Despite the difficulties that come with the onset of any conflict, particularly for those directly involved, unprecedented level of economic turbulence in recent years have left our clients feeling better prepared than they might otherwise have been. Over the past five years, they have weathered the storm of Covid-19, multiple global conflicts and resultant sanctions, and blockages of key supply routes like the Suez Canal. It is no surprise that these businesses are now poised to implement necessary workarounds for the ongoing conflict in the Middle East.
What sorts of things should be top of mind?
Delay and increased cost is inevitable
With the Strait of Hormuz effectively closed and major carriers suspending transits in the region, businesses should rapidly reroute freight away from these Gulf chokepoints. Goods avoiding that part of the world are likely to be delayed, and if there are diversions via Cape of Good Hope for instance, then this can add up to 2 weeks to transit times and, and inevitably significantly increases freight charges. Air travel, including air freight is also disrupted due to regional airspace closures and rerouting, reducing capacity for high‑value consumer goods like electronics.
Now would be a good time to do what you can to plan ahead and pre‑book alternative ocean and air capacity prioritising essential and high profit SKUs for faster (and more expensive) options, but expect competition for open routes to be fierce and regardless of how long the conflict continues, we therefore may continue to see impact here into the summer and beyond and if this continues beyond this month it may start to be necessary to consider ordering and securing supply routes early for core inventory for H2 26
The question will be who will pay for the delay or longer routes, a question potentially answered by a contract review, though it is expected that, subject to incoterms, retailers expect suppliers to absorb most of the cost. This in turn could trigger inflationary pressure – potentially globally.
Review contracts and insurance
We understand that some shipping insurers and P&I clubs have withdrawn war‑risk cover, shifting risk back to cargo owners. Some Carriers have also invoked “End of Voyage,” legally offloading responsibility at diversion ports. In this scenario it is common to see force majeure clauses being used to address potential contractual non‑performance risks.
You will want to understand your contractual position including review delivery terms (most likely Incoterms), and where necessary renegotiate in order to allocate diversion and conflict related costs fairly.
In addition, it is necessary to consider insurance coverage, force majeure provisions, supplier obligations, and exposure to diversion‑related cost.
Another area to consider in the contract is retention of title clauses. These provide protection to sellers so that they can ensure that title to the goods does not pass to the buyer until full payment of the goods has been received. Such clauses also ensure that the seller, in circumstances where payment in full has not been received, is able to take possession of the goods without the need to immediately commence legal proceedings for non-payment of sums due.
Our Insurance and contract expects can help with these risk reviews and should you need to get a lot of contracts reviewed quickly our Legal Operations division is ready to deploy contract abstraction technology to give you a quick and relatively cheap review of your entire contractual position so that you are better informed for managing risk.
Energy costs will also rise
Business with their energy costs already locked in will be in a strong position here given the impact the conflict has already had on oil prices. Brent has already risen by over 10% and analysts are predicting it may continue to raise in price if disruptions persist.
Already stretched gas supply markets also may be particularly impacted as a response to the Ukraine conflict was to restructure gas supply chains away from Russia and with c15% of European LNG transiting the Stait of Hormuz a reduction in availability is likely to see prices rise quickly. This is particularly so as it is reported that there was already limited excess capacity in the EU and volatility has near immediate impact on parts of the sector like manufacturing, packing and food processing.
Where possible strengthen inventory to create a buffer of stock
There are already reports of delays in electronics, appliances, food ingredients, and packaging materials, with Gulf retailers already reporting stock shortages. Anything that can be done to build up stocks now may pay dividends the longer the conflict continues.
One area expected to be impacted is fertiliser. It is reported that 1/3 of the EU’s needs for fertiliser raw products, like nitrogen products currently transit the Strait of Hormuz. This is seeing sharp increases in cost with reports of increases of 25% being seen. These costs will then feed into the costs of both primary production of food and other agriculture products as well as other processed foods.
To counter these types of risks it is prudent, where space allows to stockpile what is possible and consider if there are other non-gulf supply options
Consider near shoring options, but, take care with alternative sourcing
When supply chains come under pressure one of the first things that happens is substitution, both of specific products and of suppliers to find that product you need. When you do this at pace, it opens risk as often in the spirit of just getting something fixed corners can be cut, and due diligence can be missed. For foods this this can be critical as moving from one product to another even appearing to be the same can result in different ingredients and crucially different allergens being used – which if the receiving business does realise might very easily be missed and someone could consume. But, even at a more general level, in the rush to source missing products you can find yourself doing business with a business that might not meet the same standards as you or just not know enough about it to be sure that there is no modern slavery in the supply chain or even that its products are really as described. This process can be avoided by having alternatives available that can be selected and audited properly when there is adequate time.
The other option in this situation is that you wait for the product to become available. This may result in a delay which could lead to empty shop shelves or unhappy consumers waiting longer than they expected. All you can do here is communicate clearly and openly and try to manage expectations and try to come to an agreement about a revised timetable, hoping that the exceptional circumstances receive special treatment.
It has been the case the that the EU and various member states like Germany are placing increasing obligations on business to conduct diligence on their supply chains. CS3D at EU level and the German Act on Corporate Due Diligence in Supply Chains are but two examples of this at headline level. Both obliges companies to comply with human rights and environmental standards in their supply chains, e.g. the prohibition of child labour, slavery or the causing of soil or air pollution. But, in addition to this there are also a range of other topic specific laws like deforestation, or forced labour that also themselves place specific obligations on verifying the compliance of supply chains. As a result cutting corners in this type of crisis brings a much wider range if risk than just upset customers.
Conclusions
With uncertainty again the order of the day, anything that can be done to remove confusion will be a positive step and planning ahead now is key. It is time to dust off those Covid playbooks again.
