Golden days for Argentine wine could turn cloudy

By David J. Lynch, USA TODAY

MENDOZA, Argentina — From the rear patio of the Bodega Norton winery, an unbroken green vista stretches to the snow-dusted Andes on the horizon. Bright sunshine bathes the scene in crystalline, warm light. If ever there were a place that illustrates the earthy romance of winemaking, this is it.

But it's not complex noses or poignant bouquets that explain Argentina's recent emergence in global wine markets, notably including the United States. It's basic economics.

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While the palate-pleasing tastes of a vineyard gem known as malbec get much of the credit for Argentina's breakout success, the wineries of Mendoza — the country's principal grape-growing region — also owe their prominence to inexpensive labor and land, plus a near perfect mix of soil, water and growing conditions. For wineries such as Bodega Norton, success in an increasingly competitive global wine market requires agile management of currency values, shipping costs and marketing strategies.

"The reason why we have so many foreign investors here is you can get the same quality (of wine) you can in other areas, and the direct cost of production is probably one-quarter what it'd be in the United States and even less than what it would be in France," says Luis Steindl, Norton's chief operating officer.
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From 2002 to 2006, Argentine wine exports to the USA almost tripled, reaching $101.2 million. The growth spurt has continued so far this year with shipments running at an annual rate of $131.8 million, according to the U.S. Commerce Department. More than one of every four bottles of Argentine wine are sold in the USA.

Now, however, financial challenges at home and abroad are squeezing once-fat profit margins and complicating prospects for Argentina's continued emergence as a wine-exporting power. Inflation is driving up local labor costs while the dollar's decline against the euro is boosting the cost of European-made wine barrels and corks. "Like any business, we need to find efficiencies. It is the big concern going forward," says Santiago Achaval, 46, a Stanford Business School graduate and president of the Achaval Ferrer winery.

Argentina's 21st-century export surge was made possible by ample investment in the late 1990s. Capital spending in recent years has plateaued, and bank loans aren't readily available, meaning Argentine wineries may not be able to keep up with rampaging demand. Most top wineries here, like Norton, already are producing flat-out to meet plentiful foreign orders.

"This year, the main wineries have big demand for their wines. In a lot of cases, they can't respond to this demand because they can't invest," says Javier Merino, an economist at Area del Vina, a local consulting firm.

Napa Valley inspiration

Argentina, the world's fifth-largest producer, has a long history of winemaking. But, until recently, the overwhelming majority of what was produced was consumed locally.

Then, in the early 1980s, Nicolas Catena, at the time a visiting professor of economics at the University of California at Berkeley, began spending weekends touring the vineyards of Napa Valley. He became fascinated with the efforts of vintner Robert Mondavi, who was bucking the European wine establishment by seeking to establish California as a credible source of top-quality wines.

"I never imagined high-quality wine could be produced outside France. To me, it was a shock. So I thought: Why not try something similar in Argentina?" says Catena, whose Italian grandfather started the winery known today as Bodega Catena Zapata outside Mendoza at the end of the 19th century.

By 1990, Catena had returned to Argentina and begun producing wines for sale abroad. As he tiptoed into the American market, however, he made a crucial decision. At the time, most wines from neighboring Chile were selling in the USA for less than $10. But Catena eschewed the low end of the market and offered his cabernet sauvignon for $15 and priced his chardonnay at $13. It was an audacious move for a winery in a country with no global profile.

"They distinguished themselves by not coming in at the rock bottom end of the market. They did not rely on cheap wine," says distributor Jim Faber, vice president of the San Francisco Wine Exchange.

Catena, today regarded as the father of the Argentine wine industry, sold 4,000 cases of the 1990 vintage. This year, he expects to export about 440,000 cases, with slightly less than half going to the USA.

Argentina's fortunes are tied to the unheralded malbec, a grape that originated in southwest France, where it was used for blending. The word may have originated with the French mal bouche, or bad mouth, an indication of the disdain with which Old World winemakers regarded the lowly grape, says Steindl.

Transplanted to Argentina, however, malbec thrived. In the mid-1990s, it began receiving its first notices as an alternative to traditional reds such as cabernet sauvignon. But sales to the USA remained tiny. It took a financial crisis that plunged much of Argentina into poverty to give the industry its big chance.

Opportunity in crisis

The financial tsunami that hit Argentina in 2001-02 sent unemployment soaring and saw the peso plunge from a value of $1 to about 25 cents. As banks closed and the financial system neared collapse, middle-class Argentines rioted in the streets of the capital, Buenos Aires.

Though unnoticed at the time, the turmoil contained a silver lining. "You call that a crisis. In fact, it was just the opposite for the wine business," says Catena.

Overnight, the revenues Argentine wineries were earning from sales in the USA became worth four times as much once converted into pesos, thanks to the currency fluctuation. Meanwhile, wineries continued to pay their workers, and local suppliers, in pesos. The net result: a huge jump in pretax profit margins from about 10% to as high as 70% on some wines, Catena says.

The sudden profit explosion gave winemakers such as Catena the funds to expand their U.S. marketing campaigns. In the immediate aftermath of the crisis, he spent more than $2 million explaining his wines to American consumers. "Argentina was really unknown in international markets," he says.

Another factor fueling increased exports to the USA has been rising shipping costs. Higher oil prices and increased demand for scarce cargo vessels due to the economic rise of China and India sent average shipping costs up 76% the past five years compared with the five years ending in 2002, says Merino. That helped motivate winemakers to concentrate on markets closer to home, such as the USA, he says.

At the same time, the peso's plunge effectively slashed the price of Argentine land for overseas buyers. In 2001, 82% of the $146 million invested in the industry came from outside Argentina. Even today, with the peso having rebounded from its post-crisis lows, an acre of land here sells for about $30,000 — perhaps one-tenth what it would fetch in California's Napa Valley.

American winemakers such as Kendall Jackson and Paul Hobbs set up shop here in the late 1990s along with such European firms as Pernod Ricard and Chateau Lafite. Michael Evans, a former Democratic campaign worker, came to Mendoza to nurse his wounds after the 2004 election and became captivated by the local industry's potential. Since then, he and a partner have poured $3.5 million into projects here, including a 500-acre tract they are subdividing and selling to investors as micro-vineyards of 3 to 10 acres each. To date, 25 parcels have been sold. Evans says he also is in talks with hotel chains about building a resort hotel in Mendoza.

"You can make better wine here for less money than anywhere in the world," he says.

Evans arrived in Mendoza as Argentina was winning rave notices from wine gurus such as Robert Parker. "By the year 2015, the greatness of Argentinean wines made from the malbec grape will be understood as a given," Parker wrote in 2004. "This French varietal, which failed so miserably on its home soil in Bordeaux, has reached startling heights of quality in Argentina."

Challenges remain

These would seem to be golden days for Argentina's wine industry. But winemakers say they still need to broaden awareness of malbec among consumers, especially in the USA, where the red grape accounts for 48% of Argentine sales. An industry marketing arm called Wines of Argentina spends about $3 million annually trying to promote the national brand worldwide, but Argentina trails other so-called New World wine powers such as Australia and still accounts for little more than 2% of the U.S. wine market.

Inside the sprawling Bodega Norton operation, founded in 1895 by a British railway engineer, the local wine industry's strengths and weaknesses are on display. In one room, Steindl points out a conveyor where 10 workers gather to remove by hand any imperfect or over-ripe grapes before they enter the fermentation process. "Here we do manual selection of grapes for our top wines," he says. "You couldn't think of doing that in the U.S. because of the cost of labor."

But as Steindl enters an older part of the winery, a room with thick, white adobe walls dating to 1919, one of the industry's nagging challenges comes into view. Oak barrels from France line the chamber, redolent with the scent of wine.

The barrels, which contain the equivalent of 300 750-milliliter wine bottles, cost 600 euros apiece or about $880. Two years ago, when the dollar was healthier, the per-barrel price tag was about $700. On an annual basis, just because of currency movements, Bodega Norton is spending roughly $180,000 more today for barrels than two years ago.

To compensate, Steindl tries to wring greater profits out of other parts of the business. Expanding the wine-and-gifts shop at the end of the winery tour, for example, boosted annual sales to visitors to 30,000 bottles from just 2,000 three years ago.

He also can't relax because of questions about Argentina's economic future. Likewise, Catena, the former economics professor, says he fears that the current populist government will lead today's fast-growing economy into a high-inflation, slow-growth malaise known as stagflation. Already, inflation is on the march, now rising at an annual rate of about 15%, according to non-government estimates.

At Norton, Steindl frets about chronic energy shortages. Businesses in Argentina this year were hit with intermittent power cutoffs, which prompted the purchase of a $100,000 generator. That assures the winery of electricity albeit at a cost five times that of the local utility. But with customer demand surging, Steindl doesn't have much choice.

"We can't stop the winery," he says with a shrug.