Energy Resource Availability - Protection From Disrupted Supply Chains

Resource Diversification

Contents

1. Introduction

2. What Is Resource Diversification?

3. Shannon-Weiner Diversity Index

4. Herfindahl-Hirschmann Index

5. Supply Risk Index

6. Resource Substitution Index

7. Concluding Remarks

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Introduction

In exploring resource availability, my research is taking down some avenues I didn’t think it would. Today, I’ll be exploring the general concept of resource diversification.

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What Is Resource Diversification?

Resource diversification can refer to the availability of natural resources in a system, but this can also refer to technological or economic resources. Together, these considerations can ensure a project using any resource is adaptable and resilient through alternative materials and supplies.

We can receive multiple minerals from the same resource batch, but we should also have multiple sources for critical minerals; otherwise, we risk shortages. Geopolitically, this diversification can reduce heavy reliance on one nation. This is why China’s hold over many critical minerals worries some nations, especially geopolitical rivals.

For the higher cost of securing multiple avenues of supply, a nation can strengthen national security and better navigate supply or market disruptions.

There are different mathematical approaches we could take here, but I believe a general calculation of supply chain resilience would be useful in this context but also for others.

Photo by Christian Wiediger on Unsplash

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Calculations

Shannon-Weiner Diversity Index

\(H’ = - [\sum_{i=1}^{n} p_{i} ln(p_{i})]\)

This metric measures diversity by considering the number of sources and the share of the total supply from each source.

\(n = \text{Number of Sources}\)

\(p_{i} = \text{Proportion of Supply From Source i}\)

Note, the peculiar-looking symbol above is a sum symbol. This means we add the values for each individual source. The values we add will be the proportion of supply for a certain source, multiplied by the natural log of the same proportion of supply. The natural log is represented by “ln”, and it can be found on a scientific calculator. It is used to scale values and makes the index more sensitive to changes in proportion.

To better understand:

\(b^y = x\)

\(log_{b}(x) = y\)

b is referred to as the base of the log. When b is equal to Euler’s number (e), we get the natural log:

\(b = e = 2.718\)

\(e^y = x\)

\(log_{e}(x) = y\)

\(ln(x) = y\)

In such an example where even a few percentage points difference in supply from a specific source can make a large difference in the real world of supply, this is a useful tool to use.

There is a lot of complicated mathematics here, but I’ll better explain it through an example below.

Example:

Let’s say a country imports lithium from China, Australia, Chile, and Argentina in the following percentages:

• Chile: 50%

• China: 30%

• Argentina: 15%

• Australia: 5%

We calculate for each country individually first:

\(p_{i}*ln(p_{i})\)

Let’s start with Chile, and go from there:

\(0.50 * ln(0.50) =-0.347\)

\(0.30 * ln(0.30) =-0.361 \)

\(0.15 * ln(0.15) =-0.285 \)

\(0.05 * ln(0.05) =-0.15 \)

We then add these values due to the summation symbol:

\(-0.347 + (-0.361) + (-0.285) + (-0.150) =-1.143\)

But, as we can see from the equation, we have to take the negative of this figure for our H’ calculation:

\(H’ = -(-1.143) =1.143 \)

Photo by Kim Leary on Unsplash

Interpretation:

Now, it’s all well calculating this figure, but now we need to interpret what it means. Typically, a H’ value can be interpreted in the following way:

• H’ = 0 = No diversity. 100% of imports are supplied from a singular source. This is highly vulnerable to disruptions.

• H’ Between 0 and 1 = Suggests low resource diversity, with supply coming from two major sources. Such an example would be 80% from Chile and 20% from Australia.

• H’ Between 1 and 2 = Somewhat diversified, but room for more diversification of supply. If one major supplier faces shortages or restrictions, adverse effects could be felt.

• H’ Between 2 and 3 = Resource is highly diversified. More competition means lower prices and more supply stability. One source suffering a limitation, such as enforcing an export ban, wouldn’t deeply affect the supply to the country we are calculating for.

• H’ Above 3 = No single supplier dominates this market. Hence, for this resource, we have a resilient supply chain, and a resource supply is considered secure.

Hence, our value of 1.143 suggests this country has a moderate level of supply concentrated in a few countries, and some resource diversification could reduce the risk here of being caught up in supply chain struggles.

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Herfindahl-Hirschmann Index

\(HHI = \sum_{i=1}^{n} (p_{i})^2\)

This is another index that measures market concentration, exploring how concentrated supply is in a country. A higher figure implies concentration, while lower values indicate a more diverse supply chain.