Trans-Pacific BCOs keying on service reliability in annual contract talks

Trans-Pacific BCOs keying on service reliability in annual contract talks

Trans-Pacific container carriers and beneficial cargo owners (BCOs) will meet at the annual TPM conference in Long Beach March 1-4 to listen to economic and cargo volume forecasts before returning to negotiations on annual contracts that generally run from May 1 to April 30. Photo credit: Shutterstock.com.

Heading into trans-Pacific service contracting season, container lines say they’re confident they will sign all-inclusive freight rates that are slightly higher than last year, with higher fuel surcharges tied to new global regulation driving much of the increases. Concerns about securing space once coronavirus disease (COVID-19)-impacted Asian imports rebound is only further sharpening shippers' focus on service commitments. 

The existing 2019-20 service contracts that will expire May 1 resulted in rates that were about $200 to $300 per FEU higher than the 2018-19 contract rates. Carriers and their customers said they felt the 2019-20 service contract rates reflected market conditions in the spring of 2019, when import volumes were still increasing, before the fourth set of import duties on Chinese merchandise took effect and drove volumes down.

Carriers and beneficial cargo owners (BCOs) who are meeting March 1-4 at the annual TPM conference in Long Beach will listen to economic and cargo volume forecasts, and they will then return to negotiations to discuss actual price quotes before signing the annual contracts that will run generally from May 1 through April 30, 2021.

In preliminary negotiations for the 2020-21 service contracts, according to conversations with six carriers, five BCOs, and four non-vessel-operating common carriers (NVOs), shippers say they have endured nearly two years of capacity management by carriers attempting to prop up freight rates, so importers are focusing more this year on carrier reliability and fulfillment of space commitments.

Six executives from separate carriers told JOC.com cargo owners are in fact indicating their priority this year is ensuring their shipments are not rolled in Asian ports because of blanked sailings. In past negotiations, many BCOs often focused on securing the lowest freight rate in the market. Priorities have changed this year because the unprecedented number of blank sailings (more than 80 in February and March) is having a ripple effect throughout BCO supply chains in the form of increased inventory carrying costs and stock outages at critical times.

“We see a lot of the dialogue switching away from rates to reliability, transit times, and whatever quality component that’s important to customers. Not to say that they don’t care about cost, but it’s not the one [conversation topic] you just keep hashing away at,” said Uffe Ostergaard, president of Hapag-Lloyd America. “With all the consolidation and shifts in the shipping line industry in recent years, irrational competition may be a thing of the past.”

The BCOs and NVOs that spoke with JOC.com told much the same story. They said the cancelled sailings are frustrating their attempts to plan their supply chains with any certainty even a few weeks out.

“As this will likely be an ongoing way of doing business for the steamship lines, we need some commitments to maintain service levels without space constraints and rolls,” said the director of global logistics at a national retailer.

“Sometimes I don’t know about [a blanked sailing] until the last minute,” an NVO said. “When I’ve been rolled, I don’t know about it until the vessel pushes from the dock. That’s poor planning on the part of the carrier.”

Pricing still key

In conversations with more than 20 industry participants, the message was clear that freight rates, as always, will be an important topic of discussion in this year’s annual service contract negotiations that will conclude around May 1.

In the 2019-20 service contracts, rates from major load centers in Asia to the West Coast were generally between $1,400 and $1,550 per FEU, according to the six senior carrier executives who spoke to JOC.com in May on the condition of anonymity because service contracts are confidential. East Coast rates are usually about $1,000 per FEU higher than the West Coast rates.

Since the International Maritime Organization’s (IMO's) low-sulfur fuel requirement was not set to take effect until Jan. 1, 2020, carriers and their customers agreed to continue with the standard floating bunker fuel surcharges through the end of the year, with the intention of addressing surcharges for compliant low-sulfur fuel oil (LSFO) in November and December.

This year, carriers and shippers will have several months of actual LSFO pricing at the major bunker ports to refer to as they negotiate fuel surcharges. The IMO 2020 global mandate stipulates the use of LSFO with 0.5 percent sulfur content. Vessel operators can continue to burn the heavier fuel with 3.5 percent sulfur content on those vessels that have been retrofitted with scrubbers.

Blanks crimping capacity

Service issues are likely to be a major bone of contention, not only during service contract talks but for months to come, because carriers say they intend to continue managing capacity through blank sailings during what is turning out to be a weak first half of 2020 for US imports from Asia. Carriers in January had announced about 60 blank sailings to take effect in February to early March, in line with factory closures for the annual Lunar New Year celebrations in Asia that began on Jan. 25. However, with the spread of the deadly COVID-19, Chinese authorities extended many of the factory closures into mid-February.

During the January-February period, despite a drop in eastbound trans-Pacific volumes, spot rates to the West Coast remained in the $1,500 per FEU range, according to the Shanghai Containerized Freight Index (SCFI), which indicates the blank sailings kept spot rates from declining. East Coast rates were about $1,000 per FEU higher.

Carriers say they are sensitive to the service requirements of their customers, and they use blank sailings as a last resort to stem their losses when container volumes drop steeply during periods of slack demand.

BCOs the past couple of years have dealt with a wide array of uncertainties involving trade policies and tariffs, environmental regulations, and now a number of blank sailings, said Christian Pedersen, vice president and head of trades and marketing, North America, at Maersk Line.

Maersk is helping its customers to respond quickly to these uncertainties by offering a variety of channels for booking cargo in the traditional manner, online, or through third parties, with the primary question being, “What can we do to help our customers plan?” he said.

Kevin Krause, vice president of ocean services at SEKO Logistics, said NVOs with multiple customers are experiencing week-to-week space problems because of the surge in blank sailings. “I am concerned about the impact all of this is having on my named accounts,” he said, noting that it’s an NVO’s job to come up with vessel space when and where it is needed.

Since the US-China trade war began in mid-2018, carriers have been cancelling sailings during slack volume periods and adding extra-loader vessels when volumes spike in order to keep spot freight rates from deteriorating. By and large, that strategy has worked.

“Over the last two years, [trans-Pacific contract rates] have been basically steady to slightly increasing, despite the market not growing tremendously,” Ostergaard said. “The other thing is the spot rate volatility has reduced significantly, while the general utilization levels in the trade have remained high.”

However, retailers and manufacturers this year are finding it especially difficult to plan their supply chains, with 82 blank sailings already announced.

“Steamship lines should look at this from a supply chain perspective,” said Dan Gardner, president of Trade Facilitators Inc. Missing a sailing or two directly increases inventory carrying costs. Shipping delays that prevent merchandise from being delivered to stores on time have an even greater negative impact if they result in lost sales.

Gardner said logistics managers can explain a $100 per FEU rate hike to their financial department relatively easily, but when it comes to detailing the additional costs due to supply chain disruptions caused by blank sailings, “it’s harder to explain that to the CFO,” he said.

Some BCOs are even willing to pay a premium price for rapid, reliable service, according to John Lauer, senior vice president and chief commercial officer at Matson Navigation Co. Matson rarely blanks sailings in its weekly service from China to Long Beach, and BCOs are guaranteed next-day availability when the containers are discharged because the containers are trucked on Matson-owned chassis to an off-dock yard for pickup.

Matson’s China service has been in operation since 2006, and according to Lauer, the carrier has blanked only two sailings during that time. Matson this year has not missed any sailings during the Lunar New Year and COVID-19 interruptions. He added that Matson has a somewhat unique supply-demand environment in the trans-Pacific trade in that its chief competition comes from air freight carriers.

Maersk is also integrating ocean and landside services for BCOs, from booking cargo to arranging inland movement or storage of freight, Pedersen said. “We have become an integrator of solutions, moving further upstream and downstream,” he said.

More than space

Carrier executives said BCOs are already quite vocal about the impact blank sailings are having on schedule integrity.

“Reliability of carriers and consistent space offerings are super-major issues,” said Lawrence Burns, senior vice president of trade and sales at Hyundai America Shipping Agency. Customers’ desire to achieve some clarity on how to plan for blank sailings has spurred preliminary service contract negotiations to start earlier than usual this year, Burns said.

On-time performance in the trans-Pacific reached a dismal low of about 40 percent in 2019, according to maritime analyst Sea-Intelligence Maritime Consulting, although reliability improved last fall to the 70 percent range.

For BCOs, service issues may include more than securing vessel space; they often extend to lack of carrier reliability in vessel arrivals, the efficiency with which containers are handled at marine terminals, the frequency and intensity of terminal congestion, and availability of chassis.

“I’m trying to bring terminal issues into the service contract discussion from a performance standpoint,” said Jeff Solomon, director of operations at SG Footwear. However, he said it is difficult to write some service requests in contractual form.

Achieving greater clarity into the bunker fuel surcharge component of freight rates is a matter of great importance for some BCOs this year, but not to all. Individual carriers have quoted a wide range of LSFO charges to their customers, affecting spot rates initially, but eventually the surcharges will be factored into service contract quotes.

“I don’t know if the steamship lines really know what [LSFO] costs,” Gardner said.

Freight over fuel

The two main components of the all-inclusive rate quote are the base rate for ocean transportation and the bunker fuel charge. Negotiating the underlying ocean transportation cost is shaping up this year as being somewhat uneventful.

“Rates will be the least important part of negotiations since I’ve been doing this,” said the veteran logistics manager at an importer of seasonal merchandise.

However, it turned out that the front-loading of imports in late 2018 and early 2019 led to soft import volumes during the summer and fall months last year. US imports from Asia ended the 2019 calendar year down 2.6 percent, the first decline in imports since the economic recession of 2008-09, according to PIERS, a sister company of JOC.com within IHS Markit.

With imports continuing to soften in February, and at a faster rate than anticipated due to the extended factory closures in China, carriers this year do not have the same leverage they had in early 2019 to increase the ocean portion of the all-in rate.

“This year, the virus will extend the slack season, which is slack already,” said Christian Sur, executive vice president of sales and marketing at Unique Logistics International. “There won’t be a sizable rate increase from last year,” he said.

On the other hand, the global carrier industry this year is expected to incur an extra $15 billion in costs in complying with the IMO 2020 mandate, and carrier executives have been adamant in public forums that they view the higher price of compliant LSFO as a pass-through to customers.

However, carriers’ track record in passing along the entire cost of the higher-priced LSFO has not been good so far this year. At the moment, they are attempting to pass on much of the added fuel cost on to customers in spot rates, even if that means lowering the underlying ocean rate, in order to show they are recovering some of their increased fuel costs. Carriers may have to do the same when negotiating all-inclusive service contract rates for ocean carriage and fuel.

A tire importer said what the carriers choose to call the new low-sulfur bunker charge — and how they are pricing it — is largely irrelevant, as long as the all-in rate is competitive with what other lines are charging. Rather than investing a good deal of time and money in attempting to determine the cost of low-sulfur fuel, that importer intends to compare each all-in rate with those quoted by various other lines.

“From my perspective, I really don’t care what the fuel charge is,” he said. A carrier can quote an LSFO rate of $100 or $150 per FEU, as long as the all-in rate is competitive. “It works for us,” he said of his negotiating strategy.

Likewise, an NVO said discussion between carriers and BCOs over LSFO charges is confusing some of his customers, when what they want is a clear, easy-to-understand all-in rate. “Our job as NVOs is to provide one cost to the customer,” he said.

Pedersen emphasized, however, that fixing an LSFO rate for the full length of the annual contract is not a realistic business practice. “There’s too big a hedge and risk to fix it for one year,” he said.

Despite the robust discussion that is under way involving the base ocean rate and floating or fixed bunker charges, there is an underlying factor that both carriers and BCOs must address: as in the past, freight rates will be market driven.

“It’s all about supply and demand. That’s the primary driver pushing rates up or down,” said Bill Rooney, vice president of trade management at forwarder Kuehne + Nagel. In that respect, except for COVID-19, which he termed a “wild card,” Rooney said he doesn’t expect that this year’s service contract negotiations will be much different than past negotiations.

The uncertainties involving the cost of LSFO, blank sailings, and supply and demand in the second half of the year are resulting in some preliminary contract quotes that are quarterly rather than annual in duration, similar to pricing in the Asia-Europe trades, a coffee importer said. The flip side of the coin there, however, is that rates that are good for only three or four months create additional administrative costs for BCOs.

“I’m used to dealing with this for bunker, but not the ocean rate. It makes people look to NVOs for service contracts,” he said.

Contact Bill Mongelluzzo at bill.mongelluzzo@ihsmarkit.com and follow him on Twitter: @billmongelluzzo.