"You can't build a car with 97% of the parts"

The title statement summarises the challenge for the global manufacturing sector with Japan's industry and logistics disrupted for an unknown span of time.

Power shortages threaten global supply chain

Ford Motor Co., Samsung and The Boeing Co. are waiting for suppliers in quake-stricken Japan to increase one key export: information.

A top supplier of high-end components for the global technology and auto industries, Japan may need weeks to recover output lost as a result of the country's strongest earthquake on record, according to a forecast by Barclays Capital. . . .

“Our production won't be affected this week, but then we'll see,” Volvo spokesman Per-Ake Froberg said.

Supply of batteries, Blu-ray compact discs and magnetic heads used in hard drives also may be affected by the quake and power shortages, according to a report by Taipei research company TrendForce Corp.

“The reality is, the companies don't know the full extent of what's happened,” said economist Kim Hill at the Center for Automotive Research. “You can't build a car with 97% of the parts.”

Damage to ports, railroads, and factories in northern Japan has yet to be fully assessed - not least because engineers, corporate management and insurance claims adjusters have been kept at bay by radiation leaks from the Fukushima crisis-hit nuclear complex. Fuel shortages, power blackouts and disrupted land and mobile communications further stymie any effort to document damage or predict reopening schedules for stalled manufacturing plants. Rolling blackouts occasioned by damage to power generation and electricity grids mean even undamaged industries across the nation are producing less than expected. The scale of human tragedy - with half a million displaced refugees and 21,000 lives lost - mean many workers will be unable to report to work, or too concerned with rebuilding their homes and comforting their families to work more than regular shifts.

We have a highly interdependent, global manufacturing sector for modern goods, particularly high end electronics and automobiles. Japan may only account for 3 percent of the modern product, but it is usually the high value components that will be very difficult to source elsewhere. And as the title suggests, a failure to supply the 3 percent might result in halting production for the rest of the supply chain.

As this week rolls on, and the scale of disruption becomes better understood, I expect a lot of companies worldwide will start evaluating the implications for their operations of a disrupted supply chain. Without more precise information from Japanese suppliers on the expected scale of the disruption, few businesses elsewhere have been able to issue statements on the implications. As the information begins to flow, we can expect more than a few negative shocks about Q2 and Q3 earnings as inventories of parts run down globally.

So far as the media has noticed the issue, concern has been limited to supplies of the iPad 2. We may find that the implications are more serious for our economies than delayed gratification of Apple fans.

Intererestingly, the Japanese companies most directly affected are the only ones likely to be able to claim insurance for business interruption. Companies elsewhere reliant on Japanese-sourced components might have comparable losses, or even greater losses, but have no recourse except their reserves and such corporate finance as might be available in already tight markets.

Magnitude of insurance claims still almost impossible to measure

While analysts and risk modellers are daily raising their estimates of the economic damage, with the latest Barclays Capital estimate coming in at $US185 billion, many insurance experts believe it will be well over $US200 billion.

In terms of insured losses, risk modeller AIR Worldwide estimates it at $US15 billion to $US35 billion.

But some big-name brokers are quietly suggesting it could be $US70 billion, making it one of the biggest losses to the insurance and reinsurance industry.

Claims adjusters have poured into Japan in the past few days trying to grapple with the size of the damages and their clients' exposure, but cannot get near the radiation-affected area. Japanese insurance companies are also being hampered by power cuts in Tokyo that make it virtually impossible for them to appraise the damage.

A growing concern is how the tsunami is covered by general insurance policies. For example, AIR's estimates for insured losses do not factor in tsunami-related damage, business interruption costs or potential losses from nuclear damage.

Adding to the uncertainty of losses and disruption is the likelihood that insurers may contest coverage for some damage or disruption. After Katrina, many hurricane insurers asserted that their policies did not cover flood damage to properties. Similar disputes may arise in Japan where a trifecta of catastrophe has complicated claims assessment. The longer companies are kept from rebuilding and restarting production, the longer and deeper will be the losses for the industries dependent on them for their own operations, production lines and profits.