INDUSTRY INSIGHTThought Leadership

Supply-chain inflation: here to stay?

By David Fyfe, Chief Economist, Argus Media

Petrochemical prices, like most commodities, have strengthened since late-2020. Global supply-chain bottlenecks alongside asymmetric economic recovery have fed manufacturing price inflation. Contributory shipping, manpower and supply dislocations may prove temporary, but were compounded by ongoing fragilities involving long-haul trade, extreme weather, transit choke points and cyber-attack. Simmering geopolitical and trade tensions are proving disruptive too. Although cyclical inflation drivers may ease, economic regeneration choices, energy transition, and the reshoring of manufacturing could raise costs longer term.

Fundamental challenges for the petrochemical sector

Major Asian petrochemical capacity expansions for 2021 were expected at six million tons each of polyethylene (PE) and polypropylene (PP), and a further 12 million tons of ethylene. Producers had envisaged ongoing demand recovery in a world emerging from the Covid-19 slump.

Polymer prices surged from mid-February through late-March, partly due to soaring freight costs following a blockage of the Suez Canal by the grounded vessel Ever Given. However, prices have receded since April, with resurgent Covid-19 affecting India, Thailand and Malaysia among others. In the Middle East at late-May, combined daily new cases in Iran, Iraq and Kuwait were double December’s levels. Regionally, offtake in South & SE Asia and the Middle East is being hit by virus resurgence, manpower shortages are affecting processor operating rates and new capacity start-ups may also be slowed until broader demand recovery materialises.

Alternative markets in faster-recovering China and the Atlantic Basin would normally provide an offset. However, vessel and container supply has been disrupted for Asian and Middle Eastern producers alike, inflating shipping rates, despite weaker regional demand. AP Moller and others suggest elevated freight rates could extend into late-2021.

Shipping issues tighten supply-chains

Container and dry bulk shipping costs recently hit decade-highs, feeding broader price inflation in the world economy. Longer duration low interest rates have been called into question. However, despite concerns over the damage an inflationary spiral (and higher interest rates) could inflict on economic recovery, the short-run inflationary narrative is fuelling commodity price rises, with commodities traditionally a hedge against broader market inflation.

Shippers have confronted a “perfect storm” in recent months, as a strong (though unevenly distributed) rebound in commodity and merchandise goods demand has combined with manpower and infrastructure bottlenecks, exacerbated by the world’s slow return towards “normality” from the depths of the pandemic. Depleted inventory, mothballed supply capacity, displaced or idled logistical and transportation capacity and tight manpower availability have seen supplies of manufacturing and selected commodities respond slowly to resurgent demand. Many see logistical bottlenecks persisting until late-2021.

Resurgent trade highlights vulnerabilities

Shipping bottlenecks are not the sole cause. Global trade has rebounded much more quickly since mid-2020 than after the Great Financial Recession a decade ago. Trade growth in 2021 could average 8%-10%. Accommodative monetary and fiscal policy and excess accumulated household savings, plus an entrenched expectation of “goods-on-demand” have sustained container fleet demand.

Copper and iron ore prices at mid-May were 30% above start-year levels. Chinese import demand has combined with real and anticipated supply tightness. Together with concerns over Latin American mined supply this has fed a super-cycle narrative for industrial metals, albeit less so for other commodities.

Weather extremes have also disrupted supply. A February freeze hit US energy producers and manufacturers, while the worst drought in 55 years in Taiwan has exacerbated a shortage of semi-conductors worldwide (Taiwan produces 75% of the world’s complex semiconductors). Resurgent demand has coincided with supply-chain shortages to drive prices higher. Oxford Economics estimates supply shortages in semiconductors will knock between 0.1-0.3pp off 1H 2021 GDP in key automotive producing countries, with supply chain issues potentially persisting into 2022.

More recently, the 2.5 mb/d Colonial Pipeline System, feeding refined oil products from US Gulf refineries to southern and eastern states was hit by a ransomware attack. Although disruption lasted only a week, it highlighted the rising vulnerability of manufacturing, power supply, energy systems and marine transportation to such attacks. Ongoing global process automation and electrification risk making such attacks more frequent and potentially more disruptive in future.

Barriers to trade and geopolitics

Geopolitical tensions and trade disputes pre-date the Coronavirus pandemic, but the aftermath of Covid-19 is unlikely to see speedy resolution for any of these issues.

China’s Asian neighbours are seeking to loosen their economic dependence. Territorial disputes and trade bans persist between China on one hand, and Australia, India and SE Asian countries on the other. US-Russia and US-China trade relations have soured following sanctions, UK and European suppliers confront trade frictions after Brexit, and political instability in Latin America and the Middle East could impede key commodity trade. China accounts for 30% of world manufacturing, and imports around 27% of key traded commodities, so its policies to boost self-sufficiency, and its trading partners’ efforts to diversify manufactured supplies, will profoundly affect supply chains and costs for many years to come.

Energy transition and decarbonization

Energy Transition hinges on extensive electrification of the global economy.  Recent work by the IEA suggests this could multiply unit metals/minerals requirements by six to eight times for transport and power supply, more than offsetting any reduction in hydrocarbon fuels trade.

In petrochemicals, the pandemic may initially delay an international ban on single-use plastics, which have been core to dealing with the pandemic these last 18 months. Plastics recycling as an issue will not disappear though, with implications notably for the polyethylene sector, and despite recycled plastic being currently twice as costly as new product.

Finally, with 80% of traded global merchandise moving by sea, supply chain costs will be heavily influenced by environmental regulation of the shipping industry. IMO’s 2030 GHG emission reduction targets can largely be met from vessel efficiency improvements, slow sailing and a switch to LNG, but longer-term limits for 2050 could require significant propulsion from non-hydrocarbon sources such as ammonia or hydrogen, with clear cost implications here too.

Prioritising supply-chain resilience

Cyclical factors driving this episode of supply chain inflation will prove temporary. Dislocations were inevitable after shut-down of the global economy. Extreme cost and logistical pressures could ease in 2022 as new manufacturing capacity comes onstream, and logistical assets are re-optimised to reflect shifting trade flows. Moreover, cost pressures could further ease as growth rates for both the economy and world trade moderate towards historical trend.

Less certainty surrounds other structural drivers. The world will not have to wait 100 years until the next global pandemic. Cyber-crime risks will intensify as automation and electrification increase. Investment of hundreds of trillions of dollars is required to diversify the fuel mix by 2050, building new grids, storage systems and shipment infrastructure. Although predictions of global warming amid different CO2 emission scenarios are prone to massive margins of error, extreme weather events could become more frequent. That too will prioritise greater supply chain robustness.

The pandemic has encouraged resilience via the development of indigenous manufacturing capability, or the diversification of supply chains, for strategic goods and commodities. By definition, this implies greater acceptance of higher-cost future transport and storage solutions, set against more secure, diversified or local sources of supply. Uncertainties abound after such a momentous 2020, but structural increases in supply-chain costs don’t look like a “Black Swan” phenomenon.