A collapse of free-trade talks between the EU and the U.K. would significantly damage Britain's large food and drink industry, a sector already reeling from the impact of the COVID-19 pandemic, including a jump in shipping costs and delays at key ports, industry experts say.

Negotiators from the U.K. and EU are in last-ditch talks in Brussels to secure a free trade agreement before a Dec. 31 deadline. On Dec. 17, the EU's chief negotiator, Michel Barnier, said good progress had been made and a few "stumbling blocks remain," while British politicians have expressed similar optimism. Nonetheless, Britain's food and drink businesses are especially anxious about a no-agreement scenario because of the potential for new tariff-related costs and other disruptions to their operations.

The U.K. processed food and drink industry is the country's largest manufacturing sector and operates on the basis of just-in-time delivery of products with short shelf-lives and intricate links to overseas supply chains. About 40% of the food and drink that Britain consumes is imported, and 70% of that portion is purchased from the EU. A no-deal scenario would impose tariffs, as well as time-consuming paperwork and other logistical challenges, on both British imports and exports. It might also trigger a fall in the pound, which would make imports more costly.

"Undoubtedly, if there is no deal there will be significant disruption," said Richard Lim, CEO of U.K. consulting firm Retail Economics, in an interview. "We import £30.1 billion in food and drink each year, and all of that comes in tariff-free." A no-deal scenario "will add £5.3 billion in additional costs from the EU impact."

The pandemic is adding to the pressure. In the third quarter of 2020 alone, the U.K.'s food and drink exports fell 11.6% to £5.5 billion when compared to the same period in 2019, according to the Food and Drink Federation, or FDF. Exports to the EU in the latest period fell 9.3% and those to non-EU markets fell 14.8%. In the first nine months of the year, food and drink exports fell 12.9% to £15.2 billion.

"Our industry has experienced a substantial drop in exports in 2020 largely due to the impacts of COVID-19 on the global hospitality sector, after a decade or more of continuous growth," said Graham Hutcheon, managing director of group operations at closely held Scotch-whisky maker, The Edrington Group Ltd., owner of the Macallan, Highland Park and Famous Grouse brands, in a statement published Dec. 10. "With the end of the [Brexit] transition period now just days away, food and drink businesses are facing another massive export challenge."

On Dec. 17, the FDF and the British Retail Consortium said disruption from the pandemic had caused shipping costs to jump by as much as 25% week over week as a result of logjams at key ports and called for a government inquiry into the delays. "Food manufacturers now face additional cost to source key inputs elsewhere, whilst also losing sales due to missed retail promotions in the run-up to a key seasonal period — one company has lost over £1 million in sales due to the delays," the groups said in a joint statement.

The disruption at ports has been compounded by businesses seeking to stockpile goods in the event that the trade talks fall apart. Grocery retailers such as Tesco PLC and J Sainsbury PLC stand to be particularly affected as these companies "operate on wafer-thin 2%-4% margins and can't absorb the full impact of tariffs," said Lim. "Any additional costs, especially for meat and dairy products, will mean a knock-on cost for consumers."

Large food producers have more room to maneuver since they usually import raw materials rather than finished food products and are therefore less exposed to high tariffs. But they are not entirely shielded from the repercussions of the U.K.'s departure from the European bloc. Switzerland's Nestlé SA, which has a significant presence in the U.K., has said a no-deal scenario would hurt its ability to bring in skilled employees from the EU. The Unilever Group has expressed concern about the impact on its supply chain and working capital.

Beyond tariffs, Brexit will introduce new logistical hurdles for British importers. For example, for controlled goods such as tobacco and alcohol, importers need to file a customs declaration from Jan. 1, 2021, onward; for other goods, that can be done from July 1 onward. U.K.-based exporters would have to file similar paperwork at the border of the EU country to which they send goods.

"I wouldn't belittle the difficulty of doing a customs declaration," said Matthew Clark, head of customs, excise and international trade at accounting firm PwC, in an interview. British importers who only import from the EU "have never had to provide a customs declaration before. It's not easy to pull that data together."

Another bottleneck is sanitary and phytosanitary checks, known as SPS, which apply to the import of live animals or plants. To guard against animal, plant and public health threats, the EU has tough SPS rules for goods coming in from non-EU countries. Animals and animal products require veterinary checks, for example. "We don't necessarily have the infrastructure to deal with this at ports," said Lim. "It will add friction to trade flows."