Black Swan or new dawn: Why supply chain management is more important than ever

Hogan Lovells

Hogan Lovells

[co-author: Alex Snell]

Supply chains are increasingly vulnerable to a range of risks. In recent years businesses have focussed upon streamlining their supply base to minimise costs. They have sought to reduce inventory to free up working capital but these ostensibly sensible economies have left many of them more than ever at the mercy of events beyond their control.

The surge in gas prices

The unprecedented turmoil in several industries reliant, directly or indirectly, on constant and affordable gas supplies has thrown into stark relief the sudden and immediate knock on effect that one seemingly unrelated event can have across supply chains and the many businesses whose livelihoods depend on those chains.

As has been extensively reported recently, cold winters across the world in 2020 and 2021 have led to increased demand for gas whilst issues with pipelines in Norway and Russia have reduced imports. This, coupled with a reduction in supplies of renewable energy across the United Kingdom, has in turn led to a shortage of available gas and an increase in its price - the price that energy suppliers in the United Kingdom pay for gas has risen by more than 250% since January 2021. It is currently sitting at approximately 181 pence per therm.1

The immediate impact of this shortage is that most consumers will ultimately end up paying more for their gas.  There is talk in the popular press of the failure of potentially tens of suppliers who are unable on account of either or both fixed customer supply agreements or the the UK energy price cap to pass these additional costs on through the supply chain.

The knock on effects of this shortage are equally far reaching.  They have the potential to cause a material impact on the day to day operations of many energy intensive industries and production processes.  

Gas intensive industries, such as fertiliser production, have had to scale back operations (and in some cases to shut down altogether pending the grant of Government support to make production viable at a time when the costs of production exceed the price customers are willing to pay for fertilizer). Fertiliser production is one of the primary methods in which carbon dioxide (CO2) is produced in the UK. As a consequence, the recent disruption to such production has seen a meaningful decrease in the UK's food-grade carbon dioxide supply of approximately 60%. This shortage has in turn disrupted the supply chains of businesses that rely on CO2, such as food transport and logistics businesses that need it for dry ice, businesses that use it in packaging for perishable foods, suppliers of chicken and pork products as CO2 is used in the animal slaughter process, and companies that use it for drink carbonation.

It is vital that businesses, irrespective of their jurisdictions or type, understand the dynamics of their supply chains and any weaknesses inherent in them if they are to plan effectively for the opportunities and challenges of a post COVID world.

Businesses that have good visibility of their supply chains and have viable contingency plans for the pre-emptive management of  disruption are far more likely to emerge stronger from the present transitionary period and costs challenges.  While they may at first blush seem simple or obvious, the basic options and considerations for the effective management of supply chain risk remain as valid today as they did when COVID was just a twinkle in the minds of the makers of science fiction movies.  They are as follows

What is the length of your supply chain and what jurisdictions does it cross?

The longer the supply chain, the more vulnerable a business will be to delays and disruptions. In today’s era of globalisation, supply chains can be extensive, often involving multiple parties and reaching into unexpected jurisdictions. Understanding your supply chain and the different laws that might affect the effective management of insolvent supplier are key to identifying where crisis points might arise. That is also essential to formulating a robust, pre-emptive strategy to ensure continuity of supply. The most vital part of any such strategy is identifying the advantages and limitations of different countries' restructuring and insolvency regimes.

Can a replacement supplier be found?

Highly specialist industries will have fewer suppliers of component parts, and may require pre-qualification of suppliers, which can be a lengthy process. In all cases assess whether it is feasible to find a replacement supplier, keeping in mind that the issues facing the current supplier may hit any replacement supplier down the line. Establish the steps needed to effect the replacement should the need arise – for example, does the existing supplier hold key machinery or IP which would have to be transferred to a new supplier?

Can the buyer support the supplier in the short term?

If the supplier's business is suffering because of external pressures but is otherwise sound, businesses may want to look at whether to support the supplier for the short term. This could be achieved by accelerating payments to the supplier, making a short-term loan to the supplier or agreeing to make payments direct to the supplier's own creditors. If the supplier is key to the business, it may be possible to acquire the supplier or that part of the supplier's business that is essential to the customer. All of these options become more difficult if the supplier is on the brink of insolvency, raising questions such as whether any action could be overturned under relevant insolvency law.

Can costs be passed on to the ultimate customer?

Depending on the terms of the contract, customers may be exposed to pass through of increased cost; however in cases where the customer price is set, the suppliers down the chain will bear risk of performance in the face of increased cost. Customers may seek to renegotiate pricing terms or seek to defer deliveries or acceptance of services.

What will the impact be on financing arrangements?

Disruptions in the supply chain may put pressure on cash flows, trip financial and other covenants in financing agreements, enable lenders to refuse further drawdowns of loans and/or trigger payment and other defaults that could lead to creditors commencing insolvency proceedings or seeking a refinancing. Where cash flows are significantly impacted, directors will also have to consider whether the company is approaching the insolvency twilight zone and the potential impact both on their duties and their own potential liabilities.


1 ICE NAT GAS FUTR  Oct21, Bloomberg as at 22 September 2021

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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