CSCMP's Supply Chain Quarterly
October 22, 2018

Uncertainty on the high seas

Climate change and geopolitical clashes could transform commercial shipping in the foreseeable future. For global supply chains, powerful new opportunities—and new risks—are just around the corner.

Forty years ago, the maritime industry experienced a revolution. The development of the ocean container transformed commercial shipping, making it far faster and cheaper to transport goods from one continent to another than had ever been possible before. What at first seemed like simply a way to ship goods more efficiently ended up ushering in the age of globalization, a development that had a profound and enduring impact on the global economy.

Now another revolution in commercial shipping may be on the horizon. With climate change causing Arctic ice to melt and geopolitical tensions in some regions threatening to boil over into conflict, shipping routes could radically change in the not-too-distant future. Will these changes have as big an impact as the container revolution of four decades ago? It's impossible to predict exactly how things will play out. What we can say is that climate change and geopolitical tensions will have significant, lasting effects on the maritime industry. And since the vast majority of the world's trade in raw materials and finished goods moves via ocean, supply chains around the world are likely to feel the effects.

Article Figures
[Figure 1] Russia's Northern Sea Route
[Figure 1] Russia's Northern Sea Route Enlarge this image
[Figure 2] China stakes claim on ocean territory
[Figure 2] China stakes claim on ocean territory Enlarge this image

Supply chain executives should be aware, then, of the powerful new opportunities—and new risks—that could arise as the oceans get warmer and political tensions along key shipping routes intensify.

A rival route across Russia
While most observers regard climate change as the source of eventual global-scale disaster, from the top of the world there's another way of seeing it. Arctic ice melt is about to revolutionize supply chains, potentially cutting Asia-to-Europe shipping times by up to 40 percent and shortening Europe-to-West Coast North America routes.

Since the 19th century, Arctic explorers have tried to cross the fabled and dangerous Northwest Passage through the Canadian Arctic by sea. But it was only in 2013 that the first commercial cargo ship was able to traverse it. Now, Russia's President Vladimir Putin has boasted that a new Northeastern sea route will come to rival, or even eclipse, not just the Northwest Passage but also the Suez Canal. That bold statement imparts a sense of what President Putin sees as proprietary to Russia, and can therefore be economically exploited for the benefit of the country.

Putin's vision of an alternative to the Suez route is not so far-fetched as it might at first appear. It's true that Russia's remote Arctic region does not yet have much of the port and maritime infrastructure seafarers depend on for safety, supplies, and repairs. Russia's government has, though, made billion-dollar investments in new maritime infrastructure across the Northeast Passage—which, incidentally, it prefers to call the Northern Sea Route. This has helped enable commercial shipping there to increase some twentyfold since 2010. To date, commercial traffic consists of mere dozens of vessels a year, but that increase is significant.

While the numbers of ships and voyages are still small, and the route is certainly not ready for new-generation container ships, the potential to become a viable trade route is certainly there. The opening of a regular route across Russia's Arctic coast could clear the way for other opportunities, such as creating new port cities and opening previously barren Siberian and other Arctic coastlines to economic development. Indeed, countries bordering on the Arctic Ocean are already thinking about how to take advantage of emerging opportunities to tap potentially massive, previously inaccessible mineral, oil, and gas deposits in newly exposed areas.

For countries bordering the Arctic, the stakes are not small: Some 90 billion barrels of oil and 1.7 trillion cubic feet of natural gas, estimated to be about a quarter of the world's undiscovered oil and gas, are believed to be located in the region. To be sure, there will be much geopolitical sabre rattling as to exactly who owns the Northern Sea Route and sets the tolls. Case in point: In December 2014, tiny Denmark shocked the world by presenting the United Nations with its claim to sovereignty over the North Pole, including an adjoining strip of nearly one million square kilometers—an assertion likely to be vigorously challenged by Russia and Canada, among other countries. Canada is preparing to stake its own claim to the pole, and in something of a publicity stunt, in 2007 a Russian submarine planted a titanium Russian-flag marker under water beneath the North Pole. Let's hope that any serious Russia-Canada face-offs in the future will be limited to the ice hockey rink, rather than carried out over polar ice. The signs, however, point to an escalating collision of interests.

A new "Cold War" in a cold climate
Russia has never had a huge volume of maritime trade, and for good reason. One of the supreme historical ironies of Russia is that although it occupies roughly one-sixth of the world's landmass, it has very limited access to warm water. Nevertheless, its navy is a symbol of power and national pride, dating back to the days of the tsars. Russia has reinvested heavily in its submarine fleet and in naval facilities designed to support the assertion of its national interests in the region and beyond. Certainly an Arctic power play would fit perfectly into the country's strategy. Recent events in Ukraine, after all, have laid bare Moscow's true intent: to regain as much of its superpower status as possible, and to place geostrategic objectives above its immediate economic interests and trade relations.

On the other side of the world, Canada, which has the world's longest coastline, considers the Northwest Passage to be part of its sovereign internal waters. Yet even such North Atlantic Treaty Organization (NATO) friends and allies as the United States view those waterways as an international strait open to unrestricted rights of transit for foreign vessels. It is no coincidence that Canada is now making multibillion-dollar investments in a substantially revamped Royal Canadian Navy. Even Denmark (which continues to have sovereignty over Greenland) and Norway (which also has sovereignty, although qualified, over the Svalbard, or Spitsbergen, Archipelago), the other principal powers active in the region besides Russia, Canada, and the United States, have also given their navies impressive upgrades.

What does all this mean for global supply chains? Supply chain strategists know that new northern routes could shave many days and thousands of nautical miles off trade routes. Large-scale shipping volume through the Arctic is likely years away, but when it does happen, East-West transit times could decrease by up to two weeks, which, of course, means lower fuel consumption and lower costs. (In an unfortunate scientific twist, it's probable that carbon emissions north of 40 degrees north latitude are more damaging to the climate than those released farther south.)

Manufacturers should start to think now about how considerably shorter supply chains might change their plans vis-à-vis logistics, shipping, and where they produce or buy their products. For example, shorter Asia-Europe and Asia-West Coast routes could help to offset China's rising labor and manufacturing costs by boosting competitiveness through faster speed to market and reducing inventory carrying costs. Eventually, the cost and speed advantages of the northern routes could potentially lead manufacturers to reconsider their reshoring (bringing manufacturing back to its original location), and nearshoring (positioning manufacturing closer to end markets) strategies.

In any Northern shipping route scenario, the Suez and Panama canals, and even the envisaged Grand Nicaraguan Canal, which currently has an ambitious planned completion date in 2020, could very well see a dropoff in their traffic as ships bypass them in favor of a shorter, faster—albeit colder—route. The Northeastern Passage along Russia's northern coast, for instance, could cut some 2,200 miles (3,500 kilometers) off the current Rotterdam-to-Vancouver route through the Panama Canal, which tallies roughly 9,000 miles (14,500 kilometers). Similar benefits would be achieved on routes between Europe and Asia (see Figure 1).

Ice-melt patterns, shorter overall distances between major markets in Europe, North America, and Asia, and concerted infrastructure development mean that Russia's Northeastern Passage and the direct transpolar route—which would pass over the North Pole, and is a far more distant reality for shipping—will emerge as economically viable commercial routes much sooner than the Northwest Passage through Canada's Arctic waters. Given its lack of infrastructure and the fact it is much longer in nautical miles, the Northwest Passage may find a different role in "destination" shipping, including tapping the region's natural resources and for adventure tourism.

Keeping Asian trade routes open for business
Russia isn't alone in ramping up its capabilities with the latest generation of naval assets, or "hard power." Coastal states along the Arctic, Pacific, and Indian oceans are also engaged in a geopolitical "feeding frenzy" to gain access to previously inaccessible natural resources, making claims on island chains and seaways in a manner that carries real risk of military and naval confrontation. Examples of disputed areas range from the North Pole in the Arctic to the Senkaku/Diaoyu Islands in an area of the Pacific Ocean bounded by China, Japan, South Korea, and Taiwan. (Senkaku is the Japanese name; China calls the islands Diaoyu.) Given the political delicacies involved in some of these long-held territories and new claims being made on others, a seemingly small incident or infraction could escalate dangerously.

What happens in even the remotest areas of the Pacific could have an appreciable impact on international commerce. About one-third of all the world's trade passes through the South China Sea, where tensions and risks are high. China intends to become the area's dominant naval and military power, and all signs seem to be pointing in that direction. As reflected in recent headlines, China has been testing the nerves of its neighbors, particularly Vietnam and the Philippines. Its hard-power buildup is very real—including the gradual development of a true "blue water" navy, as well as frequent territorial disputes and frictions involving the Paracel Islands, situated between Vietnam and the Philippines, and the Spratly Islands (where China is constructing a military aircraft runway on reclaimed land) near Vietnam, the Philippines, Malaysia, and Brunei. As part of its strategy, China also claims the waters within the "Nine-Dash Line" in the South China Sea and in late 2013 launched an aggressively enforced "Air Defense Identification Zone" in the East China Sea (see Figure 2).

Japan, the United States, South Korea, Australia, and other maritime countries are not taking this sitting down. India, ever wary of China's ambitions, is scaling up its navy too, but there's more: India's long-forgotten Andaman and Nicobar Islands stretch for some 466 miles (750 kilometers), close to mainland Southeast Asia, and four-fifths of China's oil imports pass through this obscure archipelago. India is now turning the Andamans into a major naval, air, and military stronghold that could, in the event of a confrontation, choke off China's energy and raw-material lifeline coming from the Middle East and Africa.

In a region where many countries' vital interests converge, the present risk is less at the level of deliberate conflict than of incidents that might escalate dangerously. With North American and European retailers' dependence on Chinese exports, and the critical chokepoint role played by the narrow and trade-congested Strait of Malacca in Southeast Asia, any military escalation that inadvertently erupted into a shooting war in Asia would spell a true nightmare scenario and would seriously disrupt global trade—or much worse.

The New Maritime Age
For those land-bound citizens for whom the sea is not part of their everyday thinking, and who likely think that the Maritime Age ended with the Phoenicians, Venetians, or the Spanish Armada, it's time to catch up with reality: Seaborne trade volumes and naval buildups have now reached levels never before seen in human history.

According to a Royal Canadian Navy estimate, many companies now have up to one-third of their inventories at sea at any given time. Supply chain managers who may be unaware of just how dependent their businesses are on the world's oceans and seaways may be unprepared for the serious damage and unexpected shocks that could occur with disruptions to any part of the maritime ecosystem.

That dependence makes companies increasingly vulnerable to terrorism, piracy, and even computer hackers, who could compromise the fiber-optic cables that traverse the world's seabed. Many people think that satellites still carry most global communications traffic, but actually some 95 percent of intercontinental e-mails, telephone calls, and financial transfers travel on these cables, which are unprotected and exposed to terrorism, military attack, cyber-warfare, mischief, and even accidental damage. The cables probably are more vulnerable to physical attack or damage than to hacker attacks, but should there be a deliberate attack on underwater communications infrastructure, Internet and phone service would go down or be seriously disrupted in many parts of the world. The ensuing chaos in global supply chains and business at large would make the effects of such factors as port labor strikes and geopolitical spats pale in comparison.

That is not to underplay the impact of disruptions to maritime trade along the lines of the recent slowdowns at the massive ports of Los Angeles and Long Beach, North America's busiest, as well as other West Coast ports. Although the longshoremen's union there has just ratified a five-year contract, a lengthy strike action on the West Coast in the future could bring the U.S. and Chinese economies to a standstill.

The world's manufacturers are already dependent on unfettered, uninterrupted use of the South China Sea, and many will eventually come to depend on the Northeastern Passage over the top of Russia. However, in many cases the countries that control these and other, similarly sensitive areas have placed their national and military power ambitions above their economic interests and their wish to maintain friendly international relations. This means that companies must carefully monitor geopolitical moves, especially those made by Russia and China, that could disrupt supply chains in the event of an escalation in tensions (or worse) with the West.

In short, the role of the sea cannot be downplayed. In fact, with so much at stake on the high seas, it is no wonder so many countries are building up their navies now. And while new opportunities and dangers abound, the world's peace and prosperity sail more than ever on salt water, with a strategic significance that is more profound today than it has ever been.

Erik Peterson is a partner of the strategy and management consulting firm A.T. Kearney, and managing director of its Global Business Policy Council. Stephen Klimczuk-Massion is Senior Advisor/Fellow of A.T. Kearney's Global Business Policy Council.

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