The transpacific wildcard

Rising production costs could change dynamics of eastbound cargo volumes.

Analysis by Eric Johnson

   The container shipping industry that’s built a large part of its empire on the Asia-to-North America goods pipeline is facing a troubling question: Is the cost of producing goods going to stay high?
   Here’s the issue: Sales figures and revenues for retailers and other beneficial cargo owners actually look fairly good this year, but container volumes at U.S. ports have been stagnant or trending down in the second half of 2011.
    So how does that add up? It’s all about higher production costs per unit. With inflation causing the price of raw materials to go up, the shipper’s dollar doesn’t go as far as it once did. And that has the potential to affect the goods movement industry more than it does shippers or even consumers, because higher per-unit costs translates to less container volume. Less container volume means less revenue for shipping lines, ports, and logistics services providers.
    The mystery is whether the bump in production costs is a short-term phase, or a more permanent adjustment of what raw materials, and eventually finished goods, actually cost.
    As shippers and carriers begin to sit down and discuss service agreements on the transpacific this spring, there will inevitably be talk about overcapacity, service levels, and better forecasting. Carriers will seek volume guarantees and shippers will want space guarantees.
   

“We’re in a sensitive situation. Our success is predicated on the success of our carriers.” Sheila Hewitt vice president, Transplace International

But the unknown question of production costs may well change the tenor of contract negotiations for years to come. If volume is to be affected by higher production costs, it will necessarily impact liner decisions on capacity and service.
    “Inflation is coming and the era when retailers and manufacturers absorb price increases to protect consumers is over,” Andrew Tananbaum, executive chairman of Capital Business Credit, said in late August.
    His company surveyed global retail manufacturers and importers and found that costs for both raw materials and labor have risen throughout 2011. Logistics costs also rose, mostly due to the impact of higher oil prices.
    As one industry executive put it to American Shipper, a procurement specialist who spent $2 million in 2010 may find with the same budget in 2011 that less freight will be purchased. Collectively, this trend has resulted in tamping down volumes through U.S. ports. 
    The National Retail Federation and Hackett Associates’ monthly Global Port Tracker said October inbound volume into the top U.S. ports fell 2.3 percent year-on-year. It projected a drop of 1.9 percent in November year-on-year.
    Now for the potentially good news — commodity prices have moderated in recent weeks. Take cotton, for example. Cotton prices reached record levels in March, but have fallen off sharply in the current season. The swings are heavily influenced by players in the futures market — in other words, entities that neither grow nor will buy physical cotton.
    The volatility in the cotton market probably looks familiar to those tasked with buying and selling ocean freight services. It’s been a feature of the ocean shipping market the last few years. But the reality is that amid the volatility, carriers have truly enjoyed maybe nine months out of the last 40. The risk in the market has been inordinately heaped on them.
    Whereas shipping used to go through 48-month cycles, they now occur in 12-month periods. That’s created panic decisions both on the high-end and low-end of the lines’ business. On the high-end, carriers continue ordering larger vessels to bring down their per-container costs, while on the low-end, their sales representatives sometimes seek volume over sensibility, chasing rates down to unsustainable levels.
    It will be hard for shippers — even the most altruistic ones — to ignore that which they will see in the market this spring.
    “The last two years have been volatile — and that covers pricing, container availability, vessels and space on vessels,” said Tom Craig, president of supply chain consultant LTD Management. “Carriers are trying to implement a new price increase next month in advance of the Chinese New Year. How do you sign a contract and then create new terminology in order to raise contract pricing? What good is a contract if you cannot get containers? If you cannot get on ships?”
    One-third of eastbound transpacific shippers surveyed in November by American Shipper said they had had cargo rolled in Asia in recent weeks. Nearly two-thirds of those who had experienced rolls were non-vessel-operating common carriers or 3PLs.
       Interestingly, and most relevant to the pending negotiations, only 21 percent of respondents saw capacity as tight — the rest witnessed plentiful capacity or just the right amount. It’s hard to imagine those perceptions assisting carriers in their drive to increase transpacific rates.
    The 15 member lines of the Transpacific Stabilization Agreement have spent the last month seeking a temporary rate increase of $400 per 40-foot container from Jan. 1, a move designed to bring rates to more compensatory levels prior to the contracting season. But as of early December, spot rates on the transpacific hit nearly two-year lows.
    While there’s been a clamour in recent years for shippers and carriers to engage in longer-term contracts, one executive American Shipper spoke to suggested lines may take a different tack this spring — reduce their reliance on annual contracts rates and play the spot market more.
    The theory goes that lines won’t be in a hurry to lock in annual rates at unviable levels, and may take their chances on spot rates rising if capacity is managed better in 2012. As the executive said, “carriers realize they can’t continue the same commercial strategies as before.”
    Craig suggested that it may take a certain amount of volume from a shipper to tempt carriers.
    “Carriers have set — and then raised — the volume thresholds they want in order to deal with a shipper,” he said. “This then moves some lower volume accounts into potentially using forwarders. And this is before the idea of using forwarders as a contingency. If forwarders’ share of a carrier’s space has increased significantly, then it puts carriers on the same track as U.S. railroads do with trailer/container activity in that they are suppliers of transport and have little direct interaction with direct accounts.”
    Craig said he expects shippers to build extra flexibility in contracts this year.
    “They may break their volumes up among more carriers,” he said. “A higher rate may be the result of this reduced leveraging, but it will give the shipper additional options with container, vessel or (merger and acquisition) occurrences. Beneficial cargo owners (BCOs) could also divert volumes to forwarders, who usually have more carrier options than do BCOs. Again, create a Plan B or even C.”
    Sheila Hewitt, vice president of Transplace International, an NVO and forwarder that also acts as a 4PL, said she still sees carriers as being too transactional. “They look at things on a per-vessel basis,” she said.
    Hewitt said Transplace was hit hard with cargo rolls out of China in October, and that it’s forced a rethink of its relationship with carriers.
    “We’re in a sensitive situation,” she said. “Our success is predicated on the success of our carriers. But we’re struggling to be strategic. We tend to have to be tactical. In theory, we’re striving to achieve predictability. But in practicality, we’re doing a lot of spot market benchmarking.”
   

Shipper takeaways Higher production costs could negatively affect transpacific volume, changing the tenor of spring contract negotiations in coming years. Shippers largely see enough capacity for demand, so lines will find it hard to raise rates this spring. Export shippers shouldn’t expect to see transpacific network and capacity decisions made from their perspective.

Hewitt said Transplace brought robust forecasts from its shipper customers to the table, but that helped little as cargo was being held back in Asia.
    “Our strategy was to be well-protected in a capacity-heavy environment but that turned on us,” she said.
    Meanwhile, waiting in the wings are export shippers, even those with desirable goods.
    “Exports probably are an afterthought as (carriers) gear up for import contracting, often because the import account managers and export managers are different,” said Jeff Siewert, vice president of operations at frozen poultry and meat exporter Interra International, and former director of international logistics at The Home Depot.
    “When a carrier is getting ready to talk to Sears and others like it about contracts, they are not thinking backhaul. But the best managed carriers love exports, or certainly reefer exports. My boxes are one of the best margin businesses they have and it is rather consistent all year round, unlike seasonal retail goods. If capacity tightens up, I feel confident my reefer boxes will move as they are some of the highest money-makers on the vessel. What has been interesting to me is that as a result of this, reefer exporters attract attention from steamship lines far greater than their total TEU shipped.”
    Siewert said spring negotiations aren’t as vital to exporters, at least agricultural ones, as they are to importers.
    “There is not this ‘one shot per year’ mentality,” he said. “Unlike import negotiations, export rates can and do adjust with the market, much like our cargo commodities do. I have not found that many exporters who do a once-a-year bid event. Some export contracts are for a year, many are six months. But I have no doubt that as network plans are made, that string decisions are made based on import volume actuals and forecasts.”