Russian-Ukrainian Conflict Disrupts Tobacco Industry

Russia's invasion of Ukraine has caused severe damage to the tobacco industry in the post-Soviet region, leading to the closure of Ukraine's factory by the world's largest tobacco company. It has also led to a reduction in investments and marketing activities in Russia. The ongoing crisis may further fuel the rise of the illegal tobacco market in this region of the world.

Since the conflict began, British American Tobacco, Japan Tobacco, and Philip Morris International have faced increasing public pressure to sever ties with Russia.

On March 23, Ukrainian Finance Minister Serhiy Marchenko called on Western tobacco companies to cease their operations in Russia. In a statement posted on his Facebook page, Marchenko wrote that all cigarette manufacturers have promised to suspend new investments, and British American Tobacco is considering transferring its operations to a third party. However, he added that these measures are clearly insufficient.

Marchenko wrote, "My belief is that there is no substitute for compromise.

A study conducted by the Yale School of Management has shown that since February 24th, over 1,000 multinational corporations have announced plans to reduce, pause, or sever ties with Russia. This surpasses the number of multinational companies that abandoned South Africa during apartheid. The Russian government is attempting to counter the massive exodus of Western brands by threatening foreign companies to leave the country and forcibly nationalizing their production assets.

On May 16th, Russia faced a threat and announced the nationalization of a major factory belonging to French car manufacturer, Renault. This sent a clear message to all Western companies that limiting operations under current conditions will come at a heavy cost, as it would mean losing their production capability.

Russian authorities are making efforts to avoid a shortage of cigarettes in the domestic market, as this could lead to social unrest.

Ekaterina Pozdeeva, an analyst for the Moscow-based think tank Finam, stated that during 1990, a shortage of cigarettes led to widespread strikes and even the closure of factories. Over 100 cases of tobacco-related riots were recorded in Moscow, with workers demanding at least two packs of cigarettes per person. The Soviet Union was forced to purchase $300 million worth of cigarettes from the United States.

On the other hand, Pozdnyakov stated that western tobacco companies have invested approximately $5 billion in the Russian tobacco industry over the past 25 years. Losing this money would be quite painful, therefore most companies opt to transfer their operations to local market participants.

For example, Best Obtainable Company has transferred its business management to its Russian distributor and partner, SNS Group, which plans to maintain the same production and supply levels. Fimo International also stated that it has considered options for restructuring and transferring assets, but no specific decisions have been made yet.

Tobacco company Imperial Brands announced in a statement on April 21 that it has sold its operations in Russia, including the Volgograd factory, to local investors and plans to write off its tobacco assets worth €225 million ($294 million) in the country. Japan Tobacco International has also suggested changing the Russian owners of its local business.

The annual sales of Russian cigarettes range between 200 million to 230 million, making it one of the largest tobacco markets in the world. The Russian Federal State Statistics Service, Rosstat, estimates that in 2020, the value of the Russian cigarette market was approximately 1.4 trillion rubles or 23 billion US dollars. This increased federal revenue by 600 billion rubles in taxes.

However, Maxim Korolev, head of the Russian tobacco information agency, has stated that the Russian cigarette industry could experience serious pain, as all tobacco and almost all raw materials are imported into the country. He added that it is currently unclear whether there are viable import alternatives for the industry.

Korolev said, "On one hand, paper-based aluminum foil provided by a Russian company has undergone quality improvement over the years and is now widely used by many Russian tobacco factories. On the other hand, in terms of certain key parameters, domestically produced polypropylene film has not yet achieved the required quality level and no tobacco company is using it.

He said, "The factory also uses household corrugated paperboard as the main box, but we do not make coated paperboard for cigarette boxes." He added that it is not expected for the industry to quickly adopt imports.

In addition, Russia is facing problems with tobacco imports. In the past few months, Russian businesses have complained about a lack of tobacco raw materials for producing domestic cigarettes.

Igor Moiseev, Chairman of Pogar Cigar and Cigar Factory, has commented that supply disruptions are primarily due to logistical issues. While speaking on the matter, Moiseev explained that prior to the Russian-Ukrainian crisis, Germany, Denmark, and the Netherlands were the main suppliers of tobacco for their homemade products. Most of the tobacco was transported via Belarusian roads.

Moiseev stated, "Today, even with a down payment, no one can guarantee that goods will be transported from Europe to Russia." "Difficulties with wire transfers will also affect imports. The majority of suppliers operating in the tobacco market are small and medium-sized companies with limited resources.

According to Korolev, the Imperial Tobacco Company has been forced to cease operations at its factories in Russia due to a lack of tobacco. It is estimated that other market participants may have large enough tobacco stockpiles to sustain operations for up to six months. However, Korolev also noted that most of the tobacco used for cigarette production is imported to Russia from South American and African countries that have not publicly supported the West's sanctions against Russia, suggesting that the supply disruption may ultimately be resolved.

Oleg Barvin, the spokesperson for British American Tobacco, confirmed to the Russian newspaper Kommersant that all market participants encountered logistical problems when shipping tobacco and other cigarette production materials to Russia. Despite these challenges, Barvin added that the company ensured uninterrupted production and distribution of their products.

The sanctions are not expected to have an impact on the Russian e-cigarette market. According to Kirill Plokhikh, Director of the Synergy University School of Business, Russia imports most of its e-cigarettes from China. Plokhikh added that some e-liquids containing nicotine are supplied to Russia from western countries, but in this case, buyers can quickly turn to Chinese suppliers.

Ukrainian tobacco industry rebounds.

Russian invasion forced all Ukrainian cigarette manufacturers to cease operations, but some have since restarted production, with hopes of restoring production levels to pre-war standards.

Galina Vorobieva, the Director of Tobacco Production for the Ukrainian Empire, has stated that despite concerns expressed by officials from the West regarding the imminent Russian invasion since October 2021, Ukraine has not taken the matter seriously.

Vorobieva stated that despite speculating on the possibility, it wasn't until the very end that they believed the Russian invasion would actually occur. She went on to explain that they had a plan in place for how to take action when the safety of their employees and business was truly threatened. On the morning of February 24, they shut down their equipment and arranged for people to board buses that would take them home.

Imperial Tobacco is reportedly considering relocating its factory in Ukraine to the western part of the country, despite facing a potential six-month period to move the necessary equipment.

When we realized that the situation could be more or less controlled, we decided to resume production. This was a difficult decision because we knew that there was still some risk," said Vorobyeva, estimating that the factory had been shut down for 46 days.

According to Ukrtabak, the Ukrainian Tobacco Association, a large portion of tobacco production in Ukraine is done offline, and the demand is mainly met through imports from the European Union.

The illegal market in Russia is thriving.

The current crisis may significantly expand the scale of the illegal cigarette market in the region. A survey conducted by the analysis firm Ipsos in April showed that one-quarter of Russians have switched to using illegal cigarettes. In early April, nearly 25% of respondents admitted to purchasing illegal tobacco products, an 8% increase from mid-March.

Not only consumers and retailers have been affected by illegal products, but the Russian Treasury has also calculated that the federal budget has "lost" nearly 300 billion rubles in tax revenue from illegal tobacco products from 2016 to mid-2021.

Kantar TNS Russia, a think tank based in Moscow, has estimated that the market share of illegal tobacco has increased tenfold recently, from 1.1% to 10.7%. According to a study by the government's National Scientific Center, the market share of illegal tobacco products is projected to reach at least 11.5% in 2021.

The main supplier of illegal tobacco products to Russia is Belarus. Prior to the enactment of Russia's first anti-tobacco law, Belarus produced 15 billion cigarettes per year for its population of 10 million. Today, the population has remained relatively unchanged, but cigarette production has grown to 35 billion.

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