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Will carriers fold a winning hand?

Source: Drewry

8 mins read

Why container lines might not want a return to business as normal? Will carriers fold a winning hand?

The heart-lifting scientific breakthrough for a potential COVID-19 vaccine is now diverting the world’s attention to the logistics of how will it all be moved when it becomes available.

What will the wider media and general population find when they cast their eyes to the sectors entrusted to grease the world economy by moving goods and parts to far flung locations?

They might be in for a shock. The current state of the container market is one of dysfunction, bordering on chaos. Supply chains have been stretched to near breaking point by the unprecedented volatility in demand swings, the tale being numerous port congestion notices popping up in all continents, from Sydney to Felixstowe and many places in between.

The industry has to be commended for coping as well as it has with the unexpected demand surge, but the trade-off has been longer lead-times and massively inflated freight rates as everyone scrambles for the few available containers, which have become a precious commodity.

It is no wonder that the ocean-side supply chain has fallen into disrepair as it is simply not designed to cope with ‘Black Swan’ events, such as the one we are all living through. A glut of capacity (either ships or containers), as economics 101 tells us, will be punished with lower prices. Ocean carriers, therefore, are ever watchful to synchronize supply and demand as best they can, but they do not dare risk a strategy to cater for highly unlikely (but crucially, not impossible) scenarios.

Sometimes they get it right and sometimes they get it wrong, but generally, the imbalances are within reasonable degrees from the equilibrium line. Investing in expensive assets such as ships will always be a gamble because shipowners do not have advanced knowledge of the conditions in which those assets will operate. It is hoped that over the 20+ years lifecycle there will be more good years than bad, but every new influx has the potential to destabilize the market, one way or the other. It is also cumulative so that a run of misjudgments compounds the over / undersupply situation.

<span>Photo by <a href="https://unsplash.com/@patwhelen?utm_source=unsplash&utm_medium=referral&utm_content=creditCopyText">Pat Whelen</a> on <a href="https://unsplash.com/s/photos/cargo-carrier?utm_source=unsplash&utm_medium=referral&utm_content=creditCopyText">Unsplash</a></span>
Photo by Pat Whelen on Unsplash

The ‘sins’ of the past, when it comes to newbuild containership contracting, can always be seen in the present and this year is no exception. The heavy contracting of 2013-15, when mega-ships were all the rage and some 5.4 million TEU was ordered, meant that the industry was banking on a strong demand run in the intervening years, which did not materialize. The unprecedented capacity management tactics by carriers in 2020 can be viewed as the correction required for betting too hard on one side just a few years earlier.

However, while all that is true, having excess capacity in the system has actually been beneficial in recent months, enabling carriers to better manage the highly volatile upswing in demand than they otherwise would have been able. The speed at which some ships have shifted from being redundant to essential has been staggering, as evidenced by the rapidly shrinking idle fleet and soaring charter rates.

The problem right now is less to do with there being insufficient numbers of ships (or to a lesser extent container), rather an inability to get them where they are needed in a timely fashion. Carriers having been throwing capacity back into the market (see Figure 3), but landside bottlenecks and long queues outside of ports all point to an infrastructure that cannot cope with sudden big peaks of inactivity.

The situation does not look like it will ease until a time when the demand curve flattens, and/or when container manufacturers have added sufficient new stocks.

Amid the numerous bottlenecks, carriers are doing very nicely. The only impediment to further freight rate inflation right now appears to be fear of regulatory retribution. Conditions are ripe for further gains, but twice recently carriers have canceled planned GRIs (general rate increases) in the high-flying Transpacific market.

Governments might have the power to suppress pricing and dictate operational decisions, but they cannot force carriers to invest. Even if there is now an unofficial ceiling for freight rates, lines will still be very profitable at the current levels and would like them to remain so for as long as possible.

Therefore, what incentives are there for lines to spend their money to make the supply chain more resilient to future demand shocks? winning hand

Consider these two options from an imagined carrier’s perspective:

Invest heavily in new ships and equipment – this will improve operational efficiency, but carries a high likelihood that the market will ‘reward’ you with lower freight rates.

Freeze investment – this will most likely further disrupt supply chains and lead to more animosity with customers, but will save money and increase the probability of sustained highly profitable freight rates.

Which would you choose? winning hand

These are very simplified options, of course, but they give a flavor of how the average carrier might be viewing the market. Additionally, in playing the devil’s advocate we are also assuming that the barriers to market entry are too high for a new entrant to emerge with new investment and capacity, which would change the dynamics.

From a shippers’ perspective, you have to ask yourself if you think the current situation is temporary or permanent. If the former, you will just have to sit out a few more months of disruption and high prices before the situation normalizes and the underlying supply-demand fundamentals pop the bubble. If you are inclined to believe that high volatility will linger and become more frequent, it will require a deep rethink of planning and budgeting.

Our view

Right now, carriers do not have much incentive to take the altruistic decision. To build a more resilient supply chain that can weather extreme volatility will require a paradigm shift so that investing in a safety stock of surplus of capacity/infrastructure is not jumped on as an opportunity to drive down rates.

Source: Drewry | HellenicShippingNews

www.shipdiary.com

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