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Hedging their bets

| May 29, 2014

As the tobacco market becomes more challenging, some leaf traders are diversifying into other lines of business.

By George Gay

In announcing in February Universal Corp.’s financial results for the third quarter to the end of December, George C. Freeman III, the chairman, president and CEO, said in part that a very preliminary look ahead at 2014 crops indicated there would be increased production in some origins. “At the same time, there are possible reductions in cigarette manufacturers’ needs due to lower cigarette sales in Europe and the United States,” he added.

Now, as I sit down to write a story about leaf supply, it’s not possible to draw too many conclusions from these remarks, but I get the idea that, right now, I’d be better off as a buyer of leaf tobacco than as a seller. But nothing is certain because, as Freeman said also, Universal operates in “uncertain global markets.”

The whole business of growing leaf tobacco and getting it to tobacco-product manufacturers is fraught with uncertainties that start with the weather and that might end up with weather’s bigger, meaner brother: climate change. But taking a slightly wider view, there are the issues—some leaf-industry positive, some neutral but mostly negative—of urban migration, tobacco-grower aging, the World Health Organization’s Framework Convention on Tobacco Control, crop financing, environmental responsibilities, health and safety regulations, NTRM, vertical integration, controlled air fumigation, tobacco expansion, anti-tobacco regulation, population growth and female emancipation. And no doubt there is any number of other factors unknown to me.

I would imagine that it would be easy to drive yourself mad trying to factor all of the above variables into estimations of how much leaf of what types and varieties need to be grown where, and I have no intention of messing with my sanity. In any case, it is sometimes much easier and much more informative to sit back and watch what people in the business are doing. For instance, just as I was finishing the first draft of this story, Universal announced that it had entered the fruit and vegetable food ingredients market through its new subsidiary, Carolina Innovative Food Ingredients (CIFI). Initially the business is set to focus upon value-added ingredients derived from sweet potatoes.

“Universal continues to seek out growth opportunities that enhance our company’s value and help to sustain tobacco growers,” Freeman was quoted as saying. “With this new business, we will be able to offer high-quality food ingredients to the food and pet food manufacturing industries while providing tobacco growers with a new market for sweet potatoes. Nearly half of U.S. sweet potato production comes from North Carolina and they are often grown in rotation with tobacco.”

This surely is a great initiative that potentially edges Universal and some of its growers in the direction of a more sustainable future. After all, governments are nagging people to eat more and more helpings of vegetables and fruit each day while making it increasingly difficult to obtain and enjoy tobacco.

Alliance One International (AOI) has also been busy edging in new directions that seem to give pointers to the future. On March 12, an AOI press note described how the company’s Turkish subsidiary, Alliance One Tütün (AOT), and Öz-Ege Tütün Sanayi Ve Ticaret (Öz-Ege) had entered into a joint venture, Oryantal Tütün Paketleme Sanayi (OTP) located in Torbali, Izmir, Turkey. Under the joint venture, AOT and Öz-Ege will contract with OTP for oriental tobacco processing and storage, while continuing to maintain separate farmer contracting, agronomy, buying and selling operations.

In announcing the joint venture, Mahmut Özgener, the chairman of Öz-Ege’s board of directors, said that Turkey was the world leader for high-quality, aromatic oriental tobacco, a key ingredient in many cigarette blends around the globe. “To drive improved value for our customers, we have developed this processing and storage joint venture in our modern, efficient facility,” he said. “We look forward to the mutual benefits with AOT that this joint venture solidifies.”

This venture seems to underline the importance and potential further importance being attached to classical oriental tobacco production. Classical oriental will become an increasingly vital ingredient of American-blend cigarettes should regulators introduce more cigarette ingredient restrictions.

And the venture perhaps hints at the fact that, even given a slight hiccup in 2013, the demand/supply situation for classical oriental is pretty much in balance without much room for production increases. Indeed, classical oriental farming, perhaps even more than the farming of other types of tobacco, well illustrates the drift of people from the countryside to the cities and the reluctance of young people to become involved in farming.

Then, on March 31, in another press note, AOI described how its Brazilian subsidiary, Alliance One Brasil Exportadora de Tabacos, and China Tabaco Internacional do Brasil, the Brazilian subsidiary of China Tobacco, had formed a new joint-venture company, China Brasil Tobacos Exportadora, in Brazil. The importance of this joint venture is not difficult to spot. China has the world’s biggest cigarette market and is one of the few markets to be growing, partly because of the country’s growing population and an increase in smoking prevalence among women.

I understand also that sales of cigars in China are booming, though from a very low base. Currently, I am told, this boom is mainly being met by local leaf tobacco, though with limited amounts of imports being used for higher-quality local products. If the boom continues, there will be increased demand from China also for cigar tobaccos.

Finally, on April 7, AOI said that one of its subsidiaries and an affiliate of IOTO International had completed the formation of a U.S.-based joint venture, IOTO E-Liquids America, located in Greenville, North Carolina, USA. The joint venture is owned equally by the partners and produces a variety of flavored liquids that are sold to the growing customer base that markets and distributes e-vapor products. Again, no prizes for guessing the significance of this announcement. Given that e-cigarettes are improved, and given that regulators don’t destroy them, they, and therefore e-liquids, have the potential to sell in huge numbers. But the shift from tobacco cigarettes to e-cigarettes is going to have an effect on leaf-tobacco demand that will go beyond mere volumes, and it will have to be managed.

Cost control

When I mentioned above some of the factors that affect leaf-tobacco demand and supply, I missed one very important factor: price—or cost, depending on which side of the transaction you sit. This is clearly a significant oversight, because when I asked a medium-sized leaf dealer in March what, in general, were the factors currently affecting the global market for leaf-tobacco demand and supply, he had no hesitation in saying the biggest factor was the price pressure from all manufacturers. “They just keep driving down prices on leaf to keep profits up,” he said. “The margins for growers and dealers are thin to a breaking point. How long this can continue before the supply chain collapses is the big question.”

This raises another question too. Why is it deemed acceptable that a tobacco grower sometimes ends up earning less for his tobacco than he did the year before? How efficient would any of the big cigarette manufacturers be if their employees never knew from year to year whether they were going to earn more or less than they did the previous year, whether their head of marketing could afford the childcare that allowed her to turn up at the office?

And this is no idle question. In the U.K. these days, a lot of big corporations (I have no idea whether tobacco groups are included) “employ” people on zero-hours contracts so that those people don’t know from day to day how much they are going to earn, or if they are going to earn anything.

What happens, though, if one raises the issue of tobacco growers being paid less one year than they were paid the previous year? Well, Zimbabwe’s growers found out this year. During question time at the National Assembly, Deputy Agriculture Minister Paddy Zhanda apparently said that the international market determined the price of tobacco. “Tobacco is unlike maize, where government announces prices,” Zhanda added. “The price of a commodity which is not controlled is set by supply and demand.”

Of course, Zhanda’s statement makes it clear that the “market” does not have to rule. And it invited the question of whether tobacco should be treated like maize: whether price controls should be set. But his answer was less than encouraging as, according to one report, he insisted it would not be “prudent” for government to set a minimum price for tobacco. I wonder what he meant by that.

But surely, price controls of some type would be just as appropriate in the case of keeping tobacco prices up as they are in the case of keeping maize prices down. Maize is a staple food in that part of the world, while tobacco, we are constantly told, is internationally a staple killer.

Something needs to be done. It seems unfair to the point of immorality for poor tobacco growers in Zimbabwe to be paid lower prices for a material that is going to go into a product that will be sold at higher prices and deliver higher profits to tobacco manufacturers, and higher dividends to their shareholders.

Oh, and of course, don’t forget the question of the supply chain.


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