From The Economist's Chair: The spectre at the feast

Author David Fyfe, Argus Chief Economist

Supply chain bottlenecks, rising commodity prices and uneven progress in re-opening characterise today’s global markets, as vaccine success prompts hopes for more widespread economic recovery. But the spectre of a renewed inflationary spiral is clouding the outlook. Although cyclical inflation pressures may ease, economic regeneration efforts, energy transition, and attempts to re-shore manufacturing could raise supply chain costs longer term.

The commodity narrative turns bullish

Rising commodity prices since late-2020 have augmented broader manufacturing cost inflation. This has coincided with an asymmetric economic recovery and global supply-chain bottlenecks. Shipping, manpower and supply dislocations may prove temporary, but have been 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.

Commodity strength persists into June

Many of the immediate cost pressures represent the sorts of dislocation one would expect as the world economy begins to adapt to what may prove a more pandemic-prone future. Some cyclical inflation drivers may ease during 2022 and 2023 as broader recovery takes root and growth rates normalise.

However, other more structural factors could persist and raise industrial costs longer term. These include economic restructuring efforts, energy transition, and attempts to re-shore manufacturing and bolster supply chain resilience.

China’s strong import demand for key commodities has underpinned price strength in 1H21. Overall commodity imports there are up by +6% year-on-year for January-May, easing from the aggregate +9% growth seen in 2020.

Demand for LNG, iron ore and copper however have been buoyant, with Chinese industry having seen a sharper rebound than elsewhere after the low-point in first quarter last year.

Arguably, a prevailing commodity “super-cycle” narrative is being fuelled largely by industrial metals, much more so than for other commodities whose fundamentals look more mixed.

Resurgent trade exposes vulnerabilities

Global trade has rebounded much more rapidly since mid-2020 than was the case after the Great Financial Recession a decade ago.

World trade rebounds faster than in 2009/2010

A combination of accommodative monetary and fiscal policy ($6 trillion of proposed US stimulus alone), and excess accumulated household savings (some $5 trillion in the advanced economies), plus a well-entrenched consumer expectation of “goods-on-demand” have sustained strong demand for bulk commodity and container shipping amid economic recovery.

The growth in international trade in 2021 is widely expected to average 8%-10%.

Coinciding with strong merchandise trade growth have been weather extremes that have disrupted supply. Texas energy producers and manufacturers alike were hit by freezing February weather, June has seen a heatwave strain Texas and California power supply, while forecasters anticipate the 2021 Atlantic hurricane season could also prove more than usually disruptive.

The worst drought in 55 years in Taiwan has exacerbated a shortage of semi-conductors worldwide. Oxford Economics estimates that semiconductor supply shortages will trim first-half 2021 GDP by up to 0.3pp in key automotive producing countries, with delivery delays persisting into 2022.

Early-May saw the 2.5 mb/d Colonial Pipeline System, which feeds refined oil products from US Gulf refineries to southern and eastern states, shuttered by a ransomware attack. Although disruption lasted only a week, this highlighted the increased vulnerability of manufacturing, transportation and energy supply to cyber-attacks.

With global process automation and electrification only likely to accelerate in future, such attacks risk becoming more frequent and disruptive, unless grid and supply chain investment rises to meet the challenge.

Bulk freight costs ascending

Sticky supply chains amid unprecedented demand recovery have recently pushed container and dry bulk shipping costs to decade-highs, further stoking broader price inflation in the world economy. A prevailing assumption of “lower-for-longer” interest rates has been called into question if central banks confront an inflationary spiral.

However, despite concerns over the damage this combination could inflict on economic recovery, the short-run inflationary narrative has only helped to bid commodity prices higher, given their perceived value as a hedge against broader price inflation.

Bulk and containers freight surge continues

The pressures driving bulk freight costs higher in recent months have been several – a strong (though unevenly distributed) rebound in commodity and merchandise goods demand, manpower and infrastructure bottlenecks, plus uneven supply-side recovery after the worst of the pandemic.

The grounding of the container vessel Ever Given in the Suez Canal in March typified the strains under which global supply chains now operate. While it was not a direct result of the pandemic, it did serve to highlight the vulnerability of global trade to disruptions at key choke points.

And while the Ever Given was freed within a week, many shipping industry sources envisage broader logistical and manpower bottlenecks persisting until late-2021 or beyond.

The geopolitical dimension

Heightened geopolitical tensions and proliferating trade disputes were evident well before the Coronavirus pandemic. Its aftermath could render resolution of these issues still more problematic.

Some of China’s Asian neighbours seek to loosen their economic dependence on the Middle Kingdom as relations have soured over maritime territorial disputes, elevated debt incurred on Belt and Road Initiative (BRI) projects, and perceived human rights abuses. For its part, China is seeking to boost self-reliance in energy and strategic high-tech manufacturing.

Accounting as it does for some 30% of world manufacturing, and 27% of key commodities trade, China’s policies to boost self-sufficiency, and its trading partners’ efforts to diversify sources of manufactured goods supply, will profoundly affect both supply chains and their costs for years to come.

Geopolitical impediments to trade are about more than just China though. The incoming Biden Administration has already reinvigorated the US’ multilateral engagement, but is likely to retain a policy of ongoing diplomatic pressure on Iran, Russia and China for the foreseeable future.

UK and European industry confronts trade frictions after Brexit, and simmering political instability in Latin America and the Middle East could also impede future commodity trade flows.

Predictions that the peak of globalisation has passed may be premature, but the next decade is shaping up to be one in which international commerce becomes more complex. As such, there may be trade-offs for supply chain costs too.

Decarbonisation will be expensive and likely sustain international commodity trade

Governments worldwide have recited a “build back better” mantra as shorthand for efforts to ensure economic recovery post-Covid incorporates environmental sustainability as an essential pre-requisite.

Recent months have seen a proliferation of national target announcements for greenhouse gas emission reductions by 2050.

While detailed policy solutions to achieve these goals are rather less well developed, what is clear is a trend towards broader and deeper electrification of the global economy.

Recent IEA analysis suggests this could multiply unit metals/minerals requirements six-to-eight-fold for the transportation and power supply sectors relative to existing, hydrocarbon-based technologies.

With 80% of traded global merchandise moving by sea, supply chain costs will also 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, slower sailing and a switch to LNG, but longer-term limits for 2050 could require significant propulsion by non-hydrocarbon sources such as ammonia or hydrogen, with clear cost implications here too.

The pandemic may initially delay an international ban on single-use plastics, since these were essential raw materials for the personal protective equipment (PPE) that has been vital for dealing with the pandemic these last 15 months.

However, plastics recycling as an issue will not disappear, with implications notably for the polyethylene sector, and despite recycled plastic being currently twice as costly as new product.

Resilience vs. optimisation

The cyclical factors underpinning the current episode of supply chain inflation will, by definition, prove temporary. Dislocations were inevitable after the 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. Cost pressures could further ease as economic growth and trade expansion moderate towards historical trend levels.

But there are structural as well as cyclical factors at play. Urban encroachment and land use pressures risk making epidemics/pandemics more frequent. Automation and electrification come with an increased risk of cyber-attack.

Upwards of a hundred trillion dollars of investment is required to diversify the fuel mix by 2050, building new grids, storage systems and commodity 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 prioritised the concept of supply resilience for strategic goods and commodities via a shift towards indigenous or more local manufacturing capability, and supply chain diversification.

This necessarily implies a trade-off between higher-cost transport and storage solutions in future in return for more secure, local or diversified sources of supply.

Uncertainties abound after such a tumultuous and largely unanticipated market disruption in 2020, but structural increases in supply-chain costs seem like a fair bet for the medium and longer term.

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