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Charting equilibrium: Supply-and-demand struggle

From service withdrawals to scrapping, the industry tries to find balance.

   The one constant in the container shipping industry is the challenge of supply and demand.
   Carriers have struggled with overcapacity for years, partly because they kept ordering bigger ships, but also because constant competition for market share led carriers to undercut each other on price and end up with non-compensatory rates and a whole lot of red ink.
   Despite 2017 generally being a strong year for carriers, the outlook for the remainder of 2018 is becoming increasingly clear — and it’s not looking good. 
   Consolidation among the largest carriers over the past few years allowed companies to eliminate back-office redundancies and reduce costs, but did little to ease overcapacity, as their operating fleets and order books generally remained the same. 
   Carriers have been aggressively slashing services in recent months, perhaps in fear of another tumultuous year like 2016, which was so bad that it pushed Hanjin, South Korea’s largest carrier at the time, into bankruptcy.
   Adding fuel to the fire, uncertainty over how much and when new tariffs will impact container volumes is making it tough for carriers to navigate the supply-versus-demand dilemma.

Balancing Act. Although the container shipping industry remains oversupplied, there are various ways in which capacity can be managed, ranging from slow steaming, blanking voyages, removing entire loops, demolishing or ordering fewer vessels. 
   When slow steaming, a vessel will operate at a lower speed, completing a rotation in a longer period of time than normal. This method leads to lower fuel-consumption costs, but longer transits can result in angry shippers.
   In a blanked voyage, a carrier will cancel one voyage on a service, ranging from the entire voyage to just one port call. Carriers prefer this method when they need a short-term fix in reducing capacity, such as around Chinese New Year or Golden Week, when demand for space on vessels is low.
   Removing loops altogether is a more concrete way to cut capacity and also can be done through suspending one loop for a certain period of time or merging two loops. However, removing loops leads to idle ships, which does not bring in any revenue for carriers. 
   In general, slow steaming, blanked voyages and removing loops result in shippers having fewer options, which in turn, lead to higher costs for shippers.
   Perhaps the most extreme and long-term option is for carriers to order fewer vessels and send more to the scrapyards. However, this is not a short-term cure, since with so many new, larger vessels ordered in recent years, capacity cannot be phased out overnight. 
   Hua Joo Tan, a consultant at Alphaliner, told American Shipper that service withdrawals are the only effective way of managing capacity. 
   “Skipped sailings result in temporary reductions but do not provide a sustainable solution in the longer term,” he said. “Slow steaming only removes surplus ships, but capacity remains unchanged if the number of services is maintained.”
   Darron Wadey, senior shipping analyst and consultant at Dynamar, said that in the short term, removing services would bring the supply-demand situation closer to equilibrium, thus improving rates.
   “In fact, it may even encourage cascading as shipowners and operators try to find employment for those ships once deployed on the cut services,” he said in a recent interview. “Ironically, this could actually feed overcapacity in other, albeit smaller trades. Even if this cascading does not happen, owners who cannot find even cost-covering employment will idle them, which costs money too.”
   Ultimately, Wadey believes carriers should take an approach that involves moderate ordering with somewhat more aggressive scrapping. Pointing to DynaLiners Trade Review 2018 — A Delicate Balance, Wadey said cargo demand in 2017 grew 5 percent year-over-year while global capacity grew 4 percent, due to fewer deliveries and reasonable scrapping, thus leading to profitability. However, for the first quarter of 2018, global volumes increased 5 percent year-over-year while capacity increased 6 percent due to plenty of deliveries and virtually no scrapping, leading to struggles and losses.
   Although the container shipping industry remains oversupplied, when it comes to establishing a capacity-management strategy, carriers must remember that the supply-demand balance varies quite dramatically from trade to trade, Simon Heaney, senior manager of container research at Drewry, told American Shipper.
   “There’s little point removing tonnage from one weak trade to a stronger market only to disrupt the supply-demand balance of the healthier one,” he said. “Carriers are effectively having to spin multiple plates and will continue to utilize all of the capacity levers available to them. The lowest utilization trades will require the greatest remedial action in terms of service suspensions, whereas in healthier lanes, the option to skip a few sailings during temporary demand lulls will be more appropriate.”

Stacking Up. Global contaitner capacity has grown at a faster rate than merchandise trade volumes for each year from 2012 to 2017, as illustrated in the chart below, which was built using data from BlueWater Reporting’s Capacity Report and the World Trade Organization.
   During this time period, BlueWater Reporting shows total container capacity grew the fastest between 2013 and 2014, rising 8.5 percent year-over-year. World merchandise trade volumes grew the fastest between 2016 and 2017, rising 4.7 percent year-over-year, according to the World Trade Organization. The WTO expects merchandise trade volumes will grow 4.4 percent for 2018.

   Drewry projects that for 2018, global container port throughput will total 794 million TEUs, a 6.5 percent increase from 2017, while fleet growth will reach 5.4 percent, according to the London-based maritime research and consulting firm’s latest Container Forecaster Report, which was published at the end of June.
   In terms of demand, Drewry projects the Middle East and North America will experience the smallest container volumes increase in 2018 with year-over-year growth of 2 percent to 3 percent. Asia, which accounts for just over half of all world throughput, as well as Europe, Oceania and Latin America all are projected to see year-over-year container volumes growth ranging from 6 percent to 8 percent in 2018. Africa is expected to see growth of around 10 percent compared to 2017, while South Asia is expected to see growth of about 11 percent.
   Regarding supply, scrapping during the first quarter of 2018 was well below expectations at only 26,000 TEUs, and Drewry projects only 100,000 TEUs will be scrapped for the full year, Heaney said during a July webinar on the outlook for container shipping and freight rates.
   “We’re seeing the shipowners are preferring to squeeze as much life out of their assets as possible by taking advantage of the rising charter prices rather than sending old ships to the scrapyards,” Heaney said.
   As long as charter rates remain buoyant, Drewry doesn’t anticipate a significant prospect for more scrapping, he said.
   However, demolition might increase in 2019, Heaney said, pointing out that a lot of ships were delivered this year and the cascading of larger ships into new trades could make the incumbent ships less viable. He also said the higher bunker prices could speed up the demolition process.
   Looking farther ahead, Drewry expects greater scrapping as a result of stricter low-sulfur fuel and ballast water laws, Heaney said.
   The International Maritime Organization’s Maritime Environmental Protection Committee will lower the global cap on the amount of sulfur in marine fuel from 3.5 percent to 0.5 percent on Jan. 1, 2020, meaning that ocean carriers will have to use marine oil with less than 0.5 percent sulfur emission, install scrubbers to old or new ships, or begin using ships powered by alternative fuels like liquefied natural gas. 
   The Ballast Water Management Convention, which entered into force on Sept. 8, 2017, is designed to prevent the spread of harmful aquatic organisms from one region to another by establishing standards and procedures for the management and control of ships’ ballast water and sediments, according to the IMO. And as with the low-sulfur fuel regulations, older non-compliant vessels will need to be retrofitted with new equipment or taken out of service under these rules.

Red Flags. Despite Drewry’s projection that scrapping could pick up from 2019 onward and thus aid the supply-demand balance, numerous red flags shadow the container industry, with carriers across the board facing headwinds from lower spot rates and trade tensions. 
   Heaney said during the webinar that Drewry would likely downgrade its outlook for demand growth, but probably less so for 2018 since it will take some time to feel the impact of the United States so-called trade war with China and other close trading partners like the European Union, Canada and Mexico.
   The east-west spot rate year-to-date average for the first six months of 2018 fell 11 percent year-over-year, Martin Dixon, director of research products at Drewry, said during the webinar. This is according to Drewry’s World Container Index, which measures spot container rates on eight major routes to and from the United States, Europe and Asia.
   As of Aug. 2, the average composite index of the WCI year-to-date totaled $1,395 per 40-foot container, 8.5 percent below the five-year average.
   Drewry also believes carriers will struggle to recover much of the increase in higher bunker costs from the emergency bunker surcharges, Dixon added.
   Oil has gone up in price this year after hitting extreme lows, and because carriers didn’t expect it, they’re now trying to pass on the added cost of bunker fuel to shippers via “emergency” surcharges. Shippers aren’t very happy about it, so it remains to be seen whether they will really pay more for the same space they contracted for at the start of the year. If they won’t, that could encourage carriers to scrap more to bring down available supply, thus driving up spot market rates.
   In addition, carriers such as Hapag-Lloyd of Germany and Japan’s NYK have issued profit warnings, while numerous prominent carriers have been slashing services on various trades in recent months.
   Hapag-Lloyd in June downgraded its 2018 profit forecast due to “an unexpectedly significant and continuing increase in the operational costs since the beginning of the year, especially with regard to fuel-related costs and charter rates, combined with a slower-than-expected recovery of freight rates.” 
   In July, NYK issued a profit warning for its current fiscal year, which began April 1 and runs through March 31, 2019, citing costs related to changes within its container shipping business, problems with its Nippon Cargo Airlines subsidiary and higher fuel costs.
   Several of the top carriers reported losses for the quarter ending March 31, while results for the quarter ending June 30 are beginning to surface, with the Ocean Network Express posting a loss of $120 million.
   Meanwhile, the 2M Alliance of Maersk Line and Mediterranean Shipping Co. (MSC), the world’s two largest carriers, suspended its transpacific TP1/New Eagle loop at the beginning of July until further notice, with MSC citing a “challenging operating environment for business on the transpacific trade.”
   At the end of July, the OCEAN Alliance merged two of its loops on the Asia-Mideast trade. In the first week of August, THE Alliance combined two of its transpacific loops.
   The 2M Alliance will seasonally will close one of its Asia-Europe loops in late Q3 or early Q4, and in early September, the 2M Alliance and ZIM will consolidate operations on the Asia-U.S. East Coast trade, cooperating on five loops together. Additionally, the 2M Alliance will continue to offer its Lone Star Express service on the trade outside the new arrangement with ZIM.

Tariff Uncertainty. The general consensus appears to be that the U.S.-China trade war will have a significant, but not huge, impact on the container shipping market, but when exactly the tariffs will impact trade flows is still unclear.
   “Retailers cannot easily or quickly change their global supply chains, so imports from China and elsewhere are expected to continue to grow for the foreseeable future,” NRF Vice President for Supply Chain and Customs Policy Jonathan Gold said. “As tariffs begin to hit imported consumer goods or the parts and equipment needed to produce U.S. goods, these hidden taxes will mean higher prices for Americans, rather than significant changes to international trade.”
   In the worst-case scenario, Drewry believes that up to 1.8 million TEUs — or about 10 percent of the total eastbound transpacific market based on 2017 figures — could be lost to the market over a period of time, according to the firm’s July 8 Container Insight Weekly. “We should stress that this analysis is a rough guide and won’t happen overnight as tariff policies take months to put together and the impact often lags by a couple of quarters,” Drewry said.
   “The main beneficiaries of any trade diversion from China would be Japan, Germany, South Korea and Malaysia (as well as Mexico and Canada),” Drewry added. “They would likely see increased exports to the U.S. by container (transpacific eastbound and transatlantic westbound) and by overland transport in the case of the two NAFTA countries.”
   In mid-July, the Port of Oakland said it was too soon to project the impact of 2018 tariff increases on cargo from China. However, it said the increases would have affected about $225 million of China’s imports had they been in place last year.
   In Southern California, Port of Los Angeles Executive Director Gene Seroka said, “A continued shuffling of alliance services in the San Pedro Bay, coupled with potential impacts from recently imposed tariffs, provide a level of uncertainty and potentially softened trade flows through our port during the second half of 2018.”
   Although 2018 may end up to be a rocky year for carriers, there are signs that overcapacity potentially could be less of a threat in 2019. Clarksons Research’s June Container Intelligence Monthly, for example, estimated containership deliveries will decline between 2018 and 2019 and demolition will rise.   
   It projected that containership deliveries will fall 26 percent between 2018 and 2019, from an aggregate capacity of 1.25 million TEUs to an aggregate capacity of 924,600 TEUs, while containership demolitions will rise 37 percent, from 137,000 TEUs to 187,900 TEUs.

   Regardless of what happens next, carriers must stay on top of the current set of challenges presented by overcapacity and pay special attention to demand levels by trade lane, particularly the transpacific trade as it begins to feel the effects from the U.S.-China trade war in the coming months in order to bring the supply-and-demand balance closer to equilibrium.

Correction: A previous version of this story said the 2M Alliance will consolidate operations on the Asia-U.S. East Coast trade with ZIM, eliminating two of the seven existing loops they operate independently. However, the 2M Alliance will continue to operate its Lone Star Express on the trade, despite it not being included in the cooperation with ZIM.