EP25: The storm before the storm - Q1’24 trade and supply chain outlook

Table of Contents

Call Participants..................................................................................................................................................... 3

Presentation........................................................................................................................................................... 4

Call Participants

ATTENDEES

Agnieszka Maciejewska

Chris Rogers

Presentation

Agnieszka Maciejewska

Hello, everyone. My name is Agnieszka Maciejewska. As a part of Global Insights and aAnalysis, I manage the trade forecasting team for the S&P Global Market Intelligence. I want to introduce my colleague, Chris Rogers, Head of Supply Chain Research at S&P Global Market Intelligence. Thank you, Chris, for joining us.

Chris Rogers

Thanks very much, and thank you for joining today, everybody. Throughout the past year, we've been talking about the normalization of supply chains. And by that, we mean a move away from a period of significant physical disruptions that we saw during the pandemic.

The title of today's presentation, the storm before the storm, was originally going to be the calm before the storm. Back in the middle of December when we were putting together our outlook for the year, we figured, okay, we've had to calm down in the physical nature of supply chains, and we can look ahead now to political risks emerging.

How wrong we were. With the emergence of the challenges in the Red Sea and the disruptions that's causing to shipping around the world, supply chains are genuinely facing another round of disruptions to deal with. The challenges we're seeing in the Red Sea really are a wake-up call, if one was needed, but we're never too far away from physical disruptions to supply chains.

The new round of disruptions that we're seeing were initially caused by Israel's war with Hamas and the Houthi regime in Yemen looking to effectively support Hamas by disrupting shipping, but we believe that it's potentially going to go a bit beyond that with the Houthis also looking at their own domestic political position. And of course, there's wider geopolitical forces at play that may be looking to tie up the U.S. and U.K., amongst other militaries in the Red Sea.

At the same time, obviously, the Panama Canal operations have been disrupted due to low water levels. Now that's not quite as bad as initially foreseen. There has been some rainfall, but the canal is still operating more than 1/3 below its normal capacity. And as a result, a lot of the shipping companies who are hoping to avoid the Panama Canal by going through the Suez Canal to supply the Atlantic Basin from the Pacific Basin are now having to also go around the Cape of Good Hope. So that's effectively bringing a whole new need to redesign some of the networks.

Now in the short term, we're seeing higher shipping costs really have bounced up. So it's around $4,500 per 40-foot equivalent unit on the North Asia to North Europe trade. It was around about $1,000 before -- in fact, a little bit below $1,000 before the latest round of disruption started. But for context, the peak during the pandemic, rates got up to $15,000 to $18,000 per FEU. I'm not suggesting that we're going to see another tripling from where we are now, but it does make the point that shipping prices can be highly volatile.

Part of that is because of a reduction in effective capacity on the network. So boats having to take longer to get to where they need to get to. And it also reflects the fact that we're starting to see equipment be out of position. So effectively, containers that are required to be shipped back to Asia are spending longer on the network than they need to. And that's one of the reasons why we've seen 2 of the shipping companies start to run empty retrieval services, and we may see more of that.

Of course, the difference between now and the pandemic is that there are rerouting options. During the pandemic, it was just elevated demand, and there was really no alternative ways that you couldn't create new ports overnight. So we have had Cape of Good Hope being used, and we are starting to see some network redesigns. And obviously, the announcement of the Gemini Cooperation between Maersk and Hapag-Lloyd will bring another round of network redesigns next year.

We're also quite excited about the possibility to see more rail shipments, whether that's using shipments into the U.S. West Coast to go to the East Coast or Asia-Europe routes via Kazakhstan. We've just published a research on that topic as well. And we've seen already a change in shipments away from the East Coast of the U.S. to the West Coast. So that's showing you the share of imports of leisure goods, so toys and fitness equipment. There's already been a marked drop in shipments away from the East Coast. So we are -- we've already begun to see some of that network redesign come in.

Airfreight is, of course, expensive. Reshoring is available as well, but that is very much a long-term solution. The impact that we're seeing really is widespread across a lot of different regions, and we published a number of research reports on this topic. We have particular concerns about food products. Obviously, time at sea and the risk of spoilage are both there and the proportion of U.S. East Coast imports by product that come from Asia by sea, palm oil and rice amongst the most exposed.

Energy products, some of the bulk carriers have been happy to continue using the Suez Canal. That's beginning to change as well. And that may lead to more of a basin bifurcation between the Atlantic and the Pacific basins for a lot of these energy products, those disruptions there.

The auto industry has already faced some impact. We've seen in the past few days a number of the automakers in Europe already having to shut capacity temporarily due to a shortage of parts. And we think that's particularly pressing for the electric vehicle industry. And then also for deeper in the supply chains, the chemical industry is particularly exposed on Asia-Europe lanes and metals for Asia-U.S. lanes.

In terms of consumer goods, toys, apparel, home appliances and so on, you can see there, there is a significant exposure for imports into the U.S. East Coast, and similarly, for imports into Northern Europe from Asia. That won't become too much of an issue unless the disruptions carry on through the middle of the year.

It is likely that we're going to continue to see disruptions for quite some time yet, and that may begin to lead some of the seasonal shippers to start thinking about shipping earlier than normal or the minimum to start booking their slots earlier than normal. So the advice here is very much don't hang around, and as always, look at building a stock of alternative routings and alternative sourcing solutions, even though it can be expensive.

There are other choke points to watch, of course. South China Sea and the Taiwan Strait, connections between U.S. and Mexico proven somewhat unreliable, both in terms of trucking and in terms of rail from a mixture of immigration and protest issues. And of course, there's been inland cargo risks from strikes. We've seen those just in the past few days in Germany where I am at the moment, for example.

It's not just physical choke points on the networks that need to be considered, though. It's also the risk of strikes. And we've seen that the human element of supply chains is the most powerful. At the end of the day, supply chains don't work unless people make them work, but it's where we can also end up with some fairly unpredictable outcomes as well.

We've seen in the automotive industry at the end of last year, the United Auto Workers strike was quite visible, and that showed really a new approach to striking, effectively a ratcheted approach whereby pressure was steadily increased on the auto companies by progressive closures of more and more factories. That minimize the economic impact of the strike and meant that workers -- or most of the workers could continue to work, continue to be paid, but it did nonetheless bring the automakers to the table.

We're also seeing in Europe what we might call swarm strikes, so it is effectively deeper in the supply chain. Tesla itself is not unionized in its main factories. However, there are parts of its supply chain where there are union workers, particularly in Scandinavia, and pressure has been applied there as well.

We've also seen elsewhere in the world strikes and protests in Bangladesh, particularly relevant for the apparel industry. And also, that's having a result that generally, wages are being raised across the board. Our forecast for wage inflation is expected to slow over the next couple of years in most areas. But wage rates are still going to be increasing in a lot of the main outsourced areas by as much as 5% to 10% for the next 3 years or so. And that is going to cut into funds available for investment in other ways of improving supply chain resilience.

So as always, plenty to worry about, plenty that needs to be managed. And that's come at a time when supply chains had otherwise normalized. I'm going to hand it over now to Agnieszka to talk about the trade forecast.

Agnieszka Maciejewska

Thank you, Chris. Let's move to the macro trade forecast, which, despite what Chris is telling us is a little bit more positive than for 2023. We are summing up the 2023, and we closed it with a negative rate of total trade volume.

Our current estimate is minus 3.7%. It is due to historical data. Already, we have a historical data for the first 3 quarters, and this downgraded the overall outlook. The estimate for the fourth quarter seems to be brighter, but it didn't change the overall negative result. But our forecast is more optimistic for 2024, and it amounts around 2.7% in plus. It is even higher than a quarter ago because we estimated it to be around 2%, but it is still not showing a great expansion, rather slow and steady growth in the long run.

The main drops in 2023 in volume of trade were imports to the EU, U.S. and Africa. And those were drops around 7% to 10% in 2023 in comparison to 2022. On the export side, still, Russia and Belarus noted biggest drops in exports, but the European Union and U.S. also resulted in negative. This should brighten up for the EU and U.S. in 2024.

Now let's look at particular sectors. The sector that grew in 2023 more significantly was transportation equipment. It was led by the exports from Mainland China in Asia, Germany in Europe and Canada and U.S.A. in America. This is forecasted for the next quarters to maintain like this. And the declines in 2023, some of them will, in our opinion, persist, some of them have a chance to brighten. So mainly vegetables, in which crops, wheat, rice and corn as well as cotton, the exports declined in Americas, Asia, Europe and Africa.

Similarly, what was dragging the growth of trade was textiles. The last quarter of 2023 seems to be better for textiles, and we are anticipating some kind of recovery in the early quarters of 2024. But for food trade, the outlook is still negative due to a couple of reasons, but the new reason is the perishable food -- this perishable good and longer time at sea caused by the disturbances in Panama Canal, for example, are causing a threat for that.

Now I wanted to share with you the comparison of the global trade forecast for trade between international organizations and S&P Global estimate for 2023 and forecast. The World Trade Organization has had its growth for 2023 estimate for global goods in trade earlier this year, dropping it to 0.8% from 1.7%. IMF dropped from 2% to 0.9%. And just a couple of days ago, the World Bank downgraded its estimates for global trade to 0.2% and for the advanced economies to the negative -- minus 0.5%.

Our estimate is much more negative, that is because we are already incorporating the historical data for 3 quarters of 2023. The digital forecasting data is closer to now casting. The current estimate is minus 3.7%.

Okay. And now let's hear about the impact of politics on supply chain from Chris.

Chris Rogers

Yes. Thanks for that. I think it's an important point that we'll kind of come back to just trade is recovering, but growth isn't stellar. And what that basically means is if you're involved in global trade or supply chains, you're going to have to deal with a relatively low growth scenario whilst also managing a widening set of risks from a number of different areas.

On the political side, one of the general things we've been looking at, along with our other colleagues across S&P, is really the -- a continuation of this reemergence of protectionism in all forms. One of the challenges here is that the only thing you do know right now is that there's a lot of political uncertainty because of all the elections that are going on.

In 2024, there's 70 elections going on around the world, whether that's the European Parliament, U.S. general election, possibly a U.K. general election. And those really do generate quite a lot of planning uncertainty. And of course, the elections happening now and in the coming quarters will continue to generate policy volatility going into 2025. And I think that's particularly the case for the U.S. presidential elections, which happen in November. We won't necessarily see the policy impact of that until well into 2025.

We've also seen an increasing blending within policy of national security and economic considerations. A lot of the trade restrictions that have been put in place are quite often put there under the banner, if you like, of national security. More from the [indiscernible] though, there is also an economic side to it.

So if we think about semiconductors, that's partly national security, partly about trying to bring high-value jobs back to the U.S., EU, wherever. And that blending is difficult to handle from a planning perspective because it means there's a lot more constituencies at play when it comes to setting trade policy than they might normally be.

Good news -- I'd like to try and chuck in some good news occasionally. Good news is that there may be some new trade deals coming along. Whilst the EU failed to deliver its deal with Mercosur, there's always a chance of a reboot.

The EU's potential steel deal with the U.S., the global sustainable steel agreement, again, that hasn't happened, and that really just show the complexity of getting some of these deals done. However, the EU did complete its deal with Kenya. We're looking forward to that getting ratified probably after the European Parliamentary elections.

In case of the U.K., there's a lot more post-Brexit trade deals to come. Whether these are any better than the trade deals that the U.K. could have signed as part of the EU is largely a moot point. What we do know is that the forecast for U.K. export growth is weaker than it is for the EU.

The CPTPP members as well -- obviously, the big potential trade deal for the U.K. has joined the CPTPP trade deal, which includes Japan and other members across Asia. But that comes off the back of a period of extended downturn in exports from the U.K. really lagging most of the rest of the world. So it's quite important for the U.K. to get those deals signed.

We're also seeing the emergence of -- and we'll continue to see the emergence of -- kind of more interested parties deals. What we mean by this is they're not formal trade deals. They're rather kind of arrangements of convenience expressed through a series of smaller areas, perhaps specific to data sharing to specific industries. Critical minerals has been an example of that where we've seen kind of pseudo trade deals being announced.

The Indo-Pacific Economic Group pushed by the U.S., the India, Middle East corridor that's being promoted, but has obviously run into issues with conflict in the region, those are the kind of deals where you don't necessarily get a big flashy signing of a deal, but you do get kind of steady move towards liberalization of trade over time.

We also have the World Trade Organization's 13th Ministerial Conference to look forward to. That -- really the WTO needs reform in its appellate process, in the appeals process to ensure that it can work adequately as a police person for trade. I wouldn't be overly optimistic there. So far, we haven't seen any of the major parties to the WTO look to push some sort of solution there. So we'll have some more trade deals to come through.

The biggest risk area that we'd be focused on is rivalry between the EU and U.S. with Mainland China. In 2023, that process really was marked by stricter technology export rules and a steady expansion of the coverage of those rules. In the same way, the kind of life always found a way in Jurassic Park, technology always finds a way when it comes to trade restrictions.

And what we have seen is a change now in the rules on the U.S. side to include this kind of gray zone of semiconductor rules where, effectively, the U.S. can pick and choose which chips are banned for export. And I think we're going to continue to see a degree of a -- an arms race, if you like, with the chip makers trying to find new ways to serve markets and the regulators looking for ways to try and limit it. So that's 2023 story.

2024 is very much about the risk of retaliation. Mainland China already put in place some restrictions on exports of germanium and gallium -- Mainland China's exports of germanium, very far from a complete export ban, but we did see a steady downshift in exports overall. Graphite is now being limited, and we saw a big bounce. That's the blue line in exports of graphite from China in November ahead of the new rules coming into place. So a degree of stockpiling there.

We would be very concerned about rare earths. So the Mainland China government has already started restricting the export of rare earth mining and purifying technologies, and it's also tightened the export license rules for the rare earths themselves. That may force a number of industries, including electric vehicles and renewable energy, to look at the alternative downstream options. So it's going to take a long time to build out critical mineral and rare earth supply chains in Europe, in the U.S. and elsewhere.

So in the meantime, it could be very much about trying to just find alternative supplies of permanent magnets. Even there, though, Mainland China has built up its dominance. Mainland China's share of permanent magnet exports increased pretty steadily over time. We have seen Vietnam emerge as a new supplier. So there's one option there.

I'd also say that it's not just about EU, U.S., with Mainland China played out in semiconductors and in electrification. There will be other government rivalries at play and other industries at play as well. So really, it's going to pay to pay close attention to the state of this kind of retaliatory process that's coming through.

The other area of politics and regulation is around the environment. And I'll just hand over to Agnieszka to talk about the shipping part of that.

Agnieszka Maciejewska

Thank you, Chris. Yes. Moving from politics to environment. From January 2024, the EU Emissions Trading System, the ETS, will apply to all shipping coming to or leaving the EU or operating within EU waters. This system will impose an annually decreasing level of allowed emissions for companies to pay for the carbon emissions equivalent. So in 2024, the EU ETS will cover 40% of emissions measured, rising to 70% in 2025 and 100% in 2026. 2026 will be the year also when the ETS will cover not only carbon dioxide emissions, but also methane and nitrous oxide.

On average, the EU ETS should add around EUR 25 to the Red Sea shipping rate per TEU, but this may differ for dry and reefer containers and depend on the trade route as services that start or end outside of the EU will only be charged 50%, leaving the third country to decide on carbon charges in its jurisdiction. However, some logistic companies are already indicating that the cost might be significantly higher.

And on the other hand, there is International Maritime Organization and its carbon intensity indicator for ships of 5,000 gross tonnage and above. It is also coming to force in 2024 when the emissions reductions are required to commence. This system will assess and drag the environmental efficiency of individual ships by linking their greenhouse gas emissions to the amount of cargo they carry and the distance they travel.

The CII system will gradually tighten exactly as the ETS. So it will be setting stricter thresholds that ships must meet to ensure compliance. Each vessel would be graded on a scale from A, which means good, to E, poor. So if a ship receives 3 consecutive years of D grades or 1 year of an E grade, it will be required to implement a corrective plan -- action plan to improve its environmental performance.

So this year, already this year and towards 2026, or intensively, we may start to see more impact of environmental rules. This is -- there is no indication of scrapping the old vessels of a massive scale yet, but let's wait and see.

Chris Rogers

Yes. Thanks very much. So I think one of the important points is we're moving from a period where we've all gone to lots of webinars and conferences over the past 5 years where the environmental policies are going to start costing money at some stage, and some stage is now, right. This is really where the rubber hits the road in terms of higher costs, whether it's the EU ETS and IMO or whether it's the start of the implementation of other restrictions.

The EU Carbon Border Adjustment Mechanism, CBAM, has gone from being something that's hardly anyone talks about to now being something that everyone talks about. Clearly, that matters right now because we're at the start of the process of reporting data. And that's going to allow more and more companies to more adequately track where their exposures are.

So just to recap, the EU Carbon Border Adjustment Mechanism will apply different duties effectively on imports, depending on the emissions of the source country. The details of the rules are all still being nailed down. You're going to have complexity, like if you make -- so India, for example, is a big destination, for example, for U.K. scrap steel exports. If a steel product is imported back to the EU from India having gone from the U.K., what were its overall emissions? Those are very difficult questions to answer given the importance of these kind of long-distance circular supply chains.

The payments in the CBAM won't begin to take place until 2026. And so what we're going to see in the meantime is how other countries and other regions react. So the U.K., for example, is having to put in place its own version of CBAM because EU is so important. So for most products, it accounts for at least half of U.K. exports. As a consequence of which, we do have a U.K. CBAM, but it's being put in place a year later than the EU scheme. So 2026 steel supplies, we think there's going to be a lot of volatility as supply chain is trying to find a new equilibrium.

It's also not immediately clear, are these costs going to be passed through to consumers. Is it just treated as another cost of doing business? Will there be surcharges applied? This is all very uncertain at this stage. The good news is, as I say, whilst there's cash costs associated with shipping right now, the CBAM costs still have a little bit further to go. But really, firms should be investing in tracking their data right now.

The regulatory load is increasing more broadly as well. We've talked about the EU deforestation-free directive. One of the challenges for exporters from Africa is it's generally dealing with very small suppliers that may not have the wherewithal to complete the paperwork. So we may see a reorientation of supply chains reflecting that. And again, that's being phased in over time.

We've got the EU corporate sustainability directive, that requires a lot more reporting. And for all of these areas implied by the EU, we're going to see reactions, and frankly, but also retaliation from other countries.

Moving from politics to resilience strategies. We had a question already saying, what are the most important supply chain resilience methods for 2024 and beyond? I think the first point to make is that it's tempting to not spend on resilience at the moment because it's extra costs at a time when companies are beginning to struggle.

Generally speaking, manufacturing is under pressure. And as a consequence, when you've got depressed activity, higher costs, higher interest rates, that's going to cut the funds available for investment in resilient strategies, even though with all the Red Sea disruptions, we've just had yet another reminder of how important resilience is.

What we're seeing is a preference for strategies that can both cut costs and cut risk rather than those that cut risk but add costs. In terms of diversification by a number of suppliers, on inventory management, more inventories going to just in case, that can cut risk, but again, having more inventories at a time of high interest rates is a difficult trade to make.

What we have seen, though, is it's really something of a cyclical strategy. So a lot of retailers are cutting their inventories at the moment because they have too much in the first place. But as the auto industry have just found in the past few days, running your inventories too low does leave you exposed to short-term disruptions.

Reshoring is really kind of where you hit the sweet spot. It can cut your political risk, it can cut your physical risk if you move to a shorter supply chain. It can also cut your costs, again, lower logistics costs or you can look to shift to a lower cost environment. However, there's no perfect switch here.

Moving to different countries or different regions gives you different risks. So you might move away from Mainland China to reduce your regulatory burden. But if you move to India, you're picking up higher labor strike risk. If you move to Mexico, you're picking up higher policy instability risk.

One country that does look interesting on those risk measures is Malaysia. It's a country that's really developed its semiconductor industry or semiconducting devices industry, including solar PV. And in our research in the coming months, we'll be doing more of the reshoring analysis and looking at countries across Southeast Asia.

So to bring all of that together, we are in a situation now where supply chains are facing a new round of physical risk, new round of political risk. Activity is recovering in global trade, but at slow rate. And supply chain decision-makers have got to choose whether to make these resilience investments in a high-cost environment. We think they should. Whether they do or not remains to be seen, of course.

So with that, the one piece of advice I'd give is don't get cheap on spending on resilience. It's very tempting when activity is slowing or is slow when costs are high to put cost cutting through at any cost. It doesn't need to be a radical change in your existing supply chain. It could just be improved investments in technology rather than the full reshoring plan. But continuing to invest in resilience even during tough times will always help you. And as Agnieszka said, be ready for anything.

Agnieszka Maciejewska

Okay. That's it. Thank you for being with us today. In the next quarter, hopefully, having a brighter outlook for you. Thank you for joining us.