Shippers, carriers navigate service contracting season
By Eric Johnson
Uncertainty reigns supreme on the transpacific these days as shippers and carriers finalize annual service contracts on the key trade linking Asia and North America.
And that uncertainty extends to the most basic aspect of the carrier-shipper relationship ' rates. While transpacific carriers are seeking rate increases, including an unsuccessful attempt at peak season surcharges in January, spot rates on
the trade have plummeted to about half their 2010 peak. Meanwhile, bunker surcharges are rising. Meaning it's a difficult environment in which to project more than a few days out, much less weeks or months.
'We've kind of had to shorten the timeline with which we can predict rates,' said Greg Plemmons, vice president of Old Dominion Global, a division of North Carolina-based Old Dominion Freight Line. 'Typically we talk in terms of 30 days out for spot market. In some cases, we've have had to shorten that to stay current with the bunker adjustment. Then there's political unrest, fuel prices, inflation in key markets like China. There's no shortage of issues to keep me awake at night.'
Tom O'Rourke, vice president of business development with non-vessel-operating common carrier Network America Lines, said the number of variables involved in pricing ocean service make it difficult to project too far ahead.
'It's difficult to forecast more than a month out,' O'Rourke said. 'How confident are you of your freight costs three months out? You don't know what events out there will affect your costs. Carriers may very well. I don't.
'The validity or term that you can commit to certain rate levels, I find difficult to go more than 60 days out. No carriers committed to us that they will hold (bunker adjustment) levels long term. They made it clear a long time ago, even with the largest shippers, risk must be shared and there will be some language or mechanism in contracts to recover rising bunker costs.'
An ocean freight executive from Agility agreed.
'While it is fairly easy to procure rates at competitive levels in a downward market, we are not always able to fix rates for lengthy periods that some of our clients are looking for,' said Cas Pouderoyen, Agility's senior vice president of global ocean freight. 'Carriers are naturally not keen to lock in rates at low break-even levels for longer periods. The (bunker adjustment) component is even more difficult to lock in for longer periods in today's volatile environment.'
Fuel isn't the only worry. There's also concern about North American demand during a still fragile economic recovery. And then there's the issue of inflation in China dampening the attractiveness of Chinese exports.
'The annual pre-New Year rush has been nothing like that of recent years, causing shipping lines to reverse rate increases and cancel sailings they introduced last summer as the American economy improved,' according to a CNBC
report in late January. 'This winter, the scurrying started only two weeks before the holidays, instead of the usual four weeks, according to shipping executives. That is because many Chinese factories simply cut back production this month as their Western customers began resisting steep price increases.
| 'There's no shortage of issues to keep me awake at night.' |
Old Dominion Freight Line
'China's inflation is running 5 percent at the consumer level, according to official measures. But Chinese and Western economists describe these measures as based on flawed, outdated techniques and say the real figure may be up to twice as high.'
Against that backdrop, it's next to impossible to accurately predict demand for the rest of 2011, and the range of analyst forecasts shows that there's no clear consensus. Most analysts and container lines are projecting transpacific volume to rise from 6 percent to 10 percent. But a February report by Denmark-based SeaIntel predicted transpacific volumes could rise by as much as 15 percent to 20 percent in certain months this year.
|'Demand forecasts that carriers see as vital will be tough to generate with differing outlooks on U.S. demand.|
'Lines will insist on firm bunker recovery mechanisms, though major shippers might try to negotiate down base bunker rates to account for slow steaming.
'NVOs expect to garner more market share via many variables that shippers and carriers can't control.
'Our analysis shows that the pending rebuild of inventories will produce a very sizeable impact on container volumes,' the report said. 'This build-up of inventories, from currently very low levels, is expected to give rise to higher than anticipated demand. This increase is likely to happen relatively fast, and could result in a temporarily tight supply/demand balance, with resulting increases in total freight rates ' even when faced with the introduction of additional capacity.'
That's a bullish prediction and one to give carriers hope, especially considering that most believe overcapacity this year is more likely than undercapacity. Another analyst, U.K.-based BoxTradeIntelligence, predicts transpacific volume could rise only 1 percent over 2010, based on the moribund U.S. housing market and rising energy prices.
Whichever number is right, carriers seem cautiously optimistic.
'Rates have come down, but we are in a more stabilized world than during the past years,' said Jean-Philippe Thenoz, CMA CGM senior vice president of North America lines.
In a conversation with American Shipper
, Thenoz noted the SeaIntel transpacific growth projections and said that every category of shipper customer for CMA CGM has forecast a robust year in 2011.
'Negotiations are impacted by the overcapacity of 2010 and the latter months where expectations amongst shippers are unrealistically low rates that do not reflect the low inventory stocks, the growth, the positive economic signals from the U.S and the effect of new tonnage,' said Franck Kayser, chief operating officer of The Containership Co. 'We, however, believe that freight rates shall be in line with those of May 2010.'
The Transpacific Stabilization Agreement, whose 15 member lines carry the vast majority of Asia/North America volume, is going with growth predictions in the 7 percent to 9 percent range.
Transpacific Stabilization Agreement
|'A lot of carriers remember vividly the lessons of 2009. None of the carriers want to see that scenario again.'|
'We haven't seen anything to sway that in any meaningful way,' said TSA Executive Administrator Brian Conrad. 'It still comes down to the U.S. consumer. Seven to 8 percent from that higher base at end of 2010, that's pretty healthy. If the first half is at 6 percent, then peak season is going to be higher.'
With so many variables and contradictions swirling round, Plemmons said he relies on constant communication, and on not applying general market information to his customers' specific needs.
'We just rely on open and honest dialogue,' he said. 'We're obviously talking with our customers every day, and we hear anecdotally what's going on in the marketplace. We literally talk on a daily basis with our carriers, not just in contract season, but year-round. We don't hesitate to have that honest conversation. We don't talk too much in terms of what the TSA is projecting, we talk very specifically about our needs and our relationship with the carrier.'
And he added: 'Everything is going to be driven by volume. At the end of the day, that's what drives the market.'
Carriers, it seems, are most interested in ensuring that revenue ' either through rates or surcharges to cover rising operating costs ' grows in 2011.
'On the carrier side, the key issue is going to be the need for additional revenue and cost recovery,' Conrad said. 'We've seen all the news reports that carriers did a nice job of recovering. But when you drill into those numbers, you look at the below-the-line operating costs and the way they have gone up. The money made in 2010 hasn't brought them to where they need to be to recover from 2009. Carriers aren't looking for the same increases as in 2010, but that's going to be the key issue. How they keep that momentum going.'
Conrad admitted that shippers will likely be seeking space assurances after the travails of mid-2010, when cargo was rolled often in Asia, primarily due to a shortage of containers.
'I think they're looking for a little more predictability,' Conrad said. 'Shippers are looking for more commitment to service, which will be a two-sided thing. They'll say, 'we'd like you to guarantee space every week.' But the carrier would say 'I've juggled around commitments, positioned empties, and then the shipper doesn't show up.' '
Conrad said 'more timely and more accurate forecasting' is also required.
'We see analysts demand projections, but we've been working on how we get better at a more structured way of forecasting,' Conrad said. 'Individual shippers and individual carriers do this, but there are large shipper groups who have economies of scale, and so we'd like to look at how they see demand. They should be able to give us more accurate information. We've just initiated a formal discussion on this with shipper groups, and the initial response is that this is something we should be working on.'
When asked whether new entrants on the transpacific the past two years have affected rates, and thus revenue-earning opportunities, he said, 'there is a little bit of pressure. It depends on which carrier ' different carriers concentrate on different parts of the market. So some carriers are affected more than others. (The new carriers) are China/West Coast port-to-port focused so carriers who have a big market presence in that market may find themselves affected. But it's certainly not driving the market. Here and there, certain carriers come up against them, but it's not significantly affecting major portions of the market.'
What will affect the market more is overall capacity growth.
'At least six transpacific strings are expected to be launched this year, excluding peak season services, that would bring the weekly capacity deployed on the Far East/U.S. route to over 410,000 TEUs per week by August,' maritime news service Alphaliner
said in mid-February. 'The expected capacity influx could limit the ability of the transpacific carriers to raise freight rates for the 2011-12 contract season after a strong run last year when carriers were able to impose rate increases of over $1,000 per FEU and successfully imposed peak season surcharges in the summer of 2010. The carriers' recent failure to impose a peak season surcharge in January, due to the weaker than expected vessel utilization levels, was in marked contrast to the rush last year when spot rates were rising at almost $100 per FEU per week in the run up to the Lunar New Year in mid-February 2010.'
The economic peaks and troughs of the past two years have obscured what used to be the hottest topic in the industry ' fuel costs. But now that demand and supply have settled into a somewhat normal pattern, fuel concerns have begun anew, helped in large part by unrest in the Middle East that has driven crude prices back above $100 per barrel.
Plemmons, of Old Dominion, said carriers are looking to be compensated or reimbursed for their rising costs of operation.
'That's what they're looking for, what they're talking about,' he said. 'Rates are going the other way. It's a very tricky market at the moment. We just make sure we have access to competitive rates for our customers. There are some contradictions out there. But carriers seem to be holding the line on (bunker adjustment) from our experience.'
Conrad said carriers need to remember the impact of fuel prices on their bottom line.
'The expectations are that bunker prices will rise this year,' Conrad said. 'I don't think there's an expectation that prices will plateau or go down. With the Middle East situation, I don't know how that affects things. All this highlights for carriers the importance of their floating bunker charges. The concept of a floating bunker charge is much more widely accepted than in previous years. A shipper's formula might differ, but the concept of moving up and down in fuel compensation has some traction. Carriers are less concerned than they would have been three or four years ago.'
Carriers 'shouldn't lose sight of bunker. Bunker is a major, major concern for them in terms of getting some recovery. The prices are there and they know how much it affects them from a cost standpoint. It's not hard for a carrier to sit down and show in dollars and cents terms what it means to their bottom line.'
Conrad said fuel costs on a generic Asia/U.S. West Coast sailing are about $800,000.
'Fuel cost is still a major cost in any vessel voyage,' he said. 'Well over 50 percent of the cost in some sailings. To simply wave it away and reject any ability to recover is not realistic.'
But shippers, especially high volume ones, may push the issue in negotiations. Their ammunition in such talks? That carriers made huge profits in 2010, and that carriers are saving significantly on bunker consumption by slow steaming. High volume shippers may press lines to exclude floating surcharges if bunker stays within a 10 percent band up or down from a fixed price. Or they may ask carriers to drop the base bunker surcharge to a level commensurate with their slow steaming consumption before it floats.
Conrad said the TSA is studying the effect of slow steaming on bunker consumption and how that would affect surcharges.
'We're just collecting data from carriers to analyze how slow steaming affects fuel costs per sailing,' he said. 'It's not as cut-and-dried as many people make it out. You're slow steaming, so you must be saving fuel costs. But when you drill down, not every carrier is slow steaming on every service. There are portions of services where they're not slow steaming. If a carrier is slow steaming 60 percent of services, that means 40 percent are not. In order to slow steam, you need an extra vessel, and some carriers have had to charter in extra vessels. Feeders in Asia do not slow steam. You need extra equipment and the container market is very tight. So some of the costs that are lowered are offset by the costs to slow steam.'
Conrad said the study could result in separate formulas for slow steaming and fast steaming, or a blended formula.
'The big concern for all shipping lines is bunker evolution,' said Thenoz of CMA CGM. 'The bunker is sky high these days and this is a prime element in our cost structure. Thank god we have the bunker adjustment factor these days. We are better geared than in previous years.'
Another hot topic is vessel utilization. From the undersupply situation in the first half of 2010, carriers quickly found their vessels less full as the year progressed.
'In recent months, it seems like (carriers) are forgetting the lessons learned in '09,' said O'Rourke, a longtime liner vet with NYK Line and before that CP Ships. 'Rates seem to be dropping week by week. Every carrier has a different analysis when it comes to what their breakeven levels are. Each of their current utilization levels also vary. Some say mid-90s and some say mid-80s depending upon the string. Asia/Europe tonnage was removed, but very little on (the transpacific). They do appear to be chasing market share again and it's surprising.
'What's the rationale of keeping utilization high if it's at the expense of lower rates? There's always a rationale for certain pieces of business. There are certain individual cases where it might make sense to take rates that don't cover costs. But on a broad level, it's puzzling. The rationale could be strategic ' our pockets are deep enough to survive a tough year.'
Conrad admitted it's difficult for carriers to manage the equilibrium between full ships and robust rates.
'It's a balancing act,' Conrad said. 'There is a desire to have good load factors, and it's hard to see carriers making money if ships are sailing empty for a prolonged period. The problem in past years was carriers racing to fill ships even when the cargo isn't there. A lot of carriers remember vividly the lessons of 2009. None of the carriers want to see that scenario again. Hopefully they've learned their lessons. Yes, it's good to have high load factors, but the aim when the carriers talk (in TSA meetings) is to get back to a healthy financial footing. There are 15 different companies all with a different view to get there.'
As Brian Black, former senior vice president for Hyundai Merchant Marine, said in a mid-2009 story on carrier profits, 'Just because you fill up your ships doesn't mean you're making money.' ('Who's making money,' July 2009 American Shipper, pages 40-51, or online at www.AmericanShipper.com/links
It's hardly a secret that NVOs have benefited from negative shipper sentiment toward liner carriers. And with so much uncertainty this year, NVOs would only seem to be better placed this year.
'People need some type of commitment for space,' O'Rourke said. 'There's concern about how strong the market is, and how the carriers will manage their tonnage. Everyone understood why carriers removed tonnage in '09. But they weren't as quick to replace staff. Customer service roles were reduced or outsourced and the carriers haven't brought those people back as quickly as they needed to considering the demand bounce back. That's where (NVOs) fit in. That's a void we've filled. Even larger (beneficial cargo owners) are leaving room on the plate for NVO participations.'
O'Rourke added that NVOs at their best are aiding both shippers and carriers.
'We can assist shippers in gauging current market level rates,' he said. 'Or provide service on port pairs or pieces of business that are difficult for their carriers. NVOs are in a good position provided they can provide the customer service that's necessary. They're in a position to continue to expand their market share, and it seems like the carriers don't mind.'
In 2010, a host of individual carriers culled chassis services from their offering in North America, a signal that they are concentrating more on ocean freight services.
When asked whether carriers were increasingly interested in divesting themselves of the inland logistics functions in North America, Plemmons, of Old Dominion, said, 'Absolutely, more and more. In conversations with carriers, they're more and more interested in focusing on port-to-port or port-to-U.S. ramp. Honestly, we believe that bodes well for a company like us with the North American infrastructure that we have built.
'And the trend bodes well in general for well-capitalized transportation providers. We have the resources to add chassis to our fleet. And we'll add those as the market dictates. We're going with a model of some company-owned equipment and some sourced equipment where and when we need to meet customer demand during peak conditions. What this may do over time is weed out some less well-capitalized providers.'
The scenario was different a few years back, when carriers sought to augment their control of supply chains with inland services.
'There was a push for carriers to be a provider of all services all the way to door,' Plemmons said. 'I think they learned that was a complicated and potentially expensive proposition. We've seen them pull back and focus on their core business, which is those vessels. I'm excited about the trend.'
Plemmons said the move toward NVOs is happening on the shipper side as well.
'Given the uncertainty of shippers' business, they're a little less interested in signing these huge long-term contracts with ocean carriers, in favor of going with NVOs,' he said. 'Shippers, because of the downturn, have fewer and smaller orders. They look to NVOs, who accept these smaller orders with no sacrifice in service.
'Shippers today have a lot of options. We don't have a goal to be the least expensive. We believe we have value add. But we have to be cognizant of what the market is and offer services and rates within that market.'