By TIM THORNBERRY
Kentucky Correspondent

LEXINGTON, Ky. — The business of growing tobacco seems to be getting more difficult each season as factors such as international markets, the value of the U.S. dollar and new federal regulations affect what farmers are doing in all corners of the state.

The free market created by the quota buyout a few years back has not been as friendly lately as some would like. Many producers have experienced reduced or dropped contracts this year, forcing them out or to grow tobacco without the safety net of a contract.
Will Snell, an agricultural economist at the University of Kentucky (UK) College of Agriculture, said the decline really began in 2009.

“In reality, the beginning of this adjustment started last year when, for the first time since the tobacco buyout in 2004, U.S. burley supply going into the growing season was closely in line with anticipated demand. In response to an excess supply of burley tobacco in the world market, coupled with a lot of regulatory uncertainty, some companies actually pulled back contract volume in 2009,” he said.

But many growers overproduced to “hedge against yield risk,” Snell added.

“A significant level of acreage was planted in 2009 by non-contract tobacco producers. As a result of higher acreage amidst contract volume reduction, growers were facing a potential depressed market for non-premium styles of tobacco. However, the train wreck in many cases didn’t happen last year for decent quality tobacco in response to lower-than-anticipated yields constraining excess production.”

That “train wreck,” however, looks as though it may take place in 2010 with the decline in demand and continued unrest with U.S. Food and Drug Administration (FDA) regulation of tobacco.
“On the domestic front, tobacco companies purchasing burley tobacco over the past couple of years incorrectly forecasted a continuation of historical annual U.S. cigarette consumption declines of 2 to 3 percent, versus the observed 5 percent decline in 2008 and a 6 percent decline in 2009,” said Snell. “Plus, the recession forced many tobacco consumers to seek lower-priced alternatives, which likely contained less U.S. burley.

“Consequently, domestic tobacco manufacturers overbought U.S. burley the past couple of years (especially some of the lower quality grades), leading to some significant inventory adjustment needed for 2010. Plus, the uncertainty of FDA regulations has likely led domestic companies to be even more conservative in their purchasing plans for 2010.”

David Howard, a spokesman for R.J. Reynolds, said the decline in contracts is a reaction to the market.

“There have been reductions essentially because we’ve got to keep supply in line with demand. It’s no secret that cigarette volumes have been declining and have been for several years,” he said. “The bottom line is it’s just a matter of supply and demand and we have to keep our business in line with that.”

Howard said while the company has adjusted the amount of tobacco contracted, it has not reduced the number of contract growers.
That isn’t necessarily the case with all cigarette companies. David Sutton, a spokesman for Philip Morris (PM), USA and U.S. Smokeless Tobacco Co. (USSTC), said the company’s decisions about contracts were based on demand as well as the quality of leaf growers were producing.

“The company has always adjusted its tobacco leaf procurement on an annual basis as we go into every growing season. So, every year there are changes to PMUSA’s tobacco procurement in Kentucky and across the growing region,” he said.

“What we have done this year, we’ve looked at, as we always do, the amount of burley we are going to need from Kentucky and other states, and the amount of flue-cured we are going to need for the cigarette blends. Because volumes continue to decline, there is a logical connection there that we don’t need to buy as much burly leaf to make less cigarettes.”

Sutton also said as far as the growers go, the company – which he said values the relationship it has with them – has been proactive with them, talking individually with those having contracts reduced or dropped. He said growers with questions or concerns can always go to their PMUSA grower representative.

Another thing the company did was take a hard look at quality. “We started looking at what we call the grower’s scorecard, which is what the company and its growers work from on an annual basis,” said Sutton. “We looked at the performance of growers not only in Kentucky but across the growing region, and we looked at the fact that the company is no longer going to buy fourth- and fifth-quality tobacco.

“So, if individual growers were delivering low-tier quality, those are the type of folks who would likely be impacted with either cuts in their contract or, indeed, not being offered a contract at all.”
Sutton added that high quality leaf is still the backbone of its cigarette blends and PMUSA and USSTC still plan to buy more than $100 million worth of Kentucky tobacco from thousands of state growers.

Government involvement initiated to curtail smoking has contributed to the decline in demand for tobacco products, something it intended and something Howard said has contributed to more hardships for producers. Farmers should be contacting federal and state legislators who voted in favor of hefty excise taxes aimed at the tobacco industry, he noted.

According to a 2009 report issued by the Centers for Disease Control and Prevention, the federal excise tax increased from 24 cents per pack in 1995 to $1.01 in 2009, and the average state excise tax increased from 32.7 cents per pack to $1.20 during the same period. These increases represent a 321 percent increase in the federal excise tax and a 267 percent increase in the average state excise tax since 1995.

“These excise tax increases and smoking restrictions have an effect on the business, and those are certainly some primary drivers to reduced demand. We have to operate our business accordingly, just as any business would,” said Howard.

Snell said while dark tobacco production is still in relatively good shape, collectively he expects the number of tobacco farms to continue to shrink while the amount of revenue it produces to shrink as well.

“The value of tobacco production in Kentucky will likely fall below $350 million in 2010, compared to record high post-tobacco buyout crops valued around $380 million in 2008 and 2009,” he said.
“The number of farms growing the crop will continue to shrink in response to tobacco companies scaling down the number of desired contract growers, credit constraints, labor issues, deteriorating infrastructure and concerns over the profitability of non-contract production.” 

There is a silver lining of sorts. Snell added that low-cost/high-yielding quality growers who maintain an excellent working relationship with their contracting company will be able to survive and potentially do quite well in this uncertain and volatile tobacco industry.