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Can the Red Sea Situation Lead to Higher Prices?

The impact on Global Trade, Freight, Oil and a potential supply chain crisis

Shipping traffic through the Red Sea has dominated headlines over the last week and I’ve talked about how the Containerized Freight Index hit limit up a couple of days in a row. This is the freight index that tracks shipments from Asia to Europe and the UK. 

Politics aside, we don’t know how and when this situation will resolve but we want to try and understand how much of an impact this may have on commodity prices. We’ve put together some research that may help assess the situation. 

This comes at a time when Freight Prices have just normalized and supply chain congestions have largely been resolved. We really don’t need a repeat of what happened in 2021-2022.

Five of the world’s largest shipping lines have decided to avoid the area and re-route ships around the southern part of Africa, around the Cape of Good Hope. While oil carriers are being affected, it would seem that other container shipping is being affected a lot more. While these five container lines account for ~65% of global shipment volumes, the affected Bab-al-Mandab Straight which leads to the Suez Canal accounts for about

In summary, we expect the following:

  • Increase in freight rates due to longer routes, and more demand on ships

  • Slower delivery times mean lower inventory levels, as restocking takes longer. This is true for both raw commodities and finished goods.

  • Depending on current inventory levels and how long it takes for all this to be resolved, we may be looking at “out of stock” situations for both raw commodities and finished products. This will increase prices.

What we cover in this article

Where is the problem and what is affected? 

The attacks are concentrated at the Bab-al-Mandab Straight, which is the area marked in pink on the map below. The major shipping route takes this straight through the Suez Canal to Europe and the UK.

Source: Washington Institute

This is a chart is from the Washington Institute and lays out quite clearly how the detours are causing delays, including potential Gulf Oil shipment delays. 

But what we also see is that shipments are being cut off from entering the Suez Canal and that is more quantifiable, in terms of the impact.

Here’s another chart that shows what’s being shipped to the UK from countries in Asia, in terms of products, and where disruption could occur. The chart is a bit over the top but it’s a good representation that more than just oil shipments could be affected.

Source: Daily Mail

How Much Trade could be Affected?

As you can see, ships have to pass through the Bab-al-Mandab Straight from the south to access the Suez Canal. Quantifying some of the traffic going through the Suez Canal can tell us what to expect.

Since the pandemic, the traffic flowing the Suez Canal has increased by about 33% in the past two years. The Red Sea and Suez Canal account for about 10% of seaborne trade.

What Flows through the Suez Canal?

Oil has led this increase in trade volumes flowing through the Suez Canal followers by Bulk. The majority of this is crude oil exports from Russia to Asia, which saw a marked increase after the war.

But the biggest impact will still be on container shipping. As we saw in the first section, goods shipped from Asia are being delayed.

28% of global container volumes flow through the Suez Canal and a closure would increase container demand by about 7%. For tankers and bulkers, fleet demand would increase by about 1-2%, according to BofA.

Oil Flows and Oil Prices

As of now, there is very little impact on the actual production of oil and that’s why oil prices have been muted. There are two notable fields close to the affected area - Yanbu and Jizan - but these produce only about 1.2 million barrels per day. Production remains disrupted and the main issue is the delay of flows.

Major Oil Production still remains unaffected

The major flows come either from Russia through the Suez Canal on their way to Asia, or from the eastern part of the peninsula - Saudi Arabia, UAE and Oman - through the Straight of Hormuz and then around to the Red Sea.

According to GS, this is about 7 million barrels per day of oil flows that are being delayed.

A ~15- day delay in the journey for oil for these 7 million barrels per day of flows could result in about 100 million barrels of global oil on water in a worst-case scenario, according to Goldman Sachs. This would likely create a spike in the price of oil by $3-$4 per barrel but only for a brief period. We’ve already seen that the impact on oil prices have been relatively muted.

For the now the impact remains largely concentrated on Frieght Rates, Insurance and Shipping Fuel.

How much will prices rise?

Freight Rates have Increased

We’ve seen the immediate impact on freight rates from Asia to Europe rising drastically, one showing a 53% increase and the other showing a 31% increase since early December. Here are two of the major lines that have been impacted:

The shipping freight market is already tight. Ships are not being built as quickly as global trade volumes need them to be built. The chart below from BofA is an excellent representation of how low the order book of new builds is compared to current fleet sizes.

This keeps the market tight and if you notice the Grey line above for Crude, it’s even worse. Given these circumstances, Goldman Sachs expects a protracted situation in the Red Sea could lead to an increase in the demand for oil tankers. They project that a “1% increase in oil tanker demand leads to a c.5% increase in freight rates…. with a 100million barrel increase of oil on water, this would increase freight rates for dirty tankers by $1 per barrel (+25%) and $4 per barrel (+55%) increase for clean tankers.”

Dirty tankers carry crude and fuel oil - mostly unrefined products. Clean tankers carry refined products - mostly gasoline, naptha and middle distillates.

Insurance Costs Rising

Ever since the war, insurance costs have already gone up significantly. This is a follow on from the war in Europe. So we’re already seeing significant additions to costs of shipping. With a longer journey around the Cape of Good Hope, insurance costs are rising further, adding to the freight charges.

Bunker Fuel - Shipping Fuel Costs Rising

The first chart laid out that shipments from Asia that used to take 19 days are taking 31 days. According to S&P Insights, the voyage is 40% longer, as you can see above. This obviously increases the price of fuel for the voyage.

Source: Ship and Bunker

This is the price of Very Low Sulphur Fuel from Fujairah, UAE, which is the closest major bunker terminal. You can see how the price has spiked over the last few days. That low point in December was Dec 13. This is the type of fuel that’s used by most shipping containers around this area.

Risks remain

The key risk is not just an increase in the prices of goods because of higher freight rates but, as we’ve seen before, the availability of goods. With that comes the risk that companies start to stock up excessively leading to another bout of overstocking, and later discounting. We’ve seen this movie before and it wasn’t good at all.

Strait of Hormuz

The other risk remains attacks around the Strait of Hormuz. This by no means gives me comfort, because it’s very close to where I live. Thankfully, Goldman Sachs assesses the probability of this as very low and it’s quite likely that Saudi Arabia and the UAE will protect this strip at all costs.

17% of global oil production and 18% of global LNG supply flow through the Strait of Hormuz and a disruption could cause a 20% increase in oil prices for each month that the disruption lasts, since this will actually affect supply.

Closing Thoughts - Risks Contained but Remain

From what we’ve seen above, the main risk remains delayed shipments and higher costs of shipping particularly for goods.

US and UK Naval ships are set to patrol the area to prevent attacks on ships but, the large container lines are still not taking any risks.

For now, commodity prices have seen some pressure but not at alarming levels. The Bloomberg Commodity Index has increased +3.1% since Dec 13, but still remains below November levels.

While risks remain contained for now, there’s no saying how long this situation will last or whether it will escalate. The longer it lasts, the more we will see supply chains getting backed up and bottlenecks getting potentially worse. It’s definitely something worth keeping an eye on.

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