State of Ocean Cargo: Cutting through the fog

It’s June, and the opening of the long-awaited expansion of the Panama Canal takes place this month. Having won a lottery draw conducted at the Panama Canal Administration building in late April, COSCO’s container vessel Andronikos, which has a maximum capacity of 9,400 twenty-foot equivalent units (TEUs), will make the first transit.

If for any reason the Andronikos cannot be deployed, Wallenius Wilhemsen Lines’s car carrier Thalatta will take its place. In addition, more than 100 neo-Panamax ships have already made reservations for commercial transit through the new larger locks, which will begin on June 27, following the ceremonial inauguration and the first voyage.

However, the historic event takes place at a time when shippers are trying to make sense of quickly shifting ocean carrier alliances and partnerships—with the viability of some players even brought into question.  The mad ocean carrier race toward consolidation began earlier this year with the announcement of the 2M Alliance, comprising Denmark’s Maersk Line, the shipping unit of A.P. Moller-Maersk A/S, and Geneva-based MSC. Together, they dominate the Asia-EU trade lanes with almost 35% of market share.

Hot on the heels of this development came the grouping known as the Ocean Alliance, bringing together France’s CMA CGM SA and China’s COSCO Group, the third-largest and fourth-largest shipping lines respectively. Tagging along beside them were Hong Kong’s Orient Overseas Container Line and Taiwan’s Evergreen Marine Corp. Once the Ocean Alliance begins operations next February, analysts believe that it will control about 26% of Asia-EU share. 

All this movement left a scattering of six carriers out on their own. And with their ability to survive—much less thrive—in this new environment brought into question, a final fling into yet another alliance was made. Coming together to form a new vessel sharing agreement (VSA) that’s being referred to as The Alliance are Hapag-Lloyd of Germany, MOL, NYK, “K” Line, Yang Ming, and South Korean line Hanjin, with the possibility of adding HMM and UASC later this year.

According to spokesmen for HMM, “the door remains open” once it has finished its debt restructuring. And that’s a good thing, says Sea Intelligence Consulting analyst, Lars Jensen. “The carrier will have a hard time surviving in its current form unless it joins the new global container collaboration,” he observes.

Jensen also notes that Hapag-Lloyd is in separate merger talks with UASC, and reckons that the Dubai-based carrier will also join The Alliance. Once all the pieces are in place, The Alliance will begin service in April 2017 and will be extended over five years.

Frenzy foretold
This flurry of convenient marriages was widely predicted by a number of industry analysts, including those working for AlixPartners, a global business advisory firm in New York. Earlier this year, the firm concluded that the long-beleaguered financial state of the maritime container shipping industry would likely worsen in 2016, and that only consolidation would cure the malaise.

“Our outlook found that growing vessel supply, led by the ongoing introduction of giant megaships coupled with demand that shriveled in the second half of last year, left the industry with massive overcapacity, falling profitability, and precarious cash-flow levels,” says Foster Finley, AlixPartners managing director and co-head of the firm’s maritime practice.

A recent study issued by the firm asserts that companies with merger and acquisitions on their minds need to be proactive if they hope to reap the kind of rewards that winners in consolidated industries enjoy—or to prevent becoming acquisition targets themselves. And, along the way, the study points to the successful consolidation of the U.S. airline industry as a possible template for revival.

“Operational overhauls will also be necessary in this industry, which as a whole remains deeply troubled,” adds Finley. “In addition, these uncertain market conditions are casting a long shadow over the annual rate negotiation cycle kicking off between major importers and their carrier bases.”

The irony of mega ships
According to the AlixPartners report, due to the continued introduction of mega vessels—capable of carrying more than 18,000 twenty-foot-equivalent container units (TEUs)—industry capacity globally is expected to jump by 4.5% in 2016 and another 5.6% in 2017, while demand is expected to increase just 1% to 3% this year.

Ironically, says the study, the resulting overcapacity, and corresponding negative effect on profits, is in part the result of the industry’s drive in recent years to correct its chronic supply-and-demand imbalance by building these more-efficient, but mammoth ships.

Moreover, states the report, this new capacity in major trade lanes is likely to continue to distort the supply-and-demand balance globally, as the slate of vessel deliveries scheduled for 2016 and 2017 remains robust. In the meantime, vessel-scrapping activities remain muted.

Per the demand side, note AlixPartners analysts, last year started off with promise, as carriers generally reported improved profits through the first half of 2015 on the backs of stronger freight rates and declining fuel costs. However, the good times were short-lived, as traditional peak demand failed to materialize in the third quarter, leading to collapsing freight rates.

In fact, industry revenue in the critical, pre-holiday third quarter has declined in each of the last three years, to $39.6 billion in 2015 verses $45.9 billion in 2014 and $46.5 billion in 2013. The drop-off last year represents a 16% decline.

As a result of these types of factors, the study finds that nearly all of the key financial indicators for the ocean carrier market have declined. It finds that industry profits, as measured by EBITDA, fell 7% in the latest 12-month period, including a whopping 35% decline in the all-important third quarter.

Perhaps of even more-immediate concern, it finds that cash from operations declined by almost twice as fast as EBITDA in the 12-month period (by 12%), indicating that carriers face working-capital challenges, often a precursor to bankruptcy.

The airline model
Given the already challenged state of the industry, and the turn for the worse of several key industry barometers, AlixPartners analysts forecast continued poor financial results for at least the remainder of 2016. However, it also provides a possible consolidation template for industry companies not willing to live with what the study calls a “new normal” of anemic results.

Recent multibillion-dollar mergers such as Global Shippers’ Forum (GSF).

The GSF is calling for the establishment of a “Maritime Industries Supply Chain Forum” at an international level to address the full range of challenges facing the sector.

“Shippers have generally supported cooperation through consortia and vessel-sharing agreements as the appropriate means of rationalizing costs, provided that they themselves receive a share of the benefits in terms of enhanced quality and a wider range of services made available to customers,” says Chris Welsh, secretary general of the Global Shippers’ Forum.

Several years since the introduction of mega vessels, Welsh contends that shippers continue to experience poor quality services and disruption to their supply chains through the bunching of vessels, “void sailings” and other delays.

And one year since the publication of the Organization for Economic Co-operation and Development International Transport Forum’s report on “The Impact of Mega Ships,” there has been no serious response by the shipping industry to the issues it identified—namely the wider external costs imposed by mega ships and alliances of others in the supply chain, including shippers, port, terminal operators and governments.

“The onus is on the industry to demonstrate that the bigger ships and alliance business model is the best response to the economic and financial challenges faced by carriers, but also adds value to customers,” says Welsh. “We believe cooperation between the main international stakeholders in a new maritime industries forum would enable the wider maritime supply chain to develop solutions to the problems presented by bigger ships and alliances in a constructive and consensual manner.”

Welsh and other shippers conclude that the perceived wisdom is that bigger ships and alliances are good for competition because of the benefits they are said to confer. If the reality is that they add costs because of the negative externalities they impose on others, then that perception may change.

“If they restrict choice through reduced service competition, then other regulatory or competition policy approaches may be necessary to deal with the competition issues raised by mega vessels and alliances,” adds Welsh.