Absolute zero?

Absolute zero?

Rumors abound of zero rates on Far East to Europe services. Apocryphal or not, bottom-barrel rates are not doing carriers any good.


By Eric Johnson



      Reports of zero spot rates for ocean service on the Far East/Europe trade lane started surfacing at the end of 2008 and picked up steam in mid-January.
      Whether the idea of zero rates is rumor or fact is disputed by various carriers and analysts in the industry. But this much is clear: rates are disturbingly low and some carriers won't make it out of 2009 if it continues.
      Exhibit A is Senator Lines. The German carrier, since 1997 a
subsidiary of Korean line Hanjin Shipping, announced in February that it was closing operations. It might very well be the first domino to fall in a year of pain.
      At the root of the line's ultimate failure were the deplorable rates on offer.
      'Rates are so low that you cannot make money,' a Senator spokeswoman told Lloyd's List as the line closed up shop. 'With (ocean freight) rates around zero, it is not enough that you are as well utilized as we are.'
      Rates between the Far East and Europe have fallen 60 percent in the last year, ac'cording to Drewry Shipping Consultants.
      Philip Damas, division director at Dre'wry Supply Chain Advisors, said that while rate levels are dire, he has yet to encounter the infamous zero rate.
      'In our surveys, we have not seen any zero rates,' Damas said. 'The lowest we have seen is $50 or $100 base rates above surcharges.'
      But others who track the industry sug'gest otherwise.
      'They have already hit zero,' Charles de Trenck, founder of Transport Trackers in Hong Kong, told The Telegraph in mid-January in a report on falling freight rates. 'We have seen trade activity fall off a cliff. Asia/Europe is an unmitigated disaster.'
      It's such a disaster that de Trenck is predicting Asian trade to the United States will fall 7 percent this year, while to Europe he estimates a drop of 9 percent to 12 percent.
      It should be noted, of course, that zero rates don't actually mean free transport. A carrier offering a zero rate is still charging accessorial fees like bunker surcharge and terminal handling charges. Or a carrier might offer an all-in rate that only covers basic costs but includes no margin.
      But the wild swings in rate levels underscore just how much more volatile the Far East/Europe lane is compared to the transpacific. Another measure is how capacity in Far East/Europe has swung up and down the past three years.
      According to ComPair Data, there was 276,209 TEUs of weekly capacity in the Far East/Europe trade in January 2007. By January 2008, with every car rier introducing huge volume into Far East/Europe, capacity rose 28 percent to 353,636 TEUs. But by January 2009, capacity had dropped back down 13.8 percent to 304,779 TEUs.
      Such capacity volatility would inevitably affect rates, but to what degree is the issue these days. Some in the industry blame a select group of carriers for dropping rates in an effort to grab market share ' to grab a bigger slice of a smaller pie, as Damas put it.
   But so far, there doesn't appear to be a seismic shift in market share in the trade. Mediterranean Shipping Co. has margin'ally increased its share of the total capacity in the trade, while Maersk Line has lost a small percentage of its leading share.
      'The drop in the spot rates to near zero is a function of carriers fighting for market share in an environment of excess capacity and declining demand,' said Ben Hackett, a consultant with IHS Global Insight. 'Some carriers are making no more than $700 to $900 all-in ' that is freight rates and surcharges plus THCs. These are not economic figures.
      'There is no logical reason why the rates should be dropping so much given the reduction in capacity. The industry is not particularly well known for learning from past mistakes. If these rates continue there will be carriers that go under or will shut up shop as Senator has done,' Hackett said.
Those small shifts in market share wouldn't justify the race to the bottom that some carriers are engaging in, and everyone is feeling.
   'Carriers are removing capacity as quickly as they can in a mix of lay ups of their owned tonnage and trying to reduce the number of vessels on charter,' Hackett said. 'Estimates are that up to 25 percent of the Far East/Europe capacity has been laid up and most services are slow steaming. The recent decision by at least two carriers to avoid the Suez is also reducing capacity. Laid up ships are being used to store empty containers as these build up at both ends of the trade. In short, the drop in freight rates is nothing short of a disaster brought on by the battle for market share.'
      Part of the problem is the very makeup of the trade. When the European Union banned carrier conferences in October, it simply highlighted how fragile the balance is between carriers and their customers moving cargo between the Far East and Europe.
      That is to say, the Far East/Europe trade is far more reliant on spot rates than the transpacific. One-, three- and six-month service deals are more the norm than on the transpacific, where 60 percent of capacity is tied up in annual service contracts that run from May to April.
      Because on the transpacific, carriers agree to 12-month contracts, they won't lock in such low rates,' Hackett said. 'Maybe for two weeks they will, but not for 12 months.'

Ben Hackett consultant, IHS Global Insight
'There is no logical reason why the rates should be dropping so much given the reduction in capacity. The industry is not particularly well known for learning from past mistakes.'

      There's also more opportunism on the Far East/Europe lane, with more carriers going in and out of the trade than in the transpacific, where the list of participants is more stable.
      'The Asia/Europe trade has always been more volatile because of the lack of the an'nual contract tradition,' Johnson Leung, a Hong Kong-based regional shipping analyst for JPMorgan, told American Shipper. 'When you have a trade controlled mostly by the freight forwarders whose objective is to buy low and sell high, you tend to have higher frequency of freight rate negotiation during a year.'
      In an e-mail exchange with American Shipper, de Trenck concurred.
      'On Asia/Europe, I suspect it is the nature of the cargo owners and there being a larger forward component,' he said. 'But also it may be the volatility of the trade cycles has been greater than in the transpacific in recent years.'
   Whatever the reasons, Drewry said the average rate from Hong Kong to Los Angeles has dropped 20 percent in the last calendar year, to $1,400 per 40-foot equivalent unit. But the rate between Hong Kong and Europe has dropped by 60 percent in the same period, to $2,000 per FEU.
      While the talk of zero rates, and high rate volatility, has centered on Far East/Europe, carriers are struggling in the transpacific as well.
      The Transpacific Stabilization Agree'ment in mid-December acknowledged that member carriers as well as non-TSA lines participated in aggressive rate reductions in selected commodity and customer seg'ments in late 2008.
      'The rate actions seen in recent weeks are shortsighted and regrettable,' TSA executive administrator Brian Conrad said at the time. 'They haven't produced new business, they haven't increased anyone's market share and they do not adequately reflect operating costs.
      'No one should expect to see freight rates extended at current levels in upcom-ing 2009-10 contracts,' Conrad added. 'To maintain current rates over an 18-month time frame would threaten the financial viability of any major carrier in the market today. It's TSA's hope that the trade as a whole will take a step back and reconsider the financial impacts of recent actions, in the face of widely reported carrier losses and service consolidations.'
      The difference, of course, between the transpacific and Far East/Europe is that there is no longer any entity like TSA to call carriers to order. Though Maersk Line made a significant, if small, step in early February to reverse the tide.
      As reported by AmericanShipper.com on Feb. 4, Maersk said it was imposing $25-per-TEU rate increases March 1 and April 1 for cargo moving from Europe to Asia, the backhaul on the trade. The Danish line cited 'unsustainable rates and improved demand' for the increases.
      'The increase is also necessary to ensure that we can continue to support the trade and provide our customers with the service reliability and customer service they are accustomed to when shipping with Maersk Line,' the company said.
      On. Feb. 11, AmericanShipper.com reported that MOL would implement a general rate restoration program on the Asia/Europe trade this year. Westbound rates will increase $900 per TEU in three stages during the course of the year and eastbound rates $400 per TEU in two stages, the Japanese ocean carrier said.
      Starting April 1 the company said all cargo moving under a MOL bill of lading eastbound on the Asia/Europe route will be subject to $300 per TEU increases at the beginning of April, June and August, while westbound it plans $200-per-TEU increases at the beginning of April and September.
      Might there be other explanations for such low rates besides the obvious? Fi-nancial reasons that would justify such low margins?
      'Clearly, if you have a ship sailing tomor'row, it's advantageous for a carrier to get a contribution to the bunker surcharge,' Damas said. 'But if you sail from India or China to Europe, there's little demand on the backhaul, so you have to pay to reposi'tion the container. You get cash upfront, but you have to pay to get your container back to China. In the long-term this practice is suicidal. It really signifies panic in the marketplace.'
      De Trenck, of Transport Trackers, said there's no long-term business case to be made for zero rates.
      'I don't think so ultimately,' he said. 'Ultimately I suspect it is not only about price level but first, the time it took to help to get to price level, which was aided by destructive pricing strategies by the usual suspects last year and second, the time spent at the lower price levels, which I suspect will be longer this time than in the 2001-02 correction against, as well, higher cost tonnage.'
      Back to the issue of whether zero rates actually exist, one carrier told American Shipper that such rates can't be justified.
      'We don't believe there is a business case to be made for zero freight rates,' said Stanley Shen, inves'tor relations director at OOIL, the parent company of Hong Kong-based carrier OOCL. 'However, if zero freight rates were ever to become a reality, we do not see this becoming a trend as it is ultimately unsustainable and unrealistic.'

Shen

      Leung, however, said zero rates are occurring.
      'The zero rate story is true and we believe there is a fair amount of cargo being shipped on zero rates,' Leung said. 'Several lines told us that their average freight rates are about $400 per TEU all in. If you strip off the bunker and (termi-nal handling charges) then we are getting about zero on basic freight. We think the most worrying thing is not just about the zero rates but that the carriers cannot even cover their variable costs, which we define as the bunker, terminal costs, canal tolls, port dues, agency commission, etc. ' the costs that the carriers do not need to incur if they stop operating.'
      The low rates are a sign that current measures to cut costs aren't solving the demand problem.
      'Carriers are definitely losing their incentive to carry on, which is why we see the idling capacity increasing rapidly,' Leung said. 'Making profits is the only goal in any business. No strategic reasons can justify operating at below variable costs. We are talking about westbound Asia/Europe trade, which is not the direction the carriers are repositioning.'
   That's exactly the point Dirk Visser made in a recent issue of the newsletter Dynaliners, published by Dutch maritime consultant Dynamar.
      'Westbound rates from the Far East to Europe continue falling unabatedly, if re'ports that some carriers are now charging zero base rates are correct,' Visser wrote. 'Would those bottom out at that already suicidal level or will negative base rates be the next step? Surcharges such as THC, (bunker and currency adjustment factors) of course come in addition, but if carriers could actually live on that, they are appar'ently more than cost recovering.'
      Visser made the point that low or non'existent base rates aren't anything ground-breaking, it's just that carriers are used to charging such low rates on backhauls, not head-hauls.
      'In itself, zero and even negative base rates are nothing new,' he wrote. 'In ad'dition to the eastbound Europe to Far East route, they have been known in the trans'atlantic trade with its many inland compo'nents included in the total door-to-door rate. However, there were always 'normal' rates on the opposite main haul trade direction ensuring the carriers generated sufficient income to continue their service.'
      For shippers these are tenuous times. Zero or low rates look ever so enticing, but there's danger down the primrose path. Such low rates can't be sustained long-term and those who do maintain such low rates are likely doomed, narrowing shippers' service options down the road. Damas said Drewry is advising shippers to pick carriers who act prudently, and to diversify their carrier base to avoid being left high and dry in case one carrier fails.
      'Shippers will no doubt be well aware of the fact that any reliable shipping connec'tion based on zero rates in both directions will quickly disappear ' won't they?' Visser wrote.
      From the carrier perspective, meeting low levels often means keeping long-term customers happy ' literally at all costs.
      'In terms of relationship management, it's hard to tell your customers that you can't match the going rate,' Damas said. 'But big shippers realize they can't run carriers into the ground. The strategic shippers know this is not a good approach.'
      But Leung said that customer retention is not a major factor.
      'Customer loyalty is rare in shipping but I doubt there is any long-term carrier loyalty either,' Leung said.
      When asked whether it is better for car'riers to simply be moving containers rather than not moving containers, de Trenck said it's not so simple.
      'I would look at it first from a higher level,' he said. 'It is best to cut capacity any way one can and to cut costs faster, or as fast as possible, versus revenue decline, but also at the same maintaining one's standards on contracts made the best one can.'
      Damas said that it's simply a matter for carriers to decide whether they will lose more money turning down low-return business or taking containers at low rates to fill ships.
      'The question for carriers is, can you go down to a level to at least cover your variable costs?' Damas said. 'You come to a point where you don't cover your variable margin and don't even cover your fixed costs.'
Updated coverage on this story will be available through Shippers' NewsWire and AmericanShipper.com.