“We’ve never seen this before. We’re going into a tender season that doesn’t look like anything else historically,” said Patrik Berglund, CEO of Xeneta, a company that tracks both long- and short-term ocean shipping rates.
Berglund was referring to the exceptionally lopsided advantage shipping lines wield in 2022 negotiations for long-term contracts with cargo shippers — the contracts that determine what American importers will pay over the coming year, and increasingly, multiple years.
“If you are a carrier and you hold all the cards, you can push all the levers in order to optimize your business,” said Berglund, who affirmed that carriers are indeed pushing all their levers.
Trans-Pacific spot rates rose to dizzying heights amid the COVID-era supply chain crunch, yet spot rates can theoretically fall very quickly. It’s in the long-term market, where shippers commit to quantities and prices over time, that liner companies can lock in extended gains.
What happens to one-year and multiyear contract rates is particularly crucial to liners, U.S. importers and ultimately, consumers of imported goods.
‘Unprecedented spread,’ ‘ridiculous numbers’
Xeneta data on long-term contracts shows a further rise this year on top of gains that built throughout 2021.
In the first half of last year, the average Asia-West Coast long-term rate was around $3,000 per forty-foot equivalent unit. By October, it was up to $6,000-$6,500 per FEU. “For 2022, we see $7,000-$8,000 as an early indicator,” said Berglund.
Pre-COVID, in 2019, Xeneta estimated that the average annual Asia-West Coast rate was around $1,500 per FEU. Rates have more than quintupled since then. The lower end of the long-term market — the largest shippers getting the best deals — is now at around $3,000 per FEU, the same as the average of the entire long-term market a year ago.
“We see an unprecedented spread,” Berglund added, pointing to the difference between the lowest long-term contract rates paid by the largest shippers and the highest rate in the spot market paid by the smallest shippers.
Xeneta currently puts the Asia-West Coast spot rate at just under $10,000 per FEU, with some cargoes paying additional priority shipment fees of $1,400-$7,500. That brings the max spot rate to around $17,500, and the spread versus the cheapest, lower end of contract rates to around $14,500 per FEU.
“These are ridiculous numbers,” said Berglund, noting that in 2019, pre-COVID, “the spread was $1,300-$1,800. The gap is 10 times bigger today.”
“What that means is that the ones being penalized the most and struggling the most are the smaller importers, and the longer this situation goes on, the more favorable it is — even though it’s painful — to the big-volume shippers.”
‘Historic risk’ for trans-Pacific contracts
What happens next in the spot market will have major repercussions for long-term trans-Pacific contracts, many of which begin their terms in May.
On Wednesday, Maersk released full-year earnings guidance that assumed a sharp decline in spot rates starting in the third quarter. According to Berglund, “If I ask around in the carrier and forwarding community and the shipper side, there is an expectation that the [spot] market should soften as we go toward the end of the year, and some people claim the market might see a [sharper] drop-off. My personal opinion is that the carriers and the three alliances will fight back to avoid the market trending down too much. And there are still too many efficiencies [in the supply chain], so I would say it’s more likely to plateau than to drop.”
But what if spot rates do fall off a cliff? What does that mean to shippers that sign fixed-rate contracts for one to two years prior to such a fall?
“When you sign a 12- or 24-month [fixed-rate] agreement today, it comes with historic risk, because the market is at such a peak,” said Berglund. “You might look like a fool 12 or 24 months down the line.”
If, for example, a medium-size shipper signs a long-term contract at $10,000 per FEU but midway through the term, the spot rate falls to $5,000 and the new long-term rate drop to $4,000 — with the extra cost paid under the contract signed at the market peak multiplied by thousands of boxes — “then that becomes a massive bottom-line impact and you would sit in a burning seat in your role as a procurement person,” said Berglund.
He advised shippers of low-margin goods to be especially wary of this risk. Such shippers “need to make sure they’re in position to move somewhat with the market,” keeping contract durations to 12 months at the most.
On the other end of the spectrum are shippers of high-margin and high-value commodities that are “focusing on securing access to boxes and space on vessels, more than focusing on price.”
These players “can live with that risk [from a spot-market fall]. They understand it. It’s a strategic decision for their business. They’re paying a premium to secure the stability of their supply chains. If you have high-margin products, keeping your supply chain intact and making sure the products flow is far more important than optimizing for the lowest possible spend.”
Index-regulated multiyear contracts
Another way carriers are using their market power is to push beneficial cargo owners (BCOs) toward multiyear deals. Given the wave of newbuilds set to arrive in 2023-24, contracts that cover this period offset carriers’ spot freight market risk.
Berglund sees “a significant difference in the behavior of the European carriers, with a lot more appetite on the European side for multiyear contracts.”
Vincent Clerc, Maersk’s CEO of ocean and logistics, said Wednesday that current multiyear deals include two-year, fixed-rate contracts, but the majority are three to 10 years in duration with periodic rate adjustments, mostly using the monthly Container Trade Statistics (CTS) index as opposed to more volatile indexes such as the weekly Shanghai Containerized Freight Index (SCFI). The CTS index is fed by rate information from the carriers.
“It says a lot when the customer side needs to agree to an index that is built up by the sellers themselves,” commented Berglund. “Think about that for a second. The one supplying the data to CTS is the shipping lines. That in itself is a great worry for a lot of our customers — I know that. But since COVID, the market has transitioned from a [transportation] buyer’s market to a seller’s market. In a seller’s market the seller decides the terms.”
Through data ingested by the Xeneta platform, Berglund sees carriers using other indexes such as the SCFI for long-term contract adjustments as well. He also confirmed that Xeneta’s long-term rate indexes are being used for index-regulated long-term contracts.
As some carriers push more for more multiyear deals, Berglund questioned what will happen if and when the market turns back in favor of BCOs.
“Let’s see how these agreements play out in years two, three and four. This industry has a history of being disloyal to each other depending upon the market conditions. The only harmony is when you have some level of equilibrium. The carriers are not able to really penalize [BCOs that do not adhere to contracts]. At some point, the tables will turn. And we have plenty of BCOs that are now just holding their breath and waiting to give it back to the carriers. That’s an unfortunate dynamic, but it’s an existing dynamic.”
Cutting out the middlemen
Ocean carriers are also using their market control to take out some of the freight-forwarder middlemen and instead do business directly with BCOs.
Clerc said on the conference call, “As we increase the allocation we’re giving to our long-term customers, that means by default that we’re reducing the footprint we have with freight forwarders, to what in 2022 will be somewhere between 25-30% of what we’re doing.
“The profitability [of freight forwarder deals] is obviously very high at the moment because they are principally the ones paying the short-term spot market rates today, but we’ve made the decision to forfeit some of the spot opportunities to really invest in long-term relationships.”
According to Berglund, “One of the key concerns I have on behalf of the forwarders is how long this elevated market will remain, because the first thing the carriers have gone after is the smaller and medium-sized freight forwarders — they’re clearly pushing those onto their digital [spot] booking platforms. Carriers are literally saying, ‘You can buy here and that’s our offering for you.’
“The bigger forwarders still have the procurement power to stay relevant in the market and offer the BCOs something good. But here’s the crux: What is stopping the carriers from going after the bigger forwarders’ piece of the pie? If the market remains elevated, why wouldn’t they do that next?
“At the end of the day, if that happens, this would mean fewer supplier options. And from a competitive point of view, that would not be ideal for the end consumers: you and me.”
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