Fundamentals of Container-Shipping Sector

The global container ship fleet is estimated at 5,500 ships with a combined capacity to carry up to 23 million 20 feet containers, equivalent to 27 billion cubic feet or the volume of 730 empire state buildings at once.

An article published by Seeking Alpha explains the concept of container shipping along with an insight into what the industry looks like and it’s progress over the years.

Fleet Ownership

Close to 45% of the fleet is owned by companies like Maersk (OTCPK:AMKBY) or COSCO (OTCPK:CICOF), the so-called “liners,” that charge their clients a freight rate for each container and voyage they contract. 

The rest of the fleet, 55% of that 23 million capacity, is in the hands of fleet owners that instead of using their fleet directly, they charter it for the use of the liners.

Fleet ownership is a capital-intensive business made on 25-year life assets that are very close to a pure commodity. 

Owners charter those assets to another competitive and commodity-like industry as the maritime freight of dry-non-bulk goods. 

Charter and freight rates are very volatile in general and the sector is populated by diverse manager teams and risky corporate structures.

Marine Transport

Marine transport is the cheapest way to transport almost everything.

It is said that ships carry 90% of everything that is used in the world. UNCTAD estimated that close to 12 billion metric tons are carried every year with container ships, bulk carriers, and tanker ships.

The world fleet for seaborne trade has evolved dramatically in the last 20 years. The growth in global trade that China brought into the world economy created pressure on freight rates that fueled an expansion in the fleet that extended its effects until 2010, well after the 2008 financial crisis had already burst.

Ships take 2 to 3 years for delivery. By 2008, what used to be the pride of every shipping company before the crisis, the new-build order-book quickly became a business and financial risk that would have to be handled with care for many years.

In the case of containers, the new-build order-book reached 53% of the total fleet capacity at that time. 

By then, freight rates and charter rates were already going down. Overcapacity would cast its shadow over marine transport for the whole following decade.

The Container

The core of the container advantage is its efficiency to load-unload and to change from one vehicle to another without touching the cargo inside. 

The “box” is sealed at the factory of the user and only opened at the destination providing very efficient cargo management as there is no possible mix of cargoes. 

Standardization brought a new generation of ships that focused on its load-unload advantages and allowed for multiple time bigger boats.

That simple but powerful advantage changed the world economy. Containers brought sweeping reductions in the cost of moving freight cost, up to a point where it became almost irrelevant in business decisions that allow for specialization and scale economies on a global basis. 

Currently, the most common sizes of containers are the 20′ and the 40′ boxes which measure the same in height and width but there is a myriad of specialized adaptation of those sizes to different uses, notably reefer (cooled) containers, or flat-rack containers.

Types of Container Ships

Container ships under 3,000 TEU are generally called feeders; small ships that typically operate between smaller container ports, collecting cargo from small ports, drop it off at large ports for trans-shipment on larger ships or distributing containers from the large port to smaller regional ports. 

Then come the Panamax boats, of which size is limited by the original Panama canal’s chambers and which can take anything between 2,500 and 4,500 TEU.

Post-Panamax was developed in the late 90s to increase transport efficiency without using the Panama Canal. The maximum size quickly expanded from 6,600 to 9,000 TEU. 

As of today, they represent 30% of the global fleet by capacity.

Then came ultra-large container ships that extended drought and beam up to the limits of the Suez Canal and brought capacities beyond 10,000 TEU. 

Currently, ULCS is considered to be beyond 15,000 TEU.

In 2017 came the first ship with an official capacity of over 20,000 TEU, christened by Samsung, and at the end of 2019, the largest ships were a series of 11 MSC ships with a capacity of 23,700 TEU each.

As of 2019, the container fleet is estimated to reach c. 23 million TEU in a total of roughly 5,500 ships. 

Container Terminals

Maritime container terminals tend to be part of a larger port, and the biggest maritime container terminals can be found situated around major harbors.

It is common for cargo that arrives at a container terminal in a single ship to be distributed over several modes of transportation for delivery to inland customers. 

Both maritime and inland container terminals usually provide storage facilities for both loaded and empty containers.

The bulk of the busiest container ports of the world have moved from Europe to Asia which currently has all top 10 container ports by volume of TEUs, according to the World Shipping Council. 

The largest one is the international port of Shanghai with 42 MTEU in 2018, way ahead of Rotterdam in Europe (14.5 MTEU) or Los Angeles in USA (9.5 MTEU). The second and third are Singapore (36.6 MTEU) and Shenzen (27.7 MTEU).

Demand For Container Shipping, The Shippers

The container serves the need to transport manufactured and semi-manufactured goods which, compared to raw materials shipped in bulk, tend to be smaller parcels but with a higher value per parcel.

The more efficient transport is, the more global manufacturing clusters develop, and even more, transport is generated to take profit from the specialization advantage. 

The big gain for shippers in container ship cost came in the early 80s after truck and train sectors were deregulated. This made them turn their head to the cartel-like sector of the carriers.

From the start of that decade to its end, freight rates plummeted globally, as much as 70% to 90% depending on the routes, despite world trade tripled in the same period.

As published by UNCTAD, a total of 1,935 million tons were loaded in containers in 2018. 

Economic growth remains the more significant factor explaining current growth in containerized trade volume since freight rates reductions and global specializations trends have exhausted or diminished their torque.

Any inefficiencies in the container industry itself that led to increases in freight rates or, more importantly, any induced inefficiencies in global trade that eliminate part or all of the competitive advantages of global manufacturing clusters could exert a negative pressure in seaborne trade and container seaborne trade in particular.

The Liners, Trends and Drawbacks

Liner companies, or carriers, provide global transport for cargoes that are too small to fill a single ship and need to be grouped with others for efficient transportation. 

Ships operate a regularly scheduled service between ports, carrying cargo at fixed prices for each commodity. Obviously, the management of that business is more complex than the bulk fleet operator and the required skills and organizations are quite different.

The routes can be grouped into three types:

1. The East-West routes, that is transpacific, transatlantic, Europe to Far or Mid-East, North America to Mid-East, and Far to Mid-east.
2. The north-south trades Europe, North America, and the Far East to southern hemisphere markets.
3. The intra-regional trades within Europe, Asia, or North America.

Main Trends 

Liners have to decide which routes and services to operate, which ships to use and whether to own or charter those ships or to hire space with another liner. The main trends in the liner industry in the last decades are

1. Concentration. At the beginning of 2006, the four largest container shipping companies controlled 46% of the market in terms of TEUs, while as of the end of 2019 this is estimated to be 60%.
2. Differentiation between larger and smaller fleets. 
3. Use of global alliances for full integration of service capabilities. They have made it possible for smaller players to get access to big ships.
4. Vertical integration of carriers in the logistic chain.

Drawbacks 

All these trends point in only one direction which is economies of scale or cost reduction. But there are some drawbacks to this never-ending trend:

• Decreasing returns from port investments to accommodate for the higher share of trade done in larger ships.
• Increasing problems linked to this growth concentration in larger ships. Routes, where these ships are profitable, are limited, essentially Asia to Europe routes, so prices for those routes suffer significantly creating added concentration and container congestion issues in the few ports that can handle such huge ships.
• Increasing demand for feeder services as bigger vessels cannot call at many ports and the ones they can call are becoming increasingly over-busy.
• For economies of scale to be delivered those ships need to be filled up which puts pressure on larger ship operators.

Ownership

For each kind of marine transport (bulk, specialized, or liner transport) there is a primary fleet owned by the operators and a secondary fleet that is hired from independent ship-owners who only own the ships to charter them out without operating them directly.

In the case of the container fleet, close to 55% of the fleet is the property of non-operating owners and the rest is owned by the liners.

Ship-owners invest in a new or second-hand ship and try to get as much return from it as possible by chartering it to the liners for the maximum time and maximum rate possible.

Owners can buy ships in the second-hand market or more usually, especially in boom times, they can order new-builds to the main shipbuilders. They can buy speculative, with no charter in place for the new boat, or not.

Key Ownership Issues

Ship-owners can sell their ships in the second-hand market and they can sell it for the scrap value for demolition. Owners manage essentially three key issues:

1. The fleet. Its characteristics, like ship type, age, technical improvements, or Capex programs, and so on. Increasing or reducing the fleet. They manage this with new ships, either used or new, and trading the ships already in the fleet.
2. The contract charter portfolio. Managing the renewal of existing contracts and choosing the different alternatives that the market might provide at each moment in relation to rate level and charter length.
3. The debt portfolio linked to the fleet. Most owners finance most of its fleet with debt directly guaranteed by each vessel. Expansion decisions are easier to make then financing is abundant and cheap but that is typically when other owners might do the same thing. 

Understanding where the cycle is and where is it moving to is a key management skill. Finding its own way to play it and avoid going where everybody is, by staying one step ahead of the competition, is crucial.

The Shipping Cycle 

The shipping sector is characterized by intensive cycles, long and short in nature. The same factors appear time and again but rarely in the same way as they are not driven by a single economic model.

A cycle is created when supply cannot immediately adjust to changes in demand. 

New ships take 2-3 years to become operative since they are ordered. When demand for transport grows, it puts pressure on freight rates increasing liner returns and creating incentives to increase their supply of transport capacity. 

As ships take time to be ordered and delivered, freight rates and charter rates might continue to increase despite the increasing order-book of new-builds.

Trade Volume And Freight Rates

World GDP has been in positive territory since 2009. After a strong rebound in 2010, it has been moving in a 3-4% until 2020 when the COVID hit. 

The latest estimates point to a 5% drop in 2020 followed by a strong recovery in 2021, in line with the 2021 fall, but it is still difficult to have a clear view on how fast the pull-back to pre-COVID levels will be.

Container trade growth tends to move along GDP growth with wider swings up and down. According to MSI, the forecast for container trade is -7.3% for 2020 and +10.7% for 2021.

So, in the container demand-supply cycle we are probably in the low part of the cycle, pointing more to recovery than to a continuation of the depressing scenario that has been in place since 2016.

Liner revenues and margins

This relatively positive situation can be confirmed by the evolution of revenues and margins of public liner companies. 

Even taking into account that the last two quarters have been affected by the pandemic situation, revenues and margins are considerably higher than they were three or just two years ago.

New-builds Order-book

Despite that new-builds order-book is at historically low levels, capacity continues to grow no matter how concentrated the sector has become. 

Order-book for new container ships compared to the total active fleet has never been lower than now, according to Alphaliner. 

If the maximum useful life of a container ship is roughly 25 years, the equivalent replacement rate is 4% p.a., so 10% implies a 6% net growth. 

Charter Rates

Looking at the time charter rates since 2000, after the great boom of 2005 rates decreased sharply in the following four years, reaching a trough by mid-2009. 

Since that trough, three smaller cycles have taken place: from 2010 to 2013, from there to 2016, and from there to 2019.

Charter rates are now slightly below the average for the last two decades, clearly above the trough levels of 2009 but also extremely far from the peak of 2005.

Growth In The Sector Post COVID

Most presentations of liners and ship-owner companies insist on the idea that the order-book of new-build ships is at historically low levels but that is only if you compare it with the almost crazy times before the 2008 financial crisis.

The reality is that the fleet in terms of available TEU continues to grow, even at only 4% to 6%, especially in the ultra-large segment. 

Once the COVID effect passes, growth will recover most of the lost ground, and that global trade will also recover to previous levels. 

There are two additional factors that allow for some more confidence, and which were not so present in the failed recoveries of 2011, 2015, and 2018:

1. The oversupply of capacity is more concentrated in the ULCS category. In that size type, there is less occupation on the routes they work (mostly Asia-Europe). Fleets are younger so oversupply will be persistent on this segment of the supply, putting some pressure onliners to avoid increasing fleet size too soon.
2. There is no easy equity access by fleet owners. Values are low, making it dilutive to issue new equity. 
3. Banks are not eager to finance either. The pain they have gone through with the sector since 2008 is not easy to forget. Companies are quite levered and unencumbered collateral for new debt is scarce. 

 

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Source: Seeking Alpha