Shippers are hit with planned rate hikes, despite burden of vessel overcapacity.
By Eric Johnson
Try as the liner shipping industry might to portray a situation that rates aren’t the only factor in service contract negotiations, the reality is clear: the transpacific trade is preoccupied with rates.
The issue is particularly acute and understandable this year, with virtually every container line staring down the barrel of huge losses from 2011, diminishing cash flow, and meek demand growth from their biggest consumer markets.
Thus transpacific lines attempted to do something about their plight in February by announcing two stages of significant rate hikes in March and May. The goal is to pull rates back to profitable levels, despite a global containership supply-demand imbalance that won’t be redressed in 2012 barring an unforeseen surge in demand from North America or Europe.
The carriers have some reason for hope, however, that their increases will stick. Most analysts are predicting eastbound transpacific volume growth of around 5 percent in 2012. Coming off a year when the trade actually declined, that’s good news. The U.S. economy is showing signs of awakening.
But will shippers, who face their own financial worries despite enjoying attractive rates in the past year, be willing in this year’s round of service contract negotiations to overlook the overhang of capacity that’s haunting carriers? Will carriers be firm in their attempts to raise levels, pushed by the desperation of the billions of dollars they collectively lost in 2011?
“There are two factors that have changed over past three to four months,” said Brian Conrad, executive administrator of the Transpacific Stabilization Agreement. “If you look back to September/October last year, that’s typically when the TSA announces its GRI program. There was so much uncertainty at that time the carriers said there’s not much point issuing recommended guidelines when we don’t know what the market will look like.
“There’s now more optimism in the U.S. economy, and less uncertainty than four months ago,” he continued. “It’s shown in the pre-Lunar New Year cargo rush. Carriers were pleasantly surprised at the volumes they saw.”
Conrad said the other factor is that carriers’ financial situations have changed. The five publicly traded lines who had announced their financials in early March had lost a collective $2.2 billion in 2011, with only one making money.
“Carriers have reached an almost intolerable point,” he said. “They have said the supply-demand equation is probably still going to be unbalanced, but financially, we really need the money. Even if they don’t have full ships, they can’t afford to keep rates down at this level. Costs have gone up. We’ve reached a point where carriers cannot afford to carry cargo at these rates simply to keep utilization high.”
According to the TSA’s carrier revenue index, rates had steadily declined for 16 months through February, and were at a comparable level to the beginning of 2010 — 20 percent lower than the baseline rates of mid-2008.
So what will lines say to shippers who have enjoyed attractive rate levels and see reports of global overcapacity?
“Lines will have to go to customers who’ve seen all this news about capacity coming, carriers will have to say, yes that’s true, but we are so desperate for revenue because of our financial situation,” Conrad said. “Lines will have to overcome some traditional perception. Unfortunately, rates do need to go up, or else we are in trouble. Lines will have to say, look we’ve had three volatile years. It doesn’t benefit either party in the long run to have this kind of instability. The majority of shippers want to have stability and predictability. The lines will say, if we want to get back to a place where we’re not constantly worrying about rates going up or down, this increase is going to be needed, where things can start to become stable.”
If the end of 2011 was shrouded in uncertainty about market fundamentals, now the uncertainty lies in whether carriers will hold a line in managing capacity and during rate negotiations.
|Source: Transpacific Stabilization Agreement.|
“As for the eastbound transpacific rate increases sticking, it all depends on the discipline of carriers to restrain capacity deployed coming out of slow season,” said Paul Bingham, economics practice leader at the consultant CDM Smith. “The pace of eastbound trade is likely to continue to be moderate single digit growth over 2011 levels, unless the U.S. economy is hit harder by yet-higher oil prices and a further decline in the European economy already headed into recession.
“To justify steep rate increases, carriers will have to restrain capacity growth at or below the continued relatively slow pace of import growth. U.S. imports are growing but the question is whether carriers can resist temptation to redeploy vessel capacity from elsewhere, like the Asia-Europe trade, into the transpacific enough to not outrun the market demand,” Bingham explained.
“With the continued new builds coming out of Asian shipyards, especially the very large class vessels, it will be challenging for the global carriers to resist not redeploying vessels into the transpacific given the likely weakness of the large Asia- Europe trade.”
It’s critical to remember that the TSA’s guidelines for rate increases are just that — guidelines.
“The TSA rate announcements generally are not part of annual ocean rate negotiation between shippers and carriers,” said John Isbell, vice president of the supply chain consultant Starboard Alliance. “Rate negotiations will be based on what the shippers perceive the supply/demand balance will be during the contract year for their particular port-pair routings.
“Carriers will strive to convince shippers they are managing capacity by replacing smaller ships with larger new builds and idling excess capacity,” he said. “If a carrier’s game plan is to maintain market share over rate restoration, then negotiations could lead to offering shippers less than compensatory rates. It only takes one to two carriers discounting rates to drive all rates below where carriers would prefer them to be.”
But Jean-Philippe Thenoz, senior vice president of North America lines at CMA CGM, said the supply and the demand equation are not as far apart as they might be perceived to be.
“According to our survey, about 25 percent of the capacity to the West Coast and 12 percent to East Coast was eliminated either by idling tonnage or by the company disappearing. That is a substantial downward move in a trade which was over-tonnaged for years.”
Statistics from American Shipper liner research affiliate ComPair Data show 15 percent of eastbound transpacific capacity was removed in the second half of 2011.
Thenoz noted the signs of a U.S. recovery — higher consumption and slightly reduced unemployment — were amplified by a “quick return of volumes after Chinese New Year.”
“Our customers’ forecasts are optimistic,” he said. “This is the sign of a rebound.”
For carriers, the key will be to not only raise base rates, but also to recover bunker costs more effectively. With bunker at record levels, Thenoz said it now accounts for two-third of its operational costs on the trade.
“This is a huge concern not only for ship operations but also for the inland services, like trucking and rail, we deliver to our customers,” he said.
Martin Dixon, research manager for Drewry’s Container Freight Rate Insight, said even if short-term rate gains are made, they will only sustain if carriers withdraw capacity.
“While the economic environment has improved, demand growth will remain subdued and therefore will not be sufficient alone to support rate recovery,” he said.
The pressure weighing on lines on a global basis comes from the introduction of new tonnage. The perception from shippers is often that carriers need cargo to fill their growing fleets.
“One of the issues we have to address is what constitutes good utilization to one carrier is not the same for another,” Conrad said. “That has driven rates down, and more and more carriers are going to the side that revenue is becoming more of an issue than utilization.”
Conrad addressed the common shipper complaint that it was not them that asked carriers to order so many ships, overcrowding a market in the midst of flat demand.
“No one is saying it’s the shippers fault,” said Conrad. “I don’t think that’s ever been the carrier’s position. We tend to see this in black and white. Silly carriers chasing the rates down to bad levels. Shippers sitting back saying ‘we didn’t do this.’ It’s more gray than that. There are carriers chasing the rates down. There are also carriers who didn’t play the game. There are also shippers who are very good at driving the rates down. But carriers made the decisions to build new ships.”
Ship capacity should not be such a big factor in transpacific negotiations — not only because of capacity withdrawal in the second half of 2011, but because most of the large ships coming online can’t be handled on the transpacific.
“There are huge ships already delivered and due to be delivered in 2012,” Thenoz said. “Up to now the U.S. trade has not been directly involved in this ship upgrading movement due to the infrastructure issues which prevent liner operators from phasing in such vessels. So I don’t believe that the transpacific trade will be hurt too much by the phasing in of such big ships at least until end 2015.
“This is not only a shipping issue, in terms of water draft, air draft, turning basin, and channel width, but also a railroad one,” he added. “I don’t see railroad operators today being able to evacuate in time many ships a day ranging from 12,000 to 16,000 TEUs of capacity in any of the U.S. ports. The solution to big ships calling the U.S. will come but neither in the short- nor middle-term.”
It seems hard to imagine though that shippers will refrain from bringing up the capacity issue in negotiations, and lean on carriers to provide a suitable rate.
“The carriers face this (perception versus reality) challenge on an ongoing basis now,” Bingham said. “It will likely be a couple of more years at a minimum before shippers will accept current slow steaming and vessel capacity utilization practices as a ‘new normal.’ The transition period to a time when there is an even greater share of services comprised of larger size vessels, with lower unit shipping costs to match, will still take time because the vessels to be displaced with the new, larger ships still have to be redeployed somewhere as well.
“Carriers will need to show that the service-specific capacity that includes what they offer and the capacity from their competitors is not outpacing the trade lane volumes, as port pairs matter to shippers in actual service commitments,” he said. “However, unless a shipper is lucky enough to have sharply increased import volumes to move, few of them are likely to be going into negotiations with a perception that they’ll just have to commit to higher rates in order to obtain the needed capacity this year.”
Bingham added that shippers understand the financial vulnerabilities lines are facing, but likely won’t have a whole lot of sympathy after regressing two years since tumultuous 2009. They also still remember the sizable culling of capacity in early 2010 that led to cargo rolls through the first half of that year.
“Shippers know the carriers have been losing money again in 2011, but on the other hand they don’t want a repeat of 2010, when rates shot up so rapidly with lagged deployment of vessels out of layup from the depths of the recession,” Bingham said. “They may not believe this has happened to carriers innocently, when new build orders continued into last year after picking up with the rate restoration that had been achieved in 2010. It is not as if all the shippers are in strong financial shape themselves, despite the continued recovery, since they face higher energy costs too from more than just their ocean carriers.”
Through it all, service contracts will be negotiated, and Isbell stressed the importance of pressing carriers to improve service if rates need to rise.
“Smart shippers understand they need to have a consistent level of service throughout the year and not be in the position they were in 2010, when their minimum quantity commitments (MQCs) were met and then had to pay significant rate increases for the balance of their shipments,” he said. “If carriers do get higher rates, I expect savvy shippers will demand performance guarantees regarding MQCs, cargo bumping, and on-time performance. Carriers will also seek performance commitments from shippers regarding more accurate cargo bookings.”
Conrad said he hopes the negotiations this year expand beyond just rates, an area of emphasis from members of the TSA’s shipper advisory board.
“So many of these contracts are basically rate agreements,” Conrad said. “A lot of shippers said it would be best if we could talk about the rate one time, and then spend the rest of the time talking about managing the issues of the trade, how the carriers can serve the customers in the logistics chain.”