December 08, 2011

Blood on the sea: the impending shakeout in shipping.

Those in the container trade are calling it a consolidation; looks more like a shakeout to me. 

Soon after industry leader A.P. Moeller-Maersk merged some of its Asia to Europe services saying that it was prepared to outlast the competition in difficult times, news came in last week that the second and third largest container companies in the world- Mediterranean Shipping Co. and CMA CGM- have entered into a vessel-sharing agreement that will cover routes from Asia to Europe, Africa and South America. CMA CGM and MSC obviously feel that this is the best way to fight Maersk in the marketplace.

The hope, in the beginning of 2011, that the box trade would stage a recovery by winter or even by early next year has evaporated completely today. Instead, freight rates for the China-Europe box trade - by value, the biggest route- have fallen by almost 40 percent in the last three and a half months. The reasons for the crisis are well known- years of overcapacity ending in falling markets amidst a global economic collapse can only result in disaster. What is lesser appreciated is the fact that even today, when shipowners are trying every trick in the book to survive, too many container newbuilding orders are- inexplicably, seemingly suicidally- being executed. 

An estimated 2.5 million TEU of capacity may be added to the box fleet in the next couple of years, including a large proportion of around-8,000TEU tonnage. These orders were placed starting the summer of 2010. Amongst others, Maersk (20 18,000-TEU ships), NOL (10  14,000-TEU) and OOIL (10 13,000-TEU) are contributing to this glut of deliveries that will hit the market around 2013, give or take. Singapore based Island Shipbrokers says that the demand growth in the container trade is around 5% while fleet growth could reach 8-9%,  resulting in an additional capacity-demand mismatch. Container tonnage is not reducing; it is increasing, that too at a time when freight rates are slated to be under continued pressure for the next year or more.

Something has to give.

Some things already have. Last week, Malaysia's largest shipowner MISC pulled out all 16 of its container ships from what it said was a bleak market- after three consecutive years of losses totalling US$789 million. The sudden exit will cost the company another $400 million, MISC says, pointing out that market conditions are "challenging the validity of today’s operating models".

The strategy of the big boys in the container industry seems to be to shift to bigger and bigger ships to take advantages of economies of scale and also- in the case of newbuilds- greater fuel efficiency. Merge routes (maybe even merge companies later?) and services. Increase or maintain market share at almost any cost. Use your size and cutthroat pricing to dominate. Hold back supply cuts. Squeeze weaker players. Be the last man standing. Above all, outlast. Outlast. 

There are obviously no guarantees that this strategy will work- sometimes, as shipping as seen before, there is a thin line between the philosophy of 'too big to fail' and 'the bigger they are, the harder they fall.' Regardless, the outlast strategy will guarantee one thing for sure- the shakeout of smaller players from the market. This is inevitable. MISC could take a billion dollar hit and survive; many others will simply fold with much lower stakes, especially at a time when sources of capital are drying up for the industry.

Incidentally, the CMA CGM collaboration with MSC may be the beginning of such relationships in other sectors too. John Plumbe, the CEO of London based shipbrokers ACM Shipping said last week that owners of at least a hundred of the world’s largest oil tankers must form a combined fleet and sell their services jointly to raise depressed freight rates. Plumbe, a 37-year tanker-broker veteran, said, “There are some advantages for owners to consolidate for a short period of time. In order to have any real effect on freight rates in the VLCC market, you need a pool of a minimum of 100 ships, as there is a fleet of 600 trading.”

Seen in the backdrop of recent troubles in tanker businesses- General Maritime's bankruptcy, news reports of Frontline possibly running out of cash to pay its debts and Torm talking to creditors to restructure its own debt of around 1.8 billion dollars, this course of action may make sense. I wonder, though, whether the pockets of even the biggest in the industry- whether container or tanker or whatever operators - are deep enough to wage what appears to be a very expensive war of attrition, even if there appears to be little other choice. 

With enough resources, one can win the game of outlast, I guess. Alternatively, one can end up just cutting off one's nose to spite one's face.  

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