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How the physical market has lost positive momentum and a look at the SCFI NWE-Med correlations

By • Sep 3rd, 2011 • Category: Containers

The Coracle Container market podcast for Sept 2, 2011 in association with GFI

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Graph referred to in this episode:

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Thank you for downloading the tanker market report from Coracle Online and GFI for September 2nd 2011. This report will look at the derivative and physical markets.

We start by looking at the paper market and the Shangahi North West Europe route and note that the paper market lost some value during the course of the week. This paper fall proved to be correct, as the index also lost 6 dollars in value on Friday. On the Shanghai USWC route there was some short covering, which gave a slight push in rates. It was nothing significant however, and we expect the forward curve to fall, in line with the falling index.

The physical market has lost all the positive momentum seen in the previous weeks. Carriers did a good job in hyping up the market and getting shippers to pay more but it didn’t take long for the shippers to realise that this was pure hype. So far the excuses for the liner companies to increase rates were: extra demand, lack of containers, peak season, emergency BAF and GRI, but it feels like they are starting to run out of excuses. More and more liner companies are now using the blame game. Instead of saying I am speculating and I need to better manage my risk, the story is changing
into I have big ships, and you do not. I’ll use my elbows to push you out of the market! Our contacts in China are citing utilisation levels to be running around the 80% mark for both the Asia – Europe and Transpacific trade lanes, which is much lower than what the carriers need in order to be able to pass through a rate increase. The September PSS on the Asia Europe trade lane, that many anticipated to go through, looks like it is going to be yet another failed attempt to implement any form of surcharge. Manufacturing activity in China has slowed significantly: the exporters PMI in China is now below 50 (meaning contraction). Signs of contraction can be seen in the newspapers, but also in the real world. One of our contacts in Hong Kong pointed out: ”The long queues of trucks jostling for spots at the entrance in HK harbour is getting shorter”. In line with this we see one of the Chinese carriers actively marketing spot rates from Shanghai to Hamburg for the week of the 5th Sept at $825 / teu and falling to $800 / teu for the week of the 12th of Sept.

The partial implementation of a PSS on the US West Coast has already lost 36% of its value in the past two weeks and if it continues to fall by the same amount as we saw this week, it will lose 90% of its value in two weeks’ time. With the US economy falling back into recession, consumers are spending less and volumes are much weaker than anticipated by many shippers and large retailers this year. It doesn’t take a rocket scientist to conclude that rates will only have further to fall if carriers do not act in unison to cut capacity / lay-up vessels. Many people in the industry cited 2008 to be a ‘perfect storm’ and an ‘unprecedented event, but simple economics tells us that falling demand and increasing supply results in falling prices and the current index levels are still way above the storm of 2008. As we are now in Autumn, we are afraid that the little recovery seen in the previous weeks was only the silence before the real storm!

There is something odd happening between the various trade lanes. The correlation between the SCFI routes to NW Europe and the Med is 99% (that is, looking at data from March 2009 to now); however this correlation has only been 50% in the past 12 weeks. As we can see in the chart in the show notes, the differential between Europe and the Med is at a record high. Looking at the index data of today we can see that the Med is paying a premium of $300, something that has never happened in the history of the SCFI. The question is what is driving this huge spread? The SCFI to the Med is based on spot freight rates to the port of Barcelona, Valencia, Genoa and Naples. They are not really the parts of Europe where the economy is growing. The distance is shorter, so the BAF should be less. So what is the most plausible explanation? During our investigation into the differential in spread we noticed one remarkable difference. The ships employed on the route to NW Europe are considerably bigger (average ~ 9000 teu) than the ones employed on the route to the Med (many services still use Panamax size vessels of around 5000 teu). The cost price is simply much lower for the average post panama vessel going to NW Europe. What is good to know is that there are no physical limitations to employing bigger vessels in the Med. MSC is already operating the Dragon service with an average vessel size of 14 000 teu. Simple maths show that each service to the Med is earning $ 18.9 million (4.5 x 14,000 x $300) more per month than taking a voyage to Europe. The same story is true for the Transpacific voyages to the USWC. Maersk is already employing 10 000 teu vessels, whereas other services are using only 3,000 teu vessels. There is nothing to stop liner companies from employing bigger vessels.

Our guess would be that the 143 new build vessels with an average capacity of over 12 500 teu / each due to come into the market before Dec 2012 will rather be employed where the money is. As commodities are priced in the long run at the average production cost of the commodity, we expect to see a further deterioration in rates. It takes some time for liner companies to change their services, but in the long run ships will be employed on the most lucrative services. Fatter profit margins on the routes to the Med, the USWC and after widening the Panama Canal the USEC, should lead to having on average bigger ships getting employed on these routes.

So, to summarize: Big ships are depressing the freight rates to Europe and as liner companies order more, and even bigger, ships, the trend set for the route to Europe will soon spread to other trade lanes.

Thanks for listening