Where is the container shipping industry headed?
I was invited to speak at a panel on container shipping at the Bloomberg Intelligence Shipping Seminar. Rahul Kapoor, Asia Pacific Transportation Analyst, Bloomberg Intelligence fielded the following questions.
Rahul: From billions of dollar in losses over the last few years, the operators will reverse course on profitability and are set to make billions in profits in 2017. The rather downbeat tone of the industry has given way to renewed optimism and most are expecting much better years ahead. This has been one the best peak season in recent years. What changed? Is it consolidation, capacity, demand? If you were to highlight the single biggest factor that led the market to look so different in 2017, what would it be?
Jason: If we had reviewed the data every year in the past 5 years to make a guess on the freight rates, I would say that we would be wrong most of the time. Looking the industry from a pure data perspective neglects an important factor: The behavior of the individual shipping line. Between the alliances, the shipping lines would compete for cargo. This applies even to alliance members. This year, with the introduction of Ocean Alliance and the mergers (CMA-CGM acquiring APL, Maersk acquiring Hamburg Sud, Cosco acquiring OOCL) has resulted in market consolidation. While the demand and supply of shipping capacity have indeed improved, I would suggest that the key word here is “discipline” The shipping lines are maintaining the freight rates at sustainable levels instead of using pricing as a mechanism to gain market share. The collapse of Hanjin Shipping in 2016 has resulted in a flight to safety by shippers who are willing to pay more to avoid a similar situation.
Rahul: On the demand side, some of the latest trends on demand-side indicate a very strong recovery from depressed levels, trade to GDP multiples having being depressed for last few years are back above trend, volume growth is above 5-6%. Is it sustainable or likely to dissipate as inventory buildup and restocking phase nears completion? What is the long-term outlook for demand and is sea-borne trade decoupling from economic growth?
Jason: Demand has indeed improved in the past 6 months which is largely sentiment driven. The bullish outlook from container shipping lines has reinforced this view. We polled trade analysts on their trade growth forecast at the start of 2016Q1 and found that everyone we forecasting 1 X of GDP. This forecast was largely biased due to the negative outlook provided by the shipping lines who sensed that the demand was not sufficient compared to the supply growth. By the start of 2017, the forecasts turned bullish and we are now seeing 1.5-2.0 X being discussed. Our view is that buyers and producers adopted a “wait and see” approach in 2016 and committed to orders in 2017 when the sentiment improved. Thus, the trade fundamentals have not really changed. We are of the view that a more realistic forecast would be 1.2-1.5X GDP, depending on the structure of the country’s economy.
The other key development to note is the change in trade patterns. Firstly, the Far East-Europe trade has changed to one where China is exporting raw materials to Southeast and South Asia as well as Turkey. These get made into finished products which are then shipped to Europe. Secondly, China has been growing their domestic demand since 2009 to soak up the production capacity when demand from Europe and North America declined. This had a dampening effect on trade growth
Rahul: Turning to supply, the big ship orders are back after a period of 2 years. We have had a new order of 22,000 TEU ships, the largest ever and another major carrier is likely to embark on another big order. Why rush to order when enough capacity remains available?
Jason: This could be partially triggered by Cosco’s acquisition of OOCL and charter of PIL vessels. This would put them close to 3rd in terms of tonnage. Given that this is a boom year for the shipping lines, CMA-CGM ordered the 22,000 TEU vessels to maintain their market position and MSC did likewise. Maersk Group has a difficult year having reported losses at APMT in Q2 and the oil and gas unit affected by the decline in oil prices since 2014. While they have acquired Hamburg Sud, they have now sold their oil and gas division. It is not impossible that they could place new order to maintain their market position.
It is worth noting that while vessel capacities have increased since 2007, ship size (dimensions) have remained largely unchanged. Emma Maersk is 14,000 TEU at 397m length and 58m wide. The Triple E Maersk (18,000 TEU) and new CMA-CGM orders (22,000 TEU) are 400m by 59m. Shipyards are not able to increase the standing slots without increasing the dimensions. This would mean a longer and wider vessel. The difficulty of such a vessel would be the port infrastructure would need to be upgraded to handle the wider vessels. This would mean a number of ports which were built in the last 10 years would need to be upgraded or risk being left behind. It would probably require shipping line(s) which operate sufficient terminals along the Far East-Europe to be the first mover.
Rahul: We have seen M&A activity within the industry in the past year. Do you foresee this continuing?
Jason: Shipping lines used to be thought of as sovereign assets for countries to ensure trade flows. It is now recognized that trade can continue uninterrupted without a national carrier. This is why APL was sold to CMA-CGM. In terms of M&A, there would be interest for further consolidation but it is difficult to see who would wish to sell.
Rahul: Would the industry continue to make a profit?
Jason: Shipping cycles have gotten shorter. I would say the industry would probably do well in the next 6 months. Anything beyond that is crystal ball gazing. It would depend largely on the discipline of the shipping lines to maintain a sustainable freight rate. A key issue is that there are hardly any barriers to entry to the industry. Hanjin Shipping stopped operations in 2016 and another shipping line took its place.
Rahul: Thank you for joining us!
Source: Jason Chiang, Director at Ocean Shipping Consultants