Don Ohsman's view from America

Texas, which remains as the benchmark selection of the steer sector, has been incredibly steady throughout 2005. In the second week of December 2004, Texas were quoted between $63.50-$64. They were at $63.50 during the first week of January 2005.

Texas traded as low as $61-$62 in April 2005 (around the time of the APLF in Hong Kong) and as high as $65-$65.25 in late August and early September before the Shanghai Leather Fair. We are unable to foresee any change in this narrow range into January 2006 and immediately beyond.

As we've been saying now for more than a year, supply and demand have been essentially in balance. This is regardless of hide supply that has declined slightly compared with a year ago, and substantially when compared with two years ago.

As weekly cattle slaughter not only for steers but all selections has declined (the year should end 1.4% below 2004), demand has also fallen commensurately. Tanners outside US borders now consume approximately 80-85% of all the hides produced in America.

Although it will never be known for certain, but based on the consensus of informed observers along with conversations with leading tanners in Asia and Europe, more tanners than ever before are using lower cost alternatives to American hides which remain one of the world's most expensive.

The reasons for this are that technological advancements in tanning methods, chemicals and finishing techniques, along with new machinery, have made it possible for tanners to produce leathers that meet their customer's demands for consumer acceptability based on appearance, quality and price. The latter of course is the most important.

One glaring example of this is athletic footwear in the United States. 40% of all the footwear sold in the US in the past year has been classified as athletic. Now visit any retail store and see how much leather is in these shoes?

Try to determine how much are polyurethane coated splits, how many are full grain (you'll have to look high and low for this category!) and how many are termed 'artificial leather'.

It's a sad state of affairs in the footwear industry but at least the upholstery sector, where consumers mostly seem to be able to determine the difference between leather and plastic, although with increasing difficulty, are still consuming a large percentage of US hides, in their cars and homes.

All this means that as long as American hide prices remain in their current trading range, and lower cost alternatives such as Brazilian do not climb substantially in price, tanners will still use lower cost alternatives. However, in the past two months, two factors have the potential to challenge the status quo affecting hide prices in 2006 and beyond.

The first factor began in late November; the Chinese government advised tanners that they were considering changing the import laws on raw hides into the country.

The purpose was to curtail turning raw hides into wet-blue to help stem the tide of increasing industrial pollution in the country. In addition they want to modify existing laws so that more of the taxes due on imported hides that are now being avoided could be collected.

In December, the government partly revealed what changes would take place with more details to follow. The changes in the current tax system on imported raw hides and wet-blue were due to take effect on January 1.

Without going into the details, unless the nation's tanners can find a way to circumvent the new payment scheme, cost increases to the nation's tanners for turning a raw hide into a piece of wet-blue could go from approximately $8/hide where it is now, to potentially $12-$16 per piece.

Furthermore, an onerous increase in the operating capital of importers to fund imports under the new system will be required that will further discourage hides being tanned in China. This would take away the competitive advantage that China now enjoys, operating as much of the world's beamhouse and could potentially cause a shift in where hides are blued in the world.

The second factor that occurred at year end that is likely to eventually influence hide prices is the opening of the Japanese border in December to the importation of American beef. Other Pacific Rim countries are expected to follow suit in early 2006. It is expected that other Pacific Rim countries that embargoed US meat when Japan did will rescind their laws and start to take US beef in early 2006.

The profit margin for packers in these markets is such that a resumption of the trade they once enjoyed could increase kills conceivably by 10-20%. This, combined with a normal bottoming in the cattle cycle that took place this year, portends larger kills in 2006 and gradual growth in succeeding years.

More hides, combined with even the same but perhaps less demand, would conceivably push prices into a lower trading range, at which time other dynamics in the world market could come into play.

Although there haven't been any changes so far in the price structure of steers as well as bulls and cows, events outside the trade could influence significant changes.

Even with the muddled pronouncement from China it is certainly not clear, as well as being too early, to see what effect these changes will have on the hide market. Our guess is that any factors influencing prices will be gradual and will somehow be circumvented to one degree or another to keep the tanning industry vibrant in that country.

However, just like major shoe brands have developed sourcing in low cost countries other than China, this new increase in the Chinese cost structure will likely instigate an expansion in tanning and allied trades in other low cost countries such as Vietnam, India, Indonesia and Malaysia.

Everyone seems to agree, and we concur as well, that leather prices are NOT about to rise not only in the coming months but more than likely in the coming year. However, with very good economies in the US, improving performance in the EU and continued growth in most of the Pacific Rim, we can only foresee increased leather consumption in automotive, furniture and footwear.

By the same token, we also foresee a gradual increase in world hide supply not only from the cattle cycle rising in the US, but increased slaughter in Brazil and, perhaps most important of all, China.

Bottom line: excluding external unknowns such as was seen with the outbreak of BSE, anything more than very moderate changes in the current balance of supply and demand is hard to imagine in 2006. We can, therefore, only predict generally steady hide prices in the coming year, and from a trading perspective, hope that we're wrong!

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