The storm a-brewin’ - First Quarter 2010
Uncertainty from FDA regulation has the tobacco industry uneasy
TFQ Editorial Staff
“The question everybody is asking is, ‘What will FDA regulation look like?’” said Dr. Loren Fisher, a crop science Extension professor from North Carolina State University, as he opened his talk at the U.S. Tobacco Cooperative’s annual meeting in Raleigh, N.C. “And I think that anybody who tries to answer that at this point is just making a guess.”
Whether it be at corporate meetings, academic lectures, Extension field days or growers having breakfast at the local diner, even the most astute tobacco industry experts invariably acquiesce to Fisher’s uncertainty.
In June 2009, the Family Smoking Prevention and Tobacco Control Act was signed into law, giving the power of federal oversight of the tobacco industry to the U.S. Food and Drug Administration, which soon created the Center for Tobacco Products. Dr. Lawrence Deyton was put in charge of this outfit in August, but since then answers to questions about what the FDA would do, how and when it would do it and what all that would mean to the industry have been purely speculative. And that speculation has been building for more than a decade as several attempts at the law festered and languished in Congress.
“In 1995, [FDA Commissioner] David Kessler decided that the FDA was going to regulate tobacco,” says Rep. Robin Tallon, former congressman and current lobbyist. “That led to a court case and the Supreme Court saying the FDA couldn’t rule tobacco without Congress’ approval. And things sort of died down for a little while until [Rep. Henry] Waxman and some others were looking at recent legislation.
“For the 10 years I watched this legislation move through Congress, you didn’t have constituents running up to members of Congress saying, ‘Please pass this FDA regulation over tobacco, we have to have this!’ It was just some of the public heath people who wanted funding for grants and wanted the public money that happens to be out there.”
Now that it’s finally a reality, all agree that FDA regulation will affect the tobacco industry, but it’s impossible to figure out the how until the FDA comes forward with the what. More than ever, industry experts have been making themselves available to discuss possible scenarios and help predict what the future may hold for tobacco growers, many of whom are fearing the worst.
“Right now the FDA has a huge bureaucracy set up, and they don’t know what they’re doing,” says Tallon. “They have to hire a lot of people and they keep pushing back deadlines.
“My concern is with the personnel that will be assigned to tobacco. If you work for the FDA, do you want to be dealing with drugs and foods or do you want to be dealing with tobacco? So the FDA will have the good people working on its core mission of food and drugs, and the incompetence will be moved over to tobacco regulation. Then you’re going to have all these do-gooders on the job who don’t want to regulate tobacco but instead want to put all of us out of business. So dealing with the FDA is going to be a turkey farm.”
Albeit a well-funded turkey farm. The Center for Tobacco Products opened in August using $5 million from the fiscal year 2009 budget to “establish the necessary administrative functions for the center.” Future funding, though, will come from user fees.
“The FDA’s Center for Tobacco Products is basically creating a whole new bureaucracy in Washington,” says Dr. Blake Brown, an economist from NCSU who is knowledgeable about flue-cured tobacco. “It will probably require several hundred employees to carry this out. In one study I read—and I don’t know if it’s true or not—but it said this could occupy as much as 20 percent of the FDA budget. And that won’t be taxpayer money, that’ll be user fees from industry companies, which ultimately means it will come from the smokers. Twenty percent is big, and if that’s the case, that’s a large effort. You’re almost talking about a separate brand for the FDA.
“What will be the impact of this FDA legislation? It depends tremendously on how these rules are implemented, and of course we don’t know any of that, so unfortunately we’re just going to have to wait and see. But it will undoubtedly accelerate the decline in cigarette consumption. There are a few ways you can get people to quit smoking. You can increase the price, which we’ve seen a lot of recently through taxes, and the other way is by making it more difficult to get and to actually use the product.”
With the Obama administration in place and major gains by the Democrats throughout Congress in 2009, tobacco products came under a flurry of attacks from all directions. Federal taxes increased 159 percent on cigarettes to bring the federal take to $1.01 per pack in order to help finance the $33 billion increase to the State Children’s Health Insurance Program (SCHIP) program. The huge tax increase, however, did nothing to affect the number of Americans who smoke, according to the Centers for Disease Control and Prevention, which says the percentage of smokers remained steady from 2008 at 20.6 percent (46 million people). Those smokers are consuming less, though, with consumption dropping 6 percent last year, according to Rob Sincavich, president of Sledd Co., a wholesale distribution company that supplies convenience stores in West Virginia and the five states that border it.
“We went through the largest federal tax increase in history with the SCHIP,” Sincavich says. “Big-brand tobacco thought this would benefit them but it actually blew up on them a little bit. They were thinking that the relative price gap—the gap between discount and premium brands—would diminish and send smokers back up to the premium sector, but it didn’t happen. As a result, not only do we have cigarette consumption down in terms of units, but we’re also seeing premium brand shares starting to falter now.”
The drop in consumption combined with pending FDA involvement sounds like the building of the perfect storm on the surface, but the impact on tobacco growers might not be as severe as one would think, especially for the short term.
“I believe, although I cannot prove it, that tobacco buyers already factored into their predictions the effect that FDA regulation would have on consumption,” says Rick Smith, president of Independent Leaf Tobacco Co. “If there had been no other outside influences, that assumption may have been measurable with the last crop, but the SCHIP and excise tax both far outweighed the FDA legislation.
“There is no doubt in my mind that FDA regulation is going to have an impact on leaf growers, but I would be very hard pressed to point to any such impact that we’ve had so far. With the speed things move in Washington, we’re probably looking at five years before everything is in place and we know exactly where this thing is going to go and who it’s going to affect.”Clouds rolling in
Even though no one is exactly sure what FDA oversight will eventually look like, industry experts are encouraging growers to become proactive in terms of likely regulations and to be as flexible as possible when it comes to change. One such example involves improved record keeping. While the FDA’s authority over “leaf in possession of tobacco product manufacturers” technically excludes tobacco farms, the scope of its tyranny will certainly be felt in each field.
“As we move down this road with the FDA, I want to encourage each member of this co-op to make a commitment that you’ll keep better records on your farm,” said Albert Johnson, chairman of the U.S. Tobacco Cooperative’s board of directors, addressing the membership at the organization’s annual meeting. “The FDA isn’t going to be on the farm, but the purchaser will be. We don’t know what these regulations are going to be but I can assure you that you are going to have to keep better records. When did you calibrate that sprayer? When did you spray that field? How many times have you done whatever it is that you’ve done?”
Smith quoted Johnson at a later field day and added to his message, saying, “Tobacco farmers are going to have to do what all the leaf dealers, all the manufacturers, all the organic growers and most large conventional growers are already doing. You’re going to have to have someone on your farm designated as the compliance officer. It could be a family member or somebody you hire, but somebody’s going to have to keep some very good records on your farm from here on out.”
Other areas where FDA regulation will cause change remains to be seen. Because of this uncertainty, shrinking profits and other factors, many growers, most of the experts conceded, will choose to leave the industry.
“It’s going to be difficult,” says Tallon. “I want to caution growers over the next several years, [the FDA is] going to try to force you to do some things differently than you’ve done before. And some of those things are going to be a lot more expensive.
“We have no friends over there [in the FDA], and frankly this regulation may force a lot of folks out of the business. It’s going to be tough, but we’re going to stick with it and we’re going to continue to grow tobacco.”
Ideas for “likely regulation” come from FDA and U.S. Department of Agriculture (USDA) regulations in other areas. In addition to his work with tobacco, Brown also has extensive experience working with fresh produce for the N.C. MarketReady program. “When I look at the legislation going through Congress concerning the FDA’s regulatory authority over fresh produce and tobacco, what really strikes me is how a lot of the language is very much the same,” he says. “With fresh produce, the FDA has to set new product standards such as specifications for delivery and transport, adulteration of the product … It’s very similar to what we’re seeing with tobacco. So I’d say tobacco facilities are going to have to register similarly to some of the legislation that’s moving through Congress on fresh produce, such as manufacturers having to register annually with the FDA and be inspected every two years. The farm manufacturers must register and provide proof that products are in compliance.
“The good part of this, is I hope it will level the playing ground with foreign manufacturers in terms of what U.S. companies import. The foreign manufacturers’ burden of proof has always seemed pretty loose to me considering what domestic farmers, facilities and manufacturers have to go through in order to be in compliance. There’s a strengthening of that on the fresh produce side with the FDA, and I hope that will be the case with tobacco as well. That will help lessen competition for American farmers, at least domestically.”
Domestic gains notwithstanding, American growers will be vulnerable from FDA regulation when it comes to the export market as well. According to the USDA, American growers produced 814 million pounds of tobacco in 2009, with well more than 450 million pounds of it expected to be shipped overseas. Brown proposed two scenarios: the first where the FDA sets up stricter standards for the tobacco that will remain stateside but leaves the exported crop alone, and a second scenario where the same standards are adopted for all the tobacco grown regardless of where it is used.
“The FDA will not have to force us to do anything on the export side,” says Smith, building from Brown’s scenarios. “Foreign customers will do it for them. I’ve sold tobacco in 50-something countries, and no foreign importer that I’ve ever dealt with would dare bring anything into his country that could be considered less safe than something that U.S. customers are consuming. No sane person would consider doing that. Whatever the FDA does for the domestic side, the exports are going to be the same. I don’t care what country you’re dealing with.”
“Rick might be exactly right,” Brown says, “but I think it might still be possible that the FDA allows for a separate premium global market. It will be interesting to see how this plays out, and how it happens will have a big effect on export demands. Unfortunately, if it turns out that the export tobacco also has to meet those FDA specs, then you could have some foreign customers that don’t want to buy it and will just go to Brazil or some place like that. That’s a little bit of a scary scenario for me, but we’ll have to wait and see if it materializes.”
Whether the FDA allows for separate export standards will be of particular importance to growers of burley and fire-cured tobaccos. Dr. Will Snell, an economist from the University of Kentucky who is knowledgeable about burley tobacco, says that two-thirds of the burley market used to remain domestic, but today that has shifted to seeing 75 to 80 percent of it exported.
“We won’t be as much impacted as flue-cured with FDA regulation on the domestic market, but one has to wonder how other markets will respond to whatever our new regulations become,” Snell says. “With ample U.S. and world burley supplies, excessive inventories of lower-quality U.S. burley held by manufacturers from previous crops and declining overall demand, quality will be an even greater factor in determining the fate of the 2010 U.S. burley market.”
A silver lining
While virtually everyone involved in the tobacco is uneasy waiting to see exactly what the FDA is going to do and how it will do so, the bottom line is that the tobacco industry is not going anywhere. Marion Hawkins Jr., president of GoldLeaf Seed Co., points out how essential tobacco has been to the American economy throughout its history. He also references a study from the ’90s that says between input costs to grow the crop, its sale and the production and the sale of its final manifestation (i.e. a pack of cigarettes, for example), including the income taxes of all the employees along the way, each acre of tobacco generates more than $46,000 for the government in state and federal taxes. Even using that old number, given the 353,290 acres of tobacco that were harvested in 2009 according to the USDA, tobacco generated $16.3 billion in taxes alone (a figure that is almost assuredly closer to $30 billion today). Politicians may feel the need to slander tobacco publicly, but in the end they know they need to protect that significant revenue stream.
“We’re going to be in the tobacco business a long, long time in this country,” says Smith. “Billy Yeargin, the author of North Carolina Tobacco: A History, pointed out a possible benefit of FDA regulation. He says, ‘Congress has essentially put on itself the onus of answering any criticism about tobacco in this country. It has now taken that weight off the tobacco community, and it will probably be a lot more effective at deflecting unfounded accusations about tobacco than the industry has been.’
“That’s good, because we haven’t been real good at it. But with the money we generate, Congress is going to be real, real good at it defending us and keeping us going.”
As has been the trend since the 2004 buyout, farmers who “dabble” in tobacco will likely continue to quit the industry in light of FDA regulation, but those that remain figure to become even more profitable.
“If you look at the use of domestic tobacco versus imported tobacco here in the United States, I think it’s possible that U.S. growers will have an advantage in having their tobacco comply with the FDA restrictions,” says Brown. “So it could put downward pressure on imports and help offset some of the downward pressure on the total demand for our tobacco.
“There will continue to be fewer farmers, but those farmers who are growing tobacco in the new system may do quite well. It will require more specialized management and they may be growing tobacco to meet very specialized requirements for the manufacturer, but if that’s that case they might do very well. The key, of course, is surviving to become one of them, but I think that’s quite possible.”