Riding the Waves of Change in Ocean Shipping, an Industry in Crisis

12/20/2016

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Abigail Struxness

Over 90 percent of the world’s internationally traded goods travel via ocean shipping. It’s likely that the shirt you recently bought at the mall, the produce at the grocery store, or the tools at the home improvement center spent time aboard a container ship before being discharged at a port terminal, transferred onto a truck or a train to a distribution center, and ultimately delivered to the store. Yet despite how critical the industry is to international trade, most ocean carrier companies have nearly reached rock bottom in terms of shipping rates and profits lost, as Hanjin’s recent bankruptcy demonstrated.

Ocean carriers (the companies operating container ships) are deeply impacted by changes in the global economy, but their actions also have the power to influence the dependability and affordability with which these products enter the marketplace. In this time of uncertainty, how will the challenges that carriers currently face impact global supply chains and transportation costs in the future? The ocean carrier industry received global scrutiny this year after the world’s 7th largest carrier, Hanjin, went bankrupt in late August. The carrier’s failure temporarily stranded over $14 billion dollars’ worth of goods as ships were barred from ports for failure to pay terminal charges and their creditors began bankruptcy proceedings. While Hanjin’s exit from the industry was the most dramatic, it was not the first. The number of major ocean carriers shipping containerized cargo will have dropped from 19 to 11 by the time all planned mergers and acquisitions are completed next year, due primarily to the inability of most companies to be profitable. (Note, no major ocean carrier has carried the U.S. flag or been U.S. owned since 1997 when Singapore’s NOL purchased American President Lines). Why are these companies exiting the shipping industry? Overcapacity. In 2011, at a time when the typical ship capacity was 5,000 twenty-foot containers (TEUs), Maersk Lines placed orders for Triple- E “mega container ships,” which can carry 18,000 TEUs. In order to keep up with Maersk, other carriers placed orders for these enormous vessels, which are longer than the Empire State Building is tall. Due to their massive scale and capacity, mega ships appealed to shipping executives for their lower slot costs (the operational cost per container aboard the ship) and more efficient fuel operations. What the carriers did not predict when they placed these orders was a decline in the growth of cargo volumes shipped, thanks to the aftermath of the 2008 recession and China’s slowing growth. With the construction and deployment of these massive new ships in 2013 and 2014, global vessel capacity far out measured demand for space aboard the ships. As a result, carriers began offering cheaper rates to attract customers, a race to the bottom that has led many to offer services at rates below operational cost. The Shanghai Shipping Exchange tracks this dramatic drop in the spot-market freight rates across the industry, illustrated below: shanghai Source: Shanghai Shipping Exchange Overcapacity continues to impact carriers’ rates and decisions for the future. In February, CMA-CGM’s Benjamin Franklin, the largest container ship ever to call a United States port, arrived at the Port of Long Beach for a trial voyage and continued up the West Coast. With 18,000 TEU capacity, the mega ship arrived with great fanfare. Yet it barely managed to load 11,000 containers before turning back to Asia, a dismal number which caused CMA-CGM to pause the ship’s West Coast service indefinitely, instead returning to smaller vessels which better match demand. shangai2 In an effort to reverse the downward spiral on rates and to get maximum benefit from the new mega ships, carriers began forming ocean alliances, vessel sharing agreements in which multiple carriers some of their ships out of service and utilize space on another carrier’s ship. This has created anti-trust concerns in some countries, and has provided importers and exporters (the shippers) with fewer options in terms of vessel routes, ports served, and sailing frequency. Despite these measures, analysts predict that over capacity will continue to plague the industry for the next several years, until ship capacity and container volumes reach equilibrium. In an effort to reduce the number of ships on the market, ships as young as seven years old are being sent to scrap yards. Last year, Maersk Lines cancelled orders to build six additional mega ships, choosing instead to grow via acquisition of other companies (and their ships). Rates for bunker fuel (the heavy oil used to power container ships) also impact the operational cost for ocean carriers and therefore rates for shippers. Currently, fuel rates remain low, mirroring trends for gasoline products. However, a new United Nations International Maritime Organization law will limit sulfur, a pollutant found in bunker fuels, to 0.5 percent by 2020. Low-sulfur bunker fuel is more expensive and more difficult to source. In order for the carriers to remain in business, this additional operational cost will likely be passed along to the shippers in 2020 in the form of fuel surcharges on their rates. While a few niche carriers have commissioned container ships that are fueled by liquefied natural gas (LNG), major ocean carriers are stuck relying on bunker fuel to feed their newly acquired mega ships. It is clear that ocean rates must rise in order for carriers to make enough money to provide reliable service on up-to-date ships. But U.S. exporters are in no position to afford dramatic rate increases in the near future. The strong U.S. dollar makes it more difficult for U.S. exporters, primarily agriculture, forest products, and other commodities, to compete against providers of the same product from other countries. These high volume, low margin products are particularly sensitive to fluctuations in transportation costs. In the next few years, as the dust begins to settle, it’s clear that a new order will be established among carriers. Those prevailing will only be a small number of carriers, maybe just 3-6 companies, with massive operations—large fleets and global services. With less competition and with self-discipline to control their capacity, these carriers will be able to drive up rates and make profits again. Smaller carriers which can survive in niche markets could also remain. Where does this leave the importers and exporters? Ultimately in a more vulnerable position. Held captive to the carriers’ misguided rush to reduce costs with mega ships, shippers have ridden the waves of change as best they could, temporarily benefitting from lower rates, but ultimately bracing for a time in the future where they are beholden to a smaller group of powerful carriers who provide fewer service options and higher rates. Now more than ever, shippers are analyzing their supply chains and speaking with government regulatory bodies in hopes of maintaining some level of competition among carriers. Abigail Struxness is Programs and Policy Manager for the Agriculture & Commodities Transportation Coalition (AgTC); and President of the Young Trade Professionals. The views expressed are her own.