Security Risks in the Red Sea Put Global Supply Chains in Peril
Overview
In November 2023, the Houthis, a rebel group in Yemen allied with Iran, Hezbollah, and Hamas, began threatening and attacking cargo ships passing through the Red Sea’s Suez Canal to pressure Israel to cease its war in Palestine. Since November, the US Department of Defense has registered thirty-three attacks on commercial shipping vehicles, and has retaliated with a joint force from Australia, Bahrain, Canada, and the Netherlands.
- 15% of global shipping traffic and 10% of seaborne oil regularly travel through the Red Sea.
- In response to the heightened security risks, fourteen major seaborne shipping companies have reported ceasing operations in the region.
- Companies are citing difficulties in recruiting sailors, now demanding double pay, as well as dramatic increases in insurance requirements, all of which is expected to be passed on to consumers over the next six months as the conflict continues.
Implications on the global economy
As disputes between Israel and Hamas continue, disruptions and attacks in the Red Sea are leading the world’s largest seaborne shipping companies to divert to other means of transport, or to find new, longer, and more costly routes for world shipping trade. Flexport, a global logistics platform, reports that over a quarter of the world’s seaborne trade has already rerouted itself around Africa’s Cape of Good Hope. As seaborne shippers divert, economists are predicting a 0.7% increase in the price of goods for the first half of this year in a global market already beset by inflation.
In response to Houthi forces attacking and boarding cargo ships in the Red Sea, shipping groups have rerouted and are encouraging a trade diversion around the Cape of Good Hope. The US alongside the United Kingdom, Bahrain, Canada, France, Italy, Netherlands, Norway, Seychelles and Spain launched a coalition force to protect cargo ships from potential attacks.
The extended routes cargo ships must take around the Cape of Good Hope adds an additional 10 days to the normal route, increasing gas prices to cost around $900,000 per trip. These additional transportation costs are expected to be passed onto consumers across industries reliant on global shipping. As of January 21, average worldwide costs of a 40-foot container rose to $3,777, up 23% from the week before.
The fear of a prolonged crisis may lead to inflationary pressures. For example, shipping company Honour Lane expects the Red Sea situation to last 6 months to a year, keeping shipping rates high through the third quarter. Shell expects a 5-10% increase in prices in the short term. Further knock-on effects include increased congestion and slowdowns in European ports and terminals. The upside risks to inflationary pressures may be that central banks delay interest rate cuts.
When the Suez Canal was obstructed in March 2021 after the Ever Given container ship ran aground, the economic losses were estimated to be $9.6 billion per day. The current crisis may parallel the 2021 disruption and have a similar economic effect, and it may endure for a longer period.
Shipped international goods typically would move through alternate routes, such as the Panama Canal. But because the Panama Canal is facing an ongoing severe drought, diverting intercontinental trade through this canal may not be feasible. Organizations have cut the Canal as a potential route, eliminating more than 36% of transits. Experts and Panama Canal administrators have estimated the lower water levels will cost around $500 million and $700 million in 2024 alone.
Implications on Gas, Oil, and Petrochemical Products
While the cost of oil and gas are constantly changing, the implications led by the diversion of the Suez Canal are evident. 12% of global trade passing through the Red Sea is composed of traded oil, while an additional 8% is natural gas. Much of this oil and gas is shipped through the Bab el-Mandeb strait just west of Yemen, or the Strait of Hormuz on the other side of Saudi Arabia connecting the Persian Gulf to the Indian Ocean. While the Bab el-Mandeb strait can be circumvented with a costly trip around the Cape of Good Hope, the Strait of Hormuz has no such alternative waterway for the Gulf producers’ oil and gas exports.
While the Houthi attacks have not yet expanded to the Hormuz Strait, and risks of conflict expansion remain a low-probability, observers suggest that they are nonetheless heightened. Iran’s seizure of an oil tanker in the Gulf of Oman on January 11 is a source of this apprehension. Qatar has delayed shipments of liquid natural gas (LNG) to Europe amid rising risks.
The price of crude oil itself has, for the time being, remained surprisingly constant. Prices per barrel currently range between $74-$79, with increased production in Libya and Norway counterbalancing the impact of the security shocks in the Red Sea.
In terms of tracking the impact on prices of chemicals and petrochemical products, economists are tracking an increase in market prices. By mid-January market prices for some chemical products tripled in cost. Many believe the increased pricing is justifiable to pay for heightened security on ships and taking safer and longer routes. However, companies are beginning to worry about the duration of the conflicts and how long they will be able to support the vessels at the newer pricing levels.
Implications on Retail and Food
Retail is facing added pressures, with the disruptions coinciding with time constraints regarding spring marketing. Some companies are facing weeks-long delays and cost increases of $300-$500 per container. Various retail companies are managing these uncertainties by diverting to air freight shipments, and analysts at Xeneta have reported a 62% increase in air shipments from Vietnam to Europe, indicating a major route for apparel manufacturers and retailers is shifting to more expensive modes of transport.
Food shipments face even greater time constraints and are particularly impacted by supply-chain disruptions. While many geopolitical crises, such as conflict in the Middle East have led to supply chain dilemmas, so has the ongoing war between Russia and Ukraine. Ukraine is one of the leading exporters of grain, and the territory dispute had caused an increase in export prices, and a 29% drop in grain production between 2022 to 2023. An estimated 20%-30% of wheat exports from the EU, Russia, and Ukraine would be impacted if cargo must be rerouted from the Suez Canal to the Cape of Good Hope. While the tangible impacts have yet to play out, the impact on prices may be an initial increase as producers seek to account for risks of spoiled products amid delays.
Conclusion
Clients should be conducting assessments on the impacts of these potentially prolonged geopolitical events for their supply chains and costs to consumers. With increasing prices for inputs of the production of goods, and their transportation potentially rising, corporations should be evaluating how to mitigate the potential effects on their brand and business.
