Article by: Yong Yao Hui
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Weathering the Storm
Slammed hard by the global economic storm, many struggled to stay afloat while some managed to stay on an even keel. Navigating through five years of choppy waters have made some call 2016 their “worst year ever.” Rippling waves from the financial crash in 2008 can still be felt today, as ocean carriers continue to wrestle with volatile earnings.
The industry, a vital link to the world trade and backbone of all economies, is suffering what could well be the worst and longest downturn in decades, or perhaps in its 60-year of history.
Freight Rates at Historical Low
There was never a cheaper time in history to ship goods around the world than back in 2016. The global shipping rates were astonishingly low. The Shanghai Containerised Freight Index (SCFI), a highly cited metric used to assess the performance of world trade, dropped to just 400 in March 2016, meaning at that period, it costs just about US$400 to move a fully loaded 40-foot container from Shanghai to Europe. A rate that is barely sufficient for the ship owner to cover their fuel cost, port fees, canal transit fees. In fact, it is much cheaper to move house across continents than to move house in Singapore, considering that hiring a mover cost you an average of S$550 to move stuffs of an average-sized 3-room HDB flat.
Contributing to this price collapse is the slowdown in global trade growth, where container capacity of shipping lines expanded much faster than demand, resulting in a surplus of capacity which the market has been struggling to absorb. Several factors come into play, notably the industry’s massive shipping capacity expansion binge and the slowdown in China’s economic growth.
Extrapolating on the good times
Before the 2008 financial crisis, high fuel costs drove global carriers into a competition to build and operate the largest, most fuel-efficient vessels to drive down slot costs. As there was strong growth in global trade, carriers were ordering more vessels to meet demand. Trade prospered and everybody was doing well. Then came the subprime mortgage crisis which brought banks that were supposedly too-big-to-fail to its knees. Trades fell, and freight rates plummeted as the world went into the worst recession ever in the century.
Post-crisis, positive momentum in freight growth boosted market confidence in the recovery to a pre-2008 growth trajectory. This overly optimistic outlook prompted ship owners to double down on their orders on ultra-large vessels (Container Capacity over 14,000 TEU), with some stretching longer than the four soccer fields.
As these ships started entering the global fleet, capacity rose, and without enough cargo for them to transport, companies tried to under-bid each other on price to attract customers. The pressure to fill this capacity has sent freight rates tumbling down to unprofitable levels and sinking the whole container shipping industry into losses.
“When China sneezes, the rest of the world catches a cold”
In a period when the industry continues to add capacity, China’s economic slowdown couldn’t have come at a worse time. Being the world’s biggest exporter and second-biggest importer, China’s trade links extend deeply into the global economy. Exports of cheap Chinese goods have always been central to China’s stunning growth, a decelerating economy not only weakens exports coming out of the country but it also weaken global trade volume as China reduced its appetite for imports.
The New Economics of Shipping
As the growth of container business is not keeping up with the growth of container fleets; shipping lines will have to change tack to deal with the issue as one can’t simply grow their way out of the troubles.
“The old model of growth through acquiring new capacity, building new ships is not working any longer,”
Some of this pain may seem self-inflicted, but the idea of building mega-ships we see today is to increase efficiency by moving more goods at one go, thereby reducing cost and boosting profits. Instead, it has glutted the industry with capacity that is mostly unneeded, leaving many ships empty and waiting for cargo. One obvious indicator is the number of empty ships anchoring off Singapore waters.
The saturated market sparked a brutal price war among shipping lines to expand market share. Big companies played hardball in an attempt to squeeze out smaller and weaker players. As of any war, only the fittest survive. Larger companies like Maersk Line, MSC and CMA CGM, get to utilize their strong balance sheets and resources to get through this war, while the smaller operators faced the prospect of either becoming an acquisition target, being marginalized or becoming bankrupt.
The worst has happened for Hanjin Shipping, once South Korea’s biggest container line and seventh-largest in the world. Hanjin filed for bankruptcy after struggling under the weight of heavy debt load due to unsustainably low freight rates. The demise of the South Korean giant represented the biggest bankruptcy in container shipping that triggered a massive disruption in global trade.
Five weddings and a funeral
If anything, Hanjin’s collapse serves as a huge wake-up call for the fragmented container shipping industry, with an urgent need for restructuring. It triggered a wave of consolidation as companies began merging and acquiring competitors in moves to cut cost and to boost competitiveness. We witnessed what many call the ‘five weddings and a funeral’ across the industry.
First, we saw the acquisition and privatization of our listed national line, Neptune Orient Lines (APL) by the French group, consolidating CMA CGM the third position in the container league table.
Second, we also saw the creation of China Cosco Shipping Corporation (COSCOCS) from the state-driven merger of former rivals COSCO Container Lines and China Shipping Container Lines. The merger has pushed the entity to fourth place in ranking.
Third, the three biggest Japanese shippers, NYK, MOL, K Lines agreed to combine their container operations to form the sixth-largest box carrier in the world.
Fourth, a merger with the middle-east carrier, UASC propelled Germany’s Hapag-Lloyd to the fifth position.
Lastly, Maersk Line took over the seventh-largest box carrier, Hamburg Süd to further strengthen its position as the industry leader.
Despite having to compete with fewer competitors, overcapacity continues to be the industry’s main problem. At the end of the day, consolidation just means a shift of market shares among shipping lines, while the supply overhang remains unchanged, an issue that is beyond the power of any one company to address.
Dawn of the New Shipping Alliance
The answer to the broader issue is economy of scale. By pulling resources together, liners formed alliances to offer more flexibility in services, greater frequency of departure and improved transit time.
Operators of the two largest container fleets, Maersk and MSC, combined forces to form the ‘2M alliance’. CMA CGM, together with China COSCO, Evergreen and OOCL followed through with an alliance of their own, the ‘OCEAN Alliance’. NYK, MOL, K Lines, Yang Ming and Hapag-Lloyd + UASC moved in to form ‘THE Alliance’.