What’s Next for Container Shipping and Ocean Supply Chains?
15-minute read
For those of us who lack the crystal ball, this extract from Lodestar’s interview with the CEO of Vespucci Maritime, Lars Jensen, one of the world’s leading analysts and former shipping executive, will hopefully provide some intel on the future of the supply chain.
Mike: There’s a lot I want to get through today, including what’s happening this peak season and the future of supply chains. The world and the logistics geopolitical landscape look so different after two years of pandemic and the invasion of Ukraine.
Let’s start here and now and examine the macroeconomic situation as we talk in early July 2022.
In China right now, we have growing evidence that manufacturing and new export orders are falling or maybe I should say slowing.
In the US, Federal Reserve chair Jay Powell has pointed to the possibility of a recession.
In Europe, there’s almost no economic positivity, and war is casting a very long shadow.
The IMF has now lowered its global GDP growth forecast for this year and next.
And we have these energy, food security and inflation issues which are threatening to spiral out of control and could very easily lead to social and political unrest in those countries most affected. And that’s pretty much all of them.
Can you recall a macroeconomic environment this risk-laden for us all, never mind for container shipping?
Lars: You might be fishing for the answer no, but I can certainly remember an incident where the macroeconomic outlook was equally risk-laden.
That was in the spring of 2020, when the pandemic was in its second phase and spread outside China, which shut down the rest of the world.
At that point, it was equally risk-laden, but the problem is that there is no good way of accurately predicting what will happen economically.
It is more about understanding some very different scenarios that are all likely to unfold going forward.
So have we seen an equal uncertainty before?
We did in early 2020. In the very early phases, remember when Europe and the US shut down, everybody was completely in alignment that this would send the world into a massive recession, and consumer spending would drop through the floor.
And what happened? The exact opposite. So it is exceedingly difficult right now to predict with certainty how this is going to pan out.
Mike: It sounds like you’re veering on the side of optimism, if I may say so. In your view, how does that transpire in terms of container shipping demand?
If I may put some numbers to you, we had a 7.9% growth in global volumes last year, according to global trade analytics.
They are now forecasting a contraction of 1.7% in 2022.
What are you expecting volumes to do this year and next?
Lars: It depends on what you compare to because there are multiple elements.
Usually, the numbers you see from all the analysts out there are a matter of the growth in the number of full containers that have been moved compared to last year.
But that is flawed for several reasons.
First of all, last year was not a normal year nor the year before, so we should, in reality, still compare it to 2019 to get a sense of the underlying strength.
Secondly, it’s not enough to measure the number of containers.
You need to measure TEU miles to take the distance in. Even more importantly, you need to include the number of empty containers being moved because when we talk about demand, we usually think about full containers. After all, that is the demand for paying cargo that makes sense.
But when you look at the strength of the market, you want to measure demand for space on board vessels, and that includes the empties.
We have seen a dramatic increase in trade imbalances, especially over the last 18 months. For example, with very round numbers, the imbalance on Trans-Pacific trade has gone from 2 to 1 to 4 to 1.
So the number of empty containers has skyrocketed.
If you take the empty containers into the equation, you are still seeing relatively OK growth in container demand compared to 2019.
This growth is stronger than what is suggested if you only look at the full containers.
Mike: When you take those different metrics for container demand, how do you see that playing out over the rest of this year and maybe next year in terms of that demand situation given those macroeconomic factors we discussed earlier.
Lars: At this point, I see two almost equally likely scenarios unfold.
One scenario is that you will continue seeing relatively OK growth. Relatively OK growth in this context means global growth that might actually still show 0% compared to last year, as last year was a bit odd.
The other scenario is if the consumers decide to stop spending on goods. In that case, you might see a massive drop in container volumes over the coming months because this would be linked to an inventory restocking.
Every time you have inventory changes that hammers through on container shipping very hard.
So you could see a peak season where you are down maybe 10% on volume over a few months.
These are two extremely different scenarios, and, right now, it is not possible to say with certainty which one of the two we’re faced with.
Mike: If we can look to the peak season? As you say, Lars, there are many moving parts at the moment.
We have US East Coast port congestion, lack of warehousing, port problems, space shortages, too many empties in northern Europe, and some strikes.
In China, there was this expectation that spot freight rates and demand might get a boost as lockdowns in Shanghai and all the parts of China were de-restricted. That hasn’t materialized as much as people were suggesting it would.
What happens in this third quarter peak season? Does it depend on these two different scenarios you’ve already outlined?
Lars: It partially depends on the two scenarios, but there’s another key here. What’s going to happen precisely with the port congestion.
The challenge here is that port congestion reached an apex in early 2022 when it was extreme.
At that point, it equalled about 14% of global vessel capacity being unavailable because vessels were stuck.
The latest numbers just now came out and covered May. We are now a tad below 10% of the global fleet being unavailable for the first time since June last year.
Whilst that is a nice improvement compared to where we started the year, we have just been through the traditional low season in the industry.
This is where we had the least amount of cargo moving, and the amount of cleanup we could do in port congestion has brought us back on par with where we were in peak season last year.
So if that’s the amount of cleanup we could do in the low season, we don’t even need a strong peak season ahead of us. We just need, let’s call it, a normal peak season, and the port congestion is going to skyrocket.
When port congestion goes up, that de facto removes capacity, and we could end up in the same mess we were in 2021. So that is one scenario.
Suppose we have the other scenario where we get an inventory adjustment, and you get massive drops in demand.
From a port congestion perspective, that would be the best thing to happen because that would lower the volume and allow us to clear more of the congestion issues we haven’t solved.
So bad recession scenario, the only thing that has a silver lining is that it would allow us to address port congestion effectively.
Mike: That’s a very low bar for the peak season. Is there anything else out there that could resolve these supply chain bottlenecks?
Because that seems to be saying either we have lower demand now, or we have to have at some point in the future before any of this is solved.
Lars: What’s it going to take to clear port congestion?
One answer is time. It just takes time because you still need to deal with your normal flow if you’ve got congestion. Only your excess capacity above normal flow is really addressed towards reducing congestion.
Part of the congestion here is not necessarily down to the ports alone. It’s also down to infrastructure constraints in terms of trucks and rail and warehousing and everything else. The reason for concern is shortages on the inland capacity side that have been going on for almost two years.
It has still not been resolved.
One of the issues is a lack of trucks. But can you then not buy more trucks?
Well, it’s the same thing if you want to buy a car for yourself right now.
There is a long demand because we got a shortage of computer chips.
Why do we have a shortage of computer chips? Initially, it was the pandemic.
Right now, you’ve got a shortage of neon which you need to produce computer chips.
More than half of the world’s neon production took place in Ukraine. That’s not going to be restored anytime soon.
Then you also have a shortage of truck drivers in Europe, for example.
You have changes in cabotage rules which, to some degree, have impacted the availability of truck drivers, especially in northwestern Europe.
You had some truck traffic in Europe that was handled by Ukrainian and Russian truck drivers. They’re clearly not present there anymore.
So you have many effects here transpiring into one of the core issues, that is, inland capacity still not resolved, which does not give much hope that we can resolve the congestion rapidly.
On top of that, we have port strikes.
All eyes for the last 12 months have been on the US West Coast. The expiration of the West Coast agreement with the union was the big scary risk and the possibility of another strike in the US West Coast.
Sure, that would have had devastating effects. But people forget there are other places in the world than the US West Coast.
We can see now with strikes in Germany, Belgium, in the UK on the rail side and strikes of truckers in Korea, which also have ramifications on the ports and terminals.
So, I’m not optimistic about a short-term resolution of many of these bottlenecks.
Mike: Regarding the logistics issues you mentioned there. Are there similarities between the US and Europe challenges that we’re facing?
Or do you see these two markets differently in terms of what needs to be done to address that hinterland landscape?
Lars: If you look at the US and how chassis are owned, operated and maintained there. That’s an added complication that is very much US-specific that we don’t see anywhere else.
This is a mess that does not have one reason. It’s a multitude of different traffic jams at the same time.
When it comes to the chassis, years before the pandemic, one of the constantly raised issues was a fear of a chassis shortage.
So this was a pre-existing problem. These chassis are produced predominantly in China.
As part of the Trump trade war with China, an import tariff was placed on the chassis that were already in short supply. The Biden administration in 2021 then further increased import tariffs in a situation of acute shortages.
So you have a multitude of these different elements just piling on top of each other. If you took any single element alone, that would be addressable, but we now have a mess for the whole pot of different reasons that are all intermingled, making this quite challenging to solve in the short term.
I know everybody would like to see a short-term resolution.
You can see, especially in the USA, a political desire to show we are going to do something effective about it, but this is not something you can solve in the short term.
Mike: And in Europe?
Lars: In Europe, I would say it might be slightly different.
Even if you have the most efficient container terminal in the world, once you become chockablock full, your efficiency declines rapidly.
In Europe, we have very efficient terminals. However, when they become too full, then they can’t operate. Then a terminal might restrict how early you are allowed to gate in export containers, for example.
From the terminal perspective, that makes sense and will clear up some space.
But there would be quite a number of containers en route on trucks that can no longer be gated in, and then trucks will have to wait.
So you’re effectively reducing the amount of trucking capacity available and simply shifting the problem from one place to another.
Mike: That leads me quite nicely into the next subject I wanted to chat with you on.
It’s the relationship between carriers and their customers, which I think somewhat deteriorated over the past two years.
For many years, shippers shopped for the cheapest prices, and container lines struggled to make money.
We’ve had two years when the boot has been on the other foot. We’ve had these record freight rates, which I think has somewhat added to global inflation.
In some trades, long-term contract prices are currently surpassing spot pricing.
If that continues, will these contracts be honoured? And if they’re not, where does this leave container line revenue and profit projections and plans, which in many cases are factoring in these long-term contracts?
Lars: Every time the market hits rock bottom spot rates, you have many shippers that change their deals with the carriers.
The latest data indicates that we’re seeing spot rates dip below some long-term contract rates.
For now, we do not see that leading to any changes.
I see this as a risk management assertion on the part of shippers.
We still don’t know if we will suddenly get a strong peak season and a capacity shortage a month from now.
The reason why shippers have entered into these high-priced long-term contracts is to safeguard their access to capacity.
You don’t want to rock that boat right now as you still don’t know whether you’re going to need it. But if it becomes clear over the coming weeks and months that we don’t get that space tightness and rates will continue down, then you will see many of these contracts renegotiated.
Xeneta [freight rate market analytics platform] asked many of the shippers that provide them with data if the spot rates continued to decline will you stick to your contract or will you renegotiate.
I can’t remember the precise number, but I believe 10 to 20% said they would stick to the contract. The rest were going to renegotiate.
I don’t find that number surprising at all.
Mike: Does that mean that carriers would be put under pressure to some degree?
Lars: Nobody should be under the illusion that if freight rates start to drop rapidly, they will come down to anything normal anytime soon.
I did a small model more than half a year ago. If rates truly go into freefall, how long would it be before we’re back to something that looks normal?
I went to the only rate index we have that’s been in existence for a long time, the Chinese CCFI.
So from 1998 until now, we had five periods where rates were genuinely in freefall over a long period.
The two worst declines occurred during the financial crisis when the market collapsed, and the other was in 2015 – 2016 when we had the worst price war the carriers had ever engaged in. Rates were really in freefall there.
Then I looked at how quickly the rates fall in percentage terms.
Both of these were equally severe.
Let’s say we now get into the same kind of freefall. It could still take a year before you’re back to normal freight rates, even if rates are in freefall.
So make no mistake, rates can undoubtedly start to deteriorate rapidly, but you’re going to be way into 2023 before you had the earliest hope of something that looks normal.
Mike: Back to that shipper liner relationship. The shippers’ complaints have not just been about pricing. It’s also about service.
For most of the last two years, we’ve had awful schedule reliability, lack of boxes, lack of information, and lack of customer service.
Do you think that lines could have performed better in managing all of this?
Lars: The problem here is what does doing better actually mean?
Given the circumstance, I don’t see the carriers could have done anything differently.
In early summer last year, I looked at the carriers’ planned capacity injections on the Trans-Pacific. The Trans-Pacific trade was booming, so there was massive capacity injection. This was going to lead to a massive bottleneck problem.
So what should the carriers have done? Should they have put in more capacity?
This is what they did because the shippers were screaming for more capacity. Or what the carriers, of course, could have done is they could not have inserted more capacity. That way, they would have been able to maintain schedule integrity. They would have arrived on time but left a million containers behind.
So you would have had a much more severe capacity shortage.
If the carriers had curbed capacity to ensure they could provide a good service, freight rates would not have peaked at 20 to 30,000. They would have peaked even higher, and the carriers would have been under even more allegations for colluding to keep capacity low artificially.
So from a carrier perspective, these two years have been a no-win situation.
So all capacity has been thrown in, but the price for that is the congestion and the waiting lines.
Mike: The lines are a target due to these massive profits and high freight rates.
Let’s just look at the strategy of these carriers.
We’ve seen quite divergent strategies in terms of how they’ve invested these windfalls.
Do you think they’re investing wisely or coherently?
Lars: Coherently wouldn’t be the right word here. They are investing differently because they have different strategies now.
When we started the pandemic, the carriers were all barreling down more or less the same path.
Maersk and CMA had slight aberrations there, but now you’re seeing the carriers diverge in quite a number of different directions.
The enormous profit of 2021 and 22 have given the breathing space to choose what strategy they want to pursue and put the money into it.
Most of the carriers have been ordering enormous amounts of ships.
Some of them are barreling down the path of putting more money on either complete green ships or at least dual-fuel ships, so they’re capable of being green. That is one agenda now ramped up simply because the money is there.
You are seeing carriers making many logistics acquisitions, especially those proceeding down the logistics path.
So it has allowed the carriers to pursue some of these strategies.
I still think the carriers have an interesting problem of having more money than they can spend now.
If you’re looking at it from a green agenda, the timing is not optimal because the maturity of the green technology to have purely de-carbonized ships it’s not quite mature yet.
We don’t have the fuel yet. So even if you wanted to build green ships, you couldn’t get the fuel yet. That’s a shame because if those two components were in place, you would have seen an extreme acceleration of the decarbonization. After all, the money is there.
But it doesn’t make sense to do right now because you don’t have all the components in place.
Mike: We’ve got this war in Europe, and that has changed how many analysts view the future of globalization and supply chain security.
It’s not simply now about cost and resilience. They say it’s about shared values and national or regional security.
People are worried, for example, about what happens if China becomes embroiled in a conflict that drags the West in.
So have you changed your views in the sort of nine months since we last spoke on deglobalization or re-regionalization at all?
Lars: Not to a significant degree. One thing that I see will change over the coming years, and that’s only a change that happened here in 2022, is that we will see a significant exodus of manufacturing out of China.
Most likely, it’s going to move to other places across Asia.
We’re going to see an exodus out of China because of the shutdowns in Shenzhen and Shanghai in early 2022. To many importers, this is a problem. The Chinese government’s top priority is no longer necessarily financial performance.
In this case, the zero-tolerance policy raises the question of the next political priority for the Chinese. So from a risk management perspective, this will not happen overnight, but what’s going to happen is the next time somebody is pondering whether we should build a new factory, should we build it in China, or should we build it elsewhere.
The scales are going to tip more towards elsewhere. The next time you have a manufacturing contract expire with the supplier in China, more are going to ask themselves, maybe we should diversify this one.
This will still come down to cost, and the cost is a combination of the manufacturing costs and the supply chain.
Ultimately the supply chain will work itself out.
I expect that we would see governments, especially in Asia, that know what’s good for their economy marketing themselves as attractive locations.
I would expect to see a resurgence of infrastructure on port projects throughout Asia to attract manufacturing that moves out of China.
I’m not saying everybody will move out of China, but we would see a reduction in the reliance on China and move to other places to have a more resilient and robust supply chain.
Source: The Loadstar podcast. This interview was edited for clarity.
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