Return to an inflationary environment: rising costs add to challenge of stressed supply chains, market imbalances

This article by Mark Thomas, first published in Chemical Week on January 10, 2022, includes insights from Michael Kramer - then President of Stolt Tank Containers, now Executive Vice President, Marketing and Business Development - and Guy Bessant, President of Stolthaven Terminals.

As the industry continues its economic transition from recovery to expansion, the uneven pace of that growth around the world and the turbulence of the Covid-19 pandemic are creating imbalances between supply and demand.

Combined with the headwinds of several major natural and other disruptive events during 2021, these imbalances have led to the unprecedented disruption of global supply chains and steeply rising costs for a range of inputs. Companies now face having to operate in an inflationary environment for the first time in several decades.

Sustained high energy, raw material, and logistical expenses transformed the landscape for costs in 2021, and the specter of further inflationary pressure continues to loom over the chemicals sector as it embarks on a new year. With the resurgence of the pandemic at the end of last year through the emergence of the Omicron variant, the threat to worldwide economic growth remains substantial, with evidence already in Western Europe that the latest wave of Covid-19 and related restrictions are hindering an already lagging recovery.

“We have an optimistic view of inflation, but we do have to acknowledge that shipping disruptions, supply stickiness, and high energy prices will continue to exert upward pressure on prices, certainly across the first half of [this] year,” according to John Mothersole, director/pricing and purchasing at IHS Markit.

“We can point to some good news. Commodity prices, upstream, and supply chains have enjoyed a modest correction since May…our IHS Material Price Index [MPI] retreated 15% over the past six months,” he said in a recent IHS Markit economic webinar. This trend has started to migrate downstream, he noted, “offering the promise that cost pressures will begin to ease [in 2022], even if commodity prices do not decline further.” IHS Markit sees commodity prices dropping 15–20% this year, he added.

This good news will be balanced, however, by continuing logistical bottlenecks that are only likely to be resolved later this year as goods demand moderates and traffic normalizes, Mothersole said. “In particular, a change in the state of ocean-going shipping, which has really been the Achilles heel in supply chains, probably weights to the second half of 2022. Some shipping indicators are moving in a positive direction, but backup and port-performance data continue to show problems, especially in the key Asian/North American travel corridor,” he said.

Energy markets, which have been a source of inflation since last summer, “look slightly better” this year, he said, with increases in oil production by OPEC+ countries and the US, and gas production in Russia “alleviating pressures from energy prices, probably by the second quarter.”

In 2023, IHS Markit expects its MPI to ease by a further 5–10%. Nonetheless, this will still leave prices “above where they were at the end of 2019,” Mothersole said.

Input prices are currently still rising, according to IHS Markit’s US Manufacturing Purchasing Managers’ Index (PMI) for November. Input prices increased at their fastest pace on record since the PMI was launched in May 2007, reflecting higher costs for chemicals, plastics, metals, and transportation, it stated.

Energy-price shock

The situation is most acute in Europe. “I’d say there are some differences between the US and Europe in that regard,” said Ken Wattret, chief economist - Europe at IHS Markit in the economics webinar. “We certainly have very high rates of inflation across Europe now, and — hands up — we’ve underestimated those, particularly the energy effects. We hadn’t expected wholesale gas prices to increase by 500% year on year by the autumn of 2021. That’s been an exceptional shock, which is clearly one of the reasons why inflation has been so high.”

An inflationary environment hits “every single part of our business,” says Michael Kramer, president of Stolt-Nielsen’s tank containers business [Stolt Tank Containers]. Salaries, fuel costs, steel prices, and other operating expenses are rising and carriers must charge more if they are to continue serving customers safely, he tells CW.

“This impacts every part of our supply chain. Costs for trucking, rail and ocean freight, heating, cleaning, lifts, and repairs are all on the rise. These price hikes may be in the early stages now, but I expect them to continue throughout 2022.”

Any cost increases put additional pressure on suppliers of services and already tight resources such as truck drivers, Kramer says. Rising fuel and insurance expenses reduce earnings for drivers, who will subsequently demand higher salaries. “If these are not forthcoming then we can expect to see more drivers leaving the industry, resulting in longer delays in moving cargo,” he says.

With costs rising, rates across Stolt-Nielsen’s three logistics businesses are likely to rise, he says. “Those businesses that are unable to keep up with the increases will inevitably fail, resulting in lost business, lower utilization of facilities, and so on. It may also result in tangible changes to supply chains and cargo flows,” he says. This will change trade patterns and could result in significant imbalances and shortages of equipment as supplies adapt, he adds.

“For assets that cannot easily move or may be less flexible, disruption caused by inflation could result in lower utilization, investments being scaled back, and being harder to justify in the future,” Kramer says.

Historic supply-chain crunch

According to Peter Tirschwell, vice president/maritime and trade at IHS Markit, the impact of the pandemic on global supply chains has been historic. “The system wasn’t built to manage this level of supply,” he said in a recent IHS Markit supply-chain webinar on the outlook for 2022.

“We’re in the deepest crisis that the container-shipping supply chain has ever seen. I’d like to be able to say that we see signs of the logjam breaking, but frankly we don’t.” Tirschwell highlighted almost 90 container ships stacked off Los Angeles, California, in late November as a prime example.

The bigger story is vessel and container congestion. “The ocean carriers—the freight forwarders—tell us there are enough ships available to be able to handle the elevated volumes that we’ve seen,” Tirschwell said. “There are enough containers too. The problem is that so much of that capacity is caught up in congestion. It’s literally taken capacity off the table and you can see that in the freight rates.”

Spot container freight rates are up by multiples of three, four, or five compared with a year earlier, depending on the trade link, with the record rates “yet again historic, unprecedented. It reflects both demand as well as this very constrained supply situation that we see,” he said.

The supply-chain crisis is not likely to ease soon, according to Tirschwell. “We simply don’t see the evidence for that. It’s going to take a long time to unwind. The system has no extra capacity in it right now. All it takes is one shock after another—and that’s what we’ve seen, because the system didn’t have a chance to recover from the Suez [Canal] closure in March, or after the shutdown of the Yantian port in China.”

Global schedule reliability is already low, at about 30%, Tirschwell said. “All the ships are out of position, the containers are out of position. Any subsequent shock only sends the system into a deeper hole,” he said.

The worldwide supply constraints are “really restricting manufacturing growth at the moment,” said Chris Williamson, chief business economist at IHS Markit, during the supply-chain webinar. Although the manufacturing sector is continuing to grow, the rate of expansion “is really starting to weaken,” he said. “In the US and Europe in the fourth quarter [to end November] those expansions have been the weakest for a year and a half. The key thing that’s causing this is supply constraints.”

The logistical delays are the longest disruptions seen in almost 30 years, he said. Despite signs of the situation easing slightly owing to increasing production from Asia, the supply constraints remain “quite unprecedented,” Williamson said. The resulting shortages of materials have naturally created “a seller’s market,” with suppliers commanding higher prices and the manufacturing sector facing its highest input costs for 13 years as a result, he added.

Weakening GDP

The longer the pandemic continues to impact supply chains, the weaker global GDP growth will be, according to Williamson. “Like everyone else, we’ve been nudging our growth forecast down and inflation forecast up…Back in mid-year, we were forecasting 4.5% global GDP growth for 2022. That’s now down to 4.2% because inflation just stays stickier, so it’s looking like a weaker environment,” he told the webinar. This was before the new Omicron variant arose, he added.

Williamson highlighted a business outlook survey by IHS Markit that asked 12,000 companies their thoughts on what 2022 held in store. “They were saying that their growth is probably going to be a bounce, but their profit expectations were the weakest during the pandemic so far. [They have] big fears about price hikes, supply shortages, customer resistance to high prices, and not being able to pass costs on to customers, damaging profit margins. The new variant has just added downside risk to all of that.”

The strength of the global economic recovery in 2021 translated to a correspondingly strong performance by the chemical industry, but “here too we have seen huge unpredictability, with supply-chain disruption driven by raw material shortages and related distribution/logistics challenges,” says Steve Elliott, chief executive of the Chemical Industries Association (London, UK).

“Add crippling energy-cost increases to the mix — gas, electricity, and carbon prices have risen to unprecedented levels in 2021 with no sign of easing in early 2022 — and the fear is a coming year of more sustained than transient inflation, dampening demand in both industrial and consumer markets and challenging the case for continued and new investment,” he says.

Having to operate in an inflationary environment is already challenging investment economics, according to Guy Bessant, president, Stolthaven Terminals at Stolt-Nielsen. “Bulk liquid transport and storage businesses are being challenged by an ongoing squeeze to margins,” he tells CW.

“This will have a significant negative impact on those businesses that are unable to pass on inflationary costs to customers. There is a risk here that lower margins will result in a hesitancy to re-invest in new assets, technology, and infrastructure, which could result in less capacity being available in the longer term.”

Stolt-Nielsen sees “a perfect storm at the moment where rising inflation—coupled with growing pressure from governments including penalties such as carbon taxes—will erode margins further. The industry aims to be more efficient and sustainable, and whilst we are constantly looking at different ways to achieve sustainability targets, the fact is that customers are not always willing to share the additional associated costs,” Bessant says.