Laissez les bons temps rouler" - let the good times roll. These are good times for ocean carriers. Their profits are some of the best on record, and many container ship operators are predicting even higher earnings next year. But some are starting to wonder how long it will last.
Though shipping is notoriously cyclical, the consensus is that the current upward cycle has some additional time to run. Even though almost 170 new container ships with a total nominal capacity of 862,610 TEUs will come on the market next year, carriers say the continuing demand for shipping capacity to carry Chinese trade will continue to outstrip supply and lift freight rates for at least another year.
But what about 2006 and 2007, when even more huge new container ships will enter the market?
The chart of scheduled ship deliveries looks a bit like a python that's swallowed a pig. Although the number of new container ships to be delivered in 2006 is roughly the same as next year's total, the ships for delivery in 2006 will have more than twice as much capacity. The number of new ships on order tails off by 2008, in part because many carriers are waiting to see what happens in 2006.
Because of the bulge of new capacity in 2006, some are forecasting a drop in freight rates. Peter Hilton, an analyst at Credit Suisse First Boston, forecasts a year of declining rates and liner profits in 2006. London-based UBS shipping analysts Raymond McGuire and Tim Marshall predict freight rates will decline by 2.5 percent in 2006 after going up at least that much in 2005.
Ray Miles, chairman of CP Ships, told investment analysts last week that cyclical booms don't last forever, and that the current boom in liner shipping could fade in 2006 if demand weakens. "It's difficult to call," he said. "Our view is that 2006 is probably going to be the first challenging year for the industry." Miles said any faltering of demand "is likely to trigger the next industry downturn." He said, though, that the strong market in container shipping is expected to continue at least through next year.
But the outlook depends on demand as much as capacity. And there may yet be some surprises on the demand side that could prevent 2006 from looking like 2002, when freight rates collapsed and liner company earnings plunged into the red.
"My crystal ball gets a little cloudy when I look beyond next year, but I wouldn't be too pessimistic about 2006," said John Reeve, a maritime consultant in Yarmouthport, Mass. "I think there's another factor at work that could outweigh the number of new ships that are coming on the market, and that's the capability of the ports and railroads to keep up with the demand for imported goods, at least in the U.S."
Reeve said port and rail congestion on the West Coast will cause demand for vessel capacity to continue to grow in 2006 as more carriers launch new all-water services to the East and Gulf coasts to avoid the congestion. As long as the China boom continues to cause port tie-ups on the West Coast, the demand for vessels to fill out loops for all-water services through the Panama Canal to the East Coast will continue to sop up supply, he said. Instead of becoming excess capacity when they are replaced by the new post-Panamax vessels on trans-Pacific routes, the smaller vessels will be shifted to all-water services to the East Coast.
Will shipper demand continue to grow at current rates? That is the 64,000-dollar question. Though most carriers say they expect demand to continue at current rates, they are ready to hedge their bets by cutting rates and putting off new charter contracts.
The answer lies with China, the main driver of the increase in container shipping volume during the last several years. "The party is just heating up," said Maguire of UBS. Although he expects China's gross domestic product growth to slow from 11.6 percent in 2003 to 8.2 percent in 2005, he does not think this will slow China's export growth. He said UBS analysts see four trends that will continue to drive China's export growth:
-- U.S. companies will continue to outsource their production to China to improve their competitive positions.
-- As companies move additional high-value production there, Chinese exports will include more higher-value products such as electronics and machinery, for which carriers can charge higher rates.
-- China will capture a larger share of the U.S. and European textile-and-apparel market as their quotas expire at the beginning of 2005. The World Trade Organization expects China and India to almost double their market share of the U.S. and European clothing imports. This means China will move from an 18 percent to a 29 percent share of EU clothing imports, and will triple its market share in the U.S. from 16 percent to 50 percent when the quotas are lifted.
China's exports to Europe are rising even faster than to the U.S. and are running at about the same value as European companies follow the U.S. in outsourcing. Maguire said that while he does not expect China to gain as significant a share in Europe for exports of toys, footwear and furniture as it has in the U.S., he believes the gains in electronics and machinery will drive freight volumes in the future.
While the outlook for trade with China remains bullish, it still leaves the rest of the world unaccounted for. World economic growth will slow in 2005 to 3 percent from its 3.5 percent rate this year, said Nariman Behravesh, chief economist of Global Insight, an economic consulting and forecasting firm. Growth in global containerized trade will slow to 8 percent in 2005 from its 9.1 percent rate this year, but is still growing at least twice as fast as the rate of economic growth.
"Assuming no reversal of globalization, the growth of world trade in TEU terms will slow, but it will still be strong," Baharavesh said. "Growth will be strongest in the Asia-Pacific region. India will play a bigger role, but China will still be the dominant factor, followed by Japan."
While Behravesh sees world trade growth slowing as world economic growth cools from its 2004 pace, he thinks the recoveries in the U.S. and elsewhere have staying power. And he suggested that a temporary slowing of growth could boost long-term growth: "Could it be that - like the 1990s - a slow start to the recovery ensures an extended expansion?"