Why container lines should fear the low-sulfur rule

Why container lines should fear the low-sulfur rule

With each passing day, the realization grows that the sulfur cap on bunker fuel will have a profound effect on shipping. The rule, imposed by the International Maritime Organization, will reduce permissible sulfur emissions from vessels to 0.5 percent from 3.5 percent beginning Jan. 1, 2020.

Container carriers, like other shipowners, almost certainly will face higher costs for low-sulfur fuel, but unless they break with decades of cutthroat competition and change the paradigm on how they go to market, they risk failing to pass the full cost increases along to customers.

Some of the increase inevitably will get passed along, and shippers are bracing for that. But for an industry that is unable to generate sustainable profits, a huge cost increase could be so material that it would force the industry into a fresh round of mega-ship ordering or another round of consolidation — this time possibly involving mergers of the biggest carriers — raising questions about how many carriers, and how much competition, would remain.

Knowledgeable people we’ve spoken to recently say carriers would have to implement radical changes in how they go to market to be in a position to successfully pass along the cost increases that may result from the sulfur cap. In other words, something has to change.

Today, carriers are unable to pass along increases in bunker fuel, and that is reflected in typically lower earnings at times of rising bunker costs. This year is a case in point, with Maersk Line stating that its first-quarter results were “impacted by higher unit costs among others because of adverse developments in bunker prices.” Maersk said average bunker prices were up 28 percent year over year in the second quarter. The average cost of bunker fuel in July across the ports of Rotterdam, Shanghai, and New York-New Jersey was $454.42 per metric ton ($500.91 per ton), up 51.6 percent from the same month last year, according to data from IHS Markit, parent company of JOC.com.  

Emergency bunker fuel surcharges sought by carriers show just how poor the container shipping industry is at determining where energy prices will go. Granted, hedging has become more complicated because of geopolitical tensions involving Iran, Venezuela, and Iraq, and the emergence of major producers such as the United States, and, soon, Mexico. Asked in June why carriers weren’t able to forecast the jump in fuel prices, Pascal Hirn, CMA CGM’s vice president of North American Lines, quipped, “We’re ship operators, not energy experts.”

Container shipping’s core weakness: all-consuming cash flow quest

This goes straight to the core weakness of container shipping: the all-consuming quest for cash flow against hard assets such as ships that lead carriers to load unprofitable cargo rather than no cargo at all. This has undermined carriers’ ability to identify and pass along to customers objective costs, such as bunker fuel spikes, leading to the spread of all-in rates that expose all aspects of pricing to the volatility of supply and demand that, because of chronic overcapacity, rarely plays out in carriers’ favor.

“The players in the liner sector are going to have to make some pretty fundamental changes to how they price to ensure that the increased cost is passed along,” one knowledgeable source told JOC.com. “The alternative to an effective mechanism to recover the incremental cost will be pretty unpleasant.”

Such thoughts undoubtedly led MOL president Junichiro Ikeda to tell The Financial Times in June that because of the sulfur cap, “We’re all going to go bust.”

How would carriers change their approach to pricing? The lack of a clear answer to that question is the heart of the issue. The epochal industry consolidation over the past two years, which reduced the number of east-west carriers from 17 to 10, has resulted in virtually no change in carrier behavior on pricing. The run-up in trans-Pacific spot pricing in recent weeks is tied to market fundamentals, not a new approach by carriers.

Dynamic pricing tools such as the New York Shipping Exchange, which would move the industry down the airline route, are available, but more carriers need to take advantage of them. Strategically, carriers are taking initial steps to reposition themselves as higher-value service providers, but that requires investment, and that can be hard to justify when the track record indicates such investment doesn’t pay off.

That’s what makes the sulfur cap approach a potentially game-changing issue in the container sector specifically. In the non-container trades such as tankers and bulk carriers, charterers pay for bunker fuel, so owners aren’t on the hook for higher costs. That’s the same case for containers when a container line charters a ship from a non-operating owner. But when it comes to passing along costs to container shippers, the system breaks down, and there is nothing on the horizon to suggest that within roughly 16 months the carriers will find a way to change the paradigm on pricing.

It could be that, like the hype over the Safety of Life at Sea container weight issue, no meaningful cost increases will materialize. But that isn’t how it looks as we head into the autumn of 2018.

Contact Peter Tirschwell at peter.tirschwell@ihsmarkit.com and follow him on Twitter: @petertirschwell.

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