Reduced fuel costs benefit container carriers, but they face a parade of new, larger ships.
During 2014 the ocean carriers continued to take on increasingly bigger container vessels into their fleets and organize themselves into larger alliances.
The next few years should reveal whether these trends will be beneficial for both the carriers and their customers.
Carriers certainly performed better in 2014 than in 2013.
The 16 large international carriers included in the tables that accompany this article had operating earnings from their container operations of $4.278 billion in 2014, compared to just $618 million in 2013.
Five of these carriers had operating losses last year, compared with 11 in 2013, but nearAlixAlixly three quarters of the operating profits were earned by just two companies—Maersk and CMA CGM.
Most carriers use a fiscal year that is identical to the calendar year; however, the three large Japanese carriers have a fiscal year that ends on March 31.
(Included in the tables are the results for the container operations of 14 of the largest publicly traded container-shipping companies, as well as those of CMA CGM which is primarily owned by founder Jacques Saadé and family, and ZIM—formerly owned by Israel Corp. but after restructuring last year is now owned by former creditors and the Israel Corp. spinoff Kenon Holdings. The container operations of CSAV were absorbed by Hapag-Lloyd last December and this year American Shipper has included the results of Wan Hai, an intra-Asia specialist carrier that now operates several transpacific strings. The other top 20 carriers—Mediterranean Shipping Co., Hamburg-Süd, Pacific International Line and United Arab Shipping Co.—do not announce their financial results.)
Source: Research by American Shipper, carrier reports. Container carriers continued to do well in the first quarter of 2015.
“The first-quarter 2015 was the most profitable for the container industry in four years with a preliminary estimated operating margin of about 8 percent,” said London-based liner shipping industry consultants Drewry in a June 8 edition of their Container Insight Weekly.
But the firm added the success of carriers in the first three months of this year was achieved on the back of continued lower unit costs that have offset weakening freight rates. Drewry calculated that “average unit revenues were down by 6 percent year-on-year, but this was more than covered by an 11 percent fall in unit costs.”
Cheap Fuel. Both in 2014 and the first quarter of 2015 shipping lines have benefited from the sharp drop in oil prices.
For example, the price of the most commonly used bunker fuel—IFO 380—has fallen in Singapore, a large bunkering port, from a high of $638 a metric ton last summer to a low of $309 per metric ton this past winter.
The drop was “a welcome respite,” AlixPartners said in its report, Finding Focus: 2015 Container Shipping Outlook, but “probably not going to relieve the industry’s financial pain in the longer term.”
“2015 earnings should be higher than 2014 due to the lower bunker costs,” said H.J. Tan of Alphaliner. “However, earnings are expected to be weaker for the rest of 2015 compared to the first quarter due to the slide in freight rates, while bunker prices have climbed from their recent lows.”
As this article was being written in early June, for example, the cost of IFO 380 bunker fuel in Singapore was around $400 per metric ton.
Dirk Visser, senior shipping consultant at Dynamar and editor of Dynaliners, noted there is a lag in passing changes in fuel prices to carriers’ customers, and “we may see that benefit passed on to shippers when carriers report their second quarter results.”
Indeed, Alphaliner in an April article, “Carriers fritter away $14 billion fuel savings bonanza,” said the Shanghai Containerized Freight Index had fallen to a five-year low. Rates have slid even lower in May and June.
Some analysts suggest that with regulations for ships to have cleaner emissions—there will be a global requirement for carriers to use marine fuel with a maximum sulfur content of 0.5 percent by 2025—some carriers may choose to contain costs in the future by burning even more viscous fuels with high-sulfur content because it will be cheaper, but then use scrubbers to meet environmental requirements. Some carriers are also looking to use liquefied natural gas (LNG) to power their ships, a trend being pioneered by coastal vessel operators in Europe and the United States such as TOTE and its Sea Star Line service to Puerto Rico. Ships in emission-control areas, which include waters within 200 miles of the continental United States, Hawaii, Puerto Rico and much of Alaska, must already reduce sulfur emissions to 0.1 percent.
Slow Growth. “The biggest question mark is: what’s going to happen on the demand side in terms of load factors for the lines?” said Neil Dekker, head of container research at Drewry.
The Organization for Economic Cooperation and Development in June revised downward its projection for global economic growth for 2015 to 3.1 percent from its earlier 3.6 percent projection in November 2014. It also lowered its projection for 2016 to 3.6 percent from 3.9 percent.
The downward revision, the OECD said, was “largely on account of the unexpected weakness seen in the first quarter of 2015. Global growth is expected to pick up through 2015 and 2016 thanks to low oil prices, widespread monetary easing and a reduction in the drag from fiscal consolidation in the major economies.
“U.S. GDP growth is projected to be 2 percent in 2015 and 2.8 percent in 2016, a downward revision from the November 2014 forecast of 3.1 percent this year and 3 percent in 2016. While the stronger dollar and adverse weather weighed on growth in early 2015, unemployment continues to fall. Supportive monetary policy and lower oil prices should continue boosting demand,” the organization said.
Traditionally, container traffic has grown at more than double the rate of GDP.
But in a report this March, Boston Consulting Group said this multiplier is shrinking. Where container traffic outpaced GDP by 2.2-times in 2003-2007, after the financial crisis that multiplier fell to 1.4-times, and BCG forecasts it will be just 1.3-times GDP in 2015-2019.
Drewry Maritime Equity Research said in May the “latest economic data shows that China’s economy continues to trend downwards,” adding manufacturing and non-manufacturing purchase management indexes point to further weakening in the second quarter of this year.
Ben Hackett, whose firm Hackett Associates prepares the widely followed Global Port Tracker newsletters that currently cover 12 North American and six North European ports, said “the first quarter in Europe and in North America were pretty miserable. China is slow, because their overseas markets are slow, and Japan didn’t do as well as they expected in quarter one.
“Our belief is that quarter two and three will improve, but it is still weaker demand than it might have been,” he said.
In early June his firm was predicting container traffic growth of about 4.5 percent for the year as a whole, down from 5 percent in earlier estimates.
In Northern Europe, Hackett forecasted growth of just 2.5 percent, down from a projection earlier this year of 4.5 percent to 5 percent growth.
One U.S. statistic that had him concerned was a rising inventory-to-sales ratio.
He said this was probably a result of retailers building up inventory because of uncertainty and congestion at U.S. ports that developed during the contentious contract talks between the International Longshore and Warehouse Union and Pacific Maritime Association.
“Retailers are now having trouble selling some product and this is depressing the flow of cargo. Irrespective of what consumer demand is, the stores are just sitting on too much inventory,” he said. If that inventory-to-sales ratio “continues to go up then I think we will start saying that we are beginning to see a downturn in trade, a recession.”
Danmarks Skibskredit (or Danish Ship Finance) said in its May shipping market review that the container industry is continuing “to invest in the future based on assumptions of the past. We argue that the potential for future container demand is structurally reduced, and that long-term container volumes could contract if manufacturing is re-shored.”
The firm still expects demand for seaborne container goods in 2015 “to remain relatively strong and grow by 5 percent. Asia is expected to show the highest demand growth at 6 percent, primarily driven by 7 percent growth in intraregional trade. Over the next four years, seaborne container demand is projected to grow at an annual average rate of 5.2 percent.”
However, it also forecasts container-shipping “distances are set to become slightly shorter over the next three years.
“In the years from 2002 to 2008, distances added almost 2 percentage points to demand, but in the years ahead we anticipate a slightly negative growth contribution from distances,” Danmarks Skibskredit said.
This is partly because of shifting manufacturing costs that could result in more regional manufacturing hubs, but also due to technological advancements such as 3-D printers “are gradually reducing the importance of labor costs in the manufacturing process, which is enabling companies to move production closer to the consumers, allowing them to respond more quickly to changes in consumer preferences,” it added.
That will not “affect the near-term future for container demand, but we do believe that lower volumes and shorter distances could shape the long-term outlook for container demand within the lifetime of vessels recently ordered (i.e. before 2040). The consequences could be significant, not just for the long head-haul routes from Asia to Europe and North America, but also for the intra-Asian component trades and the back-haul volumes from North America and Europe to Asia,” Danmarks Skibskredit, explained.
BCG’s March report suggested in addition to a slowdown in offshoring production, containerization is “plateauing.”
“Most commodities suitable for containerized transportation have already been migrated to containers, stabilizing the overall containerization levels at about three-quarters of global general cargo. Significant additional containerization jumps are not likely in the years to come,” BCG said.
Supply. Dekker said Drewry was reasonably optimistic about the direction of the liner carrier industry when it prepared its forecast in March, adding “we had decent global growth last year of about 5 percent on the demand side and the head-haul trade for Asia-Europe and the transpacific were a lot stronger than anyone anticipated. Lines had managed to renegotiate better contract rates on many trade routes.”
But he added “as the year’s gone on a bit, the orderbook has increased. We’ve had a number of orders for 18,000- to 20,000-TEU ships placed recently and there are quite a few in the pipeline.”
On June 7, Alphaliner said the 100 largest container-shipping lines had 323 ships on order with an aggregate capacity of 3.2 million TEUs. That’s equal to about 17 percent of the 18.8 million TEUs of capacity in the global fleet of 5,214 containerships.
Increasingly, orders for new ships are concentrated in the very largest sizes—Alphaliner stated 21 ships larger than 18,000 TEUs will be delivered this year alone and 42 between 10,000 and 17,999 TEUs.
Maersk signed a new-building contract on June 3 with Daewoo Shipbuilding and Marine Engineering for 11 second generation, Triple-E container vessels with a capacity of 19,630 TEUs each. The order includes an option for six more vessels.
Drewry said in April that Maersk, MSC, CMA CGM, UASC, China Shipping, Evergreen, MOL, and OOCL were already members of the “18,000-TEU-and-above members club,” and Dekker said MSC has reportedly agreed to charter more of the big ships, while Yang Ming and COSCO are in the market for ultra-large container vessels.
Intense competition, fuel costs and environmental policies are all driving the decision by carriers to use bigger ships, said the container industry’s principal trade organization, the World Shipping Council.
“The majority of a containership’s operating cost is the cost of fuel. When the focus is on efficiency and cost reduction, the largest cost ‘target’ is fuel,” WSC noted. “Some savings have been derived from ‘slow steaming’ which consumes less fuel; however, larger ships are more energy efficient per container transported, and thus their use is economically inevitable.”
A report by the OECD’s International Transport Forum said “the available information indicates that the capital costs for the units exceeding 16,000 TEUs are actually not increasing in a linear manner but slightly below that.”
Slow steaming has helped “contradict the previous fear that the capital costs of larger units would increase super-proportionally as a result of a second main engine being required to maintain the high operation speeds. Hence, it is fair to say, that the new modus operandi of ‘slow-steaming’ has opened the door for the exploitation of further economies of scale as far as capital costs are concerned,” the OECD continued.
Dynamar’s Visser said this is an attractive time to order containerships, because prices are low and these vessels have such long operating lives.
Danmarks Skibskredit said in a May report that although prices were higher in 2014 than in 2013, they have been on a downward trend since mid-2014.
And costs, below $2,000 per “CGT,” or compensated gross tonnage, are less than two-thirds of what they were in 2008. (CGT is a unit used by economists when talking about shipyard capacity and costs that provides a common yardstick for different ship types, some of which are more difficult to build than others.)
“The shipbuilding industry has entered a period of adjustment. Some yards are managing to bring in orders and re-activate previously idled capacity, while others are struggling to attract any orders and must reduce capacity and ultimately close down,” said Danmarks Skibskredit. So some yards “might feel pressured to lower newbuilding prices.”
With most of the new containership capacity being added on big ships, if vessels are not fully loaded their advantages can be reduced or eliminated.
“Cost savings of bigger vessels are crucially dependent on the extent to which the ships are being filled,” the OECD study said. “The difference in utilization corresponding to a given slot cost is not very large between different vessel-size classes. If the utilization rate drops by only 3-5 percent the cost advantage of a vessel that is ‘one size’ larger will be evened out,” it explained.
Citing a 2013 study, the OECD said “the utilization rate that an 18,000-TEU ship would need to achieve cost savings relative to a fully loaded 14,000-TEU ship is approximately 91 percent.”
Alan Murphy, chief executive officer of SeaIntel, said carriers must learn to “operate in a market of permanent overcapacity. That is the name of the game now. The capacity is not going to dry up, it is here for a substantial number of years. Now, of course, if we should see a massive surge in demand that could balance out, but it doesn’t look likely.”
Carriers have been “incredibly good at managing capacity” in the Asia-Europe trade, both through slow steaming and blank sailings where carriers postpone a weekly sailing, he said. “The downside of using blank sailings as a capacity management instrument is that you are completely disrupting supply chains for shippers.
“You’d think that the shippers would be up in arms and say, ‘this is horrible, all my boxes are either late or at sea.’ But it does seem that shippers—as a group, not necessarily individual shippers—are more concerned about lowest cost. And this is what you get, horrible service but low prices,” Murphy said.
“There are options,” he added—shippers can move cargo through a different port or maybe use a different service, “but you are not getting what was originally promised.”
“I would personally hope that we see interest from shippers in saying ‘actually we are rewarding cargo and rates to the carriers that actually provide a stable, steady, and reliable service.’ But a premium does not seem to be possible, at least in current market conditions,” he said.
Alliances. To achieve higher utilization, carriers continue to organize themselves into large alliances. WSC noted this is a decades-old phenomena, pointing to the vessel-sharing agreement that former Sea-Land Service formed in 1988 with P&O Container Lines and Nedlloyd to fill up what were then seen as large ships with 4,000 TEUs of capacity.
There are, of course, other advantages to VSAs now that the ships have container capacities four-times larger today.
“In many cases a single carrier simply does not have enough customers or cargo to fill ships of this size on its own in the framework of a weekly service, which is the norm in the industry and what is required by customers,” WSC said. “In addition to allowing carriers to more efficiently use the cargo-carrying space of larger, more efficient vessels, VSA cooperation allows participating carriers to offer and provide greater service scope.
“By sharing multiple loops, each carrier in a VSA is able to offer its customers a much broader scope of service offering than it could on its own, which is pro-competitive. There are carriers in VSAs that would simply not be able to make the investments required to serve every port they cover pursuant to VSA space-sharing arrangements if they had to serve that network with their own assets,” WSC explained.
AlixPartners said longtime independents have joined alliances during the past year—MSC and Maersk formed the 2M Alliance after their plan for a three-way linkup with CMA CGM was foiled by Chinese regulators; Evergreen joined the CKYH alliance of COSCO, “K” Line, Yang Ming and Hanjin; and CMA CGM, UASC and China Shipping formed the Ocean Three Alliance.
While there has been some modest merger activity among container carriers last year, including Hapag-Lloyd’s acquisition of CSAV’s container business, Hamburg Süd’s acquisition of CCNI, and CMA CGM’s purchase of the German short-sea operator OPDR, alliances have become the preferred method by carriers to achieve economies.
Tan said, “I do not see a high chance of further consolidation amongst the top 20 carriers for the simple reason that there aren’t any attractive acquisition targets.”
Source: Research by American Shipper, carrier reports.
Falling Rates Continue. BCG said between 1998 and 2014, container freight rates, after taking into account the bunker adjustment factors, have steadily fallen at 2 percent compound annual rates. It sees a similar path ahead, forecasting rates net of BAF (bunker adjustment factor) will continue to dip at an annual rates of 1.6 to 2.6 percent through 2019.
Container freight rates plummeted in May and early June on the Asia-Europe trade, where the ultra-large containerships coming out of Asia’s shipyards are being put into service.
Spot rates have been incredibly volatile. For example, the spot container freight rate for cargo moving from Shanghai to northwest Europe, as estimated weekly by panelists for the Shanghai Shipping Exchange (SSE), jumped $518 more than doubled on May 8 from $343 per TEU to $861 per TEU. Then over the next four weeks the estimated rate has fallen $577 to $284 per TEU.
With more big ships destined for the Asia-Europe trade, “it does not look like carriers are prepared to abandon ship in what is surely becoming a survival of the fittest,” said Richard Ward, a container freight derivatives professional at Freight Information Services. “The long-term outlook for those carriers with weaker balance sheets does not bode well given the long-term downward trend in rates that will surely continue.”
With no sign of improvement on supply/demand fundamentals on the Asia-Europe trade and low load factors, carriers have waged price wars to secure their market share, noted SSE in a commentary on its website.
But as the ships in the Asia-Europe trade are displaced and cascade into other trade lanes, those services are also seeing freight rates weaken. For example, spot rates from Shanghai during the same four-week period fell $634 to $379 per TEU to the Mediterranean, $200 to $1,447 per 40-foot container (FEU) to the U.S. West Coast, and $194 to $3,116 per FEU to the U.S. East Coast.
Spot rates are so volatile that it would not be unusual to see those changes reversed, maybe in a single week.
But it’s clear that for now rates are under pressure on most trade lanes.
In the Asia-to-U.S. East Coast trade, many carriers are starting up new services seeking to attract customers who want to become less dependent on the U.S. West Coast ports because of the congestion in 2014 and earlier this year.
SSE noted rates from China to Santos, Brazil, also reached a new all-time low after falling $71 to $389 per TEU on June 5. Alphaliner’s Tan said the trade between Asia and South America’s west coast appears to be the next battleground.
Reviewing Maersk’s earnings in the first quarter, Nils Andersen, chief executive officer of A.P. Moller-Maersk, said Africa, as well as European-Africa markets, were soft.
“The global container-shipping industry continues to struggle financially, and there is no clear end in sight,” AlixPartners said. “The industry will continue to face significant headwinds in terms of supply-and-demand imbalances for years to come.”
Hackett said carriers are constantly announcing general rate increases (GRIs) only to see spot rates fall.
In March, Alphaliner noted carriers proposed GRIs of up to $1,000 per TEU even though rates were only $600 per TEU. Despite that, spot rates continued to fall. And this process has continued to happen.
Alphaliner counted five attempts to gin up rates through March of this year and asked “In which industry can you find sellers repeatedly announcing price increases of over 100 percent of the prevailing market price, while providing no reasonable justification for their actions?”
Hackett believes the container carriers are continuing to cut rates, because “they don’t want to lose market share. That’s always their first concern.”
For years, Maersk has said it orders new ships to “grow with the market.”
During a call with securities analysts in May, Andersen repeated that intention, but stated the company will not cede share either.
He said Maersk has lost some market share in the Asia-Europe trade lane, because it has not “followed the price war fully.” He promised the company would “attend to that.”
Soren Skou, chief executive officer of Maersk Line, told American Shipper earlier this year that since the fourth quarter of 2011 the company had brought costs per FEU down from more than $3,000 to $2,650, in part by reducing fuel consumption per container by 25 percent.
“Even though bunker is cheaper now than it was back then, it still makes a big difference,” he said.
Skou added the industry needs to “learn to live with lower growth, and a situation with permanent excess supply.
“Most industries actually live with that,” he said. “We, for some reason in shipping, have a kind of culture that unless the ships are 99.5 percent full, then we don’t believe we’re allowed to make money. But we have to learn to live with excess capacity.”
In early June, Maersk’s Andersen told the Wall Street Journal that the biggest container-shipping companies would dominate the business.
“I can’t speak for other companies, but small and midsize carriers—controlling a 3 percent to 5 percent market share—with very few exceptions—have been unprofitable for the last seven years,” he told the newspaper.
Maersk operates about 16 percent of the world’s container fleet.
Divesting. In recent years, many container carriers have divested themselves entirely or partly of certain terminal assets or logistics arms. For example, in 2014, MOL sold a 49 percent interest in its U.S. West Coast container terminals to Brookfield Asset Management. NOL sold APL Logistics to Japan’s Kintetsu earlier this year.
AlixPartners said it believes “many carriers are doing the right thing by shedding peripheral assets in favor of focusing on core container-shipping operations. Successful carriers will likely match this focus on investment with an in-depth understanding of profitability at the trade, route, and customer levels.”
It added, “The container carrier industry has grappled with distress for much of the past decade. The rate of decline appears to be moderating, but these results are not sustainable. The Altman Z-score, an indicator of financial distress, was only slightly higher in 2014 compared with 2013, suggesting minimal improvements in the carriers’ ability to stave off bankruptcy.
Source: AlixPartners analysis of publicly-traded company financials using the Altman Z-Score formula. “The improvement is not surprising, because asset sales have allowed carriers to focus on core operations while reducing debt. The carriers included in this analysis scored an average 1.21 for the period studied, suggesting the industry is still a long way from stability, as it has remained well within the distress zone (Altman Z-scores below 1.81). This industry has not seen a score above 2.99 (which indicates safe from bankruptcy risk) since 2007,” AlixPartners said.
BCG said there are wide cost differences among container carriers, but most have begun cutting costs by reducing bunker consumption and lowering their cost of vessel operations, and terminal, rail, truck, feeder and barge services. Such gains, it cautioned, are “table stakes,” delivering advantage only until competitors catch up.
Carriers can also achieve cost savings through staff reductions, reorganization, or new information systems.
“There will always be some fat to trim,” Tan said. “However, not all of the announced cost savings are real, as carriers fail to count the cost of reduced service quality and service failures.”
WSC said both BCG and management consultants McKinsey & Co. have recently suggested carriers may achieve additional efficencies by “expanding their cooperative efforts from traditional vessel-sharing operations to landside operations.”
One of the authors of the paper—Ronald Widdows, WSC chairman—described this vision in a speech at conference sponsored by Navis earlier this year.
Carriers might be able to achieve savings by having alliances run a group of terminals as a single entity, jointly contracting for rail or drayage services, sharing containers or even using joint customer service and documentation centers, Widdows said.
This article was published in the July 2015 issue of American Shipper.
