Flue-Cured Tobacco Outlook
A. Blake Brown
Agricultural and Resource Economics, North Carolina State University
September 7, 2000
Highlights
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The 2000 national flue-cured tobacco quota declined 18.5% from 1999 reaching a
another historical low of 543 million pounds. This is 44% below the 1997 basic
quota of 973 million pounds.
The low quota continues to reflect lower anticipated tobacco needs by U.S. cigarette
manufacturers, high manufacturer inventories of tobacco relative to anticipated use,
and depressed tobacco exports.
Possible declines in future Zimbabwean flue-cured tobacco production and the
opening of the Chinese market to U.S. tobacco could bolster depressed U.S. exports.
The 2001 quota will likely stabilize or could even increase.
Tobacco farmers received their first funds from Phase II of the tobacco settlement in
late 1999 or early 2000. Plans in each tobacco state have been made for distribution
of 2000 Phase II funds.
Farmers received payments for quota loss from USDA and will receive more quota
loss payments this fall.
The tobacco industry started a major cost-share program with flue-cured tobacco
farmers to retrofit curing barns with equipment that will insure by the 2001 season
U.S. flue-cured tobacco has reduced levels of nitrosamines (a carcinogen).
Contract production continued to expand slowly in the flue-cured areas. Philip
Morris did not pursue direct purchases or contract production in flue-cured, but did
begin contracting in the burley areas.
Continued small quotas, retrofitting of barns, and contracting will likely increase the
rate of consolidation of farms; mostly through attrition of older farmers, but also
through the exit of smaller operations.
With internal pressure for change in the tobacco program increasing both in the fluecured and burley tobacco areas and debate over the 2002 farm bill beginning, the
probability of modification of the tobacco program has increased.
The 2000 season and market outlook
The 2000 flue-cured crop was characterized by drought and consequent poor quality in
Georgia and by good growing conditions and consequent good quality and quantity in the
rest of the flue-cured areas. At the time of writing , over 15 percent of the FloridaGeorgia crop had been purchased by the Flue-Cured Stabilization Cooperative
Corporation, with larger purchases anticipated. Stabilization receipts in the rest of the
flue-cured area were anticipated to be 5 to 8 percent giving overall receipts of 8 to 10
percent. These lower receipts are in contrast to 1999 stabilization receipts of 21 percent.
Lower stabilization receipts in 2000 are due primarily to a smaller quota that more
closely fits domestic and export demand.
U.S. cigarettte manufacturers have successfully reduced inventories of flue-cured tobacco
by buying less tobacco than they use. While tobacco use by manufacturers will likely
decline slightly further, inventory reduction will likely slow so that purchases may begin
rebounding toward actual use levels in 2001. This implies that purchase intentions, as
announced by U.S. cigarette manufacturers, for the 2001 quota formula have the potential
to increase from the record low level of 286 million pounds announced for the 2000
quota.
Flue-cured tobacco from Brazil and Zimbabwe is the primary competition to U.S. fluecured tobacco in the world market. Brazil again produced a large flue-cured crop of
above average quality. While the Brazilian currency has stabilized, Brazilian tobacco
remains extremely competitively priced on the world market. Brazil’s 2000 flue-cured
tobacco crop is estimated at 947 million pounds; 400 million pounds more than the U.S.
crop.
Zimbabwe is in the midst of tremendous civil and economic strife as the government
threatens to confiscate land from mostly white farmers and distribute it to Zimbabwe’s
indigenous people. Since these farms produce most of the country’s tobacco, tobacco
production in Zimbabwe is likely to decline in the future. Despite the turmoil, a 2000
crop of flue-cured tobacco of about 485 million pounds has been produced; most of
which was marketed. If Zimbabwean tobacco production declines after 2000 other fluecured producing countries will capture Zimbabwe’s share of the world market. Under the
current U.S. tobacco program, U.S. tobacco producers are not in a position to take
advantage of this available market share. Brazil likely will be the primary beneficiary.
However, anticipated declines in Zimbabwean tobacco production and a weather related
short crop in China may bolster U.S. flue-cured exports from their current depressed
levels.
The opening of the Chinese market to the import of U.S. tobacco may also bolster U.S.
exports. China agreed to allow importation of U.S. tobacco beginning December 1, 2000.
Previously, China had banned all imports of U.S. tobacco, supposedly due to concerns
over the spread of blue-mold disease. China grows over 6 times the quantity of tobacco
produced in the U.S. However, most of it is consumed in China and it is mostly low
quality tobacco. Chinese cigarette manufacturers are purported to want some high
quality U.S. flue-cured tobacco for a growing premium cigarette market. While
forecasting the quantity that China might purchase is difficult, China may purchase some
of the current stabilization inventory, thus increasing the possibility of a recovery of the
national flue-cured quota. China could also become a regular customer for U.S. fluecured in the future. Optimism about Chinese purchases must be tempered by the
realization that Brazilian flue-cured tobacco will be very competitive with U.S. fluecured in the Chinese market.
As a result of these factors, domestic purchase intentions could increase and stabilization
inventories could decrease for 2001. These events would lead to the 2001 quota either
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stabilizing or increasing. While a 600 million pound quota for 2001 seems optimistic, it
is not impossible and some increase seems likely.
Tobacco Settlement Payments to Farmers
At the same time the settlement between the states and cigarette manufacturers was
negotiated (termed Phase I funds), a separate agreement was negotiated that set aside
$5.2 billion from cigarette manufacturers to be paid to tobacco growers and quota owners
over 12 years. These funds are commonly known as Phase II funds. Each tobacco
producing state was to receive a portion of the funds based on their share of national
tobacco production. Each state was to set up a Phase II commission, headed by the
governor, that would decide how the funds would be allocated to growers and quota
owners in their state.
In the five flue-cured tobacco producing states, North Carolina, Virginia, South Carolina,
Georgia, and Florida, the commission split the 1999 payment 50/50 between growers and
quota owners. If a person both owned and grew a quota, then that person received all of
the payment. For 1999, growers and quota owners in North Carolina each received $0.68
per pound of basic quota that they lost from 1998 to 1999. In other words, the payments
were spread over the pounds of quota decline from 1998 to 1999. In South Carolina and
Georgia growers and quota owners each received $0.125 for each pound of basic quota
they grew or owned in 1998 (not the amount by which the quota declined). In Virginia
growers and quota owners each received $0.1278 for each pound of quota they grew or
owned in 1998. Most growers and quota owners began receiving the first payments in
January, 2000.
Most states have already made decisions as to how the 2000 payments will be made. In
most cases they will be similar to the basis for the 1999 payments. For North Carolina
the 2000 payments will be based on quota loss from 1999 to 2000. Virginia growers and
quota owners will continue to receive payments based on the 1998 basic quota. The
payments will be slightly lower in 2000 since the total payment for 2000 from cigarette
manufacturers to states in 2000 is lower. Payments should be sent out in late 2000.
In some states growers and quota owners may also receive a portion of the Phase I funds.
Virginia developed the most lucrative plan for growers and quota owners. Virginia
growers and quota owners received $69 million in direct payments in 2000 from Phase I.
In North Carolina the state legislature decided to set aside 25 percent of Phase I funds to
assist growers, quota owners, and tobacco related workers. How the money will be used
has not been decided. Unlike Virginia, direct payments are not likely. Obviously the
amount for each grower and quota owner would be much less since the percentage set
aside is less and because there are many times the number of growers and quota owners
in North Carolina than in Virginia.
Government Payments to Tobacco Growers and Quota Owners
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In 1999 congress allocated $328 million dollars to assist tobacco growers and quota
owners because of loss of quota. The money was distributed to growers and quota
owners in the spring of 2000 in the same manner as Phase II funds for each state. For
2000, congress has allocated $340 million dollars as quota loss payments. This money
will also be paid based on quota loss and should be received in fall 2000. The allocation
of funds for tobacco farmers by congress was a surprise to many in the tobacco industry.
Most farm leaders feel that the continuation of such funding is not likely.
Contracting
RJ Reynolds Tobacco Company entered into its second year of contracting in 2000.
While Philip Morris considered conducting a pilot program in contracting in the fluecured areas in 2000, they decided to wait, but did begin contracting for burley tobacco.
Several leaf merchants contacted some flue-cured tobacco in 2000. All of the contracts
were essentially marketing contracts, resembling the marketing contracts for cotton or
grains. RJ Reynolds’ contract did require that farmers retrofit their barns with heat
exchangers, but Reynolds bore the cost of the retrofit.
Many people have always assumed that the initiation of contracts in the farm sale of
tobacco would quickly lead to the demise of the tobacco program. A change to
contracting will place stress on the program and require new methods for enforcing quota
and collecting assessments. However, it is not necessarily true that a tobacco program
could not function in the presence of contracts. The US peanut program, a no-net-cost
supply control program similar to the tobacco program, operates with a system of
marketing contracts and direct sales.
It seems likely that the use of contracts in tobacco purchasing will increase and may
completely replace the auction system. Some warehousemen may find roles in helping
companies arrange purchases with farmers. Contracts may also increase the rate of
consolidation of farms. Tobacco contracts likely will continue to closely resemble
marketing contracts.
Barn Retrofitting
In 2000 flue-cured tobacco growers and cigarette manufacturers entered into a major
cooperative effort to place heat exchangers in flue-cured bulk curing barns. According to
industry research, use of heat exchangers in curing barns greatly reduces nitrosamines (a
know carcinogen) occurring on flue-cured tobacco. The issue is a competitive issue since
Zimbabwean and Brazilian flue-cured producers use heat exchangers in their barns and
therefore have low nitrosamine levels in their tobacco. Flue-cured tobacco grown for the
2001 season and afterward must be cured in barns with heat exchangers.
The Flue-Cured Stabilization Cooperative Corporation and certain cigarette
manufacturers financed a cost-share program for growers to convert their barns. Growers
converting barns before August 31, 2000 could receive up to $0.15 per pound of quota
for which they were the owner or operator, not to exceed the actual cost of retrofitting the
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barns. This amounts to up to $3000 per barn. Farmers retrofitting after August 31 but
before June 30, 2001 are eligible for up to $0.13 per pound of quota for which they are
the owner or operator; about $2600 per barn. Funding will not be available after June 30,
2001. Shortages of kits and backlogs in installation were reported in late summer 2000.
Conclusions
Given the reduction in world supplies, the potential decline in Zimbabwean flue-cured
tobacco production, possible purchases of US tobacco by China, and the reduction of
flue-cured tobacco inventories, the national flue-cured quota could rebound in 2001.
Under the current tobacco program a national flue-cured quota of at least 600 million
pounds may be achievable and sustainable over the next few years. The national fluecured tobacco quota averaged about 875 million pounds in the mid-1990s. However, the
burley tobacco national quota is at levels one-third of the levels just two years ago and
further declines are expected.
Small quotas have increased quota rental rates and will likely lead to the exit of farms
over the next year. This exit will come primarily from older and smaller farmers who
find they can make as much or more income by renting their quota to younger or larger
farmers. The extremely small quotas could lead farmers to demand changes to the
tobacco program. The direction of change is difficult to predict, but successful efforts to
increase quotas probably would involve reductions in price support.
External threats to the tobacco program from anti-tobacco forces seem minimal now. In
fact, many health advocacy groups now support continuation of a tobacco program
because it restricts tobacco production and maintains a relatively high tobacco price to
cigarette manufacturers. Any change in the tobacco program likely will come from
internal pressures. A decline in Zimbabwean flue-cured tobacco production could
provide an opportunity for U.S. flue-cured tobacco farmers to increase their share in the
world market. However, U.S. market share is not likely to increase significantly without
changes in the tobacco program. While tobacco is not part of the 2002 farm bill, the farm
bill could provide a vehicle for change in the tobacco program.
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