Sanctions, fraud and the rising popularity of vaping weigh down Russia’s traditional tobacco market.
The Russian tobacco industry is facing multiple challenges, spanning from uncertainty around the future of foreign factories in the country to flourishing illegal trade.
In 2022, Russia manufactured 222 billion cigarettes, 7 percent down compared with the previous year, the Russian state statistical service Rosstat estimated. This dynamic partly reflects the harsh problems Russian factories encountered last year as Western sanctions disrupted logistics. On the other hand, the figures also show that the industry managed to bounce back in the second half of the year.
In January 2022 to June 2022, Russia saw a nearly 15 percent slump in cigarette production while the steepest decline of around 25 percent was observed in May.
There is no consensus about what the key factor was in driving Russian cigarette production down last year. Sergey Ryabukhin, first deputy chairman of the financial committee of the Federal Council, blamed a surge in sales of counterfeit tobacco products. He expressed confidence that a batch of new laws tightening regulation on the market could solve this issue.
Indeed, independent studies showed that the share of counterfeit cigarettes on the Russian market had been steadily growing over the past few years, exceeding 12 percent in 2022. An opinion poll conducted by the think tank Ipsos revealed that as many as 49 percent of smokers would be prepared to purchase a pack of counterfeit cigarettes.
A Booming Niche
Not everyone, however, agrees that counterfeit is to blame for a decline in cigarette production last year. Pavel Shapkin, chairman of the National Union for consumer rights protection, links the trend with a meteoric rise in the popularity of e-cigarettes. Over the past three years, sales in this segment skyrocketed by a factor of 50, reaching 67 million pieces. Shapkin explained that Russians massively switched from conventional tobacco products to e-cigarettes.
In 2022, Russia saw a 32 percent jump, to 16,900, in the number of stores selling vapes and e-cigarettes compared with the previous year, the Russian mapping service 2GIS calculated. E-cigarette retail has even exceeded conventional tobacco retail: In this segment, the number of outlets was estimated at 14,600, also higher than in the previous year.
These figures, however, are about to lose their meaning soon. Conventional tobacco retailers are massively expanding their range with e-cigarettes to catch up with the trend, Anton Belyikh, general director of the DNA Realty consulting firm, explained. Selling e-cigarettes in Russia has become so profitable that players forget about the rules of fair competition and pay no attention to renting costs when launching new outlets, Belyikh said.
It is not clear whether the rise in e-cigarette consumption hampers sales in the Russian tobacco market. The Russian Institute of public opinion surveys calculated that the number of smokers has not changed noticeably during the last five years. On average, every third respondent surveyed in the big cities identifies themself as a smoker.
In January 2023, the Russian State Duma, the lower chamber of the federal parliament, discussed the idea of banning e-cigarettes in the country. Sergey Leonov, a member of the State Duma, shared the results of a study indicating that 99 percent of e-cigarettes and 68 percent of liquids for their refilling were not matching any quality standards. He also cited several examples of e-cigarettes exploding in the hands of consumers, causing severe injuries.
The Russian Healthcare Ministry backed the proposal to prohibit selling e-cigarettes in the country, referring to harmful and potentially harmful ingredients that these products contain. The discussions, however, have not led to any concrete steps, and e-cigarettes are still available at virtually every shopping center in Russia.
In February 2023, BAT, which sells the Lucky Strike, Kent and Java brands in Russia, announced a decision to exit the Russian market by the end of the year. BAT’s then CEO, Jack Bowles, told the Financial Times that the timeline was not guaranteed and that finalizing the terms could be delayed until 2024.
BAT sought to transfer control over its Russian tobacco factories to a consortium of local distributors, though certain details of the deal remain unknown. So far, only Imperial Brands has pulled out from Russia completely. In July 2022, BAT calculated that withdrawal from Russia would cost it £957 million ($1.2 billion).
Other leading Western firms are not rushing to sever their ties with Russia. Philip Morris International (PMI) rolled out plans to quit the country in early 2022 but hasn’t done so yet. Japan Tobacco International, which accounts for 40 percent of sales in the Russian cigarette market, suspended investments but remains present in the country.
After temporary supply disruptions in the second quarter of 2022, imports also bounced back. In the first quarter of 2023, Russia nearly doubled cigarette import to 70 million packs. Surprisingly, Germany appeared to be among the leading sources, boosting export to Russia to 42 million packs against 19 million packs in the first quarter of 2022. Bulgarian cigarette export to Russia jumped tenfold while Korea triples its sales to Russia, a Russian government agency estimated.
The growth in imports is driven primarily by wealthy Russians, who are prepared to abandon popular brands produced in Russia in order to buy products that they consider to be of higher quality, explained Maxim Korolev, editor-in-chief of the Russian Tabaco publication. For example, the products of one of the oldest and largest tobacco factories in Germany, Von Eiken, are popular among Russians, Korolev said. South Korea, in turn, exports Esse cigarettes to the country.
While importers ramp up export, foreign owners of Russian factories might have lost their chance to exit the country.
The Russian government has recently seized control over the property of beer manufacturer Carlsberg and dairy firm Danone, both of which had been working to quit the country in the previous months.
Citing local lawyers and analysts, Russian Forbes interpreted this as a beginning of a new chapter in the sanction standoff.
Vladimir Poklad, spokesperson of the local consulting firm Delovoy Profile, told the publication that the government consolidates control over the assets of the companies willing to exit Russia to ensure the return of the Russian financial assets seized overseas.
In 2022, the Russian government demanded foreign firms leaving the country to seek permission from a government commission on foreign investments and sell their assets at a 50 percent discount to market price. This year, this might not be enough.
Investments Amid the Hostilities
In neighboring Ukraine, sales on the domestic cigarette market plummeted by nearly 20 percent in 2022, primarily owing to unprecedented immigration as roughly 7 million fled the country. Besides, a large part of the territory is currently controlled by Russian forces, and whatever cigarette consumption exists out there, it is no longer included in the official statistical data.
PMI used to be the largest player in the Ukrainian cigarette market. In 2020, it accounted for 29.96 percent of sales followed by BAT with 19.46 percent, JTI with 17.45 percent and Imperial Tobacco with 8.78 percent. Last year, however, the balance of power on the market supposedly changed after PMI suspended the operation of a factory in the Kharkiv region following a missile strike.
“The damage is not critical. Production can be resumed. However, no such decision was made because the threat of further shelling remains substantial,” said Maxim Barabash, head of PMI Ukraine.
“The production cannot be repeatedly launched and stopped depending on the situation in the region. It is technically easy to resume production. But this means putting the lives of 300 [workers to] 400 workers at great risk. And we cannot do this,” Barabash added.
The Kharkiv factory boasted a designed production capacity of around 40 billion cigarettes. To compensate for that loss, PMI embarked on a bold project of investing $30 million into a new factory in Western Ukraine, far away from the battlefield. In August 2022, PMI started manufacturing cigarettes at an Imperial Tobacco factory in the Kyiv region.
The new factory should manufacture 7 billion units of cigarettes per year, though there is no clarity as to when and where it is going to be launched.
Aside from the hostilities, Ukraine keeps suffering from illegal sales. Barabash said that Ukraine annually raises the excise rate on tobacco products by 20 percent, but the losses that the national budget suffers from the illicit trade only grow. In 2022, the country lost EUR600 million ($658.8 million) in taxes to the black cigarette market. This year, the figure is expected to climb to EUR720 million.
The only thing Ukraine needs to take down the counterfeit cigarette manufacturers is political will. Barabash said that in the EU countries, the problem primarily arises from smuggling, while in Ukraine, borders are closed now, and the illegal production comes from local underground factories and workshops “that everybody knows about.”
It is unclear why the authorities are not cracking down on these operations, especially since this would help fill the strained national budget with money.