Insights to the Scotch whisky market from Dr Alan Rutherford

 

History

Whilst the earliest written record of Scotch whisky was in 1494, the first real boom in national and international sales took place in the Victorian era.

In the early 19th century, whisky merchants were "vatting" together pot still malt whiskies from different distilleries and in 1832, the continuous or "Coffey" still was approved  by Customs and Excise (HMCE) for use in Scotland. This opened up the future for grain whiskies and in 1860, HMCE sanctioned the blending of malt and grain whiskies together under bond which opened the future for blended Scotch. The credit for being the first Scotch whisky blender usually goes to Andrew Usher of Edinburgh - a point perhaps disputed by W P Lowrie of Glasgow and Charles Mackinlay of Leith!

When compared to the earlier pot still whiskies, the new concept of blended Scotch introduced a lighter character and more consistent quality to whiskies which helped to develop a taste for Scotch south of the border and indeed across the expanding British Empire. A further boost was given to Scotch when French  vineyards were stricken by the phylloxera disease which temporarily wiped out Cognac supplies in the 1870s.

The last quarter of the 19th century saw a huge surge in international sales of Scotch and the consequent building of many  new distilleries especially in regions such as Speyside where the rapidly growing railway network enabled the efficient  transportation of barley, coal, casks and whisky. These years saw the emergence of the great "Whisky Barons" and their famous blends including Walker, Dewar, Buchanan, Mackie and Haig, all of whom came together during harder times to form the mighty Distillers Company Limited (DCL), the forerunner of today's Diageo.

The 20th century saw three serious disruptions to growth in the form of WW1, Prohibition in the USA and WW2 but since 1945 growth has continued apace with several surges and only a few pauses.

 

Distilling and blending

Historical records show that there have been over 750 legally registered distilleries in Scotland  and at the present time there are about 100 malt distilleries operational  plus 7 large grain distilleries. Registered brand names total more than 3,000 and despite the popularity of single malts in many mature markets, blended Scotch whiskies continue to account for over 90% of world sales by volume.

In their early days, the ownership of blending businesses was quite distinct from the ownership of distilleries but the larger blenders soon began to acquire or build their own distilleries in order to secure quantity and quality of supplies. Given the variability of individual malt whiskies, most blenders use  20-40 different single malts and perhaps 3-4 different grains in a blend. Malt content in a typical standard blend will be about 30-35%. "Secondary" and "own label" blends can be as low as 5-15% whereas deluxe blends (usually aged 12 years or more) will usually contain 50% malts.

The two largest owners of distilleries in Scotland today are Diageo (28 malt distilleries + 1 grain) and Pernod Ricard (13 malt distilleries + 1 grain) and these are followed with several medium sized companies (Wm Grant, Edrington, Whyte & Mackay,Inverhouse, John Dewar & Sons) each owning about 5 distilleries and finally a long tail of smaller companies, mostly owning just one distillery.

However, by "reciprocating", blender/distillers can exchange spirit of their own production with that of others to achieve an inventory broad enough to support their blends. Malts are usually  exchanged on a "one for one" volume basis whereas grains/malts are usually exchanged at 2/1, reflecting the approximate ratio of production costs.  There are of course blenders who do not own any distillery and who depend on buying new make spirit and mature whiskies for cash.

 

Supply and demand

Given that mature whiskies are needed at all ages from 3 to 12 years and beyond - demanding very high levels of working capital - there remains the most difficult question of all which is how much to distill? In years when sales are growing and optimism prevails, it is natural for brand managers to predict high levels of future growth. When these are compounded for the years ahead and allowing for evaporation losses of 2% p.a., then distillers will respond by maximising production to ensure future sales forecasts can be met.

When the inevitable downturn in growth occurs, then the distilleries must throttle back and the popular press spread alarm with headlines such as  "Whisky Loch" and "Scotch on the Rocks"!  Whilst these comments are nonsense, the difficulties in forecasting mean that modest economic cycles in sales can lead to much more pronounced cycles in production as the distillers wrestle with supply and demand.

In recent years the industry has become adept at managing these ups and downs (which occur on a 7-10 year cycle) but the impossibility of accurate forecasting has created opportunities for brokers - similar to those in other commodity markets where products can be bought, sold and (crucially) stored to balance the unequal cycles of supply and demand.

 

Bulk whisky trading

In Scotch whisky, the basic rule of trading applies so that when demand exceeds supply, then prices rise - and vice versa. There are however two unique differences in whisky brokerage: firstly,  maturing whisky stocks tend to increase in value every year as they grow older and, secondly, prices are underpinned by a "floor price" governed by the production cost of new make spirit - the latter being determined primarily by the prevailing costs of cereals and energy. These factors conveniently reduce the risk of trading and/or holding whisky stocks.

Some blenders who do not have a distillery will rely entirely on buying mature whiskies from the brokerage market and/or from the surplus stocks of distillers. Others will enter into contractual arrangements to fill new make spirit at distilleries and augment this with opportunistic purchases of mature stocks. These options apply equally to individuals, syndicates or companies who simply wish to invest in Scotch whisky.

The large number and diversity of Scotch Whisky blenders and distillers in a successful international industry have ensured that a ready market exists for bulk Scotch whisky. It can also be argued that brokers provide an essential service to the industry by helping to balance supply with demand and easing the working capital requirements of the smaller distillers.

Of course some distillers and blenders also trade as brokers and some successful brokers have gone on to become fully integrated distillers and blenders by acquiring brands, distilleries and blending/bottling facilities. Examples include Stanley P. Morrison (now Morrison Bowmore Distillers, a subsidiary of Suntory) and Peter J Russell (now Ian Macleod Distillers). Whilst an increase in inter-company trading between the larger distilling companies has reduced the number of brokers, the brokerage market remains essential for the whole industry and the small number of independent brokers are crucial to the success of SMEs and early stage businesses in the Scotch whisky industry.