Close to the base

Independent leaf merchants hold their own in an increasingly concentrated market.

By Stefanie Rossel

In the unmanufactured-tobacco trade, periods of abundance and scarcity can follow each other in short succession. Following two years of global oversupply, the number of tobacco farmers in leading leaf-sourcing countries declined steeply during the 2015–2016 growing season.

In April, Star Tobacco International predicted that global leaf supply would shrink by up to 500 million kg in 2015–2016, a decline of 12 percent compared with the previous season. The shrinkage, the company believed, would help gradually restore balance in supply and demand.

The market has also been affected by other factors, however, including a strong U.S. dollar and El Nino-related weather conditions, causing some higher-quality tobaccos to be in short supply.

“Leaf production has been pretty much in line with expectations in the major origins with one surprise: The Zimbabwe flue-cured Virginia [FCV] crop closed slightly higher than 190,000 tons—some 30,000 tons higher than predicted in April,” says Star Tobacco CEO Iqbal Lambat.

Brazil, meanwhile, anticipated some 550,000 tons of FCV this season, 100,000 tons less than last year, according to Lambat. Due to the El Nino weather pattern, however, the crop came in around 450,000 tons of FCV. Brazil’s burley crop, meanwhile, was slashed in half, to 40,000 tons.

“These shortfalls have created a scramble for flavor FCV mostly on the Zimbabwe crop,” says Lambat. “The U.S. crop is currently in harvest and processing and is also expected to be short by 10 to 15 percent due to adverse weather conditions. Regarding quality, the Zimbabwe FCV is of higher nicotine, whereas the Brazil crop suffered from low nicotine content.”

Lambat notes that flavor styles have been in short supply despite Zimbabwe’s larger 2016 crop. “We expect this situation to become critical in 2017 due to the economic crisis in Zimbabwe and the sharp drop in tobacco seed sales for the current season.”

A resurgence in Brazilian FCV production toward 600,000 tons in 2017 would help stabilize the situation, according to Lambat, but he says it is too early to make predictions about that country’s 2017 crop.

“The global leaf volume has been considerably reduced, but this reduction has had little to no effect on the demand,” observes Rainer Busch, general director of NewCo.

“I think that the tobacco farmers and trade would rather remain with smaller crops and have the supply-demand situation balanced,” he says. “The situation of oversupply bears risks for the future of tobacco growth. Farmers will receive lower tobacco prices and will be unsatisfied. The trade will bear higher costs of holding bigger unsold inventories, and the needed competitiveness will lower their margin.”

In steady demand

Oriental, the highly aromatic, sun-cured leaf that gives American-blended cigarettes their characteristic taste, has also been hit by adverse weather. “The oriental crop in the classical regions of the Balkans and Turkey is expected to be reduced to almost 100,000 tons in 2016, due to dry weather conditions and, in some cases, farmers’ unwillingness to continue with tobacco crops,” says Nikos Tzoumas, managing director of Missirian in Greece.

The expected 2016 crop compares with 125,000 tons in 2014 and 109,000 tons in 2015. Production of oriental tobacco has been declining following the “decoupling” of EU subsidies in 2006. It is also suffering from urbanization, with young people in particular preferring city jobs over farm work.

But while oriental volumes are down, quality is up. “The dry conditions that prevailed throughout the season have given to the tobacco more body, flavor and aroma,” says Tzoumas.

The current volumes, notes Tzoumas, are below cigarette manufacturers’ known usage of oriental leaf, a situation that could put pressure on prices.

Dora Gleoudis, managing director of Nicos Gleoudis Kavex, points out that demand for classical oriental tobacco is still steady, with both dealers and growers holding minimal inventories, which is in direct contrast to FCV and burley tobaccos.

Manufacturers, she adds, have in recent years migrated more toward the use of flavors as a partial alternative to expensive classical oriental. With regulators pushing for the removal of tobacco additives, cigarette manufacturers may have to start using oriental again.

She is also encouraged by the trend toward “natural” cigarettes. Full-flavor FCV and classical oriental tobaccos could help cigarette manufacturers set their brands apart in the marketplace.

Important role

For all their individual differences, the leaf firms quoted in this article share one trait—they are independent entities operating in a market dominated by a handful of multinational companies.

Independence has advantages for both farmers and clients, according to Busch, particularly in crop situations like the current one. “Independent players are generally not contracting with farmers and trade only tobaccos which they know they have a purchaser for,” he says.

“In the case of NewCo, most of our [partner companies] bear a risk by supporting their society and traditional farmers. They buy historical volumes and do not fluctuate much with their quantities. Their historical clientele buffers their risk. Nonindependent leaf merchants have to commit to buy all of the crop from their farmers, which bears economic risk, since one part of the crop is not desirable and needs to be sold under cost to get it off the books.”

Because the decision-making process at independent leaf merchants tends to be short, they are also well-equipped to seize opportunities.

Star Tobacco was founded in 2008, at the height of the last major tobacco shortage. According to Lambat, the firm works only with small and medium-sized companies to ensure that the tobaccos it sells provide value for money. It offers tobaccos from a broad range of origins.

Star serves customers who lack the resources to travel the planet and examine alternative origins and grades. “Of paramount importance is to ensure security of supply, which requires a strong partnership with farmers and leaf processing companies,” he says. Today, Star serves 45 accounts in more than 30 countries.

Being among the smaller fish in the pond, however, also involves challenges, he points out, especially now that, in many societies, all things related to tobacco have been “denormalized.”

“Life as a tobacco company is getting harder,” says Lambat. “Banks are increasingly reluctant to service tobacco companies. In many cases, banks refuse to open letters of credit that cover tobacco shipments. The ‘tobacco’ word will need to be removed from corporate names going forward in an effort to rebrand. These challenges weigh heavier on smaller independent leaf companies than [on] the larger multinational dealers.”

Tzoumas fears that crop levels could be further impacted by shrinking cigarette volumes and increasing illicit trade.

“Cigarette sales going down is a tendency that needs further study, as it is hard to determine the real drop in consumption in an increased illicit-sales environment around the world,” he says. “Should this tendency prove to be real, all markets, including oriental, will have to adopt crop levels to the new demand. Such a change may result in a slimmer list of oriental varieties and districts in the future. As demand and production go hand to hand, such a trend may lead to lean and more sustainable crop designs. A lot of factors will influence the decisions to be taken.”

In the oriental tobacco supply chain, working closely with the famers creates obligations and opportunities for both sides, says Tzoumas. His company cooperates with major cigarette manufacturers to improve the sustainability of leaf production, implementing good agricultural practices and good agricultural labor practices, among other programs.

Challenges are manifold, he adds, ranging from responsible sourcing to socioeconomic balances within farmers’ communities and flexible crop sizes to market and crop competitiveness. “As this is a great target to meet, we focus on planning crops ahead, mechanization in all stages—enhancing harvesting and curing—and commitment from our stakeholders.”

Mechanization and increased efficiency in oriental leaf production have been topics of discussion for many years. Significant progress has been made, according to Tzoumas. The industry has focused particularly on harvesting and curing, as these activities account for a major share of the tobacco production cost. “The oriental harvesting machine has been completed after many years with a lot of resources placed in R&D and testing,” says Tzoumas. “As of next year, a commercial model will be available, which can change the picture of the oriental production in the future.”

Gleoudis is less upbeat about the impact of mechanization: “Even if these mechanized trials prove successful, the resultant cost savings might still be marginal,” she says.

Crop and inventory financing, social-responsibility programs, traceability requirements and ever-stricter controls on crop protection agents place an increasingly prohibitive strain on leaf companies’ already decreasing margins, according to Gleoudis.

“The volumes required to spread these costs are significant, but being independent, we are well-placed to adapt to changing market conditions. For instance, committing to the production of organic tobacco, as we have done in Greece, is testimony that specialization in niche tobaccos and diversification in traditional tobaccos is what keeps independent dealers going.

“Established in 1927, Nicos Gleoudis Kavex will celebrate its 80th anniversary next year and is now managed by the third generation. Together with older and more recent establishments, independent companies play an important role in supplying the global leaf market.”

A straight deal

Like the companies quoted in the main article, Leaf Only is an independent tobacco dealer. Uniquely, however, the company caters to both the retail and wholesale leaf market. Established in 2009 and based in Connecticut, USA, the company sells a large variety of tobacco leaves, including cigar wrappers, binders and fillers, as well as unprocessed cigarette tobacco and pipe and hookah tobacco.

“Since we deal with mainly small to medium-sized clients, one of our personal challenges is managing customer expectations,” says John Wallace, Leaf Only’s principal. “Customers are so used to processed products that they expect the same type of quality from an agricultural commodity. A big part of our job is educating our customers and keeping expectations realistic. But there is a silver lining to every dark cloud, and the fact is that tobacco is still a top commodity with a huge demand. Consumers from around the world still love their tobacco despite increased regulation and health concerns. There is still plenty of money to be made for leaf suppliers that are willing to bob and weave amongst the ever-changing strikes of the industry.”

Wallace expects continued growth. “The reason for this is two-fold: One aspect is the fact that consumers don’t want to be controlled by their governments and forced to pay taxes on products that they can manufacture with their own two hands. It’s not much different from buying grapes to make your own wine or buying hops and barley to craft your own beer. Why pay upwards of eight times the price for something that with a little hard work you can make yourself!”

The other aspect, he adds, is the fact that now, more than ever, consumers are gravitating toward natural, additive-free products. “Buying leaves grown on a farm is about as ‘all natural’ as you can get. For retail customers, there is no wondering what’s in the products they make. … They start with the raw ingredients and decide themselves what to add. We even have organic options available for consumers who want to take it to the next level and even avoid food-grade pesticides. We have seen an increase in organic sales year after year, which confirms this reason for overall growth.”