The Financial Times reported earlier this year (paywalled):
But in 2018, the tequila boom in the US presented Antonio, who requested we not use his real name, with an opportunity to get back into the fields and connect with his father. With the price of agave, the key ingredient in tequila, reaching record heights, everyone with a patch of land was rushing to plant the crop, or to sell their land to others keen to do so. As it peaked at some 30 pesos ($1.45) per kilogramme, doctors, dentists, and many others piled into the business. The number of registered agave growers rocketed from 3,180 in 2014 to 41,000 in 2023. For several years, the region was abuzz with a sense of possibility, even among those without land to grow on. Opportunistic investment companies set up crypto-esque trading websites encouraging Tapatíos, people local to the area, to place bets that the price of agave would keep rising...
A couple of years after he planted his crops, Antonio secured a contract with a tequila producer promising to buy his plants. The deal gave him the confidence to plant more, but did not include any kind of price protection. In 2022, when his first crops were still a couple of years from maturity, he started to hear about falling prices. Within two years the spot price had plummeted to between 1 and 3 pesos per kg. “We started to plant all excited, making the investment when things were good without really knowing that it’s all cyclical,” he says.
Stories like Antonio’s are now crystallised into tequila industry lore: the hapless middle-class professionals who helped fuel the agave oversupply crisis that is now rocking Jalisco.
In my ECONS101 class, we teach a model of dynamic supply and demand that explains fluctuations in market prices such as those that the Mexican agave farmers have been experiencing. It isn't all bad news. As you will see, the farmers who can ride out the low prices and profits will likely find themselves in a period of higher prices and profits before too long.
Consider the market for agave, and assume that it is perfectly competitive - most importantly, there are no barriers to entry into the market or barriers to exit from the market. The market for agave is shown in the diagram on the left below. The diagram on the right will track changes in agave farmers' profits over time. Initially (at Time 0) the market is at equilibrium (where demand D0 meets supply S0) with price P0, and agave farmers are making profits π0. Now say there is a permanent increase in demand at Time 1, to D1. This increase in demand may be because of an increase in the production of tequila (as I noted in this post earlier this month). Prices increase to P1, and agave farmer profits also increase (to π1). There are no barriers to entry (this is a perfectly competitive market), so the higher profits encourage new farmers to enter this market (like Antonio). Supply increases to S2 (more producers) at Time 2. Price falls to P2, and agave farmer profits also fall (to π2). This is the situation that the Financial Times article describes.
What happens next? At Time 2 profits are low and some agave farmers will choose to exit the market (no barriers to exit because this is a perfectly competitive market). Supply will decrease to S3 (fewer producers) at Time 3. Price will increase to P3, and farmer profits will increase to π3. So, as I noted above, provided the agave farmers can ride out the low prices and profits, the market will recover as other farmers drop out of the market.
The problem for agave farmers like Antonio is that this was foreseeable. When prices and profits are high, and lots of farmers are moving into the market, that is not a good time to invest in an agave farm. The increase in supply is going to lead to lower prices and profits in the future. This is made even worse in this case because, as the FT article notes:
Although tequila remains the world’s fastest-growing spirit, the peak growth is over, and drinkers have been cutting back on boozing. That was already particularly true in the US, tequila’s largest export market, before President Donald Trump proposed launching a trade war. While large producers with long-held relationships with the tequila houses are able to ride out the cycle, farmers without solid contracts are now desperately trying to offload their agave in a saturated market.
Mexico's tequila lake is doubling down on the cycle of low prices and profits for Mexican agave farmers. As I noted in the tequila lake post, the price of tequila will fall, and less tequila will be produced. That means that the prospects for agave farmers are even worse than portrayed in the market diagram above, because the demand for agave isn't going to stay high at D1, but will be decreasing back towards D0. That means even lower prices and profits for agave farmers.
The Financial Times wants us to feel sorry for the agave farmers like Antonio. But honestly, they should have done some due diligence. The clever business strategy when faced with a market that is heading into a cycle like that in the agave market is the 'hit and run' strategy. It is counterintuitive, but it says that when prices and profits are high, that is a good time to get out of the market. Forget selling agave, agave farms can be sold for a high price at that point in the cycle. The time to get into the market is when prices and profits are low, because the price to buy an agave farm will be much lower. Recognising that this market is perfectly competitive is important here, as is recognising what is happening in the market around you. If Antonio looked around, and realised that lots of other farmers were getting into agave farms, that should have made him curb his excitement. Hopefully, the farmers (and others) have now learned this lesson of dynamic supply and demand.
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