The Leather Pipeline - 16.05.17
16/05/2017
The past two weeks were once again pretty quiet as far as global activity in politics and the financial markets is concerned. Politics continues to play the dominant role in the media. The presidential election in France was the main interest for most international observers. Marine Le Pen, the ultra-right candidate, lost the second round against the moderate Emmanuel Macron, who is far more Europe-friendly. The result boosted the Euro and the confidence of the European community, following on from the outcome of the election in the Netherlands and providing another demonstration that nationalism is not on the march, as was feared at the start of the year. Consequently, it is not expected that the ‘Brexit’ will be followed by a ‘Frexit’. The importance of local elections in Germany in the coming weeks and the country’s general election in September is also growing; if Angela Merkel’s conservative party can hold on to or extend its position, the general stability of Europe will have been strengthened.
The financial markets continued to trade within pretty narrow ranges. Despite the main stock markets continuing their bullish trends, they are no longer making any major advances. All other commodities are also trading within small ranges. It is only the industrial metals that should be observed with great care, because the prices of iron ore and copper have lost quite a bit of ground. This could be seen as a sign that the Chinese economy might not be doing as well as the government or the financial markets tend to believe based on the statistics available.
There is some interesting analysis circulating that suggests that general market volatility is as low as it has been in recent years. A number of pundits see this as an indication that we are pretty close to another financial crisis; they believe that low volatility has always been an indicator of rising market tensions. They argue that this unexpected peace is paralysing investors and making them believe that the market risk is low.
The main issue of concern is still the Chinese economy; a number of people believe that credit risks are far bigger than imagined. They suggest that state-owned companies in particular, as well as small- and medium-sized private companies, could be in more serious trouble than many expect. It could lead the credit bubble to get out of the control of the Chinese government, dragging the global economy into the next serious financial crisis. This is just a theory, however, and there is not yet any trouble, but it is always better to consider all the options.
The price of oil dropped quite significantly in the past two weeks before rebounding a few per cent in expectation that OPEC will extend production cuts in combination with declining stocks in the US before summer driving season. However, oil continues to be reasonably cheap and the price range between $45 and $55 per barrel is still completely intact.
Market Intelligence
The leather pipeline continues to be in the usual period of transition of spring and early summer. Automotive is in its normal gear, upholstery is on the final lap of the production season, and footwear should be on high levels, although it is still suffering from the substitution of leather for other materials. The situation for handbag leather depends on the brand.
Raw material prices continue to be under pressure and the global beef industry is doing absolutely everything to stem the tide. It seems to be the same old story in the international market reports, with sellers continuing to paint a stable picture and pretending that their daily or weekly sales are enough to match production levels and to defend against further price reductions. However, this remains pretty artificial if not enough material is sold to clean up the by-product supply from the beef industry. The exceptions are the sectors in the leather industry that have an extended added value chain: luxury and automotive. They are just a small part of the industry, however, and cannot be considered as representative of the entire leather market.
A number of people across the leather pipeline are beginning to discuss in private whether we are entering a new era as far as leather as a material is concerned. Until now, the majority of players had been convinced that we were just in an ever-repeating historical cycle between supply and demand. Leather demand and raw material supply have never really been matching each other and they have barely ever been in a long period of balance. Prices were going up and down but nobody ever considered that supply or demand could actually be failing or raised the question that there might be a period where leather demand could not be met by raw material supply. Likewise, nobody considered that leather demand is simply not sufficient to absorb the raw material that is being produced.
At the moment, we may still be quite far away from such a situation, but this scenario is at least being considered as an option for the seasons to come. The ovine pipeline is a good example; for some time, there has been a need to reduce the supply by sending skins to landfill or disposing of them by other means as they cannot be sold to the leather industry. This is because prices in many cases are not even covering the cost of processing and transport; it is pretty obvious that it is not matter of the general cycle of supply and demand. Demand for finished leather and the serious reduction of tanning capacity, particularly in China, are creating a situation where the raw material supply cannot be absorbed by leather production.
We are now beginning the new season and the kill of the new season lambs in Europe is underway. We are hearing of a noticeably higher interest from the tanning industry for double face production in particular. With very few skins already being offered, prices are jumping up and the quotes and price ideas are all over the place. So far so good, but this is just another example of what we see in other leather sectors. In premium products, and for certain production chains, leather is still in place. The difference is that this kind of demand and interest is no longer spreading into lower quality levels. For some time, there has been almost no overlap between premium and standard levels; at this stage, the price levels that we have reached can no longer be considered as fitting the normal and typical historical cycle. The question is whether this is slowly starting to reach the bovine part of the business. The structure of this industry is quite different and the position of the beef industry is far stronger to defend. In the coming seasons, it will be important to watch if the fundamental conditions are really different.
In this regard, it is going to be quite important to see if the inventory level with which we start the next winter and active season for bovine leather in September is going to be higher than in previous years. Nobody releases any inventory statistics and it is quite difficult to obtain any information beyond guesses, rumour and gossip. Quite a few people close to the sector believe that the quantity of raw hides, wet blue, crust and finished leather that are hidden in warehouses all over the world is huge and that the majority are not being offered because the sellers are aware that they cannot find homes for them at any price because there is no demand.
Leather as a material has been in a period of change for several years. It has moved from a priority material, which sets the limits and defines the functionality and specifications for alternatives, to just one of many options. The preference for leather as a material is almost exclusively defined by the added value, or extra profit, that can be achieved from the finished product. Where leather is just one of the material options, we continue to be quite concerned as to what would persuade a manufacturer to use a material that is more expensive, no longer has the ‘image factor’, and that has supply and production that is more difficult to manage than the alternatives.
If that wasn’t enough already, we also have to deal with changing public opinion. The anti-beef and anti-meat campaigns have started to spill into leather, primarily in Europe. It is far less of a problem for the consumer so far, but many global brands have started to put pressure on their suppliers to deal with animal welfare issues. What at first glance seems a positive, can also be a bit more complicated. It comes down to what the term ‘animal welfare’ means. There is already a big cultural gap between the standards of different regions around the globe; religious slaughter, fire branding, feedlot conditions and farming environment are just a few examples. What is considered normal, or even a cultural standard, in one region is absolutely unacceptable in another. It seems brands are failing to understand that they are sourcing globally; what is acceptable in the US or China could never be accepted in the EU.
The skins market is dealing with several changes. The premium products continue to be livelier. The top end for nappa leather production is doing as well as ever. After almost three seasons where double face has been suffering, it seems the stocks have been absorbed and there is a serious interest and need for new supply. It is not clear at this stage if tanners from Turkey, Spain and China already hold leather orders, but most suppliers recognise there have been a lot of enquiries. Asking prices are moving all over the place, but sellers are not afraid to quote quite hefty levels. There is still no improvement for medium- and low-quality nappa skins and there has been little activity, which is holding the value of such skins below levels that would make them attractive for collection and preservation.
The split market continues to be a major worry. Split credits for tanners are still low and lime splits are suffering from poor demand. Gelatine and collagen prices are low and the cost of tanning or salting them for use in leather can hardly be justified. Considering that we are already in May, right in the middle of the season, it is unlikely that there will be any major improvement, unless someone decides to collect the excess material for speculative reasons. Anybody who believes that split demand will one day rebound would find excellent opportunities with very limited financial investment. Such a commercial decision does not, however, change the present problem of demand for splits.
The time between now and the end of June will be decisive for the trend of the market over the summer. For the strong performers in the leather market it won’t change very much, because low raw material stocks in the preferred raw materials have been built. The situation is completely different for other raw material types; some hides and skins stocks have not been cleaned up for quite a long time. This has been camouflaged by sellers, which has led to the recovery of demand being disappointing so far. With the usual decline in production and demand after the APLF exhibition in Hong Kong, this problem has increased.
Every hide that is not sold is also not bought, meaning the inventory situation of many tanneries has been eroding too. Price corrections have already taken place in several areas. In upholstery and shoe leather in particular it will now depend on the expectations of tanneries and manufacturers for the second half of the year. Purchasing decisions will be strongly influenced by when the prices of raw hides and leather reach a level that is considered workable for the new season.
Far deeper goes the question of whether the demand for lower quality leather will also fall in the coming seasons. Alternative materials may also increase their market share. This would mean that not all the raw material is absorbed, creating a totally different environment for the supply chain. We can only hope that the brands and the consumer return to recognising the value of leather and see the sense in using a sustainable raw material instead of risking it going to waste.
It is not our intention to sound completely pessimistic, but we can’t escape the impression that many in the industry deal too much with their individual situation instead of dealing a bit more with the wider picture.
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