Increasing box rates will be necessary

Increasing box rates will be necessary

Carriers and shippers are heading for a contentious 2019, according to Lars Jensen from SeaIntelligence Consulting.

A traditional, simplistic, economic view would be that the price for any product is governed by supply and demand. If supply exceeds demand, prices drop. This could be either because too much product was made or because demand falls short of expectations. The remedy would be to remove some of the excess supply or stimulate demand by lowering prices. The customer would furthermore expect that if the quality of the product declines, so should the price.

None of this matches the reality seen in the container shipping sector – and carriers and shippers are heading for a contentious 2019 where the mechanism for rate increases have to agreed irrespective of supply, demand or service levels. Clearly not a message shippers like, or even agree with in many cases. But let us look at the underlying mechanisms leading to this outlook.

First supply. This is determined by the number of vessels available and the speed with which they move. They already move very slow and hence we cannot reduce supply much more using that approach. In other industries, a bankruptcy helps the oversupply by removing capacity. In liner shipping the vessels do not disappear – instead they are re-introduced in the market at even lower prices, as seen in the case of Hanjin where all the capacity was re-introduced within 6 months. Same thing happens by redeliveries to non-operating owners. Lay-ups then? The challenge is any carrier doing this unilaterally will take a loss, whereas competitors will benefit from the stronger conditions – not a sensible move for any CEO willing to keep his job. Avoiding this requires cross-carrier coordination, an action which is illegal and therefore also off the table. A few times we do see this happen locally – case in point is the transpacific in peak 2018 – but given the fungible nature of the vessels, such strength will be temporary and local.

Demand is for the most part inelastic. The freight rate accounts for a tiny fraction of the price of the goods being sold (with a few exceptions), and hence even large changes in freight rates do not change the underlying demand.

This has led to an inexorable downwards spiral for the carriers over the past decade. It can be argued that this is partially self-inflicted through excess ordering of ultra-large vessels, but irrespective of the cause, this is the state of the industry. It has left the carriers to be perennially loss-making when matching their cost of capital to their return on investment. This has led to an erosion of service levels, in turn reducing the shippers’ willingness to pay, further eroding freight rates.

Then we have the low sulphur rules. Present estimates place the cost at $11.7bn annually for the industry from 2020. Irrespective of whether one believes the past decade of overcapacity is self-inflicted or whether the declining service levels do not warrant increases, the fact remains that the carriers cannot absorb this added cost.

2019 will be the year where carriers will push very hard for these increases – and shippers likely push back equally hard. But failure to agree will plunge the carriers into such heavy losses in 2020 that we might well see a panic reaction similar to the one in the financial crisis of massive lay-ups and severe service disruptions. The shippers’ choice is therefore to either agree an enforceable way with the carriers during 2019 in which to take increasing fuel costs into account beyond 2020 – or await severe service disruptions in 2020 and have a solution pushed upon them.

This article first appeared in the just published latest issue of Maritime CEO magazine. Splash readers can access the full magazine for free by clicking here.

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1 Comment

  1. Thomas
    November 21, 2018 at 4:38 am

    Very well. The article tries to convince us that shippers should subsidy the carriers’ unwise practise of mass ordering of mammoth ships.No sir, this is not a free market. Carriers and their creditors should face the consequences of their own actions even if that means that the maiden voyage of their ships is from shipyard to demolition. In my opinion there will not be any serious disruption. The market will eventually find an equilibrium.