Supply Chain General 620ba1ff8e815

Supply Chain: Shifting Winds to Watch for in the 2nd Half of 2022

June 29, 2022
China restarts, semiconductor shifts and a sinking oil rig in Yemen factor into the global calculus.

The second quarter of 2022 has been a time of both new and continued disruption. The world remains a turbulent place and these five ongoing trends will impact global manufacturing, and result in a re-engineering of most companies' supply chains.  

1. China reopening cities after the expected post-Olympic COVID lockdowns

As China continues to reopen, recovery is in sight. China’s announced plans to ease COVID restrictions in Shanghai and Beijing are signs of progress and hope; however, the zero-COVID policy still presents a significant and unmitigated risk of further economic closures. The months-long shutdowns of Shanghai and Beijing had a significant impact on both manufacturing and supply chains domestically in China and across the entire world.  China remains the world's manufacturer, but we see increasing signs of regionalization and localization as manufacturers move away from the large Center of Excellence plants to a more distributed manufacturing model.  When China is hit with the next wave of COVID, we see the official zero-COVID policy driving additional disruptions in global manufacturing, supply chains and logistics. 

2. Return of the global shipping crisis

The restart of the Chinese economy will happen rapidly. As Chinese manufacturing resumes at pace in Q3, we will see renewed port congestion, first in China and then in the Americas and Europe. Shipping rates will again climb, and this will be further complicated by the loss of the rail link connecting China to Europe due to the war in Ukraine. An already overloaded and broken sea freight system is now further stressed, with more than a million additional containers that need to be moved from China to Europe on sea routes.

The Chinese, European and North America ports, which were already experiencing high volumes, will be hit hard by this next shipping bubble, but there is little that can be done to prepare. Costs to ship will increase, and shipping times will extend. We see the global shipping crisis continuing through the reminder of 2022.

3. Shifts in the semiconductor industry

The global semiconductor industry has been impacted by the neon gas shortages (pre-war, Ukraine was a primary producer), in addition to the ongoing COVID demand shifts. The new foundries that have been announced will help fill demand, but there remains a gap between planned production and future demand that will see shortages continue beyond the current builds.

The inability of Congress and governments around the world to free significant capital to build new capacity will impact consumers and be a contributing factor in ongoing higher inflation. Qualcomm’s interest in setting up a consortium to purchase the assets of processor designer Arm that are currently held by SoftBank is a clear indication that companies that have traditionally been against Capex on the balance sheet now see a need to control production assets. 

The wholesale outsourcing of semiconductors will be impacted by end users investing in additional fabrication capacity; however, we believe we remain three to five years from equilibrium.

Any move by China to take Taiwan will be seen as a black swan event, but it's highly predictable and will have a shocking impact across the global semiconductor sector and could trigger a global shortage/crisis if the island’s manufacturing capability is impacted in an invasion.  The increasing penetration flights into the air defense zone, and full backing of support from President Biden, have raised the stakes to new levels.

4. The ongoing Russian war in Ukraine  

The Russian war in Ukraine is driving a large humanitarian crisis.  Europe has stepped up to take in the Ukrainians who have fled the war as refugees, and there may be some positive impact for the countries absorbing these people as labor shortages are eased in areas where Ukrainian women are taking jobs. The true horrors of the war will not become clear until the hostilities stop, and we cannot predict when this will happen.

Beyond the immediate human toll of the war, there are real disruptions in manufacturing and food production. The loss of capable low-cost manufacturing in the Ukraine was most visible in the automotive sector to start. Now the disruptions have spread, and we see the continued disruption of neon gas production further impacting semiconductor production and Russian oil and gas restriction increasingly impacting Europe. until they become critical as the weather once again turns colder.

The war is a human tragedy that has already led to grain shortages and is driving core inflation through higher energy and food prices. It appears that food production has essentially come to a halt across Ukraine, and accusations are being made that the Ukrainian grain stores in the occupied areas are being moved by the Russians. Many large poultry farms had to destroy their animals due to lack of power, feed and water. Grain has not been planted this spring because farmers are at war, and we expect this pain to be felt in the fall and winter when fields cannot be harvested, and the food inflation accelerates.  These disruptions are having a massive impact, which we believe will drive inflation that will put and keep Europe in a recession. 

5. The potential for the largest-ever oil-related environmental disaster as the FSO Safer corrodes on the Red Sea. 

The FSO Safer is the black-swan event that the world does not want to see. As of this writing, off the coast of Yemen, there is a storage tanker holding more than 1.1 million barrels of oil. The Yemen civil war caused maintenance activities on the boat to stop, and there is a belief that it will break up when storms hit in September, if not sooner. 

If this ship breaks up, it will be the largest man-made environmental disaster in the history of the world. Oil will cover the Yemen coast down to Somalia, and the sea here is where life comes from for the people. 

Many will ask why we should care about a pending disaster in Africa, and the answer is simple: it will cause an estimated $40 billion dollars of damage and create a massive humanitarian crisis in a war zone. Saltwater desalination is the way most of the water in the region is generated. In the event that there is a massive oil spill, then we expect chaos and more global instability to emerge. Because of the war, the cost of offloading the oil from the FSO Safer will fall on western governments and is estimated at more than two hundred million dollars, but radicalization in the region and a mass humanitarian crisis in addition to the clean-up will cost the world more and impact the global economy in ways we do not yet understand.  

We had expected the major trigger this quarter to be COVID containment measures imposed by China after the completion of the Olympics; however, these measures were overshadowed by the Russian invasion of Ukraine. We have a humanitarian crisis in Europe that echoes those last seen during World War II, with projections of millions of people displaced from Ukraine. Having this in the background makes it hard to fully assess the economic devastation that this invasion triggered in Europe. The manufacturing plant shutdowns in the automotive sector alone are rapidly creating a recession from which it will take some effort to escape. Automotive manufacturers including VW and BMW were forced to close plants because of Ukraine-related supply chain disruptions. New car production remains constrained—and coupled with food and fuel, will drive inflation for the foreseeable future.  Our clients who are actively localizing or regionalizing production seem to be on the right path, but there are many companies that believe low-cost-country sourcing will continue to be the best path forward. I challenge that thinking as the wage arbitrage that drove those initial sourcing models has given way to tariffs and transportation costs. 

Among all the uncertainties, it is certain that the world will not, any time soon, be the old peaceful land where past globalization flourished. Prioritizing selected markets and supply chains by reshoring some or most of the high-value production will be a significant decision to make, but the risk cost embedded in the past global coordination supply chain model is simply now too high to ignore.

As a society, we need to also think which one is more important: lower cost for unpredictable supply or higher early investment for more ensured manufacturing completeness.  

Ambrose Conroy is founder and CEO of Seraph, an expert global supply chain/manufacturing turnaround consultancy. He launched the firm to bring together a collection of top industry talent to help firms take action to improve their operations. Prior to Seraph, Ambrose was the vice president of Supply Chain Solutions at NAI Global. His areas of expertise include M&A, crisis management, restructuring and turnaround.

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