Forecasting political risk and measuring the implications for the global supply chain

IHS ECONOMICS & COUNTRY RISK Global Economics & Country Risk Conference Forecasting political risk and measuring the implications for the global supply chain 12 November 2014 ihs.com David Hunt, Country Risk, IHS, +44 20 8276 4717, David.Hunt@ihs.com Charles Movit, Senior Principal Economist, IHS, +1 202 481 9235, Charles.Movit@ihs.com Hugo Foster, IHS Country Risk, +44 20 8276 4713, Hugo.Foster@ihs.com David H Anderson, Zurich Credit & Political Risk, David.Anderson@zurich.com

Disruption is a part of life, whether small interruptions to our daily schedules or life-changing events that put us on a new path. In business, disruption is often defined as an unplanned and often unanticipated externality that increases risk and cost. But just as in life, business disruptions can create new opportunities that, if managed well, lead to new products, services, and business models. At the core of the yin and yang of disruption is the opportunity to learn. -Scott Key, IHS Quarterly Q4, 2014 2

Dealing with Disruption: Capturing the complexity of risk Tier 2 supplier GLOBAL ECONOMICS & COUNTRY RISK CONFERENCE T3 T3 T3 Potentially sanctioned entity Russia Border closure / trade disruption European Union Materials costs volatility Tier 1 supplier Tier 2 supplier Electricity failure disrupts production T3 T3 Credit risk Ukraine outside conflict zone T2 Energy disruption T3 Disruption of cargo Ukraine conflict zone Tier 2 supplier T3 T3 Physical damage to facility 3

Information Analytics Expertise NOVEMBER 2014 POLITICAL VIOLENCE & SECURITY RISKS Mapping conflicts and modelling supply chain impacts Hugo Foster, IHS Country Risk +44 20 8276 4713 Hugo.Foster@ihs.com

Capturing the conflict footprint with geospatial data - 2,778 Ukraine conflict events were recorded in the Foresight database in the year up to November 2014. - Event data was geocoded to the exact location of the incident, otherwise to the neighbourhood or town/city level. - Each event was coded by its Severity, based on the probable damage and disruption to property and/or cargo. 5

Evolution of the conflict: Q4 2013 GLOBAL ECONOMICS & COUNTRY RISK CONFERENCE November 2013 Violent suppression of Maidan protests in Kiev. Source: IHS Foresight 6

Evolution of the conflict: Q1 2014 GLOBAL ECONOMICS & COUNTRY RISK CONFERENCE March 2014 Demonstrations by pro-russian groups in Donbass region. January - February 2014 Government buildings in Western Ukraine seized by anti-government protesters. Source: IHS Foresight March 2014 Russian annexation of Crimea. 7

Evolution of the conflict: Q2 2014 GLOBAL ECONOMICS & COUNTRY RISK CONFERENCE April 2014 Separatists seize towns in south and east Ukraine. May June 2014 Government offensive to retake towns. Heavy fighting across Donetsk and Luhansk regions. Source: IHS Foresight 8

Evolution of the conflict: Q3 2014 GLOBAL ECONOMICS & COUNTRY RISK CONFERENCE Late August 2014 Separatists launch counter-offensives, reversing gains made by Ukrainian government forces. Significant amounts of heavy military equipment used. September 2014 Ceasefire signed in Donetsk & Luhansk regions. Artillery shelling has continued around important strategic locations such as Donetsk International Airport. Source: IHS Foresight 9

Evolution of the conflict: From civil unrest to war No. events 450 400 350 300 250 200 150 Civil Unrest War/TR 100 50 0 Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct 2013 2014 Source: IHS Foresight 10

Eastern Ukraine: Percentage of Russian speakers by district GLOBAL ECONOMICS & COUNTRY RISK CONFERENCE Source: Ukraine national census 2001 11

Conflict footprint: Industrial facilities by location and type GLOBAL ECONOMICS & COUNTRY RISK CONFERENCE Source: IHS Energy Infrastructure and Markets Database and IHS Foresight 12

Political violence risk rating model Source: IHS Energy Infrastructure and Markets Database and IHS Foresight 13

Conflict footprint by geography GLOBAL ECONOMICS & COUNTRY RISK CONFERENCE Model identifies 157 industrial facilities located within conflict zone (55% of total). Event history indicates widespread use of heavy weaponry, including self-propelled artillery and multiple-launch rocket systems. Shelling has often been indiscriminate and imprecise. 132 industrial objects destroyed or damaged in Donetsk & Lukansk regions (according to Ukrainian government preliminary assessment). Source: IHS 14

Conflict footprint by industry GLOBAL ECONOMICS & COUNTRY RISK CONFERENCE Coal mining concentrated in Donetsk and Luhansk regions. 105 out of 112 coal plants located within Donbass conflict zone. Ukrainian coal production dropped by half between January and August 2014. Source: IHS 15

Cargo route risk rating model: Impact of conflict on rail Model identifies 323 events indicating damage or disruption to cargo, mostly in eastern Ukraine. USD 90 million estimated cost for rebuilding damaged railways USD 200 million estimated cost for rebuilding damaged roads. Source: IHS, Digital Chart of the World 16

Direct and indirect disruption: Avdiivka Coke Plant Damaged caused by artillery fire (July 2014) Largest coke producer in Ukraine Major supplier of steelmaking facilities in Donetsk region Located within conflict zone, 9 km north of Donetsk Airport, a major hotspot Affected directly and indirectly by fighting since late July USD 53m loss in Jan-Sep 2014 Power supply lines disrupted by artillery fire (August 2014) Disruption to work force & repair teams due to nearby shelling (August 2014) Damage to key rail link creates bottlenecks (October 2014) 17

Disruption to transportation: Azovstal and Ilyich steelmaking (Mariupol) Avdiivka plant Located 110 km south of Avdiivka plant but dependent on rail supplies from Avdiivka and other coke producers in Donetsk area. Fully operational but producing at 70-80% and 40-50% of capacity in October 2014 due to reduced iron ore supply. Highest risk stretch of rail due to fighting around Donetsk Mariupol steelmaking 18

Risk to coke producers by region GLOBAL ECONOMICS & COUNTRY RISK CONFERENCE Steelmakers heavily reliant on coke supplies from Donetsk region are highly exposed to the conflict footprint. Steelmakers sourcing coke from locations further west less exposed to the conflict footprint. Source: IHS 19

Information Analytics Expertise NOVEMBER 2014 ECONOMIC AND FINANCIAL RISKS The Ukraine-Russia conflict and its impact on supply chains Charles Movit, Senior Principal Economist, IHS +1 202 481 9235 Charles.Movit@ihs.com

Uncertainty, violent conflict and strained relations with Russia are threatening Ukrainian economic viability GDP declined 5.1% y/y in Q3 following contraction at 1.1% and 4.7% in preceding quarters of 2014 (excludes loss of Crimea). Compelled to take an IMF deal as forex reserves dwindled, the hryvnia plunged and residential gas prices were increased by 50% as conditions, boosting inflation. Erosion of business and consumer confidence, strong inflation and accelerated capital flight have dampened domestic demand. Loss of life, destruction of infrastructure, economic paralysis have led to massive out-migration from two eastern regions. Already shaky banking system threatened by rapidly rising share of nonperforming loans.

After mid-2014, activity in Ukraine s industrial heartland was increasingly disrupted 10 0-10 GLOBAL ECONOMICS & COUNTRY RISK CONFERENCE -20 Jan. Feb. Mar. Apr. May Jun. Jul. Aug. Sep. -30-40 -50 Ukraine Donetsk Luhansk -60-70 Industrial production % change y/y -80-90 Source: UkrStat

The most dramatically impacted industrial branches Ukrainian industrial output (% change from CPPY) September 2014 Year-to-Date Mining and quarrying -27.1-9.0 Manufacturing -11.0-9.4 - Petroleum refining -52.0-14.9 - Transport equipment -40.6-19.0 - Basic metals, metal products -28.3-13.7 - Computers, electronics -19.5-22.0 - Machinery and equip., n.e.c. -11.7-11.4 - Chemicals, chemical products -6.2-14.7 Source: UkrStat

Russia s economic growth has slowed dramatically after an initial rebound from the global recession 8.0 6.0 Y/Y change in GDP in percent 4.0 2.0 0.0-2.0 Russia Ukraine -4.0-6.0 Source: RosStat, UkrStat

Russia s economy has significantly slowed down further throughout 2014 GLOBAL ECONOMICS & COUNTRY RISK CONFERENCE Growth slipped from 3.4% in 2012 to just 1.3% in 2013 and 0.8% in H1 2014. The forecast for 2014 points to a fall in real GDP by 0.5%, due to lower investment, capital outflows and heightened uncertainty which undermines growth. Falling oil prices mean contraction in 2015 as well. The tense political climate will further discourage investors, both domestic and foreign; capital flight is massive, consumer confidence is faltering and ruble and asset markets have suffered further. With investment negatively impacted, Russia s future growth is undermined as well. With huge forex reserves, the CBR can slow the rate of ruble depreciation, but will not prevent further downward pressure.

Capital flight from Russia has accelerated again due to negative investor perceptions of the environment USDBN 60 10-40Q1-05 Q1-07 Q1-09 Q1-11 Q1-13 -90-140 Source: Central Bank of Russia 26

Softer oil prices will slow Russian economic growth further and threaten finances USD/BBL 120 Realized Price Urals Brent 115 110 105 100 95 90 85 80 Source: IHS

Capital flight, falling oil prices are taking a toll on the currency and boosting inflation 30 Dec. Jan. Feb. Mar. Apr. May Jun. Jul. Aug. Sep. Oct. RUB/USD-EUR Basket CPI Y/Y in % 9.0 35 8.0 40 7.0 Xrate CPI 45 6.0 50 Source: Central Bank of Russia, RosStat 5.0

Russian capital investment is declining due to financial constraints and a degraded investment environment 2,400 2,200 2,000 1,800 1,600 1,400 1,200 1,000 Source: RosStat Billion 2008 Rubles GLOBAL ECONOMICS & COUNTRY RISK CONFERENCE Q1-05 Q1-06 Q1-07 Q1-08 Q1-09 Q1-10 Q1-11 Q1-12 Q1-13 Q1-14

Lending slowdown on higher funding costs, halt in foreign bond issuance 45 40 35 Bank Loans, y/y change (RUB terms) Bank Loans, y/y change (USD terms) Exchange rate (RUB/USD) 30 25 20 15 10 5 0-5

Small banks not directly sanctioned, but more vulnerable to weak economy, outflows, with no government aid 1000 12 980 960 940 920 900 880 860 840 820 800 780 Operating credit institutions (LHS) Closures per month (RHS) 10 8 6 4 2 0

Western sanctions on Russia could run the spectrum Asset freezes directed against key individuals along with visa bans. Asset freezes and trade restrictions against Russian state-owned enterprises deemed to be cooperating with actions in Ukraine; broader travel restrictions. Freezing assets of Russian state-controlled banks abroad, prohibiting funds transfers. Trade and financial embargo against all state-controlled entities, denial of insurance to sea-going vessels. Trade and financial embargo to include private entities deemed to be cooperating with Russian aggression in Ukraine. Longer-term: Damage may already have been done and be irreparable. 32

Heightened risks to business as usual as sanctions stay in place or are strengthened Enterprises may be forced to cancel orders with suppliers or orders to deliver to customers for lack of trade credits or working capital as banks become less liquid. Western firms could lose out to domestic suppliers as weaker ruble makes imported parts/equipment non-competitive in Russia. Relations based on expansion of production capacity might not be realized as investment decisions are deferred or cancelled. Additional strains with neighboring states over ethnic Russian minorities could develop, threatening trade and transport links ports, pipelines, rail. Further retaliation by Russia against Western flagship projects in Russia. A ban on international financial transactions with Russian entities (isolation from the SWIFT system) would be the big gun. All cross-border movement of goods and funds would be interrupted. Putin views as potential Act of War. 33

Information Analytics Expertise NOVEMBER 2014 FORECASTING UNCERTAINTY Measuring, monitoring and visualising political risks to complex global supply chains David Hunt, IHS Country Risk +44 20 8276 4717 David.Hunt@ihs.com

Energy security: Risks to EU businesses if no Russia-Ukraine gas deal Gazprom halted deliveries of gas to Ukraine in June (60% of its supply) but transit to European consumers (50% of Gazprom s exports) remained stable. Risk that Ukraine would siphon gas for European consumers as the winter heating season bites and demand spikes particularly in east. Any siphoning by Ukraine would result in interruption to European consumers; IHS Energy assess that Gazprom s options to punish Ukraine are limited: curtailing transit would hit Gazprom hard. Interim deal agreed averting for now worst case of full halt to gas transit via Ukraine. 35

Political risks to metals supply chains: Disruption unlikely Palladium: Russia top exporter (~40% supply) Pricing volatility driven in part by market reaction to headline geopolitical risks. Investors more sensitive to political sentiment than industrial buyers: safe-haven buying? Titanium: VSMPO critically dependent on Airbus/Boeing: fully integrated into their supply chains Possible if sanctions continue/expand that (a) difficulties may arise with LCs (b) production affected if machinery imports affected. Russia unlikely to disrupt exports of palladium/ titanium unless political situation deteriorates badly as against economic interests. Source: IHS 36

But political decisions are often against economic interests It was in the interests of Sudan/South Sudan to keep oil flowing as it was their only key revenue: but in Jan 2012, South Sudan suspended production. Iran s pursuit of a nuclear programme has imposed enormous economic costs; inflation 40%, nominal GDP declined from $592bn in 2011 to $324bn in 2013. Saudi Arabia s periodic flooding of oil market to dampen price; against short term economic interests but maintains authority & market discipline. 37

All Source intelligence: Early warning from big data social media analytics of political instability Russian/Ukrainian language monitoring of protest-related tweets, Jan 2013-Oct 2014 30K 20 February 2014 Peak of protest violence; 88 people killed. Yanukovich later flees Kiev 20K 1 December 2013 300k protest in Kiev's Independence Square Nu 10K 21 November 2013 Yanukovich abandons EU trade agreement Source: Twitter, IHS 0K 1 Jan 13 1 Apr 13 1 Jul 13 1 Oct 13 1 Jan 14 1 Apr 14 1 Jul 14 1 Oct 14 Day of date 38

All Source intelligence: Using sentiment analysis of social media to spoke weak signals of future separatism Geo-tagged tweets from Jan Aug 2014 that reflect positive or negative sentiment towards pro-russian separatists in eastern Ukraine and towards Ukraine s Maidan movement Source: Twitter, various national statistical offices 39

All Source intelligence Satellite imagery analysis of conflict indicators 40

All Source intelligence assessing energy security indicators though IHS Maritime vessel tracking Source: IHS 41

Scenarios help navigate political uncertainty GLOBAL ECONOMICS & COUNTRY RISK CONFERENCE Scenario (as of early March 2014) indicators 60.00 50.00 (March) (April) (May) Events 40.00 30.00 20.00 10.00 0.00 24 February 2014 24 March 2014 21 April 2014 19 May 2014 Civil Unrest War/TR 42

The limits of forecasting political risks GLOBAL ECONOMICS & COUNTRY RISK CONFERENCE War raised to 4.4 (SEVERE) on 3 March 6 months War raised from 1.6 to 3.1 on 19 Feb War raised from 1.1 to 1.6 on 24 Feb Civil unrest: 2.9 HIGH War: 1.1 MODERATE Civil Unrest War/TR Source: IHS 43

Ceasefire and negotiations: Decision tree GLOBAL ECONOMICS & COUNTRY RISK CONFERENCE Will the ceasefire hold and a political resolution acceptable to Kiev and Moscow be agreed? Yes. Will all separatists and Ukrainian militias lay down arms? No. Will separatists push for further territory, potentially including land bridge to Crimea? Yes. Will new parliament ensure implementation of autonomy for separatist regions? No. Frozen conflict. Yes. Will Russia move to take Kiev? Yes. Will Russia continue to pressure Kiev via political and economic means, including gas? No. Frozen conflict. Yes. Will the conflict spread beyond Ukraine? No. Concessions from Kiev are sufficient and relations with Russia partially normalise. Yes. Russia seeks to maintain Ukraine as a weak neighbour, preventing further EU and NATO integration No. Yes. NATO responds. Maximum breakdown of Western-Russia relations. 44

Capturing the complexity of risk: Global automotive supply chains Source: IHS Seating Assembly Database 45

Capturing the complexity of risk: Global automotive supply chains LOW 11.38% MODERATE 33.04% ELEVATED 20.67% HIGH 21.81% SEVERE 13.11% 0M 20M 40M 60M 80M 100M 120M 140M 160M 180M 200M 220M 240M CY2015 80M 60M CN Political Violence (war, terrorism, civil unrest) supplier location risk scores 40M CY2 US 20M JP 0M Average SE CA #N/A CZ IN DE FR ES RO BR RU MX BE PL GB IT #N/A UZ TH TR UA Average 0.7 0.8 1 1.2 1.5 1.75 2 2.5 3 3.5 4 5 6 Avg. Political Violence Risk Source: IHS Seating Assembly Database and IHS Foresight 46

Capturing the complexity of risk: Global automotive supply chains Source: IHS Seating Assembly Database and IHS Foresight 47

Capturing the complexity of risk: Global automotive supply chains Agromash Holding, Kazakhstan ZAZ Vida, Chance, AvtoZAZ, ZAZ Vida, Chance, Lanos, Sens Source: IHS Seating Assembly Database 48

Q&A Political violence & security risks: Mapping conflicts and modelling supply chain impacts Economic and financial risks: The Ukraine-Russia conflict and its impact on supply chains Forecasting uncertainty: Measuring, monitoring and visualising political risks to complex global supply chains An Insurance perspective on global instability 49

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