Shipwrecked: Why everything may soon cost more

March 26, 2024

Let’s say you want to buy an iPhone. What do you do? You figure out what model to buy, place an order on Amazon and probably get the delivery on the same day. We’ve become so used to the convenience of shopping online that we don’t think about what happens in the background for you to get that phone.

Most iPhones are manufactured in China, using components that are sourced from hundreds of suppliers across the world. For example, the battery might come from China, memory chips from Japan, displays from South Korea and so on. If you look one level deeper, the rare earth minerals required in their manufacturing come from Brazil, Congo, Australia, China etc. All these parts are then finally assembled in China and then the finished devices are shipped all over the world.

The one common element in this entire process is that most of these components, at some point in the manufacturing process, spent time on a ship. About 80% of international trade volumes are carried over the seas. Everything from the fuel in your vehicle, to the toys your kids play with, to the fruits you eat, to the electronic device you are using to read this article probably came to India on a ship.

OEC

Without oceanic shipping, we wouldn’t have globalization and we wouldn’t be enjoying the benefits of cheap products. Think of it this way: the seas are the arteries of the global economy. If they get clogged, the global economy could have a heart attack.

You don’t have to look too far back to know what this heart attack would look like. From 2020-2023, globally supply chains experienced a crisis like never before. Everything from critical semiconductors, toilet paper to baby formula was in short supply around the world.
Why?

Let me explain what happened between 2021-2023 because it’ll help you understand what’s happening today. 

Shipmap


The 2021 global supply chain crisis rewind

When COVID-19 made its unwelcome entry, the entire global economy shut down. Factories around the world reduced production or shut down completely. In 2020, the base case for the global economy, it seemed, was a super slow recovery. What happened, however, was the exact opposite.

Between 2020 and 2021, pretty much all countries unveiled stimulus programs to reduce the economic fallout. US and Europe introduced the most dramatic of these stimulus measures. Governments put trillions of dollars directly into the hands of consumers. As 2021 dawned, countries slowly started reopening.

When the global economy reopened, consumers were flush with cash and they went on a revenge shopping spree. With people still stuck at home, there was also a shift in demand from services to goods, because restaurants, entertainment centers, malls and other establishments were still closed. This led to a massive spike in the demand for all sorts of products.

But there was a problem. Right when shoppers around the world were furiously ordering stuff from e-commerce platforms, manufacturing powerhouses like China and Vietnam were intensifying their lockdowns. Their factories were operating well below capacity. They were also grappling with labor shortages due to their lockdowns. So the demand for goods outsripped production in places, leading to massive shortages and price increases.

This demand-supply mismatch rippled outwards, affecting logistics. When the world had locked down, ships dumped their containers at their destination ports in the US and Europe instead of picking up empty containers on their way back to Asia. When the US reopened and consumers were hungry for stuff, a container shortage erupted because all the empty containers were in the wrong places. This led to further increases in shipping costs and prices of goods.

Later, as ships from Asia started making their way to the US and Europe again, there was massive congestion in ports because the demand outripped the capacity of the ports. At the same time, there were issues downstream of ports as well.

Once containers land in ports, most of them are transported by trucks to their destinations. Thanks to COVID, there was a shortage of truck drivers and truck chassis. This, in turn, led to a buildup of full containers at US and European ports. The long turnaround times in US and European ports further worsened the container shortage in Asian ports that wanted to ship goods.

All this led to severe disruptions in manufacturing, shortages of goods at retailers and massive spikes in shipping costs and the final prices of goods. The 2021-2023 supply chain crisis was a key contributing factor to the global inflationary shock. The crisis demonstrated just how interconnected global supply chains are. One disruption anywhere in the supply chain can lead to ripple effects that affect other parts of the system.

During this period, retailers had to grapple with high demand and low inventory, so they ordered more from their suppliers. This worsened things ever further:

Step 1: Retailers order more goods.

Step 2: Manufacturers get the order and they now order the raw materials. Some of these raw materials probably have to arrive on ships, which leads to further container shortages and worsens port congestion.

Step 3: Manufacturers, after delays, finish manufacturing and have to ship the goods. But again, containers are in short supply so they offer to pay more for shipping containers which are in short supply. They also offer to pay more for shipping, which further leads to an increase in transport costs.

Step 4: Somehow the goods arrive at the destination. Port congestion worsens. This then ripples out and affects the demand and supply of trucks and railcars that carry the goods from ports to the final destinations.

So one small disruption in a supply chain ripples out and affects everything else.

It has taken some time for these issues to resolve themselves. But we may soon have another shipping crisis on our hands with the same ripple effects on global trade. In response to the Israeli invasion of Gaza, Houthis, the Iran-backed military group, are attacking ships passing through the Red Sea, a major trade route in maritime shipping, to show their support for the Palestinians. As if this wasn’t bad enough, Panama canal, another key maritime trade route, is also experiencing a disruption due to severe drought.

Will these crises lead to inflation and toilet paper shortages again? Let’s understand.


The Houthis block the Red Sea

The Houthi militant group is based in war-torn Yemen, a country that sits right at the beginning of the Bab-el-Mandeb, or the ‘Gate of Tears’. The Bab-el-Mandeb is a narrow strait between Yemen, Djibouti, and Eritrea in the Horn of Africa, and acts as a gateway between the Indian Ocean and Red Sea. It is a natural choke point on the maritime route between Europe and Asia. 12% of global trade, 8–10% of the world’s oil, and 8% of its liquefied natural gas (LNG) passes through the Bab-el-Mandeb. This, it’s safe to say, makes it one of the world’s most important shipping lanes.

At its narrowest point, the strait is 18–20 miles wide. The Houthis have turned this narrow region into a shooting gallery, attacking container ships and tankers with drones and missiles supplied by Iran. So far, they’ve sunk a ship and damaged dozens of others. The biggest fallout, though, is the fact that they’ve managed to stop major shipping lines from using the Bab El-Mandeb route, which connects to the Suez Canal.

Why should I care?

The Bab-el-Mandeb sits at the mouth of a shortcut between Asia and Europe, allowing ships to by-pass all of Africa. If they can’t go through, they’ll have to take the long way around the Cape of Good Hope. This adds 3,000-3,500 nautical miles or over 6,000 kilometers to their journey.

EIA

The crisis has caused shipping costs to jump as much as 200-500%, along with added war insurance costs. So far, this spike in shipping costs isn’t as dramatic as the post-pandemic rise. But things can escalate quickly. During the worst of the inflation shock during 2021-2023, companies passed on a lot of the price increases, and so, they are in a position to absorb some costs for now. If the current crisis worsens and leads to increased shipping and insurance costs, however, companies will be forced to pass the costs to the consumers.

Although the crisis in the Red Sea hasn’t yet led to an increase in the price of goods, the situation is still fluid. The US and UK launched Operation Prosperity Guardian to protect shipping in the area, with mixed results. The European Union, which was hit the worst by the crisis, announced its own mission a few weeks ago.

SSGA

What’s the fallout?

Automakers and auto component manufacturers seem hit the worst, so far, given the centrality of Asia in auto supply chains. Several Europe-based auto plants have announced production shutdowns in response. CRISIL recently published a report analyzing the crisis’ impact on India, and fertilizer imports and capital goods have been affected the most.


When it rains (and when it doesn’t), it pours

Like the Suez Canal, the Panama Canal is another critical choke point for maritime trade. The Panama Canal is a man-made canal that connects the Atlantic and the Pacific ocean. About 1000 ships pass through it each month. It’s a critical trade route for America and the countries on the West Coast of South America like Ecuador, Chile and Peru. About 5% of global trade and 12% of US trade passes through the canal. If not for the canal, ships had to travel all the way around South America which adds thousands of miles of additional travel.

Maritime chokepoints

The Panama Canal is a modern engineering marvel. In connecting the Pacific and the Atlantic oceans, it has to solve a crucial challenge: the Pacific Ocean is a little higher than the Atlantic. And so, its architects came up with an ingenious system. The canal has a set of locks. Whenever a ship passes through, the locks are used to draw water from a nearby artificial lake and raise them 26 meters above sea level and drop the ships on the other side, and vice versa.

The way the canal works is actually crazy. Watch this video to get a sense of things.

What’s the problem?

For a ship to pass through the canal, about 52 million gallons of water is required. It draws this water from Lake Gatun, an artificial lake which relies on rainwater. The problem, however, is that Panama is facing a severe drought due to the rising intensity of climate change. On a regular day, about 36 ships can pass through the canal. This was cut down to 24 due to lack of water in the lake. The total ships crossing, as a result, have fallen by 30-40%.

About 40% of all US container traffic passes through the Panama Canal, carrying more than $270 billion worth of goods. The lack of water in the canal has impacts across the board, affecting everything from the export of grains, automobiles, to import of steel, chemicals, auto parts, pharmaceuticals and textiles. The canal is also a key transit point for energy imports and exports in and out of the US.


When things are going well, most regular people don’t bother about the sleepy world of maritime trade. But the supply chain crisis of 2021-2023 and the simultaneous crisis in the Suez Canal and Panama Canal, which together account for about 18% of global trade, have shown how vital the oceans are to the global economy.

IMF

There are more fascinating aspects to oceanic trade and I’m somewhat of an amateur shipping geek. Long ago, I had written about the history of the shipping container and how it changed the world. I’ll continue to write about this crisis as it unfolds and how it affects us all in the upcoming issues.

Financial analyst and researcher at Zerodha


Post a comment




1 comments
  1. Ajay Sharma says:

    Keep it up the Good Business. God bless you