GEOPOLITICS & SUPPLY CHAINS
The Purchaser Magazine – January 2024
John Sitilides discusses current geopolitical risks, their impact on trade and supply chains, and how they are projected to evolve in 2024.
The concept of “supply chains” was largely esoteric to most people in recent decades, known well to a highly specialized industry core of manufacturing, transportation, logistics, and just-in-time inventory experts whose professions flourished during the era of commercial globalization, largely the three decades from the early 1990s until the national lockdowns enforce by governments worldwide after the COVID-19 pandemic outbreak from Wuhan, China.
The sudden and massive lockdown disruptions to supply chains, from medical, pharmaceutical, and personal protective equipment at the strategic level, to automobiles and toilet paper for everyday consumers, introduced the curious phrase to billions of consumers rather quickly.
At the same time, the general sense of growing tensions among the world’s most powerful nations accelerated with China’s more flagrant threats against Taiwan in 2019 and Russia’s 2022 second invasion of Ukraine, following its first invasion in 2014. The broader respect among most nations for a rules-based international order seemed to be collapsing and retreating into a more brutal global security environment marked by the return of geopolitics and its accompanying exercise of raw power on the international stage.
Geopolitics is a term often and mistakenly confused with the complexity of international relations. That is partly correct. More precisely, geopolitics involves the immutable aspects of geographic realities that incentivize or constrain national leaders in the political decisions they make, and the trade-offs they must ultimately accept, in the conduct of their diplomatic and military relations with neighbouring and regional countries. For a great power such as the U.S., the geopolitical considerations are often global in scale. For aspiring powers such as China, Russia, and Iran, the considerations are mostly regional – though China is openly proclaiming its geopolitical objective to match and surpass the U.S. as the world’s leading power within the next three decades.
In joining these two concepts, a serious consideration of the geopolitics of supply chains begins with the core premise that 90% of the world’s commerce, and 80% of the world’s oil and liquefied natural gas, is shipped around the world on the global oceans, waterways, and seas that comprise 70% of the Earth’s surface. This free and open international trading system is dependent upon shipping lanes that are protected by the U.S. Navy and supported by American taxpayers, in conjunction with the military forces of our allies and partners primarily in Asia and Europe, which are most vulnerable to disruptions of imported energy, natural resources, and foodstuffs.
This U.S.-led system, in many ways inherited from the British Empire after the end of the Second World War, is essential to deterring and thwarting historic patterns of piracy, paramilitary forces, maritime terrorism, and outright imperial or nation-state aggression on the high seas and especially within or adjacent to the most critical choke points that can easily disrupt the most import commercial routes.
Supported by international legal frameworks and treaties to uphold navigation freedom in international waters, as well as in corresponding international airways, this global trading system has benefitted not only the U.S., naturally as its leader and preponderant protector, but also America’s adversaries, rivals, and enemies.
Ironically, the greatest non-U.S. beneficiary is the Chinese Communist Party (CCP), which rules with an increasingly rigid Leninist absolutist grip over a Chinese nation comprised of 1.3 billion citizens. The historical industriousness of the Chinese people is well-documented, as China and India respectively presided over the world’s largest economies for most of the past two thousand years, until their encounter with the British Empire and with dominant Western industrial and military technology starting in the mid-1700s in India and the mid-1800s in China.
Nonetheless, there is no rational strategic argument for Washington having accelerated Beijing’s economic rise on a frenetic trajectory by supporting China’s membership first as a Most Favored Nation trading partner of the U.S., followed by entry into the World Trade Organization in 2001. That was the threshold event after which China’s astonishing annual GDP growth rates of 10% or more catapulted it past the United Kingdom, Germany, and Japan in short order to its current status as the world’s second-largest economy.
The willful outsourcing of U.S. and European manufacturing to low-wage, highly efficient, and environmentally indifferent factories and logistics centres in China only hastened the hollowing out of middle-class manufacturing industries in leading Western countries, especially across the American Rust Belt and Midwest regions.
Today, CCP General Secretary Xi Jinping seeks to propel China towards the Great Rejuvenation, in which China will regain its global economic primacy, essentially toppling the U.S. as the world’s largest economy by nominal total GDP, even if continuing to trail in per capita GDP, given the relative $64,000 wealth in 2023 of the average American compared to the significantly poorer Chinese counterpart at about $13,000.
Beijing has used this spectacular growth to undertake the greatest peacetime military buildup in a century, since Germany in the 1930s. The People’s Liberation Army has enjoyed a 900% increase in the military budget since the 1990s, and the Chinese Navy is now larger than that of the U.S., even as American lethality and overall power projection capability is superior for now.
China is rapidly growing its nuclear arsenal, once considered largely defensive at just about 60 warheads in 1970 to deter a Soviet or American attack.
Today, China is rapidly expanding its warhead arsenal to about 500 and is projected to deploy 1,000 nuclear warheads by 2030 and 1,500 by 2035. Beijing nuclear scientists are surpassing their American peers in developing hypersonic technology to enable intercontinental ballistic missiles to enter and exit space orbit and evade defensive anti-missile systems, potentially rendering the continental U.S. vulnerable to a first strike.
At the conventional level, the CCP is determined to expel the U.S. military from East Asia. American forces have been stationed in Japan and South Korea for seventy years, to prevent the rise of a hostile hegemonic power on the Asian continent and to deter a North Korean invasion of its southern neighbour. Beijing perceives the U.S. military presence not as a benign force protecting the free and open shipping lanes that enable China and every Asian country to trade regionally and globally. Rather, it sees a foreign power from the other side of the planet constraining China’s natural ascension to Asian hegemon and restoring its historic place at the centre of a continental tributary system whereby all of its smaller and weaker Asian neighbours must assent to its political, diplomatic, and military will.
China’s relationship with neighboring Vietnam highlights this American conundrum. The Biden Administration is actively seeking to graduate Vietnam from a non-market economy to a market economy, which would relax the current framework of the Commerce Department’s enforcement of U.S. antidumping and countervailing duty laws. The main purpose is to accelerate the rerouting of supply chains from China to Vietnam, as well as other Asian countries such as India, Indonesia, and the Philippines, as part of the broader U.S. strategy of de-risking U.S. trade from overdependence on Chinese factory floors. President Biden’s visit to Vietnam in September 2023 underscored his administration’s intentions.
The problem is inherent in the governing system in Hanoi, like Beijing ruled by a rigidly ideological Leninist Communist Party, as well as in the geopolitical limitations Vietnam’s 806-mile-long border imposes on its political leadership. Vietnam currently imports more intermediate goods from China than from any other country, exceeding those from Japan, South Korea, Singapore, and the U.S. combined. Its position as a final assembly point for Chinese products makes it one of the largest sources of transshipped Chinese goods in the world.
Several U.S. Senators have complained to Commerce Secretary Gina Raimondo that graduating Vietnam to a market economy would enable Beijing to more effectively circumvent U.S. anti-dumping laws and sanctions imposed on Chinese exports due to human rights abuses. Washington’s effort to reshore supply chains in Asia would fail under the growing number of CCP-run businesses that have already begun “offshoring” to Vietnam in anticipation of Hanoi’s elevated trade status, to increase exports of predatorily priced Chinese goods into the U.S. market. In December, Xi Jinping visited Hanoi, which declared its wish to join the Beijing-led “community of nations with a common destiny,” and entered into 36 trade, logistics, defence, and security cooperation agreements with China.
Beijing’s “strategy of the periphery” is geopolitically most evidently manifested towards Taiwan, the self-governing island of ethnic Han Chinese since 1949 which the Communist Party considers a rogue entity that must be unified with the Chinese mainland. Taiwan has never been ruled by the CCP, and it rejects any pressure from Beijing to come under its rule. The fate of Taiwan is of strategic importance to the U.S. and its advanced industrial Asian allies for several reasons.
Taiwan is home to the company that manufactures the most advanced semiconductors providing the computing power of the modern world. The microscopic integrated circuits produced by the Taiwan Semiconductor Manufacturing Company (TSMC) enable the most advanced military technologies, satellites, and space vehicles, as well as the frontier technologies such as artificial intelligence and quantum computing that will power the leading global technology sectors in the decades ahead. China’s potential capture of TSMC would disrupt one of the world’s most vital technology supply chains and leave the U.S. and most advanced industrial countries in the G20 and beyond at the mercy of the Communist Party in Beijing.
Political control over Taiwan would render Japan highly vulnerable to further Chinese military expansion. Japan’s main islands are distant from Taiwan, but its lengthy archipelago of smaller islands bends southwest to the north and east tip of Taiwan. Beijing could use the island as a launching base for expeditionary operations against sovereign Japanese islands, several of which Beijing has claimed as Chinese for more than a decade. Given that Japan is a treaty ally of the U.S., Washington would be compelled to defend Japan, threatening yet another potential conflict with China’s powerful, nuclear-armed military.
The People’s Liberation Army could extend its reach beyond Japan and project power closer to Guam, America’s westernmost island in the Pacific Ocean, 1,700 miles east of Japan and Taiwan. Guam hosts 10,000 U.S. Marines who supplement military operations to protect and defend international freedom of navigation near Asian waterways, especially the South China Sea. Approximately 30% of annual global trade traverses this strategic waterway annually, and China, Japan, South Korea, Taiwan, and many southeast Asian economies depend upon access to this vast sea for existential energy and food imports, and to connect to distant trading markets in south Asia, Africa, the Middle East, and Europe. Chinese control over Taiwan directly threatens American capability to defend the high seas, and to deter Beijing from undertaking military aggression against its immediate neighbours – so far.
Another recent encounter with the geopolitics of supply chains occurred across the Eurasian continent after the Russian invasion of Ukraine. As the war enters its third year of trench warfare attrition, reminiscent of the carnage of the first world war a century ago, global markets have somewhat adjusted to the initial supply chain shocks to global trade in essential foodstuffs and fertilizers without which entire societies in Africa, the Middle East and South Asia might have confronted mass hunger. Freight and shipping charges were directly impacted in early 2022 just as many economies were emerging from the destructive COVID lockdowns, which had already shaken global commercial shipping and led to massive logjams at critical ports in the U.S. and other countries.
Among the most decisive supply chain effects were the self-imposed cutoffs by Brussels of Russian seaborne oil and gas to European Union countries. This was not uniform, as several EU members far more dependent on Russian hydrocarbon supplies were granted a measure of relief. Moscow in turn shut down pipeline natural gas to almost all of its EU customers.
The EU sanctions did contain additional loopholes. No sanctions were imposed on the import of Russian liquefied natural gas, and the EU as a bloc was expected to purchase more LNG from Russia in 2023 than in 2022, with the bulk sold to Belgium, Spain, and France. Europe’s LNG purchases totaled about $1 billion monthly by the end of 2023, providing Moscow with essential financial resources to continue building up its military to attrit Ukrainian defenses and erode its will to resist.
A Russian natural gas pipeline that crosses Ukraine west into Slovakia continues to provide LNG to that country, which then connects with LNG markets in the Czech Republic and Hungary, all with Brussels’ approval. According to Columbia University’s Center on Global Energy Policy, Austria and Slovakia still derive a substantial portion of their LNG imports from Russia, while Italy and Hungary have been drastically reducing their Russian dependence. Ukraine has been earning about $7 billion annually in transit fees from Russian companies Gazprom and Naftogaz to continue the flow of Russian pipeline gas through Ukrainian pipelines to eastern European countries, under a deal that expires this year and which Kyiv is not expected to renew.
In addition, the U.S. continues to purchase about $800 million annually in uranium from Russia to power its nuclear energy plants, dependent on an international nuclear fuel supply chain to provide one fifth of America’s electricity needs. In December, the House of Representatives passed a bill to ban further imports from Russia starting in 2028. The state-owned Russian uranium company Tenex warned that Moscow was considering preemptively barring exports to American electric companies immediately if the bill is signed into law, potentially devastating U.S. nuclear power generation.
The scramble to identify new energy supply chains in the wake of the Russian invasion of Ukraine underscores the continued importance of the Middle East and its vast oil and natural gas resources. The technological breakthroughs of hydraulic fracturing and horizontal drilling in the past two decades has transformed the U.S. into an oil and gas superpower and net exporter. Russia remains the world’s second largest gas producer and third largest oil producer, second to Saudi Arabia. As Europe importers and American exporters reconfigure global energy markets, Asia’s leading economies depend on the Middle East for about 80% of total energy imports.
According to the American Enterprise Institute’s China Global Investment Tracker, China is now the world’s largest importer of oil, purchasing just under 50% of its total $176 billion supply from Saudi Arabia, and another 20% from Iraq, Oman, United Arab Emirates, and Kuwait. Beijing has also been circumventing the U.S. & EU sanctions on Iran, and is Teheran’s highest-volume customer, purchasing about 40% of Iran’s total annual exports. China also purchases about 20% of its total LNG from Qatar.
The world’s third-largest economy is also heavily dependent on the Middle East for its energy supply. Japan is the world’s fourth-largest importer of oil, with 95% of its crude supply dependent on Saudi Arabia, UAE, and Kuwait. South Korea purchases about two-thirds of its oil supply and one-third of its gas supply from Middle Eastern countries. Taiwan is similarly dependent on maritime crude oil imports for more than 40% of its total energy needs, with almost three-fourths of its oil imports sourced in Saudi Arabia, Kuwait, UAE, Oman, and Iraq.
EU countries now mostly cut off from Russian oil and pipeline gas have turned more towards the U.S. to meet domestic energy demand than to the Middle East. The one exception is the number of long-term contracts by several European countries to secure LNG supplies from Qatar. In October alone, France, Italy, and the Netherlands entered into respective multi-decade agreements. Germany has been planning to enter into a similar arrangement with Qatar, but Berlin’s political leadership is locked in a debate over Doha’s financial support and haven provisions for Hamas and its leaders, especially in the wake of the October 7 assault in which 1,200 Israeli civilians and 39 Americans were killed and more than 200 individuals, including Americans, were taken, hostage.
Qatar’s role as Hamas’ diplomatic protector has come into the energy spotlight, but the longer-term concern regarding Middle East stability to ensure continued access to regional energy supply chains necessarily focuses on Iran. The U.S. Department of State has designated the radical Shia theocracy as the world’s leading state sponsor of international terrorism since 1984, across Democratic and Republican administrations. Iran openly aims to destroy Israel and destabilize its Sunni Arab neighbours in order to achieve hegemonic status that determines the fate of the Middle East.
As the Israeli Defense Forces continue their mission to degrade Hamas and prevent it from ever governing Gaza again, Jerusalem is also warily eyeing Iranian-supported Hezbollah forces in southern Lebanon across the northern border. Hezbollah fighters are believed to possess an arsenal of over 200,000 rockets, many of which have been transformed into precision-guided missiles thanks to the technical support of the Iranian Revolutionary Guard Corps (IRGC), the external paramilitary force of the Iranian armed forces.
An expansion of the war against Hamas could pull Iran into direct hostilities with Israel, at which point the narrow choke points around the Arabian peninsula become more vulnerable to military disruption. In March 2021, the world learned a valuable lesson in the importance of maritime choke points to global supply chains. A 1,300-foot-long container ship lodged sideways for almost a week in the Egypt’s Suez Canal, at the northwestern vector of the Middle East connecting the maritime superhighway of the Indian Ocean through the Red Sea to the Mediterranean Sea and its many large European ports. The flow of finished goods along with petroleum and LNG supplies was cut off for days, delaying the passage of hundreds of other vessels and costing the global economy billions of dollars each day that maritime traffic flows were impeded. In addition, shipping was thrown off schedule for months, and available cargo capacity was cut 20%-30% for several weeks.
About fifty ships pass daily through the Suez Canal, but more than seventy pass daily through the Strait of Hormuz, along the eastern shore of the Arabian peninsula atop which sits the Iranian landmass. A wider Middle East war could lead to military attacks on shipping that delay or prevent the passage of oil and LNG supplies vital to the functioning of the Chinese, Japanese, and other Asian economies.
A key phase of the 1981-1988 Iraq-Iran involved attacks on oil tankers and commercial ships – mostly bulk carriers and freighters – in the Persian Gulf. Both Iraq and Iran deployed anti-ship cruise missiles or air-to-surface missiles in the course of the “Tanker War,” as the phase came to be known. Though most attacked ships sustained little damage, shipping and insurance rates skyrocketed, and Kuwait’s ability to export oil through the Strait of Hormuz was severely obstructed. The emirate secured the support of the Reagan Administration to reflag Kuwaiti tankers into U.S. ships eligible for safe naval escort and passage in and out of the strait, as well as for shipping for neutral Gulf countries.
Given the enormous cash flow into Tehran from oil and gas exports since 2021, as much as $80 billion according to the advocacy group United Against Nuclear Iran due to lax sanctions enforcement by the current administration, Iran has little incentive to close off the Strait of Hormuz. Major energy customers such as China could dispatch their naval fleet from the South China Sea, or from Beijing’s first overseas base in Djibouti, at the southern mouth of the Red Sea, to ensure safe passageway for its critical supplies.
Currently, the Djibouti base will prove to be decisive in protecting not only Chinese but all international shipping entering the Red Sea through the third critical regional choke point at Bab el-Mandeb, through which about sixty ships pass daily. The small country, the size of New Jersey, nestles between Somalia, Ethiopia, and Eritrea on the northern corner of the Horn of Africa. Djibouti’s strategic geographic location at the intersection of the Red Sea and the Gulf of Aden has enabled it to host military bases for China and the U.S., as well as for France, Japan, Italy, Germany, and Spain.
Across the Red Sea from Djibouti lies the war-torn country of Yemen, whose Saudi-backed Sunni government has been under assault by Iranian-sponsored Houthi rebels since 2004. In the weeks after the Oct. 7 Hamas invasion of southern Israel, Houthi rebels began attacking Red Sea shipping they believed was bound for Israeli ports. Just as Hamas would not have attacked Israel without Tehran’s prior approval, just as Hezbollah would not launch a full-scale attack on Israel without Tehran’s prior approval, so are Houthis attacking Israel-bound shipping with Tehran’s approval.
By late 2023, Houthi militants escalated their attacks on merchant ships, leading several of the world’s largest container shipping companies, including Italian-Swiss giant Mediterranean Shipping Company, France’s CMA CGM, Germany’s Hapag-Lloyd, Belgium’s Euronav, oil giant British Petroleum, and Denmark’s A.P. Moller-Maersk – the latter alone accounting for 15% of global container freight – to pause transits from Asian ports and the Indian Ocean through the Bab el-Mandeb Strait and consider rerouting around the entire continent of Africa to otherwise reach their European destinations, adding up to three additional weeks and reduced efficiency to the shipping routes.
About 12% of all global trade, worth as much as two trillion dollars, including 12% of oil and 8% of LNG traded by sea depends on access through the Bab el-Mandeb and the Suez Canal, according to the U.S. Energy Administration. Egypt depends on Suez Canal transit fees to generate nearly $10 billion, about 2% of its annual GDP. Though the Houthi attacks are intended to paralyze the Israeli economy, European economies are also expected to suffer due to the huge volume of imported refined fuels from the Middle East, especially LNG from Qatar, since halting imports from Russia over the past two years. The lengthy route around Africa adds thousands of miles to the trade routes, with attendant increases in fuel costs, climbing insurance costs, as well as significant cargo delivery delays.
In recent years, Houthi missile and drone attacks have included oil installations and vital infrastructure targets in Saudi Arabia and the UAE. The Houthis possess Iranian-modelled ballistic missiles and armed drones capable of striking targets including Israel within a 1,200-mile range. They have also acquired advanced anti-aircraft missiles, naval missiles, and helicopters, though they prefer using fast boats armed with machine guns in their operations against shipping.
Just prior to Christmas, Washington unveiled Operation Prosperity Guardian, a U.S.-led multi-national task force including the United Kingdom, Bahrain, Canada, France, Italy, Spain, Greece, Seychelles, Norway, and the Netherlands to respond to Houthi ballistic missile and drone attacks with military strikes to protect shipping and preemptively eliminate offensive weaponry, cautious to avoid possible escalation of hostilities with Iran.
The asymmetrical nature and economic cost of this peculiar military operation, where the U.S. will use complex $2 million missiles to destroy easily replaceable $2,000 Houthi drones, will test the fortitude of this multi-national force. The Houthis control the Yemeni capital of Saana and most of the western regions of the country along the Red Sea coast. Washington will likely need to assess the trade-off between attacking the missile, rocket, and drone bases in Houthi-controlled Yemen, let alone IRGC military assets within Iran proper, without escalating the Israel-Hamas war in Gaza to draw Iran in directly.
The precarious international security landscape in these early weeks of 2024 will likely intensify in the months ahead. Iran is determined to weaken Israel and its Sunni Arab neighbours while it advances its nuclear weapons program to deploy warheads atop increasingly accurate ballistic missiles that can strike into Europe. The war between Russia and Ukraine may be reaching a kinetic stalemate, as U.S. and European weaponry to Kyiv begins to scale down and Russian sustains a multi-layer strategic in-depth defense through which it may launch another offensive across eastern Ukraine by mid-year. In Beijing, the Communist Party awaits the decisions and directions of General Secretary Xi Jinping regarding the balance between economic growth, internal repression, and regional aggression that will determine not only the fate of a vast and complex society but also that of Taiwan’s 24 million free citizens and the semiconductor industry that powers the advanced industrial markets of the world. The resilience of the global supply chain networks and their impacts on procurement and purchasing operations are being tested more dynamically than at any time in nearly a half-century.