Supply Chain Resilience

This week there will be a Group of Seven summit in Hiroshima, Japan (more and more). Last week the finance ministers and central bank governors of Canada, France, Germany, Italy, Japan, United Kingdom, and United States (and EU too) completed their related pre-meeting. In Saturday’s joint communique, the Niigata group teed-up attention to supply chain resilience (more and more). Here’s the paragraph:

We commit to further strengthening collaboration among G7 members and beyond to enhance supply chain resilience. Our “High-level Policy Guidance for Public Finance Tools to Build Resilient Supply Chains in the Era of Decarbonization” published in April, recognizes the urgent need to address existing vulnerabilities within the highly concentrated supply chains of important products for clean energy. Diversification of supply chains can contribute to safeguarding energy security and help us to maintain macroeconomic stability. To turn the guidance into specific actions, we are currently developing “Partnership for RISE (Resilient and Inclusive Supply-chain Enhancement)” with interested countries in collaboration with the WBG and relevant international organizations with the aim of its launch by the end of this year at the latest. Through mutually beneficial cooperation by combining finance, knowledge and partnerships, RISE aims to support low- and middle-income countries in playing bigger roles in the midstream and downstream in supply chains of clean energy products.

This is an example of how diplomatic prose often makes less of more. I imagine a delegation or two originally offering something like: “We commit to further strengthening collaboration among G7 members to enhance supply chain resilience. Diversification of supply chains can contribute to safeguarding security and help us maintain macroeconomic stability. We are developing Partnership for RISE (Resilient and Inclusive Supply-chain Enhancement) for launch before the end of this year.“

Certainly vague, but enough to justify further discussion and processing for the next G7, G20, and other future consultations (including specific projects such as that noted). De-risking through friend-shoring, friend-making, and network diversification stays on the agenda. Another delegation or two, however, worries too much might be implied by this aspirational vagary. So, the implicit potential is explicitly narrowed to help low- and middle-income countries play bigger roles in midstream and downstream supply chains for decarbonization. Small steps? Perhaps, but the wrong sort of specificity can also become a strategic distraction.

Diversification of supply chains is — incrementally — moving forward because of fundamental risks (and opportunities) rather than waiting for diplomatic wordsmithing. See here and here and here and here and here and here (and much more). Substantive progress at this scope and scale can be slow, but is seldom as sluggish as too many diplomatic negotiations.

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One example of capacity concentrations in need of diversification are several so-called rare earths. Last year the Wilson Center brought together a set of related maps. One set is shown below. And… evidence of change in recent months is also available, for example, here, here, here, and here, but also here and here.

The April Consumer Price Index shows another month of stable to lower food-at-home prices (see chart below). According to the Bureau of Labor Statistics:

The food index was unchanged in April. The food at home index fell 0.2 percent over the month, following a 0.3-percent decrease in March. Four of the six major grocery store food group indexes decreased over the month. The index for fruits and vegetables decreased 0.5 percent in April, and the index for meats, poultry, fish, and eggs declined 0.3 percent over the month. The dairy and related products index decreased 0.7 percent in April as the milk index fell 2.0 percent, the largest decline in that index since February 2015. The nonalcoholic beverages index declined 0.1 percent over the month. In contrast, the index for other food at home rose 0.2 percent in April, following a 0.4-percent increase the previous month. The cereals and bakery products index increased 0.2 percent over the month, after advancing 0.6 percent in March… The food at home index rose 7.1 percent over the last 12 months. The index for cereals and bakery products rose 12.4 percent over the 12 months ending in April. The remaining major grocery store food groups posted increases ranging from 2.0 percent (fruits and vegetables) to 10.4 percent (other food at home).

This is further evidence of general equilibrium of demand and supply in the grocery sector. There are always some stock-outs. There may be somewhat more now as supply adapts to late-pandemic and post-pandemic demand patterns. But for the vast majority of SKUs in the vast majority of places, where there is effectual demand there is also supply.

The May 1 post on freight flows includes, “More has been normal — not always year-over-year, but consistently decade-over-decade.” Not for everyone, not everywhere, but by the early 18th Century the experience of more and more was widening and accelerating. Please see chart below. Since the mid 20th Century our planet’s economic output has recorded exponential rates-of-change.

Given the outcome of three-plus centuries, the expectation of more is not unreasonable. Especially since 1950, failure to lean-into anticipation of more would have been delusional. (Despite early, earnest warnings of an eventual slow-down.) The growth of effectual demand and real output has been persistent. I perceive it has also been precipitous (meaning steep, sudden, and potentially dangerous).

This rate-of-change has, of course, prompted profound consequences: economic, social, cultural, ecological, and from almost any other angle. Since 1950 the planet’s population has increased from 2.5 billion to more than 7.9 billion while the proportion “living in poverty” has declined. Just since 1990 those living in extreme poverty has declined from over one-third to less than one-tenth of total population. Much more has been much better for millions.

We are also increasingly aware of the trade-offs — and potential limits — of more and more (here and here and here).

Explosive demand has generated revolutionary changes in scope, scale, and methods of supply. Given population growth and even faster growth in demand, change has been necessary. When changes are effective, they have usually been profitable. In the 1980s Walmart demonstrated how to deliver more for less. Walmart, Amazon, and many others continue to compete by delivering even more for relatively less. Supply chain design and execution is a source of crucial competitive advantage.

Recognizing the trade-offs and limits of living on our current precipice, there are ambitious efforts underway to better sustain the ability to deliver more for less… including fewer long-term climate impacts (here and here and here). So far, supply chain sustainability and resilience seem to be compatible traveling companions. (It is, however, complicated.)

But in some places more is, arguably, no longer needed. According to Reuters, “Last year Italy recorded more than 12 deaths for every seven births and the resident population fell by 179,000 to 58.85 million… Italy could lose almost a fifth of its residents, with the population set to decline, under a baseline scenario, to 54.2 million in 2050 and 47.7 million in 2070.” The Japan Times reports, “Japan’s population shrank by 556,000 in 2022 from a year earlier to 124.9 million, marking the 12th straight year of decrease.” China’s demand will increase as per capita wealth increases. But in 2022 the population of China began what is expected to be a long-term decline (more). In most of the world’s wealthiest places, population growth is slowing or reversing.

Where and when population declines, demand for volume tends to follow. But there is evidence — already observed in Italy and Japan — that as volume becomes less exacting, velocity may become more valuable. Speed — both fast and, when appropriate, slow — becomes a key competitive differentiator. So does specific direction, both in terms of time and place and/or personal preferences and perceived value. For many consumers, quantity advantages (including related volume pricing) defer to aspects of quality… with profound implications for the production, distribution, and consumption of goods and services.

Last week UPS “announced first-quarter 2023 consolidated revenues of $22.9 billion, a 6.0% decrease from the first quarter of 2022. Consolidated operating profit was $2.5 billion, down 21.8% compared to the first quarter of 2022, and down 22.8% on an adjusted basis. Diluted earnings per share were $2.19 for the quarter; adjusted diluted earnings per share of $2.20 were 27.9% below the same period in 2022.” During a teleconference with financial analysts, Brian Newman, the CFO, explained, “In the first quarter, we expected average daily volume to decline between 3% and 4%. For the quarter, average daily volume was down 5.4% year-over-year, primarily because volume in March moved lower than we expected.” This is consistent with other freight market measures (for example, see first chart below).

Freight demand is down in the United States and in most of the world (here and here). Less pull prompts less push. Demand (even for durable goods, see third chart below) remains considerably higher than pre-pandemic patterns. But three consistent months of declines in durable goods purchases — from high levels in the context of purposeful demand destruction via North American and European monetary policy — does not support prospects of a swift bounce-back. In terms of future flows, last week the UPS CFO noted, “The biggest change in terms of the base case versus downside is the volume. We were looking at volumes of down one percent in the base case, and now we’ve pivoted to the downside of down three percent. “

On Friday FreightWaves headlined a “trucking bloodbath.” According to this report:

America’s $875 billion trucking industry is struggling. The number of authorized interstate trucking fleets in the U.S. declined by nearly 9,000 in the first quarter of 2023… Folks throughout freight — from CEOs to truck drivers to dispatchers — are raising red flags about a downturn that could go in the history books. J.B. Hunt President Shelley Simpson wrote in a LinkedIn post recently that the current conditions remind her of 2009, which was the longest and most brutal freight recession of the 21st century.

Year-Over-Year spot rates reinforce the sense of dread. Flat bed rates are down nearly one-fifth. Both van and reefer spot rates are down more than one-quarter. (More and more.)

But what seems like a bloodbath to some is a process of “normalization” for others. Two weeks ago J.B. Hunt also hosted an earnings call. The freight firm’s President pronounced a “freight recession”. The executive team assiduously avoided offering any formal forward guidance. But CEO John Roberts clearly does not feel trapped in a movie by Sam Peckinpah or Quentin Tarantino:

Well, I think the real question is the timing… it’s not really a question of if the freight demand will come back to normal. It’s just really a question of when… And so, if we look at where we are right now, and we think, oh well, maybe this time we didn’t quite get that right. That’s going to be part of the reality that we live in. And because we have the experience and because the folks that are around this table have made mistakes and made good decisions, I think we’re really just questioning how we — how we time our reentry into a more normalized system… Those things are teaching us that we’ve got to be a little bit more fluid… while we get to that other side which we know is not a question of if it will present itself but when. So we just have to be patient and careful and thoughtful.

Global and US freight markets have been anything-but-normal for at least three pandemic-punctuated years. A prior year (2019) featured an accelerating US-China trade war that had already skewed pattern expectations. John Kemp at Reuters has put together a chart book that highlights the challenges of accurately perceiving reality or even conceiving what a normal freight market might mean anymore. (Please see Yossi Sheffi’s The New (AB)NORMAL.) The same data that looks awful month-over-month can look fine year-over-year and, sometimes, fantastic over five years. Perhaps paradoxical is the new normal.

The global economy is undergoing significant shifts in terms-of-trade, cost-of-credit, energy flows, demand patterns, sourcing behavior, inflation, and much more. Fundamental structural changes are likely. The war in Ukraine is skewing agricultural, energy, and many freight markets. The war’s global impact will almost certainly loom larger in 2023 than during the war’s first year. The prospect of war(s) in East Asia is a veritable crash of gray rhinos grazing entirely too close. The extreme effects of climate-related shocks accumulate as systemic stresses reflected in mass human migration, political turmoil, economic uncertainty, and immediate human suffering. We should now better recognize pandemic probabilities. Combine these risk factors with an increasing proclivity for political self-subversion and normal seems rather elusive.

Freight movements are the most obvious expressions of supply chain flow. Current US and global freight capacity is robust — potentially even a bit excessive. Near-term (through September) pull prospects are more uncertain than usual. Credible arguments can be set-out for either increased or diminished freight demand over the next few months. Since widespread use of steamships and railways, the behavior of high volume, high velocity freight flows have usually increased (here and here). More has been normal — not always year-over-year, but consistently decade-over-decade. Given human aspirations and potential, more flow is likely. But there is “a real question of timing”, related adaptability, and strategic evolution by freight carriers, shippers, and receivers.

Both murders and births can be bloody.

In November 2022 the North America Electric Reliability Corporation (NERC) released its Winter Reliability Assessment. This report warned, “A large portion of the North American BPS [Bulk Power System] is at risk of insufficient electricity supplies during peak winter conditions.” NERC also highlighted the challenges associated with transmission system limitations during “large power transfers during stressed conditions.”

Of twenty regional transmission organization’s (RTOs), PJM was assessed as being more robust and resilient than most. NERC reported, “PJM expects no resource problems over the entire 2022–2023 winter peak season because installed capacity is almost three times the reserve requirement.” PJM coordinates movement of wholesale electricity in all or parts of Delaware, Illinois, Indiana, Kentucky, Maryland, Michigan, New Jersey, North Carolina, Ohio, Pennsylvania, Tennessee, Virginia, West Virginia, and the District of Columbia. PJM serves more than 65 million customers and covers almost 370,000 square miles. (This is larger than France, United Kingdom, Belgium, and Netherlands combined.)

On December 20, 2022 PJM issued a Cold Weather Advisory for what some would call Winter Storm Elliott. On December 21 the warning was upgraded to a Cold Weather Alert. Over the next three days additional warnings and alerts were released, all focused on maximizing generating capacity for expected high demand. Millions of Americans traveling for the year-end holidays were also quite aware of impending extreme weather. My wife and I almost decided to stay home, then adjusted our travel times and routes to better ensure we were in a safe place before the worst would arrive.

On the morning of December 23 PJM declared a Synchronized Reserve Event. The SRE instructs all generation resources to manually increase output to full. At 5:30 in the evening that same day PJM released an emergency instruction for operator-specific load-reductions and a separate order to deliver maximum generation to the network. Still, over the next 24 hours PJM struggled to avoid wide-spread blackouts. Other RTOs and individual electric providers were forced to initiate rolling blackouts (here and here).

There was a sharp increase in demand that supply just barely matched (please see the first chart below), despite all the warnings and efforts to increase supply, despite having installed capacity 3X reserve requirements. On December 24, shedding non-residential demand was probably as important to maintaining flow as increased generation.

On Christmas Eve PJM and the rest of us were rudely reminded that installed capacity is not necessarily operating capacity. According to immediate after-action assessments,  over one-fifth (almost one-quarter) of PJM’s generating fleet was offline on Christmas Eve because of plant equipment problems and fuel supply failures. As highlighted in the second chart below, gas-fired (non) generation accounted for 70 percent of unplanned outages at PJM.

Consistent with prior agreements, over $2 billion in penalties have been assessed for failure to comply with PJM’s maximum generation orders. At least one utility is in the process of bankruptcy reorganization as a result of these penalties. Various efforts are underway to mitigate potentially counter-productive consequences of such penalties (here and here).

PJM’s internal analysis of causes and consequences related to Winter Storm Elliott is still underway. There will, no doubt, be a host of functional, financial, and technological reforms to consider. But from a Supply Chain Resilience perspective it is valuable to recognize the fundamental risk dynamics at play when fixed production/distribution capacity interacts with highly volatile demand and exogenous shocks. A reserve capacity thought to be three-times necessary in November was just barely enough one month later… not because the capacity per se was reduced, but because upstream channels delivering resources to the electric generation and distribution systems literally froze. Figurative freezing is an even more frequent risk.