Burley Tobacco Outlook
William
M. Snell[1]
The
U.S. tobacco industry continues to face a multitude of legal and political
challenges that generates much uncertainty about the future of the industry.
In response to this environment, burley marketing quotas have plummeted
to record low levels.Tobacco farm
income losses have been cushioned by an influx of tobacco settlement dollars
and federal disaster assistance. But, the future status of these income
supplements remains questionable. An improved outlook beyond 2000 will
depend greatly on the movement of loan stocks, opening of new markets,
program changes to improve competitiveness, and a calming of the political
and legal environment facing the U.S. tobacco industry.Even
under the most optimistic market conditions, the demand for U.S. burley
tobacco during the immediate future will likely remain well below traditional
levels.
Current Situation
The
2000 basic burley quota declined to a record low of 247 million pounds,
45 percent below the 1999 basic quota and 65 percent below the record 1997
basic burley quota level. The national effective quota for 2000 totaled
367 million pounds, compared to more traditional levels exceeding 600 million
pounds. This dramatic decline in U.S. burley quotas can be attributed to
numerous factors, including the following:
- Declining U.S. cigarette consumption (of approximately 10 percent since 1997), primarily in response to the price increases associated with the national tobacco settlement and increasing excise taxes.
- Increased substitution of less expensive imported burley tobacco for U.S. burley in domestically-produced cigarettes.
- Movement of U.S. cigarette production overseas, and to a lesser extent, weakness in Asian and Russian economies, resulting in U.S. cigarette exports falling by more than 40 percent from their record level in 1996.
- World burley supplies exceeding world burley demand, further hindering U.S. burley export price competitiveness in international markets.
- U.S. burley pool stocks escalating to more than 400 million pounds with a large volume of these stocks considered by the trade as undesirable quality and/or undesirable grades of tobacco.
- Political and legal uncertainty inducing manufacturers to continue to pursue conservative buying strategies.
Can Demand/Quotas Recover?
Domestic
demand for U.S. burley will continue to be adversely affected by abundant
stock levels, imports, and the retail product price increases associated
with legal costs facing the tobacco industry. The $145 billion verdict
against the tobacco industry in the Florida class action suit is not expected
to have significant devastating effects on the industry in the short-term.Most
legal analysts project the appeals process will proceed slowly with the
award being reduced significantly or potentially dismissed.In
the interim (assuming no other major political or legal event), cigarette
prices are likely to continue to rise (but at a slower pace than in recent
years), resulting in domestic consumption to revert back to its more traditional
two to three percent annual decline. Higher cigarette prices will likely
result in an increased use of cheaper imported tobacco as companies attempt
to hold down costs and consumers switch to lower price brands which typically
have less U.S. tobacco.
While
economic conditions may begin to improve in international markets, rebounding
of U.S. tobacco exports of leaf and tobacco products may be slow to materialize.In
fact, leaf exports in the short-run will likely fall in response to abundant
world supplies and limited available supplies available from the 2000 burley
market. Based on recent import patterns, projected export levels, and anticipated
cigarette production levels, current demand for U.S. burley may be more
in the 350 to 400 million pound neighborhood, compared to traditional annual
demand levels of 600 million pounds.
Following
the 1999 marketing season, the burley tobacco cooperatives had 415 million
pounds (farm-sales weight) in their inventories, approximately one year’s
supply.In recent weeks the burley
cooperatives offered bids on these stocks and have reportedly come to terms
on moving around 50 to 60 million pounds of this inventory.The
cooperatives plan to continue to meet with tobacco companies and dealers
in an attempt to move more of these stocks (ideally to some non-traditional
markets or to replace imports) prior to the 2001 quota announcement.
What
about moving some pool stocks into a non-traditional market like China?
The PRC recently agreed to remove its trade restrictions on U.S. leaf.
While the opening of the Chinese market does present some opportunities
for U.S. tobacco growers, tobacco dealers are unsure of both the short?term
and long?term effects.China accounts
for around 30 percent of world cigarette consumption. Although cigarette
consumption has reportedly peaked in China, demand for American-blended
cigarettes continues to grow in this market. As the Chinese economy rebounds,
and as the growing middle and upper income classes continue to emerge,
opportunities will likely exist to move some U.S. burley into this enormous
market.But this market will evolve
slowly over time and will not likely be the immediate answer to the industry's
short?term problems.
Given
all the domestic and international market uncertainty, quota projections
remain very cloudy for 2001 and beyond.Excessive
world burley supplies are expected to be reduced in 2001, but probably
not enough to move a significant volume of U.S. pool stocks without large
price discounts. It remains uncertain whether the recent pool stock sales
will simply displace potential purchases from the 2000 crop or 2001 purchase
intentions. If pool stocks and purchase intentions remain relatively flat,
the 2001 basic quota may stay relatively unchanged as well.However,
even if the 2001 basic quota remains near the 2000 level, the limited volume
of carryforward quota anticipated from the 2000 crop will still induce
an effective quota reduction of more than 20 percent for 2001.To
stabilize the 2001 effective quota, the burley cooperatives would have
to reduce their inventories by more than 250 million pounds --- a scenario
that is extremely unlikely to happen, unless the cooperatives are successful
in their efforts to obtain some type of loan forgiveness on the poor quality
1999 crop.
Tobacco
Program Issues
Numerous
political issues will once again confront producers in 2000.Always
at the top of the list is the survival (and potential modification) of
the tobacco program. While the program is always vulnerable, it currently
appears that support for the program in Washington D.C. has been enhanced
in response to an improved understanding of the effect the program has
on tobacco consumption, taxpayer costs, and family farms. Probably the
biggest threat to the program today is from internal forces.How
long will grower support for the program continue amidst declining quotas,
increasing lease rates, higher no-net cost fees, and contract growing?
Also, will the tobacco companies continue to support the program publicly
and through their actions?Burley
tobacco growers and quota owners will have the opportunity to vote on the
fate of the program in a referendum scheduled for February 2001. If the
program survives, legislation passed in June 2000 will modify the program
to limit the volume of carryforward quota and disaster leasing, and modify
the reserve stock adjustment in the quota formula. However, additional
changes in the structure of price supports and movement of quota to active
growers may be necessary to improve the competitiveness of U.S. burley
and enhance the longevity of the price support program.
Contracting
Philip
Morris initiated a pilot project for 2000 on purchasing tobacco directly
from Kentucky and Tennessee burley tobacco farmers within the guidelines
of the current federal tobacco program.According
to company officials, this action was taken primarily in response to better
controlling the very specific grades and styles of tobacco that may not
be available in a declining quota (supply) market.While
the contracts offered under this pilot program did offer a few production
guidelines, the agreement was basically a marketing contract. Under the
arrangement, contracting farmers would agree to deliver the tobacco to
a designated receiving station.Company
officials would grade the tobacco and prices would be established based
on a pre-announced price schedule. No-net cost and burley promotion fees
would be deducted, but contracting farmers would not have to pay grading
or warehouse fees.Farmers would
have the option of rejecting the offered price and sell their tobacco through
the traditional auction market system. As of August 28, 2000, Philip Morris
officials reported more than 60 million pounds of the 2000 crop had agreed
to be sold under their “partnering” program.By
their September 29, 2000 deadline, it is likely that Philip Morris will
have secured over 20 percent of the anticipated 2000 burley marketings
under their pilot program.
While
the terms of the current tobacco contracts being offered by Philip Morris
were publicly released, there are still a lot of questions regarding this
contractual arrangement and potential future contracts by other tobacco
companies.These general questions
include: