$8 wine might be a tough sell this year: California forecast

California's wine industry is experiencing challenging times, with growers in the Central Valley coping with the lack of water, excess supply on the low-end segment and more competition from overseas producers.

The state's total harvest was down 7 percent last year from the prior year, and some premium vintners from Napa Valley report going into 2016 with supply constraints and feeling the impact of a strong U.S. dollar and weakness in China.

"What we see right now is the under-$9 segment struggling and the above-$9 segment doing pretty well," said Rob McMillan, executive vice president and founder of Silicon Valley Bank's wine division based in Saint Helena, California. "Our prediction is we'll start to see additional market share taken from domestic producers."

According the bank's annual wine industry forecast, the fine-wine end of the market (over $20 a bottle) will see sales growth of 9 percent to 13 percent in 2016, a slight deceleration from the roughly 14 percent pace in 2015. The forecast is for bottle prices to rise 4 percent to 8 percent for the above-$10 category, while volume and price drops will be impacting the below-$8 bottle market.

"While demand for premium wine will increase this year, there are clouds on the horizon that should be considered," the bank said. "We believe total and per-capita wine consumption in the U.S. will drop for the first time in more than 20 years due to emerging generational shifts in consumption patterns that we see accelerating in the near term."

SVB's forecast also looks for "tens of thousands of additional grape acres" to be permanently pulled from the California's San Joaquin Valley, an agriculture region hit by the drought and where many grape growers have looked to convert some or all of their acreage to more lucrative nut production. The pullouts also reflect old vineyards that are no longer economically feasible due to the lack of production and the lack of demand because of low prices for certain varietals.

"If we can get back into supply and demand balance, the overall price of grapes down here should rise," said Peter Vallis, executive director of the San Joaquin Valley Winegrowers, a group representing approximately 60 percent of the state's total grape crush. "It should rise because right now the pricing … and market for grapes is relatively at production cost."

Vallis insists that the drought hasn't been the biggest factor affecting Valley grapes nearly as much as the weak price due to what some analysts have called as "a worldwide glut," particularly of cheaper wines from New Zealand, Australia, Chile and Argentina. "The strong dollar does have an effect on the low end of the market but also has an effect on every end of the market."

The California Department of Food and Agriculture's preliminary wine-grape crush report released last week said the state's total crush was valued at $2.5 billion in 2015. By volume, the statewide grape crush was down 7 percent to 3.86 million tons but still was the fourth largest harvest on record.

"There's plenty of wine," said Gladys Horiuchi, a spokesperson for the Wine Institute in San Francisco. "And it's extremely high quality."

In 2015, the Napa region accounted for just 4 percent of the statewide wine production, but due to its premium prices it represented about 21 percent of California's total crush value (revenue to growers). The state's figures show the Napa Valley region's 2015 tonnage fell by 29 percent from 2014. Unfavorable weather hurt the Napa harvest last year. Vintners say they are hopeful for a better crop this year but it's too early to tell.

A lighter harvest in 2015 and strong demand for luxury segment wines is encouraging some Napa region vintners to raise prices this year.

"We held our pricing the last few years," said Michael Honig, president of Honig Vineyard & Winery in Rutherford. "People seem to be somewhat receptive as long as you don't become egregious and take huge markups."

Emma Swain, CEO of St. Supery Estate Vineyards & Winery in Rutherford, said her winery is feeling the effects of decreased harvest in 2014-2015. "We had two short years and we've really been trying to not increase pricing, but essentially what we've had to do is remove some of the ways we do business for by-the-glass (with restaurants) and things like that because we just don't have enough wine to do it."

Swain is optimistic about 2016. "Our business is very solid. It's been continually growing, especially in the high-end segment."

Honig said overall wine consumption has generally been going up but "kind of peaked a little now. People are going up-market so we're seeing some interest in the higher-end wines."

The bank's forecast agrees, predicting a decline in U.S. per capita wine consumption after more than two decades of growth. "The decline is really the lower-priced segments," said SVB's McMillan, explaining that this reflects a generational shift from the mature and baby boomer consumers to "younger consumers (particularly drinking-age millennials) with a desire for better stuff."

California vintners also see opportunity in the foreign market despite the challenges of the strong U.S. dollar that make the product more expensive in many key markets such as Canada.

"India is the one market I'm actually most excited about because there's not as many people as China but over a billion people," said Honig. "They are really drinking it as a beverage in India to enjoy and not just for toasting purposes."

Swain said Japan remains a strong market for Napa wines and Canada remains significant, too, but is showing the impact from the exchange rate. As for China, she said it's become tougher due to "these austerity measures in place where the government spending on items like wine has decreased a lot. I don't know anybody who has seen dramatic growth there when they are going through traditional channels."