at home have enjoyed the delights of domestic tipples for decades, it was the mid-1990s before Aussie wine captured attention overseas. The consistent quality and affordable pricing of Australian wines made them a fast hit in Britain, where wine lovers had long been hostage to the French, Italians and Spaniards. In 2006 wine was Australia’s number three agricultural export, behind beef and wheat but ahead of wool.  

Among the vanguard of Australian wines were wines from the state of South Australia where most of the nation’s wines are produced. The venerable old vines found in South Australia’s Barossa Valley and Adelaide Hills, through their isolation, had survived the great phylloxera plagues that wiped out the vines of North America and Europe, and somewhat later, devastated Australia’s eastern vineyards. In addition to being host to some of the world’s oldest vines, the state also has a diversity of regions ranging from the relatively warm temperate climate of the Barossa Valley through to the maritime precincts of the McLaren Vale, Southern Fleurieu, Currency Creek and Langhorne Creek regions on the Fleurieu Peninsula and across the cooler Adelaide Hills region to the hotter Riverland region on the Murray River.

In 1997, aided by industry visionaries, the Australian government launched “Vision 2025”, which forecasted that by the year 2025 the Australian wine industry would achieve AUD 4.5 billion in annual sales by being the world's most influential and profitable supplier of branded wines, pioneering wine as a universal first choice lifestyle beverage.

Initially, the surge in demand had been too much for winemakers to deal with - in 1995 they could have sold another 300 million litres if only they had had the grapes to make it, figures from the Australian Wine and Brandy Corp show.

How were the government to increase Australia’s acreage under vines? Not wanting to interfere directly, they came up with the idea of a tax break – Managed Investment Schemes or MIS – which were to bring external investors into the wine industry at a time when additional grape supply was required. Unfortunately, Australian farmers themselves started an orgy of planting vines in the late 1990s. Thanks to prices for grapes going through the roof, farmers had placed their bets on vines. Orchards in irrigation zones such as South Australia's Riverland were ripped up and vines put in. In 1998 alone, some 16,200 ha of land were planted with wine grapes, increasing the national cropping area by 22 percent. Between 1996 and 2006, Australia's vineyards more than doubled in size to 154,000 ha.

 

Shredding money

If truth be told: Australia overplanted. In only five years farmers planted as many vines as the consultants had projected for the 1997 to 2022 period. Even when the overproduction of grapes became a serious problem in early 2000, the MIS continued to put areas under vines. They got their tax break – so why worry about zero profits?

You could argue that if investors wanted to burn money, it was their right to do so. The trouble is that these MIS overruled market mechanisms. Representing only 10 percent’s of Australia’s total acreage under vines, they nevertheless proved the last that broke the camel’s back (apologies for this crass mixing of metaphors).

These MIS were so cashed up they could afford to buy water licences at inflated prices and push other growers out of the market simply because running a profitable business was not their first business objective. The tax break was abolished in July this year but that has not stopped new MIS vineyards from being planted.

Australia’s farmers are a hardy lot. Just take the aforementioned Riverland farmers. Initially, they planted citrus trees. When the market fell out because imported citrus concentrate was cheaper, they switched to planting vines and almonds for the higher yields. Now they seem to have reached the end of their tether because their belief in the market economy and the self-regulation of supply and demand has been seriously shattered. Whereas the introduction of the water market in Australia was supposed to make water distribution fairer and more transparent, the premises on which the system was based have finally turned out to be pure fiction.

In plain English: what do you call a market that has nothing to trade? There is trade in entitlements, abstract rights and pieces of paper. But this does not mean that these entitlements entitle you to any water allocation. The fact is that for the past three years in South Australia farmers have not received their full allocation of what their licenses said. This year, it is forecasted that the allocation of water will be two percent of people’s entitlements. This may improve during the season. Still, who knows?

Rather than calling the “water market economy” a big sham, Australians have taken to pointing fingers. As the majority of Australians depend on the Darling-Murray Basin for some of their water, South Australians blame the Queenslanders, Victorians the people of New South Wales; city dwellers blame the farmers, dairy farmers blame the grape growers and together they give the finger to politicians. The water shortage is poisoning relations between Australians at all levels: from the local communities up to the states, whose bureaucrats and politicians cannot agree on whose needs are more urgent. In September this year the decision of the New South Wales authorities to release water for use by its irrigators and cattle farmers caused an outcry because this water was “wasted” at the expense of South Australian farmers.

To all intents and purposes the whole issue of who’s responsible and who’s to do what in Australia’s current water crisis is conveniently obfuscated by Australia’s federal system. For as long as four states have to slug it out among them who can take how much water out of the Darling-Murray Basin, politicians, bureaucrats and the stalwarts of public opinion will continue their cacophonous shoutfest and painful but necessary actions will be deferred.

Readers who have been following this discourse on water diligently may begin to wonder what on earth Foster’s current woes have got to do with this. Actually, a lot. Both reveal that our trust in the absolute rationality of markets needs to be questioned. Globalisation Mach I, which we presently see coming to an end as Wall Street investment houses crash and stock markets tumble, rested on the belief that everything was possible, necessary and doable if it made economic sense. The reduction of strategies and policies to purely economic logic helped conceal the fact that it was people after all who were pursing and implementing them and that their reasons for pursuing them had as much to do with shareholder value ideology as with personal vanities.

Foster’s story is remarkable as a brewer that had been reduced to ashes when their first global structure crashed, rose from the self-same ashes only a few years later in order to re-invent themselves as a global wine company. Foster’s probably knew better than anybody else that ranking was everything. Being the world’s 18th largest brewer sucked.

Investors, or rather the gentlemen in their tailored suits who issued credit and subscribed to bonds, had been praying the mantra of “only the first five count” for so long that they began to believe it. Like they believed in the so-called immutable law of market economics that no less than 60 percent market share would do. Or that you have to achieve an EBIT of 30 percent.

Foster’s executives listened carefully and then did as told. Whether they really believed wholeheartedly that they could pull this stint off – becoming the number one wine company in the world - only the autobiographies of Mr Kunkel and Mr O’Hoy, Foster’s past two CEOs, will tell. One thing is certain, though. They knew that they were driven by their bankers as much as they were driving their company. And for as long as they could engage their bankers in their favourite pastime – mergers and acquisitions - they were safe. Sort of.

Listed companies like Foster’s, Scottish & Newcastle and Anheuser-Busch, for that matter, whose shares are spread widely, may have prided themselves in their good investor relations. Yet only those suffering from some sort of megalomania would have forgotten that their investors are the enemy in their bed. Here today, gone tomorrow and with them the family silver!

In retrospect the first period of globalisation resembled a session in auto-suggestion. Whatever was desired to be true, had to be true. The trouble is that as brewers dashed forward in their scramble for companies and markets they discarded any luggage that could have proven heavy and cumbersome. That meant the history books but that also meant people who would have issued some caution.

If you want to know why beer and wine do not mix – there’s going to be a Part II.

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