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How do Red Sea disruptions affect global supply chains?

25 January 2024 |
Commercial shipping in the Red Sea has been significantly disrupted by attacks from Houthi rebels operating out of Yemen.

Fast reading

  • The Red Sea, connected to the Mediterranean by the 120-mile Suez Canal, is the primary maritime gateway for cargo flows from Asia to Europe and the Mediterranean.
  • Container shipments operating in the Red Sea have dropped 75% as a result of the disruptions as vessels re-route around Africa. But longer routes can add to journey times and push up costs.
  • The Federated Hermes Trade Finance Strategy’s investment portfolio is not directly affected by recent events in the Red Sea, and we do not anticipate the need to increase near-term financing as a result of the situation.

Maritime trade flows passing through the Red Sea have been significantly disrupted by Iran-backed Houthi rebels operating out of Yemen over the last few months.  The attacks – involving drones and rockets and the commandeering of commercial vessels – began in October, and have increased amid escalating tensions in the region related to the conflict in Gaza. The impact of the attacks has been primarily regional to date, affecting trade flows between Asia and Europe.

The Red Sea, connected to the Mediterranean by the 120-mile Suez Canal, is the primary maritime gateway for cargo flows from Asia to Europe and the Mediterranean. Container shipping is typically the most cost-effective way to move freight and 25%-30% of global container shipping volumes pass through the Suez Canal1.

The Bab-el-Mandeb strait, a narrow 20-mile stretch of the Red Sea, holds similar strategic importance for container shipping as the 30-mile Strait of Hormuz for crude oil shipments – a narrow maritime passage that has the potential to become a chokepoint.

The present situation is different to March 2021 when the Ever Given container ship became lodged in the Suez Canal, blocking the passage for a week. While all cargo types have been affected, the primary targets of the attacks – which appear carefully orchestrated – have been container ships with perceived links to Israel.

Figure 1: The Bab-el-Mandeb strait

Source: Getty Images

The impact on shipping

Container shipments operating in the Red Sea have dropped 75% as a result of the disruptions2.

In response, charterers are re-routing vessels around Africa to avoid the attacks and protect crews and cargo. But this longer route can add another two weeks to the typical 30-40-day journey time between Asia and Europe3.

As a result, cargo shipping has become more expensive and less time-efficient; and maritime insurance premiums and container ship spot charter rates have soared.

We expect the economic impact of the disruptions to become pronounced during January and February as the number of voyages contracted prior to the attacks are phased out and new voyage charter contracts are negotiated.

Deliveries to Europe over the Christmas period were not materially affected.

The upcoming Lunar New Year in mid-February will see Chinese factories wind down activity, resulting in trade flows trending seasonally lower for some time. If trade flows in the Red Sea continue to be disrupted, then attention may turn to assessing the wider financial impact of disruption and potential for delays to product deliveries during the Easter period and beyond.

Economic implications

In the event that shipping voyages between Asia and Europe become longer, the demand for shipping containers and vessels will increase.

However, any spike in demand comes against a backdrop of overcapacity and price pressures in the container sector. There is not currently a capacity shortage. The recent rises in container shipping rates are significant but are not near the sharp rises in 2020 and 2021 during the Covid-19 pandemic.

The situation in the Red Sea has, in fact, turned what would otherwise have been a bearish operating environment for shipping in 2024 on its head.

The chief economic impact felt by container shipping companies has been positive – a significant boost to income from four-times higher charter rates. The downside has been felt by Europe-based international retailers that have had to absorb higher shipping costs, which has hit profitability.  

To date, the disruptions have most severely affected container-based cargo trade.

The longer-term impact on corporate earnings from the disruption remains difficult to gauge. The duration of the Israel-Hamas war is unknown, as is any potential regional escalation of the conflict. It remains to be seen how effective the US-led military operation to safeguard maritime trade routes (Operation Prosperity Guardian) will prove to be. The multinational operation is in its early stages.

  • In December, shipping group Maersk resumed Red Sea journeys but backtracked on this move days later and suspended all passages after one of its ships came under attack.
  • Political debate around the scope of the Operation Prosperity Guardian mandate is ongoing and evolving. The US-UK joint air strikes against Houthi targets in Yemen represents a further escalation.
  • Multinational coordination at short notice and the logistics of implementing measures to prevent attacks have not yet been fully addressed.

Federated Hermes Trade Finance Strategy

While the situation in the Red Sea make can make for attention-grabbing headlines, we believe the Federated Hermes Trade Finance Strategy is largely insulated from its effects and has no direct exposure. To date, the disruptions have most severely affected container-based cargo trade.

Our Strategy focuses on the trade of primary and essential goods, not manufactured goods, and this alone helps to significantly protect the Strategy. Much like the headlines and photos of ships queued at ports during the Covid-19 pandemic, these are container ships carrying manufactured goods, not the types of trade flows we typically finance.

The Federated Hermes Trade Finance Strategy also implements aggressive diversification. One factor of diversification is transaction structure type. The portion of the market most disrupted by the events in the Red Sea is discounting instruments as part of the wider supply chain finance sector. While our Strategy is active in this sector, it is a fraction of the overall allocation. We do not invest in discounting instruments for container-based cargoes. We only invest after commercial terms are settled and shipping costs and possible delays are factored in, and where an irrevocable payment obligation has been previously accepted by the purchasing party. We make case-by-case, finite fiduciary investment decisions. The Strategy does not buy from platforms, nor is it involved in binding ongoing commitments.

We will continue to monitor the situation closely but are confident in the construction and outlook of the Strategy.

For further information on the Federated Hermes Trade Finance Strategy, please contact Douglas Anderson, Head of Consultant Relations, or Clive Selman, International Head of Sales.

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