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U.S. burley faces challenges from foreign producers and e-cigarettes

 

University of Kentucky College of Agriculture, Food and Environment

 

LEXINGTON, Ky. — The tobacco buyout celebrated its 10-year anniversary this past year. Of course, that means tobacco buyout checks are history, and the remaining tobacco growers face a market without any safety net measures to protect against market volatility.

As anticipated, the buyout did bring about massive consolidation, increasing scale of production, and geographical shifts in production. But volatility in burley prices and production has not evolved in the post-buyout era as expected … until now.

In reality, tight domestic and global supplies of burley enabled a seller’s market to evolve for most of the post-buyout era. This resulted in relatively strong prices for lower quality leaf, a home for non-contract tobacco, and a viable auction market. However, a 30-35 percent increase in global burley production over the past two years, coupled with blended cigarette sales falling 5 percent or more in many traditional U.S. cigarette markets, abruptly changed the favorable supply/demand balance this past marketing season. Internationally, export demand for U.S. leaf is off by more than 20 percent, due not only to lower blended cigarette sales, but also in response to an abundance of lower-priced leaf and an increasing value of the U.S. dollar. Collectively, these factors threaten to generate lower U.S. tobacco prices and contract volume for 2015.

One factor that could disrupt this projection has been the recent devastating flooding in Malawi, the world’s largest burley producer. While being a low-quality burley producer, Malawi’s leaf output certainly impacts the overall global burley supply. A sizable loss of the 2015 Malawi crop, which is still much unknown at this time, could constrain the anticipated reduction in U.S. burley contract volume for 2015. If Malawi losses are minimal, the industry will need much less burley from U.S. growers in 2015, inducing double-digit percentage reductions in burley contract volume for the coming year, and significantly increasing the marketing risk of any non-contract burley production in 2015.

The demand for U.S. burley beyond 2015 remains very uncertain. One factor that may play a noticeable role will be the rapidly emerging e-cigarette/vaping market. Currently, the e-cig/vaping market is only around 2.5 percent of total U.S. tobacco product sales, but some analysts anticipate that it will continue to grow and could overtake domestic cigarette sales within the next decade. Most of these “alternative” nicotine delivery products are presently derived from non-U.S. leaf sources, primarily China. While research and production efforts are evolving to see if U.S. tobacco growers can be a part of this market, it remains unclear if U.S. tobacco growers can supply the liquid nicotine at a cost-competitive/profitable level.

Currently, the e-cigarette/vaping market faces limited regulation and taxation. However, this is likely to change in the near future as policymakers, regulators, and public health officials debate the health issues surrounding these new products, and as governments face declining tax revenues from a loss in cigarette sales. Interestingly enough, it took domestic cigarette companies a couple of decades of watching increasing snuff sales before they entered the smokeless industry. However, the major cigarette manufacturers entered the growing e-cigarette/vaping market quickly and continue to test consumer acceptance of new nicotine delivery products.

It appears that U.S. cigarette companies have greater economic incentives to expand alternative tobacco product markets, at the expense of traditional cigarette sales, in response to reportedly higher per-unit profit margins, limited regulation/taxation, and lower Master Settlement Agreement (MSA) payments, since the latter is volume adjusted based on cigarette and not e-cig/vaping sales. If this market continues to grow, displacing traditional cigarette sales, it will most likely induce further reductions in U.S. tobacco acres unless domestic growers become a part of this emerging market.


This article was written by Will Snell, agriculture economist at the University of Kentucky College of Agriculture, Food and Environment. The article first appeared in the Jan. 27 edition of Economic and Policy Update.