The slew of earnings reports disgorged by publicly listed ocean container lines over the last few weeks had three things in common: Profits were down as much as 50 percent in their latest reporting periods; freight rates were down even as cargo volumes increased; and expenses were up - way up - because of the soaring cost of bunker fuel and inland transportation.
For carriers, it wasn't a pretty picture, effectively marking an end to the boom that the big liner companies have enjoyed for the last two years. Nearly all of the companies warned of more bad times to come, signaling that they may be careening down the backside of the boom-bust cycle that has characterized liner earnings for decades. But is this cycle the same as earlier ones, when vessel capacity far outstripped the growth in trade volumes? Does the decline in carriers' profitability foreshadow losses to come?
The answer is not yet clear. Forecasts of capacity growth suggest it might be the same old bust story, but trade volumes continue to grow and other factors may soften the impact of rising capacity. Inland and port congestion, the growing popularity of all-water services and fuel-cost-induced slower speeds may combine to erode effective vessel capacity even as more ships are delivered. Carriers already are gearing up for the next set of rate negotiations in the hope that they can stem the tide of falling profits and recover more of the cost of bunker fuel.
"You'll see a much stronger push in coming months by the carriers to emphasize the importance of collecting the bunker surcharge," said Brian Conrad, deputy executive director of the Transpacific Stabilization Agreement, whose 11 member carriers discuss export trends and agree on voluntary rate guidelines for U.S.-to-Asia shipments. "With fuel costs becoming so large and profits being hit so hard, the carriers are saying, 'You know what, it's time to change.' Bunker has got be to be an absolute necessity and not a negotiating item."
Although the carriers' bunker fuel surcharge is supposed to cover the cost of fuel, it tends to get negotiated into the rates of contracts with large shippers. Last year, contracts were negotiated at the relatively stable fuel cost that then prevailed.
"The cost of bunker was stable for a while there last year, so the carriers said, 'OK, we'll rely on the bunker surcharge,' " Conrad said. But the cost has increased by about a third since then. At the beginning of August 2005, bunker was about $283 per ton in the trans-Pacific trade. At the start of this month, it was $376 a ton. In that same period, freight rates on the main east-west trade lanes declined 10 to 15 percent before recovering slightly in the last month or so.
"Now there's no other way to offset fuel costs but to collect the bunker surcharge," Conrad said. Some TSA carriers already are meeting with their key customers "at the CEO level" to talk about bunker fuel costs. "A number of our CEOs have told us, 'I am actually arranging appointments and meetings with our key customers to sit down with them and explain: Look, this is something we have got to change. We have got to work together as carrier and customer to make sure our fuel costs are covered.'"
No matter how shippers respond to the carriers' pleas for fuel-cost recovery, they are unlikely to be sympathetic to carriers' calls for higher freight rates. The problem carriers face is that the shipping market believes the supply of container ships is far outstripping the demand for cargo space, despite the continuing steady growth in demand.
Last year, shippers were quick to take advantage of the perception of pending oversupply that dominated the markets to negotiate lower rates for this year, even though the carriers' research showed that capacity would not grow quickly enough to swamp demand. Carriers took the biggest hit on the Asia-to-Europe trade lanes, where rates dropped about 15 percent in the fourth quarter of 2005 year and the first quarter this year. Rates plunged about 10 to 15 percent on the trans-Pacific.
"The lines lost the mental wars," said Dominic Edridge, an analyst for UBS's transportation group in London. "The mindset is still difficult for the carriers since the ships are full and the volumes still are very strong, but there hasn't been a big uptick in rates," he said.
Edridge said there has been some recovery in freight rates from Asia to Europe, where rates have increased by about $50 per container in the last month. "I would call it more of a stabilization than anything else, which is not surprising since they had the most dramatic downturn," he said. Rates on the trans-Pacific also have been largely flat, with perhaps a small uptick with the advent of peak season, "but there's no reason to get to excited," Edridge said.
"Rates collapsed on the Asia-to-Europe trades in the last quarter of last year and the first quarter of this, but most people agree this was an overreaction," said Philip Damas, research director at Drewry Shipping Consultants in London. He said rates had dropped on the other major east-west routes as well, but nowhere near as much as on the Asia-to-Europe lane.
"Both carriers and shippers still have an excessive tendency to seek short-term benefits and act in an opportunistic manner as soon as the market turns," Damas said. "Carriers are not reluctant to push rates up by 25 to 30 percent when the market is strong, and shippers also seek large, immediate rate reductions during - and sometimes before - a downturn."
Other factors that undermine price stability are the practice of systematic bids (or electronic contract tenders), the lack of differentiation between carriers and the willingness of carriers to undercut each other to raise market share, he said.
Drewry is forecasting a capacity increase of 16 percent for all of 2006, and further increases of 13 percent in 2007 and 2008. "We see no prospect of rate increases in the second half of this year or for next year either on the trans-Pacific or the trans-Atlantic, so things will be tough for the carriers," Damas said. By 2008, increases in trade volumes will start to catch up with the additional capacity coming to market, so carriers may be able to negotiate rate increases then, he said.
In the current season, shippers negotiated a small decrease in freight rates when they renegotiated their 12-month trans-Pacific contracts in May despite the increase in bunker costs, Damas said. The introduction of new services on the Atlantic by CMA CGM, China Shipping and Evergreen this year has resulted in a 10 percent reduction in freight rates, and the Trans-Atlantic Conference Agreement has "unofficially" dropped its general rate increases of July and October, he said. Rates on the eastbound leg increased in July because of strong volumes.
The market's mindset that overcapacity is imminent could subject carriers to another round of rate declines through 2007. "I believe large shippers will see a subtle drop in rates next year compared to 2007," said Paul Svindland, senior director of global logistics at ICG Commerce, which advises shippers on transport trends and negotiates and manages ocean transport contracts for them. "Ships are chockablock full right now, but there's a lot more capacity coming on the market in the second half of this year and into next year," he said.
Svindland thinks there will be a 2 to 5 percent decrease in rates for large shippers on the trans-Pacific, although small shippers might see flat rates or get a small increase.
He said rates on the Asia-to-Europe trade lanes, which "fell through the floor," are firming. The Asia-to-Europe trade tends to run ahead of the Asia-U.S. trade by six to 12 months because the large new container ships are deployed there first and thus affect rates sooner, he noted. "North European ports like Bremer-haven, Rotterdam and Antwerp are better suited to handle those vessels than our Long Beach, Los Angeles, Tacoma and Seattle," Svindland said.
Trans-Atlantic rates are not moving much in either direction. "We are advising our clients not to anticipate any great rate reductions on that trade lane," Svindland said. On the north-south trade lanes to Latin America, northbound ships are seeing strong utilization, but "there's a little bit of wiggle room," so he expects rates to be stable. Rates on the Australasia trades are experiencing upward pressure because capacity is tight, he said.
The TSA's Conrad said there are several factors that could mitigate the impact of the new capacity that is coming into the market through 2008. As bunker costs increase, some carriers are trying to reduce fuel consumption by slowing their vessels, which effectively cuts capacity.
Further, the introduction of more all-water services from Asia to the U.S. East Coast effectively cuts capacity because the longer routing requires more ships, and the ships are smaller and take longer to reach their destinations. In addition, any congestion at the Panama Canal, such as that which occurred this spring and early summer, reduces capacity by tying ships up to await transit. All of these factors combine to cut effective capacity by 2 to 3 percent, Conrad said.
But none of this may be enough to change the market's mindset that there is or will be overcapacity. "The shippers keep saying, 'No, no, no, we want less,' and eventually somebody will say, 'We can't string this out any longer, so we've got to lock these people up in a long-term contract," Conrad said. "All it takes is one carrier."