Racing to the Bottom

A year ago, to the surprise of many in the ocean shipping industry, container lines drove up rates and restored profitability after sustaining an estimated $5 billion in industrywide losses in 2011. Eighteen weeks into 2012, the Shanghai Containerized Freight Index to northern Europe and the U.S. West Coast was up 165 percent and 33 percent. Pressure on rates later in the year hacked away at those gains, but rates ended the year up nearly 67 percent to northern Europe and 23 percent to the West Coast, and several carriers returned to profitability for the full year as a result.

This year, there was no spring rally. Eighteen weeks into 2013, the situation is strikingly different: Shanghai-to-northern Europe rates are down more than 37 percent since the beginning of the year, according to the SCFI. As of May 3, they had plummeted for seven consecutive weeks, losing 44 percent of their value during that stretch.

Rates to the West Coast, which have been consistently stronger than in the Asia-Europe trade, are down nearly 7 percent since the beginning of 2013, with little if any of carriers’ hoped-for rate increases incorporated into annual eastbound trans-Pacific service contracts that rolled over on May 1.

The alarm bells are ringing. Maersk Line CEO Soren Skou told Lloyd’s List late last month that the industry “is at the risk of a full-fledged rate war unless the industry comes to its senses.” “Where is the bottom for container rates?” Jefferies’ Johnson Leung asked in his most recent weekly update. “Arguably, there is still over 50 percent downside risk to the current Asia-Europe spot rates,” he said, adding, “We believe (the container sector) is unlikely to see sustainable fundamental improvement over the next 18 months.”

Leung estimates carriers’ average cost to move laden containers at $1,039 per 20-foot-equivalent unit, substantially more than the current spot rate of $796 per TEU. The takeaway? More losses are in the offing.

Little help is coming from the capacity side, because carriers are practicing little if any price discipline in the face of overcapacity. According to Alphaliner, 20 new ships capable of carrying 8,500 to 16,000 TEUs will enter the Asia-Europe trade by the end of June. Although scrapping primarily of 3,000- to 5,000-TEU ships with little remaining usefulness will hit a record 450,000 TEUs this year, total new ship deliveries in 2013 could approach the previous record of 1.57 million TEUs even allowing for deferrals, it said.

Some, but not much, capacity is being removed via skipped sailings, a tactic Skou told The Journal of Commerce’s TPM Conference in March would be increasingly frequent.

Referring to Asia-Europe, Alphaliner said, “Carriers have limited options to keep capacity in check, with the incessant deliveries of new tonnage hampering their ability to make any meaningful capacity.”

The fix carriers find themselves in has yielded some interesting advice. What allowed the carriers to rally in 2012? Fear is the most common explanation I’ve heard. The estimated $5.2 billion in losses rekindled recent bad memories of 2009 when, with its $20 billion in losses, the industry was truly staring into the abyss. It reversed those losses in grand fashion in 2010 when a surge in replenishment caused a squeeze in capacity and put the lines billions in the black, but the memories were fresh.

So what do the carriers need to do now? “Carriers should crash the rates,” SeaIntel President Lars Jensen wrote last week. “A deliberate rapid rate decline may be the way for carriers to become profitable in 2013.”

Carriers, he continued, “can try to limit the weekly rate erosion, thus limiting the added losses taken each week. However, this also prolongs the time until we reach the bottom of $500 per TEU and the scene is set for a drastic rebound. Conversely, if just one carrier was to aggressively lower rates each week, we would quickly reach the $500 mark and the subsequent recovery would appear much sooner.”

He said a mathematical modeling of rates points to a three-stage rebound once rates reach that trough, similar to how last year’s rebound played out.

Over two months, he predicts rates will rebound in a series of rate increases, first to $1,000, then to $1,500 then to $1,750, with dips in between as is typical of spot rate behavior between GRIs. His premise is that rates will only rebound once they reach a certain low threshold and that an upper limit of $1,750 can be maintained until mid-October when the peak season is over. “If these premises are correct, then there is no doubt that it would be in the carriers’ own interest to aggressively lower the rates, to force through the discipline associated with an unsustainably low rate level.”

Could this scenario play out? It’s certainly headed in that direction.

Peter Tirschwell is senior vice president of strategy at UBM Global Trade. Contact him at ptirschwell@joc.com and follow him at twitter.com/PeterTirschwell.

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