Russia has created a war with Ukraine presumably because it wants Ukraine’s assets to create more cash flow. When there is a war and other countries come together as a peacekeeping mission, it is for the world’s good. It is to remind the offensive country that if they don’t keep the peace between countries, they won’t be a piece of the financial pie in the future.
It’s hard enough to keep industries going during good times. It’s harder to keep them going when there is a natural disaster. But to have industries in upheaval over one man’s obsession over what he considers his makes companies question how much they can do business with this country in the future. The “if I can’t have her, no one can” thought process is old and tired.
Russia and the supply chain
S&P Global Mobility (formerly the automotive team at IHS Markit) sent an email noting that the conflict in Ukraine exposes the fragility of the world’s economy and the automotive supply chains. The damaging war and severe sanctions against Russia are already having a serious effect on energy prices, raw materials, and agricultural goods.
On top comes the disruption of the automotive supply chain due to logistical challenges and production shutdowns related to the West Ukrainian border operations.
As a result, S&P Global Mobility has downgraded its 2022 and 2023 global light vehicle production forecast in the latest update by 2.6 million units for both years, to 81.6 million for 2022 and 88.5 million units for 2023.
In 2022, 1.7 million units will be cut from Europe alone, which broadly includes just under 1 million units from lost demand in Russia and Ukraine.
The remainder of cuts are split between:
1. worsening semiconductor supply issues and
2. loss of Ukraine-sourced wiring harnesses and other components will impact production in other markets.
In addition, the complete loss of Russian palladium is a tail risk with the potential to become the industry’s biggest supply constraint.
Amid the backdrop of the Russia and Ukraine conflict, the March 2022 forecast update for North America reflects broad-based reductions spanning virtually every automaker amid the potential for the conflict and subsequent sanctions to impact the production of semiconductors in the second half of 2022.
North America’s light vehicle production
North America’s light vehicle production outlook was reduced by 480,000 units and by 549,000 units for 2022 and 2023, respectively. Further, lingering supply chain, labor, and logistics challenges remain material concerns.
“With the March forecast release, we removed 2.6 million units from our 2022 and 2023 outlook, but the downside risk is enormous. Our worst-case contingency shows possible reductions up to 4 million units for this and next year,” said Mark Fulthorpe, Executive Director for global production forecasting. S&P Global Mobility.
In total, nearly 25 million units were removed from the S&P Global Mobility light vehicle production forecast between now and 2030.
Pent-up demand reduced by roughly one-third because of Russia
Pre-Ukraine invasion on February 24, the global auto industry had spent more than a year under capacity-constrained conditions, with estimated pent-up consumer demand of up to 10 million units (or 12%) above this year’s achievable production, based on S&P Global Mobility forecasts. The sudden loss of economic confidence (via high oil and raw material prices, weak equity markets, and tightening interest rates) is dampening demand. Though significant pent-up demand remains, it could now reduce that shortfall by roughly one-third.
The supply chain remains the constraining factor.
While the macro concerns are significant, the supply chain (and not underlying consumer demand) will continue to set the upper limit for vehicle unit sales in the medium term. The key crunch points weighing on production levels post-invasion fall into two broad categories: Semiconductor materials supply (specifically via Ukrainian neon and Russian palladium) and electrical wiring harness sourcing.
Ukraine neon supply could be in jeopardy
Semiconductor supply challenges worsen on two fronts: First, via neon gas supply disruptions. Our primary research suggests that immediate risks are low based on semiconductor makers holding sufficient gas (neon) inventory but poor visibility. Suppliers in Ukraine control nearly half of high purity neon supply to the semiconductor industry, where the element is used in lasers that etch patterns onto chips.
The second challenge is the availability of palladium, used in semiconductor plating and finishing. In an additional negative twist, China COVID-19 cases at a 2-year high are triggering quarantines and plant closures in northeastern manufacturing hubs, including Shenzhen and Changchun. All of the above raises the risk of losses from ‘stranded’ chips, i.e., semiconductors for which the ‘right’ car cannot be built due to other constraints.
Ukraine has assets that are difficult to substitute
According to S&P Global Mobility research, Ukraine-built wiring harnesses were likely destined for approximately 500,000 to 1 million vehicles pre-invasion. These harnesses comprise complex and manually constructed assemblies of cable. Although some dual sourcing arrangements exist, switching will be difficult due to already-constrained harness capacity in and around Europe. If the situation is not resolved soon, it is estimated that production relocations could take 3-10 months due to wait times on machinery and multi-month staff training times. Almost half (45%) of Ukraine-built wiring harnesses are normally exported to Germany and Poland, placing German carmakers at high exposure. On the plus side, lost production could be recovered quickly into late 2022 and beyond once ramped up.
Russia Palladium: Next potential challenge or as expensive as Gold?
While low probability as things stand, palladium has the potential to become the industry’s biggest supply constraint. According to the United States Geological Survey, Russia produces 40% of the world’s mined palladium. Around two-thirds of palladium use is in vehicles, where it is the active element in catalytic converters for exhaust after treatment.
If Russian palladium supply were suddenly interrupted (due to a western boycott or Russia stopping supply), production of all vehicles using such sourcing (including hybrids) could potentially stop. Although platinum is an alternative element, it is similarly expensive and largely Russia-originated.
Substitution of any kind is a regulatory minefield since design changes require regulatory re-homologation, which can take months. However, at this time, S&P Global Mobility does not currently incorporate major palladium disruptions in its forecast.