By Eric Johnson
That sentiment seems to apply well to another concept that's been bandied about for years ' the idea of structuring ocean freight contracts over longer terms. As shippers and carriers shake their heads clear of the nightmare that was 2009, now seems a perfect time to examine just why long-term contracts have yet to stick in the ocean freight world.
Long-term contracts have many of the same benefits and drawbacks as fuel hedging contracts, offering price stability in exchange for potential short-term cost savings or revenue. But with fuel hedging, there are rarely concerns about service levels, and contracts are rarely amended if prices drop substantially. In short, fuel hedging is more prevalent than long-term ocean freight contracts because there are fewer variables.
The idea to structure contracts for longer periods is nowhere near new, but there appear to be reasons why it's never taken hold:
' Shippers and non-vessel-operating common carriers (NVOs) don't seem to inherently trust carriers enough to structure deals that last longer than one year.
' Variables that influence rates fluctuate so wildly that carriers and shippers seem reticent to be caught overpaying or under-collecting.
' It's difficult for all but the most sophisticated shippers to be able to project demand so far into the future.
' Don't underestimate the power of the status quo, or in this case, doing things the way they've always been done. It's hard to change the direction of an entire industry.
Yet, the beginning of 2010 seemed to be the right time for a paradigm change. It was the start of a new decade, and it came on the heels of the worst year for container shipping since Malcom McLean invented the box. Perhaps 2010 was the year that shippers and carriers would put into practice what countless conference speakers had suggested, that long-term contracts would provide stability to both shipper and transporter.
In fall 2008, a few weeks after Lehman Brothers went belly up, a representative with the boutique carrier Emirates Shipping Line said this was the only way forward for the industry.
'If we continue to do what we have done in the past, then we will repeat what's happened before,' Vijay Minocha, managing director of Emirates Shipping Agencies, India, said at a conference in Mumbai attended by American Shipper. 'We follow some primitive structures. Critical pricing decisions are made by sales people who don't have an overall perspective. In other businesses, senior people make these
decisions.
'In an up cycle, we expand to try to target short-term gains, and we antagonize our customers. In down cycles, we drop rates, cut costs, which usually means getting rid of trusted staff, and exit trade lanes where we spent time establishing ourselves. Or we may sell and merge. Essentially we keep repeating ourselves in every cycle. The majority of consolidations take place in market troughs.
'We carriers sell in an uncoordinated manner when our ships are not full,' he continued. 'Now, the time period in a cycle, from peak to peak, is four to five years. What stops us from negotiating with our customers for the entire cycle? It's a win-win for both sides.'
Chance Lost. Not two weeks into 2010, however, the chance appeared to be lost.
Transpacific lines, under the auspices of the Transpacific Stabilization Agreement, began pressing for what they dubbed an emergency revenue charge, which varied from $320 to $505 per container. The ERC was intended to help transpacific carriers improve their revenue collection in the first quarter of 2010, after which they were expected to hold the line in spring rate negotiations this year, with a benchmark of $800 to $1,000 increases per container. Shipper groups reacted furiously to the mid-contract increases, suggesting that it violated the very spirit of the one-year covenants.
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| Dekker |
Meanwhile, on the Far East/Europe lane, shippers are bemoaning the constant drumbeat of rate hikes sought by carriers that have dragged rates up from the very lowest depths of early 2009 to respectable levels by the end of 2010.
'Rates have been rising dramatically in trade lanes like Asia/Europe, which are dominated by non-vessel-operating common carriers' contracts that are subject to periodic changes by the ocean carriers,' said John Isbell, vice president of the Starboard Alliance and a former Nike logistics executive, in his first piece for American Shipper in mid-January.
On this lane, where contracts are measured in days not months, long-term deals seem even more improbable.
'For shippers there is no point in entering a long-term contract when the service levels and standards are so unreliable and unpredictable and when contracts get ignored anyway, unless you can put in clauses about reviews,' said Nicolette van der Jagt, secretary general of the European Shippers' Council. 'But even these probably don't deal with the increases being attempted. Shippers are right now being confronted with a sharp deterioration in service quality, slow steaming and changes to schedules at very little notice without their prior agreement. This is causing great uncertainty for shippers. Their main fear is that the service changes will affect their supply chains, causing stock-outs and production being brought to a standstill.'
Carriers' attempts to bring the supply/demand balance into equilibrium are justified given the poor rates they endured in 2009. But the measures ' idling ships and slowing down vessels ' are likely to only antagonize shippers to a greater degree, which drives down the likelihood of long-term contracts being negotiated on any broad basis.
Van der Jagt said lines will not accept longer-term contracts because 'they want to increase the rates over the period (of the deal)' and because 'they may be linked to volume commitments which shippers will often be hard-pressed to give at the moment, due to uncertain market demand.'
She said another concern for shippers is that 'there may also be some uncertainty over the financial well-being of the carriers and whether they will still be in business or under new management during the course of a long-term contract.'
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| 'For shippers there is no point in entering a long-term contract when the service levels and standards are so unreliable and unpredictable and when contracts get ignored anyway' | |
| Nicolette van der Jagt secretary general, European Shippers' Council | |
Carriers' Upper Hand? For the transpacific, a key issue is that demand growth is likely to exceed supply growth in the first half of 2010 due to carriers' determined drive to soak up excess capacity and defer delivery of new capacity. While that trend may not hold through the second half of the year, transpacific spring rate negotiations will occur within a period when supply will be much better aligned with demand ' transpacific capacity has dropped 15 percent since the end of the third quarter of 2009.
Shippers will be cognizant of the fact that the supply/demand equilibrium only exists because carriers have shelved so much capacity. But carriers, having made such strides in the past few months to raise rates and employ excess vessels, won't want to negate the positive momentum they've gained since the last quarter of 2009.
'Carriers have been very successful in boosting transpacific rates by $200 per TEU as of Jan. 15 following the announcement of 'emergency rate restoration' in December,' said a Jan. 28 report on Maersk Line from Danske Markets Equities. 'Carriers are eager to push for more rate increases during the transpacific May-June rate negotiations. We believe discipline will remain intact at least until these negotiations are completed in June. We expect strong container freight rate momentum to continue during (the first half of 2010). Carriers now have the upper hand in negotiations with the position set to improve further as industry vessel utilization will rise significantly' in the first half of 2010.
Danske cites container trade growth on the transpacific in December and January as a reason to believe the market is recovering and that carriers are gaining strength. However, growth will occur in the first half of 2010 simply because volume in the first half of 2009 was so poor. A better benchmark is the first half of 2008, against which the early volumes of 2010 don't yet measure up.
But Danske still expects Maersk's average all-in freight rates to increase 16 percent in 2010.
Either way, signals point to carriers driving a hard bargain in rate discussions this spring. That atmosphere, again, is not conducive to long-term partnerships.
Long-term Deals Desirable? There's another aspect to this whole picture, and that's whether carriers are even inclined to lock in long-term deals with major shippers. In a 2007 piece on the ocean carrier industry, American Shipper reported that Hans-E. Mahncke, managing director of Rhenus IHG Asia, a subsidiary of Hellman Logistics, asked carriers why they sought out high-volume contracts that were often less profitable per TEU than volume from smaller shippers. He wasn't arguing for more long-term contracts; in fact he was asking why big shippers get long-term deals and capacity guarantees that smaller shippers don't.
But in the intervening years, the industry has seemed to move away from the idea that volume alone equals worth. Perhaps, long-term deals just aren't in the interest of carriers?
'Due to the volatility of the market, the depths of the recession last year and the fact that carriers are playing hardball with rate increases, the contracting process has changed and probably shippers are not so much locked into long-term deals now,' Dekker said. 'Carriers do not so much need volume as a matter of priority, they need revenue, and so locking in a big shipper long-term, but at a relatively low rate with no chance to renegotiate on bunkers or other factors, cannot be a priority to them. You will probably find that shippers will negotiate their tenders with more carriers this year in order to spread their volumes around and not rely on just one or two players who may roll their cargo over when capacity is very tight. Each individual carrier may therefore have fewer big volume VIP customers.'
George Chien, director of Asia trades for Southern California-based NVO Dependable Global Express, Dependable Hawaiian Express and Dependable AirCargo Express, said the reason why carriers, shippers and intermediaries fail to lock in long-term deals is a simple conflict of interest.
'There's only so much money on the table,' he said. 'If the money is not in your pocket, it's in my pocket. That's why no one works closely.'
Chien also said the intense competition among carriers keeps shippers from being loyal to any one carrier, and it keeps carriers constantly on the lookout to make sure they aren't being undercut. He added that annual service contracts are constantly being amended throughout the year, by both the shipper (if they have enough clout) and the carrier.
'Fifteen years ago, a shipper would sign a one-year service contract with one carrier,' he said. 'Now, a sizable shipper signs with at least three carriers. If the price goes down with one, he shops that rate around to the other carriers. The market is so volatile, no one wants to lock in because you don't know what your competition is going to do.'
For larger shippers, the volatility of rates can mean huge amounts of money. If you move 100,000 TEUs a year on the transpacific, a rate increase from $1,000 to $2,000 per TEU means an additional $100 million. Perhaps that is why high-volume shippers are more attracted to the idea of longer-term deals.
'One thing I learned from the dramatic rate swings in the transpacific trade from 2002 to 2003 is that the 50 percent decline in the 2002 rates was greeted by senior management with high-fives and words like 'great job in getting those carriers to drop rates,' ' Isbell wrote in January ('An endurance race,' www.AmericanShipper.com/links). 'Then in 2003, carriers succeeded in raising rates back to 2001 levels ' a 100 percent increase in the rates! Executive reaction was certainly less enthusiastic to say the least. I spent my time reassuring senior managers that the company's rates were still competitive relative to other similarly situated shippers.
'What I took away from that experience is it made sense to better manage year-to-year rate fluctuations so they would be less severe,' Isbell continued. 'That whipsaw event changed the framework for contract negotiation discussions between my former company and some of its more strategic carrier partners. Our team looked at the pros and cons of multiyear contracts and formulas that could make the natural market swings in ocean rates work better for the way the company priced its products. Both parties adopted a longer-term perspective rather than only considering what could be gained at the expense of the other in one year.'
As the industry heads toward a defining spring contract negotiation season on the transpacific, it doesn't look like the nature of contracts is likely to change anytime soon, at least for the vast majority of shippers. In fact, it's more likely that the protection provided by annual contracts will be slightly eroded.
'On the transpacific side, where the norm is to agree to one-year contracts, we would imagine that carriers wherever possible would steer away from all-in deals and make provision as much as possible to have the ability to adjust base rates and/or surcharges throughout the year,' Dekker said. 'Shippers have in the past been able to sign special clauses which protect them as they want to know through the course of 12 months what they are paying for transportation. Carriers have historically been weak in this respect. This year, it must be expected that carriers will drive a much harder bargain, otherwise their exposure on this trade may substantially change ' and this is why there are more and more operational alliances to share the heavy cost burdens.'
Van der Jagt added, 'Longer term contracts with carriers can only be developed when contracts are mutually accepted and influenced by both parties on an equal basis.'
