Tobacco Contracting Issues and
Update for 2001
William M. Snell and Daniel Green
University of Kentucky
Department of Agricultural Economics
March 2001
Agricultural Economics
Contracting in Agriculture/Tobacco
• Approximately 1/3 value of agricultural production is
contracted
– Examples include broilers, hogs, milk, fruits,
vegetables, turkeys, eggs, cotton, peanuts, and identitypreserved grains
• Agricultural contracts are generally classified as either
production or marketing contracts.
• Tobacco is contracted in many parts of the world (e.g.,
Brazil, Argentina, Mexico)
Agricultural Economics
2000 Market Review
• Marketings (315.7 mil lbs)
– 223.7 mil lbs sold auction
– 87.5 mil lbs contracted (28%)
– 4.5 mil lbs sold direct
• Gross Price
– $195.49/cwt -- auction
– $198.43/cwt – contract (+3 cents/lb)
• Average contract price netted approximately 10 cents/lb
higher than the average auction price
Agricultural Economics
Observed Advantages for the
Contracting Grower for 2000
• reduced marketing costs and higher net return relative to
the auction market
• potential of selling tobacco earlier in the year
• no tobacco placed under government loan (i.e., pool)
• price premiums for quality
• payment day of delivery
• improved direct communication with buyer regarding
company/consumer preferences
Agricultural Economics
Identified Advantages for the
Contract Buyer in 2000
• improved quality of marketings
• improved supply management
• improved strip yields in response to reduced tobacco leaf loss
and lower moisture levels
Agricultural Economics
Contracting for 2001
• PM expanding contracting
• All other manufacturers contracting
• Most export dealers contracting
• Competition to sign-up growers
• What percentage will be contracted? 50-75% ?
• Impacts on program/grading/grading service/auction markets?
Agricultural Economics
Contract Characteristics
• Tobacco must be produced and cured using recommended
agronomic and cultural practices.
• Tobacco must be stripped and separated into at least three
(and preferably four) stalk positions.
• Tobacco must be delivered free of foreign matter, weighing
less than 100 pounds per bale and with a moisture content of
less than 24%.
• Tobacco must be marketed under the federal tobacco program
and adhere to all other applicable government
rules/regulations.
Agricultural Economics
Contract Characteristics (cont.)
• Contract lengths range from from 1 to 3 year agreements.
• Contracting seller must offer entire crop and may not lease
out any part of the contracted crop.
• Schedule deliveries to a specified receiving station
• Minimum prices offered by grade and stalk position
• Grading procedures and dispute options
• Sampling procedures (e.g., moisture, temperature, pesticide
residues)
Agricultural Economics
Contract Characteristics (cont.)
• Provisions presenting the maximum allowable carryover
tobacco sales
• Payment procedures and terms
• Contracting firms’ rights to the access of the contracting
farm/grower production practice record-keeping requirements
(if any).
• Terms regarding the resolution of disputes are outlined,
including the applicable state’s law governing the agreement
and the location of any actions, suits, or proceedings arising
from the agreement.
• Contract terms are subject to revision upon major changes or
elimination of the federal tobacco program.
Agricultural Economics
Contract Price Analysis
• Contract prices do vary across companies.
• Some companies not offering a price for certain grades such as
mixed, green or variegated (K-style) tobaccos.
• Given the following grade distribution of marketings; flyings
(8%), cutters (30%), leaf (50%) and tips (12%):
– the average company price for the 2001 crop (based on the
current contract prices) ranges from $199.4/cwt to
$202.5/cwt, assuming 100% of the tobacco falls in the
company’s top quality grade grouping.
– the average company price for the 2001 crop (based on the
current contract prices) ranges from $194.4/cwt to
$197.5/cwt, assuming 100% of the tobacco is categorized
in the company’s second highest quality grade grouping.
Agricultural Economics
Selected Grade
2000 Price
Support
($/cwt)
2000 Average
Auction Price
($/cwt)
2000 Contract
Price ($/cwt)
2001 Contract
Price Range
($/cwt)
X3F
$188
$192
$192
$192 - $200
X4F
$188
$191
$192
$192 - $197
C3F
$187
$188
$192
$190 - $198
C4F
$187
$188
$191
$190 - $198
B3F
$186
$194
$187
$188 - $198
B4F
$186
$192
$187
$188 - $198
B3FR
$193
$198
$197
$199 - $201
B4FR
$193
$196
$197
$199 - $201
T3FR
$206
$207
$210
$207 - $212
T4FR
$206
$207
$210
$207 - $212
T3R
$206
$207
$210
$207 - $212
T4R
$206
$208
$210
$207 - $212
X5M
$168
$174
$178
$0 - $190
B4K
$149
$164
$172
$60 - $160
C4G
$113
$135
$92
$60 - $155
M4FR
$127
$164
$0
$0 - $175
Potential Advantages for the
Contract Buyer:
• enhanced quality control in terms of obtaining the desired leaf
characteristics, stalk positions, moisture levels
• improved supply management in terms of the total volume,
specific grades, and flow of tobacco to the market
• increased rate of adoption of technological innovations
necessary to address specific quality or regulatory concerns
(e.g., reduced nitrosamines/nicotine levels)
• potential lower long-term marketing costs due to concentration
of markets/buying personnel
• improved strip yields in response to reduced tobacco leaf loss
and lower moisture levels
Agricultural Economics
Potential Concerns for the
Contract Buyer:
• reduced selectivity
• higher leaf costs
• additional short-run costs associated with establishing
receiving stations in terms of rent/building acquisition,
buying agents, labor, and technological adoption
• additional strained relations within tobacco industry (e.g.,
growers, warehouse owners, and farm groups who oppose
contracting)
Agricultural Economics
Grower Concerns
• Tobacco Program ???
• Federal Grading Service ???
• Price Supports ???
• Market Access/Auction Markets ???
Agricultural Economics
Auction Market Issues
• How many will survive and where will they be located?
• What volume of sales will they attract?
• What changes will the survivors adopt to attract buyers and
growers?
• How many buyers will participate?
• How many sales per year?
• Will auction markets become a market for primarily low
quality tobacco?
• How will auction market prices be affected by contract
prices?
Agricultural Economics
Other Grower Issues
• What will be the typical size of the future contract grower?
• Will all growers who want a contract be able to obtain one?
• Will contract production eventually be concentrated in certain
geographic areas?
• What will be the degree of producer independence in making
future management decisions?
• Will contracting producers be obligated in the future to make
large capital investments?
Agricultural Economics
Other Grower Issues (cont.)
• What will be the degree of buyer competition in awarding
contracts?
• How will the distribution and overall average of prices change?
• Will the higher prices initially induced by contracting result in
long-term losses in exports, encourage more imports and boost
lease prices?
• Will a changing production and marketing system continue to
improve the quality and integrity of U.S. burley? If so, how will
this affect future quota levels?
• Will grading be done by a third-party or company reps, or both?
Agricultural Economics
Other Grower Issues (cont.)
• Will grading evaluations vary depending on current
supply/demand conditions?
• How will the contracting firms respond to a very low quality
crop?
• Will contracting firms continue to commit to contract the
farmer’s entire crop?
• Will contracting companies in the future offer grower financing
and/or other inputs?
• Will the industry experience a reduction in public market info
on prices, quantities, grades, etc., as a result of contracting?
Agricultural Economics