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Russia-Ukraine war places 2.6 million light vehicles in production at risk according to S&P Global Mobility

15 March 2022 Demian Flowers

With Russia-Ukraine war comes more reminders of the fragility of the world's automotive supply chains. The March light vehicle production update from S&P Global Mobility (formerly the automotive team at IHS Markit) is likely to downgrade its 2022 car production forecast by 2.6 million units (i.e., to 81.6 million). The downgrade decomposition of light vehicle production will broadly comprise just under 1 million units from lost demand in Russia and Ukraine; and the remainder split between 1) worsening semiconductor shortage issues, and 2) loss of Ukraine-sourced automotive wiring harnesses and other components respectively. In addition, the complete loss of Russian palladium is a tail risk with the potential to become automotive industry's biggest supply constraint.

Pent-up light vehicle demand reduced by roughly one third

Pre-Ukraine invasion on 24th Feb, the global automotive industry had already spent over a year under capacity constrained conditions, with (we estimate) pent up consumer demand up to 10 million units (or 12%) above this year's achievable light vehicle production. The sudden loss of economic confidence (via high oil and raw material prices, weak equity markets, and tightening interest rates) is dampening the demand of light vehicles and could now reduce that shortfall by roughly one third - though significant pent-up demand remains.

Automotive supply chain remains the constraining factor

While the macro concerns are significant, the automotive supply chain (and not underlying consumer demand) will continue to set the upper limit for light vehicle unit sales in the medium term. The key crunch points weighing on light vehicle production levels post invasion fall into two broad categories: Semiconductor materials supply (specifically via Ukrainian neon gas and Russian palladium), and electrical wiring harness sourcing.

Specialist material outages could curtail semiconductor shortage recovery

Semiconductor supply challenges are worsening on two fronts: First, via neon gas production disruptions. Ukraine's firms control around half of high purity neon gas supply to the semiconductor industry, where the element is used in lasers that etch patterns onto chips. Our channel checks suggest immediate risks are low thanks to semiconductor makers holding sufficient neon gas inventory, but visibility is poor. The second challenge is availability of palladium, used in semiconductor plating and finishing. In an additional negative twist, China COVID-19 cases at a 2 year high are triggering quarantines and plant closures in northeastern manufacturing hubs including Shenzhen and Changchun. All of the above raise the risk of losses from 'stranded' chips, i.e., semiconductors for which the 'right' car cannot be built due to other constraints.

Ukraine automotive wiring harnesses difficult to substitute

Our channel checks suggest Ukraine-built automotive wiring harnesses were likely destined for around 0.5 to 1 million vehicles before the Russia-Ukraine war took place. These automotive harnesses comprise complex and manually constructed assemblages of cable. Although some dual sourcing arrangements exist, for the most part switching will be difficult due to already-constrained harness capacity in and around Europe. Production relocations could take 3 to 10 months due to wait times on machinery and multi-month staff training times. Almost half (45%) of Ukraine-built automotive wiring harnesses are normally exported to Germany and Poland, placing German carmakers at high exposure. Our analysis suggests VW is most exposed (via Leoni, Sumitomo, and other suppliers), followed by BMW. On the plus side, once ramped up - lost production from automotive harness suppliers could be recovered quickly into late 2022 and beyond.

Palladium: Next 'black swan' candidate

While low probability as things stand, palladium has the potential to become the automotive industry's biggest supply constraint. Russia produces 40% of the world's mined palladium according to United States Geological Survey (USGS). Around two thirds of palladium use is in vehicles, where it is the active element in catalytic converters for exhaust aftertreatment. If Russian palladium supply were suddenly interrupted (due to a western boycott, or Russia stopping supply), production of all vehicles using such sourcing (including hybrids) could potentially stop. Although platinum is an alternative element, it is similarly expensive and also largely Russia-originated. Substitution of any kind is a regulatory minefield since design changes require regulatory re-homologation, which can take months. We do not currently incorporate major palladium disruptions in our light vehicle production forecast base case.

Posted 15 March 2022 by Demian Flowers, Automotive Financial Analyst, S&P Global Mobility

This article was published by S&P Global Mobility and not by S&P Global Ratings, which is a separately managed division of S&P Global.


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