IMO 2020 – the global cap on sulfur in fuel and emissions that begins next January – is widely viewed as a positive for this year’s ocean shipping pricing. Hundreds of vessels will be pulled from service to retrofit exhaust gas ‘scrubbers,’ leading to lower capacity on the water in 2019, which should theoretically increase freight rates, all else being equal on the demand front.
But in the container shipping sector, there’s a caveat. According to multiple executives of container-ship leasing companies, as well as analysts, the charter rates being secured for larger box ships – i.e., the size category that scrubbers are being retrofitted aboard – are rising significantly faster than rates for smaller container ships, for which scrubber installations are uneconomical or impractical due to space constraints.
Container line operations, unlike ‘tramp’ tanker and dry bulk shipping companies, have fixed schedules. If their owned ships are pulled from service for scrubber installations, these would have to be temporarily replaced by chartered-in tonnage to keep the schedule.
An increase in charter rates for replacement vessels is a boon for container-ship lessors, but for liner companies, escalating chartering costs could offset higher revenues obtained from shippers of containerized cargo.
As Stifel analyst Ben Nolan explained in a recent client note, “There continues to be the strange dynamic where larger vessels are seeing charter rates move up without the underlying box rates moving up in tandem. We believe the higher rates for the larger ships are being driven by liner companies needing to cover their routes while vessels are taken out of the market to have scrubbers installed. This dynamic has left the smaller vessels out of the fun as scrubbers are less likely to be installed on the smaller vessels.”
The underlying box freight rates are reflected in the Freightos Baltic Index, which tracks rates on various lanes for 40-foot containers. The global index shows a pronounced rise in the second half of 2018, as U.S. importers raced to bring in cargo before tariffs went into effect, followed by lower rates in the first half of this year. In contrast, charter rates for larger box ships have increased substantially in the first half of 2019.
Container-ship lessors speaking on first-quarter conference calls with analysts all agreed that rates for larger vessel classes are up sharply and outperforming those for smaller ships. However, not all of them agreed that IMO 2020-induced scrubber installations are the driver.
During a call on May 14, Danaos Corporation (NYSE: DAC) chief executive officer John Coustas highlighted the rate disparity between different size categories. “Vessels over 5,500 TEU [twenty-foot-equivalent units] have seen significant improvement when compared to recent lows in the fourth quarter. The market for larger vessels has improved considerably.”
For smaller 4,000 TEU vessels, he added, “The market went from $12,000 a day for these vessels back in May , to $8,000 a day in November or December, and now it’s hovering around $9,000-$9,500 a day.”
George Youroukos, executive chairman of Global Ship Lease (NYSE: GSL), echoed views on large-ship strength during his company’s May 7 conference call. “A recent surge of demand for high-reefer-capacity post-Panamax [larger than 5,000 TEU] vessels has enabled us to secure profitable, multi-year charters for some of the older vessels in our fleet.”
“Leasing by liners with very large scrubber programs has been very active,” he said. “The liners have been securing larger tonnage for longer periods, for a year or two, as larger vessels are taken out of service for scrubber installations. This is proving to be a positive factor for charter rates, and has significantly increased rates in the 8,500-10,000 TEU segments.”
One executive who does not agree with the scrubber theory of higher large-ship charter rates is Gregory Zikos, chief financial officer of Costamare (NYSE: CMRE). During his analyst call on April 23, he said the increase in time-charter rates has been “remarkable” for ships of 6,500 TEU or larger, reporting that 9,500 TEU vessels had signed contracts at $12,500-$13,000 per day in the fourth quarter of 2018 and were now getting $23,000-24,000 per day.
Asked whether he thought scrubber retrofits were fueling the rise in post-Panamax charter rates, he responded, “From our experience up to now, it is not. When we’ve chartered ships for a year, I’m not sure the one month off-hire for a ship to be retrofitted was a crucial factor. But as we get closer to year-end, in the third and fourth quarter, there may be some relevance.”
He believes the charter-rate increase is being driven by fundamentals. “Liner companies are launching new services. There are few big quality ships available. This all has to do with supply and demand,” he maintained.