The Leather Pipeline - 10.07.18
10/07/2018
Although the past two weeks saw a fair amount of interesting regional news, such as the elections in Mexico and Turkey, the government crisis in Germany or the Brexit negotiations, the dominating news was the rising threat of a trade war between the two largest global economies, China and the US. What has started to a minor extent between these two nations could easily spread and become a serious global problem.
The first important tariffs came into effect last weekend and the debate between the two giants is becoming rougher. The tariffs between the US and Europe are playing a minor role for the time being.
The biggest problem is that the corporations and analysts were not prepared for the situation, which means nobody knows what this will all mean for the global supply chain. In simple bilateral trade it is easier. Several Chinese manufacturers are already feeling the pain of losing export business to the US, but American exporters, in particular in the agricultural sector, feel the same and prices for some of the major farm products have already suffered quite a bit.
The situation makes it difficult to make any forecasts for the global economy. So far, the stock markets have almost completely ignored the potential risks and corrections have been moderate. The economies of Europe, the US and Asia are not yet displaying any weakness, but it would be naïve to believe an escalation will not have a major impact on global business.
Oil prices have become a subject of discussion. For the moment the price rise of crude oil has taken a break and the analysts are busy trying to analyse what influence price movements for energy will have on inflation. They are also assessing the potential consequences of a trade war for consumer prices, and if rising energy prices and a slowdown in the global economy could paralyse each other.
Fear of a trade war has also started to negatively impact the dollar. After not being able to break the level of $1.15 against the Euro, it has fallen back to levels about $1.17, reflecting the fear that the current situation could have a negative effect on the US economy.
Gold and silver prices continue to suffer and are not currently considered a safe haven against general global economic turmoil.
Market Intelligence
It would be fair to say that the first half of 2018 was one of the most difficult six months in history for the majority of the leather industry. There have been crises before, even deep ones, but it has always been clear that the leather industry has its ups and downs. There were often different reasons, but the cycle of boom and bust had been intact for a long time. In the past, every crisis was considered to be temporary; as bad as things sometimes looked, there was always absolute conviction that things would turn around relatively quickly. There was never any doubt about sufficient demand for leather as long as the price was right and the product attractive. The industry was always convinced that good ideas and competent management offered enough opportunities to sell leather in sufficient volume.
It looks completely different this time. It seems that major changes in consumer products could eventually make leather a niche material. What has been happening to cattle hides in the past two years had already been seen years before in the sheepskin and lambskin market. At the same time that nappa leather for garments lost market share for fashion reasons, casual outdoor fashion replaced leather in the garment industry. A normal leather jacket is now a niche product in the discount store.
Sheepskins and lambskins have been able to defend their position in decoration, high-quality linings and double-face garments, but they have almost disappeared as a material in garment or shoe manufacturing. Consequently, the surplus of raw material at the bottom end is ending up in landfill or rendering. Globally, there is more supply than demand so the low end of the quality range has to be taken off the market and no longer has any value.
Unless leather as a material is rediscovered by big brands and retailers, the industry will find it difficult to avoid a similar trend for cattle hides and bovine leathers. Leather will always be produced and it will always be used, but unfortunately it is almost impossible to quantify by how much leather consumption has declined or by how much more it will shrink.
High-quality materials aside, there are two major problems facing the industry at the end of the first half 2018. Firstly, there is massive congestion in the supply chain, which has created a spread of inventories which must be cleared first. Secondly, the current supply of raw material as a by-product of the beef industry exceeds the demand for leather in finished products.
Not all bad news
At the same time, we have possibly the most positive movements in the sector for a long time. Collecting news from the past few months, we see that the strong and successful players are preparing for the future. Some large groups are planning production expansion and are building new tanneries. This applies for Asia as well as Europe. Others have decided to buy capacity or know-how. We cannot remember so many tanneries being sold or bought or joint ventures being agreed in such a short period of time. One of the biggest Italian tanning groups is reportedly up for sale, more evidence that the industry is going through a restructuring process and that new strategies have to be considered a healthy and necessary development. The strong players see the present situation as a great opportunity to prepare for a successful future.
Amidst all the debate and concerns around leather products in the public domain, luxury groups are giving a completely different impression. Almost all the luxury conglomerates are planning to increase the production and turnover of their leather divisions. As a result, we can expect quite significant growth in production, particularly in Europe. In order to commit to investing this money and effort they must be confident that they can find a big enough market for their products.
What is interesting is that this expansion in the luxury segment can definitely not be covered by standard high-quality raw materials. We have no idea what the companies are really planning and if they have made any analysis of the raw material they will need, but the rising demand is likely to spread into alternative materials too. In any case, we need to be patient as it will take time before these new facilities and ideas become a reality.
Splits and skins
The split market continues to be in the same doldrums as before. Basic lime splits are in oversupply and, like everywhere else, it is only the specialities which are doing well. We see the exact same in the wet blue split market, as quality and specialties continue to run well while standard commodity items struggle to even find a customer these days.
There is no news in the skin market after the hype created in spring for new season lambs quickly imploded. It was another example that it is useless to think in the old patterns. Just believing without any analysis that a little bit of interest would be immediately followed by more sales and higher prices was another mistake. Asking prices for new season lambs, which had been pushed very high, came down and sellers are now beginning to struggle to find any buyers for their products. Apart from that, the market is the same as it has been. Niches for lightweight, dense and fine wool, and top-quality skins are doing quite well, while the rest struggle to even cover the cost of collection, sorting, grading and transport.
Holiday season
We are now heading into the peak holiday season in Europe. From mid-July until the end of August most tanneries will close down for three to four weeks. Some automotive tanners and some other groups still working well will continue to use contract tanners to keep limited production going during their holidays.
Lower kills in Europe and higher kills in the US seem to have balanced each other out, but the general oversupply of medium and lower-quality raw material persists. Prices continue to fall and the falling revenues for splits, in combination with rising production costs, are slowly but surely leaving their footprints in the higher end of the market. Supply and demand are still reasonably well-balanced in this section, however, so only minor corrections are expected.
It seems like it will be a hot and difficult summer for the rest of the market, with the only hope that some of the Chinese industry will overcome concerns about tariffs and a further depreciation of the Chinese currency. As quiet as it might be, the leather business is still going on in China. Despite more obstacles and trouble, there are still more tanneries working than being closed.
The million-dollar question remains when will the congestion in the pipeline be resolved and when will the cash situation of many tanners, especially those in China, improve. For the time being, it seems that quite a significant number of contracts would need to be taken before we can return to a more balanced market situation.
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