The Economic Implications of the Red Sea Crisis

Iran-backed militants have launched attacks in the Red Sea, resulting in the closure of a major trade route for container ships carrying various goods. This closure, combined with its connection to the Suez Canal, has the potential to disrupt global supply chains and cause an increase in the prices of manufactured goods, impacting the ongoing fight against inflation. The Suez Canal is a crucial waterway, accounting for 10-15% of world trade, including oil exports, and 30% of global container shipping volumes.

The Houthi militants in Yemen claim they are retaliating for Israel's actions against Hamas in Gaza. Despite increased maritime security by the US military and its allies, the attacks persist, with 21 Houthi missiles and drones being shot down on Tuesday.

Amid the ongoing crisis, the impact on the global economy is intensifying. Retailers are issuing warnings of delays, and the cost of shipping goods is on the rise.

The World Bank's biannual report issued on Tuesday cautioned that the disruption of crucial shipping routes is diminishing the flexibility in supply networks and raising the risk of inflationary obstacles.

Out of the 10 largest container shipping companies, namely Maersk, MSC, Hapag-Lloyd, CMA CGM, ZIM, and ONE, six are mostly or entirely avoiding the Red Sea due to the danger posed by Houthi militants.

Carriers have been forced to reroute ships around the Cape of Good Hope in South Africa due to the danger it poses to crew, cargo, and vessels. This has led to delays of up to three weeks, significantly increasing shipping costs and potentially impacting consumer prices. Chief economist Mohamed A. El Erian warned that the longer the disruptions persist, the greater the potential for stagflationary effects on the global economy, referring to a harmful combination of low economic growth and high inflation.

If the Israel-Hamas war leads to a larger regional conflict or if the Houthis target oil tankers and bulk carriers carrying essential raw materials such as iron ore, grain, and timber, the global economy would face even more serious consequences.

According to a report from the World Bank, in a situation of escalating conflicts, there could also be major disruptions to energy supplies, causing a significant increase in energy prices. This, in turn, would have significant impacts on other commodity prices.

Capital Economics stated that the biggest risk is the threat to energy prices. According to economists Simon MacAdam and Lily Millard, while the current shipping disruptions are unlikely to disrupt the global trend of falling inflation, a marked escalation of the underlying military conflict could increase energy prices, leading to higher costs for consumers.

Delivery delays

Oxford Economics also projects a continued easing of inflation, but still identifies an upside risk to prices. According to Ben May, director of global macroeconomic research at the firm, if container transport costs remain at their current elevated levels   almost double the level from early December  this could potentially increase global inflation by approximately 0.6 percentage points. This information was provided in a note on January 4.

Several European car manufacturers have changed their shipping routes to avoid the Cape of Good Hope, resulting in increased costs and approximately two-week delays, according to a representative from the European Automobile Manufacturers Association. In addition, retailers like Ikea have cautioned customers about potential shipment delays and product shortages. Next, a British clothing retailer, also expressed concern about possible delays in stock deliveries due to ongoing issues with access to the Suez Canal.

Crocs (CROX) has also reported that products intended for Europe are experiencing a two-week delay in delivery. The company anticipates no significant impact on its business at the moment, but has stated that it will be closely monitoring the situation. This is not an isolated case, as businesses globally are anxiously waiting for the disruption to resolve, and are starting to prepare contingency plans last utilized during the pandemic.

Abercrombie & Fitch (ANF) has announced its intention to utilize air freight whenever feasible in order to prevent delays, as mentioned in an email to suppliers obtained by Bloomberg. "We shift transportation modes and/or shipping lanes when warranted to maintain flow of goods," stated a company spokesperson to CNN.

Ikea has warned of shipment delays and potential shortages of certain products due to disruption in the Red Sea.

Nathan Howard/Bloomberg/Getty Images

Shippers are expected to face increasing challenges in the upcoming weeks as they hurry to fulfill orders from China before factories shut down for the Lunar New Year holiday. "The period leading up to Chinese New Year on February 10th will pose significant difficulties for shippers and the shipping industry," stated Philip Damas, head of Drewry Supply Chain Advisors, in comments shared online on Monday.

Total crunch

However, he observed that the surplus shipping capacity would lead to a further decline in spot rates, the price of individual freight shipments not negotiated in advance, following the Chinese New Year.

Following the increase in spot freight rates due to the Red Sea attacks, carriers are adding emergency surcharges. Estimates by Judah Levine, head of research at logistics firm Freightos, indicate that the "all-in prices" for major trade routes originating in Asia are currently 2.5 to 4 times higher than the "normal levels" for this time of year, ranging from $5,000 to $8,000 per container.

Levine noted that, however, it is still 45%-75% below their "pandemic peak" in late 2021. At that time, soaring demand for goods from housebound consumers collided with supply bottlenecks, ranging from container shortages to port congestion.

The Port of Los Angeles in the United States on December 4, 2023.

Eric Thayer/Bloomberg/Getty Images

The Suez Canal crisis compounds the existing shipping woes, as traffic through the crucial Panama Canal is already limited due to a severe drought.

Prior to the escalation of attacks in the Red Sea, certain ocean carriers that typically pass through the Panama Canal had opted to redirect their routes to the Suez Canal, as reported by logistics company C.H. Robinson.

As stated by Matthew Burgess, the vice-president of global ocean services at the company, the capacity for global shipping will remain limited for the foreseeable future. He mentioned to CNN, "There will be a lack of available space for shipments from Asia to Europe for at least the next eight weeks, due to the extra time required for the Cape of Good Hope routing."

Container vessel Maersk Hangzhou sails in the Wielingen channel, Westerschelde, Netherlands on July 15, 2018.

Rene van Quekelberghe/Handout/Reuters

Houthi attacks close vital Red Sea route for Maersks container ships

Previous global shipping disruptions have shown that shortages of empty equipment often quickly follow, leading to further delays as companies may have to wait an additional two to three weeks for an empty container.

For now, major ports in Europe and the United States, such as the Port of Rotterdam, the Port of Los Angeles, and the Port of New York and New Jersey, have seen minimal impact from the Red Sea crisis. However, they are closely monitoring the situation for potential repercussions.

Gene Seroka, Executive Director of the Port of Los Angeles, told CNN that it is another significant disruption in the supply chain that will not be resolved in the next few weeks. Even if the attacks ceased now, there would still be lingering impacts and delays that will take a long time to resolve, according to Burgess of C.H. Robinson.