Shipping giants are still rolling in cash — but time is running out

This conversation has been lightly edited and condensed for readability.

MODES: So just to get started, set the scene for us. In the containerized ocean trade world, what were people kind of thinking would happen in 2022? What was the situation in 2021?

MILLER: “The way I’d explain it is, thinking about rates and volumes in the current market, we just have to remember that the pandemic was a one-off or hopefully one-off event. And we can never forget about that when trying to interpret it. With people at home, the government doling out all that cash, interest rates low, there was an artificial boost on the demand side. 

“And at the same time, on the supply side, in terms of effective transport, there was also a major effect. You had the labor constraints on the landside due to people being out or people having to work in special ways. You had congestion at the ports, which reduced effective transport supply. In the beginning, you had an actual shortage of container equipment. 

“We’re coming from a time when we had an artificial boost to demand. At the same time, we had an artificial constraint on effective transport supply. That’s why you saw both the volumes jump and then you also saw the rates jump. 

“What we have now, where we are coming out of that, is we’re seeing this sort of winding out of this one-off event. That raises the question, given that this is such an exceptional case, of how do you draw any conclusions out of that? On the demand side, there’s clearly less demand for transport. You can see it with the lower bookings in Asia.” 

Sometimes changes in ocean freight volumes and rates have nothing to do with the broader economy.

MILLER: “The question is, to what extent is peak season not materializing, or to what extent is this a timing change? What were the cargo volumes brought forward?

“Back in the Trump era, you had the Trump tariffs. And so in 2018, U.S. imports went up because everyone was racing the clock to get the cargo in before the tariffs. And then imports fell in 2019. 

“How much of this is a timing effect of future demand being brought forward and how much of this is real demand disappearing? 

“On the transport supply side, it’s the same thing. You had all of those bottlenecks. There’s still a lot of them there, but it’s clearly easing.

“On the Asian side, [it takes less time for goods to get from Asian factories to the ship]. We have plenty of containers in the world. We built a record amount last year. There’s a lot less congestion on the West Coast. There’s still congestion on the East Coast and Europe, but that also looks like it’s easing. 

“All of that puts more ships out into the market. That’s more transport supply. There’s also more land-based workers, simply because there are fewer people that are out or dealing with COVID restrictions. This of course affects the spot rates because you have lower demand and more transport supply. 

“There are these caveats, and how do we interpret that? I think one example I bring up is the Baltic Dry Index, which is a spot index that measures dry bulk shipping. 

“For decades, you’d listen to CNBC and they’d look at the BDI as this magical indicator of what was going on in the global economy. Over the last decade, BDI was very, very low and it really didn’t say anything about the global economy. It was because shipowners shot themselves in the foot and built too many dry bulk ships.” 

Ocean contract rates are quite inflated this year.

MODES: That was one thing I wanted to get into was spot rates versus the contract rates. Obviously, the contract side is far less volatile than the spot side. What’s happening on the contract side as these spot rates collapse or return to normal or however you might be looking at it?

MILLER: “There’s so much focus on spot rates, and that’s simply because of visibility. We have all these various spot rate indices that we can all see. 

“More than half of the volumes that are coming into the United States are on contracts. All the big guys, those are contract volumes. For example, Maersk has 70% of all of its volumes on contract. And those rates were negotiated much, much higher [this year]. Unfortunately for the people that signed those contracts, I think they’re somewhere between 50 and 100% higher this year than last year.”

MODES: Wow!

MILLER: “And they’re higher now. The contract rates are higher than the spot rates. So it’s deceptive to look too much at the spot rates because the contract rates are very, very strong and they’ve increased so significantly year upon year. 

“The question is, well, to what extent are those contract rates going to be honored? Because there’s going to be some slippage, obviously there may be some renegotiations. In the past, people have actually not honored those. We’ll see what happens there. 

“But I think that even if there is slippage, enough of the contract rates will hold so that it will sort of put a floor on the effect that the spot rates are having on the ocean carriers. It’s going to keep the cost of transport relatively high, compared to what you might think if you just look at these charts of the spot rates going down.

Our retail giants, manufacturers and other shippers now have “egg on their face.” 

MODES: This kind of goes back to your recent piece on why it is that, even though the supply chain crunch is easing, inflation is still pretty high. Part of this may go back to this idea that contract rates are just going to be higher, even though we’re seeing spot rates and bookings decline.

MILLER: “Exactly. That’s definitely part of it.”

MODES: When are these contracts typically determined for ocean shipping?

MILLER: “In the United States, it’s mostly annual, usually starting in May.”

“In different places, they’re different durations. Maersk has a large portion of its annual contracts on multiyear, so two years, five years, sometimes even 10 years.” 

MODES: With contract rates 50 to 100% higher this year than last year, it seems like the contract rates and the demand are mismatched.

MILLER: “They negotiated these contract rates at the height of the chaos. They were in a situation where, at that time, they felt that they had to protect themselves and there was always the risk this would happen — but at least it should give them some security. At that time, they were worried about getting anything moved. 

“But they did run that risk. There were a lot of people at the time talking about, well, they’re going to have egg on their face if this happens and it happened.”

When contract rates start to slip, ocean carriers will be able to use two “relief valves” to pump rates back up.

MODES: What happens to all of that extra capacity that was built? You mentioned the containers that were built, and I’ve heard of ships that were supposed to head to the junkyard or the scrapyard but didn’t. What happens to that other capacity? Is that all parked? Does it head to the scrapyard?

MILLER: “I think all of last year, no container ships were scrapped, or very few.

“Usually a certain portion of the fleet ages out and it doesn’t make sense to operate them because it’s so much more efficient to use a newer vessel. 

“But in this case, the freight rates were so high that it made sense to keep them in service. Even older vessels were being sold for huge amounts of money. 

“That’s one of several relief valves that the carriers will have soon. They can just start scrapping all of those ships.” 

MODES: Has that started yet?

MILLER: “No, it hasn’t. They’re still making plenty of money. 

“That’s the funny thing, I mean there’s all this schadenfreude when you see people looking at these rates, like, ‘ha ha ha, carriers are going to get theirs.’ 

“But I just sort of scratch my head when I see that because they’re still making a ton of money. I mean, Maersk is going to make another $10 billion in the third quarter. And in the fourth quarter, the carriers are still going to be making tons of money — even with these spot rates going down. 

“We’re way off the point where we’re going to be talking about carriers being in the red, certainly not this year.

“As long as they can make money off those vessels, they’ll keep them in service. The other relief valve is that ocean carriers basically charter in — and it’s different for each carrier — about half their fleet. These ships are chartered for various lengths of time. 

“Lately, they’ve been chartered for three to five years. Down the road, as all these charters expire, if they have too many ships, not only can they scrap all the old ships they bought to make money during the boom or scrap the ships that they held onto during the boom, they would just let the chartered ships go off the lease and they’d give them back and say, ‘No thanks, I’m not going to renew this.’ 

“That will also reduce the capacity and help them deal with all this.”

There’s a whole lot of ships coming in, and that’s not good news for the ocean shipping industry.

MILLER: “We haven’t even talked about all the ships they ordered. There’s a huge orderbook — about 30%. They calculate the percent of TEUs on order versus the TEUs that are on the water. Now it’s up to around 30%, which is very high. It’s not as high as it was back in the 2000s, but it’s very high.

“Most of those ships are going to be delivered in the second half of next year and in 2024. So that’s when there’s this huge slug of capacity that’s coming online. That’s when the carriers will take these nice new ships that are more fuel efficient. They’ll get rid of their older ships and give it back at the end of the charter. It still may be too many ships, but they do have these relief valves.

MODES: Do they tend to just scrap older, uneconomical ships?

MILLER: “I don’t think you can say that. A lot of companies, when they order new ships, won’t actually order them themselves. It’s a financing thing. They’ll lease them from another owner who buys the ship on their behalf. 

“The companies that really suffered after the financial crisis and in the bad times and the companies that are really in the first firing line in 2024 — assuming as one would assume that demand is going to be lower and capacity going to be higher — are going to be these companies that lease or rented the ships out to the liners.

“The liners have these ways they can pull capacity down. They can sell the ships, they can give the ships back to the lease, but those guys are stuck with the ships. Those are the ones that tend to have real problems. 

“The carriers can also do all these other things. They can just slow the ships down. There’s all sorts of ways that they can mitigate the capacity. And of course they can blank the sailings.”

The most recent shipping downturn was in 2015 to 2016, and it was sparked by too many ships.

MODES: What did the 2008 recession look like in the ocean shipping world?

MILLER: “The imports into LA in 2007 were 4.4 million TEUs. They went down in 2008 and then in 2009 there were 3.8 million TEUs. That was a drop of 14% over two years. So that’s not that much. 

“But every recession is different. I mean, that was a financial crisis primarily. Whatever the next recession could be, it could be much more consumer focused. There’s no way to say. But it didn’t seem catastrophic from an import volume point of view. The liners themselves didn’t go bankrupt. The spot rates went down, but the spot rates came back up again in 2010. 

“It was really 2015-2016, which was the real problem for the container shipping industry.

“Rates are about not just demand, but supply and demand. In that case it was a supply problem. It was all of the ships that they had ordered, because they were building a whole new series of larger ships. All of them were delivered. What happened in 2015-2016 was there was a price war among the carriers and that led to the bankruptcy of Hanjin.” 

A price war could break out and spark another shipping downturn. But it’s less likely.

MILLER: “That sort of raises the question of [what happens in 2024 when] we have all of these ships delivering. The analogous situation would be what happens if we have some economic problems and demand is low and you have all these ships arrive. 

“As I said, I think the people that are really going to bear the initial brunt of that would be the companies that lease the ships to the carriers and the carriers have the way for a smooth landing for themselves. However, it all depends upon whether they get into a price war again.

“The theory is that they will not, because there are fewer people to fight over prices now. There is a smaller number of carriers out there. So it’s less likely for that to spiral out of control. 

“Everyone points to the second quarter of 2020, when the pandemic really hit and all the lockdowns occurred. That was the real time that you saw this abrupt collapse in demand. It was very brief, but it was very abrupt. The carriers didn’t go into a price war. They blanked the sailings to bring capacity down and closer in line with demand. They averted a price war at that time.

“Over the previous years, they had been doing a better job [avoiding a price war] because blank sailings happen all the time. They happen in Golden Week, they happen in Chinese New Year, and they’ve been doing a better job of not getting into these price wars because it’s in no one’s benefit. But I mean, who knows? We’ll see. 

Miller says there’s “nothing insidious” about blank sailings

MILLER: “All these blank sailings, it’s perfectly allowed. There’s nothing insidious about it. If you think about a company that suddenly sees demand for its product fall, what do they do? They lay off staff. They have to. There’s nothing wrong with that. If there’s a bus line and suddenly no one’s going on this bus route anymore because whatever, they remove the service.

“It’s not like they’re communicating with each other, but there’s just less of a chance that one person is going to fight, because they’ve learned that that makes no sense. But who knows?”

MODES: What sparked that downturn in 2015-2016 for ocean carriers?

MILLER: “There were just too many ships. And then that led to the price war. And then once that got started, there it went — sort of the downward spiral.”

MODES: And how did they end up with so many ships in the first place?

MILLER: “Back in normal times, before the pandemic, there was no pricing power. So all they could do was compete on cost. The only way that they could lower their cost was to lower their unit cost. So they built a fleet that was more cost efficient for them so they could compete more on cost.” 

The most looming ocean giants will likely avoid a “hard landing,” but the little guys are more exposed. 

MODES: Do you think it’s possible to avoid the “hard landing” as Maersk CEO Soren Skou said was likely? 

MILLER: “You could interpret that as him talking about Maersk specifically. Maersk is a completely different company than the others. It has, as I say, a lot of long-term contracts, multiyear contracts. It’s very, very heavily into landside logistics and they cross-sell those logistics to their top clients. So it’s sort of a special case. 

“As opposed to [a company] like Zim, which is much more exposed to the spot market. 

“The way you could avoid the hard landing is — first of all, they’re still making so much money. When you look at spot rates, they’re still, as of today, even two to three times what they were before the pandemic. 

“You still have these contract rates that are very high. You also have all the money that the carriers just made. I mean, they made this insane amount of money over the last couple of years. Not only did they have a lot of cash as a cushion, but they paid off a huge amount of debt. So their capital costs are much lower, they have much lower leverage. 

“They’re in a much, much better shape to soften the blow when it happens. As I said, they are in a position where they can manage their capacity down either by getting rid of ships or giving them back or laying them up or just blanking sailings.

“It is conceivable on the carrier side, the ocean carrier side, that they could manage their way into a slower period. But still, who’s to say if there’s a global recession on the horizon we haven’t seen before, combined with all these ships coming into service, it’s possible at least some of them could run into problems. 

“But they just have so much money, it’s hard to see how they would be in any sort of distress before 2024.”

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