Red alert in the Red Sea: Is nearshoring the answer?

On 19 November last year, Iranian-backed Houthi rebels in Yemen hijacked the ship Galaxy Leader in the Bab al-Mandab Strait, a strategic link between the Mediterranean Sea and the Indian Ocean via the Red Sea and the Suez Canal. The British owned, Japanese operated cargo vessel, whose parent company is co-owned by Israeli businessman Abraham Ungar, now sits at a Red Sea port in Yemen, where it has become a tourist attraction popular with Houthi youths and social media influencers. 

The Houthis’ say they hijacked the ship in response to Israel’s war with Hamas in the Gaza Strip. But since then, dozens of vessels have been targeted by Houthi drones, missiles and speed boats in the area, many of which have no connections with Israel. 

In response to the ongoing attacks, a US-led coalition has deployed naval vessels to the area in order to protect merchant shipping from the Houthis. In addition, US and UK forces have launched proportionate air strikes against Houthi targets in Yemen. 

To say the current situation in the Red Sea is complicated and precarious is an understatement. 

A critical supply chain link 

When you consider that over 80% of international trade in goods is transported by sea, and that 30% of global container trade passes through the Suez Canal, the potential impact on supply chains of the current Red Sea shipping crisis is seismic. 

In December 2023, shipping giants AP Moller-Maersk and Hapag-Lloyd paused their activity in the Bab al-Mandab Strait. MSC and CMA CGM have since followed suit, meaning the world’s biggest shipping lines are no longer transiting the Suez Canal. Indeed, Suez Canal traffic is at its lowest level since the 2021 blockage, when the 400 metre long Ever Given container ship ran aground, blocking the waterway for six days and holding up £7bn of goods a day. 

Shipping companies are now ordering their vessels to traverse the Cape of Good Hope, a lengthy detour that adds around 4,000 miles and a 30% increase in transit times to every journey. This reality sees ships burning more fuel and taking longer to reach their destinations, a situation that is also creating larger carbon footprints in the process. For the shipping industry – which is already one of the most polluting in the world – this is less than ideal, as it strives to reduce its greenhouse gas (GHG) emissions. 

According to figures from London-based shipping services provider, Clarksons, container ship arrivals in the Gulf of Aden – which connects the Red Sea to the Indian Ocean via the Bab al-Mandab Strait – in the week to 5 February were down 92% on the average for the first half of December. 

In terms of costs, ocean shipping rates from Asia to Northern Europe have risen significantly in recent times. Figures from online freight marketplace, Freightos, published on 10 January, show that shipping rates from Asia to Northern Europe rose 176% week over week to £3,481 per 40 foot equivalent unit (FEU). Freightos data from the previous week showed an increase of 151% week over week to £3,204 per FEU. In other words, the cost of shipping from Asia to Northern Europe increased by 327% in the space of two weeks. 

Nevertheless, present shipping costs remain well below the levels seen during the pandemic. As Judah Levine, Head of Research at Freightos Group, pointed out: “The additional costs and capacity taken up by the longer transits are pushing rates up significantly, but even at $5,000 (£3,964) – $8,000 (£6,343)/FEU, Asia – N. Europe and Mediterranean prices would be 45-65% lower than their $14k (£11,100)/FEU pandemic peak in late 2021.” 

Furthermore, the current Red Sea crisis comes as the Panama Canal faces one the worst droughts in its history. Another key shipping channel, the Panama Canal normally allows 38 ships a day to pass through it. Right now that number is down to 24, meaning more delays and higher costs until at least the end of April, according to Ilya Espino De Marotta, Panama Canal Deputy Administrator. 

One potential silver lining is that there is an excess supply of container ships globally. Many that were ordered during the COVID-19 pandemic continue to enter service, meaning that we will likely see shipping rates fall relatively rapidly once the situation in the Red Sea stabilises.

Maersk and other shipping giants have re-routed vessels around the Cape of Good Hope

Considerable impact 

Earlier this month, S&P Global released its latest UK Manufacturing PMI figures, which shone a light on the impact the current situation in the Red Sea is having. 

In January 2024, UK manufacturers saw output, new orders and employment decline. In addition, input costs and selling prices both rose. Manufacturers linked lower output to weaker new work inflows, efforts to reduce inventory holdings and disruption caused by supply chain delays. 

The seasonally adjusted S&P Global UK Manufacturing Purchasing Managers’ Index (PMI) posted 47.0 in January, up from 46.2 in December but below the earlier flash estimate of 47.3. The PMI has now signalled a deterioration in operating conditions in each of the past 18 months. 

S&P data showed that attacks on ships in the Red Sea had a notable impact on supply chains in January, affecting delivery times across a variety of manufacturing sectors. Unsurprisingly, the impact was greatest in Europe, as re-routing resulted in two-week delays in some instances being added to average lead times for European producers. Consequently, supplier delivery times in the UK and eurozone lengthened for the first time in a year. 

Moreover, of the European countries monitored, UK manufacturers were the worst affected, accounting for 12% of those surveyed who said they saw lead times deteriorate in January. Greek producers also frequently saw delivery delays (nine percent), followed by France and Germany (eight percent). 

Commenting on the latest PMI data, Rob Dobson, Director at S&P Global Market Intelligence, said: “Cost and stock management initiatives are being complicated by the Red Sea crisis. Diverting purchased inputs, especially those sourced from the APAC region, around the Cape of Good Hope is raising prices and extending supplier lead times. Some of our panel members estimate that a minimum of 12-18 days could be added to some expected deliveries, disrupting production schedules and raising inflationary pressures at a time when manufacturers are already struggling with weak demand both at home and overseas.” 

However, UK manufacturers have shown their resilience throughout the current Red Sea crisis, keeping facilities operational and continuing to make goods. This is in stark contrast to some of their European-based counterparts, including Tesla and Volvo Car, who paused some of their operations in Europe in the face of component shortages.  

Tesla temporarily closed its factory near Berlin between 29 January and 12 February, citing a lack of components after many ships were forced to go around the southern tip of Africa. Meanwhile, Volvo Car paused operations at its Belgium facility for three days in January due to a delayed delivery of gearboxes. 

Marco Forgione, Director General of the Institute of Export & International Trade, said: “The manufacturing sector is at particular risk, given it operates on a ‘just in time’ process. A significant proportion of different components, commodities and ingredients all come through the Suez Canal, and if these are being delayed then this will feed through into the ability of manufacturers to maintain the production of goods.” He warned that other companies will likely follow Tesla and Volvo Car’s lead if the situation does not change. 

Is nearshoring the answer? 

Even before the current Red Sea crisis, UK manufacturers were already showing a penchant for nearshoring. Indeed, a March 2023 report from Make UK and Infor showed how manufacturers were scrutinising their supply chains and adopting a range of strategies to manage relationships with suppliers at home and overseas. 

Among these strategies outlined in the No Weak Links: Building Supply Chain Resilience report was the reshoring and nearshoring of suppliers to mitigate supply chain disruption and increase resilience. In fact, 40% of manufacturers polled for the report said they have already increased their supply from the UK, while a similar number said they will do so over the coming year. 

It’s a similar story too when it comes to nearshoring, with 20% of companies reporting that they increased suppliers in the EU, while a further nine percent did so in non-EU countries. Meanwhile, 24% said they had plans to increase EU suppliers over the coming year, highlighting manufacturers’ desire to shore up their supply chains. 

Separate research from INVERTO, part of Boston Consulting Group, released in December 2023, echoed the findings of the Make UK/Infor report. According to the INVERTO Near-shoring Study, over 90% of companies surveyed said they viewed nearshoring and reshoring as key ways of safeguarding their supply chains. 

Increased efficiency, improved flexibility and shortened delivery times were all cited among the benefits of nearshoring and reshoring supply. 

Positively, we recently saw the government announce some proactive steps to mitigate the risks posed by supply chain fragility. The new Critical Imports and Supply Chains Strategy, launched in January, is designed to safeguard supplies of critical goods such as medicines, minerals and semiconductors.  

Contributed to by more than 100 top UK firms, including pharmaceutical and manufacturing leaders, the strategy is designed to further equip UK businesses to deal with global supply chain problems and access the imports they need which are essential to the functioning of the UK. 

Minister for Industry and Economic Security, Nusrat Ghani, who launched the strategy at Heathrow Airport, said: “There are many unpredictable events that can threaten our access to vital goods, from the pandemic, Russia’s illegal war in Ukraine, and the ongoing attacks in the Red Sea. That’s why we’re taking action to ensure crucial imports like medicines can reach consumers, no matter what happens around the world.”

One option is for manufacturers to reshore or nearshore their supply chains to boost resilience going forward

Lessons 

While UK industry learned a lot from the pandemic and the Ever Given crisis, implementing contingency plans in the face of supply chain disruption, the Suez Canal/Red Sea choke point will always remain just that as long as manufacturers continue to rely on the Far East for many of their components and raw materials. 

Then there is the Taiwan conundrum. With Britain’s semiconductor industry relying heavily on Taiwan, which produces over 90% of the world’s most advanced microchips (found in everything from smartphones to cars), any instability inevitably leads to uncertainty 6,000 miles away in the UK. And right now, instability could be on the horizon in Taiwan. 

That’s because the recent presidential elections in Taiwan saw Lai Ching-te emerge victorious. Taiwan’s new president-elect has vowed to safeguard the island’s de-facto independence from China and further align it with other democracies, a stance that Beijing will undoubtedly rebuke. 

Political change and the prospect of increasing regional tension do not bode well for UK manufacturers which rely on Taiwan for chips. And while the US and EU have both enacted ‘CHIPS Acts’, designed to mitigate the risk of chip shortages, the UK’s National Semiconductor Strategy, announced in May 2023, is significantly smaller by comparison in terms of the investment and support pledged. 

Reshoring or nearshoring supply chains can offer UK manufacturers various advantages in terms of risk mitigation, cost savings, quality control, sustainability and responsiveness to market dynamics. However, while reshoring or nearshoring may offer numerous benefits, manufacturers must weigh these advantages against the potential challenges and risks associated with bringing supply closer to home. 

While the Suez Canal serves as a critical artery for global trade, its significance is underscored by the vulnerabilities it poses to supply chains. The recent attacks on commercial shipping and the blockage due to the Ever Given incident highlight the potential for disruption, exposing the intricate interdependence of international commerce.  

When all said and done, the Suez Canal remains a pivotal choke point that demands continuous attention and strategic planning from manufacturing stakeholders worldwide. Its enduring importance underscores the importance of resilient supply chain management in navigating the complexities of global trade.