1. Future Demand for U.S. Flue-Cured Tobacco: Heat-Not-Burn vs Nicotine Solution May 13, 2015 Dr. Blake Brown Hugh C. Kiger Professor Agriculture & Resource Economics College of Agriculture & Life Sciences

3. Global Supply of Flavor Style Flue-Cured: U.S., Brazil and Zimbabwe Source Brazil & U.S.: Universal Corporation. “World Leaf Production as of Feb 3, 2015.” Source Zimbabwe: Zimbabwe Tobacco Association “Weekly FCV Report 14.07.2014”

4. Domestic Use and Exports of U.S. Flue-Cured Tobacco

5. U.S. Unmanufactured Exports of Flue-Cured Tobacco (Tonnes farm weight) Source: USDA-FAS

6. EU & US Cigarette Consumption billions of cigarettes Sources: Tax Burden on Tobacco, Historical Compilation. V48, 2013 Orzechowski and Walker. Releases for consumption of cigarettes 2002-2013. Taxation & Customs. European Commission

7. Market Challenges to US Flue-Cured Large flue-cured inventories in the global tobacco supply chain Unfavorable exchange rates Continued erosion of cigarette consumption in developed countries due to health concerns Hostile regulatory and tax environment for cigarettes in EU & US Changes in nicotine delivery technology; e.g. E-cigarettes & heat-not-burn

8. Market Opportunities for US Flue-Cured Farmers Increased demand for high quality flavor style flue-cured –bans on flavorings in cigarettes –growing market in China for “higher end” cigarettes Ability of US farmer for strict adherence to both production and social protocols

9. Tobacco products will undergo a technological revolution over the next 5-10 years Will non-combustibles dominate traditional combustibles in the U.S. and EU? How new products are regulated and taxed will greatly impact their growth

10. e-liquid products: “e-cigarettes” Sales estimated at $2.5 billion in U.S. in 2014 Estimates of slightly smaller sales in Europe but sales are slowing Vaping category showing dominance –cig-a-likes category slowing in growth –Closed and open systems showing growth All major tobacco manufacturers have invested in e-cigarette products

11. “heat-not-burn” products CONTAIN TOBACCO LEAF PMI introduced iQOS “Marlboro HeatSticks” in Japan and Italy –$680 million invested in reduced-risk factory in Italy Reynolds American introduced new heat-not-burn product, Revo, in Wisconsin in February 2015

12. “heat-not-burn” products PAX JTI buys Multitude of “Vape Pens” on market –Most can use pipe tobacco

13. Both categories face similar challenges Regulation looms –FDA has issued deeming regulations –Some municipalities have issued bans –Will regulation be less stringent than for combustibles? Mixed taxation at state and local level Health community is divided Do they yield a similar experience to combustibles? How many smokers will switch?

14. “IBISWorld expects the growing popularity of e- cigs to drive the growth of international trade at an average annual rate of 2.5%, to an estimated $30.5 billion in 2019.” IBISWorld Industry Report. Global Cigarette & Tobacco Manufacturing. P.7. June, 2014.

15. Impacts of Technological Change Consider 4 scenarios: 1.Base Case: No growth in E-Liquid or Heat-not-Burn products 2.E-Liquid products grow to $30 billion by 2019 in US &EU 3.Heat-not-burn & E-Liquid products, equally split, grow to $30 billion by 2019 in US & EU 4.Heat-not-burn products grow to $30 billion by 2019 in US & EU

16. Impacts of Technological Change E-Liquid products –Tobacco production for nicotine production –Currently 8,165 Tonnes (18 million pounds) of tobacco for $5 billion in e-cig sales Heat-not-burn products –Quality of tobacco is more important than ever –Change in quantity demanded…less tobacco per “smoke” than combustibles

17. EU & US Non-Combustibles grow to $30 billion by 2019 US Flue-Cured Production for EU & US Markets: US provides 20% of US&EU E-Liquid Market Heat-Not-Burn contains 40% tobacco content of Combustible Cig

18. EU & US Non-Combustibles grow to $30 billion by 2019 US Flue-Cured Production for EU & US Markets: US provides 30% of US&EU E-Liquid Market Heat-Not-Burn contains 60% tobacco content of Combustible Cig

19. What can we conclude? Many unknowns –Will either product be preferred over combustibles? –Will E-Liquid or Heat-not-burn dominate? –How much US vs foreign tobacco will be used? –How will non-combustibles be regulated and taxed? –How rapidly with non-combustible use grow?

20. What can we conclude? Many unknowns Using a projection of $30.5 billion in sales in US and EU in 2019 decreases use of US flue-cured in the US & EU by 5-10 thousand Tonnes

21. What can we conclude? Many unknowns Projected $30.5 billion in sales in US and EU in 2019 may decrease use of US flue-cured in the US & EU by 5-10 thousand MT BUT success by heat-not-burn could spur rapid change from combustibles to non-combustibles. Success could be characterized as: –Demonstrated lower risk than combustibles –Less strict regulation than combustibles –Lower taxation than combustibles –Consumer adoption over combustibles and preference over e-liquid products

22. What can we conclude? Many unknowns Projected $30.5 billion in sales in US and EU in 2019 may decrease use of US flue-cured in the US & EU by 5-10 thousand MT BUT success by heat-not-burn could spur rapid change from combustibles to non-combustibles Domination by E-liquid products could cause US tobacco production to be larger than if heat-not-burn dominates…but production would be very different

23. What can we conclude? Many unknowns Projected $30.5 billion in sales in US and EU in 2019 may decrease use of US flue-cured in the US & EU by 5-10 thousand MT BUT success by heat-not-burn could spur rapid change from combustibles to non-combustibles Domination by E-liquid products could cause US tobacco production to be larger than if heat-not-burn dominates If heat-not-burn dominates over E-Liquid products: –Quantity demanded of tobacco could be smaller –But needed acreage may be larger –Producers will earn higher premium for high quality tobacco for heat-not-burn