U.S. Flue-Cured Tobacco Situation and Outlook
September 24, 2001
A. Blake Brown
Agricultural and Resource Economics
North Carolina State University
2001 Season
The effective quota for U.S. flue-cured tobacco for the 2001 season was 545 million
pounds, slightly less than the basic quota of 549 million pounds. Marketings for 2001
will likely approach 103 percent of the quota, about 560 million pounds. The September
crop report forecast 2001 U.S. flue-cured production to be 582 million pounds. As a
result, on-farm carry-over is expected to be substantial, but less than the previous year.
As of September 20, about 500 million pounds had been sold at an average price of $1.85
per pound. The season average price in 2000 was $1.79 per pound. Over 80 percent of
2001 flue-cured production is selling via marketing contracts. As of September 20, about
374 million pounds of the 2001 crop had been sold through receiving stations at an
average price of about $1.86. About 82 million pounds had been sold through auction
markets at an average price of about $1.80.
Both flue-cured imports for consumption and general imports fell 20 percent or
more from 1999 to 2000. However, flue-cured imports have increased substantially in
2001. Unmanufactured exports of flue-cured tobacco recovered slightly in 2000 after
falling 22 percent from 1998 to 1999. Unmanufactured exports of flue-cured were about
290 million pounds (farm weight) in 2000. Exports are likely lower in 2001. Increased
production of flue-cured tobacco by Brazil has more than offset lower production in
Zimbabwe.
U.S. cigarette consumption was 423 billion cigarettes in 2000, down only about
11 percent from 1997 despite price increases of more than 100 percent. Exports of
cigarettes stabilized in 2000 at about 150 billion cigarettes. Cigarette exports fell from
217 billion in 1997 to about 150 billion in 1999.
Use of U.S. flue-cured tobacco by U.S. cigarette manufacturers was about 435
million pounds in 2000, about the same as in 1999 and down from 492 million pounds in
1998. Purchase intentions for 2001 were 297 million pounds (up from 286 million in
1999) indicating that manufacturers continued to reduce inventories by purchasing less
U.S. tobacco than they used. The supply of U.S. flue-cured tobacco fell from 2.07 billion
pounds in 1998 to 1.75 billion in 2000. The 2001 supply is expected to be about 1.6
billion pounds. Manufacturers may be nearing desired inventory levels so that purchases
of U.S. flue-cured tobacco may return to near the levels of actual use over the next 1 to 2
years.
Outlook for 2002 Quota
The quota formula is the sum of three components: purchase intentions from U.S.
cigarette manufacturers, a 3 year average of unmanufactured exports, and a reserve stock
adjustment. The reserve stock adjustment is based on the end of season stocks held by
the Flue-Cured Tobacco Cooperative Stabilization Corporation. Stabilization entered the
2001 season with about 65 million pounds of stocks. As of September 20, about 2.6
percent of net sales had been purchased by Stabilization. If this trend continues then
receipts for the 2001 season would be about 16 million pounds, placing total stocks at 81
million pounds. Under the current program rules the reserve stock adjustment is the
greater of 100 million pounds or 15 percent of the previous year’s basic quota minus
stabilization stocks. This rule implies a positive reserve stock adjustment of about 19
million pounds. Efforts are underway to change the reserve stock adjustment to the
greater of 75 million pounds or 10 percent of the previous year’s basic quota minus
stabilization stocks. If this change were made it would imply about a negative 6 million
pound reserve stock adjustment. This change would require legislation. It may be
unlikely that such a change can be made in time for the December 15 quota
announcement. Thus, a modest positive reserve stock adjustment is the most likely
scenario at this time.
Unmanufactured exports of flue-cured tobacco (farm weight) were 342 million,
262 million, and 290 million pounds, respectively, in 1998, 1999, and 2000. Exports will
likely be lower in 2001. For the 3 year average for the 2002 quota calculation the 1998
exports of 342 million will drop out and an estimate of the 2001 exports will be included.
As a result the 3 year average will decline. For example if unmanufactured exports for
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2001 are estimated at 275 million pounds, then the 3 year average for the quota
calculation is (262+290+275)/3 = 276 million pounds. While the 3 year average for
exports is expected to decline, the estimate for 2001 exports, and consequently the export
component of the quota formula, will not be known until around December 1.
The most unpredictable portion of the quota formula is purchase intentions.
However, with inventories held by cigarette manufacturers being reduced by over 400
million pounds over the last 3 years and domestic use still over 400 million pounds, some
increase in purchase intentions seems likely. Cigarette consumption has not declined as
much as expected. Domestic use may continue to decline as cigarette consumption
continues a slow decline and imports of foreign tobacco increase. These trends will
moderate increases in purchase intentions, but intentions should gradually increase back
toward the level of actual use as manufacturers stop reducing inventories.
In summary, the reserve stock adjustment will most likely be positive. The export
average will be lower, but purchase intentions may increase. Given these expectations,
some increase in the 2002 quota seems likely. For example, suppose purchase intentions
are 300 million pounds, the reserve adjustment is 19 million pounds, and the export
average is 275 million pounds. This scenario gives a basic quota of 594 million (without
any discretionary adjustment by the Secretary of Agriculture), up 8 percent from 2001.
Any substantial increase in purchase intentions could put the basic quota over 600 million
pounds.
Events that could lead to a decrease in the 2002 quota would be a legislative
change in the reserve stock level requirements that lead to a negative reserve stock
adjustment plus much lower exports than expected or surprisingly low purchase
intentions. Suppose that the reserve stock adjustment rules were changed and the
adjustment was –6 million pounds, the export average was 265 million pounds and
purchase intentions remained at the 2001 level of 297 million pounds. This scenario
gives a 2002 basic quota of 556 million pounds; still above the 2001 basic quota of 549
million. In this scenario either the export average or purchase intentions would have to
be over 7 million pounds lower to cause a quota decline. In short, a decline in quota
seems unlikely.
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A Tobacco Program Buyout
Undoubtedly, the most talked about topic among quota owners, tobacco farmers, and
farm organizations is the possibility of a “buyout” of the tobacco program. In general all
buyout plans include elimination of the current tobacco program and some level of
compensation to quota owners and growers for quota owned and grown. The most
publicized (and most formalized) plans for a buyout are the recommendations of the
Presidential Commission on tobacco. This plan would replace the current quota system
with production permits held only by active tobacco growers. Quota owners (including
growers) would receive $8 per pound of quota owned. Growers would receive
compensation for pounds grown as well as owned. For each pound of tobacco a grower
agreed to stop producing he would receive $4. For each pound of tobacco that a grower
continued to produce he would receive $2. Total cost for the compensation could range
from $15 billion to $17 billion. The commission recommends a $0.17 per pack cigarette
tax increase to fund the buyout. Most political analysts agree that a cigarette tax increase
to fund such a proposal would be very difficult to accomplish. Further, there is
substantial disagreement among farm organizations over the form that a replacement
tobacco program should take.
Congressman Richard Burr (R-NC) and Congressman Walter Jones (R-NC)
formulated a bill to fund a buyout of the tobacco program. The funding would come
from use of the already scheduled increase in the federal cigarette excise tax of $0.05 per
pack for an unspecified period of time. The bill (H.R. 2334) was introduced to the U.S.
House of Representatives in June, 2001 and has been referred to the House Ways and
Means Committee and the House Agriculture Committee. The bill only specifies how a
trust fund would be set up and funded in order to “carry out a program established by the
Secretary of Agriculture to buyout tobacco quota and study the future of growing tobacco
in the United States.” It does not specify compensation amounts or make
recommendations regarding a future tobacco program. As with any government
sponsored buyout of the tobacco quota, a significant hurdle would be avoiding limitation
of compensation to quota owners and growers because of preset limitations on
government payments to individuals.
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Another potential source of funding suggested by some is for U.S. cigarette
manufacturers to increase cigarette prices by $0.10 per pack for 10 years to fund quota
compensation of $8 for each pound owned and $2 for each pound grown. The current
tobacco program would be eliminated. With the source of funding and payments from
the private sector, payments might not be subject to limitations even though the proposal
would require legislation and government intervention. Normally such price increases
would be considered collusion and thus illegal. Apparently, some legal experts think
such a price increase could be accomplished under the protection of the Master
Settlement Agreement. Cigarette manufacturers would receive support from farm groups
for their preferences with regard to FDA regulation of cigarettes (currently only one
manufacturer supports FDA regulation). This proposal would also settle the grower
lawsuit and the Department of Justice Lawsuit against manufacturers. The proposal
suggests that the current tobacco program be replaced with some type “safety net”
program.
While prospects for some sort of “buyout” appear better than in the past, a buyout
is far from certain. Significant and difficult hurdles must be overcome to achieve the
level of funding required for a buyout.
Contracting
Sales of tobacco via marketing contracts and receiving centers escalated from a small
amount of flue-cured tobacco production in 1999 to over 80 percent of sales in 2001.
Whether or not the share of tobacco sold under contracts will continue to grow
significantly is uncertain. Some farmers currently selling at auction will likely exit
tobacco production, while others will switch to contract production. However, there may
be some room in the market for some tobacco to be sold through some type of auction
system. If any sort of auction system is to exist, then substantial changes must be made.
Several groups or companies are openly discussing the concept of marketing centers.
These might be centrally located, highly efficient operations that receive tobacco and
then auction the tobacco in a manner similar to either the Canadian or Zimbabwean
system. The primary customers would likely be smaller, mostly foreign, cigarette
manufacturers who want the ability to select only certain stalk positions or grades in their
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purchases. As now leaf merchants would be the purchasing agent. Stabilization has
purchased some existing auction warehouses with the intent of transforming them into
marketing centers. Of course leaf merchants provide the service of sorting, selectivity,
and storage to manufacturers in Brazil without the service of an auction market.
Regardless of the outcome of the marketing center concept, it seems that most tobacco
will be sold through receiving stations.
Much concern has been expressed over whether or not the tobacco program can
be maintained if most or all tobacco is sold via contracts. Peanuts are grown and sold
under a similar program to tobacco. Peanuts have always been sold either directly to the
buyer or via contracts; never by auction system. What is critical is that quotas be
enforced. Further, in order to operate the price support system third party grading should
be a part of the contract system. If these two conditions are met, then the program can
persist under a system of contract sales. As with the peanut program (which is likely to
be dismantled next year), other issues, such as loss of market power, may be more critical
in the demise of the tobacco program.
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