Quota buyout clouds tobacco's future

The reason for this over-riding concern, says Russell Sutton, Clemson University Extension economist, is that a buyout would mean significant money for quota holders, current buyout proposals either would eliminate or drastically change the government’s tobacco program, and — if no legislative action is taken in the near future — the present program likely will encounter survival problems and the quota will be worthless.

The 2002 tobacco season was influenced by several different but important factors, says Sutton. "First, we started the flue-cured/burley production year with two previous seasons of good weather, high yields and generally excellent quality. Our market system was different due to contracting and a major reduction in the auction markets," he says.

Many areas, he says, reported increases in quota rental rates due to quota reductions and Master Settlement Agreement (MSA) payments. Tobacco producers and quota holders participated in the phase I and II agreements, and contract prices generally were higher than auction prices, he adds.

Flue-Cured Stabilization operated 14 auction market centers this year — two in Georgia, two in South Carolina, two in Virginia and eight in North Carolina. The only known market center for burley is in Kentucky and is owned by the Burley Tobacco Growers Cooperative. The Tennessee co-op currently is considering opening some centers, notes Sutton.

For all flue-cured through Sept. 17, contracts accounted for 83.5 percent sales; independent auctions, 6.1 percent; and marketing centers, 10.3 percent.

"One producer issue is the price differences between these marketing systems," says Sutton. "Presently, flue-cured contract prices are averaging about $4.78 above the marketing centers and $13 over independent auctions.

"However, for many contract producers, the latter two systems are dumping outlets for lower quality tobacco. For example, one flue-cured contract calls for no more than one-third of all production being lower stalk grades while the minimum contract price is in the $1.72 to 1.75 range. There are several lower-stalk grade price supports well below this level."

Curent tobacco world issues aren’t all in the trade arena, says Sutton. First, President Mugabe of Zimbabwe has instituted a campaign of taking white-owned tobacco land and distributing it to black Zimbabweans. There are questions about the unrest and production potential, at least initially, under the new system.

Zimbabwe, the fourth largest producer in the world, already is late in planting for next year, and it’s questionable if it’ll be an important producer in the future, he adds.

China, the world’s largest tobacco producer, is drastically changing their system, he says. After entry into the WTO, China has required that all tobacco industries significantly reduce tar levels for cigarettes, and those with high tar levels should not be sold by the year 2005.

"This will mean that China will produce blended tobacco cigarettes and will enhance their future export capabilities. There is a new round of WHO-connected international tobacco health negotiations taking place this fall in Geneva. With some exceptions, several of the issues look like those that have taken place in the United States in the past few years.

"These include tobacco control measures, labeling, advertising restrictions and education. There are unique issues such as countries’ rights, evaluating health concerns above trade concerns, smuggling and package labeling to include the country of destination. Parts of this treaty may not be in effect in the near future but likely will impact world usage and trade over the next several years."

In the trade area, the United States continues to be a net quantity importer with a positive trade balance by value, says Sutton. The 2001-02 gross average value of U.S. exports is $3.10 per pound while the average value of imports is $1.27.

This trend generally is widening although import values vary from time to time because of changes in origin, exchange rates and other factors. "The United States persists in losing flue-cured/burley world market share. Brazil soon will — if it hasn’t already — pass the United States as the Number Two world producer."

Questions are being asked about production changes and price levels without a program, says Sutton. Although U.S. flue-cured and burley tobacco is under a program, more than 82 percent of flue-cured and 66 percent of burley production already has come under contract in the past two years.

"This is a marketing contract, and it is presumed that without a program, as much or more tobacco would continue under some type of contract — possibly moving to a production contract. What does this industry have as a basis to guide them in the future? One standard may be the poultry industry."

The establishment of a poultry contract generally has been based on the contractor instituting a system of contract payments for the growers to receive sufficient returns on their investment to remain in business and make a profit over the long term, says Sutton.

The second principle has been to reward those efficient producers according to the value of their production ability. These "premiums" are paid only to the efficient growers and are based on improvement in net returns back to the contractor.

The major poultry financial measure has been "Return on Investment" or ROI. "From experience, most have started with a level of ROI that is equivalent with other agricultural enterprises, and this often has been about 3 percent. Thus, this may be considered as the ‘contract base’ ROI goal."

Tobacco is a crop, says Sutton, and yield (quality) could become much more important without a program or an annual production quantity. Also, broilers are produced in a more controlled environment than tobacco, and their quality premiums are more precise than tobacco quality measures (at least to date).

"If tobacco quality standards or premiums cannot be as specific, one would expect a payment structure of fewer extremes than in poultry. This would mean we wouldn’t see near the range from the base to the maximum premiums as in poultry."

The second point about quality is that contractors could strive for consistency of quality across years and use this as partial basis for premiums and discounts, says Sutton.

"There may be some payment scheme like the board pricing of livestock, where the payment level (premium) is based in part on historic quality. In addition, if more rigid quality standards become the justification for premiums, one would expect practices such as irrigation to become more common and change production costs."

If future tobacco is contract produced without a program, one would expect the following, he says: (1) changes in the standards for quality, thus payments, and changes in production; (2) possibly a lowering of average prices but not profitability; (3) quality could become more important; and (4) the payment system to depend largely on the accuracy of measuring quality as reflecting these differences in returns to the contractor.

"The major issue is the contractor’s ability to accurately determine base price levels and incentives that will allow producers to be motivated to produce quality tobacco and make a reasonable long-term profit.

The hot topic within the industry is a buyout, says Sutton. The concept was started with the Master Settlement Agreement in 1997. Growers and quota holders receiving money became reality when they were included in the MSA for loss of quota and income.

A 2001 report of the President’s Commission (growers, health organizations, others) recommended voluntary buying out existing quota owners/growers at $8/$4, a tobacco production control program being in the best interest of the public health and tobacco producer communities, and tobacco-growing states and communities receiving funds to enhance economic infrastructures.

"There were several legislative buyout proposals in the 107th Congress. Growers and quota holders have a major financial interest in a tobacco buyout law. Tobacco was told earlier they were not welcomed to attach tobacco to the farm bill, but this really wasn’t an issue since the industry did not — and still does not — have a unified proposition.

"Most proposals would be a one-time quota adjustment. These would allow inactive/voluntary quota holders and producers to receive compensation while allowing active growers to continue. Details about the funding source and compensation levels vary, but most total costs range from $15 to $20 billion."

Flue-cured quota levels for the year 2002 were increased 6 percent, but remained only 60 percent of the 1998 level. Burley basic quota, which had dropped below 250 million pounds in 2000, was at 324 million pounds in 2002.

"However, this was only 46 percent of the 1997 level. Industry comparisons always relate back to the 1997-99 era, primarily because it often is considered to be the apex of modern times. Why has there been such a decline since?

"First, this was the start of the Master Settlement Agreement, and part of the reason for the many rounds of price increases and a decline in usage. Around the early to mid-1990s there also was a world shortage of tobacco.

"China, which accounts for more than 50 percent of the world’s flue-cured production, reacted after 1995 and doubled production in two years. This more than doubled world production in two years and solved the shortage crises. To help confusion, the production data about China was unknown for several years."

As long as there is a program with the present quota formula and there are no major shocks to the system, it’s expected to be a period of burley/flue-cured quotas not changing significantly from year to year, says Sutton. "It could be much like in the late 1980s and early 1990s. Long-term, it’s expected that quotas will continue a general downward trend."

The future remains uncertain for U.S. tobacco production, says Sutton, and a continuation of change likely will be the rule rather than the exception.

"Producer confidence needs to improve. There are several positive signs such as rapid technology adoption and producer interest in efficiency and quality for long-term production. The market also is becoming more focused as it is in its second year with the contract as the major marketing method. This also has had an impact on increasing marketing productivity."

The possibility of legislation could be a positive indication of potential changes for keeping the system competitive and viable, he adds.

"However, many producers are holding on to see what happens. For South Carolina producers, profits continue to shrink. There have been significant increases in rental rates, large investments in technology, changes in production back to quality - not efficiency - and sale prices close to those seen eight years ago. "This is a large part of the reason why so many farmers are not interested in legislative detail but in the money. They are more concerned about short-term survival. If there is no legislation, how long will farmers keep hope?

"Regardless of legislation, the industry will continue to transform. Future success likely will be most available to those who put effort in planning and thoughtful action, being the most efficient, and fully utilizing this short-term assistance toward long-term survival - some feel that it also may be for those with contracts."

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