2014 Rate Outlook: Ready to corral costs?
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January 01, 2014
While the Institute of Supply Management (ISM) reports that economic activity in the manufacturing sector was strong for the sixth straight month, logistics managers may still wish to examine this “exuberance,” say economists. With that said, transportation rates are unlikely to surge this year, no matter how vibrant the manufacturing sector remains.
According to ISM, manufacturing firmed once again at the end of 2013, climbing to its best level since April 2011 in both production and new orders. But there’s still reason for skepticism, says Michael Montgomery, U.S. economist with advisory firm IHS Global Insight.
“The problem remains the chronic lack of confirmation in government data on manufacturing,” says Montgomery. “It shows gains as barely over tepid growth, but the ISM report hardly indicates robust growth.
Montgomery adds that the surveys seem to be reporting that the strengthening is broad-based, and that the most recent industrial production data did show gains. But what does it take for gains to be both broad and deep? The answer is simple, say IHS economists, who contend that the world manufacturing and goods trading markets need to all be moving in synch.
“Right now the world is growing at several different speeds,” says Montgomery. “The U.S. and Japan are both reporting good gains in the surveys. The UK is booming, but the Eurozone and China are struggling with very modest gains.” He adds that if China and Europe can catch up to the growth pace of the other three, then the manufacturing sector will be on a roll. “If that’s the case,” says Montgomery, “with one side of the ocean pushing the other to strength, that will spur growth in the first.”
But it’s that synchronization that’s currently absent as Europe struggles with its structural problems. Meanwhile, industry experts in the fuel, rail, trucking, air, ocean, and parcel sectors are telling shippers to ready themselves for a gathering concentration of rate hike attempts.
Fuel: Loaded with uncertainty
Surplus oil production capacity has been an unreliable metric to date, notes Derik Andreoli, Ph.D.c., senior analyst at Mercator International LLC and Logistics Management’s popular Oil & Fuel columnist. He adds that, historically, when surplus production capacity declines to 1.5 percent of total liquid fuels consumption, oil prices increase and become much more volatile.
“This year, surplus production capacity fell from 3.0 percent of total consumption to 1.7 percent by August, but rebounded to 1.9 percent in September,” says Andreoli. “With such a thin cushion, any price forecast will be loaded with uncertainty.”
Andreoli adds that if global oil demand picks up faster than producers are able to add capacity, prices will ramp up, and any credible threat of disruption will have the same effect. “Alternatively, production disruptions currently amount to more than 2.0 percent of global capacity, so if just half of these bottlenecks are relieved, surplus capacity could rise to a comfortable level and price pressures would ease.”
With these caveats in mind, Andreoli says that weak demand in emerging markets, continued “sustainability” gains in Europe and the U.S., and continued growth in domestic production of shale oil will likely cause oil prices to decline slightly through the first half of the year. Then, he believes that price levels will spike in the second half of 2014 as the pace of global economic growth accelerates.
“And as a result, diesel prices are likely to remain elevated, and alternative fuels, especially compressed natural gas, will continue to sell at a steep discount on an energy equivalent basis, even as natural gas wellhead prices rise,” says Andreoli.
According to Andreoli, Mercator International has modeled dozens of fuel price scenarios in order to evaluate the feasibility of CNG and LNG fleet conversions from a firm-level cash flow basis. “We’ve concluded that conversion offers significant savings in many, but not all, cases,” he says. Hear more from Andreoli during Logistics Management’s 2014 Rate Outlook Webcast.
Over the coming year, he adds, shippers can expect the rapid adoption of CNG alternatives, but the current fleet is so small that even a doubling of the number of natural gas vehicles will not dent diesel demand.
Trucking: Modest bump
Andreoli’s forecast resonated with Stifel Nicolaus trucking analyst John Larkin, who observes that the expense of diesel will remain stable. Meanwhile, trucking rate increases lost momentum in 2013, as the much-anticipated capacity crunch failed to materialize—even after the implementation of new capacity sapping hours of service (HOS) rules on July 1.
“Some truckload carriers were able to push rates up 1 percent to 2 percent on average, with most of those gains realized early on in the year,” says Larkin. Others, he adds, were able to push unit revenue up a little beyond that level by applying technology to better select higher rated freight and improve their freight mix.
“LTL carriers also experienced some deceleration in the amount of year-over-year rate increases as the 2013 wore on,” says Larkin. A sluggish economy seemed to be the culprit in this instance, he adds.
So, as 2014 looms the question remains: Will 2014 be the year when the capacity crisis actually kicks in and drives trucking rates up mid- to high-single digits?
“While we would like to think that’s a real possibility, without the economy shifting into a higher gear this outcome is unlikely,” Larkin says. “We would expect more of the same for both truckload and LTL carriers—low-single-digit year-over-year rate increases.”
According to Larkin, until the electronic logic devices (ELDs) are mandated across the board by the federal government, the sluggish economy, coupled with collaborative supply chain efficiencies put in place by shippers and carriers alike, will drive “pedestrian” rate increases.
“Once the ELD’s go into effect, we may finally have the catalyst that drains enough capacity from the market to drive the much anticipated mid- to high-single-digit increases,” adds Larkin.
Rail/Intermodal: Increase on track
Brooks Bentz, a partner in Accenture’s supply chain management practice, jokingly referred to “yawns of surprise” when evaluating rates in 2013, and does not see a significant change this year.
“I believe that the economy will continue recovering, but at a very modest pace, and that rate making in carload and intermodal will reflect that,” says Bentz. “Exceptions may be there in the really hot areas, such as drilling pipe, frac sand, as well as petroleum and gas output. But since there’s not much of a long history there, it will be hard to gauge.”
Bentz says that intermodal is doing well domestically and still lagging internationally—a trend he sees as ongoing. The “market-changers” will be the willingness, followed by the ability, of some carriers to mount an assault on the shorter-haul markets with their hub-and-spoke approach. According to Bentz, this is a burst of new thinking and an approach to penetrating the market segment that has some of the largest volumes.
“Railway operating efficiency is very strong across the board, but they are still striving to do better, which will make them a very competitive force for a long time to come,” says Bentz. “That means, shippers who are new or casual users of rail—either carload, intermodal, or both—should do the due diligence to examine rail as an alternative mode.”
According to the Intermodal Association of North America (IANA), the Southeast region led the intermodal sector in the third quarter of 2013, boasting an 11.3 percent gain over the same period last year. Following immediately behind was the Northeast region, which posted an 8.3 percent gain compared to the same quarter in 2012. The Midwest maintained its year-over-year third quarter hold on the largest percentage share of regional traffic, with 28 percent.
“It is also worth noting that the trailer segment grew in all three months of the third quarter, reversing three years of decline and contributing to domestic growth,” says Joni Casey, president and CEO of the Intermodal Association of North American.
Finally, says Casey, there is always variability in these factors between domestic and international intermodal services. Shippers are mitigating their exposure to sudden rate increases by segmenting lanes and repositioning warehousing closer to hubs and ocean cargo gateways. “We keep knocking miles off the length of the haul,” she adds, “and that is going to address a lot of rate issues for us now and in the future.”
Ocean: Hikes unlikely
An ocean carrier price fixing case currently under investigation by the European Commission (EC) may indicate how desperate things have become in this sector, say analysts for the London-based consultancy Drewry Supply Chain Advisors.
“On one hand, carriers will argue that they are only doing what they have always done, namely notifying shippers of future price increases in good faith,” says Philip Damas, Drewry’s director. “Moreover, the way that they’ve been carrying out the function hasn’t gotten them anywhere, as evidenced by the downward spiral in freight rates in the past four years.”
On the other hand, the EC can counter that since the historical practice of announcing general rate increases (GRIs) started, the lack of financial justification for them has become more evident, suggesting that the targeted increases are now only motivated by supply and demand.
“The EC’s legal proceedings are certainly badly timed for the P3 alliance because Maersk, MSC, and CMA CGM need to be seen as responsible carriers in the eyes of industry regulators,” says Damas.
Martin Dixon, Drewry’s research manager, also notes that there is an “increasing disconnect” between market fundamentals and freight rates. He notes that despite respectable load factors, carriers are struggling to achieve sustainable rate increases on the spot market—and this is strengthening cargo owners’ hand in contract rate negotiations.
“Carriers continue to be spooked by the specter of imminent big ship deliveries and so are fighting to hold onto market share,” says Dixon. “This market behavior will put further pressure on freight rates through 2014.”
Rosalyn Wilson, senior business analyst with Delcan Corporation, maintains that the proposed rate hike by the transpacific stabilization agreement is also unlikely to succeed.
Air: Flying low
Overcapacity seems to be plaguing the air cargo sector as well, says Charles “Chuck” Clowdis, managing director of transportation advisory services for IHS Global Insight. Still, he predicts a slow gradual increase in tonnage by the end of this year’s first quarter.
“The European air cargo lanes are increasing, but still have a ways to go despite being up slightly over last year,” says Clowdis. “Africa is the only region to show a decline from a year ago.”
Meanwhile, North American airlines returned to a solid growth rate in October after a slight drop in September. Significantly, says Clowdis, the October increase was not affected by the 17-day, U.S. federal government shut down. Manufacturing activity in North America appears to be supporting demand for air transport of goods produced, but the expansion rates are still extremely small—and three times slower than at this time last year.
“Rates will follow growth, but capacity still is abundant and until some is absorbed, rates will still remain sustainably low,” concludes Clowdis.
Analysts with the International Air Transport Association (IATA) agree, but say that the skies may brighten for carriers in the new year. Late last month, the Geneva-based organization announced an upward revision to its industry financial outlook.
“For 2013, airlines are expected to return a global net profit of $12.9 billion. This is expected to improve to a net profit of $19.7 billion in 2014, says Tony Tyler, IATA’s director general and CEO.
Parcel: No smooth skating
No matter how good shippers have become at negotiation, chances are that delivery costs have gone up much faster than they expected, says Jerry Hempstead, president of Orlando, Fla.-based Hempstead Consulting.
“The exit of DHL from the domestic playing field some five years ago has left shippers at the mercy of a duopoly,” says Hempstead. “Shippers have little recourse. If one marries a carrier, there’s a good chance that there are yearly increases built into the agreement someplace.”
Hempstead says one of the largest changes since DHL left has been the escalation of the minimum charge. Shippers with big discounts often experience the jump in minimums the most. Since January of 2009, the ground minimum is up over 35 percent.
“Both FedEx and UPS have experienced laudable earnings growth in spite of a tepid economy,” says Hempstead. “Imagine how they might fare if the economy picks up? When we consider all the complexities of carrier pricing, we can’t envision many shippers skating by without some pain.”
But one mega-shipper may transform the scene in coming years, Hempstead predicts. “Amazon has sent a warning message out to the private carriers,” says Hempstead, “that it’s willing to explore alternatives to traditional services.”
Although Amazon may be a big customer of FedEx and UPS, they could become a threat as a competitor—and only time will tell if all three will work together to leverage each other’s strengths.
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