Shipping in Over Supply, Capacity up 27%, Freight Rate Fall 30%
The
global shipping industry is oversupplied. Because supply far exceeds demand,
shipping rates have plummeted, as have the prices of ships. Some shipping
companies have sought to capitalize on this trend by purchasing newer, larger
ships at lower prices so that they can remain price competitive. But unless
demand rebounds by the time these ships become operational, the industry’s
oversupply problem will only worsen.
It is unclear whether the global shipping industry will
normalize before these new ships enter the market. Demand could rise as the
global economy recovers, or the supply of ships could somehow fall. But the
economy’s recovery could just as well be slower than anticipated. Several
factors could prevent the industry from righting itself, not the least of which
are inaccurate forecasts of future market behavior.
In fact, the current state of global shipping was caused in part by incorrect
predictions of continued growth prior to the 2008 financial crisis. In any
case, continued poor performance and a sluggish global economy could eventually
force the shipping industry to restructure.
The
most important factor to consider, in assessing the state of the shipping
industry, is the state of the global economy. The international shipping
industry accounts for approximately 90 percent of
global trade by volume and is essential for connecting large sectors of the
world’s economy. Since 1734, the industry has seen more than 20 boom-bust
cycles, which occur roughly once per decade. The most recent cycle began in
2004 and peaked in 2008 before declining rapidly at the onset of the global
financial crisis.
The downturn afflicted each of the industry’s three main
categories: tanker, dry bulk and container. While the volume of global trade
has recovered somewhat - it grew 4 percent in 2011,
marking a 16 percent growth in ton-kilometers - the shipping industry is still reeling from
the financial crisis.
The
industry right now has far more ships than it needs. Most shipping companies
tend to reduce the price of their services in an effort to underbid their
competitors. Either they reduce the cost per ton or the cost per container.
This means most companies try to accrue the biggest and most efficient ships
possible. Between 2007 and 2012, the average container ship’s capacity
increased by 27 percent.
From a shipping company’s perspective, overstocking a fleet
with large ships while prices are low is a sound business move. Ships are
long-term investments that can yield returns for 20 or 30 years, and trade will
almost certainly pick up during the life span of any given ship. While
purchasing new ships may seem counterintuitive in an oversupplied market,
companies know that the capital cost of a ship plays a disproportionately large
role in determining how profitable that ship will be, representing roughly half
of all expenditures - including port fees, labor,
fuel and other costs - over the course of the ship’s lifetime. Buyers therefore
take advantage of low prices whenever they can.
The more efficient these ships are, the lower the price their
owners can offer to potential customers. Maersk shipping company recently
christened the first ship in its Triple-E line, which is now the largest line
of container ships in the world. These ships are a quarter of a mile long, and
they can hold roughly 11 percent more cargo than
their nearest competitors.
Overcapacity is a problem in itself, but the issue is
complicated by the inherent lag in acquiring inventory. On average, it takes
two to four years after the placement of an order for a ship to be built and
delivered. Thus, ships ordered in 2008, when the industry began to decline,
were not delivered until well after the financial crash. While shipping
companies had hoped the economic downturn would end quickly as many had
forecast, they could not afford to let their competitors build superior fleets
- they were forced to continue buying just to stay competitive.
Along
with the economic downturn, the contest to outbid competitors
helped keep shipping rates low. In turn, low rates have forced shipping
companies to work for fees that often cover only the operating costs of the
ships. In these instances, companies that are still paying off the capital
investment of the ship are actually losing money. This is notable, considering
the Drewry global freight rate index dropped more
than 30 percent from July 2008 ($2,727 per forty-foot
container) to May 2013 ($1,882 per forty-foot container).
The threat posed by untenably low rates could transform the
shipping industry. The world’s three largest container lines - Maersk, CMA CGM
and Mediterranean - have formed an alliance of sorts in an effort to reduce
operating costs. The fact that the three largest companies in the industry are
acting in concert indicates just how hard it has become for them to survive the
downturn (to say nothing of smaller, poorer companies).
Their informal alliance could portend further consolidation.
Past consolidation efforts to control shipping prices were unsuccessful, but several
outstanding issues, such as China’s slowed growth and the European crisis, may
keep global demand low enough to force the industry to restructure itself.
In previous boom-bust cycles, demand and shipping rates
rebounded as new ships became operational. It is unclear whether this will hold
true in the current cycle. If it does not, newly acquired ships will only
aggravate the industry’s problems.