Cruzan says it is casualty of rum wars
Published: April 28, 2014
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ST. CROIX - The rum wars rage on.
Even as the V.I. Government grapples with its own financial woes and an estimated $40 million budget shortfall this fiscal year, local rum-maker Cruzan VIRIL has asked for more government money to help the company stay afloat as it battles to hold onto its bulk rum customers and tries to reclaim some of the market share it has lost to Puerto Rico in the last two years.
Members of the 30th Legislature and Gov. John deJongh Jr. met with Cruzan officials about the issue in a closed-door meeting last week.
"Cruzan has illustrated that they are losing a lot of their bulk customers to Puerto Rico because of better-structured deals with subsidies from Puerto Rico," Sen. Clifford Graham, who chairs the Senate Finance Committee, said in a phone interview. "So of course they are fighting for their survival and pretty much gave us the information for us to consider how to assist Cruzan to continue to be a viable rum producing entity here in the Virgin Islands."
He described it as a "Catch-22" situation for the government.
"The government is already cash-stricken. But at the same time if Cruzan loses any more of the bulk customers, we lose more of the cover-over dollars coming into our coffers. That puts us in a 'Catch 22,'" Graham said. "If we do nothing, Cruzan is not able to hold onto the bulk customers, and we get less cover-over coming in.
"If we assist them, Cruzan can hopefully retain the bulk customers that they have and hopefully in the future regain more bulk customers - but that would require us to give concessions and some of our rum cover-over as well," Graham said.
Senators who spoke to The Daily News said they plan to discuss the issue more before making any decisions - and said the matter could potentially come up at the May 8 and 9 legislative session.
At this point, they said, they have not received any sort of proposed amendment to the existing agreement between the V.I. Government and Cruzan or proposed legislation from the governor.
Senators said they have simply been tossing ideas around about the best path forward. So far, the matter has not been discussed at all in a public forum.
In an interview, Cruzan President Gary Nelthropp said that Cruzan's branded products are growing faster than the competition in U.S. markets.
He declined to answer questions about the status of the company's bulk rum business or what the company is seeking from the government. Bulk rum is rum that is sold to other companies to use in their own branded products.
Nelthropp acknowledged the meeting last week with senators and the governor, saying Cruzan values its relationship with the V.I. Government and tries to keep officials informed. He said the meeting included confidential business information that he would not disclose.
Government House spokesman Jean Greaux Jr. did not return Daily News calls for comment.
When locally-produced rum is sold in the U.S., a direct revenue stream is generated for the V.I. Government through rum excise tax revenues.
For every proof gallon of Virgin Islands-produced rum exported to the U.S. mainland, the federal government collects $13.50 in excise taxes, of which $10.50 is returned to the territory. That rebate is also called the rum "cover-over."
In 1999, the U.S. Congress passed legislation that temporarily increased the cover-over rate to $13.25 per proof gallon.
Since then, that temporary increase has been renewed or extended multiple times, every year or two with a package of other tax measures.
The extensions have been retroactive, if the measure has been allowed to expire. The higher rate most recently expired Dec. 31, but Congress is expected to consider renewing the tax extenders again this year and they have already passed through one committee.
Puerto Rico receives the same kinds of benefits from the cover-over program as the Virgin Islands does.
In recent years, the V.I. Government has taken to providing significant subsidies to local rum-makers from its cover-over revenues, with an eye toward growing that revenue stream to the territory.
The so-called "rum war" started around the time that Gov. John DeJongh Jr. announced in June 2008 that he had struck a deal with Diageo PLC, an international spirits, wine and beer company, for the V.I. Government to build the company a rum distillery and warehouse where the company would make and age its Captain Morgan rum on St. Croix.
The move sparked controversy in Puerto Rico, where Diageo was in an agreement with third-party supplier Destilería Serrallés to produce rum for the Captain Morgan brand.
There were protests from Puerto Rico when the V.I. Legislature considered the Diageo deal, and the deal generated controversy even in the territory, where opponents argued that the government gave too much away.
Ultimately, though, the V.I. Legislature ratified the agreement and the distillery was built.
Under the deal, Diageo agreed to produce all its Captain Morgan Rum for sale in the U.S. on St. Croix for the next 30 years and the V.I. Government agreed to build the company the distillery, financed with a portion of the territory's future rum tax revenues. The deal also included additional and significant government subsidies for Diageo, as well as tax breaks.
In 2009, the V.I. Government inked a similar deal with longtime local rum-maker Cruzan.
Puerto Rico fought back, launching a publicity campaign against the "excessive" level of subsidies the V.I. Government was providing to rum manufacturers.
Puerto Rico's non-voting member of Congress, Pedro Pierluisi, introduced legislation in Congress aimed at limiting the amount of subsidies the territories could give rum manufacturers. By 2010, other legislation seeking to alter the way rum tax revenues are administered had been introduced in Congress.
Those measures did not move forward, though.
However, eventually Puerto Rico's legislature passed a law that increased the amount of subsidy the Puerto Rico government could give to Puerto Rico's rum manufacturers.
Currently, the law in Puerto Rico has its government setting aside up to 25 percent of the cover-over as a subsidy for rum manufacturers - but also gives the Puerto Rico governor the discretion to increase that cap up to 46 percent through executive orders.
In April 2012, the V.I. Legislature approved changes to the V.I. Government's 2009 agreement with Cruzan, to give the company more subsidies for its bulk rum production.
Nelthropp told senators at that time that competitors in Puerto Rico - emboldened by incentives offered by the Puerto Rican government - had taken advantage of Cruzan's lower bulk rum incentives to gain a substantial cost advantage and steal customers.
He said at the time that Destilería Serrallés - which had by then lost Diageo as a customer - had "lured away" two significant Cruzan bulk rum customers. The changes that the 29th Legislature ratified two years ago increased the bulk rum subsidy for Cruzan to 25 percent of the cover-over through 2018.
Senators at the meeting last week told The Daily News that they were told Cruzan has lost more of its bulk rum business to Puerto Rico and needs additional help from the government.
"They are concerned they will not be able to remain competitive," said Sen. Nereida Rivera-O'Reilly.
In the phone interview, Nelthropp said the bulk rum business is competitive, but declined to comment further or provide specifics.
However, in early April, Destilería Serrallés announced that it would increase its production of rum in Puerto Rico, adding up to 8 million proof gallons in the next three years because of several new contracts.
The press release said the Puerto Rico government and its Industrial Development Company through its Rums of Puerto Rico program had been instrumental in these new deals, supporting Serrallés as it identified prospective U.S. customers and negotiated the contracts.
Sen. Judi Buckley said that Cruzan representatives told senators they had lost business to Puerto Rico.
"They met with us to let us know what kind of assistance they are going to need to be sustainable. Their production levels have gone down significantly. Obviously, their revenues have dropped," Buckley said. "They're looking to us to help get them through this downturn."
She said she does have concerns.
"Given what we now know about their fiscal condition, it has been made very clear that if we don't act in some fashion, they will have to make a very tough decision about whether they can keep their doors open," she said.
Senators are looking at two possible approaches: Changing V.I. Code to allow the governor to change the level of subsidy to rum producers within a certain range or changing the terms of the Cruzan agreement.
The governor would have to submit any proposed changes to the agreement to the Senate for ratification. He could also submit proposed legislation.
Senators who spoke with The Daily News said the change to the subsidy for bulk rum that is being discussed would raise it to 46 percent. That change would make the Cruzan subsidy competitive with Diageo and level the playing field with Puerto Rico, said Sen. Craig Barshinger.
Barshinger said Cruzan is an "heirloom industry" for the territory.
"It has value of a cultural nature, so we need to work with them in terms of being part of our culture, and also they have historically been of value in bringing in rum cover-over," he said.
Barshinger said the territory is in the midst of a rum war - one that Puerto Rico seems determined to win.
"They have made a commitment to having a rum war and winning it. And in a rum war you cut your profits so thin that you drive the other guy out of business," Barshinger said, adding that he supports the V.I. Government helping Cruzan out.
He also noted that the V.I. government will see less rum revenue as Cruzan decreases production because its bulk rum sales have gone down.
"We have lost a tremendous amount," Barshinger said.
Sen. Terrance Nelson said he, too, has concerns - including concerns over transparency.
"I already don't support the level of subsidies we give to these rum companies, but I'm sensitive to Cruzan's request," Nelson said, adding that the Diageo deal created challenges for Cruzan. "I'm sensitive to their issue; however, they have to also be sensitive to our issue."
He noted the territory's extreme financial difficulties. He also said he has concerns about transparency if the governor is given discretion to change the subsidy, as is done in Puerto Rico.
Officials plan to meet again soon to discuss the matter, senators said.
-Contact Joy Blackburn at 714-9145 or email firstname.lastname@example.org.