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The Current and Future State of the Global Supply Chain

COVID-19 Insights February 17, 2022
COVID-19 Insights February 17, 2022
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BMO recently held an event to discuss the current state of supply chain bottlenecks, strategies for managing the crisis and when we can expect the situation to begin to normalize. Joining us to offer their insights were two well-respected individuals who extensively cover the supply chain:

  • Bill Thomson, Head, U.S. Logistics, Rail and Shipping and Managing Director, BMO Commercial Bank

  • Fadi Chamoun, Transportation Analyst and Managing Director, BMO Capital Markets; and

  • Eric Starks, Chairman and CEO of FTR Transportation Intelligence, a leader in freight transportation forecasting.

Listen to the full episode:

BMO COVID-19 Insights podcast is live on all major channels including Apple, Google and Spotify.

The current chaos in the global supply chain has been on everyone’s mind. From logjams at major ports to material shortages to a lack of truck drivers, it’s a situation that has impacted nearly all business sectors. But what are the expectations moving forward? When can we expect stability to return to the flow of goods?

Following is a summary of the event.

An evolving predicament

The pandemic exposed existing issues within the supply chain. As Starks pointed out, freight markets were on a downward trend in 2019 before COVID-19 completely disrupted the supply chain in 2020. The resurgence in trucking and intermodal traffic in the summer of 2020 set the stage for the current predicament, as low inventories clashed with surging consumer demand. Meanwhile, the labor problems facing the U.S. is being mirrored across the globe.

“Ultimately, if you don't have the labor, you're not able to get velocity in the supply chain, so you start to lose the capacity that you already have,” Chamoun said.

It’s led to a situation where shippers are looking for alternative ports that will allow them to get their goods moving inland. While the ports of Los Angeles and Long Beach continue to experience gridlock (more than 100 ships were parked off their shores in mid-December), ports on the East and Gulf coasts—New York and New Jersey, Savannah, Georgia, and Houston—are getting a boost in traffic. But Starks pointed out that’s creating its own set of issues.

“What we're finding is you have a significant amount of inbound traffic on the East Coast and Gulf Coast and you don't have the same type of growth on outbound traffic, and that is not normal,” Starks said. “This is why we're seeing spot rates for trucks very high.”

Transport rates are higher across the supply chain. Chamoun pointed out that air freight and ocean spot rates both set new records recently. “On the land side, things are easing up a little bit, but it's still far, far from being at a normalized level. I think it's going to take a little bit of time before we see that normalization occur.”

The next phase: Opportunities and risks

Both Chamoun and Starks expect shipping prices to remain elevated through 2022, but they believe the key issue next year will be the ability for shippers to secure capacity and mitigate their risks. Chamoun said he’s seeing more companies attempt to bring more efficiency to their supply chains. He also noted that hiring has improved, with training programs among railroad companies providing a boost. Starks noted that companies are placing more emphasis on building relationships.

“Relationships are being built to last,” Starks said. “The shipper wants to be a preferred shipper. They want the carrier to say, ‘Yes, I want to move your goods.’ That's how you secure capacity, and those are the things that we're going to continue to see for the foreseeable future.”

Meanwhile, another risk is looming: the omicron variant, which Chamoun called a “real and present danger for the supply chain for the next three months.” Given how much the delta variant has impacted the supply chain over the past six months, Chamoun said there’s a significant risk that omicron could have a similar effect.

“We’ve seen at least one occasion where one omicron case caused two ports to shut down in China,” Chamoun said. “If that starts to happen at a much larger scale, I think you're looking at exacerbating some of the problems solving the last three six months.”

Ultimately, navigating the supply chain woes will require shippers to be nimble and understand where their risks lie.

“What's the global market going to look like?” Starks said “In general, we have an expectation that manufacturers are going to continue to grow, and we have an expectation that the consumer is going to start to shift a little bit from goods into the service sector. Understanding and trying to assess those shifts are something that we’re really trying to get people to understand as they look out over their forecast horizon.”

And given the global scope of the crisis, it’s going to require patience.

“The ability to produce and get goods is globally challenging,” Starks said. “Everybody’s playing in the same sandbox. It’s going to take a while for us to get out of the conundrum we’re in right now.”

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Bill Thomson: Hello and good afternoon, I'm Bill Thomson. I'm managing director in the commercial banking unit at BMO. I'd like to thank you for joining us today as we discuss the current state and the future state of the global supply chain. For the best part of my career, which has been 20 years at BMO, I've been working with transportation companies across the US, helping them with their capital needs and partnering with my colleagues in the investment bank when our clients needed their services.

Since the onset of the pandemic, my colleagues and I have been thinking about all the issues that have been coming about, having frank conversations with our clients about what their impacting issues are and how we can bring some assistance to them. As part of our key principles at BMO, is to add value to our clients' needs. That's why we're here today. We're here to discuss this dynamic topic. Today we have two well-recognized and highly respected individuals who cover the supply chain extensively.

The first is my colleague Fadi Chamoun, who's with BMO Equity Research. Fadi covers transportation companies across the spectrum, from ocean, air, surface transportation verticals. Fadi has been with BMO for well over 10 years. He's a highly ranked analyst in the Brendan Wood survey for auto parts industrial products and the transportation sectors. On a monthly basis, Fadi publishes an article called Cargo Connections, where he covers all modes of transportation and what's going on.

Also joining us is Eric Starks. Eric is the chairman and CEO of FTR transportation forecasting. Eric and his colleagues bring a unique perspective across many industries or focus on the key drivers of the various modes. The team at FTR offers customized database and reports to their clients so they can make sound decisions on aligning their production and freight needs. Additionally, in September of each year, Eric hosts an industry best three-day conference that's well attended by companies, not only in transportation but across all industrial companies so they can learn about the current state and outlook of the industry from, not only executives at FTR but industry leaders.

Before we kick this off, there's a few housekeeping items. Please feel free to ask questions throughout the webinar. You can submit these through the Q&A box, that's to the right of the video box on your screen. Your question will be sent directly to me. Those on the call will not be able to see your questions. It'll just be you and I seeing them. I'll do my best to address all questions submitted. Also, today's event is being recorded, so a link will be shared at the following event so everyone could go back and review this.

It's been an interesting 18 months with the pandemic impacting nearly every business, while commercial businesses have opened their doors to employees, a large amount of individuals have come back to work from home. There's been an increase in e-commerce, sourcing raw materials and finished goods have been problematic. Inflation's the most recent issue that's impacting the economy but the supply chain is still in duress. I don't think there's a business out there or anyone on this call who hasn't been impacted by that. I'd like to start with you, Eric. When do you think this disruption really started? Is it all because of COVID or were there issues prior to COVID that were out there?

Eric Starks: Bill, it's great to be a part of you. It's wonderful to hang out with the two of you. There's a lot of complexity here. We actually saw the freight markets starting to ease in 2019. That was already on a downward trend. It's really hard to say, "Okay, what disconnect in some of the things that we're seeing?" Ultimately, COVID really drove this home. We were already at an environment that was starting to slow down and then COVID hit and so everything got completely disrupted.

What was really fascinating as we went through the first three months of COVID, things really dropped off, and that was no surprise, but the amount of resurgence that we saw, specifically in truck, and relatively quickly as we moved into the summer months, started to set the stage for some of the things that we are running into now. It was very clear that as we moved into the January of 2021 that the supply chain issues were getting worse.

We have seen a lot of consumer demand out there with inventory levels low relative to activity, and that creates supply chain issues in and of itself. Then you start looking at manufacturing coming back on. As manufacturing came back online, you had two pressure points happening at the same time. You had manufacturing growing, and you had the consumer demand growing. That is really what's caused a lot of the crux of the problems that we're running into right now as well as, finally, we can't ignore COVID. COVID blew up global supply chains.

Labor has been an issue for every single country. It's not just a US issue. The ability to produce and get goods is globally challenging. It always feels like when we're talking about the North American market specifically that's where everything is sitting, and that's not it at all. Everybody's playing in the same sandbox right now. We've clearly seen this market move in this direction, but it's going to take a while for us to get out of the conundrum we're in right now.

Bill: Well, thanks. Fadi, I'd like to level set from your perspective where we're at today amongst the chain because there are so many parts that are intertwined together between everyone focusing on LA in the ports and the containers there but now you have the chassis pool, you have trucking and drayage and rail and intermodal and then warehousing, too. Where do you think we're at today?

Fadi Chamoun: Eric painted really a great picture explaining a lot of things, maybe I can add a few points to that. If I look at something like the truckload market, we're about 2%, 2.5% higher volume than we were pre-pandemic, but we are still 3% to 4% fewer drivers for long haul trucking than we were pre-pandemic. If I look at something like the air freight market, the gap is almost 17%, so you have 10% more demand and you have about 7% or 8% less capacity.

All of the things that Eric described I think were exacerbated really by that labor issue. I think labor is a big part of that supply chain disruption, that supply chain velocity loss that we have seen throughout 2021. The wheel turn gets worse and worse because ultimately if you don't have that labor, you're not able to evacuate the warehouse, you're not able to really get the velocity in the supply chain so you start to lose the capacity that you already have.

I think when you look at some of the surface transportation, long haul trucking is like I said in some [inaudible 00:08:06] the demand is and where the capacity is. I think, ultimately, the capacity has been also hurt by the loss of velocity in the supply chain, but you also see what happened on the commerce side. The employment for short-haul trucking and local deliveries has gone through the roof, so that absorbed a lot of the labor that could have otherwise gone elsewhere.

I think COVID ultimately has had issues in terms of opening up the employment opportunities, but I think the velocity of the supply chain has been lost as a result of all of these displacements that we've seen. I would say, at this point, it doesn't look any better. If you look at air freight rate, we've set new records this week. Ocean spot rates, Asia to the US, China to the US, specifically, again, we've set new record rates this week. The same thing. Within the land side, I think things are easing up a little bit, but it's still far, far from being normalized level. I think is going to take a little bit of time before we see that normalization occur.

Bill: What's it going to take on the land side because I think that's what everyone I've been talking with is focused on because it impacts them more directly, trucking especially, given the spot rates that have been out there and anyone's trying to get their product move is almost willing to pay whatever they need to to get it there? When do you think that's going to subside? I'm hearing people think perhaps in 2022, but who knows? That's why I'd love to see what you guys think. You're in the weeds in this more than most of us, considering your connectivity. Fadi, if you want to take that-- [crosstalk] Go ahead, Eric. Eric, please.

Eric: Yes, that's fine. There's a lot of things happening here. Let's talk about a couple of things that are happening in supply chain. First and foremost is inventories. If you look at inventories relative to the retail market, they're low, but that's also because you're comparing it to very high levels of activity for the sales environment. In general, they're actually pretty robust.

Where we're seeing the problems is in the automotive space, and that is also having a ripple effect. You have huge demand for retail goods and then you are looking at an environment where retail continues to be strong but they need more inventory. When that happens, in general, when you have a disconnect in your inventory, the sales ratio number goes low, there's a push and a need for transportation demand.

What we find is that, and Fadi alluded to this, is we find that you don't typically move it very efficiently because you have underlying demand that says, "I need it." If you get 75% of your load full and they say you've got to go, then you go. Those are the types of things that are happening within the overall transportation market. The other thing too is we're finding that businesses and industries that typically didn't compete with each other for transportation that is clearly happening now because things are so tight.

2018 we saw 100% utilization of the fleet. That was so abnormal. Now, we are back to 100% utilization. If you have a driver sitting in a truck, that person is and that piece of equipment is moving. Those things are happening. If I had told you before that the railroads would be flat to down on the number of loads that they're moving relative to historical basis in an environment where we have a supply chain disruption that's this bad, we would've said, "No way." You would've said no.

I'm going to put this just briefly into context because I think Fadi is going to have some good commentary on this. If we look at what's happening with the ports. The ports is a microcosm of everything that's going on, so it's very easy to pinpoint that. It is not just a labor thing at the ports. It's not that you just say, "Great, I'm going to make everybody work 24/7. Let's go."

The reality of it is that you have, one, labor issues, two, Fadi mentioned it with regards to having somebody work, in this case, at a warehouse. You have warehouses that are completely full but you have people who they need more workers at those warehouses to keep the throughput going. You clearly need some more drivers but the drivers in that drayage environment is not the constraint but if you open it up and you just say, "Ah, let's go 24/7." That doesn't help it.

The other thing too is we're seeing a significant shortage of chassis to move those containers away from the port. That is one of the big problems, so then you have more congestion at the port. As that congestion builds, then they say, "I need to look for another port." Well, you can't really go up to Canada because they've been having some weather issues on their line that created disruptions for the railroads to move it into Chicago. That's a typical pathway that they like, so then they start moving into the East Coast and into the Gulf Coast.

Well, those aren't a rail move then, that's a truck move, and then you're now taking chassis away from those ports and bringing those further inland, so you create an additional imbalance that wasn't there before. It's a lot of things happening at once that is creating this. Let me pass this back to you, Bill, and get Fadi's input because I think people think it's just an easy solution, and it's not.

Bill: Yes, I agree. Fadi, I'd love to hear your thoughts. One of the areas I know you're paying attention to is the port in LA. I think last month in November there were about 81 container ships sitting out in the port. I'm just curious, where's that at today? Eric brought a bunch of good points with 24/7 at the ports and Washington's involvement to try to alleviate some with the congestion. What do you see in there? Is that where we're at today? If that gets cleared up does that help solve a lot of problems?

Fadi: Look, there are some positive signs. If I look at the railroad side of things we're caught with not being able to anticipate the difficulty that they are going to have with recruiting and trying to fill the recruiting pipeline. It takes nine months to train an individual to become an engineer or a conductor on a train. Attrition rates. I think a couple of companies at least have come out and said attrition rates are two times higher than they had been historically.

People are resigning going to do a different job, attrition rates are typically higher, and then you've got the demand environment that's very strong. It took a lot longer to refill those training pipeline. I think we're at a position now where these initial problems that were not necessarily anticipated have been factored in. I think all these companies have started to tell us the pipeline of training is now full, "We feel good about that." They found solutions, paying bonus, doing all these things to refill that training pipeline.

There's a lot of chassis being added to the market as well. I think ultimately if we go into some seasonal weakness in the demand in the next three or six months, that could be really good for velocity of the supply chain as well. I'm just going to give you an example, I think comes to what Eric was highlighting. There's a company that have a very large market share in the intermodal space. They run their own 53-foot containers and chassis and equipment. The box turns, the container turns per month have gone from [inaudible 00:17:09] times a month to 1.6 times a month. Just to give you an example, 30% of the capacity is down 20%.

I think that problem is probably the same across the entire industry. I think the lack of velocity in the supply chain, which has been exacerbated by strong demand that we have seen and Eric described, and I think ultimately some of these labor issues. I think as you start to put some velocity in the supply chain you start to increase capacity in the process and you start to get to a solution of some sort. I think there has been a lot of solution put in place. The same company I just talked about that lost 20% of capacity is adding significant amount of new capacity in the next three or six months in terms of chassis, in terms of containers, the trailers.

I think we're going to see that velocity come back gradually, but look, demand is strong. Inventories are still lean to some degree. It's going to stay tight, I would say, throughout 2022, but I think we'll see some improvement in that utilization factor that Eric described being 100%. I think it should start to ease maybe somewhere in the mid to high 90s. Though it will stay very tight, but I think all ease gradually as we go through 2022, if that makes sense.

Bill: Well, that's really positive to hear that the training pipeline for the companies in various industries are improving significantly. As I think about employment just across the whole economy and how challenging it's been for everybody, do you guys see that that's improving? Wages are definitely going up, it's a competition for getting a body in the door, no matter where you go. I've heard some of the people are leaving just for a dollar to go to a different-- across the street to a warehouse leaving a pretty good job. Eric, what have you heard about that from your clients?

Eric: That's clearly happening. We're clearly seeing people jump, but at the same time, it's not as pervasive as I think people expect. COVID has put people on edge and they want some of that stability, so we're not seeing them jump a whole lot. It does give them some pause to say, "Should I?" One of the things that's happening in the labor market is-- I'll talk about the commercial vehicle space, is a great example, right?

You have the end product waiting for chips. They basically have built the truck and they're waiting to put a chip in it, but then you have this issue that works its way all the way back, and each of the suppliers then are saying, "Okay, I need workers. Let's go. I'm ready to go three shifts," and they start pumping those out and they hire everybody and then the next week they're like, "I don't have a part," or "I have a bottleneck up in front of us that I can't send them anymore. I need to wait." Then you move back to two shifts or you go back to one shift.

That can happen for a little period of time and the people that are the employees there say, "Fine, I can live with that," but when it continues to keep happening, that ability to say, "Is this a job that I can make money at?" comes into question. We're seeing that happen in a lot of sectors. The other thing though too, is we are seeing that there is a shift away from some of the service sectors into manufacturing.

I know here in the Midwest specifically we have had a large problem, where you're going into a drive-through at a fast food place and you're sitting there forever like, "Where is everybody?" Well, when you finally get to the root of the problem, you start realizing that a lot of those people have actually moved into manufacturing work or warehouse work or things that they weren't traditionally doing, so you don't have that traditional overflow worker that you had before, but in general, the overall market has blown up as it relates to workers.

The final thing I'll add though too is when we came out to the great recession, one of the problems that we had is that we didn't have a transient workforce because we had so many people who owned a house and were upside down on a house and they couldn't move. Even if a job was out in California and you were out in New York, you couldn't do it. We're seeing a similar thing here, except for it is a COVID-related issue, whereas they are unwilling to be transient. They're saying, "I'm holding in place. Even though a job may be over at a different spot, I am not willing to move quite yet," and so that is actually very similar to the behavior that we saw coming out of the Great Recession.

Bill: Great. Hey, Eric, if I can a step back, we're going to talk about some of the ports, and you had said that people are looking at alternatives. I know some of the East Coast ports have always been trying to pull traffic out off the West Coast ports. Is it working or what are people doing? Because they want to get to [crosstalk] those 81 ships. Yes.

Eric: It's working just by default, so the shipper ultimately is we're looking at what is the time until I get delivery. If they can expedite that in any fashion, let's say that it's taking traditionally seven days to a week and a half to two weeks to get across country. If they can say, "You know what, I can get it a few days before that if I bring it into the East Coast." It's less efficient of a move for them but they may say, "Let's do it." Because they're going to be waiting, not only are you waiting to get to the port but then to get it across the country takes a while.

Clearly, the shipper is saying, "I just need it," and so they're looking at any port that they can find to get that inland. We've seen clearly where Savannah has benefited heavily. Houston has benefited. We've seen actually New York, New Jersey. All of the different ports have benefited, but what we're finding though is you have a significant amount of inbound traffic on the East Coast and you don't have the same type of growth on outbound traffic. That is not normal, right?

If you are in Houston, traditionally you brought something in and then the port sent something out. It was well balanced. Now they're bringing a bunch of stuff in and they're not sending the same amount out. That imbalance is creating a lot of the problems that are really difficult to get over. In this case, the East Coast and Gulf Coast ports are very excited that they're getting more freight, but it's created other headaches that you're like, "If it had been traditional organic growth that was more normalized, then they could have handled that and everybody wouldn't have as much of the problem as we're seeing."

I'm not saying that the East Coast or Gulf Coast have done anything wrong, it's just that the global markets are so crazy right now to try and find any path that they can get to do that. This is why we're seeing spot rates for trucks very high. That's part of it. They are trying to figure out how do they get stuff to the end and product to what Fadi was talking about, if you look at the spot rate data out there, dry van, refrigerated van, very, very high rates, that they're getting paid still.

We had thought that the spot market would basically normalize this past summer and that we would start to see some easing in that pressure point. That really hasn't happened. That clearly is a result of what we're seeing because of the global supply chain issues and trying to get freight moved.

Bill: Do you think this is a short-term fix then by having some of the vessels go over to the East Coast or are they committed from a long-term basis now that they've been able to work over there and see how the solutions are working for them plus what the shippers want?

Eric: I think it's short term in the sense that you'll see some of them come back because again, it's still a more efficient move to come to the West Coast if they can. Some people, they'll say, "Oh, well, I'm going to look at these ports that I never looked at before." They'll gain some market share, don't get me wrong. I do think that that-- but it's not a permanent shift.

Bill: Yes. Fadi, what are you hearing from the container lines about their position in the West Coast and looking to resolve what's going on? To fold, let me ask, Washington's involvement, what they're trying to do to create some ideas and hopefully alleviate some of the issues, is that working to improve the situation?

Fadi: Yes. Look, we looked at imports into the US over the last 5 and 10 years, 3 years. We published something that I'm happy to send to your audience if they want and ultimately we identified that there is a shift in the supply chain towards Southeast Asia, towards Mexico. If you look at the percentage of growth in imports to the US, it is the highest from Southeast Asia and from Mexico and it's actually been flat from China for a number of years.

When you look at the East Coast ports, I think there is a gradual shift towards the East Coast ports. The Canadian rail as well has jumped into the fray in the last 6 to 12 months, launching up operations out of the Canadian East Coast ports, which can potentially serve the Midwest market faster and maybe $400 or $500 cheaper per container than doing it through, say, New York, New Jersey or somewhere else on the East coast because the volume would come through the Suez Canal, which is actually faster to go through the Suez Canal than to go through the Panama Canal from certain parts of East Asia than it is.

I think there is a trend that had already started before the pandemic and I think it's going to probably accelerate post-pandemic and will continue to grind from the West Coast to the East Coast. I think the Canadian port, which has been big gainers of market share on the West Coast, if you look at Vancouver and Prince Rupert ports, they've been gaining share from LA/Long Beach and some of the other West Coast ports. I think that's going to continue to play out also over the next number of years. That just adds a lot of capacity to the market.

If you look at the combination of a railroad like CP and Kansas City Southern, I think it's going to create a little bit even more connectivity in that north-south trade and being able to divert volume to other ports in LA/Long Beach potentially and still get to where you want to go to US Midwest. These are not things that are going to be the solution for the next 6 to 12 months. Those are potentially going to be changes in the supply chain over the next three to five years and play out that way.

I think LA/Long Beach will always have a dominant position, but I think that the stress on that land bridge, that everything coming from Asia has to go to LA/Long Beach and then move on that land bridge towards the east and the Midwest and middle of the country, I think the stress on that bridge is going to ease over time.

Bill: Do you think this is going to cause a shift then as people see more containers come to the East Coast, and how do they get them back to where they started from? Because today it's not set up that way.

Fadi: I think the issue is, once you get to the East Coast, it becomes more of a truck market, truck traffic. 80% to 90% of the traffic coming to East Coast ports is typically handled by trucking. I think the railroad have to play a bigger role potentially going forward. Yes, I think the entire supply chain was really built around the West Coast port, and that also takes time to spread out that supply chain and start to deal with having to come from the East Coast and start to develop the supply chain that ultimately refills those containers with export products and go to the East Coast.

I'll give you one example, 10 years ago, there was nothing going on in Prince Rupert in Canada. Today, you've got a port that is doing over a million containers a year and has a balance between empties going back that is very competitive relative to LA/Long Beach, although there's 15,000 people who really live in that town where these containers come in. They were able to develop an export market that's coming out of the Midwest, out of the Canadian market that ultimately refills those containers and go back.

I think that could potentially develop over time as you go and you start to see, again, a balance going towards the East Coast, but these things in the supply chain take a little bit more time to play out. That's not going to be something that solves the problem that we're in right now.

Bill: If we go back to the second part of my question, sorry, Eric, do you see Washington's involvement helping out?

Eric: I do think it's helpful because they do have some levers that they can pull. They can say, "Okay, we're not going to enforce some of the regulations," hours of service, things like that, try and move things through, but it's going to have a limited impact right now. I applaud what they're trying to do for the moment, but this is just really going to have to work its way through the system. I can't come up with a scenario that Washington can really solve this particular problem for them in the short term.

I think longer term structurally, clearly, there are some things that can be done and helpful, but for now, I think that's more incentivizing different behavior. Right now it's just unlikely to see any traction.

Bill: How about with OSHA's mandate that they're trying to push through with the vaccine and companies with over 100 employees. Now it's being held up in the courts but let's say it gets cleared up and they prevail, what does that do to the supply chain? Fadi, I don't know if [crosstalk] you want to take that one. Sorry, Eric.

Eric: Go ahead, Fadi. Yes, go ahead. We're tap dancing.

Fadi: Yes. I want to follow up on what Eric said because I completely agree with him. We watched the data as the government interfered a little bit at the port level. I think I remember at the time there were somewhere between 70 and 80 ships parked outside LA/Long Beach. Now we're over 100. The last number I saw was 101 ships. We haven't really seen much of an impact from these interventions. It seems way too complex to assume that this is going to be resolved by a degree of 24-hour work or whatever.

Like I mentioned earlier I think the industry itself is starting to find the solution to those problems. We're seeing it in terms of the pipelines of training at the railroad, a trucking company I cover I was talking to the CEO yesterday, and he was saying, "In the third quarter we had 12% of our trucks parked because we couldn't find drivers to basically drive them." He said, "In the fourth quarter, it's a little bit better. It's still pretty bad, double-digit, but it's a little bit better than it was in the third quarter." They seem to be signaling that going into the next few months things should start to continue moving in that direction.

I think you are seeing people learn from where the difficulties are and coming up with innovative ways to find solutions to deal with these problems. The same on the railroad side. These are companies that have been laying off people for the last 20 years. Now they're trying to recruit and having a tough time. Through the pandemic they let go a lot of people and usually they go back and call them and everybody comes back and now they're going to call them and nobody is coming back.

They're having to go and refill these, but six months ago they were saying, "We're going to hire 500 people," but then hire 200 because they couldn't fill that pipeline. Now we're starting to see that improve and advance. I think you're going to find the solution coming from this initiative. I wouldn't discount the importance or the potential of the demand feedback to the supply side being a big factor. If we go into a seasonally weaker environment in the next three to four months, and potentially even weaker demand because a lot of these economic data have softened a little bit, I think that could be potentially where you can start to get velocity into the supply chain to come back.

Bill: You think that's more from an inflationary perspective that you think there could be some softness that would help alleviate the congestion?

Fadi: I think we are seeing it already in our data. In our rail demand index, which has been highly, highly correlated with six months lead time with rail carloads, I can tell you, we've seen that soften every single month for the last four months and across the board. Not that we're calling for a contraction in demand but I think that big surge that was around six or eight months ago is definitely moderating right now.

Bill: Fadi, one last time, on the port side, do you foresee any labor issues? I know the West Coast has been in discussion for a while and they're pushing back against what the East Coast had from automation perspective. Do you see any disruptions coming in '22 from that side of the country?

Fadi: Is that to me?

Bill: Yes. Sorry, I didn't know if you heard me.

Fadi: Sorry. Yes, I think it's going to be a potentially contentious issue. Technology introduction is still going to dominate that negotiation. I think it's going to be a pretty difficult negotiation. If you go back for the last two, three rounds of this contract negotiation, they've almost never been going very smoothly. I think now there is a little bit more tension even between the two sides around the technology introduction, and I think could be problematic, and that's where I think the next biggest stress to the supply chain in the next six months.

Bill: It can be interesting, just from the perspective of that's the labor force that helped the president get elected. It's going to be a dance between Washington and the labor force there. Hey, Eric, something I've talked with you [unintelligible 00:38:52], I think the audience would appreciate hearing this is, a lot of discussion about newer sourcing or bringing manufacturing back to the US to try to avoid these situations that we're going through right now. What are you seeing? What are you hearing on that front?

Eric: Most of all the nearshoring that's happened over the last several years is already done. I think it's run its course in a lot of ways. Most of the things that we're running into from a supply chain standpoint are things that are not going to be efficient to produce here specifically within the US. We might see a little bit more moving down into Mexico, but the last wave of nearshoring is where we saw that happening. We were seeing a lot of movement into Mexico.

Some of the issues, I'll give you are an example, that we talked about, semiconductors, they've said, "Oh, maybe we should be doing semiconductors here. Oh, the investment is huge." You have to have a huge investment for very little return. The margins are thin. Doing that and having a higher-priced labor force here within the US, it just really doesn't make sense. It still makes sense to import that even with what we're seeing here.

One of the things, and I'm going to take a step back because Fadi was alluding to some of this stuff. I'm going to connect the dots a little bit. One of the things that I don't think we fully appreciate it, is how much e-commerce and what we'll call "omnichannel ordering." People can order it any way they want, from their phone, from their laptop, iPad, whatever it is. They can get it delivered when they want, where they want, how they want.

That ultimately is a very inefficient move. We are seeing the industry in its infancy of trying to embrace that. Therefore, we have all of these supply chain issues that are coming to a head at the same time that we're seeing record orders for manufactured goods here domestically. Core capital goods orders are way, way high. Record levels. They continue to keep growing.

All of these things are happening. Even if you nearshore it, I'm going to go back to that now, even if you nearshore it, you don't have the labor to do that and the cost structure. This is a catch-22 all the way through. You still have strong orders for domestic goods and we're still having a hard time finding labor. How do we nearshore something for that at the same time we're having supply chain issues that is continuing to get disrupted by not just manufacturing but the e-commerce-- We call it the "e-commerce revolution." Even though we felt like it's happened before, it's really here now. COVID put it on steroids.

Bill: Eric, one of the audience members asked a question while you were talking, "Is there a risk of oversupply when the supply chain normalizes?"

Eric: Probably not. It is always possible, but where there would be some concern from an oversupply standpoint is consumer goods. Yes, that is very possible, we start seeing things normalized; you have too much inventory, and we haven't had a good holiday sales season for a while. I think that's really what you do. The industry goes on a binge and they say, "We're just going to sell everything at a 50% rate," and they get rid of it. I think that that's a likely scenario.

I think that that's relatively short-lived. It's when you start having over supplies within manufacturing, that's where that becomes really concerning because you have no place to put it. You can't just be like, "Oh, I'm going to fire sale it." It just isn't possible to do that. Because of the constraint in the supply chain and the expectation of how long it's going to last, they won't do that, that won't be a problem. If they overshoot, it would be sometime in 2023 that they would overshoot on manufacturing because they're so lean at the moment that we feel like there's that pressure that they could be able to continue to build without interruption at least through 2022 and the first part of 2023.

That's maybe the part and time that we're a little bit worried about if we had to say that there was some concern, but right now, I'm not overly concerned. I think I'm more concerned about just some of that inflationary pressure that's in there. If you're not selling stuff and demand is there, you're going to continue to see high prices, specifically within the commodity markets.

Bill: Fadi, let me get your perspective [crosstalk] on-- Oh, go ahead.

Fadi: I wanted to tag along a little bit to Eric's comment, completely agree with him. I think maybe 2023-2024 timeframe where you can see the probability of oversupply potentially or that supply-demand basically becoming a little bit more imbalanced, but the other way was low utilization because I think this is probably the timeframe where if you're looking at the ocean side of things all the books of new ships get delivered around that timeframe.

Ultimately, when you look at recovery in travel and the return of cargo capacity in the passenger aircraft fleet, I think again, that's probably the timeframe, 2023, 2024, maybe even, where you can maybe start to see that supply accelerate. Between now and then, I'd be surprised to see any issues on the supply-demand side across everything pretty much, ocean, air, or land transportation.

Bill: You bring up a good point there, I think a lot of us tend to forget about it from the air cargo perspective, is that it's a lot of passenger air that uses the belly of the plane to ship that air cargo around. Although a lot of us have been on flights and they've been pretty crowded, there's still a lot of airplanes sitting on the sidelines that haven't been brought back. We need more momentum in the economy to get that back.

Fadi, one question to you on just the global perspective, from a port's perspective is we saw previously China shutdown a few ports with some of the COVID variants picking up. We now have Omicron, do you think that we're still at risk from that having a rippling effect throughout the system?

Fadi: Yes. I think that's a real and present danger for the supply chain for the next three months. We saw how Delta variant impacted the supply chain in the last six months because of a shutdown at the port in China that really clogged up all this issue. I think it was probably in one of the top three problems that exacerbated the supply chain problem in the last six months.

Omicron I think brings a lot of risk to the supply chain in the next three months. If we start to see that happen in a more meaningful way, I think we've seen at least one occasion now where one Omicron case caused basically an entire supply chain shut down in China. If that starts to happen at a much larger scale, I think you're looking at exacerbating some of the problems we saw in the last three, six months.

Bill: Let's hope that doesn't happen. Before we get into the audience Q&A, I just want to get your perspectives on what you've seen the positives have come about through all this disruption because there's going to be some good that's come out of it, lessons learned, what should our clients be thinking about from their perspective regardless of what industry they're in? Fadi, if we could start with you, and then follow up with Eric and your perspectives.

Fadi: I think that clients and the shipper community is trying to understand how in 2022 they can do things that are better, how they control the risk and not supply chain. Everybody is trying to figure out where to get capacity, how to lock in capacity. Pricing is almost not a big question mark. The question is, how do we get the capacity basically as we go into 2022 and ensure that we have the inventories in place.

I think that a lot of the supply chain changes that we think will happen over time as people try to redesign their supply chain to be more efficient, more effective, and more [inaudible 00:48:05] durable. I think a lot of the focus is on, "Where can I find the capacity, and how do I ensure that this capacity is going to be available to me over the next 12 months?" Which is why we think ultimately pricing is going to continue to be, at least for contracted business, I think will continue to be very, very robust. If you're a shipper, I think you have to assume that you have to pay a little bit more going into next year still to move your cargo.

I think the spot market could soften a little bit as that supply-demand like we indicated starts to enter more into balance. Gradually through the year, I think the spot market could soften a little bit, but most of the freight moves in contracted capacity, and I think that's going to continue to be highly competitive and [inaudible 00:49:06] more for 2022. I think that's across pretty much every mode, intermodal, truckload, refrigerated, rail obviously, even in the air I think in the short-term.

I'll give you an example. One of the large air cargo company had said that they have missed almost 165 flights last quarter because of COVID protocol that basically ate into the crew capacity. They didn't have enough crews to fly their aircraft because of these COVID protocols that were occurring across various airports in Asia, in Europe, and in the US, but mostly in Asia obviously.

That is going to continue to be a pretty tight market, and Omicron is going to eat into how fast the passenger capacity comes back and ultimately provides some relief. [inaudible 00:50:06] shippers' biggest focus is ensuring that they have the capacity. I think they have to be prepared to continue to see elevated pricing throughout 2022.

Eric: I could add on some things that we're seeing across the board. One is that we're seeing that the owner-operators clearly have a place at the table. That hasn't been the case for a period of time. A lot of that is coming about because of the tightness that we're seeing and the gig workforce started to mature. The owner-operators were that first gig worker that was out there, and they've been there for a long time. They were starting to slowly decline, and that really has jumped up again.

A big part of that is digital freight matching. Digital freight matching has been accelerated, and they continue to refine it. I think that's one of the positives that's come out of this. Also, as part of that, we're finding that companies, not just the shippers, not just the carriers, manufacturers, everybody has to be nimble. They have to understand where their risks are, they can't just take things for granted, but the ability to now change on a dime is so much there and that is ingrained in the system that if you had told somebody that they would be able to turn on a dime three years ago some of them would've just laughed at you. They realize that they have to continue to be relevant.

The final thing then is productivity. Not just the digital freight matching but overall productivity, how do they continue to put automation into their system, continue to digitize things, continue to train better, and then figure out how do they use the workforce that they have to their best ability. Therefore, it's changing how businesses are thinking about all of that. The risk mitigation stuff that Fadi talked about is that is power paramount now. We would have thought that during the Great Recession that everybody would have said, "I'm going to start doing risk mitigation. I need to understand that." That is now top of everybody's mind right now.

As they are seeing growth, they are very excited about that, but they're also now saying, "Where are my risks and how do I alleviate those risks?" Fadi is absolutely right. Price really doesn't matter right now. It's securing capacity and so what we're finding is that relationships are being built right now to be able to last. They talk about "shipper of choice" a lot of times. The shipper wants to be a preferred shipper. They want the carrier to say, "Yes, I want to move your goods." That's how you secure capacity. Those are the things that we're going to continue to see at least for the foreseeable future.

Bill: Yes, I agree. This is a topic that is at the forefront of every CEO's office board of directors meeting, supply chain is paramount. They're always trying to figure out what to do. Your point about the preferred "shipper of choice" is that the folks that were commodity buyers in the past and didn't want to develop relationships are being squeezed a little bit right now because those who were committed to certain transportation company they're getting taken care of. It's a shift in mindset. Hey, Eric, I think this thing is fundamental to everybody else on the call is that as you think about '22, '23, what should they be considering as they're preparing their forecasts and their budgets? Just from a holistic perspective.

Eric: Absolutely. Trying to understand what the base fundamentals are. Are they going to shift? What's the global market going to look like? In general, right now, we have an expectation that manufacturing is going to continue to grow. We have an expectation that the consumer is going to start to shift a little bit from goods into the service sector. Overall, that growth is there. Understanding those shifts and trying to assess those shifts are something that we are really trying to get people to understand as they look out over the forecast horizon and saying, "Here's what my forecast should be."

Don't get so hung up on, "Oh, why can't I find a worker?" Understanding that is hugely important, but I think people get very frustrated about that. A lot of it is trying to say, "Okay, what's that solution going to be and how are businesses meeting that with unique solutions to continue to move forward?" From a business planning perspective, those are the things. Like I said before too, one of the risks continues to be some inflationary pricing, but it's less of a risk of, "Are we going to see a slowdown?" It's more of a risk of, "How much money can you make and how do you pass that onto your end customer?"

We just don't see inflation being the driver to say it derails everything at the moment. There's just too many unknowns.

Bill: Well, Fadi, Eric, thank you very much for joining us today. It's been a very insightful conversation. As I mentioned at the onset to those that are listening, our goal at BMO is to add value to our client's business. I hope this added value to yours today by participating and listening in on this. There will be a replay that will be circulated for those who weren't able to join us. If you have any questions about what we can do at BMO to help out your supply chain needs, please reach out to your BMO banker. Thank you for joining us. Happy holidays.


[00:57:54] [END OF AUDIO]

Fadi Chamoun, CFA Transportation Analyst


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