When ocean carriers in the eastbound trans-Pacific this month said they planned to raise rates by 50 percent, reaction from retailers and cargo consolidators was swift, if not sharp: It was obviously a desperate attempt during desperate times, and a move that had little chance of success.
Then a strange thing happened. Carriers stopped offering spot rates as low as $750 per FEU from Asia to the West Coast. Some lines actually approached consolidators and demanded a $50 to $100 rate hike, their first increases in months.
Now some carriers are publishing increases in their tariff rates, a sign perhaps that there is as much resolve as desperation. Orient Overseas Container Lines, one of the more financially stable carriers in the trade, last week filed a $500-per-FEU increase in its published tariff.
While tariff rates rarely reflect service contract rates, which are based on volume discounts, OOCL’s action sets the stage for negotiating rate increases in its service contracts.
Couple these halting first steps with the normal seasonal increase in container volumes now under way and maybe, just maybe, carriers will be able to stop the bloodletting that is ruining what should be their most profitable U.S. trade lane.
The Transpacific Stabilization Agreement, a discussion group of 14 lines that carry U.S. imports from Asia, surprised most everyone, including shippers, on July 7 by announcing a proposed $500-per-FEU rate hike, effective Aug. 10. The recommendation is only a guideline because the TSA has no enforcement powers.
But it was the strongest statement yet among carriers across a transportation world, from trucking to air transport to ocean trade, that the precipitous slide in pricing that’s accompanied this year’s meltdown in demand simply must end.
The shocking announcement came just weeks — and in some cases just days — after carriers concluded service contract negotiations with freight rates of about $1,000 per 40-foot container from Asia to the West Coast, and about $1,700 on all-water services to the East Coast.
What changed so dramatically in such a short time to make carriers think they could increase their rates 50 percent? Brian Conrad, the TSA executive’s director, said carrier losses simply became too much to bear. “Every week the red ink gets redder — another $100 million in losses,” he said.
According to a recent Container Forecaster report published by Drewry Shipping Consultants of London, ocean carriers globally are losing so much money that they will dig the industry into a $20 billion black hole by the end of the year.
Drewry’s supply-demand index, in which a reading of 100 indicates vessel capacity and shipper demand are in balance, has dropped to 83.4. That is the lowest reading (indicating weak shipper demand versus capacity) since 90.3 in 2001. Drewry projects a further drop in 2010 to 76.9.
The TSA’s own numbers highlight the pain. Freight rates in the eastbound Pacific in late May were $1,000 to $1,200 per FEU lower than a year ago. As rates sank this spring, carriers negotiated service contracts purely out of panic.
Shipping lines face the worst trade environment since the Great Depression of the 1930s, 20 years before the dawn of container shipping itself. They are losing money in every trade lane, and the supply-demand imbalance will get worse before it gets better as shipyards deliver massive new ships ordered several years ago — when global trade was booming.
Mediterranean Shipping Co., one of the fastest-growing carriers in the world, has increased its fleet capacity by more than 10 percent since the beginning of the year, Chairman Gianluigi Aponte said at a vessel christening in Barcelona last week. MSC has 12 more ships of 11,000- to 14,000-TEU capacity scheduled for delivery this year. But MSC has suggested it may lay up ships if pricing does not improve.
Carriers’ panic is understandable, considering the confluence of weak demand and a capacity overhang that will continue beyond 2010.
Shippers may pity carriers for this legacy, but they offer no sympathy. Andrew Traill, a 20-year veteran of the freight transportation industry and now publisher of shippersvoice.com, said customers view the carriers’ problems as resulting from mismanagement and arrogance.
“These are not my words, but theirs,” Traill said.
The TSA in April warned its members the low rates will inevitably lead to bankruptcies. Carriers then told their customers further consolidation in the shipping industry eventually would cause a capacity crunch and monopolistic-type pricing by those lines that survive.
Industry analysts scoffed at the warning. “When a line goes under, it doesn’t mean that the capacity goes away,” said Paul Bingham, managing director of global trade and transportation at IHS Global Insight. Competing carriers simply purchase the vessels at fire-sale prices and then cut prices in an attempt to fill them, he said.
Carriers attempting to push unreasonable rate increases by threatening future bankruptcies and capacity crunches insult their customers. Shippers are well aware of reports that banks and investor groups in recent weeks have come to the support of troubled lines such as Chile’s CSAV, Germany’s Hapag-Lloyd and Israel’s Zim Integrated Shipping Services. Some Asian lines are owned by their governments or have close ties to the governments and national banks.
While these deep pockets cannot last forever, current levels of support could be enough to get carriers through the end of the year, Bingham said. In fact, monthly container volumes indicate imports are increasing as the major east-west trade lanes move into the traditional peak shipping season.
Nigel Gault, IHS Global Insight’s chief economist, said in a July 13 report that imports would increase in the second half of the year as “U.S. demand recovers and the inventory cycle turns.”
IHS Global Insight does not believe the seasonal spurt in cargo volumes will lead to significant increases in freight rates. Rather, carriers will enjoy increased revenue based mostly on greater cargo volumes in late summer and fall. In this environment, Bingham said, carriers can survive, and one day they may prosper if they exhibit pricing discipline.
Industry veterans marvel at how carriers attempt to fill their ships by undercutting each other on rates. A vessel sailing at 90 percent capacity in which every container is carried at a loss loses money, but a ship operating at 70 percent capacity in which every slot produces a small profit makes money for the carrier.
Even in these tough times, vessel utilization rates are respectable. According to the TSA, ships arriving on the West Coast in late June were operating at 86 percent of capacity, and average vessel utilization from Asia to the East Coast was 82 percent.
Carriers, however, were engaged in a vicious rate war. One or two lines would offer a spot rate of $900 from Hong Kong to Los Angeles, and other lines would match it or drop their rates to $850. An NVO would get commitments from customers for 100 containers at $800 and would shop that rate until a carrier would accept it. Never mind that carriers were losing money on every container they carried.
No one expects shippers to accept a $500-per-FEU increase on a current rate of $1,000. Carriers couldn’t get a $500 increase in the past when trade was brisk, after all, and rates were $2,500. Furthermore, any traffic manager who told top management that the company’s freight bill was going up 50 percent would be fired on the spot.
This is especially true of the large discount and fixed-price retailers that operate on thin margins and have profited from today’s low rates. Family Dollar Stores, in reporting its fiscal third-quarter earnings last week, said its gross margin rose to 36.2 percent from 34.6 percent due in part to lower freight expenses.
But rational shippers do not expect carriers will continue to carry cargo for a loss. Importers generally concede they can tolerate an increase of $100 to $150 per FEU, at least through the peak season.
Importers also stress, however, that they cannot accept even a modest increase unless their competitors’ rates increase the same amount.
“Carriers are going to ask everybody they can for an increase,” said Dave Akers, managing director of the Toy Shippers Association. That’s alright, as long as everyone stays competitive, he said.
Rational carrier executives, meanwhile, know they must be more disciplined in their pricing, especially now that traffic is increasing in the eastbound Pacific. “The current rates are unsustainable. Each line has to move forward according to its own contracts,” said Frankie Lau, director of marketing at OOCL.
Contracts vary from line to line and among customers of the same line, Lau said. Some contracts allow reopeners by mutual agreement of the carrier and shipper. Other contracts allow a rate change based upon changes in the public tariff.
Other contracts prohibit a rate increase during the life of the agreement, but carriers may even try to reopen those agreements. Carriers note when rates are dropping, shippers do not hesitate to amend their contracts. By the same token, some customers who are asked to renegotiate their contract will shop their business to other carriers or to NVOs.
Lau said any carrier that follows the TSA guideline and files a $500 rate increase to take effect in mid-August should be prepared to negotiate hard. “It will trigger a lot of discussion between now and then,” he said.
Contact Bill Mongelluzzo at email@example.com.