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A Viral Market Update X: A Corporate Life Cycle Perspective

A Viral Market Update X: A Corporate Life Cycle Perspective

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Fear and greed are dueling forces in financial markers at all times, but especially so in periods of uncertainty, when they pull in opposite directions, causing wild market swings and momentum shifts. I think that no matter what your market views are right now, you would agree that we are in a period of intense uncertainty, with divergent views on how this pandemic will play out, not just in the coming months, but in the coming years. It is this divergence that have been at the heart of both the steep fall in equity markets in February and March, and the equally precipitous rise in April and May. As US equity markets climb back towards pre-crisis levels, the focus on market levels may be missing the underlying shift in value that has occurred across companies. In this post, I will focus on this shift, using the framework of a corporate life cycle, and record a redistribution of value from older, low growth, more capital intensive companies to younger, high growth companies. It is possible that this shift is the result of irrational exuberance on the part of young, inexperienced investors, but I think that a more plausible explanation is that it reflects not only the unique nature of this crisis, but also a changing business landscape.

Updating the Market
As with my previous updates, I will start with a chronicling of how markets have behaved in the two weeks since my last update, and overall, during the crisis. Let's start with equity indices, where we saw one week of relative stability (5/29-6/5) and a week of drama (6/5-6/12), after surges in April and May:
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For those who thought that the worst of the crisis was behind them, June 11 delivered the message that this crisis is not quite done, as the S&P 500 dropped 7%, and markets around the world followed. I have computed the returns since February 14, broken down into two time periods, with the first stretching from February 14 to March 20, and the second from March 20 to June 12. Every equity index that I list in this table dropped in the first phase, with some indices losing more than 30%, as fear stalked markets around the world. In the second phase, every index posted positive returns, with some climbing back almost to pre-crisis levels. I will return to look at equities in more detail in the next section, but as stocks were going through contortions, US treasury yields were also on the move:


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US treasury rates dropped in the first weeks of the crisis, and with 3-month yields dropping close to zero and 10-year rates declining below 1%. While it is convenient to attribute everything that happens to interest rates to the Fed, note that much of the drop in rates occurred before the Fed's two big moves, the first one on March 15, where the Fed Funds rate was cut by 0.5% (almost to zero) and a $700 billion quantitative easing plan was announced, and the second one on March 23, when the Fed lifted the cap on its easing plan and extended its role as a backstop in the corporate bond and lending markets. While treasury rates were not affected much by the Fed's actions, its entry into the corporate bond market played a key role in turning the tide, where default spreads across ratings classes had been on the rise since February 14:
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Default spreads followed the path of equities, widening significantly between February 14 and March 20, and falling back by June 12, albeit to levels higher then on February 14. The fear about how the pandemic would slow economic growth also affected commodity prices, and I chart the path of copper and oil, two commodities sensitive to global economic growth below:

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As with corporate bonds and equities, it is a tale of two periods, with commodity prices dropping between February 14 and March 20, before clawing their way back in the subsequent period. With copper, the market has retraced its entire decline, and it is now back to where it was trading at, on February 14. With oil, it is a different story, with a decline of more than 50% between February 14 and March 20 in both Brent and West Texas crude. and oil prices, notwithstanding a strong recovery between March 20 and June 12, are about 30% lower than they were on February 14. Finally, I look at gold and bitcoin, gold, because it has historically been a crisis asset and bitcoin, because it has been marketed by some as an alternative asset:

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Gold has held its value and is up 9.28% during the crisis, though it saw less upside during the first few weeks of this crisis than in prior ones. Bitcoin has behaved more like equity, and very risky equity at that, during this crisis, dropping almost 40% between February 14 and March 20, before recovering to close down only 10.67% by June 12.

Equities: A Breakdown
In keeping with a practice I have adopted on my prior updates, I downloaded individual stock data on 37,050 publicly traded global companies, with market capitalizations exceeding $5 million, and computed changes in market cap, by region:
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Looking at overall returns from February 14 to June 12, the worst performing regions in the world are mostly in emerging markets (India, Latin America and Africa), with the UK as the worst performing developing market, down about 20%.  Breaking down the companies by sector, I look at returns across the period, broken down into two sub periods:
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The sectors with double digit negative returns over the entire period are energy, utilities, real estate, industrials and financials, with the first four being punished for their capital intensity and debt dependence, and financials reflecting the fear of debt defaults. Health care shows almost no change in value over the entire period, and tech is down only 3.2%. Breaking the sectors down into industries, and looking at returns over the crisis period, I list out the ten worst and best performing industries between February 14 and June 12, 2020:
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There are no surprises here, given the earlier sector assessment, with a strong representation of infrastructure and financial service companies among the worst performing sectors, and health care and technology on the best performing list. 

Crisis Effects across the Corporate Life Cycle
In each update on the crisis, I have tried to look at a different facet of market performance, hoping to get some understanding of  what the market is pricing in, and whether it makes sense. This week, I will use the concept of a corporate life cycle, a structure that I have found useful in thinking about both corporate financial questions and in valuation, and look at how this crisis has played out across the life cycle. 

The Corporate Life Cycle
I believe that companies, like humans, go through a life cycle from newborn (start up) to toddler to teenager, peaking as successful growth companies, before becoming middle aged (mature) and then declining. 

While there are companies that find pathways to reincarnation (IBM in 1992, Apple in 1999, Microsoft in 2013), they remain the exceptions to the rule that fighting corporate aging creates more costs than benefits. The life cycle is useful not just as a device for chronicling corporate age but also in identifying the challenges that companies face at each stage. It is also worth noting that the free cash flows, i.e., cash flows left over after taxes and reinvestment, vary as companies move through the life cycle:


In general, negative cash flows (cash burn) are a feature of young companies, cash build ups occur as companies grow and mature, and declining companies return cash as they shrink. Finally, to understand how companies change as they move through the life cycle, I will draw on another general construct, the financial balance sheet:

Note that young companies derive their value mostly or even entirely from growth assets, i.e., the value of investments that they are expected to make in the future, and that the portion that is attributable to assets in place increases as companies age, with mature and aging firms deriving most or all of their value from existing investments. Young companies, lacking the earnings and cash flows to service debt, are also more dependent on equity to fund their businesses than mature firms.

The Crisis Effect across the Life Cycle
A crisis tests all companies, but the dimensions on which they get tested will vary depending on where they fall in the life cycle. 
  1. Start up and very young companies: For young companies, the challenge is survival, since they mostly have small or no revenues, and are money losers. They need capital to make it to the next and more lucrative phases in the life cycle, and in a crisis, access to capital (from venture capitalists or public equity) can shut down or become prohibitively expensive, as investors become more fearful. These companies will either have to shut down or sell themselves at bargain basement prices to larger, deeper-pocketed competitors.
  2. Young growth companies: For young growth companies that have turned the corner on profitability, capital access still remains critical since it is needed for future growth. Without that capital, the values of these firms will shrink towards assets in place, and in a crisis, these firms have to hunker down and scale back their growth ambitions.
  3. Mature firms: For mature firms, the bigger damage from a crisis is the punishment it metes to assets in place, as the economy slows or goes into recession, and consumers cut back on spending. The effect will be greater on companies that sell discretionary products than on companies that sell staples.
  4. Declining firms: For declining firms, especially those with substantial debt, a crisis can tip them into distress and default, especially if access to risk capital declines, and risk premiums increase. 
In summary, the answer to the question of which companies (young or old) get affected more in a crisis will depend  on how the crisis affects the real economy and capital access. In most crises, it is access to capital that takes the early hit, with the pain from economic effects showing up more gradually. As a result, in the first parts of the crisis, it is the firms at either end of the life cycle (young companies and declining ones) that are most dependent on new capital to survive that are hurt the most, with the pain spreading more slowly to mature firms, and least to firms that sell consumer staples.   How has this crisis played out in terms of damage to companies across the life cycle? Let me start with a very simplistic measure of life cycle, company age, as measured from the year of founding:
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The table tells an interesting story. In the down phase (2/14-3/20), there was little distinction between younger and older firms, as firms in every age group lost about 30% of value. In the second phase from 3/20 to June 12, younger companies have seen a much more robust comeback than older firms, resulting in much lower negative returns over the entire period for younger firms (the bottom five deciles) than older ones (the top five deciles).  You could argue that company age is not a composite measure of where a company falls in the life cycle, since some companies move through the life cycle faster than others. To counter this critique, I break firms down by expected revenue growth, as estimated prior to the crisis, building on the assumption that expected revenue growth should be highest for young firms and lower for firms further along in the life cycle:
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Note that expected revenue growth estimates are available for just over a third of all the firms in my sample, and across those firms, the differences are stark. Firms in the lowest revenue growth decile are down substantially over the crisis period (2/14 - 6/12) whereas the firms with the highest expected revenue growth, coming into the crisis, have seen their values increase over the same period.  

In summary, this crisis seems to have had a much greater negative impact on older, more mature companies than on younger, high growth ones. perhaps because it started at a time, when capital markets were buoyant and investors were eagerly taking on risk, with risk premiums in both equity and bond markets at close to decade-level lows, with a global economic shut down, with a cessation of most business activity.  That shut down came with a time frame, though there was uncertainty not only about when economic activity would start up again, but how vigorously it would return. Young companies have also benefited from the fact, that after being on hold in the first few weeks of the crisis, risk capital came back in the middle of March, both in public and private markets. The big story, still unfolding, from this crisis is that access to risk capital has held up remarkably well, coming back into markets earlier and in larger magnitudes, than in prior crisis. The Fed has undoubtedly played a role in this comeback, especially with its  intervention in lending markets, but it has succeeded only because it tapped a willing investor base.That access to risk capital has also benefited distressed companies at the other end of the life cycle, explaining why you have seen surges in airline stock prices and in portions of the oil sector. To those who attribute the shift to amateur investors, subject to so much scorn from market watchers, there is collectively too little capital in the hands of these investors to have caused this much of a change in markets.

The divergence in the market treatment between young and older companies during this crisis also explains why value has underperformed growth, since value investing strategies skew towards more mature companies and growth investing is more focused on younger companies. It may also explain why so many market "pros" have been left in the dust by amateurs, since many of the former have been using scripts developed in prior crisis to decide when and where to invest, and this one has followed a different path. While value investors and pros may still be vindicated, the lesson that I would take from this crisis is that while it is true that those who do not remember history are destined to repeat it, it is also true that those who let history alone drive their investment decisions are in just as much danger. 

Conclusion
The trajectory of markets in this crisis has followed the path of the virus, with markets rising and falling on news about viral breakouts in different parts of the world, and vaccines/medication to mitigate its effects.  It should therefore come as no surprise that just as the virus has had its most deadly effects on the elderly and the infirm, the market is meting out its biggest punishment to mature and aging companies. As we pass the four-month mark since this crisis started roiling financial markets in the US and Europe, it is still an evolving story and there will be more twists and turns before it is done. 

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Data
  1. Market data (June 12, 2020)
  2. Regional breakdown - Market Changes and Pricing (June 12, 2020)
  3. Country breakdown - Market Changes and Pricing (June 12, 2020)
  4. Sector breakdown - Market Changes and Pricing (June 12, 2020)
  5. Industry breakdown - Market Changes and Pricing (June 12, 2020)
  6. Age breakdown - Market Changes and Pricing (June 12, 2020)
  7. Growth breakdown - Market Changes and Pricing (June 12, 2020)
Viral Market Update Posts
  1. A Viral Market Meltdown: Fear or Fundamentals?
  2. A Viral Market Meltdown II: Pricing or Valuing? Investing or Trading?
  3. A Viral Market Meltdown III: Clues in the Market Debris
  4. A Viral Market Meltdown IV: Investing for a post-virus Economy
  5. A Viral Market Meltdown V: Back to Basics
  6. A Viral Market Meltdown VI: The Price of Risk
  7. A Viral Market Meltdown VII: Market Multiples
  8. A Viral Market Meltdown VIII: Value vs Growth, Active vs Passive, Small Cap vs Large!
  9. A Viral Market Meltdown IX: A Do-it-Yourself S&P 500 Valuation
  10. A Viral Market Meltdown X: A Corporate Life Cycle Perspective

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Zika Vaccine Targeting Nonstructural Viral Proteins Found Effective in Mice

UCLA scientists report positive preclinical results on the safety and efficacy of an RNA vaccine (ZVAX) against the mosquito borne Zika virus that severely…

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Positive preclinical results on the safety and efficacy of an RNA vaccine (ZVAX) against the mosquito-borne Zika virus that severely compromises brain development in children of infected mothers, were published in the journal Microbiology Spectrum on September 28, 2022 “Replication-Deficient Zika Vector-Based Vaccine Provides Maternal and Fetal Protection in Mouse Model.” The investigators tested the vaccine in pregnant mice and report the vaccine prevents systemic Zika infection in both mothers and developing fetuses.

“The ongoing COVID-19 pandemic has shown us the power of a strong pandemic preparedness plan and clear communication about prevention methods—all culminating in the rapid rollout of safe and reliable vaccines,” said senior author of the study, Vaithilingaraja Arumugaswami, DVM, PhD, an associate professor of molecular and medical pharmacology at the University of California, Los Angeles (UCLA). “Our research is a crucial first step in developing an effective vaccination program that could curb the spread of Zika virus and prevent large-scale spread from occurring.”

Vaithilingaraja Arumugaswami, DVM, PhD, an associate professor of molecular and medical pharmacology at the University of California, Los Angeles (UCLA) is a co-senior author of the study.

Engineering the vaccine

The experimental vaccine is composed of RNA that encodes nonstructural proteins found within the pathogen that trigger an immune response against the virus.

Arumugaswami said, “Engineering the vaccine involved deleting the part of the Zika genome that codes for the viral shell. This modification both stimulates an immunogenic reaction and prevents the virus from replicating and spreading from cell to cell.”

Eliminating structural proteins that mutate rapidly to escape the immune system also ensures that the vaccine trains the recipient’s immune system to recognize viral elements that are less likely to alter. The researchers packaged the replication deficient Zika vaccine particles in human producer cells and verified antigen expression in vitro.

Nikhil Chakravarty, a co-author of the study and student at the UCLA Fielding School of Public Health
oversaw data analysis and writing of the manuscript.

“We deleted not just the gene responsible for encoding the capsid, but also those encoding the viral envelope and membrane. This vaccine is replication-deficient—it cannot spread among cells,” said co-author of the study, Nikhil Chakravarty, a master’s student at the UCLA Fielding School of Public Health.

Chakravarty clarified, “The deletion itself does not lead to stimulation of immune response but it makes this vaccine safer by rendering it replication deficient. The nonstructural proteins encoded by the RNA packaged in the vaccine stimulate more of a T-cell immune response that can specifically recognize Zika-infected cells and prevent viral replication and the spread of infection.”

The team showed increased effector T cell numbers in vaccinated versus unvaccinated mouse models. Using mass cytometry, the researchers showed high levels of splenic CD81 positive T cells and effector memory T cell responses and low levels of proinflammatory cell responses in vaccinated animals, suggesting that endogenous expression of the nonstructural viral proteins by the vaccine induced cellular immunity. There were no changes in antibody mediated humoral immunity in the vaccinated mice.

Co-author Gustavo Garcia, Jr., oversaw and conducted much of the experimentation reported in the study.

“We saw complete protective immunity against Zika virus in both pregnant and nonpregnant animals, speaking to the strength and utility of our vaccine candidate,” said Chakravarty. “This supports the deployment of this vaccine in pregnant mothers—the population, perhaps, most at need—upon further clinical evaluation. This would help mitigate some of the socioeconomic fallout from a potential Zika outbreak, as well as prevent neurological and developmental deficits in Zika-exposed children.”

The investigators administered the RNA vaccine using a prime-boost regimen where an initial dose was followed up by a booster dose. To estimate the durability of the vaccine, the researchers monitored the mice for a month-and-a-half, which is equivalent to approximately seven years in humans.

Chakravarty said, “Since the vaccine is geared toward stimulating T-cell response, we anticipate it will induce longer-lasting immunity than if it were just stimulating antibody immune response.”

Pandemic preparedness

The global Zika outbreak in 2016, led to efforts in developing effective therapies and vaccines against the virus. However, no vaccines or treatments have been approved for Zika virus yet.

“Other Zika vaccine candidates mainly focused on using structural proteins as immunogens, which preferably stimulates antibody response. Our candidate is unique in that it targets nonstructural proteins, which are more conserved across viral variants, and stimulate T-cell-mediated immunity,” said Chakravarty.

Epidemiological studies have shown that the Zika virus spreads approximately every seven years. Moreover, the habitats of Zika-spreading mosquitoes are increasing due to climate change, increasing the likelihood of human exposure to the virus.

“Given that RNA viruses—the category to which both Zika and the SARS family of viruses belong—are highly prone to evolving and mutating rapidly, there will likely be more outbreaks in the near future,” said Arumugaswami.

Kouki Morizono, MD, PhD, an associate professor of medicine at UCLA is a co-senior author of this study.

“It’s only a matter of time before we start seeing the virus spread again,” said Kouki Morizono, MD, PhD, an associate professor of medicine at UCLA and co-senior author of this study.

Before the vaccine candidate can be tested in humans, the researchers will be test it non-human primate models.

The post Zika Vaccine Targeting Nonstructural Viral Proteins Found Effective in Mice appeared first on GEN - Genetic Engineering and Biotechnology News.

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Why is Russia sending oil and gas workers to fight in Ukraine? It may signal more energy cutoffs ahead

Russian President Vladimir Putin has not hesitated to use energy as a weapon. An expert on global energy markets analyzes what could come next.

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The new Baltic Pipe natural gas pipeline connects Norwegian natural gas fields in the North Sea with Denmark and Poland, offering an alternative to Russian gas. Sean Gallup/Getty Images

Russia’s effort to conscript 300,000 reservists to counter Ukraine’s military advances in Kharkiv has drawn a lot of attention from military and political analysts. But there’s also a potential energy angle.

In its call for reservists, Russia’s leadership specifically targeted oil and gas workers for the draft. One might assume that energy workers, who provide fuel and export revenue that Russia desperately needs, are too valuable to the war effort to be conscripted. But this surprising move follows escalating energy conflicts between Russia and Europe.

The explosions in September 2022 that damaged the Nord Stream 1 and 2 gas pipelines from Russia to Europe, and that may have been sabotage, are just the latest developments in this complex and unstable arena. As an analyst of global energy policy, I expect that more energy cutoffs could be in the cards – either directly ordered by the Kremlin to escalate economic pressure on European governments or as a result of new sabotage, or even because shortages of trained Russian manpower as a result of conscription lead to accidents or stoppages.

Dwindling natural gas flows

Russia has significantly reduced natural gas shipments to Europe in an effort to pressure European nations who are siding with Ukraine. In May 2022, the state-owned energy company Gazprom closed a key pipeline that runs through Belarus and Poland.

In June, the company reduced shipments to Germany via the Nord Stream 1 pipeline, which has a capacity of 170 million cubic meters per day, to only 40 million cubic meters per day. A few months later, Gazprom announced that Nord Stream 1 needed repairs and shut it down completely. Now U.S. and European leaders charge that Russia deliberately damaged the pipeline to further disrupt European energy supplies. The timing of the pipeline explosion coincided with the start up of a major new natural gas pipeline from Norway to Poland.

Russia has very limited alternative export infrastructure that can move Siberian natural gas to other customers, like China, so most of the gas it would normally be selling to Europe cannot be shifted to other markets. Natural gas wells in Siberia may need to be taken out of production, or shut in, in energy-speak, which could free up workers for conscription.

European dependence on Russian oil and gas evolved over decades. Now, reducing it is posing hard choices for EU countries.

Restricting Russian oil profits

Russia’s call-up of reservists also includes workers from companies specifically focused on oil. This has led some seasoned analysts to question whether supply disruptions might spread to oil, either by accident or on purpose.

One potential trigger is the Dec. 5, 2022, deadline for the start of phase six of European Union energy sanctions against Russia. Confusion about the package of restrictions and how they will relate to a cap on what buyers will pay for Russian crude oil has muted market volatility so far. But when the measures go into effect, they could initiate a new spike in oil prices.

Under this sanctions package, Europe will completely stop buying seaborne Russian crude oil. This step isn’t as damaging as it sounds, since many buyers in Europe have already shifted to alternative oil sources.

Before Russia invaded Ukraine, it exported roughly 1.4 million barrels per day of crude oil to Europe by sea, divided between Black Sea and Baltic routes. In recent months, European purchases have fallen below 1 million barrels per day. But Russia has actually been able to increase total flows from Black Sea and Baltic ports by redirecting crude oil exports to China, India and Turkey.

Russia has limited access to tankers, insurance and other services associated with moving oil by ship. Until recently, it acquired such services mainly from Europe. The change means that customers like China, India and Turkey have to transfer some of their purchases of Russian oil at sea from Russian-owned or chartered ships to ships sailing under other nations’ flags, whose services might not be covered by the European bans. This process is common and not always illegal, but often is used to evade sanctions by obscuring where shipments from Russia are ending up.

To compensate for this costly process, Russia is discounting its exports by US$40 per barrel. Observers generally assume that whatever Russian crude oil European buyers relinquish this winter will gradually find alternative outlets.

Where is Russian oil going?

The U.S. and its European allies aim to discourage this increased outflow of Russian crude by further limiting Moscow’s access to maritime services, such as tanker chartering, insurance and pilots licensed and trained to handle oil tankers, for any crude oil exports to third parties outside of the G-7 who pay rates above the U.S.-EU price cap. In my view, it will be relatively easy to game this policy and obscure how much Russia’s customers are paying.

On Sept. 9, 2022, the U.S. Treasury Department’s Office of Foreign Assets Control issued new guidance for the Dec. 5 sanctions regime. The policy aims to limit the revenue Russia can earn from its oil while keeping it flowing. It requires that unless buyers of Russian oil can certify that oil cargoes were bought for reduced prices, they will be barred from obtaining European maritime services.

However, this new strategy seems to be failing even before it begins. Denmark is still making Danish pilots available to move tankers through its precarious straits, which are a vital conduit for shipments of Russian crude and refined products. Russia has also found oil tankers that aren’t subject to European oversight to move over a third of the volume that it needs transported, and it will likely obtain more.

Traders have been getting around these sorts of oil sanctions for decades. Tricks of the trade include blending banned oil into other kinds of oil, turning off ship transponders to avoid detection of ship-to-ship transfers, falsifying documentation and delivering oil into and then later out of major storage hubs in remote parts of the globe. This explains why markets have been sanguine about the looming European sanctions deadline.

One fuel at a time

But Russian President Vladimir Putin may have other ideas. Putin has already threatened a larger oil cutoff if the G-7 tries to impose its price cap, warning that Europe will be “as frozen as a wolf’s tail,” referencing a Russian fairy tale.

U.S. officials are counting on the idea that Russia won’t want to damage its oil fields by turning off the taps, which in some cases might create long-term field pressurization problems. In my view, this is poor logic for multiple reasons, including Putin’s proclivity to sacrifice Russia’s economic future for geopolitical goals.

A woman walks past a billboard reading: Stop buying fossil fuels. End the war.
Stand With Ukraine campaign coordinator Svitlana Romanko demonstrates in front of the European Parliament on Sept. 27, 2022. Thierry Monasse/Getty Images

Russia managed to easily throttle back oil production when the COVID-19 pandemic destroyed world oil demand temporarily in 2020, and cutoffs of Russian natural gas exports to Europe have already greatly compromised Gazprom’s commercial future. Such actions show that commercial considerations are not a high priority in the Kremlin’s calculus.

How much oil would come off the market if Putin escalates his energy war? It’s an open question. Global oil demand has fallen sharply in recent months amid high prices and recessionary pressures. The potential loss of 1 million barrels per day of Russian crude oil shipments to Europe is unlikely to jack the price of oil back up the way it did initially in February 2022, when demand was still robust.

Speculators are betting that Putin will want to keep oil flowing to everyone else. China’s Russian crude imports surged as high as 2 million barrels per day following the Ukraine invasion, and India and Turkey are buying significant quantities.

Refined products like diesel fuel are due for further EU sanctions in February 2023. Russia supplies close to 40% of Europe’s diesel fuel at present, so that remains a significant economic lever.

The EU appears to know it must kick dependence on Russian energy completely, but its protected, one-product-at-a-time approach keeps Putin potentially in the driver’s seat. In the U.S., local diesel fuel prices are highly influenced by competition for seaborne cargoes from European buyers. So U.S. East Coast importers could also be in for a bumpy winter.

Amy Myers Jaffe does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.

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Butter, garage doors and SUVs: Why shortages remain common 2½ years into the pandemic

The bullwhip effect describes small changes in demand that become amplified as they move down the supply chain, resulting in shortages. The pandemic put…

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Consumers have been seeing empty shelves throughout the pandemic. Diana Haronis/Moment

Shortages of basic goods still plague the U.S. economy – 2½ years after the pandemic’s onset turned global supply chains upside down.

Want a new car? You may have to wait as long as six months, depending on the model you order. Looking for a spicy condiment? Supplies of Sriracha hot sauce have been running dangerously low. And if you feed your cat or dog dry pet food, expect empty shelves or elevated prices.

These aren’t isolated products. Baby formula, wine and spirits, lawn chairs, garage doors, butter, cream cheese, breakfast cereal and many more items have also been facing shortages in the U.S. during 2022 – and popcorn and tomatoes are expected to be in short supply soon.

In fact, global supply chains have been under the most strain in at least a quarter-century, and have been pretty much ever since the COVID-19 pandemic began.

I have been immersed in supply chain management for over 35 years, both as a manager and consultant in the private sector and as an adjunct professor at Colorado State University - Global Campus.

While each product experiencing a shortage has its own story as to what went wrong, at the root of most is a concept people in my field call the “bullwhip effect.”

What is the ‘bullwhip effect’?

The term bullwhip effect was coined in 1961 by MIT computer scientist Jay Forrester in his seminal book “Industrial Dynamics.” It describes what happens when fluctuations in demand reverberate and amplify throughout the supply chain, leading to worsening problems and shortages.

Imagine the physics of cracking a whip. It starts with a small flick of the wrist, but the whip’s wave patterns grow exponentially in a chain reaction, leading to the tip, a snap – and a sharp pain for anyone on the receiving end.

The same thing can happen in supply chains when orders for a product from a retailer, say, go up or down by some amount and that gets amplified by wholesalers, distributors and raw material suppliers.

The onset of the COVID-19 pandemic, which led to lengthy lockdowns, massive unemployment and a whole host of other effects that messed up global supply chains, essentially supercharged the bullwhip’s snap.

How the bullwhip effect works.

Cars and chips

The supply of autos is one such example.

New as well as used vehicles have been in short supply throughout the pandemic, at times forcing consumers to wait as long as a year for the most popular models.

In early 2020, when the pandemic put most Americans in lockdown, carmakers began to anticipate a fall in demand, so they significantly scaled back production. This sent a signal to suppliers, especially of computer chips, that they would need to find different buyers for their products.

Computer chips aren’t one size fits all; they are designed differently depending on their end use. So chipmakers began making fewer chips intended for use in cars and trucks and more for computers and smart refrigerators.

So when demand for vehicles suddenly returned in early 2021, carmakers were unable to secure enough chips to ramp up production. Production last year was down about 13% from 2019 levels. Since then, chipmakers have began to produce more car-specific chips, and Congress even passed a law to beef up U.S. manufacturing of semiconductors. Some carmakers, such as Ford and General Motors, have decided to sell incomplete cars, without chips and the special features they power like touchscreens, to relieve delays.

But shortages remain. You could chalk this up to poor planning, but it’s also the bullwhip effect in action.

The bullwhip is everywhere

And this is a problem for a heck of a lot of goods and parts, especially if they, like semiconductors, come from Asia.

In fact, pretty much everything Americans get from Asia – about 40% of all U.S. imports – could be affected by the bullwhip effect.

Most of this stuff travels to the U.S. by container ships, the cheapest means of transportation. That means goods must typically spend a week or longer traversing the Pacific Ocean.

The bullwhip effect comes in when a disruption in the information flow from customer to supplier happens.

For example, let’s say a customer sees that an order of lawn chairs has not been delivered by the expected date, perhaps because of a minor transportation delay. So the customer complains to the retailer, which in turn orders more from the manufacturer. Manufacturers see orders increase and pass the orders on to the suppliers with a little added, just in case.

What started out as a delay in transportation now has become a major increase in orders all down the supply chain. Now the retailer gets delivery of all the products it overordered and reduces the next order to the factory, which reduces its order to suppliers, and so on.

Now try to visualize the bullwhip of orders going up and down at the suppliers’ end.

The pandemic caused all kinds of transportation disruptions – whether due to a lack of workers, problems at a port or something else – most of which triggered the bullwhip effect.

The end isn’t nigh

When will these problems end? The answer will likely disappoint you.

As the world continues to become more interconnected, a minor problem can become larger if information is not available. Even with the right information at the right time, life happens. A storm might cause a ship carrying new cars from Europe to be lost at sea. Having only a few sources of baby formula causes a shortage when a safety issue shuts down the largest producer. Russia invades Ukraine, and 10% of the world’s grain is held hostage.

The early effects of the pandemic in 2020 led to a sharp drop in demand, which rippled through supply chains and decreased production. A strong U.S. economy and consumers flush with coronavirus cash led to a surge in demand in 2021, and the system had a hard time catching up. Now the impact of soaring inflation and a looming recession will reverse that effect, leading to a glut of stuff and a drop in orders. And the cycle will repeat.

As best as I can tell, these disruptions will take many years to recover from. And as recent inflation reduces demand for goods, and consumers begin cutting back, the bullwhip will again work its way through the supply chain – and you’ll see more shortages as it does.

Michael Okrent does not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.

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