Burley Tobacco Outlook
William M. Snell1
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:
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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.
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Increased substitution of less expensive imported burley tobacco for U.S. burley
in domestically-produced cigarettes.
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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.
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World burley supplies exceeding world burley demand, further hindering U.S.
burley export price competitiveness in international markets.
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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.
Extension Professor, Department of Agricultural Economics, University of Kentucky. Paper presented at the 2000
Southern Region Agricultural Outlook Conference, Atlanta Georgia, September 26, 2000.
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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:
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how many, size, and location of contract producers?
what will be the degree of producer independence in management decisions?
will contracting producers be obligated to make large capital investments?
will contract terms change much over time?
what will be the degree of buyer competition in awarding contracts?
what percentage (volume) of the crop will be purchased directly?
what about potential premiums/discounts for quality?
will company grading differ from USDA grading?
what rejection terms are outlined in the contract?
how will contracting affect auction market prices?
will the auction system become an outlet for mainly lower quality tobacco?
what will be the effect of current auction prices on contracted prices?
will contract delivery of tobacco be predetermined?
what will be the impacts of large-scale contracting on the auction marketing system and the
USDA Grading Service?
what is the legal liability facing contracting growers?
does the contracting system jeopardize the future existence of the tobacco program?
The answers to many of these questions are unclear at the present, but will become more
apparent over time. Obviously the farm groups, warehouse operators, policy makers, farmers,
along with contracting and non-contracting tobacco companies will be closely monitoring and
evaluating the development of this alternative marketing system. Each group will be making
adjustments to better serve their own interests. Furthermore this movement will likely spawn
additional changes in the current tobacco program and the current auction marketing system in
an effort to enhance the efficiency and competitiveness of the U.S. burley tobacco industry.
What will evolve under this alternative marketing system remains uncertain, except for the likely
scenario of continued consolidation of tobacco growers and tobacco warehouses.
Conclusions
Burley tobacco farmers are facing some critical decisions on whether they continue to be
a participant in a depressed and uncertain industry, reallocate resources more towards alternative
agricultural enterprises or even pursue off-farm employment. Worldwide tobacco consumption
patterns indicate a niche market for the quality of burley tobacco produced in the United States.
Thus, while domestic demand for tobacco likely will continue to decline in the foreseeable
future, U.S. tobacco—especially burley—will likely remain an important ingredient for tobacco
companies as they try to meet the increasing global demand for the American blended cigarette.
The ability for U.S. burley demand to rebound from recent lows will depend greatly on program
and marketing changes to enhance the competitiveness of U.S. burley as well as the opening of
new markets (e.g., China). In addition, the political relationship between tobacco companies and
growers and of course the outcomes in the legal system will also play huge roles in determining
the future direction of this industry. Nevertheless, current demand patterns suggest that a
significant number of efficient burley tobacco growers will be able to survive in this turbulent
political, legal and economic environment. Although a smaller tobacco sector is likely to be
sustained, a major concern focuses on the possibility that tobacco dollars will be concentrated
among fewer farmers and across fewer geographic regions. The degree of concentration over
time will also hinge greatly on potential changes in the federal tobacco program and tobacco
marketing.