The root of the problem

The root of the problem

Overcapacity in the ocean container shipping market is a problem that doesn't just affect carriers. The industry's inability to keep capacity in line with demand has decimated freight rates on the major east-west trade lanes. It also has put carriers into a relentless cost-cutting mode that has forced terminals, harbor truckers, tugboat operators and many other suppliers to accept lower rates from carriers, operating under a regime of what James Devine, president of Howland Hook Container Terminal in New York, calls "marginal economics." Carriers' desperation to increase terminal throughput efficiency in the face of weak freight rates resulting from overcapacity partly explains the 10-day lockout of West Coast dockworkers this fall, and all the chaos that resulted. The carriers' pressure on harbor truckers, again stemming from overcapacity, has provided an opening for the Teamsters to attempt to organize that sector. The trickle-down effect gets more insidious. Companies tied to the container lines aren't able to pay enough to avoid the degradation of work force quality that has been much discussed in recent years.

All this is not necessarily a boon for shippers, either. While companies that depend on ocean container transportation have benefited from lower rates, they also have to live with unpredictability. Some carriers may not survive and others may merge in 2003, a circumstance that always wreaks havoc on customer service. Carriers are asking their trans-Pacific import customers to accept a 50 percent - yes, 50 percent - rate increase next year. Carriers no doubt need that kind of money to return to profitability, but if you're a shipper, good luck explaining that budget item to your chief financial officer.

The only hope is that container lines as an industry would somehow realize the error of their ways and figure out how to avoid overcapacity through restraint in acquiring ships. Recent history is not encouraging. According to a November report issued by the service of Paris shipbroker Barry Rogliano Salles, capacity in container shipping as measured by TEUs grew an average of nearly 11 percent per year over the past seven years, serving a world trade industry that grew only 7 percent per year. Competition and distrust among carriers, which is only magnified by their vastly divergent national and cultural perspectives, seems to drive a system in which carriers act more or less unilaterally or at best within their alliances when planning vessel acquisitions. The result is that freight rate predictability is thrown out the window. Ultimately, the best long-term solution appears to be consolidation to the point where a carrier with a dominant market share of 30 percent or more can set freight rates as a market leader. But while perhaps inevitable, that is years away. The largest carrier, Maersk Sealand, currently controls about 12 percent, and the top 10 lines control only half the market.

In the meantime, the industry is stuck with the current set of circumstances - little coordination among carriers, little control over capacity, no predictability about freight rates. It's hard to see any of that changing, but cyclically the industry may be entering a less difficult period. The major vessel-ordering cycle of the late 1990s, driven in part by the 1997 Asian financial crisis, is largely over. A number of reports issued over the past month suggest that 2003 and 2004 will not be years in which capacity surges the way it has in the recent past. U.K.-based Clarkson Research Studies says capacity will increase only 6 percent next year, meaning that trade growth could outpace container ship fleet growth for the first time in years. Clarkson noted that at the moment 2004 also looks like a light year for ship deliveries, but warned that could still change. Alphaliner estimates that slot capacity will increase 7.4 percent each year through 2005, a strong figure but not likely to be significantly out of line with trade growth.

Ironically, a recovering container freight rate market could be bad for shippers in more ways than one. Shippers could end up paying more in higher freight rates, though the resulting pain will be limited because rates have been so low. But a strengthening market may spur the next, long-awaited round of consolidation. The industry has seen a string of minor deals, but no blockbuster transaction on the level of an APL-NOL, P&O Nedlloyd or Maersk Sealand. Part of the reason is that market conditions have been so bad that deals look terrible on paper. If that changes, look for large-scale consolidation to resume, and with it the temporary implosion of service quality that is virtually guaranteed to result.