TOBACCO ECONOMY SHAKEN
Producers upset after Philip Morris cancels contracts
By Kara Keeton
The Farmer’s Pride, April 1, 2009
After signing contracts in December, creating business plans, and pre-purchasing everything from plants to inputs for their 2009 production year, some Kentucky tobacco farmers were surprised in mid-March when they learned that their contracts with Philip Morris USA had been reduced or eliminated.
“I got a phone call last week telling me I was suffering a 30 percent reduction in my contract with Philip Morris USA,” said Hoppy Henton, a Woodford County producer. “Later that evening at a Woodford County Farm Bureau meeting I learned that some producers had been cut 100 percent, that is just devastating for a farmer.”
Since the buyout, most tobacco farmers have turned to contracting with Philip Morris USA, Philip Morris International, Reynolds, Universal, or Alliance to secure a market for their tobacco crops. In those early post-buyout years, these partnerships flourished as U.S. burley demand exceeded supply.
In the last several months, the tobacco economy has changed dramatically. The global economic downturn, increasing foreign supplies of lower quality tobacco, tax increases, smoking restrictions, health issues, shifts to smokeless tobacco products, increasing availability of imports, movement of cigarette production overseas, and possibly anticipated FDA regulation are reducing domestic needs for U.S. burley.
“My analysis indicates that we have quickly moved from a period of excess demand for U.S. burley to a more balanced supply/demand scenario or possibly an oversupply situation, given these deteriorating demand conditions for burley,” said Will Snell, UK ag economist.
This change in the U.S. and world tobacco economy has led to companies, like Philip Morris USA, to reassess their buying contracts.
“The company continually reviews what is going on in the market and looking at what we will need in 2009,” said David Sutton, spokesman for Philip Morris USA, in explaining the recent announcement of contract cuts. “When you get into a challenging environment as we are in, we have to continually look at those forecasts and make adjustments on what we will have to buy from growers.”
For several years, Philip Morris USA has been grading their contracts with producers, basing the grade on quality of the leaf and delivery of contracted pounds. According to producers, Philip Morris USA has taken this grade card average to place producers in one of their four tiers for contract cuts for the 2009 production year: no cut, 10 percent cut, 30 percent cut and 100 percent cut.
“We knew this was coming; we didn’t know when,” said Ray Tucker, a Shelby County producer. “With the new taxes and predicted changes in U.S. consumption of tobacco, I suspect Philip Morris USA saw a need this year to make a change in their purchasing.”
While cutting contracts may be a good business decision for Philip Morris USA’s bottom line, producers who have contracted only with Philip Morris since the beginning are questioning why Philip Morris has waited so late in the season to inform their “growing partners” they are no longer needed.
Sutton said Philip Morris USA is trying to be as open and as honest as they can to address concerns during this challenging economy, and the company regrets any impact the decisions (on contracts) may have on their growers.
“It is difficult for the company, and it is difficult for the growers,” said Sutton. “We have to manage our business as well, as have the right supply of the types of leaf we need.”
Meanwhile, growers are left with few options.
“I only have one contract, Philip Morris. I’ve called the receiving station and I’ve been told there is no redress, there is no appeal, not a second thought, there is no way to respond to the decision; it is final,” said Henton. “So now you have farmers like me facing 30 percent cuts and those facing 100 percent cuts that are having to make tough decisions.”
Decisions on workers who have been hired and will not be needed because of reduced production. Decisions on what to do about pre-ordered inputs that are no longer needed. Decisions regarding loans based on contracts that have changed.
“As a lender we have to look at each situation on an individual basis,” said Harry Young, Central KY Ag Credit. “If a person is facing a change in their contract, they need to go talk to their lender to address the issue.”
NON-CONTRACT MARKET A HIGH RISK
For those producers suffering cuts, there is also the tough decision about whether to produce the tobacco they had planned to this season and take the chance that there will be a market.
“Some farmers without a marketing plan have been able to find a home, such as the auctions or cooperatives, for their tobacco during the recent excess demand situation,” said Snell. “I am not confident that these other marketing outlets can absorb a significant boost in production in 2009 without some major price adjustments, especially on lower quality tobacco.”
In the past two years the Burley Tobacco Growers Cooperative has provided a market for some producers, buying 8 million pounds of burley this past marketing season. Even with the interest the Burley Cooperative is seeing on the international market for US burley, they are not at a point to where they can offer contracts to growers.
“We are working hard to identify and open up new markets for U.S. burley,” said Brian Furnish, manager of the Burley Cooperative. “We hope to grow these markets in 2009 to help more growers, but we will not be offering contracts to anyone this year.”
Jerry Rankin, Farmer’s Tobacco Warehouse in Danville, says his goal is to sell as much, if not more, to provide service to tobacco farmers. He admits though that what he is seeing today makes him believe that producers and markets will be facing a serious situation as the 2009 crop year unfolds.
“We are getting an average of 10 phone calls an hour from producers without contracts, and people are calling me at home on the weekend,” said Rankin. “The three auction markets in the area sold a little over 10 million pounds last year and found a home for all that tobacco. Even with the auction markets and the Co-op buying in 2009, it will take a miracle for us to absorb all the tobacco that people are talking about producing without contracts.”
Rankin says he isn’t just getting calls from those who have had their contracts cut, he is also getting calls from producers facing challenges in these rough economic times and considering turning to tobacco once again.
Since tobacco companies are not extending any new contracts for the 2009 season, these individuals would have to depend on the few remaining open markets, like Rankin’s, to sell their leaf.
“I’m telling producers, especially the new ones that are considering raising tobacco for the first time this year, that this is not the year to start producing,” said Rankin. “For those that are going to take the risk, I can’t stress enough that the need to grow quality tobacco has never been greater than what it will be in 2009.”
“Unlike other crops that might have access to safety net measures of the farm bill or futures markets, tobacco farmers have no way to manage price risk other than through contractual agreements, primarily with multinational tobacco companies,” said Snell. “At this time there is limited communication within the industry, no market news to report prices received, no federal grading, and minimal public data and analysis for growers.”
-30-