Spot rates in the trans-Pacific ocean trade continue to reach epic new heights, leading to talk of price gouging.
“Container lines have done well during the global pandemic, but are they profiteering from the crisis?” asked U.K.-based consultancy Drewry.
“Perversely, lines look set to make more money than they have in a long time,” Drewry continued. The practice of “blanking” (canceling) sailings “has paid off handsomely.”
“From a public-relations perspective, the optics of making big profits during a global crisis are not great” and will lead to “more animosity and accusations of profiteering,” said Drewry, adding that it “is inclined to give carriers the benefit of the doubt for now.”
The ultimate question is: Will trans-Pacific rates prompt action by the Federal Maritime Commission (FMC), the agency that oversees alliances?
The answer appears to be: highly unlikely.
First, the FMC has given carriers specific permission to blank sailings in line with demand. Second, blank sailings are now rapidly dwindling at the same time spot rates are rising. And third, carrier agreements with the FMC do not forbid reasonable price increases and service decreases.
New peak for spot rates
Asia-West Coast spot rates (SONAR: FBXD.CNAW) were $2,776 per forty-foot equivalent unit (FEU) as of Monday, according to the Freightos Baltic Daily Index. That’s up around 70% versus the past two years and more than double late-February lows.
The Shanghai Containerized Freight Index put the cost even higher, estimating the Shanghai, China-West Coast rate at $2,920 per FEU for the first week of July, at or above decade highs.
At the beginning of this month, carriers successfully implemented their third general rate increase (GRI) in the past six weeks. According to Freightos Chief Marketing Officer Eytan Buchman, this “is a rarity in ocean rates that didn’t even happen in the lead-up to the trade war in late 2018.”
Blank-sailing permission for alliances
There wouldn’t be any debate on anti-competitive pricing if the container sector were not so acutely consolidated.
Alphaliner estimates that the alliances now control 89% of the market share between Asia and North America (including both coasts). The 2M Alliance (Maersk, MSC) controls 20%. The Ocean Alliance (COSCO/OOCL, CMA CGM/APL, Evergreen, HMM) has 39%. And THE Alliance (Hapag-Lloyd, ONE, Yang Ming) has 30%.
A letter to the FMC from the European Shippers Association (ESA) in September 2014, prior to 2M’s approval, exemplifies concerns toward alliances.
“Accepting that operators can ‘blank sailings’ can clearly be seen as market manipulation to restore freight rates if needed by playing on the supply side,” argued the ESA. It warned that cooperative agreements would allow carriers to “distort the market for the purpose of price increases.”
The FMC approved 2M and other alliances over shipper association objections. Alliance agreements with the FMC state, “The parties are authorized to blank sailings when utilization is likely to fall below such thresholds as may be established by the parties” and “blankings must be proportionate to the expected fall in demand.”
If at any time the FMC determines that an alliance agreement creates “an unreasonable reduction in transportation service or an unreasonable increase in transport cost” as a result of “a reduction in competition,” the FMC can bring a civil action in the District of Columbia district court “to enjoin the operation of the agreement.”
Blank sailings sharply reduced
By this standard, it’s hard to imagine how the trans-Pacific situation would elicit court action.
Carriers did indeed reduce capacity in the second quarter. But they did so in line with “the expected fall in demand,” which was inherently uncertain given the unprecedented nature of the coronavirus outbreak. As it turned out, demand exceeded expectations, so carriers added some sailings back in.
Rates are now rising despite carriers canceling many fewer sailings. Thus, rates are rising because demand is up, not because of a “reduction in competition” (i.e., reduced capacity).
Buchman described the early July GRI as “remarkable” because it was “happening as carriers have largely returned capacity to normal levels.”
Data provided to FreightWaves by eeSea.com shows that carriers blanked 12.7% of Asia-West Coast sailings in the second quarter, but only 3.3% so far for the third quarter (6% this month, 3% August, 1% September).
Surging US demand
Tightly restricted capacity increased rates in June, said Buchman. But demand is the rate driver this month, with importers favoring the West Coast over the East Coast.
“This demand surge is likely driven by many U.S. businesses adding inventory that’s finally run down since their last orders in May or April,” Buchman said. “As restrictions in some areas are reduced, businesses are reopening and even U.S. manufacturing is recovering somewhat.”
He added, “Some of this demand in what may be an early peak season could be motivated by the August expiration of certain tariff exemptions for hundreds of products, from coffee filters to skateboards.”
The reasonableness factor
While China-West Coast spot rates are extremely steep, it seems highly unlikely that they meet the regulatory threshold of being “unreasonable.”
According to FreightWaves Maritime Market Expert Henry Byers, some cargo shippers passed on the option to sign annual contracts at lower rates in April, wagering that they could do better in the spot market. Higher rates being paid by shippers are, at least to some extent, a function of their own bet on market direction. Is it unreasonable that some shippers pay more for betting wrong on rate trajectory?
SeaIntelligence Consulting CEO Lars Jensen also highlighted the reasonableness factor. “In very round numbers, ocean freight accounts for 1.3 cents of each dollar of goods,” he wrote. “The rate increase in 2020 means that each dollar of goods has seen a freight rate increase of $0.0009. Is that tantamount to profiteering?”
He continued, “My own recent estimate was that if carriers can maintain the [first-half rate] increase they could see profits of $9 billion in 2020. If they fail, the year could still end at a loss of $7 billion.
“Is $9 billion an unreasonable profit?” he asked, pointing to a McKinsey report estimating that carriers destroyed $110 billion in value on invested capital in 1995-2016. Jensen emphasized that this track record is clearly unsustainable. Click for more FreightWaves/American Shipper articles by Greg Miller
MORE ON BLANK SAILINGS: For an in-depth Q&A on blank sailings with Sea-Intelligence CEO Alan Murphy, see story here. For extensive data on blank sailings from eeSea.com, see story here. For a comparison of second- and third-quarter blank sailings to U.S. ports, see story here.
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Gary Ferrulli
Niels Erich comments above are very much on the mark, but many other issues point to the absurdity that carriers are profiteering or gouging. Besides looking at spot rates of a few minutes ago, why not take a real business look at the container shipping industry? Look at returns over the last 10 years and see collective losses of over $30. Billion with one year of profit, all the rest losses. 2020 is still a work in progress but “experts” in April said the industry could lose $28. Billion, despite seeing first quarter results and at least one month of the second quarter. The same “experts” now say that the industry could make $9. Billion in 2020 – or lose $7. Billion, a mere $16. Billion swing. Do you need to be an expert to make those types of projections, or just using hyperbole to get quoted in industry publications?
Even looking at the most recent spot market rates, which of these experts tells us that spot market rates are not the primary driver of carrier revenues, but contracts are and those rates are hundreds of dollars below the spot rates. We didn’t get down to 4 major carriers globally (those with more than 2 million teus of capacity), or 3 major Alliances because of profiteering or gouging.
The major issue is that most shippers are shocked at not seeing more red numbers from carriers, they have seen it for ten years, and suddenly in 2020 there appears to be the second year of profits over what will be an 11 year span. The carriers have themselves to blame for those ten years of collectives losses, but they have apparently finally decided that long term viability and ability to provide services does depend on profitability – even a small one as will happen in 2020 (look at the rate of return, less than 3%).
Even the highly subsidized carriers are being disciplined in managing capacity to the markets – the global economy has them not deploying excess capacity which would drive rates down, along with the bottom lines. Several of them will still lose money while the truly for-profit companies will benefit from the discipline shown for nearly two years now.
History tells us that 2020 is an anomaly in many ways, carrier profitability is one of those anomalies. Profiteering and gouging are perceptions of those who have seen mostly large losses and are somehow convinced that the 2020 anomaly constitutes cause for alarm and concern, imaging one year profit in a row with the potential of a second year in 2021 being the cause.
Niels Erich
A helpful, balanced article. Blanked sailings are an inevitable tool at this point for carriers to individually adjust to market supply and demand in a targeted way without idling ships or eliminating routes that are both costly to restore later. A $2700 China-West Coast rate reflects heightened uncertainty in the COVID-19 environment. Inventories need to be replenished but follow-on business amid 11% US unemployment and 50,000 new cases per day is in no way assured. Where was Drewry when the same rates fell below $600 in 2016, leading to consolidation and the formation of alliances? Calling for “market discipline,” that’s where. Can Drewry somehow produce for regulators an optimal “reasonable” trans-Pacific rate for all carriers in a given market and point in time? For each individually? Didn’t think so.