Macroeconomics

There is often a situation in which one wishes one had not been right. We have been talking here for months about the possible consequences of geopolitical upheavals and have also mentioned the massive threat and danger of war in Eastern Europe several times.

Now it has happened. A megalomaniac and irrational despot has brutally attacked a neighbouring country without regard for civilians and international law. The only astonishing thing here was that until the very end there were still many who believed that a troop deployment of 150,000 soldiers with a full complement of war equipment and air force support was a training exercise. If this had been only a threat, Russia would not have deployed one-third of its armed forces. The involvement of a vassal state in the form of Belarus and the use of its leader as a puppet only add to the difficulty.

Enough has been said in the mainstream media about this campaign, so it is only worth pointing out here that it is in every respect a turning point in international politics, the consequences of which cannot yet be foreseen at all. The hope that some commentators still have today that a quick end to the war and possibly even successful peace negotiations would represent a quick success is just as naïve. The leader of a great power has gambled away all trust, and this means a completely new constellation for future global relations and the security architecture in Europe for a long time to come.
In the midst of war, it is nonsensical to discuss possible economic damage and long-term changes. Too much remains unknown and the consequences for international trade, logistics and, above all, prices are far too complex to make any assumptions about today.

What can be said with certainty is that the discussion about inflation has become obsolete in any case. Prices for goods and services will rise further in the near future. Under the compulsion of events, the question of efforts with regard to climate protection also no longer arises for the moment, even if activists do not like it. The transformation to renewable energies and other resources cannot simply be accelerated at will, and owing to sanctions, fossil energies will become considerably more expensive than they have been on average in recent years.

Since Russia and Ukraine have been notable suppliers of many plant-based foodstuffs, we must expect price increases and supply problems in this sector for some time. In addition to foodstuffs, both countries also play an important role in the international supply of many other raw materials. If, and this seems more than likely at the present time, supply of these can no longer be assured, it will certainly not be possible to meet the increasing demand resulting, for example, from electromobility in the short term.

Our readers will probably follow the prices for energy and thus for oil and gas as closely as we do. Oil is approaching prices of $140 per barrel in some cases, which is not far from the historic highs. The OPEC+ group of oil-producing countries is, of course, by no means dissatisfied with these levels after such low prices in 2020 and is making no effort to compensate for the possible loss of supplies from Russia with increased production elsewhere in the short term.
Stock markets fell and are falling at an accelerating pace. Inflation and war are probably the most toxic mix of all. Only defence stocks and some commodity stocks were able to defend themselves successfully.

Gold is again functioning as a crisis shield at the moment, reaching levels above $1,900 per ounce. The US dollar, as a safe haven, was able to profit somewhat from the political situation, but the euro did not develop as weakly as one might have expected.

Leather Pipeline

The two weeks since our last Leather Pipeline report cover a time before Russia’s invasion of Ukraine and a time after. 

The invasion coincided with the Lineapelle exhibition in Milan. Even though the number of visitors was lower than in normal times owing to the still existing restrictions because of the covid-19 pandemic, the first two days not only saw a very satisfying number of visitors, but actually also a lot of happy faces on the stands and among the exhibitors.

We felt somehow reminded of the times when this fair was still held in Florence and then in Bologna and was a very familiar meeting place for creative, high-quality leather producers from Italy and, later, from all of Europe. At that time, insiders talked to insiders, experts talked to creatives; people were among members of their own community and everyone had an enthusiasm for the product. Even though this state of affairs has not been completely restored, we can still say that we were positively surprised by the quality and intensity of the conversations and by the visitors at this most recent edition of the fair.

The main topic of conversation was not the usual complaining about lack of orders, but almost exclusively the topic of how to pass on the increased costs of production to customers for the seasons ahead. This was what was worrying tanners as they considered by how much the price of leather might rise and how increased costs can be apportioned and passed on.

For suppliers, a downward adjustment in raw material prices was not an option and, on the contrary, some wanted to take advantage of the friendly atmosphere at the fair to increase prices, based on a reduced kill in many countries. This varied across the different product ranges, but basically the vendors’ price expectations pointed in one direction, and that was up.

By the Wednesday evening, a clear market situation had developed. In the case of heavy and high-quality male hides from Europe, there was an extremely wide spread between the buyers’ and sellers’ ideas, which could not be bridged by the end of the show. Only a few deals for smaller quantities for smaller productions were successfully concluded. The big players, however, were not willing to follow asking prices and there were no significant sales at significantly increased prices. The situation was somewhat easier for sellers of high-quality calfskins; both the order situation and the supply situation have put the buyers under a little more pressure.

For medium qualities, especially cowhides for the furniture industry, the tension was released much more quickly, since the price differences between buyers and sellers were not so great and people seemed prepared to find a compromise relatively quickly. However, in the end it was closer to the buyers’ ideas than to the sellers’ demands.

In this whole discussion, it should not be overlooked that price levels in Europe are significantly higher than they should be in relation to other options. The significantly increased transport costs for imports from overseas and the rapid availability of delivery play a decisive role. The delivery times owing to the delays in international transport have become so incalculable and long for many that, to avoid doubt, they prefer to buy in Europe.

Of course, all of the above only applied until the Wednesday evening. With the invasion of Ukraine starting the following morning, everything changed abruptly. Many were still of the opinion that this could not be a serious invasion and thus a long-term conflict. As we know today, this was a mistake and everyone involved realised this in the week that followed.
Everyone is following the daily developments in Ukraine in real time via the internet and other media. One can at least assume that the information outside Russia is much more reliable than inside.

The developments of the past week, especially the political decisions and sanctions, are having a delayed effect in our sector. In the leather business, the automotive industry is particularly affected. More than 20 direct suppliers to the automotive industry have production facilities in western Ukraine and have had to shut them down very quickly. This has meant that many car factories in western Europe have already had to think about closures and interruptions to production in many factories.

With few exceptions, car sales in Russia and Ukraine do not play an immediately important role. When it comes to interrupting production, one can assume, as during the pandemic, that mainly vehicles in the middle and lower price categories will be suspended from production first. The high-end models, which are more likely to be equipped with leather, will certainly be much less affected in the immediate term. Nevertheless, some manufacturers report a drop in call-offs for leather of up to 60%, which has a strong effect in the ‘just-in-time’ supply chain. Nevertheless, it can be assumed that production for automotive tanners will remain fairly stable, at least for the next few weeks until a clearer picture becomes available and decisions on production from April onwards can be made. The real impact will only unfold afterwards, as it cannot be assumed that the situation can return to normal in the short term. The reorganisation of supply chains and, thus, the return to normal production levels, usually takes at least three months. This also assumes that there will be no further supply bottlenecks for other raw materials such as metals.

In the other sectors, the consequences will in all likelihood only become apparent after a delay. A quick look at the annual reports and balance sheets of the major consumer goods manufacturers that use leather show that between 2% and 15% of global sales find their way to the regions affected by the war. Even though well-known brands were quick to announce that they were stopping sales in Russia, the impact on the supply chain will be delayed. Large, global producers simply need some time to adjust and reorganise their organisations. The current state of affairs hardly allows for any other conclusion than that production is likely to reduce. It seems quite unlikely at the moment that other markets can compensate for the declines in sales.

Of course, this depends very much on how one looks at the situation in Eastern Europe. It can be seen in conversations and exchanges of ideas with our sources in Asia and the Americas that people there are reacting in a much more relaxed way to the possible effects on business. The emotions and fear that are presently driving most Europeans have not yet arrived there. It can therefore be assumed that a reaction in the leather business will probably come, but it may not be as quick or as extensive as one might expect in Europe.

Commodity markets react faster and in a more volatile way to changed market conditions. You don’t even have to look at the market for raw materials for the leather industry to see this; all other raw materials in all other sectors demonstrate this every day.

As we mentioned at the beginning, the reaction of suppliers and buyers in the leather industry is, of course, completely different. The old rule that military crises cause the price of the raw material for the production of leather to rise immediately only applied in the times when war was synonymous with the immediate increase in the production of boots, belts, straps, et cetera. Well, that is not the case today.

We all know that leather is no longer a basic material. It is, rather, something for consumption in sectors that are not characterised by pure need. For this type of consumption, a pleasant, relaxed, positive and calm environment is usually more favourable. Depending on how things develop, this may hold true for Asia and the Americas, but not for the European continent. We will probably have to deal with a large number of refugees in the near future, with sharply rising costs for energy and food, and these are not the best conditions for ordinary people to consider consumption that they do not urgently need. It is undoubtedly not right to play the prophet, but it is probably sensible to look very closely at this possibility. It will only unfold with a certain delay, because first everyone will try to continue to maintain normality as best they can.

The great price pressure has opened up some new options for split leather. On the one hand, supply is decreasing because more and more split is going into gelatine and collagen production, but on the other hand, owing to its price advantage, demand for split leather has increased significantly in recent months. It gives the impression that many processors are trying to absorb price increases by selling split as a good material for the coming fashion seasons. This naturally leads to higher demand and thus also to rising prices. The next weeks and months will show to what extent this is sustainable in the new current situation.

The situation with sheepskins and lambskins will also have to be reassessed in the short term. Basically, the demand for high-quality products at the Lineapelle fair in Milan was very positive. If you look at the prices of the privileged raw materials, some people will be very surprised by the levels that have already been reached again. However, there are of course also sectors in which the war in Ukraine is leaving very negative traces. This will certainly be the case for trade between Turkey and Russia or Ukraine, for example. Traditionally an extremely important market for many Turkish tanners and clothing manufacturers, it will only be possible to serve this market to a very limited extent as a result of sanctions and the war. It will be particularly problematic for those who have delivered goods to Russia without immediate payment; they will probably be hit hard by the devaluation of the rouble and the interruption of international payment systems. Here, too, it will only be possible to assess how extensive the effects will be in the coming weeks. One thing we can say with certainty is that they will not be positive effects.

In the next few weeks, we will certainly have to analyse the changes in the markets calmly and in depth. The influencing factors come from many directions and are by no means limited to questions about sales and production; the task is extremely complex. In particular, the reaction in China and the US will be very important. Inflation and general economic developments will play a big role, as will the way consumers come to view the situation in Europe. Should the markets react to the situation with the greatest possible normality, the impact on supply chains in the leather industry could be much less than one might fear today. The difficulties would then be reduced again to those we already knew about: increased costs for energy, labour and chemicals in combination with problems in international transportation. In any case, the situation for the leather industry will not be easy in the coming weeks and months.

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