Low-sulfur rule top threat to container shipping

Low-sulfur rule top threat to container shipping

The International Maritime Organization's 2020 low-sulfur fuel rule requires carriers to use bunker fuel with a sulfur content of no more than 0.5 percent, down from 3.5 percent today. Photo credit: Shutterstock.com.

Heading into the 2019 TPM conference, the chief worry for the container shipping industry remains what it has already been for months: that carriers will fail to pass through enough costs related to low-sulfur fuel and will be forced to withdraw capacity, seeking to get out of the spot rate what they could not get out of surcharges.

Given how the dialogue around the International Maritime Organization’s (IMO’s) low-sulfur rule is unfolding early into this year’s trans-Pacific eastbound service contract negotiations, the risk of severe disruption in early 2020 should be on the minds of all beneficial cargo owners (BCOs) and forwarders. Jan. 1, 2020, is the date the IMO low-sulfur rule takes effect.

Carriers are already speaking openly about the risk of bunker fuel surcharges being rolled into the base rate, and base rates, of course, result from the give and take of negotiation, which seldom benefits the carrier. “At the end of the day, our objective is to delink bunker fuel discussion from the freight discussion. The worst thing we can see is all-in rates,” George Goldman, US president of Zim Integrated Shipping Services, told the Georgia Foreign Trade Conference in Febuary.

The industry knows from experience what can happen when carriers find themselves in a loss-making situation. They resort to the only tool they have available, laying up tonnage. We all know how that plays out. Capacity dries up, and shippers get held to strict weekly minimum-quantity commitments with any space beyond that coming at a steep premium above the contract base rate. In the chaos, the value of contracts is degraded, and legal recourse is not a practical solution given how few carriers remain in the market.

Industry analyst Lars Jensen perfectly stated the problem in a February blog. “If the carriers fail in getting the BAF [bunker adjustment factor] through (which is a distinct risk), the shippers will be in a situation where contracts without BAF are exceedingly unlikely to be of value if the carriers suddenly face a [$10 billion] loss — and consequently the concept of having a contract rate will cease to have meaning and instead it will be a de facto spot market.”

Some carriers remain optimistic. “We have seen a very high percentage of contracts that either took our new formula or had a similar customer formula, which in the end had more or less the same effect,” Hapag-Lloyd CEO Rolf Habben-Jansen told JOC.com in January, referring to contracts already signed covering 2019.

But others see plenty of reason for concern. IHS Markit energy analysts say the change will be too abrupt, warning of the inability of the refining industry and the shipping industry to adapt in time. “The rapid pace of the implementation of this new regulation is making it very challenging for the refining and shipping industries to respond,” said Sandeep Sayal, vice president of downstream research at IHS Markit.

Those who witnessed the shouting match at the Retail Industry Leaders Association’s annual supply chain conference in 2010, the last time carriers were forced to withdraw capacity en masse to prevent bankruptcy, can attest that the potential supply chain disruption is real.

It ought not be this way. Given that the IMO rule is straightforward — it limits sulfur content of bunker fuel to a maximum of 0.5 percent versus 3.5 percent today — and the price of low-sulfur fuel is publicly quoted, creating a mechanism for carriers to objectively and transparently pass along any added costs should be straightforward. Unfortunately, it’s anything but.

The legacy of non-transparent BAF formulas shippers saw as a revenue source is already coming back to haunt carriers in some early discussions. It’s no easier now than it ever was to create an objectively fair and transparent BAF, given trade imbalances and differences in base rates on the different legs that comprise a service, as well as size and speed of vessels and factors, as Jensen points out.

Adding to the complexity is the lack of a tradewide BAF formula since the Transpacific Stabilization Agreement shut down early last year. Shippers are looking at either proposing a surcharge to carriers — which, Jensen said, carriers don’t have the capacity to manage outside those of a handful of very large shippers — or more likely having a different formula applied by each carrier, an accounting and reconciliation challenge.

That shippers are already questioning forwarders’ attempts to pass along the recently introduced China Low Sulfur Surcharge covering the China Emissions Control Area, or ECA, as of January fails to inspire confidence that shippers will easily absorb the much larger IMO costs.

The bottom line is that it will be very difficult for the market to make what amounts to a major adjustment. Going from an all-in rate to a broken-out BAF, given the relatively low, roughly $1,200 West Coast rates in 2018-2019 contract rates, will result in a significant overall year-over-year increase in ocean costs on May 1 when most trans-Pacific contracts renew.

Shippers will do whatever they can to resist this, and carriers as always will balance prioritizing volume and price.

How simple would it be to tell shippers: pay the surcharge. Accept that there is a cost for air pollution, and the bill is coming due. A better argument is this one: pay the surcharge if for no other reason than to protect your supply chain in 2020. It will build goodwill with carriers who you may well depend on in a crunch come early next year.

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