War Could Have Dire Impacts On Global Supply Chains

Source: Forbes; Reuters
Date: 24th February 2022

After months of troop buildups, Russia has massed some 150,000 troops along Ukraine’s borders, according to US estimates based on satellite imagery.

This conflict could impact global supply chains.

Rising Transportation Costs
Oil prices jumped, with Brent rising above $105 a barrel for the first time since 2014 exacerbated concerns about disruptions to the global energy supply. “Russia is the third-largest oil producer and second-largest oil exporter. Given low inventories and dwindling spare capacity, the oil market cannot afford large supply disruptions,” said UBS analyst in a Reuters article. Global oil supplies remain tight as demand recovers from pandemic lows. “Supply concerns may also spur oil stockpiling activity, which supports prices.”

Analysts believe that Brent is likely to remain above $100 a barrel until significant alternative supplies become available from OPEC, U.S. shale or Iran, for example. The United States and Iran have been engaged in indirect nuclear talks in Vienna that could lead to the removal of sanctions on Iranian oil sales. Saudi Arabis has signaled they won’t pump more.

Fracking shale has made the U.S. the world’s largest producer of oil and gas and adds a layer of protection to the US supply. Recent oil busts, exacerbated by the pandemic, drove many producers to bankruptcy, but the rebound under way since early 2021 is transforming the economics of the shale industry once more. With oil over a $100 a barrel again, shale production becomes much more attractive. Shale companies have the ability to quickly ramp up or scale back production. Even before the invasion, ExxonMobil had announced plans to increase their production by 25% in the coming year. Chevron announced plans to increase their production by 10%. However, smaller shale players, who suffered more from this boom and bust market, are sticking to a “disciplined-growth strategy.”

Rising Electricity Prices
While rising gas prices drive up the price of transportation, rising natural gas prices also affect global supply chains. Natural gas has become increasingly important in generating electricity. In the US, for example, natural gas accounted for 40% of total utility-scale U.S. electricity generation in 2020.

Rising electricity prices can cut into the profits of manufacturers, distributors, and retailers who are reliant on this form of energy for powering their facilities. Energy cost increases, in turn, often lead these companies to raise their prices. This is particularly true in Europe, where Russia is the largest provider of natural gas to Europe, providing about 35% of its supply.

The fight over Nord Stream 2 might not dramatically change the price outlook for natural gas this winter. The pipeline hadn’t been expected to come online until the second half of the year.

However, about 10% of the total supply of liquid natural gas (LNG) flows through Ukraine to the European Union. These pipelines could be damaged in the fighting, or Ukraine could decide to cut them. But the worst-case scenario is that Russia, which has already reduced its gas exports to Europe, might decide to restrict exports further in response to Western sanctions.

LNG from the United States and Qatar will help the EU to withstand disruptions to gas flows through Ukraine. But if the supply is totally cut off, the impacts will be dire for Europe. But the financial impacts would also be dire for Russia.

The Raw Material and Commodity Supply Chains
A reliable company did an analysis of likely impacts on the global raw material and commodity supply chains. While the impacts of disruption of trade between US and Europe and Russian and Ukraine are miniscule in comparison to the disruption of trade with China that occurred because of the pandemic, the impacts are not insignificant.

“More than 2,100 U.S.-based firms and 1,200 European firms have at least one direct (tier-1) supplier in Russia. More than 450 firms in the U.S. and 200 in Europe have tier-1 suppliers in Ukraine. Software and IT services account for 13% of supplier relationships between U.S. and Russian/Ukrainian companies. Consumer services represent another 7%. About 6% account for trading and distribution services and 4% for industrial machinery. Oil, gas, steel and metal products account for other everyday items purchased from the two countries.” In terms of trade, these are not critical, single-sourced Tier 1 inputs needed in manufacturing.

But the impacts get larger as we move from direct Tier 1 impacts to indirect Tier 2 or 3 relationships. “More than 190,000 firms in the U.S. and 109,000 firms in Europe have Russian or Ukrainian suppliers at tier 3. More than 15,100 firms in the U.S. and 8,200 European firms have tier-2 suppliers based in Ukraine.”

Food inflation is a risk from a supply chain disruption. “Ukraine is on track to being the world’s third-largest exporter of corn, and Russia is the world’s top wheat exporter. Ukraine is also a top exporter of barley and rye.”

The conflict could squeeze metal markets. Russia controls roughly 10% of global copper reserves and is also a significant producer of nickel and platinum. Nickel has been trading at an 11-year high, and further price increases for aluminum are likely with any disruption in supply caused by the conflict.

Russia, along with the United States, China, Israel and the United Kingdom – are believed to have the most developed cyber warfare capabilities. Russia has been one of the most aggressive nations in deploying these capabilities. Russia is strongly believed to have used cyber weapons to attack Georgia during the military incursion into the country in 2008. In early 2014, there was Cyber Snake program that attacked Ukraine.

In the Interos article, it was stated that the 2017 NotPetya attack on Ukrainian tax reporting software spread across the world in a matter of hours. The attack disrupted ports, shut down manufacturing plants, and hindered the work of government agencies. The Federal Reserve Bank of New York estimated that victims of the attack lost a combined $7.3 billion.

Further, Russian anger at sanctions could lead to cyber warfare directed at the West. The spread of Public Cloud enterprise software has made the risks greater. Shutting down a large Cloud player could impact the ability of tens of thousands of companies to effectively manage their supply chains. Of all the potential impacts of war, this is potentially the most dire.

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