Drewry: Riding the waves
Trade always seems to find a way, even in the most inhospitable conditions. Drewry’s latest Container Forecaster report, published at the end of September, revealed that world container port throughput confounded expectations in 2Q20 (and most probably 3Q20 too) to register a far smaller decrease than envisaged of around minus 8% year-on-year (as opposed to the anticipated 16% drop as published in June).
Not quite a full recovery then, but first half port throughput performance was sufficiently good enough for us to upgrade the annual global forecast for this year to minus 3.3%, up from minus 7.3% as given in June.
Similar to economic analysts, we have been backwards and forwards with this year’s demand outlook. It now seems that our interim update in May and the June reports were far too pessimistic.
So, where did we go wrong?
The relationship between GDP and container trade activity has been on a diminishing and inconsistent trend in recent years, but simple logic was telling us that given the seismic impact that the pandemic was having on the world’s economy that 2Q20 port handling was going to sink by a much larger margin.
Recall that in 2009 a one percentage point drop in the global economy translated into a near 10% contraction in global container throughput. Fortunately, that exponential multiplier effect has not repeated during this crisis.
We, along with most analysts, seriously under-estimated the addiction of Western nations to consumption, particularly when shielded from some of the harsh reality by huge government safety nets.
We assumed wrongly that populations, fearing long-term job security, would hunker down and limit non-essential purchases. It discounted the resourcefulness of human spirit when faced with adversity and, perhaps more tellingly, the untapped potential of e-commerce.
Involuntary savings gained from restrictions to commuting, holidays, entertainment and fuel costs were instead used to purchase consumer goods, all just a click of a button away.
Physical goods, such as home office and gym equipment, were suddenly back in vogue, a complete reversal of the recent trend favouring services.
Carriers’ capacity management programmes also generated some additional traffic. Blanked sailings or suspended services during the second quarter led to more transhipment taking place with all its wonderful double-counting properties.
Restocking inventories and fast forwarding some orders due to second wave fears have seen volumes swell not only on the East-West trades but also in the North-South corridors. Container handling is expected to still record a small decline between July and September as the spread of the virus has lagged behind in parts of the globe, but it should reach a breakeven point in the final three months of the year.
While we are certainly more optimistic about the market’s outlook than three months ago, it is difficult to shake the nagging feeling that some of the recent upturn in container traffic is built on less than solid foundations.
The virus is still the number one risk to our forecasts and it remains weighted to the downside, with a second-wave outbreak having the potential to shatter the fragile economic recovery, with consequential impact on global port handling.
Many of the state support programmes have been extended into the winter months but, once governments start to unwind these schemes, unemployment could rise steeply and reduced household disposable income would dampen consumer purchasing.
Equally, once entertainment activities fully resume there could be less discretionary spending on goods. It is also not clear how much frontloading is taking place via stockbuilding, which may be concealing a vacuum of cargo at some future point.
This year, ocean carriers have controlled capacity more tightly than in previous crises and were able to secure very high load factors, very high rates and lower costs.
Some carriers say that they have “learnt a lesson” during the COVID-19 crisis about how to manage their business in times of volatile demand. This could have long-term repercussions on carrier resilience and profitability in what is normally a cyclical, boom-and-bust business.
Drewry estimates that the industry secured an operating profit (EBIT) of around $3.5 billion and margin of 7.7% in 2Q20, easily the best quarterly performance in many years.
Drewry anticipates that 3Q20 will set an even higher water mark for carrier profitability given the rapid inflation in spot rates during the period, before subsiding a little during a slower 4Q20 season.
Following meteoric third-quarter spot rate increases, we have upgraded our guidance for industry-wide operating profit in 2020 to $11 billion, up from $9.2bn as forecast in the June edition. This would represent the industry’s most profitable year since 2010 (c. $20 bn).
The major influences driving the recent amazing freight rate increases are, in Drewry’s view:
- The higher level of concentration of the ocean carrier industry, combined with new, tighter capacity management discipline among carriers;
- Unexpectedly strong demand in North America and Europe, partly on account of replenished inventories;
- A seasonal rush to bring in cargoes before Chinese factories close for the Golden Week holiday at the start of October;
- Limited container inventory stocks in Asia, not helped by service disruptions (blank voyages etc.)
- It is difficult to apportion weights to these factors and how they interact with one another, but the true test of carriers’ discipline will come when these exceptional circumstances caused by the pandemic recede and the more traditional supply-demand dynamics reassert themselves. Drewry expects this commercial discipline to sustain, but there remains some risk that the resolve wavers and one or more players break ranks and take rates lower.
Another major risk is regulatory oversight. We warned previously that posting bumper profits during a pandemic could raise the hackles of cargo owners and draw unwanted attention from regulators, and lo the industry is now on the watch of China’s Ministry of Transport (MOT) and the US Federal Maritime Commission (FMC).
Thus far authorities have refrained from imposing any hard rules, but a number of carriers immediately withdrew Transpacific GRIs and reinstated planned void sailings for October.
This places carriers in a very tough spot. Any loss of operational autonomy would put them at the mercy of the highly unfavourable supply-demand fundamentals and it is unlikely that they would find such heavyweight supporters to plead their case if rates fell sharply. In the meantime, lines will somehow have to carefully navigate a path to ensure they stay profitable, but not “too” profitable.
Container trade has so far proved quite resilient as consumer confidence has been given a shot through government support. Next year is still highly unpredictable and the hoped-for V-shape recovery is starting to look overly optimistic.
We think carriers have realised the opportunity that COVID-19 has given them to buck the underlying supply-demand pressures, but that they ultimately will not be allowed to fully deploy those tools in the future.