Risk and Sustainability in Supply Chains

Investigating how firms can protect and decarbonise the arteries of the global economy

Modern Supply chains are both a major source of greenhouse gases and highly exposed to climate risks. Progressively minded companies should critically assess their supply chains and ask two questions:

➡️What are the climate risks inherent their supply chains and how can they be mitigated?

➡️How can supply chains be decarbonised to help push the world towards net-zero.

Below I will delve into how companies can assess and attempt to reduce the carbon emissions in their supply chains. Companies need to reduce carbon emissions to slow the impact of climate change. A warming planet means more incidents of extreme weather. These climate risks will impact supply chains more frequency and with greater ferocity as climate change accelerates.

Climate Risks

⛓️2021 and 2020 were unprecedented tests for supply chains. The impact of the pandemic meant volatile demand for products and energy as well as political turmoil. The result was disruption, inflation and many companies reconsidering their supply lines.

🔥🌊Extreme weather events also disrupted supply chains. Typhoons in Asia, a deep freeze in Texas and flooding in Canada and Germany, plus many other events interrupted trade across the world.

Climate change is already increasing extreme weather events. Over the next decades the world can expect more frequent hurricanes, flood, and extreme heat. Supply chains will be tested by ever more frequent, random, and intense acts of nature. Likely scenarios include:

🌊Flooding of a major export centres such as ports and cities. The flooding of Vancouver in 2021 effectively cut off large parts of Eastern Canada to road traffic. Floods like this will become a regular occurrence causing billions in damages and interrupting the transportation of goods and people to afflicted areas.

🔥Extreme heat resulting in drought and the failure of a major crop across multiple geographies at the same time (Rice, wheat, barley). This scenario would see supplies of staple goods fall and prices rocket. Countries will ban export of staple food products to feed their own populations. The result would be starvation, political unrest and food price inflation across the globe.

🌊Heavy rain in South-eastern China could disrupt the supply and production of rare earth metals. Rare earth metals are a key ingredient in the production of electric cars and many other modern electronic devices. Other countries like the US are now increasing the production and supply of these metals to reduce dependence on China.

⛏️Currently China is responsible for around 80 percent of the world’s production of rare earth metals. Disruption to one region could severely damage the supply chain for the likes of battery makers like CATL, car manufacturers or smart phones.

Identifying Climate risks along the supply chain. Climate risks can be either acute or chronic.

Chronic risks are long term trends such as changing rainfall patterns and long term rising temperatures that impact the environment. These are long term shifts damaging crop yields or industries which in turn impact supply chains.

For example, rising temperatures are already threatening the international coffee sector. A changing climate will cut coffee production, causing many existing suppliers to collapse or experience reduced production. This in turn will force producers to look to alternative suppliers.

Widespread droughts and desertification will force many farmers out of business. Climate impacts will be especially hard hitting in Africa, the Middle East and the Indian Sub-continent. Supply chains will be forced to shift in response to this by finding other sources of coffee or disappearing altogether.

Acute risks are one off or recurring incidents

💨Acute risks include hurricanes, extreme heat and rain and flooding. Extreme weather is already becoming more frequent and intense. Disruptions are already hitting supply chains. Weather related insurance claims have rapidly increased over the last decade. This trend will accelerate over the next decade.

Companies are ill prepared for these disruptions partly because understanding how climate risks are changing the world is a relatively new concept for most of the corporate sector. Most organisations are only now discovering and measuring the risks that climate change poses through application of the TCFD principles.

⛓️Companies will also face problem because they do not fully understand how their own supply chains operate. Companies will need to tackle the complexity and opaqueness of supply chains to discover how risky they really are.

💡Understanding supply chains in more detail will allow companies to identify sectors particularly vulnerable to extreme weather events. Armed with this understanding companies can make contingency plans, consider alternative supply routes or even using dual suppliers.

Other ideas are disaster proofing supplier facilities or production, allowing more stockpiling to be build a buffer for delays and taking out insurance to allow for losses. Of course, it is impossible to forsee how complex unpredictable weather events may play out. But it is possible to be well prepared.

Threat Multiplier

🪖Climate change will also act as threat multiplier, increasing the risk of conflict, uncontrolled migration, and political instability. In turn this places pressure on supply chains. Political violence in the Sahel and Sahara regions have been linked to increasing pressure on scare resources such as water.

⛈️Water supplies are threatened by falling rainfall and rising temperatures (connected to climate change) as well as by a growing population. These knock on, or second order effects, will become more common. However, they will be difficult to predict or even directly connect to climate change, but will contribute to a sense of a more chaotic and unpredictable world.

Firms that consider risk and address decarbonisation in their supply chains will undoubtedly gain a competitive advantage. Consumer demand, government regulation and shareholders are all pressuring companies to decarbonise their activities and by extension their supply chains. The first movers will decarbonise and (partially) derisk their supply chains before competitors.

However, whatever progress is made on decarbonisation a dangerous amount of climate change is “baked in”. Therefore, disruption to trade, logistics and supply chains are sadly inevitable and companies need to be assessing and mitigating these risks now. Of course it is difficult to mitigate many sudden and unexpected events such as hurricanes, or extreme heat waves. Firms will have to learn to live with and adapt to this more volatile, risky and dangerous world.

How should companies react

Companies should be analysing their supply chains for potential climate risk. However, modern supply chains are extremely complex and often opaque. It is difficult for even well-resourced companies to understand how all the commodities, products and components that flow across the globe to create their goods originate from. Supply chains have multiple layers stretching across different continents and run into hundreds or thousands of different suppliers.

This picture is not static, suppliers are constantly changing which adds another layer of complexity. Even a relatively simple product like an electronic toaster can have thousands of different components from hundreds of different suppliers. Despite this many companies like Unilever have tried to push systemic change through their supply chain to make it more sustainable.

Understanding Supply Chains

The first step for a company is understanding their own supply chains. Whether they are manufacturing company in China, a shoemaker in Ethiopia or a pharmaceutical company in Germany. All firms are reliant on a complex globalised supply chain to efficiently create a product. While it is probably impossible to track every step and supplier in modern trade networks. It is possible to focus on the most critical suppliers.

Companies should start with the basics. Identifying tier one suppliers of products and commodities and opening a dialogue with them around carbon emission and setting targets around how they can be reduced.

This is by no means an easy process and tier one suppliers may not want to, or easily be able to reduce emissions data. Another step companies can take to encourage suppliers to green themselves is to set transparent, public targets on emission cuts to act as a target and incentive for change.

Companies may need to take strategic decisions such as buying locally to reduce transportation (and hopefully carbon) costs. In other cases, suppliers may not be able to reduce their carbon emissions and alternative suppliers will have to be found.

Car Manufacturing

🚗The car manufacturing industry is unsurprisingly a heavy user of steel. Traditional steel production is highly carbon intensive. Swedish manufacturers have recently pioneered an innovative technique to create zero carbon steel. but this technology remains in its infancy and has not been widely adopted across the industry. Also using low carbon steel is currently more expensive – costing around 50 % more.

🏭Manufacturers will be forced into difficult choices that increase costs. The good news is that as zero or low carbon solutions become more common, costs will fall. So as zero-carbon steel becomes adopted by more manufacturers and production scales up. Over time the cost of producing steel in a sustainable way will fall making it a more viable alternative.

Second and Third Tiers

The next stage is engaging suppliers in the second and third tiers. This means the firms that indirectly supply a company. In many cases there may be no existing relationship or knowledge of these suppliers, which makes the task much more difficult. In theory there should be a cascading effect as first tier suppliers push change onto second and third tier suppliers.

As firms engage the first tier of supplier for low carbon alternatives, they will naturally turn to their suppliers to ensure they can also reduce carbon emissions. However, this is much harder to track as it relies on monitoring supply chain activity and trusting that suppliers are providing accurate information.

🛰️Improved data and analytics around supply chains can also be an ally in progress. Satellite data, the Internet of Things (which means real time tracking of products), blockchain to verify the exchange of goods can also make it much easier to track, locate and validate supply chains.

Companies have a long road ahead in terms of identifying climate risk and decarbonising their supply chains. But the firms that take the lead in decarbonising, desrisking and understanding their supply chains will give themselves a competitive advantage.

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