Ocean Shipping: Cool, Calm Correction
As the global rate structure stabilizes for ocean carriers, what can shippers expect by way of specialized service and available capacity? Our panel of industry experts provides an overview of current market trends and a working rate forecast to help shippers set future strategy.
By Patrick Burnson, Executive Editor -- Logistics Management, 9/1/2009
Peak Season is an oxymoron this year, as volumes fell far below the demand cycle of years past. But carriers seized the opportunity nonetheless, by rationalizing service and pulling in capacity in the most lanes with heightened traffic.
Meanwhile, shippers are being charged more for value-added services irrespective of shipping and sourcing imperatives, and the rates seem to be sticking. As supply chains become leaner, ocean shippers are now looking for market intelligence that can offer transactional advantages as well as strategic direction as they're gearing up for their 2010 planning—and that's just what we set out to offer.
Our panel of international ocean carriage specialists consists of: Jon Monroe, president of Shanghai-based Monroe Consulting.; Philip Damas, division director of Drewry Supply Chain Consultants in London; Michael Berzon, president of Mar-Log Inc., a supply chain optimization consultancy specializing in international trade and chairman of the Washington, D.C.-based National Industrial Transportation League's ocean cargo committee; and Paul Bingham, managing director with IHS Global Insight Inc. in Washington, DC, who has 26 years of experience providing trade and transportation economic analysis.
The spirited give-and-take nature of the discourse should give shippers an idea of how collective and individual carrier behavior will affect their own global operations.
Logistics Management: With so many carriers scrapping tonnage and canceling new orders, will shippers have the capacity when the economy recovers?
Paul Bingham: The simple answer is yes. The pace of the recovery in trade will not see shipper volumes overtake containership fleet capacity. The large overhang in worldwide container capacity, even accounting for increased scrapping and order cancellations, will continue to exceed underlying container trade demand for several years.
Jon Monroe: But no one expects the economy to rebound anytime soon. While the economy will recover, we may not see the same level of volumes that we saw in 2007 for many years—and let us not forget that the EU market has dropped as well. It may be well into the middle of the coming decade before there is a shift in the supply and demand equation in the Pacific. What we are seeing is not a correction but a restructuring of the buying habits of America; and if this turns out to be the case, we may have ships sitting idle for some time.
Philip Damas: The problem is not whether there will be enough capacity, but whether enough ocean carriers will survive and whether the capacity will be operated where required, rather than laid up and mothballed.
LM: Can shippers expect any new capacity coming online?
Michael Berzon: Many carriers are trying to minimize overhead, given the reduced revenues during this recession, by trying to defer or cancel new capacity. Others are going ahead with their earlier orders on the assumption that the new tonnage will be needed when conditions start to return to earlier volume levels.
What capacity is being mothballed can eventually be returned to service to meet demand. During these periods, as demand pushes the supply of space, we would expect rates to increase. In those trade lanes that are particularly squeezed, one can expect lines with capacity to enter them in order to achieve market share in a now profitable trade lane.
Damas: I'll be blunt: With the huge orderbook for new containerships, we forecast that there will be at least 20 percent global over-capacity in 2010, 2011, and probably also in 2012.
LM: In the meantime, what's happening to the existing price structure?
Damas: The Drewry Hong Kong-Los Angeles container rate benchmark for week 28 was $871 per 40-foot container, a 57 percent fall from this time last year. Pricing structures for freight rates have collapsed as volumes fell and overcapacity increased. The relationship between freight rates and carrier costs in this sector has vanished. In fact, ocean carriers are currently trading with negative cash flows and often not even covering their variable costs.
Bingham: Supply and demand dynamics have worked with falling prices encouraging more scrapping and lay-up of vessel capacity. With the bottom of the recession and trade demand declines having been reached, the market is now just starting to recover, especially with the rationalized service offerings and vessel lay-ups, though at levels well below those necessary for carrier financial health.
LM: Would you say rates have hit bottom?
Monroe: I would say that rates have hit bottom. In fact, the carriers, after having negotiated in good faith, are now renegotiating by trying to implement a second GRI (General Rate Increase). While everyone sympathizes with the carrier's plight, no one is happy to go back to the drawing board after they already calculated their costs for the year. So, it's a tug of war between carrier and customer to stabilize the pricing structure.
Berzon: Obviously, given the reduced volume cargo and a high degree of capacity, prices are at historic lows. However, there are signs of increases in a number of trades. The Transpacific Stabilization Agreement (TSA), which serves the Asia/U.S. trade, has set a significant target price increase. They still do not understand that shippers are aware that different carriers have different cost structures. In addition, within a fleet, different ships have different economics.
LM: Bunker fuel rates are always a concern. Will surcharges keep pace with demand in the future?
Berzon: The problem with surcharges is that the basis of determining them has been historically non-transparent. Some carriers, to their credit, have attempted to disclose the formula for calculating them. When prices rise, as they did last year, the high surcharge level tends to stay in place long after fuel prices have fallen. Bunker surcharge formulas can be jointly developed by a shipper and a carrier and included in a service contract.
Monroe: I share Michael's view. It will always be a supply and demand structure, meaning commercial consideration may force the carriers to compromise on the bunker. But if the carriers do not get their proposed GRI, don't count on it.
Bingham: Agreed. If the carriers show discipline, surcharges could keep pace with demand in the future. This would mean surcharges would be used to represent the neutral pass through of variable costs that they're intended to be. However, it may also be that carriers fall to the temptation to use the application and setting of rates of bunker surcharges to become a mechanism for hidden rate competition, in which case they won't keep pace with demand.
LM: U.S. West Coast ports have been losing share in recent months, with more direct calls being made to Canada and Mexico. Is this a trend?
Monroe: Yes and no. Many companies started shifting their distribution to the East Coast from the West Coast. Especially after inland rates took the big hike over the past three years. So while carriers and importers started to move from Southern California, the port of LA/Long Beach was already losing business to the East Coast.
I think there are few trends, only reactions...and those reactions will be based upon the real cost of distribution. As to how the Canada and Mexico ports will affect the West Coast: It will probably shift business away. However, if West Coast inland rail costs were to go down, ocean carriers will call there again. So I don't see a trend, only reactions based upon finding the lowest cost to market.
Bingham: Unwanted growth in global containership fleet capacity makes the addition of more direct calls possible, and an alternative to laying the ships up. With the exception of the two weekly calls at Prince Rupert, new calls in Canada are serving the Canadian market. Likewise, the Mexico calls are not driven by U.S. trade diversion through Mexican ports but the underlying Mexican trade.
The long-term trend will be a continued rationalization of selection of port gateways by shippers, driven by inland distribution networks that are partly influenced by patterns of consumption, locations of distribution centers, and intermodal rail and trucking rates. Some U.S. Atlantic Coast ports have gained share (despite declining volume) in the recession in advance of the expansion of the Panama Canal, with low all-water service rates combined with improved inland connections from these ports.
LM: How have market conditions affected intermodal?
Berzon: As far as intermodal freight is concerned, recent increases in costs for operating in and out of the U.S. West Coast is forcing transportation decision makers to look for alternatives. This includes Canada's Prince Rupert that now has excellent rail service to the Midwest and is a day shorter in sailing time from many Asian ports.
Mexico is also making improvements in their port and rail infrastructure which should become viable in a few years. There is also the fact that when the Panama Canal expansion is finished early in the next decade, that will present still another alternative. Of course there will always be significant traffic through these ports to serve large local markets.
LM: Carriers are also telling us that they'll be "slow steaming" on more routes around the capes rather than through the Canals. Any truth to this?
Berzon: That question is best answered by the carriers based on the agreement they have with their customer for time, place, and price for service. It's not unusual for some shippers to look for "slower" services, usually carriers that call at many ports on extended routes. The carrier benefits from carrying the cargo and the shipper benefits from having inventory in transit which frees up space in landside warehouses—it's a win-win situation.
Bingham: We can confirm that slow steaming is now quite common while the number of services diverted around the Cape routes instead of transiting the Canals is very limited. The fact that any east-west services previously operated through the Canals would divert that far is a measure of the overcapacity in the industry, the relatively low bunker costs, and the lack of discounting of Canal tolls.
LM: Barriers to entry are high, but do you see any new players entering the business? An integrator perhaps?
Monroe: I can't say it would be a smart thing to do. But you're correct, barriers to entry are high and the operational costs are high as well. I just don't see it. Where is the money?
Bingham: Though ships can be acquired very cheaply right now, it's hard to imagine any company being attracted to enter the sector as a new operator with such an overhang of capacity and consequential poor outlook for significant rate recovery. It's possible that a new player could buy into an existing carrier in poor financial shape to set the stage for a possible larger role several years down the road, but even that seems unlikely given that the integrators and other potential players are not in strong financial shape in their original markets either during the recession.
Berzon: Well, before we see new players entering the ocean liner business we will likely first see some mergers among existing ocean carriers and a few current players departing. Anything beyond that is pure speculation.
LM: Considering everything we discussed, what advice can you offer to ocean shippers heading into 2010?
Damas: Shippers must pay more attention than ever before to risks in transportation procurement. The risk of carrier bankruptcies, intermediary bankruptcies, unexpected termination of ocean services, cargo theft, and cargo liens are just some of the high-risk areas this and next year.
Actually, I'm sure many shippers would prefer to go back to the time when the key risk was infrastructure congestion and delays. As Drewry said in its recent report on risk management in international transport and logistics, savvy shippers are implementing formal risk management plans to mitigate new risks and respond to unavoidable risks.
Bingham: Shippers should closely watch recovery of the economy and trade volume growth to understand the demand conditions in which they will be purchasing services. They should also closely watch the collective management of container capacity by the industry to see if some carriers add service capacity back so quickly in attempts to grab market share that utilization actually falls. Then the shippers will know whether the supply demand balance of deployed capacity remains in their favor even as recovery in the economy and increases in volumes take hold.
Monroe: Put your head down and look for stability. But do not look for lower costs. They are as low as they will get now. Work on stabilizing and securing your inbound supply chain.
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