Impact of Climate Change on Supply Chain Resilience

Introduction

Global GDP loss from climate change will increase exponentially, and the planet will get increasingly warmer as its cascading impact on global supply chains is factored in, a new study led by UCL researchers finds. The study, published in Nature, is the first to chart “indirect economic losses” from climate change on global supply chains.

In recent years, one of the global challenges facing supply chain professionals is the escalating impact of climate change. From extreme weather events to shifting environmental regulations, the ramifications of climate change ripple through every aspect of supply chain operations. In this article, we dive into the impact of climate change on supply chains and explore strategies for building resilience in the face of environmental uncertainty.

Most global economic production is organized around a complex system of interdependent supply chains. Supply chains facilitate the production of everything from computers and cars to lifesaving medicines and food and support world trade in goods that are worth almost $20 trillion annually. End products have up to many thousands of parts sourced from diverse geographies around the world. Over time, these supply chains have been honed to deliver maximum efficiency and speed.

The complex and interconnected nature of global value chains that shape today’s international trade system also means that disruption in critical locations can have an exaggerated effect on the worldwide economy. This is particularly problematic when disasters hit regions that produce hard-to-replace, highly-specialized goods (for example, as per reuters.com, the production of electronics parts was disrupted during the Thailand floods of 2011).

One thing is for sure: a lack of consideration for climate change’s impact on supply chain operations could have significant future consequences. Climate-related disruptions are projected to intensify in the coming years as the globe continues to warm. While climate change impacts all aspects of society, the impacts can be particularly impactful to global supply chains, which play a critical role in providing vital products and services to people.

Understanding the Climate Change Challenge

The previously unquantified disruptions in supply chains will further exacerbate projected economic losses due to climate change, bringing a projected net financial loss of between $3.75 trillion and $24.7 trillion in adjusted 2020 dollars by 2060, depending on how much carbon dioxide gets emitted.

As the global economy has grown more interconnected, disruptions in one part of the world have knock-on effects elsewhere in the world, sometimes in unexpected ways. Crop failures, labor shortages, and other economic disruptions in one region can affect the supplies of raw materials flowing to different parts of the world that depend on them, disrupting manufacturing and trade in faraway areas.

The more the Earth warms, the worse off economically it becomes, with compounding damage and economic losses climbing exponentially as time goes on. Climate change disrupts the global economy primarily by health costs from people suffering from heat exposure, work stoppages when it’s too hot to work, and economic disruptions cascading through supply chains.

Implications of Climate Change on Supply Chain Vulnerabilities – By Sector

Each link in a supply chain adds value to the product but also contributes to environmental degradation, particularly climate change, through greenhouse gas emissions. These links also face risks and opportunities from climate change effects such as extreme weather events, desertification, sea-level rise, temperature fluctuations, changes in local weather patterns, increased storm intensity and frequency, water shortages, and disease spread. Thus, climate change and supply chains are closely interconnected.

Climate change impacts create a more volatile business environment. Customers are increasingly seeking high-quality, low-cost products and services that consider environmental factors such as carbon footprint and energy efficiency.

Companies that fail to include this consideration in their supply chain strategies or address climate change issues may lose environmentally conscious customers. Given that “supply chains compete, not companies” (Christopher, 1998), supply chain management (SCM) will be critical in meeting new customer requirements due to climate change. An adequate supply chain strategy can help a company take full advantage of climate change opportunities while minimizing threats.

In the low-carbon era, we’re now in, low-carbon SCM appears to be the key to enhancing competence. Climate change drives regulatory, physical, and market changes that create threats and opportunities for supply chains. As a result, several implications for supply chain strategic and operational management need to be effectively addressed.

• Manufacturing

Manufacturing processes must adhere to numerous regulations regarding carbon emissions, and more are anticipated. For instance, the automotive industry has to stay updated with regulatory changes in areas like fuel efficiency standards, environmental taxes, and biofuels targets.

Regarding opportunities in manufacturing, international market-based trading mechanisms could encourage investments in renewable energy and energy efficiency projects. They could also increase demand for biofuels and other renewable energy sources in the energy sector.

An oil refinery flooded by Hurricane Ida at Belle Chasse, Louisiana, on September 3, 2021. Source: PO2 RYAN DICKINSON / U.S. COAST GUARD / ALAMY LIVE NEWS

• Energy Sector

The Energy sector is faced with risks due to the uncertainty of future changes in post-Kyoto regulation, including increased costs attributed to the introduction of carbon taxes.

• Pharmaceuticals

In the Pharmaceuticals sector, inputs to production may be affected due to the loss of biodiversity or water scarcity which will eventually disrupt manufacturing processes. It may see an increase in demand for its products as there will be a need for greater disease prevention and more patient treatments.

• Utilities

Extreme weather conditions could affect many operations of the Utility sector (e.g. transmission cables impacted by higher temperatures and greater electricity use during extreme heat). The proximity of energy generating plants may be subject to disruptions as their proximity to water renders them vulnerable to storm surges and rises in sea level.

Air pollution regulations and carbon emissions reduction targets could stimulate the demand for non-emitting (at point of use) products such as electric vehicles in the Utilities sector.

• Heavy industry & Raw Materials

The Materials sector is vulnerable to precipitation patterns and water availability. Shortages of water could increase operational costs and could lead to increased competition for water between local communities and the operations sites. More heavy rains over shorter periods could cause flooding in transport infrastructures, disrupting roads so the delivery of products is compromised. Sourcing materials may become more complex, resulting in price rises and resource constraints. The Industrial sector is vulnerable to physical risks, such as extreme weather events and rising sea levels, because the latter could cause production factories to shut down.

However, market leaders may take advantage of rigid regulating emission schemes to deploy lower carbon intensity operating practices compared to their rivals and, of course, to gain bigger market shares.

Also, investment in research for greener technologies in the Automobile sector (e.g. electric cars, hybrid cars) will be stimulated. As a result of regulatory requirements, the Industrials sector will experience new commercial opportunities for products and services (e.g. products that track GHG emissions and energy consumption, and products with suitable durability to extreme increases/decreases in temperature). Companies in the Industrial sector are currently seeking opportunities to lobby and influence regulations and international accords, moving customers towards their own products and services.

• Transportation

Transportation, like production, is one of the significant contributors to the global warming effect and, indeed, an essential factor for energy efficiency in the supply chain. It is through movement, at least in most modes of material transportation, fuels, particularly fossil fuels, get directly used and pollutants, including GHG, are released into the atmosphere.

In other modes of transportation (e.g., liquids transported via pipelines), fuels are indirectly used in direct (first-tier), and all other suppliers further up the supply chain (e.g., for pipeline construction).

A general increase in temperature and a higher frequency of hot summers are likely to result in an increase in buckled rails and rutted roads, which involve substantial disruption and repair costs.

• Wholesale and Retail Trade

They both use infrastructure, equipment and processes, that are vulnerable to climate change risks. Trade is synonymous with supply, which, implies the use of inventory facilities (buildings, material handling equipment etc), material movement and transport facilities and infrastructure (e.g. ports, highways, trucks, trains etc), personnel, communications, etc. All these may be hit by extreme weather events due to climate change.

Food retail sector runs a reputational risk as its visibility in the market and the increasing transparency of its operations, combined with NGO power, drives companies to source more sustainable materials.

In addition, new regulations for product labeling could increase the costs associated with producing consumer goods. For these increases to be absorbed, the retail sector would have to increase the price of the products, causing a reduction in demand for these products.

• Consumption and Customer Service

The output of the supply chain finally reaches the consumer. Consumers are now becoming more environmentally savvy, and demand for sustainably sourced products is increasing continuously.

The automotive industry is a very typical example of the severity of a sector’s products in terms of GHG emissions during the utilization phase. It is estimated that while about 10% of the lifetime GHG emissions from a vehicle occur during its production phase, the remaining 90% is emitted while customers are using it. According to several studies, products and packaging are associated with a large share of greenhouse gas emissions, and this share is even more prominent when products are imported and not produced inland.

Mitigating Climate Risks

The evidence that our world is experiencing a changing climate is now undisputed. In the past year, the Intergovernmental Panel on Climate Change (IPCC) has issued a string of reports, each more depressing reading than the last. The message is stark: Climate change is affecting every inhabited region across the globe. This includes the United States, which experienced 20 separate billion-dollar weather events in 2021, and Australia, which has seen a 16% decline in rainfall since 1970.

The impacts of climate change are typically split into three groups:

• Transition risks arise from policy and market changes as we transition to a lower-carbon economy. For example, if the cost of carbon and regulations on emissions increases, fossil fuel assets may become stranded. Stranded assets are subject to premature write-down and don’t yield expected financial returns.
• Physical risks can be event-driven (acute) or represent longer-term shifts in climate patterns (chronic). Event risks include floods and wildfires. Longer-term shifts include the risks of increased average temperatures, rising sea levels and chronic heat waves.
• Climate change opportunities can be realized as consumer preferences for products or services change or as new markets open for products. For example, we are seeing growth in the adoption of electric vehicles and the associated charging infrastructure.

So, Where Do We Start Taking Steps to Mitigate Climate Risks?

• The Why

Supply chains and the infrastructure that supports them are designed for a stable climate. As hazards evolve, it will be necessary to increase investment in adaptation, possibly at the expense of efficiency. There is significant potential for many industries to adapt in the next decade, including conducting risk diagnostics, protecting manufacturing assets, redesigning operations (for example, by increasing the safety stock of critical inputs), broadening the supplier base, shoring up infrastructure, etc. Indeed, measures of this kind are already underway in some areas, including from public authorities, suppliers in high-hazard locations, and customers in the downstream sector.

• The How

Increasing climate resilience requires supply chain managers to identify critical suppliers and their climate hazards. An assessment can then determine where the most significant climate-related supply chain risks lie. This complex task may benefit from digital analytics to simulate different adaptation and risk scenarios. Actions to limit risk include prioritizing key risks, ensuring insurance coverage, practicing simulations, and enhancing supplier-buyer collaboration.

Other Adaptation Measures

• Redesigning Supply Chain Operations

Working to improve the extreme weather preparedness of suppliers could help by encouraging suppliers to keep reserve capacity of critical supplies on-site, increase the flexibility of production so it can continue even through minor asset damage, or hold a war chest to be able to invest quickly to repair damages after a natural disaster.

• Reducing Exposure by Creating Alternatives

Where possible, companies could source commoditized, generic parts and avoid at-risk materials or products. Another option includes increasing modularity in product design to make it possible to replace parts with near substitutes without implications for other parts.

• Allocating Risk by Using Financial and Contractual Mechanisms

Suppliers should consider hedging commodity price extreme risks to limit the impact of price volatility, engaging in long-term fixed-price contracts with resilient commodity suppliers to prevent price flare-ups in a disaster, and investing in insurance to help recoup repair costs.

• Strengthening Supply Chain Infrastructure

Actions that can be taken to adapt include investment in understanding granular local hazards and infrastructure vulnerabilities to help businesses and communities adapt, organizing public-private partnerships to foster collaboration on climate change adaptation for exposed infrastructure, investing in infrastructure hardening to increase resistance to extreme weather, etc.

Conclusion

Not all actions will make sense for each supply chain category, as there often is a tradeoff between efficiency and resilience. For example, dual-sourcing may not make sense if economies of scale are too large, as usually is the case in pharmaceuticals or aerospace.

Building safety stock may be too costly if holding costs are high (for example, airplane fuselage), inventory depreciation is high (for example, in semiconductors due to rapid innovation lifecycles), or if there already is a supply backlog, meaning building inventory would limit current sales. There are “win-wins,” however—some actions that increase resiliency can also improve efficiency or product quality.

About Zetwerk

Zetwerk works with original equipment manufacturers in North America and worldwide, fulfilling their manufacturing requirements for customized components and assemblies. We act as a second brain to the OEMs. Our team of experts not just executes the customer’s manufacturing strategy, but adds tangible value at every step of the process, right from vetting designs to finding and managing the suppliers to quality control and logistics. Our customers regard us highly for our transparent and hands-on approach to manufacturing.

Zetwerk executes these projects through its network of partner suppliers spread across USA, India, China, Vietnam, and Mexico. These world-class facilities provide practically unlimited production processes, capacities, materials, part sizes, and weights as well as secondary operations, surface finishing, assembly, and related services. Importantly, we have our teams established in all these countries with a huge presence in the US.

Zetwerk recently acquired Unimacts, a US-based manufacturing services company, providing further impetus to our commitment to serve North America as a primary market. We have more than 2,000 customers across North America, Asia-Pacific and the Middle East, and a network of more than 10,000 manufacturing partners worldwide. Founded in 2018, we are backed by some of the world’s leading venture capital firms including Sequoia, Kae Capital, Accel Partners, Lightspeed, and GreenOaks. As of 2023, Zetwerk was valued at US$ 2.8 Bn.