Supply Chain Resilience

[Updates Below] Flows of fossil fuels — especially diesel — are much more viscous than usual. Sources of many manufactured products in China have been cut-off or slowed. Disequilibrium has deepened (again) between demand and supply for semiconductors. Flows of easy credit are being purposefully curbed. The specialty formula debacle has unnerved many who are not involved in feeding infants. Food and related — such as wheat, fertilizer, sunflower and palm oil — are stuck behind enemy lines or maritime blockades or defensive walls of export controls.

In each of these cases the cause is not a loss of core capacity or even — yet — lack of abundant supply. Rather, government actions intended to mitigate plague, war, inflation, or hunger are complicating or curtailing flows from going where they would often otherwise go.

In most cases, the policy intentions are unimpeachable (Putin’s excepted). Execution is innately complicated and too often can be clumsy, contradictory, and even self-subverting (Putin’s Ukraine policy is a fair example). Recent outcomes are prompting concern or alarm or, in some places, panic. For many of these flows, current risks have been amplified by a long series of choices — both public and private — that have concentrated supply or demand or both, pooling risk in fewer places and players. The resulting structure tends to amplify both good and bad. Just now, bad seems ascendant.

Time, space, and cost constraints are fundamental in each of these flows. Some of these flows — ultimately, all of these flows — are interdependent. Taking on one problem can cause two more. As always, there is a risk of the urgent obscuring or fatally delaying opportunities to engage what is most important.

The time-dimension of growing food pushes me to give food flows strategic priority.

For the highest volume global food producers, agriculture is seasonal. Crops must be planted in different places encompassing enough space within a particular time-frame or yields will suffer. Sufficient water and fertilizer must be applied in a timely way or yields will suffer. Harvesting must be completed within narrow seasonal constraints or yields will suffer.

Once the harvest is gathered other time-and-space factors accumulate, but these tend to be much less austere than the planting-to-harvest temporal “bottleneck”. There is cause to perceive that China’s manufacturing capacity will be reengaged whenever policymakers decide to get out of the way. Carbon extraction and fossil fuel production are not seasonal. Meanwhile, wheat or corn or barley is produced this season — or not.

Too much food — especially too much wheat and sunflower oil — is currently trapped in Ukraine (more). There are roughly 22 million tons of last year’s harvest still in storage across Ukraine. With Odesa, Kherson, and other major Black Sea ports blocked, these stocks are seeking other routes. For example, the Romanian port of Constanta is less than 300 miles south of Odesa and familiar to Black Sea carriers (more). These innovative flows have near-term implications for feeding millions in the Middle East, Horn of Africa, and South Asia. As of mid-May Ukraine’s grain exports are only about one-third of last May’s volume.

Moving last-year’s harvest is also necessary to make room for this year’s harvest. In early May it was estimated that even in the midst of war Ukraine’s farmers may be able to plant about 11 1/2 million hectares — about one-fifth to one-quarter less than usual. In recent years Ukraine’s proportion of global grain exports has been a bit more than ten percent overall, but well over half for specific markets such as Egypt, Indonesia, and Pakistan (more). The United Nations World Food Program has also purchased significant amounts of Ukraine’s grain for emergency food assistance. Depending on yields and flows from other grain producers, losing two percent or marginally more of international grain exports ought not be catastrophic.

But as of mid-May only about one-third of Ukraine’s lower-than-usual number of hectares had actually been planted. Fuel and fertilizer shortages in Ukraine are complicating planting (more). It is reasonable to assign a risk premium for harvesting whatever is finally planted. As a result, Ukraine’s reduced food output is causing a price surge in several food commodities, especially wheat. There are other risks: Russia is usually a major grain exporter too, but its exports are complicated by sanctions. Due to drought, this year’s US winter wheat yields were well below normal. Heavy rains decimated China’s winter wheat harvest. Below is a chart that provides one angle on wheat futures contracts since the beginning of the year. (More.)

Even with price controls, in Egypt bread costs at least one-quarter more than one year ago. It is getting more difficult to find bread to buy in Lebanon. (More and more and more). Many countries do not have sufficient dollar reserves to buy enough higher priced grain to fulfill local demand.

Some key food supplies are tighter than typical just now. Given what is not happening now, supplies could be even tighter next Spring. In some places that typically depend on food flows from Ukraine and Russia, delays and uncertainty are prompting pull signals (price increases) to fill the gap between demand and supply with flows from other places. While this stronger pull is motivating the emergence of new push channels, some downstream prices now exceed the local ability to pay. Demand persists, but an increasing proportion of demand cannot be effectually expressed and is essentially being excluded from pull and push (see Yemen, Somalia, Sri Lanka, etc.).

As the links above and this week’s UN Security Council special meeting demonstrate, the problem with food flows is well-recognized. It is not, however, claiming the priority required to make practical progress. Disrupted Ukrainian food flow is a problem that will get worse without sustained, significant action starting now. Key steps should include:

1. Maximize and optimize the Constanta Corridor for discharge of Ukraine’s food exports.
2. Increase deliveries of fuel, fertilizer, and other key inputs to Ukraine’s farmers.
3. Reinforce effectual food demand for people in places where pull signals have encountered the most interference due to currency gyrations and physical disruption of preexisting supplies.

Ukraine is an important preexisting node in global food flows. Reassuring markets that these flows are likely to persist will reduce price volatility for everyone. Focusing on preexisting network capacity and players is the most efficacious means for doing this. Providing effective mechanisms for expressing real demand will target flows and reduce misdirection caused by consumer hoarding or market manipulation or dependence on relief programs.

Global networks of demand and supply are morphing in response to Ukraine’s flows and future possibilities. To the extent upstream push can be more confidently anticipated and downstream pull can be better balanced, midstream rapids or portaging can be minimized. And… famine threatening hundreds-of-thousands can be avoided.

+++

May 24 Update: Bloomberg reports: “Russia has continued to ship its wheat at the now-higher price, finding willing buyers and raking in more revenues per ton. It is also expecting a bumper wheat crop in the next season, suggesting it will continue to profit from the situation. Global wheat prices have risen by more than 50% this year, and the Kremlin has collected $1.9 billion in revenues from wheat export taxes so far this season, according to estimates from agricultural consultant SovEcon.” While this is unwelcome in terms of sanctioning Russia’s invasion of Ukraine, it is good news for flows and fulfilling demand. Bad can sometimes unveil good. The reverse is also possible. The full Bloomberg report is helpful to read.

May 25 Update: Reuters reports: “Russia is ready to provide a humanitarian corridor for vessels carrying food to leave Ukraine, in return for the lifting of some sanctions, the Interfax news agency cited Russian Deputy Foreign Minister Andrei Rudenko as saying…” (more and more and more and more). LATE ON WEDNESDAY: Bloomberg reports: “Russia’s Defense Ministry said it’s opening two sea corridors for international shipping from seven Ukrainian ports, after growing international criticism of an unfolding global food crisis triggered by a Russian blockade.” (More)

May 26 Update: Bloomberg reports: “The Netherlands would consider joining an alliance to send warships to escort grain supplies stuck in Ukrainian ports but would need assurances from Russia and, ideally, involvement from Turkey, according to the Dutch defense minister. Estonia and Lithuania have been calling to establish a coalition of the willing to send naval escorts for grain freighters, as European officials decry Russia’s effective blockade of Ukrainian ports that’s left Kyiv struggling to get grain shipments out.” (More)

Above in my original post I focused on the Constanta Corridor — instead of Ukraine’s Black Sea ports — because I considered the prospect of Russia cooperating to be scant. The Constanta Corridor should still receive priority attention. But the last two days suggest a slightly improved possibility of restarting flows from preexisting nodes using preexisting channels… which would certainly be the most effective and expeditious means of reclaiming prior capacity. There is also an urgent need to address the second priority noted in the original post: supplying Ukrainian farmers who are currently planting the fall harvest. Their fuel supplies are very tight and tightening.

May 27 Update: Bloomberg offers a concise update on Black Sea flow options for grain, including the following map. Constanta Romania is about 260 miles by road or rail south of Chornomorsk (more and more). S&P Global also reports on potential social instability related to food price increases. (More channel options in this very helpful May 29 report by Bloomberg. The report includes, “For now, the most realistic solution remains Romania, Constanta and the Sulina Canal that links the Black Sea with the Danube.”) (Related S&P report on sunflower oil.)

May 29 Update: The Financial Times reports on a Saturday phone call: “Putin, Scholz and Macron discussed whether a negotiated solution could be found to open Odesa to allow grain exports to leave Ukraine, according to an Elysée briefing after the call. The French and German leaders “noted the Russian president’s promise to allow ships to access the port to export grain without it being used militarily by Russia — if the port was demined in advance”, according to the briefing. Berlin said the call lasted 80 minutes and was “devoted to Russia’s ongoing war against Ukraine and efforts to end it”. These negotiations with Putin are not supported by all European leaders (more and more).

During April, diesel volumes via the Colonial Pipeline declined. Mid-Atlantic diesel inventories saw sharp drawdowns (more). US Gulf Coast refiners diverted flows toward higher prices in Latin America and other markets (more and more).

During the last week in April the price of diesel delivered into the New York Harbor market increased from $4.27 per gallon to $5.16 (see chart below). US diesel prices have mostly continued to climb (more). The second chart below is for June futures contracts on NY Harbor diesel.

Meanwhile, Latin American demand has softened. After the end of the trading day on Friday, May 13, S&P Global reported, “Latin American diesel prices are fading from record highs… Waterborne premiums also were falling in the US Gulf Coast, the main source of diesel for the region, and plunged May 13. The premium paid for barges and cargoes compared with the more liquid pipeline assessment had risen to 13.45 cents/gal by mid-April, the highest level in at least seven years. But it was tagged May 13 at pipeline plus 3 cents/gal. Market sources from both sides of the Atlantic attributed the waterborne decline to less USGC cargo demand from Latin America.”

Refining capacity is tight for all products. Global demand is strong for refined product — especially diesel. The US Energy Information Administration recently predicted that US refineries will operate at up to 95 percent of operating capacity for the summer driving season (with about 31 percent of capacity dedicated to diesel). Given constrained capacity, the tendency for push to follow the highest-priced pull is especially strong. New York is much more attractive this week than three weeks ago.

Attractive enough to pump more diesel volume into the Colonial Pipeline?

It is possible to track flows of natural gas in Ukraine’s pipelines (even in war time). Flows of refined product from Greensboro, NC to Linden, NJ and in-between are not as transparent. Colonial typically transports about 100 million gallons of fuel per day. Several have claimed that late April pipeline flows were well below this capacity. How much? I don’t know. I have talked to three old friends who focus on the fuel market everyday. None of them are sure if more is flowing today. But they each independently expect (one offered to bet) that we will all know by Memorial Day. Two of the three perceive that the increased price into NY Harbor will pull enough to meet demand — and even rebuild inventories a bit.

If I was in a different position — say, the Governor of North Carolina’s chief-of-staff, the CEO of a mid-Atlantic chain of truck stops, the Executive VP of a national trucking firm, staff with the National Security Council — I probably would be calling my friends in Alpharetta with some questions. And if I did not have any friends in Alpharetta, I would decide it was time to make some new friends.

New York Harbor June Diesel Futures as of May 15

+++

Special Note: On May 13, S&P hosted a podcast focused on tanker market dynamics since the Russian invasion of Ukraine. Sanctions on Russia have complicated and at least marginally reduced flows of Russia’s diesel into the European market. This disruption and related uncertainties have created new opportunities and widespread volatility, especially for midstream transportation providers. The podcast’s discussion does a good job of framing this context and (for better or worse) allowing outsiders to listen-in while insiders talk through some rather arcane midstream realities.

[Updates below] This morning there are 111 vessels at the Port of LA with at least sixty-seven on the way, according to MarineTraffic (see chart below). This is less crowded than last fall, but still plenty congested compared to any pre-pandemic day. On Friday the Executive Director of the Port of LA said April cargo volume had been the second highest on record (last year was higher). He does not see dramatic changes in vessel traffic heading his way from China (more and much more).

Covid-related lockdowns in China have decimated domestic demand, imports are down from oil to soybeans (more). Production is down and very spotty. For example, take steel exports, according to S&P, “In the first four months of 2022, China shipped 18.156 million mt of finished steel, 29.2% lower on the year.” Transportation to and from many major ports is deeply disrupted (very helpful link). Flows between China and North Europe are clearly declining (so is European demand). Prices for trans-Pacific transport are softening (more and more). Upstream drought will eventurally reduce downstream discharge.

And… where there is pull there is often push. So far, Americans are continuing to buy. Purchases of imported consumer goods during 2022’s first quarter were higher than 2021 and well above pre-pandemic patterns. Most of these goods originate in China. Despite crazy covid constraints, steel is still being shipped. China’s aluminum production is strong and exports have increased. While Shanghai is locked-down, Shenzhen has reopened. Over the last month, the number of vessels arriving and departing Shanghai has typically ranged between 1200 and 1500 per day; nearby Ningbo is running about about 600. Yantian (Shenzhen province) serves fewer — but very big — vessels and has seen comparatively normal come and go. Some sources see China’s port congestion slightly easing… There is a drought, but the well is not yet dry.

There are profound problems with China’s recent economic productivity. Prospects for early improvement seem to be dissipating. What started as short-term delays are edging toward systemic demolition of some flows. There have been and will be implications for US consumers (and more). But what will be impacted when and where — and how badly — are not yet clear to me. I absolutely perceive a demand and supply network under severe duress, but I also see surviving demand, surviving capacity, and considerable adaptation. It is plausible to lean toward worst cases. A bit more analytic restraint — and patience — may, however, be prudent.

Totals through midnight on May 8, 2022

+++

May 14 Update: In a long-form detail-rich assessment of China’s economic slowdown, the Wall Street Journal concludes, “The amount of drag China puts on the global economy will depend on how severe the country’s downturn gets. Fortescue Metals and Rio Tinto both said they are optimistic that Chinese demand will recover and some economists are hopeful that ebbing caseloads and government stimulus will propel faster growth later in the year. With Western demand easing, supply-chain strains may not get as bad as they were last year, some analysts say.”

May 15 Update: A Financial Times “Big Read” joins us in looking closely and trying to discern what is happening inside China and with outbound flows. The FT reports profound problems across China, but — so far — reasonably responsive flows still emerging from China. Please see chart below. Shanghai is especially troubled, yet cargo is still being loaded and shipped. Shanghai is important, but there are other — less troubled — ports in China that continue to receive and discharge flows. Other East Asian ports are operating close to normal. The disruption of domestic demand and supply in China does have dramatic consequences for China’s consumers, producers, and mid-stream providers. There are accumulating constraints on fulfilling global demand. Impacts differ category to category and product by product. For what it is worth (and probably not much), I currently perceive that US consumers are unlikely to experience generalized short-falls in China-sourced flows until September-October with the stock-build for Christmas. How big and troublesome these gaps could become will reflect demand and supply variances that I cannot yet confidently predict.

Financial Times and project44 as of May 12

May 16 Update: Economic data released today confirms a contracting China economy. According to Reuters: “Retail sales in April shrank 11.1% from a year earlier, the biggest contraction since March 2020, data from the National Bureau of Statistics (NBS) showed on Monday, a steeper decline than forecast in a Reuters poll. Factory production fell 2.9% from a year earlier, dashing expectations for a rise and the largest decline since February 2020, as anti-virus measures snarled supply chains and paralysed distribution.” (More and more and more.)

May 17 Update: Helpful report on trans-Pacific flows from Bloomberg, including excerpts from an interview with the Executive Director of the Port of LA. Gene Seroka said, “Freight is “finding its way through to the Yangshan deep-sea port and if not, it’s going down to neighboring port Ningbo, which is up 25% over this past two months,” the L.A. port chief said. “We’re watching day and night, but so far, the cargo flows seem to be very consistent.”

May 18 Update: The Financial Times provides a concise overview of demand destruction in China. The unanswered question is: how much does this domestic demand destruction bleed into disrupted global supply capacity? Time-and-space factors are especially unclear. Given calendar and context, is capacity relocating? How much, how quickly? How sharply can capacity rebound? How gradually will capacity rebound? Does cratering demand in China reinforce softening demand in other markets?

{May 11 update below] Russia’s natural gas suppliers continue to pay Ukraine’s pipeline operators to transport product to paying customers farther west (please see map below). As shown in the chart, bookings and flows have been roller-coastering, but recent volumes often remain within range of early 2020 and most 2021 levels (more from Reuters and S&P and NYT). Russia’s oil outputs have been harder hit by Western sanctions (more from the BBC). But at the right price, buyers can still be found. Quick price hikes for global fossil fuels following Western sanctions have been contained by China’s economic slowdown… and the potential of lower global demand (more). More stubborn demand equals more stubborn supply. Less stubborn can also generate symmetries.

May 11 Update: According to Bloomberg: “Ukraine’s gas network operator said late Tuesday it would stop receiving Russian fuel through the cross-border Sokhranivka station at 7 a.m. local time because it can’t control the infrastructure in the occupied territories. Russian gas giant Gazprom PJSC said it can’t reroute supplies to another entry point, Sudzha, because of how its system currently works.  The development marks the first time the war in Ukraine has disrupted gas deliveries to Europe via the country. Russian gas had been flowing normally through both entry points despite the conflict, although most of the time at lower rates than the transit deal envisages.”

On April 28 Amazon opened its First Quarter 2022 report (through March 31) with these three outcomes:

• Operating cash flow decreased 41% to $39.3 billion for the trailing twelve months, compared with $67.2 billion for the trailing twelve months ended March 31, 2021.
• Free cash flow decreased to an outflow of $18.6 billion for the trailing twelve months, compared with an inflow of $26.4 billion for the trailing twelve months ended March 31, 2021.
• Free cash flow less principal repayments of finance leases and financing obligations decreased to an outflow of $29.3 billion for the trailing twelve months, compared with an inflow of $14.9 billion for the trailing twelve months ended March 31, 2021.

This is not the direction you want these flows to go.

Amazon’s CEO, Andy Jassy, is quoted to provide context:

Our Consumer business has grown 23% annually over the past two years, with extraordinary growth in 2020 of 39% year-over-year that necessitated doubling the size of our fulfillment network that we’d built over Amazon’s first 25 years—and doing so in just 24 months. Today, as we’re no longer chasing physical or staffing capacity, our teams are squarely focused on improving productivity and cost efficiencies throughout our fulfillment network. We know how to do this and have done it before. This may take some time, particularly as we work through ongoing inflationary and supply chain pressures, but we see encouraging progress on a number of customer experience dimensions, including delivery speed performance as we’re now approaching levels not seen since the months immediately preceding the pandemic in early 2020.

During the third week in April I visited several warehouses, distribution hubs, and fulfillment centers — including Amazon facilities — in one US West Coast metro area This was my first time back since late-2019. It is an amazing build-out. I had, of course, read about the tight market for logistics space (here and here and here). But walking pre-pandemic empty lots and derelict buildings, now featuring dozens of dock doors, fresh tarmac, and ambitious landscaping was eye-popping and mind-expanding. This urban area’s collection of Amazon facilities is a fascinating example of the transition from hub-and-spoke networks toward rhizomes. Million square foot hubs can still be important for procuring price-advantaged volume, but velocity is better advanced by much smaller nodes more intimate with demand.

Nonetheless even a “modest” quarter-million square foot structure is a challenge to insert into an already dense urban web and especially residential neighborhoods — no matter how nice the landscaping. Siting is an intricate dance of snuggling as close as possible to high velocity demand (population multiplied by wealth), divided by real-estate costs (often weighted by transportation, topographical, and zoning constraints). Simple availability is not a given. Given limitations of time and space, I am impressed by what Amazon so quickly accomplished.

But some are asking: Has Amazon built too many warehouses? Amazon’s own comments can imply an affirmative answer. Last week Amazon’s CFO, Brian Olsavsky, told financial analysts:

We currently have excess capacity in our fulfillment and transportation network. Capacity decisions are made years in advance, and we made conscious decisions in 2020 and early 2021 to not let space be a constraint on our business. During the pandemic, we were facing not only unprecedented demand but also extended lead times on new capacity. And we built toward the high end of a very volatile demand outlook. Now that demand patterns have stabilized, we see an opportunity to better match our capacity to demand. We have lowered our operation’s capital expenditures for 2022 and are evaluating other ways to increase our fixed cost leverage. We estimate that this overcapacity, coupled with the extraordinary leverage we saw in Q1 of last year, resulted in $2 billion of additional costs year over year in Q1.

But then — crucially — Mr. Olsavsky added, “We do expect the effects of the fixed cost leverage to persist for the next several quarters as we grow into this capacity.” During 2020 and 2021 Amazon did what it could to fulfill an extraordinary surge in demand. There were understandably rough relations between supply and demand for an extended period, but in most places, most of the time, Amazon mostly succeeded in delivering what was expected. Amazon led the way in demonstrating that consumers could have confidence in ecommerce… even in times of considerable duress.

In many urban areas Amazon has now claimed the forward operating facilities needed to fulfill future growth with increasing velocity and profitability. The value of this investment — especially operationally, especially in terms of flow velocity — will more often grow than slow. As every supply chain nerd will assert, these are not warehouses. These are crucial intersections and accelerators of flow.

The Amazon Chief Financial Officer is apparently a supply chain nerd too (as investors would hope). Deep inside last week’s analyst call Mr. Olsavsky said that Amazon’s productivity depends mostly on, “the right capacity and the right demand matched at the warehouse level and the transportation node level.” Bingo. Bingo. Bingo.

During my late April tour of one metro area, I visited several distribution/fulfillment centers that were disconcertingly ghostly. Most of these had been leased for the first time in the last 18 months. Interior racks were not overflowing. Outbound stock was not being hurriedly lined up. Selectors seemed remarkably relaxed. These were mostly traditional large retailers (with ecommerce operations). Amazon is not the only enterprise experiencing over-capacity. For what it’s worth, at each of the handful of Amazon facilities personally observed there was, in contrast, sustained inbound and outbound flows, busy selectors, and an impressive line of Prime delivery vans heading into surrounding neighborhoods (especially for a Sunday morning).

Deploying the right capacity within the right configuration of nodes and channels to fulfill the right demand is how the most sustainble flows and profits are achieved. Agile, adaptable networks organized (and disciplined) around effectual demand can, like Goldilocks, find flows that are “neither too hot nor too cold, but just right.” These just-right equilibria are typically ephemeral (even fragile), but possible. The possibility, better yet probability, of just-right flows is improved when we don’t (like Goldilocks) just stumble across these possibilities, but (like the three bears) do the cooking ourselves. Amazon is a smart and adventuresome cook.