Everything old is new again.
Liner shipping, like all other sectors, suffered a bad year in 2016 and prospects for 2017 are just as dim. It’s curious that it was the first year in living memory that every shipping sector was simultaneously depressed and there was no in-house innovation around the corner – like a switch from sail to steam or (later) steam to oil power or, more recently, the introduction of containerisation – to provide future relief. It simply was a bad year all around.
The title and the words above, sans 2016 and 2017, were the opening paragraph of a 1982 year-end wrap up on shipping published in the February 10, 1983 edition of the Hong Kong-based Far Eastern Economic Review. It was a depressing article about poor returns, shifting alliances [liner conferences], excess capacity, mergers and bankruptcies.
But the story serves as a reminder that we’ve sailed these seas before and the author was wrong in 1982 and would be wrong again today, despite the temptation to write, “For the first time ever all shipping sectors went bad.” In reality 1982 wasn’t the first time nor will 2016 be the last time, but understanding underlying causes could prove useful in making the dips a little more palatable.
The year 2016 was indeed a very bad year for liner shipping and the prospects for year 2017 seem dim albeit with numerous caveats that could alter any prognostication.
Like the year 1982, containership operators are not alone in their distress as virtually every sector from tankers to bulk and break bulk carriers are all bumping along the bottom. Mitsui OSK Lines’ CEO Junichiro Ikeda, who was around a half-year at the helm, pretty much summed up the sorry situation, when in January 2016 he wrote in the New Year Message, “Our business climate remains severe. Fleet oversupply is still an issue, and we see few prospects for recovery with the Chinese economy slowing down and markets stuck at historically low levels for both containerships and dry bulkers. The drop in crude oil prices does provide a tailwind with the twin benefits of reducing bunker costs and spurring the tanker market. However, low crude prices also raise concerns…we cannot realistically expect favorable conditions will go on forever in the tanker market.”
Ocean shipping has with annoying regularity pitched into depression and risen again from the depths, only to repeat the pattern all over. Admittedly, with each gut wrenching, nauseating cycle there have been structural changes to the industry and that’s happening today. However, thus far, those structural changes have done little to smooth out financial turmoil.
The Makings Of A Very Bad Year
There are many factors that contributed to making 2016 a bad year for container ship operators starting with the ROI (return on investment) and container freight rates. Like most things, the seeds of the problem were sowed several years back (it takes approximately three years to build a containership) and the industry is now reaping the rewards (or lack thereof) from their endeavors. In a nutshell, there are too many large containerships chasing too little freight.
How bad is bad? Since 2015 CCI (Containerized Freight Index) composite index has steadily plunged from around 1160 (see graph) to a low of under 650 and even with the recent modest recovery is only around 800. After the 2009 global, financial meltdown, which saw ocean freight rates effectively plunge 0 return on voyages, there was a rapid bounce back in 2010. Following an age-old pattern, ship owners went into a building spree and from 2010 to 2015 added 311 vessels and 5.7 million TEU of capacity. Although vessel layups and scrapping have accelerated in 2016 and slow-steaming is de-rigueur, these solutions failed to redress the supply and demand imbalance. In turn, with slots out running demand, ocean freight rates plunged.
Again the $0 freight rate voyage has impaled any run at rate recovery. For example, in March it cost around US$400 to ship a forty-footer between China and Europe, a freight rate that would barely cover basic overheads – in essence a $0 freight rate. Rolf Habben Jansen, CEO of Hamburg-based Hapag-Lloyd noted at the time, “Rates must go up. We have too many trades where we are moving cargo below operating cost.”
For containership operators the mantra is “rate restoration” – a goal easier said than done.
For the most part improving revenue in the cash starved system meant adding a menu of surcharges and fees, such as the Peak Season, Bunker, Currency Adjustment, Equipment Imbalance, Port Congestion, Inland Service, or Container Sealing fee, and Administrative just to mention a few.
These serendipitous charges are vexing to shippers. BIFA (British International Freight Association) Director General Robert Keen revealed a level of frustration when he wrote, “Forwarders do not like shipping line surcharges and we have been challenging their legitimacy…Our members [BIFA] have become used to shipping lines adding peak season, fuel and currency surcharges, but the number of surcharges and fees continues to grow – often with no real explanation or justification. For instance, what does an extra ‘administration fee’ or ‘container sealing fee’ cover that is not in the standard service [contract] offered?”
But it is undeniable that shippers have largely benefited from this wind fall of surplus capacity and depressed freight rates. The ocean portion of the supply chain represents pennies when compared to total cost of items to consumers. For example, on $100 plus athletic shoe the freight charges are less than a dollar and the entire supply chain might account for only $5.
Still there are major concerns among retailers with the new road map for the containership industry. Alliances, slot charter agreements and mergers are occurring at a dizzying rate as liner competition gives way to cooperation. For shippers the once wide highway of global trade seems to be more a narrow lane leading to a cul-de-sac of fewer options and higher costs.
Recently the EC (European Commission) approved the take over of Emirates-based UASC (United Arab Shipping Corp) by Hapag-Lloyd. EC Commissioner Margrethe Vestager in charge of competition policy noted, “European companies rely on container liner shipping services for their transatlantic shipments. It’s very important that the markets remain open. The commitments offered by Hapag-Lloyd ensure that the takeover will not lead to price increases on the routes between Northern Europe and North America.”
For the moment, “price increases” are modest in respect to historical rates, but BCOs are nervous about the long-term impact of industry consolidation on rate-making.
Surcharges aside and with the low freight rates, containership operators are hemorrhaging cash. For many the losses have and will be fatal. The London-based shipping consultant Drewry’s estimates that the containerships’ operators will collectively lose $5 billion in 2016. While there has been a modest increase in revenue, and Drewry’s is forecasting revenues of $143 billion for this year, this pales in comparison to $218 billion the carriers notched back 2012. What is particularly chilling is the low freight rates are occurring during a period of exceptionally low bunker prices (Over $700 per ton 2012 to less than $300 per ton 2016), which are likely to rise in the near future.
The containership industry has few answers to the dismal returns. Ships are now larger and more efficient. How much larger and more efficient can they be? Slow-steaming is already in play and layups, once an extreme answer, are as much a part of the operating routine as the endless surcharges. Ship scrapping has increased but has yet to yield a significant impact on over-tonnaging. The containership industry long ago squeezed out the inefficiencies of the back office - there is little more to pull out.
The only answer for containership operators is consolidation either through alliances, agreemeents or outright acquisition. But will any of this be enough to stop the bleeding?
The Hanjin bankrutpcy more than any other event has shaken the industry. Perhaps industry consolidation would have occured on its own accord but few can doubt that Hanjin slipping under a sea of red ink had an impact. Take for example the forming of “The Alliance”. “The Alliance” was formed by Hapag Lloyd (and UASC), the Japanese carriers MOL, K-Line and NYK (who have said they will form a single entity from their containership divsions) and the Taiwanese carrier Yang Ming. Hanjin was to be a part of the new alliance prior to the bankruptcy which unsettled the entire industry.
FMC Commissioner William P. Doyle at the NAPA (North Atlantic Ports Association) meeting in December when speaking about the ocean carrier alliances said, “It is noteworthy to point out that THE Alliance was filed in the wake of the Hanjin bankruptcy. Hanjin’s bankruptcy has disrupted the entire international maritime supply chain. I am an advocate (and have advocated) of the alliance members providing safeguards in the event of future liner bankruptcies. Having said that, for the first time we are seeing an alliance agreement attempt to make forward projections on ways in which to deal with a failed carrier in an Alliance – or – more importantly, how the non-failing carriers can help the failed carrier’s shippers and other customers.”
Once approved by regulatory authorities the three main ocean carrier alliances in 2017 will clearly dominate the trade lanes. For example, on the Asia-Europe routes the Ocean Alliance, 2M and The Alliance will account for 95% of the slot capacity. On the Trans-Pacific, the tally is over 93%.
Recently, it was announced that Maersk would acquire Hamburg Sud Line, which follows the announcement of a merger of containership divisions for the three main Japanese containership carriers (see above), Hanjin’s demise, NOL’s (APL) sale to CMA CGM, the merger of Cosco and China Ship, and Hapag Lloyd’s merger with UASC - which follows the takeover of CSVA.
The consolidation along with the new alliances dramatically alters the competitive picture.
Will these moves make 2017 a better year for the containership operators? Perhaps. On the other hand, will it change the boom and bust cycle? Unlikely.