Drewry: Carrier profitability to be tested

Drewry: Carrier profitability to be tested    Carriers will be tested on their abilities to focus on profitability in the coming years, according to a report released last week by London-based Drewry Maritime Research.
   The report, Unmasking Freight Rates, provides five-year forecasts for each of the major east-west trades, drawing on Drewry's archive of freight rates on key lanes. The report delves into three different scenarios 'that take into account future economies of scale, market sentiment, and potential capacity management tactics of carriers, in particular carriers' potential to cascade ships to/from the east-west trades alongside deliveries of newbuilds into the market.'
   Simon Heaney, one of the authors of the report, told American Shipper that it's far from certain how liner carriers will cascade bigger ships into trades to North America.

Heaney

   'In the best case scenario (i.e. better capacity management and cascading, less emphasis on market share, more on profitability, and fewer ships orders) we can see carriers being able to maintain load factors at levels that should deliver solid if unspectacular profits over the next few years,' Heaney said. 'In the worst case (essentially the reverse of above mentioned) we think carriers will be forced into more layups.'
   Drewry said carriers find themselves at a crossroads as to how they manage capacity versus striving for market share. Carriers that can effectively follow through on service promises will have an advantage in the years ahead.
   'During discussions with shippers it is clear that carriers do have an opportunity to generate some form of price premium for offering better quality of service,' Heaney said. 'This extends to more than just service reliability, but also better documentation processes, more user-friendly e-commerce tools, and generally sticking to contract terms. In most other industries these would be considered the basic elements of service, but the fact that the industry is lagging behind does provide opportunity to carriers to polish their brand.
   'How much extra revenue a carrier can expect for making the necessary investments in these areas is debatable, but it will certainly improve their chances of being the carrier of choice so to speak,' he added. 'Our various scenarios look at the implications for the east-west trades rather than individual carriers, but ultimately we believe future carrier profitability will be put at risk by repeating the market share grabbing antics that nearly bankrupted some of them in 2009. This is a very real threat as anecdotally we hear that carriers are agreeing to very low freight rate deals in order to tie in volume this year on services where utilization factors are falling.'
   At its core, the report attempts to decipher how capacity affects rates.
   'One of the main reasons why we put together the Unmasking Freight Rates report was to illuminate the relative impact of supply and demand on rates,' said Heaney in response to a question about whether there is a tipping point at which too much capacity sends rates spiraling, or whether rates climb and fall in a more simple inverse fashion with capacity.
   'Our analysis revealed no specific load factor 'tipping point' for rates, although there is clearly now a floor at which point carriers will remove tonnage in order to boost utilization and rates. For the westbound Asia-Europe trade, we estimate this minimum to be in the mid-60 percent range,' he said.
   Heaney added that myriad factors subtly influence how rates rise and fall.
   'There is no getting away from the fact that basic supply/demand economics is the major driver of freight rates,' he said. 'For example, the correlation between average spot rates and Drewry's east-west supply/demand index from first quarter 2010 to third quarter 10 was 0.8,' he said. 'However, our historical analysis shows that the closeness of the relationship varies depending on the time period and trade lane examined and that other factors such as sentiment, new entrants into markets, predatory pricing and future expectation of overcapacity among other modifiers can all have a big influence on prices.'
   As for what impact Maersk Line's recent order of 18,000-TEU vessels might have on its liner rivals, Heaney said it's tough to speculate.
   'Logic and the order book are not always in sync,' he said. 'It is unlikely that we will see the same deluge as seen in the 2006-2007 hey-day, mainly because financing is tougher to come by and the KG market is much shallower and somewhat humbled. That said, ego plays a big role in container shipping and there is every chance that having seen what Maersk has done with its 18,000-TEU order, some rivals will feel compelled to react.
   'As 2011 progresses there has been more momentum with orders placed in the big ship sizes ' Seaspan, Hamburg S'd and now OOCL. The primary incentive from the carrier perspective is to have ever lower slot costs, but the combined effect on the supply/demand balance at the individual trade route level ' given that these ships cannot be deployed on too many routes ' could be very different at the time they are deployed. We see this momentum as an increasing threat, especially with more outsiders entering the fray with readily available funds.'
   The report is available here. ' Eric Johnson