NOVEMBER DECEMBER 2018

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1 22 NOVEMBER DECEMBER 2018

2 Turbulent Waters By Dan Zeiger After an industry shakeup, container shipping still faces uncertainty stemming from cooling demand, stagnant freight rates, increased costs and a trade war. L ike any industry analyst, Simon Heaney hates disseminating a maybe or to be determined (TBD). The senior manager, container research at Drewry, the London-based global maritime research consultancy, wants reports and forecasts to reflect the calm seas of certainty. As the container-shipping industry looks to 2019 and beyond, however, researchers and forecasters continue to be tested. The waves from the 2008 financial crisis culminated in unprecedented turbulence during the last three years, with the financial demise of a carrier giant (Hanjin Shipping), consolidations and new alliances. With the industry still regrouping, such factors as fuel costs, trade tensions, vessel sizes and environmental standards all of which are rising combined with ISMMAGAZINE.ORG 23

3 I think Hanjin and the aftermath have changed the industry. Whether the industry changed for good is questionable. Clearly, it spurred another round of M&As and consolidation in the market as carriers realized they were vulnerable. SIMON HEANEY Drewry stagnant freight rates have bit into profits and delayed projections of demandsupply equilibrium. In many respects, things are TBD, which is awkward for our own position because we don t like to be on the fence, Heaney says. We want to have a high degree of confidence with our forecasts, and with conditions at the moment, we have to constantly put in caveats. This dynamic re-emerged in early October, when Drewry downgraded its projected global container throughput for 2018 from 6.5 percent to 5.3 percent, as well as its forecast for container demand over the next five years. After projecting the container market would be close to a rebalance around 2023, Drewry citing a cooling world economic outlook and growing tariffs concerns expects oversupply to last for several more years. Drewry s carrier-profitability projection calls for a break-even 2018 for the industry, but Heaney says that initial expectations of a US$7-billion profit were dashed due to higher fuel and operating costs. The forecast revisions were another dip in a wild ride for the container market this year, with a sharp second-quarter demand drop sandwiched between increases in the first and third quarters. Economy Impacts Growth Container-market growth is tied to world economic growth, says Peter Sand, chief shipping analyst at the Baltic and International Maritime Council (BIMCO), a Bagsvaerd, Denmark-based shipping association representing 2,100 ship owners and operators. He cites the trade-to-gdp multiplier, explaining that before the 2008 financial crisis, containerized trade grew 2 percent for every 1-percent growth in global gross domestic product (GDP). However, going forward, as advanced economies are expected to account for a smaller share of global GDP, the multiplier will become more influenced by emerging markets and developing economies. This will push the multiplier from two to one, Sand says. In October, the International Monetary Fund (IMF) cut its global economic forecast for the remainder of the year and Citing such factors as the U.S.-China tariffs tit-for-tat, weaker performance by eurozone countries and rising interest rates that put pressure on emerging markets, the IMF projects 3.7 percent GDP growth by the end of 2019, down from 3.9 percent. If this one-multiplier development materializes, Sand says, the containershipping industry will see slower growth going forward, with demand growing only at the same pace as global GDP which would be a reversal for the industry. The container-shipping industry, which handles about 90 percent of nonbulk cargo worldwide, enjoyed overall profitability in However, the best operating margins through the first half of this year have been mostly by the largest carriers. Four of the five biggest lines in the world Maersk Line, CMA CGM, China Ocean Shipping Group Company (COSCO) and Hapag-Lloyd reported a profit in the second quarter of 2018, with Wan Hai the only smaller carrier in the black. The average operating margin in the second quarter was minus-3.8 percent, after an average 3.1-percent first-quarter loss. The world s secondlargest carrier, Mediterranean Shipping Company (MSC), did not post its quarterly results. (Third-quarter 2018 reports were due for release after Inside Supply Management went to press.) Carriers have been largely unable to raise rates to defray increased fuel costs. But those involved in the U.S. West Coast trade have had some success in recent months, thanks to peak season demand and shippers likely rushing to move freight before tariffs take effect, according to Xeneta, an ocean-rate benchmarking platform. How much those rate increases will offset 24 NOVEMBER DECEMBER 2018

4 year-over-year declines from the first six months of 2018 remains to be seen. Add a brewing trade war that could result in declining volume between the U.S., China and European Union (EU) nations, Heaney says, and current conditions are not conducive to big profits. It s also an environment of uncertainty, which, says Gene Seroka, executive director of the Port of Los Angeles, is not something our industry handles well. How the Industry Got Here When Seroka started in the containershipping industry more than 30 years ago, he says, there were about 200 carriers in the trade. When I came to the Port of L.A. (in 2014), there were a little more than 20. Now, there are even fewer than that. The industry previously was overpopulated with carriers, Heaney says, and low earnings and high debt levels claimed one: Hanjin, which filed for bankruptcy in A trickle of mergers and acquisitions became a flood after Hanjin s demise among them, CMA CGM acquiring American President Lines, COSCO merging with China Shipping Container Lines, and Maersk purchasing Hamburg Sud. Three major alliances were formed: 2M (with Maersk and MSC as its biggest players), Ocean (CMA CGM and COSCO) and The Alliance (Hapag- Lloyd). Through the alliances, carriers aim to share assets to (1) increase services, (2) reduce operating costs, (3) fill gaps if a company goes out of business or is unable to deliver cargo and (4) enhance negotiation power with ports. It s always going to be a supplyand-demand game, Seroka says. We re working with these new alliances (to determine) pricing that allows for service-provisioning levels required by the supply chain stakeholders, specifically the cargo owners. The most recent M&A announcement: Container-shipping camaraderie The collapse of Hanjin Shipping in 2016 set off a reorganization of the container-shipping industry, and after a flurry of mergers and acquisitions, three alliances of global carriers were formed. Combined, these alliances account for 93 percent of East-West trade lanes. 2M Alliance 31% Maersk and Damco, a logistics provider and freight forwarder, will merge in early Maersk is one of multiple carriers looking to expand into service beyond port-to-port ocean freight. Heaney says that some shipping companies, thanks in part to generous government support, became like some financial-services companies before the Great Recession too big to fail. In some respects, Hanjin was the shipping industry s Lehman Brothers. I think Hanjin and the aftermath have changed the industry, Heaney says. Whether the industry changed for good is questionable. Clearly, it spurred another round of M&As and consolidation in the market as carriers realized they were vulnerable. Has Bigger Been Better? To a casual observer of the containershipping industry, the most evident trend is that of mega-ships. According to a 2015 report by the Organisation for Economic Co-operation and Development (OECD) and the International Transport Forum (ITF), the average container-ship capacity has doubled in the last decade. Maersk s 18, foot-equivalent unit (TEUs) series of ships set the bar for the newest The Alliance Ocean Alliance 26% 36% 2M Alliance (Mediterranean Shipping Company, Maersk Line, Hamburg Sud, Hyundai) The Alliance (NYK Group, K Line, Mitsui O.S.K. Lines, Yang Ming, Hapag-Lloyd, UASC) Ocean Alliance (CMA CGM, APL, COSCO, China Shipping, OOCL, Evergreen) Source: United Nations Conference on Trade and Development 2018 Review of Maritime Transport vessels that exceed 21,000 TEUs ships that are nearly 400 meters (a quarter-mile) in length and 60 meters in breadth. The mega-ships are designed to maximize economies of scale and reduce costs to offset depressed freight rates. But the ships need to be pretty close to fully loaded to largely reap the economies of scale, Sand says. The OECD/ITF report states that an 18,000-TEU ship would need 91-percent utilization to deliver cost savings. Economies of scale are also limited by the strain on port infrastructure and inland supply chains. The Port of Los Angeles; Port of Long Beach, California; and Port of New York and New Jersey are among U.S. ports that have invested in infrastructure to attract more container-shipping business. In June, the L.A. port, the busiest in America for container traffic, announced it would invest $1.3 billion in terminal expansion and information technology. We had visionary leaders who envisioned 30 or 35 years ago that bigger ships would be coming our way, Seroka said. We ve been nimble and made sure the land-side capabilities ISMMAGAZINE.ORG 25

5 were there the right crane heights, enough railway lines and cars, and fluidity at the truck gates. Each one of our seven terminal operators can handle those big ships. The proper infrastructure is not universal, and Heaney says some carriers are spinning plates to maneuver capacity and get cargo on ships that can be accommodated by their destination port. The returns aren t as grand as what they were first envisioned to be, he says. If the port infrastructure was there, it would be a different story. But it s not. Costs and Tariffs Worries Regardless of vessel size, fuel costs have been onerous for the containershipping industry. The average fuel price in August was $444 per metric ton, up 43.7 percent compared to July shippers are primarily exposed to surcharges. Some carriers have slowed down ships to reduce fuel consumption. While this measure increases capital expenses and requires more ships, Heaney says, it lowers per-ship costs. Another option: Some carriers might simply suspend services, and instead hire chartered ships or freight forwarders. Citing the level of idle container space, Maersk and MSC in September announced plans to withdraw from a coalition of 11 mega-ships from the Asia-Europe trade until demand increases. With these measures, and even if there are extra volumes, it s likely that they will only be good enough to break even, Heaney says. Sand and other analysts have sounded For the container-shipping industry, the route to recovery has been delayed by critical dynamics that can change by the quarter or month. And the rough waves of uncertainty are not likely to recede soon For carriers, fuel costs are likely to get worse before they get better, especially as an International Maritime Organization (IMO) mandate reducing sulfur emissions from 3.5 percent to 0.5 percent takes effect in Carriers are attempting to offset some expenses through emergency surcharges, an additional fee on top of contract charges related to fuel. Shippers and freight associations have fumed at the surcharges, calling them profiteering and vowing to pursue legal action; however, the EU Commission rejected their complaint in September. Heaney says that big companies like Walmart or Target have contracts that preclude fuel cost increases, so smaller 26 NOVEMBER DECEMBER 2018 the alarm on another threat to container-ship volumes: tariffs. BIMCO research indicates that, if the U.S. and China proceed with the latest round of tariffs announced in September, the impacted products would have accounted for about 22 million tons of container-shipping volume in In all, 85 percent of seaborne imports from China and 59 percent of those from the U.S. would be affected by the trade war. The dry-bulk shipping industry is the sector affected the most in terms of tariffed volumes, Sand says. But containerized goods will also be affected, mostly on the eastbound transpacific trade lane. Traderestrictive measures are, in principle, bad for shipping. They result in uncertainty and make trade more cumbersome for the nations involved, and that can limit demand for shipping globally. Extra Points Among other issues that are trending in container shipping: Blockchain: It will take years for the technology to influence the industry, in big part because of the number of parties involved suppliers, shippers, carriers, distribution centers, customs agents and port authorities. That requires a lot of buy-in. Engaging in new technology makes sense, and if it can lower (operating expenses) or improve ship positioning, the industry will use it, Sand says. But being technologically ahead is not a unique selling point if it does not add value for a cargo owner. Sustainability: The IMF s sulfuremissions mandate is one of a number of environmental-friendly measures affecting container shipping. Another is the Clean Air Action Plan (CAAP), a collaboration of the Ports of Los Angeles and Long Beach to convert to zero-emissions technologies by We ve reduced diesel particulate matter by 88 percent, nitrogen oxide by 57 percent and sulfur oxides by 97 percent, all while growing the port by about 10 percent in volume over the last decade, Seroka says. The reductions have been spectacular, but there s still work to do. For the container-shipping industry, the route to recovery has been delayed by critical dynamics that can change by the quarter or month. And the rough waves of uncertainty are not likely to recede soon. I suppose the simplest summation is that there s been gain for carriers, Heaney says. But there s also been some pain. ISM Dan Zeiger is senior copy editor/writer for Inside Supply Management.

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