Despite the difficulties that come with the onset of any conflict, particularly for those directly involved, unprecedented levels of economic turbulence in recent years have left our clients feeling better prepared than they might otherwise have been. Over the past five years, they have weathered the storm of Covid-19, multiple global conflicts and resultant sanctions, and blockages of key supply routes like the Suez Canal. It is no surprise that these businesses are now poised to implement necessary workarounds for the ongoing conflict in the Middle East.
What sorts of things should be top of mind?
Delay and increased costs are inevitable
With the Strait of Hormuz effectively closed and major carriers suspending transits in the region due to attacks on vessels – 16 confirmed attacks as of 16 March - businesses should rapidly reroute freight away from these Gulf chokepoints. Goods avoiding that part of the world are likely to be delayed, and if there are diversions via Cape of Good Hope for instance, then this can add up to 2 weeks to transit times, and inevitably significantly increases freight charges. Air travel, including air freight, is also disrupted due to regional airspace closures and rerouting, reducing capacity for high value consumer goods like electronics.
Now would be a good time to do what you can to plan ahead and pre book alternative ocean and air capacity prioritising essential and high profit SKUs for faster (and more expensive) options but expect competition for open routes to be fierce. Regardless of how long the conflict continues, we may continue to see impact here into the summer and beyond and if this continues beyond this month it may start to be necessary to consider ordering and securing supply routes early for core inventory for H2 26.
For goods which are already in transit, questions of delay may arise but losses caused by delay are invariably excluded under marine cargo policies. For future shipments, it is likely that, in the immediate future, carriers will opt for longer routes for East to West transits, as voyages proceed via the Cape of Good Hope rather than the Red Sea. Cost of freight will almost certainly increase significantly as carriers seek to pass on the additional fuel costs and transit time costs to cargo interests. Indeed, supply chain analytics firm project44 found that container shipment diversions had surged more than 360% since the strait was declared closed at the beginning of March.
Alternative discharge ports for transits to Gulf states may also present logistical difficulties for cargo interests and may require significant forwarding charges to deliver goods to the intended destination.
Review contracts and insurance
Three crucial limbs of the contractual framework should be considered: insurance; carriage; and purchase/sale. Each contractual position concerns different parties and deals with different aspects of any transit.
Insurers and P&I Clubs have issued various Notices of Cancellation pertaining to the war risks cover provided to shipowners and cargo interests alike. It is advisable to check when goods were shipped and whether cover for war risks had attached prior to the expiry of any relevant notice of cancellation. For future shipments, it is likely that notices of cancellation will mean there is no cover available to cargo interests for the war perils contemplated in the region.
Secondly, the contracts of carriage between cargo interests and the carrier will need to be considered as to any rights, liabilities or remedies arising from delay or disruption to the contemplated voyage or damage to goods during the voyage. It is often the case that liability of the carrier is excepted where loss or damage has arisen due to war. In circumstances where carriers will be considering how to complete voyages safely, cargo interests are likely to have very limited input in the event there is any deviation or variation of the contemplated voyage. It is necessary to consult the insurance position in the event of any such deviation or discharge of goods to an alternative port to that contemplated.
Finally, contracts of purchase and sale will provide for different rights as to title and risk to the goods as between the buyer and seller. For example, retention of title clauses may provide protection to sellers so that they can ensure that title to the goods does not pass to the buyer until full payment of the goods has been received. Such clauses also ensure that the seller, in circumstances where payment in full has not been received, is able to take possession of the goods without the need to immediately commence legal proceedings for non-payment of sums due.
Our Marine Insurance and contract experts can help with these risk reviews. Please get in touch with Chris Dunn or Freddie Mehlig should you require assistance with any such reviews.
Energy costs will also rise
Business with their energy costs already locked in will be in a strong position here given the impact the conflict has already had on oil prices. Brent has already risen by over 10% and analysts are predicting it may continue to raise in price if disruptions persist.
Already stretched gas supply markets may also be particularly impacted as a response to the Ukraine conflict was to restructure gas supply chains away from Russia and with c.15% of European LNG transiting the Strait of Hormuz a reduction in availability is likely to see prices rise quickly. This is particularly so as it is reported that there was already limited excess capacity in the EU and volatility has near immediate impact on parts of the sector like manufacturing, packing and food processing.
Where possible, strengthen inventory to create a buffer of stock
There are already reports of delays in electronics, appliances, food ingredients, and packaging materials, with Gulf retailers already reporting stock shortages. Anything that can be done to build up stocks now may pay dividends the longer the conflict continues.
One area expected to be impacted is fertiliser. It is reported that 1/3 of the EU’s needs for fertiliser raw products, like nitrogen products currently transit the Strait of Hormuz. This is seeing sharp increases in cost with reports of increases of 25% being seen. These costs will then feed into the costs of both primary production of food and other agriculture products as well as other processed foods.
To counter these types of risks it is prudent, where space allows to stockpile what is possible and consider if there are other non-gulf supply options.
Consider near shoring options, but, take care with alternative sourcing
When supply chains come under pressure one of the first things that happens is substitution, both of specific products and of suppliers to find that product you need. When you do this at pace, it opens risk as often in the spirit of just getting something fixed corners can be cut, and due diligence can be missed. For foods this this can be critical as moving from one product to another even appearing to be the same can result in different ingredients and crucially different allergens being used – which if the receiving business does realise might very easily be missed and someone could consume. But, even at a more general level, in the rush to source missing products you can find yourself doing business with a business that might not meet the same standards as you or just not know enough about it to be sure that there is no modern slavery in the supply chain or even that its products are really as described. This process can be avoided by having alternatives available that can be selected and audited properly when there is adequate time.
The other option in this situation is that you wait for the product to become available. This may result in a delay which could lead to empty shop shelves or unhappy consumers waiting longer than they expected. All you can do here is communicate clearly and openly and try to manage expectations and try to come to an agreement about a revised timetable, hoping that the exceptional circumstances receive special treatment.
It has been the case that the EU and various member states like Germany are placing increasing obligations on business to conduct diligence on their supply chains. CS3D at EU level and the German Act on Corporate Due Diligence in Supply Chains are but two examples of this at headline level. Both oblige companies to comply with human rights and environmental standards in their supply chains, e.g. the prohibition of child labour, slavery or the causing of soil or air pollution. But, in addition to this there are also a range of other topic specific laws like deforestation, or forced labour that also themselves place specific obligations on verifying the compliance of supply chains. As a result cutting corners in this type of crisis brings a much wider range of risk than just upset customers.
Conclusions
With uncertainty again the order of the day, anything that can be done to remove confusion will be a positive step and planning ahead now is key. It is time to dust off those Covid playbooks again.
