Executive Briefings

Economics 101: Did Ocean Carriers Miss the Lecture?

Judging from their actions, ocean carriers would love to toss out those irritating economics textbooks, with their tedious lessons about supply and demand. Too much capacity? No pricing discipline? Sluggish volume growth? Forget about it. Why should any of that prevent them from raising freight rates?

Perhaps carriers are emboldened by their experience of the last couple of years. In 2010, they won big rate increases in the eastbound trans-Pacific trade, against a backdrop of high utilization levels, shortages of vessel space and equipment, and cargo being left on the docks during periods of peak demand. In the 2011-2012 season, they managed some additional boosts, even though load factors weren't as strong as in the previous year, demand was relatively weak and there was no peak-season cargo rush. Understandably, then, they're hoping to pull off the same trick in 2013.

Carriers might further believe that they can continue to fiddle with market dynamics on a short-term basis, by slowing down vessels to save on fuel costs, and temporarily pulling ships from the trade when capacity outstrips demand for space. Clearly the strategy has worked before, with the lines laying up hundreds of ships in Singapore and elsewhere over the last few years, in order to constrict supply and sustain high rate levels.

If market conditions didn't favor higher rates in 2012, then what did? Tan Hua Joo, executive consultant with the industry research service Alphaliner, chalked it up to desperation. Speaking on a panel at the Journal of Commerce's annual Trans-Pacific Maritime Conference in Long Beach, Calif., he said carrier's margins in the fourth quarter of 2011 and first of 2012 "were absolutely dismal." Returns were in the neighborhood of minus 10 percent.

"At those levels, not many carriers would have survived last year," Tan said. "The situation was unsustainable."

Whether carriers can carry that sense of urgency into 2013 is another matter. They are certainly hoping for a repeat of 2010. The Transpacific Stabilization Agreement is recommending an April 1 general rate increase (GRI) of $400 per 40-foot container from Asia to the U.S. West Coast, and $600 per FEU to all other destinations served by its members. That's on top of a January 15 increase of $600 per FEU to the West Coast and inland coastal destinations, and $800 per FEU to other points. But most of that earlier boost is said to have evaporated, due to weak demand for imports and persistent overcapacity. Both actions were taken with the goal of "shoring up" gains achieved to date, and preventing an erosion of rates in the current contracting season.

So what kind of reception will carriers find for their latest round of rate hikes? Not a very warm one, if Tan and other industry analysts are right. Start with the supply side - the part over which service providers have control. Approximately 1.69 million twenty-foot equivalent units of new tonnage are expected to enter the trades in 2013, versus 1.26 million TEUs in 2011. Figure in 400,000 TEUs of scrapping - around 2.4 percent of the fleet - along with some deferrals of ordered ships, and you have a net increase in supply of between 6 and 7 percent.

And demand? Tan expects trade growth to remain weak. It will be flat or slightly positive in the Asia-Europe trade, and about 2 percent in the trans-Pacific this year. What's more, those are the trades that will absorb the new and bigger ships. The largest of them, including Maersk Line's 18,000-TEU Triple-E behemoths, will beginning hitting the Asia-Europe routes later this year and in early 2014, while the trans-Pacific will see new vessels of between 8,000 and 9,000 TEUs (in addition to ships displaced from the Asia-Europe trade by the 14,000- to18,000-TEU arrivals).

Carriers could have read the warning signs last year, when they were unable to replicate steep rate increases on the Asia-Europe route in contracts with shippers in the trans-Pacific. In the former trade, explained Tan, the top three carriers control a larger combined market share than they do in the latter.

All lines remain trapped in a "vicious cycle of overtonnaging" that could stretch into 2015, despite efforts to forestall rate erosion by delaying delivery of some new ships. ("Pushing back orders is only going to prolong it," said Tan.) In fact, the overcapacity situation is even worse than it looks, when one accounts for under-employment of the tonnage that remains in service.

"Expect significant volatility in freight rates," Tan predicted, "especially in the spot market." As freight cycles continue to contract, carriers will find themselves scrambling to respond, initiating rate changes - both up and down - at a more hectic pace.

Their twin strategies of idling tonnage and slow-steaming ships in service can only do so much. "They are not enough to keep rates up for a significant amount of time," said Tan.

Analysts seem somewhat more chastened this year about the prospects for growth in the major liner trades. They've been wrong in the last two years, erring on the high side, said Tan. TPM panelist Johnson Leung, an equity research analyst with Jefferies Hong Kong Limited, admitted to being "way off" in his prediction of a turnaround for carriers in 2012. Mario Moreno, chief economist with the Journal of Commerce and PIERS, forecast 2.5-percent growth in the trans-Pacific eastbound trade in 2012; the actual number was just 0.3 percent.

Several factors cropped up during the year to frustrate those forecasts, including a shift of manufacturing capacity from China to North America, especially Mexico, and sluggish U.S. retail sales. But carriers did themselves no favors by continuing to flood the trades with more tonnage, even if the bigger vessels are more efficient and cost less to operate per container slot. What does that matter if the slots are empty?

Expect more challenges this year, including the still-uncertain impact of the budget sequester on the U.S. economy. Yet the ships keep on coming, and so do the GRIs. Bottom line: the bottom line still matters. Turns out the law of supply and demand hasn't been repealed after all.

Next: About those megaships...

Comment on This Article


Keywords: supply chain, supply chain management, international trade, global logistics, transportation management, trans-Pacific trade, Asia-Europe trade, container freight rates, logistics & supply chain, supply chain services, retail supply chain

Perhaps carriers are emboldened by their experience of the last couple of years. In 2010, they won big rate increases in the eastbound trans-Pacific trade, against a backdrop of high utilization levels, shortages of vessel space and equipment, and cargo being left on the docks during periods of peak demand. In the 2011-2012 season, they managed some additional boosts, even though load factors weren't as strong as in the previous year, demand was relatively weak and there was no peak-season cargo rush. Understandably, then, they're hoping to pull off the same trick in 2013.

Carriers might further believe that they can continue to fiddle with market dynamics on a short-term basis, by slowing down vessels to save on fuel costs, and temporarily pulling ships from the trade when capacity outstrips demand for space. Clearly the strategy has worked before, with the lines laying up hundreds of ships in Singapore and elsewhere over the last few years, in order to constrict supply and sustain high rate levels.

If market conditions didn't favor higher rates in 2012, then what did? Tan Hua Joo, executive consultant with the industry research service Alphaliner, chalked it up to desperation. Speaking on a panel at the Journal of Commerce's annual Trans-Pacific Maritime Conference in Long Beach, Calif., he said carrier's margins in the fourth quarter of 2011 and first of 2012 "were absolutely dismal." Returns were in the neighborhood of minus 10 percent.

"At those levels, not many carriers would have survived last year," Tan said. "The situation was unsustainable."

Whether carriers can carry that sense of urgency into 2013 is another matter. They are certainly hoping for a repeat of 2010. The Transpacific Stabilization Agreement is recommending an April 1 general rate increase (GRI) of $400 per 40-foot container from Asia to the U.S. West Coast, and $600 per FEU to all other destinations served by its members. That's on top of a January 15 increase of $600 per FEU to the West Coast and inland coastal destinations, and $800 per FEU to other points. But most of that earlier boost is said to have evaporated, due to weak demand for imports and persistent overcapacity. Both actions were taken with the goal of "shoring up" gains achieved to date, and preventing an erosion of rates in the current contracting season.

So what kind of reception will carriers find for their latest round of rate hikes? Not a very warm one, if Tan and other industry analysts are right. Start with the supply side - the part over which service providers have control. Approximately 1.69 million twenty-foot equivalent units of new tonnage are expected to enter the trades in 2013, versus 1.26 million TEUs in 2011. Figure in 400,000 TEUs of scrapping - around 2.4 percent of the fleet - along with some deferrals of ordered ships, and you have a net increase in supply of between 6 and 7 percent.

And demand? Tan expects trade growth to remain weak. It will be flat or slightly positive in the Asia-Europe trade, and about 2 percent in the trans-Pacific this year. What's more, those are the trades that will absorb the new and bigger ships. The largest of them, including Maersk Line's 18,000-TEU Triple-E behemoths, will beginning hitting the Asia-Europe routes later this year and in early 2014, while the trans-Pacific will see new vessels of between 8,000 and 9,000 TEUs (in addition to ships displaced from the Asia-Europe trade by the 14,000- to18,000-TEU arrivals).

Carriers could have read the warning signs last year, when they were unable to replicate steep rate increases on the Asia-Europe route in contracts with shippers in the trans-Pacific. In the former trade, explained Tan, the top three carriers control a larger combined market share than they do in the latter.

All lines remain trapped in a "vicious cycle of overtonnaging" that could stretch into 2015, despite efforts to forestall rate erosion by delaying delivery of some new ships. ("Pushing back orders is only going to prolong it," said Tan.) In fact, the overcapacity situation is even worse than it looks, when one accounts for under-employment of the tonnage that remains in service.

"Expect significant volatility in freight rates," Tan predicted, "especially in the spot market." As freight cycles continue to contract, carriers will find themselves scrambling to respond, initiating rate changes - both up and down - at a more hectic pace.

Their twin strategies of idling tonnage and slow-steaming ships in service can only do so much. "They are not enough to keep rates up for a significant amount of time," said Tan.

Analysts seem somewhat more chastened this year about the prospects for growth in the major liner trades. They've been wrong in the last two years, erring on the high side, said Tan. TPM panelist Johnson Leung, an equity research analyst with Jefferies Hong Kong Limited, admitted to being "way off" in his prediction of a turnaround for carriers in 2012. Mario Moreno, chief economist with the Journal of Commerce and PIERS, forecast 2.5-percent growth in the trans-Pacific eastbound trade in 2012; the actual number was just 0.3 percent.

Several factors cropped up during the year to frustrate those forecasts, including a shift of manufacturing capacity from China to North America, especially Mexico, and sluggish U.S. retail sales. But carriers did themselves no favors by continuing to flood the trades with more tonnage, even if the bigger vessels are more efficient and cost less to operate per container slot. What does that matter if the slots are empty?

Expect more challenges this year, including the still-uncertain impact of the budget sequester on the U.S. economy. Yet the ships keep on coming, and so do the GRIs. Bottom line: the bottom line still matters. Turns out the law of supply and demand hasn't been repealed after all.

Next: About those megaships...

Comment on This Article


Keywords: supply chain, supply chain management, international trade, global logistics, transportation management, trans-Pacific trade, Asia-Europe trade, container freight rates, logistics & supply chain, supply chain services, retail supply chain