Q&A: How coronavirus threatens container supply chains

Chinese subway riders

The coronavirus outbreak is intensifying, with more than 4,500 confirmed cases and over 100 deaths. Given its epicenter in China, the epidemic has the potential to significantly disrupt the trans-Pacific container supply chains of U.S. importers.

To better understand the potential risks ahead, FreightWaves interviewed economist Paul Bingham, director of transportation consulting at IHS Markit (NYSE: INFO). The following is an edited version of an interview conducted on Tuesday, Jan. 28:

Manufacturing disruptions

FW: The outbreak started in Wuhan in Hubei Province, which is now on lockdown. There’s a lot of manufacturing there.

Bingham: “It’s not Shenzhen, but it’s a manufacturing area. Also, once you’ve cut certain metro areas off from the rest of the country, presumably some supply chains will have first-tier suppliers [that sell parts to manufacturers] in those areas, and once those suppliers start to get affected, you could get into serious disruptions and factories shutting down [elsewhere].

“But we have to get far enough away from Chinese New Year to tell the difference. The timing will make it statistically hard to say ‘this is when things stopped in China.’ Because things would have stopped anyway for the Chinese New Year, so you need to be really careful about over-ascribing coronavirus to a pause in production right now.”

It’s essentially extending the Chinese New Year effect?

“That’s exactly what’s happening. People were already closed for a week and they’re extending it.”

Supply-chain managers were already planning for a holiday shutdown. How long will it be before coronavirus impacts start becoming apparent in container flows?

“What’s happening is that the gap you managed against is now extended. If these factories don’t restart or if they restart and then they run out of parts [due to issues with first-tier suppliers], how quickly that trickles down will depend on how tightly supply chains are being managed in terms of lead times and buffer stocks. But I think that it will be less than a month before you’d start to see evidence of disruptions.”

What about the more important manufacturing regions like Shenzhen that are more focused on exports? There have been some infections there, but nothing like in Wuhan. Wouldn’t it make sense for U.S. importers with goods being produced in the more important manufacturing provinces to pull forward shipments before lockdowns might spread to those areas?

“That would have been the reaction two weeks ago. It would have been prudent supply-chain management. But the problem was Chinese New Year. It would be harder to accelerate output for shipping then than at any other time of the year.”

If U.S. importers couldn’t pull forward cargoes before or during the holiday from places like Shenzhen, maybe they can do so now, given that Chinese New Year is over?

“They could. But there are workers that went to Wuhan for Chinese New Year and they can’t get back. That’s the problem with closing off part of the population right as you had people going home for the holiday. The timing is extremely awkward. [Outside of the lockdown areas] you may not have the same workforce that you did before Chinese New Year.”

Transport issues

Wuhan is an inland province. The more serious scenario for transoceanic container supply chains involves large-scale infections and travel restrictions in the coastal provinces. In past outbreaks, ships at ocean ports have had to implement new safety procedures that slowed operations.

“That would definitely be an impediment, an additional friction on operations. There would be extra steps that would reduce the velocity of cargo through the ports. And if you had crew getting sick onboard and having to be evacuated, that would create even more disruptions.”

I’d think though that the port issues would be the least of it. The much bigger problem in an epidemic scenario would be getting the cargo from the factories to the terminals.

“Exactly, the main problem would be on the land side, the truck drivers and others involved in freight handling within China, moving between cities. When you get into these quarantine situations, that’s clearly where you start to crimp the ability of the supply chain to function.”

Container-line fallout

For the container lines, do you believe this is going to be a negative, given demand destruction in China and output destruction that reduces exports?

“Absolutely. Some of this production you would never get back. And when you’re telling people to shelter in place, that definitely reduces consumption, and some of that’s not recoverable.

“The lines’ hopes of some sort of [rate] recovery after Chinese New Year doesn’t look very positive right now. They have already blanked [canceled] some sailings for Chinese New Year and they can blank more sailings. They seem to be more willing to do that.”

The coronavirus crisis is coinciding with the implementation of the IMO 2020 rule, which requires the use of more expensive low-sulfur fuel. In the dry bulk sector, where rates are very low, ship operators have been unable to pass along the extra cost to cargo shippers. In the container sector, if the situation in China cuts demand, wouldn’t that reduce lines’ ability to pressure box shippers into covering the higher cost of IMO 2020-compliant fuel?

“Yes, there was already skepticism about the lines’ ability to recover their increased cost. Add in a factor like this in terms of demand destruction, and it’s even harder to imagine they’ve got enough pricing power [to pass along fuel costs].”

On the other hand, bunker [marine fuel] pricing is tied to crude oil pricing. The coronavirus crisis has caused a sharp drop in crude, so container lines should at least get that advantage, with the caveat that bunker prices fall more slowly than crude prices.

“Right, the total fuel cost for bunker fuel is not increasing when you’ve got the underlying crude feedstock dropping in price.”

Trade fallout

Not only is the outbreak coinciding with IMO 2020 implementation, it has coincided with the Phase One trade deal between the U.S. and China. When it comes to promised purchases of agricultural exports and other goods, there were comments from the Chinese side that these were contingent on market conditions. Do you think the economic damage caused by the virus makes it less likely that China will buy those goods?

“If China’s economy is weaker than what they were expecting, they won’t have the demand they expected and some of that demand they were planning to fulfill with U.S. exports. If demand declines and they’ve got that wiggle room in the language [of the agreement], they can say, ‘Sorry, we can’t meet that level of commitment. We don’t have the consumption level to justify it.’”

Another major trade consequence involves currencies. This whole situation has caused the U.S. dollar to jump versus the developing economy currencies. How do you see that affecting U.S. imports and exports?

“This is once again hitting U.S. exporters, making them less competitive selling into end markets overseas. That has already happened. On the import side, it makes some imports more attractive.”

Corporate planning

Finally, there seems to be an immediate effect on corporate decision-making. Companies such as Scorpio Bulkers (NYSE: SALT) are taking a more defensive approach when it comes to balance-sheet and capital-allocation decisions. Also, it seems like this situation could spur managers — whether in supply-chain companies or any other industry — to put major decisions on hold, at until the situation is clearer.

“Absolutely. They [managers] are not going to sign those contracts until they have more confidence that they’re not throwing this money away they were about to commit to. They’ll say, ‘Look, can we hold off on committing to this decision? Let’s wait a month and then decide.’ When they can get more information, they can raise their confidence that the risks are still acceptable.

“This [epidemic] is now in an acceleration phase. There’s just so much uncertainty — and I’m sure there are an enormous number of companies scrambling right now to figure out how serious this is and what their contingency plans are.” More FreightWaves/American Shipper articles by Greg Miller