Seeking Rate Stabilization

If freight carriers needed another reminder of just how slight their market power is in the face of weak demand and plentiful capacity, the reaction of shippers to the announcement that Maersk Line will rejoin the Transpacific Stabilization Agreement, giving the carrier group control of more than 90 percent of the capacity in the Asia-U.S. trade, was telling.

Shipper organizations plan no formal complaint to the Federal Maritime Commission, the agency charged with ensuring robust competition in U.S. ocean trade. "We'll watch it," was about as much heat as Peter Gatti, executive vice president of the National Industrial Transportation League, could muster in response to news that the world's largest shipping line was rejoining the carrier discussion group.

The National Customs Brokers and Forwarders Association of America was all but dismissive. "If you like antitrust immunity, it's fine," said Ed Greenberg, the NCBFAA's transportation and general counsel.

The forwarder group certainly does not believe carriers should have immunity from antitrust laws. But apparently allowing the emaciated carriers a 90 percent share in the largest U.S. trade lane is little cause for concern only a few months after shippers responded sharply to carrier requests for antitrust immunity to collectively reduce capacity. In a shipping world where spot ocean rates remain more than 25 percent below year-ago levels by some estimates, where domestic trucking rates have fallen more than 10 percent this year, and where the peak season passed with barely a ripple, consolidated market power doesn't carry the weight it once did.

Maersk's return to the TSA and the muted shipper reaction show how the financial pain in all corners of the economy is changing the way carriers and shippers address rates and relationships across the transportation world. With the shipping downturn heading into its second year, the TSA last month started pushing its peak-season recommended rate increases for 2010, and APL told customers it wants to go back into already completed contracts to make up the difference between what the carrier received and what it needs to return to profitability.

The rate equation is a major reason domestic truck shippers and competitors are grading the survival prospects for the United States' largest industrial trucker, YRC Worldwide, and looking for new price competition as a result of a pact between the country's largest railroad, Union Pacific and intermodal marketing giant Pacer International.

Ocean carriers are trying to take a long view toward the future because the near term looks so grim.

After capacity cuts and "rate restoration" announcements picked average rates off historic lows in the middle of the summer, average weekly rates measured in Drewry Shipping Consultants' Container Rate Benchmark have flattened and slipped back as business in the meager fall season has waned. At $1,304, the average spot rate for Hong Kong-to-Los Angeles transit for a 40-foot container during the second week of November was down 12.2 percent from the mid-September high, according to Drewry.

That's a spot rate on one lane, but it's a reason carriers are focused so sharply on the longer-term contract rates and the industry structure for setting pricing guidelines.

Facing severe overcapacity and a 10 percent decline in cargo volume, ocean carriers have little pricing power this year, and many believe prospects for rate increases in 2010 look equally bleak across the supply chain. Historically, even when supply and demand in eastbound Pacific lanes were in balance, shipping lines rarely used cartel powers to increase freight rates to the level the TSA suggested in the "voluntary guidelines" it announced each year.

The FMC will review the ocean agreement, which it received Nov. 9, and take comments from shippers and carriers. The commission will analyze the implications for market share and capacity. If there are no serious challenges and the commission believes competition will be preserved, Maersk will officially become a TSA member on Dec. 24 after a 45-day comment period.

Maersk was a TSA founding member line in 1989. However, the Danish carrier pulled out in 2004, saying the discussion group, which has no enforcement powers, was unable to provide stability for trans-Pacific trade lanes, especially when freight rates entered a periodic cycle of rapid decline.

And the TSA, like the rate-setting conference known as the Asia North America Eastbound Rate Agreement that preceded it, had a confrontational approach in dealing with shippers. Whether the TSA recommended a large or a small increase in rates, the announcements appeared to importers to be abrasive and detached from market conditions.

The TSA changed its approach in 2007 when the chief executives of its member lines took control of the discussion and research group and held outreach sessions with cargo interests in order to generate a frank discussion of issues.

That new attitude caused Maersk to take a second look at the TSA. "Our customers are telling us TSA is taking a refreshing approach," said Lars Mikael Jensen, vice president of the Pacific at Maersk.

Of course, a decline of up to 50 percent in eastbound freight rates in the Pacific over the past year and a 10 percent drop in containerized imports even as carriers continue to take delivery of new vessels also played into Maersk's decision. "What happened the past 12 months was completely unheard of,"Jensen said.

By rejoining the TSA, Maersk intends to foster stability in the Pacific, for shippers as well as carriers, so both parties can position themselves for a rebound hoped for in 2011 and certainly no later than 2012.

For one shipper, the move is an unambiguous signal of carrier discipline on rates next year. "This is a foreboding sign for shippers who have 'sold' freight rates within their firms that are not sustainable," said the shipper, who spoke on condition of anonymity. "I'd expect a 25 percent uplift in rates with a year."

Carriers since late 2008 have attempted to stay one step ahead of the declining cargo volume resulting from the global economic recession, but the decline was so rapid that their efforts to cut vessel strings, form vessel-sharing arrangements and operate ships at slower speeds to reduce capacity were futile.

Vessel utilization plunged, and when this happens, carriers have followed only one course of action & protect market share at all costs. They launched a vicious rate war that caused rates to the West Coast to drop almost overnight from about $2,000 per 40-foot container in late 2008 to less than $1,000 this past summer, according to Drewry.

Although carrier-shipper contract rates are confidential, the TSA indicated the extent to which rates had fallen when it announced April 9 that its member lines would attempt to charge minimum rates of $1,350 per FEU to the West Coast and $2,500 on all-water services to the East Coast.

The announcement coincided with 2009-2010 service contract negotiations that had already started, and it proved ineffective. Carriers were in a panic, slashing the benchmark spot rate from Hong Kong to Los Angeles to less than $900 per FEU.

Carriers reached a new low, according to industry observers, when they began to adopt these money-losing spot rates as their contract rates for the coming year. In the container business, spot rates historically have been lower than contract rates. Like last-minute sales by airlines, they are intended to fill slots that would otherwise go unfilled.

Contract rates come with longer-term service commitments from carriers to customers. A spot rate simply tells a shipper, show up with your freight and you can get on the vessel if there is space.

While many shippers admit they were enjoying last summerÕs low rates, the service degradation that invariably accompanies less-than-compensatory rates has worn on many of them. Carriers had eliminated entire strings of vessels, making it especially difficult for shippers to plan logistics on lanes beyond highest-volume routes.

Retailers with extensive service requirements accused carriers of eliminating services to artificially prop up rates. Carriers responded by noting retailers, too, had scaled back in the economy by closing stores.

Then in August, carriers unilaterally and uniformly raised spot rates to almost $1,400 from less than $900 per FEU. Carriers then pulled another shocker by telling customers they wanted to renegotiate rates in service contracts with the ink barely dry on the agreements. While that fell flat with many larger customers, carriers were able to get sizable increases on cargo that exceeded their customers' especially low minimum volume commitments for 2009.

Although Maersk was not a member of the TSA amid the chaos, the company has never retreated when its market share was in jeopardy. Maersk was at least as aggressive in cutting its freight rates as its competitors were.

While the TSA with Maersk should be able to prevent rates from declining further, it is far from certain carriers can gain significant increases in service contract negotiations next spring. The TSA last month announced its voluntary guidelines for those negotiations that call for an $800-per-FEU increase to the West Coast and $1,000 on all-water services from Asia to the East Coast. While the proposed hikes are large in year-over-year percentage terms, they would barely bring most contracts back to 2008 levels.

The carriers argue that longer history and more recent attention to investments in operating efficiencies make the case for better returns. As an indication of how efficient carriers have become with their modern, 8,000-TEU vessels, a rate of $2,000 per FEU in 2010 dollars would still be only about half the $4,000 (in 1980 dollars) carriers were charging 30 years ago with vessels of less than 2,000-TEU capacity.

Whether shippers will listen, carrier executives remind them today's costly mega-ships have lowered their per-unit cost of shipping a container across the Pacific to a fraction of what it was in the 1980s and 1990s. There are still more than 100 vessels of 8,000- to 12,000-TEUs on order. Many deliveries have been delayed, but capacity in the major east-west trades will continue to grow through 2015.

In today's harshly competitive environment, shippers see no red flags on the Pacific demanding a challenge to the TSA. Greenberg said the NCBFAA traditionally does not challenge a line when it applies for membership in a discussion agreement. "I see no grounds for an FMC complaint," he said.

The NITL is prepared to respond if its members find that TSA lines, with their 90 percent market share, suddenly are ceasing to negotiate and are acting in lockstep with rate increases that are higher than warranted in today's market, Gatti said. Shippers want stability in the eastbound Pacific, and they expect rates will go up somewhat next year, especially if volume picks up. "We just don't want rates to stabilize at a level higher than what the market dictates," Gatti said.

Maersk is prepared to discuss its intentions with the FMC. "No doubt the FMC will ask questions. We obviously will answer those questions," Jensen said.

He said the company had already set the groundwork by telling its customers about the impending move. "The feedback was very positive," Jensen said. "From what I am sensing, there is support for having some industry structure back," he said.

But he also notes there are limits to what carriers can accomplish through the TSA. The FMC, for instance, has been clear in opposing any move by carriers to manage or manipulate capacity through group action. "I believe that capacity will regulate itself," Jensen said. "All regulatory stuff aside, the lines need to individually manage their capacity so it fits into their own system." 

Contact Bill Mongelluzzo at bmongelluzzo@joc.com.