Analysts Examine Ocean Carrier Trends In New Global Supply Chain Arena

Now that the IMO 2020 fuel sulfur regulation is firmly in place – with new discussions about what to do next to reduce greenhouse gas emissions from ocean cargo shipping – carriers are back on their heels.

“The environmental profile of shipping companies is critical today for a host of interconnected reasons including social responsibility, shipper requirements, long-term business planning, regulatory certainty, and operational safety,” notes John Butler, President and CEO of the World Shipping Council.

Yet cost is “a necessary conversation,” he adds, since they have to play out in the marketplace among fuel suppliers, carriers, and shippers.

“When you add that broad operational and geographic scope to the cost impact, it is obvious that if there is not a level playing field,” says. Butler. “There is a real possibility for economic distortion. The key to keeping the playing field level is for IMO member countries to be very clear and very public in reminding the industry that compliance will be required for everyone.”

Furthermore, he says, national governments have to follow up to make sure that vessels flying their flags and calling their ports are obeying the law.

“But the sulfur rules and their expected costs do factor into the business case for making a major push to find the next generation of marine fuels,” declares Butler. “That connection is that the industry is continually faced with new and more costly regulations associated with the burning of fossil fuels.”

According to Butler, there is a high probability that whatever fuels end up replacing fossil fuels for shipping will have a related benefit of reducing or eliminating many of the air pollutants associated with fossil fuels that the supply chain is increasingly paying to mitigate.
“That means that there is a direct business case that supports finding the fuels of the future as soon as we can identify alternatives that are safe, operationally realistic, and commercially viable,” he concludes.

Fuel volatility

Meanwhile, the world had been going through a “synchronized slowdown” in 2019 with lower GDP growth, alongside rising trade barriers which had a major impact on the container shipping market, says Peter Sand, chief shipping analyst for the Baltic and International Maritime Council (BIMCO) in Copenhagen.

“Considerable cost pressure remains despite some of the trade war damage being offset by a reshuffling of manufacturing in Asia,” he says. “Adding to this pressure is bunker price volatility.”

Sand notes that in recent decades, the carriers have experimented with bunker adjustment factors (BAFs) in order to mitigate some of the bunker price volatility. However, the implementation of BAFs has often been received with mixed results, to “non-transparency.”
BIMCO believes that the ongoing slowing of container volume growth could result in more cutthroat competition among the carriers for container volumes.

“If carriers end up in a competition of undercutting each other, the probability of implementing BAFs will certainly be decreased significantly,” says Sand.

A plethora of uncertain variables lie ahead, BIMCO believes. Fuel oil availability, compatibility and price levels are all variables that will be closely followed in the months to come. Seemingly, the oil price fluctuations are no longer driven by fundamentals, but instead dictated by market uncertainty and speculation. A widening spread could have dire consequences for some owners, whereas others would be in a much more advantageous position.

“No matter the outcome, IMO sulphur regulation will entail higher expenses for the industry,” Sand concludes. “Owners hoping to pass on the costs associated with the regulation might have a difficult time doing so, if the underlying market fundamentals are not balanced.”

Insurance woes

The existing money problems carriers now face are exacerbated by higher insurance rates and to repair & maintenance spending, say analysts for Drewry Supply Chain Advisors. In a new report, “Ship Operating Costs Annual Review and Forecast 2020.” According to analysts, 2019 was the third consecutive year in which costs had risen, following marked declines in operating expense during the “capacity ravaged” years of 2015-16.

Now, Drewry estimates that average daily operating costs will increase by as much as 2.2% in 2020.

In the most recent rise, spending rose across all six of the main cost categories, indicating how broad-based inflation continues to be, analysts say. That cost-inflation curve has been dampened slightly by a continued recovery across most cargo shipping markets.

“While cost pressures remain, this trend confirms the end of the deflationary era that prevailed mid-decade, as the depressed state of shipping markets forced operators to slash costs in order to survive,” Drewry’s director of research products, Martin Dixon, says. “There are limits to cost cutting, beyond which the safety of the vessel and crew are put at risk, and as freight markets have recovered, so pressure to reduce spend has lifted leading to modest acceleration in cost inflation.”

Heading into the new year, market conditions are expected to be challenging for many shipowners as the trade outlook remains uncertain and benign capacity conditions prove temporary when the current round of retrofits recedes.

As a consequence, Dixon expects the pressure on costs to remain, which will dampen any likely inflation, particularly in areas where owners have greater control, such as manning, stores, spares, and management and administration.

“Other cost heads, beyond the direct control of shipowners, will prove tougher to manage, particularly insurance where we expect costs to rise sharply in 2020,” says Dixon. “Continued attempts to clean up and decarbonize shipping will add to owner cost burdens, affecting management & administration, repair and maintenance, and dry docking costs in particular, as retrofitted equipment adds to maintenance costs.”

Slow recovery

Amid the flurry of ocean carrier consolidation earlier in the past decade, global business sentiment took a hard hit, say analysts for JPMorgan Global PMI compiled by IHS Markit.

“If the demand slowdown would have happened a few years earlier, the impact on the container carriers would have been catastrophic. But one of the greatest consolidation events in the container shipping industry is shielding them from that impact,” said Rahul Kapoor, head of research and analytics in the Maritime & Trade business of IHS Markit. “We're seeing very strong capacity discipline by the carriers and in turn expect the volatility to subside and annual freight rate escalations to cement.” 

According to IHS Markit, the remaining carriers increasingly are acting to control their own destiny by more effectively controlling capacity through restraint in ship ordering and by more actively managing spot capacity through blanked sailings.

“This is a fundamental shift that some believe could be permanent,” say analysts. “Simply put, this means the year-over-year reductions in rates that many shippers enjoyed for years is likely coming to an end. Instead, shippers are looking at a future of higher rates, a change that will take some getting used to.”

Dan Smith, a Principal, The Tioga Group, Inc. is among the many industry analysts who are concerned about excess tonnage.

“As long as overcapacity exists, the question is not how much it costs to operate the vessels, but how much they can recover from shippers that have multiple options,” he says.

Panjiva Research Director Chris Rogers, agrees, noting that consolidation may be one important route to improved profitability.

“The container-lines' consolidation is already done – the top 10 liners represented 87.4% of U.S. inbound shipping in 2019, but in the freight forwarder sector the ratio is just 14.1%,” he says.

But he also observes that while container line profitability improved in 3Q 2019 to an 11.1% Earnings before interest, tax, depreciation and amortization (EBITDA) margin that included a benefit from lease accounting changes at Maersk and Hapag-Lloyd and only leaves the ratio at 3Q 2017 levels.

“The shipping industry may therefore need to cut costs,” he adds, “yet, cutting headcount to compensate could generate labor unrest.”

For Mirko Woitzik, EMEA Risk Intelligence Manager, Resilience360, the main worry is about fewer providers.

“There remain only a limited number of large targets for further consolidation among the biggest container shipping lines in the ocean industry,” he says. “Most of the big players are now linked up in a global shipping alliances or have government ties, making them unlikely takeover targets outside their home nations.”

“Finally, he says, there is also likely to be more regulatory scrutiny should there be another large-scale merger or acquisition.

“To be realistic, logistics managers should understand that the potential candidates for further consolidation are likely to be found in regional or niche carriers which own less than 1% of the global containership fleet.”

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