Price wars, cheap contracts, & new ships
There is widespread interest in the next steps for the container trade following a series of significant changes. For example, the past few months have seen new shipping alliances, increasing price competition, the risk of over-capacity, and drastic changes in trade volumes. Ocean carriers are considering the falling spot rates and whether they will turn into a long-term pattern. This is particularly true of Asia-USA trade which is a prime target. A massive wave of new container vessels have arrived, is starting to arrive, or is expected to arrive soon. These changes are bound to have an impact.
The experts offer a range of predictions and expectations
The Global Supply Chain Week (GSCW) virtual forum was organized by FreightWaves on Tuesday. Patrik Berglund (CEO, Xeneta) and Lars Jensen (CEO, Vespucci Maritime) addressed these issues during this forum. Jensen highlighted the possibility that the termination of the 2M shipping alliance (Maersk and MSC, the leading carriers globally) could be the first step in seismic changes in container shipping. Even though the final termination is scheduled for 2025, the changes and impact are already starting. For example, THE Alliance and Ocean Alliance may be reconsidering their options.
According to Jensen, these alliance disintegrations do not always portend lower rates for cargo shippers. Therefore, focusing too much on the perceived differences between alliances and non-alliance arrangements would be a mistake because they do not always reliably predict whether rates will be low or high. For instance, the rapid increase in rates that characterized the height of the Covid-19 era was not dependent on whether an alliance/non-alliance service provider offered them. Rather, the critical aspect was the physical unavailability of vessels caused by the congestion. Jensen does not expect the 2021-2022 boom to be repeated soon.
The conundrum of price wars and blank sailings
The 2nd quarter of 2020 was crucial in these trends because the Covid-19 lockdowns peaked in Europe and the USA. At this time, container alliances showed their prowess at blanking or canceling sailings. This was designed to artificially reduce capacity supply so that it could match the limited demand. Nobody wants to deal with the over-capacity issue. Besides, proper capacity management helps limit the impact of falling prices by artificially creating shortages that bring the prices up again. The predictions that the same playbook would be used to prevent a significant rate collapse after the Covid-19 boom did not come to fruition.
Berglund speculates that the fear of declining consumption rates following the pandemic inspired shipping companies to drastically reduce their capacity. Instead, the rise in consumption led to a squeeze in capacity, which raised or maintained prices. Currently, the situation is different because there is less sales volume than predicted, and reducing capacity is not as easy as it was during the Covid-19 pandemic. Strategies, such as blanking, are being used but not at a fast enough pace or wide-reaching enough to make the kind of difference that will keep prices up.
The makings of a price war
The industry may end up with too many ships chasing too few customers, meaning the rates could drastically fall. According to Jensen, the emerging price wars among carriers do not indicate that they have failed to learn capacity management lessons taught during Covid-19 and even through years of experience. Rather, businesses are becoming more adept at strategically leveraging their control over blank sailings. For example, blank sailings dramatically increased to reduce capacity following the Chinese New Year. Still, this may not be enough to revive a market that is collapsing.
Indeed, Jensen argues that the lessons of capacity management were picked up before the Covid-19 pandemic rather than in response to its effects. For example, most carriers know the need for consolidation to open the possibility of blank sailings. This will then translate into a more stable environment. However, that does not mean shying away from price wars if necessary to keep customers and acquire new ones. The era that preceded market consolidation was riddled with ubiquitous price wars. The post-consolidation era has changed that by opening opportunities to increase market share through capacity management and consolidation.
Fewer price wars and with a less negative impact
Consolidation has been instrumental in reducing price wars’ frequency, length, and overall impact. This means stability and sustainability in shipping rates. The ongoing price war is a case in point. First, it has led to a significant drop in rates. This is especially true of the trans-Pacific market. On the 8th of February, Xeneta indicated that the average Asia-West Coast spot rates ranged between $1400 and $1500 per forty-foot equivalent unit. The lower end of the market is recording as little as $1000 per FEU. The spot market is proving challenging for carriers.
Nevertheless, profits remained quite high in the 4th quarter in defiance of the freefall within the spot-rate sector. This was due to the counterbalancing effect of annual contract rates. On the 1st of January, most annual rates for Asia-Europe reset, while the trans-Pacific ones reset on the 1st of May. However, the fall in spot rates means that the next round of contract rates will reset lower. Berglund anticipates that long-term rates will drop to the short-term market average. Yet, that may not satisfy the Beneficial Cargo Owners (BCOs). Big-volume importers from the USA have meant that the lower end of the long-term market is still more optimistic than the short-term average.
Changing contractual terms to reflect a volatile market
It is anticipated that the Big-volume importers will expect bigger discounts than their small-volume counterparts if the spot market does not change from where it is today. Indeed, this has been a historical agreement that carriers implicitly or explicitly sign up to. This is in recognition of the larger volumes that BCOs require, greatly increasing carriers’ revenue streams. The big concern for carriers is how they will find ways of propping up the short-term market so that they do not suffer big losses when longer-term contracts are forced on them.
A case in point is how, last year, many shippers negotiated their contracts for the Asia-USA route before the 1st of May deadline. This was justified by the ongoing supply chain crisis of the time. However, experts expect a different approach this year. For instance, Jensen believes that many will opt for late negotiations. Customers are not too enthused about signing contracts early when rates continue to fall within a demonstrably weak market. The sentiment is also impacted by experiences of the past two years. Moreover, the fact that new container ships are poised to reach the market means that capacity will likely be higher than before. This will continue to push down prices.
An order book in flux
During the pre-pandemic era, there had been a trend for under-ordering vessels. This was because the balance sheets were not that strong. During Covid-19, a boom inspired an upsurge in requests for replacement ships. These had to be more fuel efficient to reduce operating costs. Others required dual-fuel capabilities as future proof against anticipated environmental restrictions. Carriers need to make room for these new vessels arriving throughout 2024. One of the trends might be to scrap or retire older ships. However, this may not sufficiently protect against the risk of over-capacity.
Shipping remains a cyclical industry. For example, towards the end of 2019, the press was reporting a historically low order book. Yet the apex of an upturn leads to revenue for carriers. There is a two-year time lag after orders. The current trends are, therefore, part of an ongoing cycle in shipping and not necessarily the after-effects of Covid-19. Stefan Verberckmoes of Alphaliner sees a significant rise in ship deliveries from March, even as demand for capacity shrinks. According to Maritime Strategies International (MSI), there will likely be 717,900 twenty-foot equivalent units in the 2nd quarter of 2023. This is up 62% sequentially from the current quarter. Indeed, it is anticipated that deliveries will rise to 764,800 TEUs in the 3rd quarter of 2023.
When demand for shipping capacity is uncertain, the potential delivery of new ships in 2024 and 2025 portends a significant fall in spot rates. So far, the market has been buoyed by long-term contracts. However, the pressures plaguing the short-term market mean that even the contract market will likely suffer later. Therefore, shipping companies must carefully manage their consolidation and blanking practices to ensure a more even distribution of revenue streams.