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Supply chain disruption still a major challenge
Global supply disruption pales into insignificance compared to the trauma being inflicted on Ukraine’s population, but for corporations, it is the chief day-to-day business challenge created by the war.
At a time when many had hoped disruption from Covid-19 was beginning to fade, Fidelity International’s latest monthly analyst survey shows supply chains are still high on the list of corporate concerns.
From titanium supplies for the aerospace industry to aluminium for soft drink cans, manufacturers have been telling our analysts how they are piecing together the second and third-order effects of the war and scrambling to react.
Oil, gas, metals and more
The broad strokes are well known. Russia is the world’s second-biggest exporter of oil and gas and Europe’s chief supplier; together with Ukraine they provide a third of global wheat exports; and both are major suppliers of a range of important industrial metals, ores, and gases. In some areas, there are concerns over availability as well as cost.
That said, Russian commodities are still making it out of Russia. Gas flows to Europe have continued and it is hard to see both how Russia could pipe those volumes elsewhere and how Europe could avoid rolling power blackouts next winter without them.
As for oil, if Europe ceases to buy the 4 million barrels per day that it previously imported from Russia, we would expect China and India to take up to 1 million bpd each, with another 500,000 bpd being bought by purchasers drawn by the big discounts on Urals crude. OPEC and shale producers should then fill the gap, leaving the market initially tight but likely to improve.
Ukraine also provides around 12 per cent of world wheat exports, and is expected to cut exports by at least 7 million tons this year, raising concerns about immediate supplies, particularly to countries including Egypt and Turkey who rely on Black Sea imports.
India, by contrast, has 15 million tons of excess wheat supply in storage, and raised exports from 1 million tons to 6 million tons last year. Another bumper harvest is forecast in the coming weeks, although there remain questions over how well it has resolved the logistical barriers to upping exports further.
In the metals market, some material continues to flow from Russia: we think that material purchased pre-war generally has to be taken unless there are get-out clauses in the contract, even if actually transporting it is getting more difficult. As these materials have not yet been sanctioned, avoidance of Russian material right now is really a function of self-sanctioning and logistics challenges.
Spot power prices continue to put pressure on European metals businesses which are energy intensive. For aluminium, 16 per cent of European capacity is currently offline. So an underlying market that was already tight on the supply side is vulnerable to further shocks, although we must not forget that eventually, there is likely to be a demand consequence of everything that we are seeing.
Harnesses and chips for cars
While Russia and Ukraine’s role in global supply chains is chiefly commodities-led, Ukraine has made some progress since the Orange Revolution in 2005 in duplicating Poland and other central European states’ progress with greenfield factory projects.
The car industry, for example, has placed manufacturing of wire harnesses - effectively vehicles’ electrical shell - at sites across the country. One European crane maker warned on profits last week, cutting volumes by 20 per cent due to a shortage of the trucks onto which it places its cranes, caused by a shortage of harnesses. It expected truck producers to take at least three months to resolve the problem by shifting locations and that truck volumes overall would fall by 20 per cent in the meantime.
Some Ukrainian production lines are still delivering, albeit at 40 per cent of previous volumes. Others we spoke to are now scrambling to reorganise, in some cases flying in harnesses to European plants from other global sites. This was previously thought to be unworkable on a cost basis.
One German industrial vehicle producer warned last week of a pincer effect of rising steel, logistics and energy costs that, allied to supply chain bottlenecks, would leave EBIT earnings next year “significantly below” those for financial year 2021. The cost base, they said, was rising sharply while volumes, hurt by its halt in sales to Russia, would fall.
For most carmakers, however, the biggest problem remains the chip supply issues that have dogged new vehicle output for the past 12 months. Here, the disruption caused by the conflict, and by southern China’s new round of Covid-related lockdowns, have pushed lead times for chip production back out beyond where they were even in last year’s crunch. Notably, Ukraine also produces 90 per cent of the semiconductor-grade neon gas used in the US.
The chip problem had already left carmakers running far behind demand for new vehicles over the course of the last year, pushing used and new car prices higher. In a series of meetings in the past fortnight, producers and distributors told us there was no sign yet of any dip in consumer demand or incoming orders. One major distributor our sector analyst spoke to said they expected production would again fall further behind after April, leaving them short again on the cars they need. They expect supply and inventory will not normalise before 2023 at the earliest.
Hedged for cost but not availability
Companies were already resigned to the prospect of major rises in labour and other production costs this year before the war, but many now expect to revise up the scale of those cost increases.
There are caveats. Power costs, for example, have already been fixed for the months ahead and will only see the impact of this year’s spot price rises in 2023. Similarly, one big consumer goods producer told our sector analyst that, financially, they are hedged for aluminium prices to the end of the year and through swap contracts for other commodity ingredients for a period of up to 36 months.
Several manufacturers, however, said the issue may soon prove to be availability of metals rather than cost.
Air industry manufacturers, for example, said they were generally protected by deal terms that provide for rises in labour, raw material, and other input prices. They are, however, still scrambling to pin down sources for titanium, which after recent design changes can make up around 13-15 per cent of the weight of an airliner.
The sector also faces second-order effects. Our discussions with aerospace firms revealed the inability of western producers to service planes stuck at Russian airports - making them effectively unusable. Whether the insurance industry will carry the cost of this event for plane owners may take years of legal wrangling to decide.
Much is in flux. Most European industrial companies we spoke with said they were still trying to establish whether their Tier 2 suppliers sourced metals from Russia. Manufacturers told us they were working on design changes to get around bottlenecks, but some changes are easier than others. One maker of industrial equipment was considering drilling larger holes in one product to allow it to accept a larger screw - because the smaller one was now unavailable. This is a quick and easy fix, requiring little or no regulatory approval - but companies also face the risk that the new component in turn becomes unavailable.
One mining equipment provider told us Russian mines had no choice but to start buying Chinese equipment that is cheaper, and would face higher overall maintenance costs as a result, when factoring in durability, servicing, and other elements. They said they would ship product previously intended for Russia elsewhere, but were facing a similar squeeze to that in 2021 on the availability and cost of shipping.
The China-Europe rail freight route that goes through Russia, a key part of Beijing’s Belt and Road initiative, boomed in 2021 - driving a seven-fold increase in prices - on the back of congestion in major ports. It is now facing cancellations from European clients but also greater use as a conduit for increased Russian trade with China.
Strategically, eyes are turning to Latin America, an investment backwater in recent years but now a potential new commodity superpower, as prices and the removal of Russian supplies make its energy and metals exports more profitable and more investable. Chile and Argentina are sitting on huge reserves of lithium, vital to a renewable energy revolution that should only be bolstered by the impact of the war. Much has already been written about moves to bring Venezuelan oil back to the global mainstream.
Growth at stake
As markets and companies rush to respond to a rapidly changing world order, the entire length of the value chain is coming under scrutiny. Whether it is historically high input costs such as energy shutting down transportation or manufacturing, or the struggle to obtain key commodities for processes, our analysts continue to engage with firms to establish the scale of the problems they face, and how they are changing their businesses in response.
This is crucial to understanding where and how new supply chains may form and the extent to which the impact of war-related disruption - and of further Covid lockdowns in China - will squeeze global economic growth over the next 12 months.