Commodity prices surged during the pandemic's early days due to massive stimulus spending, production cuts, and widespread supply chain disruptions. Geopolitical tensions, slow transitions away from fossil fuels, and delayed decarbonization policies continue to create supply-demand imbalances, exerting continuous upward pressure on prices. Addressing today's supply chain challenges requires not only industry efforts but also government intervention and specialized financing.

As the global economy absorbs the effects of Russia's invasion of Ukraine and the military response to one of the worst acts of terrorism in history by Hamas in Gaza, we explore how supply chains are evolving and consider less publicized factors impacting them.

Deglobalization and Energy Security

The shift towards deglobalization, with a focus on energy and food security, has significant implications. For example, Germany has reduced gas usage in power generation and industry to ensure adequate gas storage for winter, switching to coal not for cost reasons but to safeguard future gas supply.

High natural gas prices have driven utilities to seek cheaper alternatives like petroleum products, biofuels, and LNG. The explosion at Freeport LNG in Texas, which had been supplying Europe with 70% of its cargoes, illustrates how even minor supply disruptions can dramatically impact prices.

Replacing Russian natural gas, which powers much of Europe, is a pressing challenge. Europe needs to replace two-thirds of its 155 billion cubic meters of annual Russian imports, with half expected to come from LNG. However, LNG operators are already at full capacity, and increasing production will take time. In the US, ramping up production takes about six months, with current levels still below the fracking boom peak of 2015.

The nuclear market is also seeing a push for localized sourcing, with Japan reactivating reactors and France reinvigorating its nuclear industry. However, increasing production from oil fields and other energy sources is a complex process requiring significant financial liquidity.

Impact of the China-US Trade War and Pandemic

The move towards regional sourcing, which began before the pandemic due to the China-US trade war, has accelerated. Western companies are reducing their dependence on Chinese manufacturing and Russian transportation. Political factors, such as potential Chinese support for Russia, further drive regionalization. Decarbonization policies also play a significant role, with industries like electric vehicles and renewable energy requiring various commodities, such as copper, nickel, zinc, lithium, and aluminium. Companies like Tesla are planning to build upstream supply chains to increase control and integration.

Batteries, which store rather than create electricity, highlight the need for expertise in managing supply chains involving coal, uranium, natural gas power plants, or diesel-powered generators. Major commodity corporations may step in as specialists in energy distribution.

Transportation Costs and Sanctions

Rising oil and gas prices naturally lead to higher transportation costs. Sanctions on Russia have also constrained the use of Russian infrastructure for moving goods from Asia to Europe. Alternative routes and methods are being implemented, requiring significant investment and financing to shift supply chains efficiently. The risk of demurrage penalties and static products eroding profit margins underscores the commercial need for effective solutions.

Commodity finance underpins the movement of raw materials, linking global trade and development. Transactions, traditionally managed by major global banks, are now facing regulatory pressures, such as Basel IV, impacting market liquidity.

Key Commodity Players and Financing

Key players in physical commodities trading, such as Louis Dreyfus, Cargill, Bunge, ADM, Vitol, and Trafigura, have robust business models and significant turnovers. These companies, along with BP, Shell, Total, Anglo American, and Glencore, have withstood various crises and are well-equipped to navigate the current volatility.

Large financial institutions and major commodity corporates have historically provided most of the credit needed for trade. However, capital constraints on banks are impacting the availability of financing, especially for small and medium-sized traders. This is exacerbated by regulatory pressures on bank lending.

Global Energy Shifts and Supply Chain Adjustments

With Russia producing over 30% of the world's energy, finding alternative supplies is crucial. Europe is seeking replacements for Russian crude and products, with OPEC and countries like Kuwait and Saudi Arabia increasing production. The US is also becoming a key exporter, requiring financing for waterborne transactions.

European and Nordic markets are shifting to waterborne oil and LNG, with LNG inflows to the EU and UK reaching record levels. However, developing the necessary infrastructure is expensive and time-consuming, requiring significant investment.

Refining Capacity and Product Markets

The disruption in refining capacity, combined with reduced exports of Russian products, has tightened product markets. Refining capacity is expected to rise, but the products market will remain tight, with concerns over diesel and kerosene supplies. Oil demand growth is set to accelerate, driven by a returning China and increased consumption during peak seasons.

Understanding Risks and Due Diligence

Ensuring no sanctioned products or disguised Russian ships enter the supply chain requires increased scrutiny and due diligence. As Russia's sanctioned products find new markets, establishing their origins becomes critical. Dry bulk cargoes for metals and agricultural products pose risks due to less stringent maritime processes and lower financial requirements.

Crude oil, with its large notional size and good-quality counterparts, remains the most robust underlying commodity. However, due diligence across the value chain is essential to mitigate risks, including understanding the flows behind transactions and verifying counterparts' roles.