The global shipping industry is suffering from a significant slowdown. Cosco Shipping, a market leader in the Asian shipping industry, reported a rmb7.2bn loss for the first six months of 2016, a quadrupling of their losses compared to the same period last year. This was followed by a bankruptcy filing by Hanjin Shipping, a Large South Korean shipping line, on August 31st. As a result, 66 ships with cargo worth $14.5bn were cast adrift at sea due to concerns about whether docking costs would be paid.
Reduced profits are not restricted to Asia. All but one of the twelve largest shipping companies published losses in the third quarter of 2016. The Baltic Dry Index, an indicator of the price of worldwide shipping, shows that the industry recovered strongly from the financial crisis of 2008. However, freight rates then declined almost uninterruptedly from 2010 to the low levels experienced today. Lower prices depress a shipping line’s margins, which results in lower profits.
Why have freight rates followed this negative trend? As with any market price, shipping rates are determined by a mixture of demand and supply-side factors. The volume of global trade has long been held to reflect the health of international output. Weak growth rates across most countries have led to less trade and therefore little demand for shipping overseas freight.
The public and political opinions have turned against trade agreements, which would have stimulated demand for global commerce. An example is the Transatlantic Trade and Investment Partnership (TTIP) between the US and the EU. Donald Trump stated that he would withdraw from TTIP if he were elected president, while European leaders are suffering from populist backlashes against trade.
The Fall In Trade Vs The Big Containers
On the supply side, multinational enterprises are cutting back on the need for overseas trade and increasing operational efficiency by shifting their manufacturing focus to local countries. Major shipping lines have also expanded the capacity of their ships. The average size of container ships has increased by 90% over the last two decades. This supply increase stands out because it was an intentional decision to engage in predatory pricing. Large shipping companies increased the supply of freight to lower freight rates in order to eliminate smaller shipping companies with less capital and earn higher long-run profits
The Maersk Line triggered this glut in capacity by issuing two contracts to Daewoo Shipbuilding for 20 triple-E class container ships in 2011. These vessels are 400 metres long, with a capacity of 18000 twenty-foot-equivalent units (TEU), which made them the largest container ships in the world at the time of construction.
Other large players in the shipping industry, such as the Mediterranean Shipping Company (MSC) and CMA CGM, followed suit. There is no question that their strategy succeeded. A number of smaller shipping lines preceded Hanjin Shipping in filing for bankruptcy. However, the predatory pricing scheme may have worked too well. Hanjin Shipping was the seventh largest global shipping line in terms of container capacity. Most industry leaders are reporting losses this quarter.
The shipping giants’ decision to overexpand capacity was based on information available at the time. In the first half of 2011, the shipping industry was rebounding from a small slump in the second half of 2010, while the global disposition towards trade tended to be positive. President Obama successfully enacted trade agreements with Panama, Columbia and South Korea in October 2011. Despite feeble output growth, international trade performed robustly. Increasing capacity could then be viewed as an adequate response to rising demand for shipping, as well as performing the strategic function of reducing competition.
Greater capacity would have lowered prices to a level suitable to predatory pricing. Yet demand fell instead of rising. This led to additional downward pressures on freight rates. At this level, cargo prices did not just harm smaller shipping lines, but also their larger cousins. The direct solution to this problem would be to reduce the supply of capacity. The Baltic and International Maritime Council’s industry-wide forecast in September expects 400,000 TEU to be demolished this year, which is 60% greater than its forecast in January.
However, this will only make a small dent in the capacity built over the 2010-2015 period according to Drewry, a consultancy firm. What other approaches could be taken to increase the profitability of the shipping industry? Shipping alliances that allow for the sharing of space on board could reduce spare capacity upon vessels and thereby raise freight rates. A relevant example is the ten year 2M Alliance between Maersk Line and MSC signed in January 2015. Existing ships could also be retrofitted to allow for better data collection. This would improve profitability in a number of ways.
A well-known concept in the shipping industry is the speed-fuel trade-off. Swifter speeds allow for more journeys and therefore larger revenues. By contrast, larger journey frequencies entail a higher fuel usage, which drives up cost. The use of data would allow for the best trade-off between revenue and cost by determining optimal shipping routes and speeds. Better data usage would also improve the handling efficiency of port terminals and reduce docking times.
Lastly, data on the health of ship hulls would allow for tailored maintenance instead of scheduled repairs. This would reduce costs by eliminating unnecessary servicing. Unlike the short-run consequences of scrapping spare capacity and shipping alliances, the use of technology will increase the long-run profitability and productivity of the shipping industry. This course of action would then be the most suited to steering floundering freight lines to calmer waters.