Could tobacco bonds be driving political resistance to the ecig market?
Over the last few months the electronic cigarette industry has been enjoying a more favourable press with more balanced debates, more sensible arguments and more information made available to the general public. We have even seen developments in the area of regulations for the future which, although onerous in some areas, at least let electronic cigarette companies know where they stand. Indeed, some of these proposed regulations could well change in the ongoing consultation period and we await further news. However, there is a very challenging situation emerging in the midst of a more favourable reception for the electronic cigarette industry. Tobacco bonds, which effectively resulted from the 1998 legal settlement between 46 US states and large tobacco companies (to cover additional healthcare costs associated with smoking), could sway the opinion and the direction of politicians in the short, medium and longer term. What are tobacco bonds? The infamous tobacco bonds were created by various US states which decided they would rather have their money up front as opposed to waiting for the annual compensation payments agreed in the 1998 settlement. Therefore, using annual compensation payments to cover interest on the tobacco bonds, they effectively sold "IOUs" to investors thereby enabling them to access the majority of their long-term payments upfront. This is nothing out of the ordinary in the financial markets, effectively packaging together future income streams to sell bonds to investors so that more money can be made available upfront. The situation regarding tobacco bonds is a little worrying, especially when we know there is $96 billion worth of these bonds still in existence, because of the way they were structured. If we cast our minds back to 1998, the electronic cigarette industry was relatively unknown, seen as no threat to the tobacco sector and indeed many of the general public were not even aware of them. Therefore, the tobacco bonds were structured in such a fashion as to be able to withstand an ongoing reduction in tobacco smoking of between 2% and 3% per annum. When we tell you that the average yearly drop between 2000 and 2013 has been 3.4%, the alarm bells are already starting to ring. Further pressure on tobacco bonds Some experts believe that the decline in tobacco sales could reach 7% in the short to medium term with speculation that some tobacco bonds would be forced to default on interest payments. As these bonds are backed by the various US states this would place pressure on individual state credits ratings and could potentially see their cost of finance rise significantly. This is pure speculation at this moment in time as nobody really knows how the electronic cigarette industry will grow and how regulations will impact the sector in the medium to long term. However, it is worth noting that some US states have already been forced to dip into their financial reserves to cover shortfalls in interest payments on these bonds. The general consensus seems to have been, prior to the recent rise in electronic cigarette sales, the first tobacco bonds could potentially default within 10 years. Some experts have now reduced their timescale to between 5 and 10 years. Conclusion When you bear in mind the ongoing reduction in tobacco sales, the fact that some states have already been forced to dip into their financial reserves to cover interest shortfalls and the redemption proceeds which will eventually be required to buy back these bonds, this is a tricky situation. The annual tobacco company payments are based upon direct sales of tobacco and therefore, in principle, if politicians can reclassify electronic cigarettes under the current US tobacco regulations, could income from the ecig market then come under the guise of the 1998 agreement? There are many aspects to take into consideration, not least the potential growth in the electronic cigarette industry, and we await further updates with interest. Article brought to you by OK Ecigs: