When Union Pacific Railroad’s intermodal volume slipped 1 percent in the second quarter, including a 2 percent drop in international containers, barely a ripple of concern or financial pain fluttered through North America’s largest railroad. That’s because revenue per unit jumped 14 percent over 2010’s second quarter, a demonstration of pricing power in the U.S. shipping market that spread throughout the railroad industry.
Over that same second quarter, Singapore-based container shipping line APL rode improving global trade demand to its strongest volume ever, 58,000 weekly 40-foot equivalent units, a 7 percent improvement over the year before. But the ocean carrier’s average revenue per FEU fell 9 percent, just one in a series of pricing setbacks shipping lines reported in releasing financial results for the quarter ending June 30.
The divergent results in the most recent quarter provided a stark example of how the major transportation channels serving supply chains are coping with weakening demand as they compete for a greater share of shipper spending in the coming peak season.
U.S. railroads are increasing their intermodal rates and reporting healthy profits. Truckload capacity across parts of the country is tight, but motor carriers are expanding cautiously in order to protect their profit margins.
But the ocean carriers have responded to weaker-than-expected cargo volume for much of the year by returning to rate-setting policies that have proved near ruinous in years past. The lines increased vessel capacity 9 percent in the first half of the year, which sent freight rates on the spot market down to the lowest level in 20 months.
With rates on some lanes down by double digits — Japanese carrier MOL said in its second quarter report that Asia-Europe rates declined 30 percent in the fiscal quarter ending in June even though volume on the route increased 13 percent — several container lines are preparing for financial losses in the second half of the year.
On the surface, it’s another lesson that placing high utilization rates and market share ahead of profitability is a money-losing proposition.
Carriers, however, had expected volume in the eastbound Pacific to increase 6 to 9 percent, and they increased capacity accordingly. That sent rates spiraling. In the week of Aug. 1, the spot rate for shipping a 40-foot container from Hong Kong to Los Angeles stood at $1,525, according to Drewry Shipping Consultants’ Container Rate Benchmark. That was a 52-week low, and was 46 percent lower than the rate in August 2010.
Contrast that pre-surcharge behavior with the intermodal revenue-per-unit numbers reported by North American railroads in the second quarter. Rail revenue increased between 4 and 14 percent over the same period last year.
Jack Koraleski, Union Pacific’s executive vice president of marketing, told investment analysts UP was able to shed some of its legacy contracts with customers and reprice those services to bring revenues to “re-investable levels.”
The truckload industry suffered deep losses during the recession, which for that industry began in 2007. In addition to laying up trucks and slashing orders for new ones, motor carriers lost more than 330,000 drivers, according to the Bureau of Labor Statistics. Freight volume picked up in 2010, and truck capacity tightened.
But motor carriers remain cautious about increasing their capacity, ACT Research’s Kenny Vieth says. They are more interested in rebuilding profit margins than carrying more freight for the sake of carrying more freight. Even if freight surges later this year or in 2012, a “capacity shortfall” would result because it would take motor carriers several months to rebuild their fleets.
Less-than-truckload carriers also are concentrating on profits.
A 9.5 percent increase in yield — a combination of pricing and fuel surcharges — helped LTL carrier ABF Freight System return to profitability in the second quarter after 10 consecutive quarterly losses, but that didn’t satisfy Judy R. McReynolds, president and CEO of the parent company Arkansas Best. “The progress made so far does not produce sufficient returns for our shareholders, nor does it allow us to adequately recapitalize the business,” she said.
ABF Freight is going back to customers for more. “Further profitability gains should result from improved pricing on ABF’s existing account base,” she said.
Shipping lines were able to manage capacity in 2010, but they benefited because vessel space was unexpectedly scarce after many carriers reduced capacity during the 2008-09 recession to stave off bankruptcy. When demand spiked in 2010, the lines were slow in returning ships to the major trade lanes. They also experienced a severe shortage of containers because container manufacturers in China had slashed production.
The result: Freight rates in 2010 increased much of the year, and the spot market peaked last August at $2,838 per FEU.
But slowing economies in Europe and the United States, along with weakening consumer sentiment and lighter industrial production, arrested the momentum carriers expected after the Lunar New Year.
The first casualty was the $400-per-FEU peak-season surcharge many carriers sought to implement in June. “It was bad timing,” said Ben Hackett, who publishes the Global Port Tracker along with the National Retail Federation.
However, rather than lay up vessels, they continue to take delivery of new ships. Carriers are scheduled to increase their global capacity 9 percent a year from 2011 through 2013.
Railroads, by contrast, have parked unneeded well cars and locomotives and matched new orders to intermodal volume. Industry analysts also note railroads have benefited from strong domestic intermodal traffic for much of the year as high fuel prices motivate shippers to shift freight from over-the-road to intermodal.
Motor carriers are picking up the pace of orders for new trucks, and manufacturers are struggling to keep pace with the orders, but truckload carriers are using the tight capacity situation and driver crunch to seek freight rate increases of 5 to 7 percent in preparation for the holiday shipping season. Shippers say the motor carriers may not get all they are seeking, but rates likely will increase along with volume this fall.
LTL carriers already have signaled they believe they have a strong hand for raising rates.
Since UPS Freight announced a 6.9 percent general rate increase in late July — an unusually large price hike at an unusual time of year — virtually every publicly traded carrier has fallen in line with the same increase. Only rival FedEx Freight broke ranks, if a 6.75 percent increase can be termed breaking ranks.
Still, the competitive dynamics in the ocean transportation environment are far different from those in trucking and rail. An international industry with almost no barriers to entry, ocean operations can lure foreign investors seeking a quick profit to move quickly into a trade when freight rates are favorable.
Last year, niche carriers chartering small, 3,000-TEU vessels at favorable rates began services from China to Los Angeles-Long Beach. The lines getting in early enough were able to undercut market rates and fill ships.
The bonanza for shippers was short-lived, however. When freight rates began to drop late last year, the carriers found the higher unit costs for smaller ships made for rough financial waters. This year The Containership Company went out of business, Chile’s CSAV dropped its trans-Pacific service to Southern California, and Matson Navigation discontinued one of its two China services.
With so many shippers now tied to the spot market, they’ll be watching how carriers respond when volume picks up this fall. Global Port Tracker predicts container volume will remain flat through August and then increase 10.4 percent in September, 8 percent in October, 6.2 percent in November and 3 percent in December over the same months last year.
Carriers are sending signals of resolve. The Transpacific Stabilization Agreement, which represents 15 carriers in the import trade from Asia, implemented its $400-per-TEU peak-season surcharge on Aug. 15 after a two-month delay, and rates on the Drewry benchmark promptly jumped 21 percent. The TSA also projected new confidence in demand. Carriers have seen “more robust forward bookings and other favorable market signals,” TSA Executive Administrator Brian Conrad said.
That resolve may be finding its way into the market. The SCFI Shanghai Containerized Freight Index was inching up week-to-week in the major east-west trade lanes in August, including 3.5 percent expansion over a month earlier in the deeply discounted Asia-Europe lanes.
Still, with economic headlines so negative, it may be too late to salvage the peak season, Bingham said. “I see no rebuilding of inventories in the works for later this year,” he said.
Retailers are more optimistic. “Cargo figures for this fall clearly show that retailers are expecting a healthy holiday season,” Jonathan Gold, vice president of supply chain and customs policy at the National Retail Federation, said in the Global Port Tracker.
The more important focus may be on how carriers manage capacity after the peak, however, because that will be crucial to their financial performance this year and next. Some carrier executives predict that after keeping an unusually large number of vessels in operation late last year in anticipation of an early Chinese New Year break, there will be an “early winter” in the industry this year.
Shipping lines normally lay up some vessels or dry dock them for maintenance when freight volumes decline after the Christmas holidays. This year, the slightest indication that peak-season volumes will fall short of expectations could lead to vessel layups before the holidays. Research analyst Alphaliner predicts idle container capacity could jump to 400,000 TEUs later this year from 120,000 TEUs now.
But over the long term, carriers will deploy larger and larger vessels, “cascading” smaller vessels into other trade lanes. As more large ships operate in Asia-Europe service, they will displace ships of 10,000- to 12,500-TEU capacity, which will end up in the trans-Pacific.
This could lead to the demise of niche carriers if freight rates in the trans-Pacific remain under pressure. “The smallest carriers are having the greatest trouble with the rate declines,” Bingham said.