The container ship operators continue to build mega-ship fleets and form mega-alliances. It’s a numbers game to scale up to bring down slot costs, but will it be enough to bolster the bottoms line?
There is something mystical in divining the relationship between mega-ships, mega-carriers, mega-alliances and the bottom line.
The belief is that by building larger vessels the “economies of scale” will lower the per slot costs to provide a containership operator an opportunity to turn the ever elusive profit, or at least a decent return against capital investment.
The prevailing winds of “economies of scale” has driven an unprecedented increase in the size of vessels and a spate of mega- [operational] alliances that would have even brought a smile to the perpetual scowl of “Old John Swire.” He was the driving force behind the establishment of the Far Eastern Freight Conference (FEFC) in 1879 that once controlled (or monopolized, depending on point of view) freight movements between the Far East and Europe. Swire’s noble cause, not much different than today, was to try to avert freight rate wars: a race to the bottom with predatory pricing that has characterized ocean shipping for a millennium.
In establishing the “conference” system in 1879, Swire said, “We are trying to work a combination for the China freight trade so that P&O, M.M., O.S.S., Glens and Castles may not ruin each other.”
While it’s a much-changed regulatory environment, for ocean carriers, the goal of “not ruining each other” still holds true.
Although there are hundreds of container ship operators in existence, there is an almost historic concentration at the very top. Currently there are only twenty carriers operating with more than 100,000 TEU worth of slots. (See Top Containership Operators chart on page 8) Of the top twenty, only three, the Danish owned Maersk/Moller, Italian/Swiss privately held Mediterranean Shipping Co. (MSC) and French owned CMA-CGM group have more than one-million TEU in slots (Although the newly merged Hapag Lloyd-CSAV group is knocking at the door). Coincidentally, these three mega-carriers compose the newly anointed P3-Network, which collectively controls an astounding 6.6 million TEU slots and nearly 1500 ships. (See Paul Richardson “Alliances order of the day” on page 6).
The container ship fleet is still growing. According to shipping & energy consultants Platou, there are some 342 container ships set for delivery in 2014 that are larger than 8,000 TEU with another 125 vessels next year.
Essentially eleven operators have over 100,000 TEU worth of ships on order (Alphaliner statistics). As one might expect, some of the larger players dominate the order book. MSC, for example, has 38 ships over 400,000 TEU on order, and fellow P-3ers, CMA-CGM has 37 ships of over 370,000 TEU and Maersk a more modest 15 ships just over 255,000 TEU. However, there are also some obvious efforts to redress market share evident in the orderbook. Taiwan based Evergreen Line has 25 ships on order of nearly 300,000 slots, while the other major Taiwanese carrier, Yang Ming has another 20 vessels of over 230,000 TEU. Perhaps the most surprising carrier on the list is UASC (United Arab Shipping Company), which has a 19 ship 280,000 TEU orderbook; a TEU capacity that exceeds the current operational total. Undoubtedly, some orders will be cancelled or pushed into other years, but the ordering binge has been on since 2011 adding 8% to 11% per year to the fleet slot capacity, while scrapping has only been deleting 1%-3% of capacity. In addition most of the scrapping has been in the 3,000-5,000 TEU size range of ships over twenty years old.
At the beginning of the year (Alphaliner) there was around 700,000 TEU worth of slots in layup with a significant portion of these owned by non-operating containership owners. The UK-based shipping consultants Drewry’s reported in March the laid up TEU count was around 550,000 with less than 200,000 TEU owned. How many come back into service or hit the breakers will largely depend on trading conditions, which although improving are far from in supply & demand balance.
At the moment, it appears that the shipbuilding boom should begin to wane in 2016-2017, but such forecasts are etched in beach sand and could be rubbed out with the next high tide.
But it isn’t just that the owners and operational alliances are getting larger, the ships themselves are getting super-sized. According to Platou, there are some 342 container ships set for delivery in 2014 that are larger than 8,000 TEU with another 125 vessels due next year. Put into perspective, there are more slots coming onstream in fewer ships. According to BIMCO, an international shipping association, “since 2009 nominal capacity has grown by 49%, while the number of ships has grown only by 7%.”
With ship bunkers weighing in at 30%-40% of operational costs, some of the mega-ship ordering was driven, as much by improving vessel performance, as pure “economies of scale.” There is a view among shipping economists that the adjustment to the new economics [i.e. larger more efficient ships] has been now made, and the supply and demand equation will begin to balance out as developed economies like the US improve and developing economies continue to grow. However, the alternative view is that the actual pricing structure for freight is flawed, and the supply and demand cycles will continue to be out of sync with capital investment pretty much ad infinitum.
“Bad Bank” & Other Bad Things About the Shipping Sector
The ship owners aren’t the only parties impacted by the growth spurt of mega-ships. Their bankers haven’t fared too well either.
At the end of 2013, The Royal Bank of Scotland (RBS) in an effort to put its house in order did an extraordinary thing: they established an internal “Bad Bank” to handle their more vexing assets. They also did another remarkable thing: for a bank with a long tradition of bankrolling ship owners, RBS put a big slice of the shipping portfolio (rumored at $4 billion-$5 billion out of total of around $16 billion including some performing contacts) – into the “Bad Bank”. Since the bank is now owned 81% by British taxpayers, it might be a bigger personal risk to hang on to the shipping sector interests, but still this illustrates just how out of favor the sector has become.
RBS is not alone. HSH Nordbank AG, reportedly the largest financier of ships, lost $1.1 billion in 2013 (the bank expects to return to profit in 2014). The bank, which was bailed out in 2009 by the state owners Hamburg Schleswig-Holstein, also has tried to cut its ship portfolio, trimming it to Euro 21 billion from Euro 23 billion in the fourth quarter of 2013. The ban also increased risk provisions for the ship sector to Euro 3.3 billion from Euro 2.7 billion. HSH in April said that it had increased provisions for bad loans, mainly on ships, to Euro 882 million. Like many banks, HSH doesn’t expect the sector to return to normal before 2015.
Esben Christensen, a Director in the Maritime practice of AlixPartners, isn’t overly optimistic about the short-term prospects for containership operators. Christensen, an industry veteran who started as a cadet with Maersk, in a wide ranging interview with AJOT suggested that the carriers will be “cashed strapped” from poor returns over the next few years, and this could [and already has if you look at the Hapag Lloyd-CSAV hookup and the Seaboard-Tropical deal) lead to consolidations and forms of “market restructuring”.
In March AlixPartners released their annual “2014 Container Shipping Outlook” Change of the Horizon, which outlines, mostly for the publicly traded containership operators, just how dismal the results have been. While everyone is aware of the operational advantages of the mega-boxship, thus far these efficiencies haven’t necessarily trickled down to the bottom line.
In all fairness, not everybody has done badly. Rodolphe Saadé, CMA CGM’s Executive Officer said, “2012 was an important year for CMA CGM, which delivered a very good performance. As we had announced, we also completed our financial restructuring and significantly strengthened our balance sheet with the sale of a new equity interest to FSI and an additional stake to Yildirim. We have therefore begun 2013 on solid foundations from which to pursue our growth.”
But this is more the exception than the rule.
Christensen takes the view that unlike previous mismatched supply and demand cycles, this one is very different. “We’ve had volatile cycles…disruptions between shippers and carriers but this long depressed rate cycle with no sustained period of recovery…no seller’s market…no time for the carriers to rebuild their finances [is different].”
Although a round of M&A (merger & acquisition) between ocean carriers is quite possible, most analysts think it will be difficult among the top echelon. There are too many factors involved to make pure mergers and alliances easy to fashion. The exception might be, as the Hapag Lloyd-CSAV deal shows, an elite carrier could be looking for niche carriers in specific trade lanes. Alternatively, with lots of venture capital looking for a home, assembling smaller regional carriers under one umbrella not only can happen but is likely to happen over the next few years.
While Christensen and other container ship sector analysts are gloomy about the prospects of the industry in the immediate future, there is hope the sector will turnaround by 2015. This turnabout comes with the caveat that the lines do a better job with their customers, the BCOs (beneficial cargo owners).
Does Bigger Really Count in Performance?
The ultra-large container ships count on the long Far East to Europe route. Size is of considerably less importance on the routes to North America, where the container ship revolution started. For ocean carriers, after bigger is better, they have few arrows in their quiver, for improving the bottom line. The most important arrow left is service speed – slow and very slow speed – to save bunker fuel costs.
In theory, when the goods arrive, as long as it is within the expected date of delivery, it is not so much a function of speed, but of the service. For example, more port coverage, even with slower average transit speeds, should give similar if not better delivery times. After all, even FEDEX doesn’t fly its planes any faster. But is the system working? And secondarily, with mega-alliances how will the different cultural workings of individual carriers impact the holistic value of the share enterprise?
According to Norwegian shipping analysts SeaIntel’s numbers, the service segment of the equation isn’t going so well. “Global schedule reliability decreased again in February, to a new all-time low performance of 68.4%, down from 69.5% in January 2014” as measured in the company’s March 2014 report “Global Liner Performance”.
The analysts reported Hamburg Süd remained the most reliable carrier in February seen from a global perspective with a performance of 84%, Maersk Line 79.5% and CSAV 75.5% following. The main east-west trade lanes, Transpacific Eastbound, Asia to North Europe, Asia to the Mediterranean and Transatlantic Eastbound, saw their performance decline significantly by 8, 10, 6 and 8 percentage points, respectively.
So how will the container ocean carriers convince BCOs that the new mega-world system is better? At this moment in time, it is difficult to divine how they can.