Failure of Alliances to Lift Rates to Hurt Shippers Long-term

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If the global mega-shipping alliances launching in April don’t drive compensatory freight rates, shippers should expect more bankruptcies and mergers, much like the airline industry has experienced over the last two decades, former Hyundai Merchant Marine CEO of the Americas David Arsenault warns.

The top global shipping lines, which today operate in four vessel-sharing alliances, will reorganize effective April 1 into three larger groups with more leverage over beneficial cargo owners and ports.  The Ocean Alliance will have a market share of 41 percent in the trans-Pacific, THE Alliance will have a market share of 29 percent, and the 2M Alliance with its slot-sharing arrangement with Hyundai Merchant Marine will have a market share of 21 percent, according to Alphaliner.

The alliances collectively will control 91 percent of the vessel capacity in the trans-Pacific.  If the alliances and their members exert self-discipline and succeed in matching supply with demand, higher freight rates will take effect in the new service contracts in the eastbound Pacific beginning May 1, he said.

Arsenault told the Propeller Club of Los Angeles-Long Beach that if the global mega-alliances do not succeed in returning the liner shipping industry to profitability, BCOs will eventually face a scenario that has played out over the past two decades in the airline industry.  After numerous bankruptcies and mergers, the smaller number of airlines that remain have balanced capacity with demand to such a degree that airplanes are always full and fares continue to increase.

The key to improved carrier profitability will not be further cost-cutting by container lines, which may have gone as far as it can go, but rather higher freight rates.  Indeed, liners seem to be already moving in that direction.  Last week, thanks to the normal seasonal peak associated with the coming Chinese New Year celebrations in Asia at the end of the month, the spot rate for shipping a 40-foot container from China to the West Coast hit a recent high of $2,082, according to the Shanghai Containerized Index published on JOC.com under the Market Data Hub.

Carriers are usually able to negotiate higher contract rates for the contracting year that runs from May 1 to April 30 when spot rates are strong during the winter months.  Carriers are angling for this advantage, as is already being seen in the Asia-Europe trade, where carriers are delaying service contract decisions to give the spot market more time to peak during the pre-Chinese New Year period when ships are full and BCOs pay a premium for space.

Speaking directly to BCOs about the need for the mega-alliances to succeed, Arsenault said, “If this doesn’t work, you won’t like the next step.”  The next step would be rapid consolidation through mergers and acquisitions that would leave the industry with a handful of extremely powerful shipping lines that could set freight rates at will.  “Be careful what you ask for,” he said.  

Citing numbers from industry publications, Arsenault, who is president of Logistics Transformation Solutions, said container lines collectively lost about $10 billion in 2016.  The last time the liner industry reported a collective profit was 2010, when a huge number of vessels were laid up at the same time that cargo volumes unexpectedly spiked following the recovery from the 2008 to 2009 recession.

Carriers have already responded to six straight years of losses through high-profile mergers or acquisitions that were completed last year or will be in the coming year.  They include Cosco Container Lines with China Shipping Container Lines, CMA CGM with APL,  Maersk Line with Hamburg Süd and a merger of the three major Japanese carriers, NYK Line, ‘K’ Line, and MOL.  “These are very significant events,” Arsenault said.

What’s more, carriers are reducing capacity by idling vessels and by scrapping older, and some not-so-old vessels, at a record clip.  The idle capacity today globally is at the level it was at during the depths of the recession.  The big difference, Arsenault said, is that eight years ago many of the idled ships were carrier-owned and were thus brought back to service quickly.  Today, most of the ships are chartered and may not reenter service.

The Hanjin Shipping bankruptcy filing on Aug. 31 was an industry-changing event that is still on the minds of many BCOs, equipment providers, bunker fuel companies, truckers, and other vendors who got burned when $14 billion in cargo and 500,000 containers were stranded at sea, Arsenault said.

As BCOs prepare to enter contract negotiations with shipping lines following the Hanjin bankruptcy, the rules of the game are changed.  In the past, BCOs were encouraged to diversify risk by spreading their cargo out over a number of carriers.  Now, they are concentrating their bookings with fewer carriers they judge to be financially secure, he said.

Yet despite how gut-wrenching the Hanjin experience was, the single most significant event to unfold this year will be the sudden change in the global container trade from four alliances to three, effective April 1, Arsenault said.  The more powerful alliances should be able to nudge the container lines into a better balancing of supply and demand.  Ostensibly, supply and demand on the major east-west trade lanes should not be difficult to achieve, with predictions that cargo volume this year will increase 2.4 percent and capacity will grow about 3 percent.  However, Arsenault noted, with an overcapacity overhang of as much as 30 percent globally, there will be enough pressure on ocean carriers to prevent rates from escalating rapidly.

BCOs surveyed by the JOC recently said they are bracing for service contract rates of about $1,500 per 40-foot container to the West Coast this year.  Arsenault said that number sounds about right, although he added that “all it takes is one or two carriers to cut the rates” to collapse the market.

Although $1,500 per FEU sounds impressive compared with last year’s service contract rates that were as low as $750 per FEU, even those higher rates would probably not be compensatory for most carriers under current industry habits, he said.  In order to return carriers to profitability, individual shipping lines will have to get together with their customers and put an end to “giveaways” such as extended free time for container storage and chassis. Those insidious practices quickly destroy carriers’ overall profitability, he said.

If a positive scenario is to develop in the coming years, and a viable shipping industry is to emerge, everybody must give a little, Arsenault said.  Carriers must improve service so that they can compete on the quality of their service instead of how low their rates are.  BCOs must agree to pay compensatory freight rates for improved service, and they must stop demanding extended free time for equipment.

Global shipyards also fit into this equation.  The massive orders for new ships placed several years ago resulted in part from decisions by shipyards to slash their prices in order to keep their workers employed during the recession.  Governments made the problem worse with subsidies that artificially propped up ailing shipyards and shipping lines, Arsenault said.

After six years of losses, the container shipping industry today is the most fragile it has ever been, Arsenault said.  The Hanjin bankruptcy should be a wakeup call for everyone.  If it does not serve that purpose and freight rates collapse again this year, additional carriers will go bankrupt and the lines that remain will quickly consolidate their power and will be in a position to dictate pricing.  “It can happen overnight,” he said.

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Source: JOC

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