Will 2017 mark the turning of a page for trans-Pacific container shipping, with an end to the near five-year stretch of slowing demand growth, worsening overcapacity and unsustainable freight rates? The short answer is, apparently yes. At least for now.
Container lines finished 2016 moving some 7 million 40-foot containers (FEUs) of freight for the year, up 3.8% from 2015. The National Retail Federation (NRF) similarly reported a 3.2% gain in containerized retail imports from all markets in 2016.
Most 2016 cargo growth came in the fourth quarter, versus flat or declining quarterly numbers during the rest of the year. Demand has accelerated into early 2017, with surprisingly little falloff leading up to the Lunar New Year holidays and the week-long closure of Asian factories at the end of February. NRF forecasts 4.6% containerized retail imports growth in the first half of 2017; JOC-PIERS forecasts 4.8% growth for the year.
Several factors contribute to persistent growth in the early months of 2017:
- Unemployment in the U.S. remains low, as average wages rise more quickly, adding to consumer confidence.
- A strong dollar increased Americans’ purchasing power and favored imports.
- A post-election rally in the U.S. stock market, based on heightened prospects for tax and regulatory reform, and repatriation of corporate income earned overseas, has added to households’ net worth.
- Despite revenue erosion from discounting, holiday sales volumes were strong, helping to work down old inventory and allow re-stocking. Holiday sales were extended into January by gift cards and returns.
Larger ships have steadily cascaded into the Pacific, but carriers have been able to optimize their networks through M&A and vessel-sharing alliances. Twenty major global carriers are to become 14 this year, and four major alliances have shrunk to three. Congestion from terminal consolidation and increased network operational complexity have disrupted schedules and caused temporary space and equipment availability issues. And all of these challenges were made worse by the seventh largest global carrier filing for bankruptcy.
Shippers and carriers thus head into the 2017 trans-Pacific service contracting season facing a very different environment than a year ago.
A round of new vessel orders was timed in 2013 to take advantage of low interest rates, concessionary shipyard terms and scheduled completion of Panama Canal expansion in 2015. The orders for larger ships assumed long-term trade growth, but also aimed to lower per-slot operating costs through increased fuel efficiency and comply with new international standards for reduced vessel emissions at sea and in port.
Once the Panama Canal was widened to accommodate ships up to 14,000-TEU in size, it would be possible to replace 4-5,000-TEU Panamax ships in nine-ship services, with 10-13,000-TEU ships in five-vessel rotations at lower cost.
Construction delays threw off the timing, however, as mega-ships on order were delivered into the Asia-Europe and intra-Asia markets. New ships cascaded into the Pacific were forced into U.S. West Coast and Suez deployments where ports could accommodate them. Cargo demand, meanwhile, was stalled. The resulting overcapacity drove short-term rates to the West Coast to record lows by mid-2016.
Carrier operating profits had already been at zero or negative for most quarters since 2011. They had canceled specific port calls and entire service strings, slow-steamed to save on fuel costs and keep excess capacity operating, blanked individual sailings, centralized customer service and documentation functions and formed alliances to extend their combined service reach with fewer vessels.
As the widened Panama Canal has opened, carriers have scrapped Panamax ships- some less than 10 years old- to prevent their redeployment at bargain basement charter rates by new market entrants. Some 200 ships, mostly Panamax and smaller representing 699,000 TEU, were scrapped in 2016, up from 187,000 in 2015. Even after charter returns, delayed deliveries and scrapping, a net 1.4 million TEU in new capacity, 78% of it in ships 10,000-TEU or larger, is scheduled for 2017 delivery.
Various estimates, meanwhile, place 2016 operating losses for the top 20 global carriers in the range of $5-13 billion.
Few container lines operate as stand-alone entities. Most either operate within trade or shipping conglomerates, or as government-subsidized entities that generate hard currency and support home country exports and/or shipbuilding. While it is relatively easy, with patient capital, to enter the liner shipping market, it is harder to leave without serious impacts for customers and investors. This has, over time, created a market perception that large container lines are too big to fail- until 2016, and Hanjin.
The Korean carrier’s August 31 bankruptcy filing stranded 66 of its 97 containerships at sea, carrying $14.5 billion in freight- as many as 540,000 TEU, according to Korean government estimates. Hanjin’s market share was 3% worldwide and 7% in the Pacific.
With an estimated $155 million cost to unload stranded cargo, ships remained at anchor, first out of fear they would be seized and later as terminals, truckers and cargo handlers feared they would not be paid.
When a U.S. bankruptcy court extended protection to Hanjin ships in port, new problems arose. Loaded containers were stranded in port, incurring per diem charges, with shippers arranging truck pickups; empty Hanjin containers were stranded at terminals and inland destinations; equipment lessors had to make separate arrangement to retrieve chassis.
According to Alphaliner, 34 Hanjin-operated ships in the 7,000-13,000-TEU range were idle at the end of 2016; 28 of those were chartered ships redelivered to owners.
Hanjin was by no means alone in terms of its financial challenges. Its primary lender, Korea Development Bank, simply made a business decision to reject a further debt restructuring proposal for the line. Many traditional bank lenders by that time were also extricating themselves from ship finance. KDB’s decision, more than any other factor, sent shipping lines and their customers a wake-up call.
China GDP growth slowed for the sixth consecutive year in 2016 but yearend shipments have picked up. North-south Asia trade ex China has remained strong, and Southeast Asia takes market share in lower-end manufactured exports to the U.S. and Europe as China focuses on its domestic market and production costs rise.
The typical falloff in cargo surrounding the Lunar New Year holidays has been less pronounced than in past years, suggesting business and consumer momentum for a strong first half. But optimism is based on expectations of U.S. tax and regulatory reform, including repatriation of foreign-earned income, which will lower costs and jumpstart new investment and hiring. Under current reform scenarios it is far from clear whether or to what degree trade will benefit.
Given that health care reform tops Washington’s priority list and serious differences remain about how best to balance tax cuts and revenue, Congress may not complete tax and regulatory reform before 2018, with benefits to follow months later. Also, major uncertainties surround U.S. trade policy, from abandonment of the Trans-Pacific Partnership, to the heightened potential for trade disputes, to VAT-like taxation of U.S. imports at the water’s edge.
Companies importing finished goods and inputs will likely bring forward those shipments and carry the added inventory as a precaution. That suggests strong overall growth, unevenly distributed, throughout 2017. After that, prolonged tax and trade policy uncertainty could reverse optimism and confidence quickly.
For shipping lines the choices going forward are clear: Revenue is critical. Successive rate increases have held as carriers have responded to financial pressures and improved demand. Short-term rates have risen in response to tightening space and the Hanjin collapse. There is no maneuvering room left for rolling over existing contracts at last year’s rates, for less than full recovery of fuel
costs, or for giveaways on equipment-related charges. Too much is at stake,