Year of the Sea Monsters

The term “unsustainable” has been used frequently for years in describing the container shipping industry; when it is, the eyes start rolling. Despite the persistence of rising costs, lack of profitability and slowing growth faced by the major container lines, the industry has, in fact, been quite sustainable. No major bankruptcies or mergers have occurred in nearly a decade, there has been plenty of new investment in vessels, and the portion of world trade moved in containers has been flowing without major disruption. 

But a day of reckoning is approaching. It’s not just that profits are elusive, with public financial information revealing just a 1.7 percent average profit margin over the past 15 years, according to Seabury. It’s that the efforts to control costs, primarily fuel cost, by building ever-larger ships are reaching an end game that will surely result in a more consolidated industry and a different pricing dynamic.

Accelerating growth in container ship sizesAccelerating growth in container ship sizes

The current model of the industry — to build ever-larger ships to lower unit cost but do nothing other than implement periodic rate increases to boost revenue — is unsustainable.

“For the last few years, we (carriers) have done everything possible to reduce cost — build large vessels that lower the slot costs, slow-steaming, outsource backroom functions, automate as many functions as possible, form super-VSAs (vessel-sharing agreements) to share assets and costs,” Liu Hanbo, president of Cosco Americas, writes in a commentary on page 82 of the JOC’s 2014 Annual Review & Outlook. “We’re getting down to the gun metal in reducing costs before these reductions start to affect a viable service.”

The headlong plunge by carriers into ordering and operating mega-ships as a cost-saving measure is the main factor driving the industry to the breaking point. Fifty-seven ships of 10,000 TEUs or more will be delivered in 2014 compared with 36 delivered in 2013, according to Jefferies. This will mean capacity growth globally will accelerate to 7 percent in 2014 from 6 percent in 2013.

Ships aren’t just getting bigger; they’re also getting bigger at a faster rate. Carriers aren’t evasive on the reasons for building larger ships. The order by United Arab Shipping in August 2013 for five ships of 18,800 TEUs and five of 14,000 TEUs “is about having low unit costs, and one way to get that is by using bigger and more fuel-efficient ships,” CEO Jorn Hinge said.

But the measures carriers are resorting to in order to keep up the pace on cost-cutting are approaching the extreme. The proposed P3 alliance that will include half of all ships of 10,000 TEUs, and that regulators still had to approve as of this writing, shows the lengths to which the world’s largest carriers will go to ensure they have access to the largest tonnage available and thus the lowest per-container costs of transport.

This will prompt an arms race by other alliances to narrow the gap in ship size. The larger size of the P3 ships will “widen the margin between the P3 operators and the rest of the field. Asian operators may have to take action to counter P3’s scale advantage,” Jefferies’ Johnson Leung said. Amid this environment, it will be harder for the weaker lines to hang on, increasing strains between the carriers and the national governments that provide varying financial lifelines to their carriers. “The industry may finally see its first major merger since 2005,” Leung said.  

Peter Tirschwell is executive vice president/chief content officer at JOC Group. Contact him at ptirschwell@joc.com and follow him at twitter.com/PeterTirschwell.

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