Outlook 2019: Containers

Reasonable economic growth and supply scenarios are likely misleading — complexities abound and 2020 and the digital revolution will have an impact of on the outlook this year.

News ID: 80301

Date: 01 December 2018 - 08:28

The cautious optimism that carriers expressed for 2018 has not quite come to pass, and there are more sharks still lurking beneath the surface. Looking forward to 2019-2020 the carriers still face challenging conditions, although the nature of the challenges will be changing — some gradually, and some more acutely.

LOOKING at the developments in the Pacific in the third quarter, one might find grounds for renewed optimism in the short term. This is after all a trade that has seen the strongest peak in more than a decade when judged on the strength of the spot rate market.

However, scratching the surface leads to the more sombre conclusion that the strength appears to be founded more on tactical actions and short-term demand drivers than a more fundamental global strengthening. In essence we have seen not only capacity reductions stemming from service rationalisation just prior to the peak, but also a record high amount of blank sailing in parts of the peak season.

This is further fuelled by what appears to be importers trying to frontload cargo before new tariffs are implemented in the US. Whereas this is undoubtedly a welcome addition to the carriers’ bottom lines in third-quarter 2018, it cannot be taken as a sign of a structural improvement.

It is well known that the problems that have plagued the carriers for the past years are due to a significant amount of overcapacity fuelled by the ordering of large amounts of mega sized container vessels. This is a problem that will take time for the industry to work out, but given time this will eventually happen.

When assessing the industry developments for 2019-2020 and beyond, the usual supply and demand analysis alone is insufficient in terms of understanding the coming dynamics.

Two additional elements warrant attention. One is the issue of the new low-sulphur rules from 2020. The second is the digitalisation development in the industry, which is in part driven by the commoditisation of the industry and in part by emerging competitive pressure from digital non-carrier entities.

Demand

Demand growth in the key deepsea trades tend to fluctuate, and peaks and troughs do not always coincide. A look at the two major deepsea trades confirms this.

In 2018 the Asia-Europe trade has been weak, with five months having shown negative year-on-year demand growth. Overall, the first eight months of the year have seen this backbone trade grow by only 0.9%.

The transpacific, conversely, has shown strength, with demand in the first eight months having grown 5.4%, spiking in spring when year-on-year growth was 8%.

But as vessels can be freely moved around — although with restrictions on especially the ultra large vessel class — what truly matters is the development in global demand. Individual trade lane fluctuations can cause temporarily strong or weak markets, but reassignment of capacity will over time absorb such differences.

When looking at the development in global demand growth, a more concerning view emerges. Looking at the trend from 2014 to 2018, it is clear that demand growth has been slowing down. From a long-term trend perspective we should now be at a growth rate of 4%, but the data shows the actual global growth to be only 2%.

This development is concerning, because it indicates a decoupling from the underlying global economic growth. In the same period global gross domestic product growth has been in the range of 3.2%-3.7%, with the Organisation for Economic Co-operation and Development projecting continued 3.7% growth for 2019 and 2020.

This means that for 2019 and 2020 we could be facing global demand growth of just 3%-4% in a scenario of continued strong global economic growth. The upside to this forecast is if the slowdown is temporarily driven by inventory reductions and the container factor reverts to former higher levels, in which case global demand could be as much as 7.5%.

The downside to the forecast is that an expectation of continued high global GDP growth ignores the risk of a slowdown, or even recession, as a consequence of the escalating trade disputes. In that case global demand growth can slow even further compared with current levels.

Supply

Currently the remaining confirmed orderbook amounts to 2.7m teu of nominal capacity. In itself this is not a daunting amount of capacity — it only corresponds to a fleet growth of 12%, which is not much considering the delivery period for these vessels stretches into 2021.

Depending on developments in relation to vessel scrapping, this could be reduced further down to a net fleet growth of some 7.5%-10% cumulatively over the coming three years. That being said, there is still room to order more vessels for delivery in 2020 and 2021, and therefore the orderbook could indeed grow further.

The main challenge with the orderbook is not the magnitude. Even with the conservative demand outlook, we are currently poised to gradually absorb the overcapacity. The challenge is the fact that the orderbook is heavily skewed towards the larger vessel sizes. The ultra large vessel class above 18,000 teu is particularly problematic. This segment will grow 61% in the coming years based purely on already-known orders.

In essence these vessels are only well suited for the Asia-Europe trade — a trade that has seen virtually no growth in 2018 despite positive economic development. The carriers have no choice but to continue to phase in these vessels, and to obtain the scale benefits associated with them the consequence is a reduction in the number of weekly services and a cascading of ever larger vessels onto all other trades. This is not a new phenomenon, in fact it has been very visible in the past five years, but given the nature of the orderbook it is a trend that is set to continue in 2019-2020 as well.

From a port and terminal perspective this has the consequence that irrespective of the size of vessels currently calling a given port, it is highly likely that the vessels will become larger in the coming years due to the cascading. And for temporary periods, the upscaling might be quite severe as is witnessed presently with Maersk Line temporarily deploying 18,000 teu vessels to the US west coast.

The low-sulphur issue

The new low-sulphur rules remain on track to go into effect in January 2020, despite efforts to postpone the effective implementation. This is a development that has the potential to increase tensions between carriers and shippers in 2019, as the carriers attempt to pass on the costs to the shippers.

Carriers can abide by the new rules in three different ways. They can use low-sulphur fuel, they can install scrubbers or they can use liquefied natural gas-powered vessels. LNG-powered vessels account for a very tiny fraction of the fleet and for the next few years will remain a minor exotic part of it, and therefore not have any material impact on the overall developments.

The installation of scrubbers allows a carrier to continue to use normal heavy fuel but carries a significant capital expense. Overall, a scrubber installation has a cost of $2m-$5m and takes three to five weeks of work in a yard to install. Furthermore, it appears the capacity for installing scrubbers in 2019 amounts to some 3,000 vessels — and that should be seen in the context that the merchant fleet is comprised of some 60,000 vessels whereof container vessels are only a minor part.

Hence, irrespective of any merits related to the scrubber solution, the majority of container vessels will in 2020 be forced to use low-sulphur fuel. The balance between scrubbers and low-sulphur fuel might then gradually change from 2021-2025 if scrubbers become a preferred method, but for the immediate future, low-sulphur fuel will dominate the chosen solutions.

It is uncertain what the exact price spread between normal heavy fuel and low-sulphur fuel will be. However, it is estimated that the additional cost to the industry will be $11.7bn annually from 2020. That is an amount that exceeds the combined profits from all main carriers over the past seven years, and therefore it is clear that this cannot be absorbed by the carriers.

Containers Charter Rates Outlook

Rewind to the start of the summer and there was a degree of optimism for a resurgent box charter market. Rates were up, fixture activity was up, idle numbers were down, and owners were (whisper it quietly) earning money.

But a prolonged slowdown in scrapping numbers and a steady rollout of newbuildings has reversed fortunes. Rates gradually fell by the wayside, spot tonnage steadily rose, and short-term or flexible charters are once again the norm, with the market swinging firmly back in the operators’ favour.

Heading into early 2019, analysts envisage a similar scenario. Although the tide of falling rates could be stemmed to some extent if owners of older tonnage see this as an opportune moment to send ageing ships to breakers, particularly in the long-suffering 1,700 teu class where daily rates have sunk to near $6,000 per day.

Making any firm forecasts beyond the first quarter is, however, a risky business.

Owners, understandably, are adopting caution as they wait to see how the US-Sino trade war plays out, deploying ships only where they are needed. This also makes forward analysis of supply and demand difficult to call, as the charter market sits in a state of flux.

Indeed, it is the second half of 2019, when things could get interesting.

While the full extent of the US-Sino trade war should be much clearer by then, there is also the impact of the new emission standards set by the IMO to consider.

Whether vessels are to be fitted with scrubbers or have their engines cleaned in readiness for the fuel switch, they will have to come out of service for a period. As ships head to the yards, there is every likelihood of a shortage of available spot tonnage and of course a sudden surge in rates.

The steepness of the rate curve will depend on how owners manage to juggle the necessary upgrades of their respective fleets when push comes to shove. Some analysts even suggest a 30%-50% short-term spike as operators fight from a limited pool.

The question, however, is what mechanism will be implemented to handle the transfer of this additional cost. Several main liners have announced new bunker surcharge formulas specifically designed to address this issue. It is equally clear that these formulas, for now, have received significant push-back from the shippers.

The coming year will therefore be heavily dominated by the carriers’ attempts to implement a new effective cost-transfer mechanism for fuel price increases, a task that is not easy given the fact that the fuel cost increases seen in 2018 have not been fully passed through to the shippers — if that was the case, global rate levels in the third quarter of 2018 should have been 13% higher than what was de facto the case.

The carriers are therefore faced with the challenge that the fuel price increase seen in 2018 have not been passed on to the shippers in full, yet they need to get acceptance from the shippers for potentially much more substantial increases by January 2020 – and the first litmus test of this will take place on the transpacific in spring 2019 as the annual contract negotiations get under way for contracts that will stretch into April 2020.

Digitalisation

Given the perennial overcapacity problems combined with a commoditisation of most deepsea trades have led many carriers to search for a new strategic focus.

In this context, digitalisation is often mentioned. However, digitalisation in itself is not a new strategy. More than 100 freight technology companies have sprung up in the container shipping sector in the past few years, and in essence their new tools and techniques can be divided into two main groups.

One group consists of technological solutions aimed at cost reductions. This could be sensor technology allowing optimisation of engine performance, or optimisation software aimed at reducing the amount of empty container movements on the landside.

The other group consists of solutions aimed at improving the value proposition given to the customer. This could be sensor technology allowing real-time monitoring of reefer conditions, exception-driven tracking notifications or new ways in which to book containers or enter into contracts.

We are currently at a point in time where all carriers are engaged in various types of solutions spanning both above groups. None of the solutions can be said to have reached large-scale mainstream adoption yet, but some appear to be on a sharp upwards trajectory and we are poised to see the mainstream adoption of some of these companies in 2019.