How will the war in Ukraine affect materials supply?

In response to the further escalation of the Russia-Ukraine conflict, the US, the EU and the UK have imposed a severe package of restrictions on Russia. This new wave of sanctions targets broad areas of the Russian economy and high-profile political and military leaders in Russia and Belarus. The conflict and related sanctions are causing, and will continue to cause, renewed disruption to supply chains, which were just showing signs of improvement after the pandemic. This article explores the impacts of the conflict on global supply chains and steps construction parties can take to mitigate the consequences. Parties should seek specific legal advice on these issues and the potential impact on their respective businesses.

Global supply chains, which had already been severely impacted by 18 months of the pandemic, face renewed disruption. Russia and Ukraine are critical suppliers of metals, raw materials, chemical products and machinery. Russia controls around 10% of global copper reserves and is a major producer of nickel and platinum.

Ukraine is one of Europe’s top producers of uranium, titanium, manganese, iron and mercury ores and has the third largest shale gas reserves in Europe. In anticipation of access to and production of these materials being hindered, prices are already increasing and the market is looking to other countries and alternative supply chains.

The lessons learnt from the pandemic can be applied to managing projects as this crisis evolves

Moreover, Russia supplies 30% of Europe’s oil and 35% of its natural gas. The markets have reacted accordingly, and the price of Brent crude oil soared to $130 per barrel on 8 March. Materials used in construction containing petrocarbons or in energy-intensive manufacturing will suffer from inflation.

The increased price of oil and gas is likely to affect the costs of production as well as transportation of equipment, materials and project parts. Shipping – particularly tanker, dry bulk and container shipping – rates have already increased but military action could curtail ship movements in the Black Sea, a key transit point for dry bulk exports. Finally, the closed airspaces around Europe and North America, together with the destruction and grounding of the Antonov fleet, removes the option of expedited delivery of spare parts for emergency maintenance services.

The lessons learnt from the pandemic can be applied to managing projects as this crisis evolves. As experienced in spring of 2020, some might prioritise certainty through reaching deals on the potential impacts whereas others might prefer to see how things unfold and deal with issues as and when they arise. We are now seeing two main streams of disputes: firstly, parties who need to circumvent a deal reached in 2020 that has proved unfavorable because the pandemic went on for longer than expected; and secondly, parties who sat it out and are now trying to deal with the consequences retrospectively, separating the impacts of the pandemic from other events.

Parties within the construction sector might consider:

• Reviewing contractual requirements, particularly where there are condition precedents, even though the long-term effect remains an unknown.
• The allocation of risk and how long the bid price remains valid for projects currently under tender.
• Refreshing due diligence and sanctions screening to identify if counterparties include any entities owned, controlled by or affiliated with the new sanctions targets.
• Improving visibility in the supply chain beyond immediate suppliers and planning accordingly. For example, your immediate supplier might be a French company, which is supplied by another French company, which in turn is supplied by a Ukrainian or Russian company or routes its own supply chain through Russia or the Ukraine.
• Whether certain materials need to move away from a just-in-time procurement strategy and/or it is possible to stockpile key materials.
• Whether it is possible to diversify sources of supply, by scoping different routes or suppliers.
• Preparing a risk response plan for the most vulnerable parts of their supply chains.
• Diarising regular reviews in recognition that the situation is evolving and plans that are being made now are likely to need revisiting and adjusting.

The Ukraine crisis is likely to have a longstanding impact, particularly in Europe, and may well accelerate the global trends in mitigating the impacts on supply chains that were sparked by the pandemic, the blocking of the Suez Canal and other events. We have already seen a shift from long supply chains to shorter ones, more onshoring and tighter controls on technology exports. Finally, as Europe seeks to reduce its dependence on Russian oil, the impetus to develop greener sources of energy is about more than climate change concerns and it would not be surprising if the increased interest in new liquefied natural gas (LNG) facilities that was seen in Europe after the annexation of Crimea in 2014 is replicated.

Roberta Downey is a partner in Vinson & Elkins. She was assisted in the writing of this article by Ciaran Williams, a senior associate, and Elena Guillet, an associate, at Vinson & Elkins.