Consulting firm says requirement to use low-sulfur fuel could raise costs by $10 billion for industry.
In 2019, shippers can expect pressure from container carriers seeking to recover their added fuel costs and improve profitability, says the consulting firm AlixPartners in the 2019 edition of its annual Global Container Shipping Outlook.
“The implementation of the IMO 2020 regulations will pose a daunting challenge for carriers,” says AlixPartners.
Starting next year the IMO mandate will require carriers globally to use more expensive fuel with a maximum sulfur content of 0.5 percent or use emission scrubbers to clean engine exhaust. Today, bunker fuel can have a sulfur content of 3.5 percent.
The website Ship & Bunker said that today the average price of high-sulfur ISO 380 for the 20 largest bunkering ports was $772.50 compared to $435 for low-sulfur marine gas oil.
AlixPartners says the IMO mandate could raise fuel costs as much as $10 billion annually, $3 billion alone on the eastbound transpacific and Asia-to-Europe routes.
Ships on those two routes account for about 20 percent of shipping trade volume but use a greater amount of fuel because of the long distances they travel.
“According to our analysis of large carriers that publish bunker adjustment factor (BAF) rates (tracked by maritime research consultant Drewry), carriers plying the Asia-Europe route in 2018 would have had to increase their BAF rates by 40 percent, or $270 per 40-foot equivalent unit (FEU), to achieve the same financial result; carriers working the EBTP route would have needed to increase of 33 percent, or an additional $150 per FEU,” says AlixPartners.
It makes those forecasts based on the assumption carriers are operating 18,000-TEU ships in the Asia-to-Europe trade with a 79-day rotation and 13,000-TEU ships in the transpacific trade with a 36-day rotation and that headhaul shippers will pay 66 percent of bunker costs.
It says, “Carriers will have to impose significantly higher fuel surcharges in 2019 and beyond to maintain their margins, with no guarantee that those charges will stick or that they’ll be able to realize recovery in a timely manner. Failure to do so will depress cash flow significantly.”
Jim Blaeser, a director at AlixPartners, says that while the low-sulfur rule does not go into effect until Jan. 1, 2020, carriers need to address the issue this year.
Carriers have not been able to pass on fuel costs in a consistent manner over history, he says, and “need to get their house in order as to passing on fuel costs ahead of IMO 2020 if they have any hope of doing it under the new regime.”
The price difference between low-sulfur and high-sulfur fuel may become even wider, “and if it does go up sharply, that is enough to drive carriers into bankruptcy if they can’t recover that cost,” he says.
AlixPartners says shippers moving cargo on the eastbound transpacific route “may benefit by holding off from locking in contract rates until volumes along the route subside following inventory buildups in anticipation of tariffs. Shippers that have in the past relied on forwarders to afford access to multiple carriers should keep careful watch of where those forwarders’ allegiances lie, given the number of forwarders that are now captives of one carrier or another.”
Blaeser says while there is no shortage of carriers that will offer shippers all-in freight rates, “Our position to shippers has always been to separate fuel from freight in all transportation modes,” not just container shipping, but trucking for example.
“Take fuel off the table as a negotiation issue and understand that is a market risk” that both the carrier and shipper must contend with. Fuel costs should be “fair, visible and clear with a reset point that has some frequency to make sense.”
In that way he says shippers and carriers can negotiate rates that are appropriate and spend their negotiations on the parts of the business that are more within their control.
The financial condition of the container shipping industry remains precarious, says the consultant. Each year AlixPartners calculates the Altman Z-score of the leading container carriers that publish their financial results. (The Altman Z-score is a commonly used measure to determine a company’s credit strength and the likelihood it will seek bankruptcy protection in the next two years. A score of 1.8 or lower signals that a company has entered the “distressed zone” and has a high risk of bankruptcy, it explains.)
While only one major container carrier has become insolvent and gone out of business in recent years — Hanjin in 2016 — the collective Altman-Z score for the industry was in the “distressed zone” from 2011 to 2017. (Several weaker shipping companies have received state aid during or been acquired in recent years.) In the 12-month period ending Sept. 30, AlixPartners calculates the industry has climbed out of the distressed zone, but just barely, achieving a score of 2.02.
The container industry also is taking on more debt. AlixPartners says the debt-to-EBITDA ratio for the industry has climbed to 10.1 for the 12-month period ending Sept. 30, up from 7.5 in 2017 and 2.2 in 2010. That has been driven by carriers taking on debt to expand their fleets and acquire other companies.
AlixPartners notes that the container industry also faces plenty of other uncertainties because of trade disputes resulting in higher tariffs and the U.K.’s impending exit from the European Union.
“Significant revenue increases seem unlikely in 2019, in light of growth in fleet capacity that continues to exert downward pressure on rates for most major trade routes, including the busy westbound Asia-Europe lane,” it says.
Container carriers got a shot in the arm as they commanded higher freight rates and saw increased volumes from China to the U.S. in 2018 as companies rushed to land cargo ahead of actual and threatened tariff increases. But already AlixPartners notes rates have declined and could fall further to customary levels.
Carriers such as Maersk, which has integrated its Damco unit with Maersk, and CMA CGM which has made a tender offer for remaining CEVA shares are moving toward vertical integration, expanding forwarding, customs house brokerage and logistics services.
The ability of other carriers to make similar moves faces a number of challenges, said Blaeser. Carrier financials have been challenged for a long period of time, and leverage may make acquisitions difficult for carriers.
At the same time third party logistic carriers are trading at high multiples and “margins in the 3PL sector are compressing despite strong revenue increases in recent years,” says AlixPartners. “Our analysis of 26 logistics companies reveals that less than a quarter of them
improved their EBITDA margins by more than 50 basis points in 2018 compared with about half whose margins compressed. “
If you are a carrier “you can’t buy your way to profitability or remarkable profit improvement,” said Blaeser.