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Is container shipping industry boxed in?

Uncertainty remains whether recent changes will set lines on a profitable course.

   During the past several years, shippers have watched containerships grow dramatically in size, mergers and acquisitions rapidly reduce the number of liner companies and the remaining global carriers organize themselves into three consortiums.
   Some of the putative benefits of those changes have been slow to surface for both carriers and shippers.
   While many shipping lines carried more containers and had higher revenue in 2017 than in 2016, many also lost money and by one metric — the Altman Z-Score, a tool for forecasting bankruptcies — the industry is in a tenuous financial position.
   BlueWater Reporting estimates that the 11 largest carriers (not including the privately held Mediterranean Shipping Co.) lost nearly $10.6 billion in 2016, about $1.4 billion in 2017 and already $1.3 billion in the first quarter of this year.
   Shippers, while recognizing freight rates remain low, complain about deterioration in service. Some even wonder whether the changes that have swept the industry in recent years have been for the good.
   Larger ships and slow steaming have allowed carriers to reduce the cost of moving a container substantially and remain attractive to shippers. 
   However, the changes carriers have made may have been the price of survival. Fuel costs have soared and are expected to climb much higher when carriers are required to use low-sulfur fuel under an International Maritime Organization’s mandate beginning in 2020. 
   While big containerships dominate orders placed with shipyards for newbuilds, there is hope that the reduction in the number of large carriers may result in more discipline in their decision-making on when to add capacity. The orderbook for new containerships was just 13 percent of capacity in April of this year, according to Danish Ship Finance. In 2007, it was 64 percent.
   Rolf Habben Jansen, Hapag Lloyd’s CEO, noted in the company’s annual report for last year that “since 2014 nine of the biggest container liner shipping companies have disappeared, either through mergers or insolvency.”
   As to the alliances, U.S. Federal Maritime Commission Chairman Michael Khouri in April told members of the U.S. Senate Subcommittee on Surface Transportation and Merchant Marine Infrastructure that they “can be very beneficial for U.S. exporters, importers and consumers. Such alliances allow participants to obtain efficiencies and cost savings that can be passed on to domestic consumers, especially when healthy competition exists among vessel operators.”

Uncertain 2018. In its annual report, the parent company of Orient Overseas Container Line (OOCL) noted “the economic backdrop for 2017 was more robust than forecasters had expected. Following a decade of low growth, we saw healthier performance in both GDP and trade volumes across most of the world’s major economies. This was a welcome change after the industry’s low point of 2016.
   “This synchronicity of growth, a rare phenomenon in recent memory, may bode well for the sustainability of the recovery,” the Hong Kong-based carrier added. 
   Maersk said in the first quarter of 2018 container demand grew by around 3 percent to 4 percent when compared to the first quarter of 2017.
   “This development reflects a weakening momentum of the global economic environment, driven by soft global retail sales. Container demand on the east-west trades softened in Q1 2018, partly driven by weaker imports in the U.S. following high-growth rates in previous quarters. European import growth was also slowed down, mainly reflecting the drop in retail sales growth. Meanwhile, Asian imports from the U.S. and Europe declined significantly, reflecting the ongoing Chinese ban of waste and scrap materials as well as a gradual slowdown of the Chinese economy.”
   Lars Jensen, CEO of SeaIntelligence Consulting, noted there is a mismatch of demand and capacity on some trades: “All is not well. Year to date the Asia-Europe trade has only grown 1.5 percent, with Asia-North Europe capacity in the same period being up by 11 percent and Asia-Med capacity being up 9.4 percent,” he said.
   The picture is brighter on the north-south trades, according to Maersk, where container demand “continued to strengthen considerably, mainly in parts of South America and Africa. The development reflected an economic stabilization in countries such as Brazil, Argentina and Nigeria, but also came on the back of a strong correction in inventory dynamics following sharp reductions in preceding years.”
   Soren Skou, Maersk’s CEO, said, “We saw quite some headwinds from the rate of exchange during the quarter. The real negative story this quarter is that our margins in the ocean segment were significantly impacted by higher unit cost — partly by adverse developments in fuel price and exchange rates but also partly due to our own cost management.”
   Carriers like Maersk and Hapag-Lloyd are working to reduce costs following their big mergers, and the consulting firm AlixPartners said carriers have cut their administrative expenses from 4.7 percent in 2013 to about 4 percent.
   Speaking in May, AlixPartners consultants said they had expected trade growth would be in the 4 percent to 5 percent range earlier this year when they had prepared an outlook for 2018. But they said some analysts are predicting growth could be reduced to 2.5 percent if commodities are impacted by higher U.S. or Chinese tariffs.
   With stronger demand of 4 percent to 5 percent, AlixPartners thought the capacity oversupply in the container shipping industry would reduce as the year went on. But because of protectionism, the firm now thinks capacity may increase.
   OOCL also identified growth on the supply side as a challenge.
   “Even if the ordering of new vessels remains muted in relative terms, upsizing of capacity continues in certain key routes. Ultra-large vessels ordered in the past few years are now being delivered and brought into operation. Furthermore, as trade growth improves, the industry continues to introduce additional services using cascaded or previously idled capacity,” the carrier said.
   Citing figures from Alphaliner, AlixPartners said vessels with capacities of more than 13,300 TEUs could represent nearly 20 percent of the fleet next year, up from 13 percent in 2016.
   In a recent interview with American Shipper, Patrick Berglund, CEO of Xeneta, said looking at the major container carriers, “I’m a bit flabbergasted that their financial performance hasn’t been stronger,” but he expected this was partly because of the costs associated with mergers and acquisitions.
   “I used to be very bullish about the landscape for the carriers not many quarters ago,” Berglund said.
   Following the Hanjin bankruptcy, Berglund’s outlook for the industry seemed to improve in the second half of 2017. “But again, the market is trending downwards,” he said. 
   Xeneta aggregates millions of ocean freight rates — both spot rates and contract rates — and sells the information to shippers so they can benchmark themselves and see general market trends.
   When short-term rates rise or fall, long-term rates generally move in the same direction about one quarter later, and this spring Xeneta’s data showed long-term rates following short-term rates downward in both the China-North Europe and China-West Coast North America trade lanes. 
   When that happens, it has an outsized effect on a carrier’s revenues, both because contract customers tend to be larger and they lock in that trend for an extended period.
   More recently, short-term rates were headed up, so Berglund said it was important for carriers to keep them headed upward, or big volume beneficial cargo owners “will request discounts as their contracts expire and it will be just more painful to carriers.” 
   AlixPartners said large carriers remain in poor financial condition. The firm noted operating earnings (EBIT) for the carriers it follows bounced back from 0.4 percent of revenue in 2016 to 3.2 percent in 2017, adding that “provides low potential for strong returns.”
   The industry’s overall Altman Z-score remains low at 1.44. That’s up from 1.1 in 2016, but “still puts the industry squarely in the danger zone — and certainly nowhere near the safe zone of 2.99, which we’ve not seen since 2007,” AlixPartners said.

Who Benefits? “It is wrong to suggest that carriers have not benefited from the use of larger ships, slow steaming, formation of alliances and consolidation,” said H.J. Tan, a principal at Liner Research Services. “All of these moves have clearly brought cost savings to the carriers.
   “The problem is that most of these cost savings have been passed on to the shippers in the form of lower rates. There is very strong and clear empirical evidence to show that freight rates have fallen over time, not just in real terms after adjusting for inflation, but they are lower even in nominal terms,” he said.
   Khouri said during the recent Senate subcommittee hearing that “data confidentially filed at the FMC indicates that ocean carriers regularly experienced capacity utilization of over 90 percent on the inbound major transpacific trade throughout 2017 and about 90 percent on the transatlantic.
   “Each of these trade lanes saw capacity utilization rise toward the end of 2017 compared to earlier in the year. However, vessel utilization on the backhaul route from the U.S. to Asia is only about 50 percent, with only slightly higher levels from the U.S. to Europe. Although ships are sailing relatively full, rates have remained comparatively low and are 22 percent below their peak in 2010. When adjusted for inflation, real rates are down 31 percent since 2010. According to FMC monitoring data, rates have remained steady on the major transatlantic trades,” he explained.
   Don Pisano, president of American Coffee Corp. and a director of the National Industrial Transportation League, said this about consolidation and big ships: “We want to have strong partners that we are dealing with, strong partners in the supply chain. So if it makes them stronger and in a better position to compete, then great.
   “I just think that we haven’t necessarily seen any true benefit. As a matter of fact, it is probably to the contrary. We’re worried about more congestion coming up. We are going into peak season and from what we’ve seen … we can only expect it to get worse.”
   He thinks carriers have “concentrated on the waterside of operations and not the landside.”
   Tan said, “The beneficial cargo owner (BCO) complaints are real. But that is the price to pay for the cheap freight rates. If the BCOs want to see an improvement in service levels, then they will need to pay for it.” 
   Pisano, however, said while many carriers talk about wanting to differentiate themselves and not sell a commodity, he believes by building larger ships to reduce their per container cost, “they wound up having to form these vessel alliances just to fill up the ships. So they’ve become the commodity they’ve been trying to avold. They created their own dismal situation.”
   He also faults the industry for failing to collaborate with their customers. 
   But Simon Heaney of maritime industry consultancy Drewry said, “It’s early days in terms of seeing any benefits from the recent wave of M&A. It’s probably a little bit early to really be making a definitive judgement. Our feeling is that the long term it’s required and eventually it will lead to a better environment for carriers.
   “Clearly carriers are still hurting in terms of their bottom line. They mostly lost money in the first quarter and probably will do again in the second quarter thanks to their higher fuel costs. So it hasn’t quite panned out yet,” Heaney said.
   “And from a shipper’s point of view, they would argue that they haven’t benefited either. They’ve obviously got fewer choices, fewer options on the table for them to go to and from what I hear certainly service quality hasn’t improved as a consequence of all of this,” he said.
   M&As have “an impact elsewhere in terms of network decisions. It has an impact on ports as well, they have fewer customers and that makes life tougher for them,” he noted.
   Drewry’s view is “consolidation is required, it’s necessary for the industry to be sustainable,” Heaney said. “There is probably still a need for more M&A. … Initially we felt that what had happened was sufficient, but the market is fragmented even after what we’ve seen to be able to really push through the changes that are required “
   The major global carriers have organized themselves into three major consortia: the 2M+H of Maersk, MSC and Hyundai Merchant Marine; the Ocean Alliance of CMA CGM, COSCO, OOCL (which has agreed to be acquired by a COSCO-led group) and Evergreen; and THE Alliance of Hapag-Lloyd, Yang Ming and OCEAN Network Express (a joint venture of the container businesses of Japan’s three major shipping companies NYK, MOL, and “K” Line).
   “You have three carrier groups, but obviously there’s still individual companies within that competing with one another,” Heaney said. “From the shipper’s point of view, you’ve still got — depending on which route you look at — decent competition.”
   While it varies from trade lane to trade lane, he said, “there’s a competitive environment in the main,” even on the major east-west trade lanes dominated by the big three consortia. “Once you get out of the east-west trades, in particular, there’s still a wealth of competition out there.”
   Similar views were expressed by Khouri in his Senate testimony: “Notwithstanding the reduction in the number of major shipping lines serving the international trades, the container industry remains very competitive. Using traditional antitrust analysis measures, the major transpacific and transatlantic trade lanes remain unconcentrated and competitive.”
   He noted that when the FMC reviews mergers, the Department of Justice’s Antitrust Division uses a metric called the Herfindahl-Hirschman Index (HHI) and regards an industry as not concentrated if the HHI is below 1,500. The HHI for the Asia-U.S. West Coast trade lane is 826; for the Asia-U.S. East Coast trade it is 943; and for the North Europe-U.S. trade it is 1,179. The Mediterranean-U.S. trade’s HHI is 2,114, which Khouri said is “moderately concentrated,” but which is also much smaller than the other trade lanes.
   Neil Dekker, lead container consultant at ClipperMaritime, said it may take some time for carriers to reap the benefits of consolidation as they merge their staffs, blend back-office procedures and align information technology systems.
   He pointed to press reports about shipper complaints regarding service during launch of ONE, the merger of the container arms Japan’s shipping giants. He thinks these may be “teething pains” that will go away in due course.

Bunker Outrage. The decision in late May by many container carriers to implement emergency bunker surcharges or peak season charges because of soaring fuel prices has sparked an outcry by some shippers. 
   “Prices of steel, chemicals and freight have risen substantially in our industry over the last 12 months, and in some cases even dramatically, as anyone who reads our published financial reports will know,” said Bjorn Vang Jensen, vice president of global logistics at appliance maker Electrolux. “But we have neither a ‘steel adjustment factor’ nor a ‘chemicals arbitrary’ or a ‘freight increase surcharge’ in our contracts with our customers. There is a risk attached to doing business, which we accept, and which we expect that our suppliers accept too. No matter whether they supply steel, gaskets, wire harnesses, compressors, circuit boards, switches, finished products — or freight.”
   Global Shippers Forum (GSF), of which the NIT League is a member, complained the surcharges were imposed “almost in unison. In most cases, these emergency surcharges are imposed on top of existing bunker surcharges.”
   It’s not clear what percentage of shippers will have to pay surcharges.
   GSF called the charges “an indictment of the liner shipping industry. Few transport operators in other transport sectors would risk imposing such short-notice emergency surcharges because of the likely strong reaction from customers, including the loss of business.”
   James Hookham, deputy chief executive of U.K Freight Transport Association and newly appointed secretary general of the Global Shippers Forum, said, “You don’t get haulers (truckers) slapping in a surcharge to cover an increase in fuel costs.”
   Such increases should be transparent, negotiated and shippers “should have a stake in the discussion,” he said.
   In other transport modes, Hookham said shippers “are not simply rate takers in the way that they are in the maritime market.”
   “A decade since the abolition of the liner conference system in October 2008, the container industry is still using conference-style pricing methods to impose surcharges on its customers,” GSF complained.
   Fabien Becquelin, manager of the maritime transport council of the European Shippers Council (ESC), said his group was planning to write to competition officials in the European Commission to “let them know what is happening in the market.”
   “If you have a contract, it’s not fair to come back to your partner and try to change the rules during the game,” he said.
   The ruckus about surcharges is happening just as the EC’s competition directorate announced in May that it will review the regulation that allows cooperation among liner shipping companies to see if it’s still “relevant and delivering on its objectives,” after the mergers and consolidation that have occurred in the industry in recent years.
   In 2008, the EC prohibited carriers from participating in shipping conferences, but under a provision in the treaty, it has allowed liner companies to continue participating in consortia through a block exemption regulation that was first adopted in 1995 and has been extended and amended four times. The most recent extension expires April 25, 2020.
   John Butler, CEO of the World Shipping Council, the main trade association for the liner shipping industry, has called vessel sharing like that practiced by shipping consortia “the backbone of many liner services,” providing for better service, greater efficiency and environmental benefits.
   Block exemptions are allowed under European law, if “they contribute to improving the production or distribution of goods or to promoting technical or economic progress, while allowing consumers a fair share of the resulting benefit,” the ESC said, which is polling its members to see if they’re getting that “fair share” in the form of better coverage of ports, frequency of sailings and port calls, scheduling or better or personalized services.
   Becquelin remains concerned that transit times have increased on some routes, while there are fewer port calls on some strings. That’s understandable, he said, given the growing size of ships, but there also has been a deterioration in the on-time performance of those ships.
   A study by SeaIntel found that about two-thirds of the time containerships arrived on time in the first quarter of 2018, that is within a day of when scheduled in port.
   “And if I look only at those 33 percent of the vessels that are late, on average they are 4.5 days late,” Jensen said. “That’s how bad it is.”
   He said the problem with keeping to schedules is a vicious circle. When ships are delayed due to port congestion, difficulty getting a berth, weather or any number of issues, carriers are reluctant to speed up their ships to get them to the next port faster because fuel is so expensive and they are already losing so much money.
   “I am increasingly hearing from our British members that … you wouldn’t believe the amount of additional air cargo movements we’ve had to make because we cannot rely on conventional sea trades at the moment,” Hookham said. “That’s what they’re resorting to in order to keep to deadlines and take some of the risk out of the current arrangements.”
   Jensen said while shippers say they want reliability, they often are not willing to pay for it.
   He gives this hypothetical example: A cargo owner ships 50,000 containers annually, but delivery of only 5,000 are time critical. If those containers are spread over 25 routes, that amounts to 200 boxes on each route that are really time sensitive.
   “Am I going to pay a premium on all 50,000 boxes for that? Of course I’m not, so you end up in this vicious cycle where the carriers don’t feel they are fully remunerated, so reliability goes down,” Jensen said.
   Hookham noted another source of “intense frustration” to shippers is finding out that their cargo has not been loaded on a particular ship as agreed but has been “rolled” to a subsequent vessel.
   That bad news sometimes comes “through secondary channels and often after the event when a box that you are expecting at a particular port on a particular date is simply not just not arrived but wasn’t on the vessel at all, and it’s still back at the port of embarkation,” he said.
   “If that sort of thing happened in any other service, the responsible and certainly commercially astute provider of the service, the carrier, would notify and say, ‘Look, you know stuff happens, I’m sorry but we’re not able to carry it at this time.’ Or, ‘Regrettably, your load hasn’t turned up. Do you want to explain to us when you were expecting it to be delivered?’ That kind of competent discussion between carrier and customer just hasn’t really seemed to take root in the container shipping industry,” Hookham said.
   Carriers sometimes overbook vessels because shippers overbook space on vessels and then fail to show up with their containers. A venture, called the New York Shipping Exchange, has created an online platform that allows shippers and carriers to enter into forward ocean contracts with binding clauses to prevent overbooking and cargo “fall down.”

Premium Services. APL now offers shippers an “Eagle GO Guaranteed Service” on many of its routes connecting North America with Asia, Europe and Australia/New Zealand, which provides a money-back guarantee if the cargo is rolled.
   Hyundai Merchant Marine also provides a premium service that guarantees space on a particular ship and rapidly discharges containers for an extra charge upon arrival.
   Carriers increasingly are offering such premium services. APL has two other Eagle Guaranteed services — one that assures an expeditious discharge of cargo on board several of its services in Los Angeles and another that offers day-definite arrival of containers at certain inland destinations.
   CMA CGM has introduced a new cargo insurance product, called Serenity, that will refund shippers if their cargo is either damaged or lost.
   Maersk’s Skou has outlined plans for the Danish shipping company to become a “global integrator of container logistics” and provide “simple end-to-end solutions to meet our customers’ complex supply chain needs.”
   Maersk already owns freight forwarder Damco. “As part of this we are planning several value-added services online to complement the physical offering, including inland services and custom house brokerage, connecting and simplifying our customers’ supply chains,” Skou said.
   COSCO recently announced plans to “upgrade the company’s product gradually from current ‘route products’ to route products plus digital services plus end-to-end solutions in order to create value for customers.”
   In April, CMA CGM acquired a 25 percent in the logistics giant CEVA.
   Of course, many shipping companies have logistics arms and they haven’t always been successful. APL, for example, spun off its APL Logistics business before it was sold to CMA CGM.

Digitization. Several carriers, among them Maersk, have touted their efforts to “digitize” their businesses.
   Skou said in Maersk’s annual report that the firm “continued to progress on the digital transformation of our core business, moving customer transactions online and digitizing the way we operate our assets. Our e-pay solutions have launched and are ramping up successfully. We launched Twill, a digital forwarder, primarily in Asia-Europe trade lanes and customers are responding well in adapting to new self-service solutions.”
   Drewry’s Heaney said many of the functions at shipping companies are still manually intensive and involve a lot of back-and-forth phone calls, emails and paper invoices that are time-consuming and costly.
   “If you have more seamless transactions with your customers, clearly there is less room for irritation and more likelihood of retaining that customer if your business is nice and smooth,” Heaney said.
   Peter Sand, chief shipping analyst for international shipping association BIMCO, warned, however, that the ocean shipping business may not be as simple to digitize as booking seats with a passenger airline, since container shipments aren’t as standardized as one might seem.
   “There are so many regulations to take into consideration. What kind of cargo are we talking about? Is it hazardous or not? What kind of box exactly?” Sand said.
   “It still remains the fact that some companies have put up digital solutions for many years now, but it’s not the preferred way of booking cargoes even by large shippers,” he added.
   Sand believes digitization will make inroads in certain niches — for example in the movement of refrigerated goods. The shipper of a valuable 40-foot container filled with frozen lamb is more likely to be willing to pay for additional services than an importer of cheap wooden furniture.
   He sees lots of bandwidth for carriers to use technology to reduce costs — for example, to monitor and optimize the performance of their ship engines and reduce fuel usage.
   “This is a highly competitive industry, so you are unlikely really to become a price-setter. You become profitable if you cut your costs,” Sand said.

Chris Dupin

Chris Dupin has written about trade and transportation and other business subjects for a variety of publications before joining American Shipper and Freightwaves.