The Leather Pipeline - 24.01.17
24/01/2017
The world of economics and business is beginning to return to the normal routine after the start of the new year. One has the gut feeling that the start of 2017 is different from that of previous years; it could become a year of significant changes.
The Trump administration is still not really completed as a lot of posts are still open. President Obama was on his farewell tour and the massive changes in almost everything between the old and the new have become visible. Anyone expecting a big difference between the new president’s campaign and his administration will so far have been disappointed. His first speech as the new president on January 20 made it totally clear: what we can say so far is that there appears to be no good news for free global trade. Taxes, customs and possible import-export restrictions have become a serious threat to free global trade. The ‘America-First’ policy could become a serious problem for the US consumer. Anyway, this is the responsibility of the new presidency and the people can decide for the next term if they liked it or not. In the globalised world everything is connected and it seems unlikely that the trend of nationalism, which is not only seen in the US, will be good for anyone in the end.
Apart from the changes in US we in Europe have to deal with the consequences of Brexit. The UK prime minister, Theresa May, has finally published some details of how the country’s departure from the EU will be handled and this will have a greater impact on the wider economy than many people might expect. No matter what people think about the decision to leave, it will definitely make the situation for trade and business relations no easier. We will go back to more documentation, more control and more administration, which is generally never good news for business.
In many parts of the world, the threat of populism and nationalism is on the horizon. A number of elections in 2017 will tell us if this trend is going to dominate in other members of the European Union, which will definitely raise the risk of further tensions within the community. Many even see the risk of the whole European idea failing if more countries decide to leave. We are dealing with three superpowers: the US, Russia and China. A fourth would be a united Europe, but it is presently destroying itself. A threesome is normally one too many so it would have been more comfortable to have a united and strong Europe at the table too to balance things and manage global questions and challenges on an even basis. For the time being, Europe is a lame duck with a dramatic lack of any common leadership at the big global negotiation tables.
The financial markets remain expectant. Stock markets and currencies are trading more or less sideways, waiting to see what the new US president has to offer. Is he going to respect the independence of the Federal Reserve? Will his policy influence decisions on interest rates? What are his plans for investment in infrastructure, et cetera?
For the moment, the price of oil, the US dollar and the main commodities haven’t changed very much.
Market Intelligence
By the end of last week the Western world was finally back to normal production after the Christmas break while their colleagues in China and in many other Asian countries began preparing for their annual leave for Lunar New Year. Asia today is far more important and dominant in terms of demand and the production break for Lunar New Year is becoming more and more important to the international supply chain.
Everybody knows that Chinese business people are always available when they want to be, even when they are supposed to be on holiday. It is going to be interesting to see if they are willing to follow activities in the raw material markets over the next three weeks. In the meantime many factories have already stopped production or will finally do so this week. The good news is that we hear from our sources that existing contracts for raw material are being rewarded with quick and continuous openings of letters of credit, or the equivalent payment of deposits. This is extremely important because it allows shippers to continue with their supplies, even during this period when their customers are absent. This also prevents any kind of product congestion, which can make suppliers around the globe nervous if they can’t be sure if a product that has been sold is going to be shipped and if the contract is going to be honoured in the end.
At the moment it seems there is very little risk around this, which confirms the impression of the last two or three months, that the factories in Asia, and in particular in China, have depleted their inventory positions and have begun the new production season with adequate, but not too high, raw material stocks. That has kept them regularly in the markets and has made business rather smooth and regular without too many hiccups in terms of price or demand. This applies in particular to the standard business in automotive, but also to upholstery leather production, for which more than half of the season is already behind us. The situation in shoe leather production is a bit different because we are just at the start of a new season. With upholstery now in the final lap of the seasonal highs, normally shoe leather production with the production of shoes for winter 2017-2018 should become significantly more active now.
Automotive is so much less influenced by seasons and has been extremely stable. We have taken the opportunity to look at the average delivery times for certain models of car. This figure is usually a pretty good indicator of the production of cars for the next three months or so. Focusing on the models that have traditionally had higher leather consumption, we can be pretty relaxed and optimistic about the demand for automotive leather until the summer holidays. Yes, many consumers in certain parts of the world are presently concerned about what kind of engine they should buy considering what kind of second-hand value they expect for their vehicle in the end. Betting on the technology can have a serious, negative impact on what your car is going to be worth when you want to get rid of it in a couple of years. However, in the short term, it seems that enough cars are still being sold because the average delivery time today is anywhere between 12 and 18 weeks. For certain luxury models, for specific lines, one has to wait up to a year for the new car to be delivered. This situation makes the supply of components pretty safe for the coming months. However, car sales should slow down for the year 2017 overall. This is expected by most pundits, but the variations on a global scale are not expected to be very big versus the numbers we have seen for 2016.
The situation is such that supply is going to become a big issue once again. If we look at European hides, which are predominantly used in the automotive leather, we can say that the production peak, the biggest time of year for cattle slaughter, is already behind us. Traditionally, the months of January and February are relatively slow with beef consumption ebbing after Christmas and New Year. With regular demand for heavy and good-quality hides, reduced supply will make the surplus of material of the last quarter of 2016 fade pretty quickly.
This would normally make everyone expect higher prices, but it seems that the key players on both sides of the table have understood that prices are still at historically high levels and it might be much smarter to hold these levels steady for as long as possible instead of challenging the automotive industry to rethink its material use for cost reasons. It is also no secret that the automotive industry is trying to bring material prices down and to reduce leather content in cars without compromising the quality and luxury appearance of car interiors.
This leads us to the main challenge for the leather pipeline in the coming months. The further down you go on the price-tags of consumer products that can be produced from leather, the greater the importance of the raw material price. The leverage of the material, the performance in production, the delivery times, the flexibility and the cost and speed of manufacturing play a much more important role today. The life-cycle of many consumer products has become so short that quality and usability are in the background, despite all the talk about sustainability. If manufacturers want to sell a new pair of shoes every three months and the consumer wants to buy in the same timeframe, there are many reasons why leather will not be the number-one material of choice.
The price gap between high-quality products that usually require carefully selected raw materials and the raw material for mass production is quickly becoming wider. The issue has been discussed for almost two years now, when the trend really began to accelerate. However, a solution hasn’t been found yet. One can still sell specific high-quality raw materials at very high prices, which are totally justified because of the value of the finished product. At the same time we are actually dumping certain hides and skins, because they cannot compete with manmade products. Pretty ridiculous, but still true. So the key question for the coming year is if there going to be a recovery in the demand for leather as a material to enable tanners to make use again of a lot of hide and skin resources.
It is also fair to say that this problem relates not only to leather but to many other raw material resources too. Despite rising global wealth and demand, certain products that nature has to offer find themselves in a similar situation to leather today. And the same rules apply to these products: at the luxury end, they sell well, but standard products struggle enormously. We might just quote wool as one example.
We also have to accept that production costs for leather are continuously rising. The cost for chemicals, labour, waste management and so on are rising quite significantly. It is true that the alternative materials will become more expensive too because of the rising price of oil, but the rise is significantly less. The rising cost of production, in particular in the price-sensitive, sector is another factor that makes it so difficult for the raw material market at the low end.
We are entering the last 10 or 12 weeks of the peak leather production season and for the time being we face all the fundamental problems discussed above. This is already reflected in the markets. There is very little reason to believe that we can expect any kind of the fundamental change in the general market pattern any time soon. The general hope for the low-end of the market can only be price pressure.
The split market has not really taken off yet. This market segment is even more influenced by the holiday break we are entering now in Asia. Niches and special qualities are doing as well as the luxury segment for grain leather. Consequently there is very little to report. The next round of trade fairs, in particular Lineapelle (February 21-23) will give us a better indication of what fashion is going to do. On the raw material for gelatine and collagen we saw a certain slump in prices in the last quarter of 2016 but this trend has stopped for the moment and we have even seen a small rebound.
There is very little change in the skin business too. Good-quality skins are still finding enough demand to be cleaned up and so we are finding a similar situation to that of cattle hides. High-quality and specialty raw materials continue to enjoy decent and regular business while the low-end is facing the same pressure as everywhere else. The consequence is that many skins are sold either at prices that do not even cover processing and transportation costs, or they are dumped. It is a tragedy that a part of a valuable raw material resource is not being used. Many optimists who were willing to process skins over the past 18 months in the expectation that this market would turn around have been disappointed. You can see a large number of stock lots still circulating and skins can be bought in wet blue at prices that do not cover the cost of tanning. There is a little bright spot in the goat skins market, which is gaining more traction and has even seen a small rebound in prices too.
For the coming two weeks everything indicates that business will become pretty light. It doesn’t seem that the Asians will be too active during their holidays. It seems they have their product flow pretty well managed and are neither over- nor under-stocked for maybe the first time in a long time. The bad news is that this will not allow sellers to find much interest in the weeks to come, but the good news is that after that, tanners will have to replenish their inventories. Maybe this more regular style of business is what we should really look for anyway. Speculation and gambling on inventories in the hands of traders and wholesalers, plus the tanners who have the gambling gene, have never done anything good for the business.
In Europe the continuous management of supply is already very common and has been for many years. Over the next two weeks a number of tanneries in Europe will have to renew their regular supply programmes. This means that sellers will at least have a chance of getting rid of product they need and want to sell. A generally positive outlook for another 10 to 12 weeks for the upholstery business in China and the regular business for the automotive part of the main raw material producing origins should be covered. For the rest it might still be a bit more complicated and price will remain the big headache. At the end of the month many people will travel to Asia to visit or exhibit at the leather fairs in India and Pakistan. With the declining importance of Chinese leather shoe exports, India could help leather gain market share. Maybe the leather fair in Chennai (February 1-3) will give an indication of the possibility of this for the year 2017.
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