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11 reasons why container lay ups WON’T happen.. Container report Sep 23

By • Sep 23rd, 2011 • Category: Containers

The Coracle Container market podcast for Sept 23, 2011 in association with GFI

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Thank you for downloading the container market report from Coracle Online and GFI for September 23rd 2011. This report will look at the derivative and physical markets.

Starting with the paper markets and the forward curve on the route to NW Europe lost 3 to 5% in value this week; roughly in line with the index going down by 4.9%. What is interesting to notice is that the outlook is getting more and more depressed. The next 10 months are trading at below $1000 / teu and so we hope for a drastic move, and a quick fall in rates as it is time to set the bottom in the market…

Looking at the curve for the route to the USWC we can see a similar decline as for the route to Europe. It is interesting to see that the Chinese traders on the SSEFC are expecting a rate increase to happen in January. That is not priced into the CFDA forward curve. If we use history as guidance for the future, than we should see a GRI being implemented in January.

Thinking about the physical market and the Shanghai Europe route and it’s a case of the bear market blues all over again. Speaking to a number of our contacts in both Asia and Europe this week, rates have fallen by approximately $50-$75/teu and volumes are much weaker than expected. In response to the daily Maersk marketing campaign we see that other carriers are offering attractive rates for the remainder of the year. It is not that difficult to book an all-in rate of $675 for a 20’ or $1200 for a 40’. So far, Maersk is dropping its pants as quick as the other carriers, and there are no signs of them achieving significant premiums for the spot. The 90% utilisation levels seen in the previous month are no longer being achieved and our sources tell us that utilisation is more realistically running at 80%. Supply and Demand are not in balance, and we wonder how much capacity will actually be pulled for the winter program. Some people actually think not much, given the early Chinese New Year…

Looking at the backhaul routes and the WCI has been publishing the backhaul rates for the route Los Angeles to Shanghai for the past few months, and there is some volatility on the horizon. First of all we understand that some of the smaller lines have filed last week for rate increases starting the 15th of October. As most business is conducted by NVOCCs under service contracts, we might see the $300 GRI actually getting implemented at first. The main question is whether the US exporters can face such an increase in rates. A $300 increase is actually 12 dollars extra in freight cost (given 25 tons per box) and this might kill the average grain interest. Grain traders are working at the moment with margins in the range of 4 -5 dollars, and you can imagine that such an increase can’t last for long. Nevertheless, it is the time of the year that grain has to come out of the field and carriers are giving it a try. Grain contracts have already been agreed to and have to be performed, but it will kill all future deals. As you can imagine, this is the reason why we are starting to market the idea of hedging back haul freight through derivatives. Almost 95% of the service contracts are open to GRI’s, and the example given shows that grain traders can potentially face significant losses. So far the spot rates are pretty flat and stable, with the WCI index at $784 and flat, and in volume you can book freight in the range $500 – $550. This week there are no signs of container shortages, but as mentioned, the grain season is about to start. What is also important is that the anti-dumping situation regarding DDG (left overs of making ethanol / chicken and pork feed) is cleared up. DDG is the big swing factor hanging above the market. This week we have seen the first smaller exporters testing the water, and already moving the first boxes. For now it is nothing significant, and with inventories being tight due to domestic demand the impact will be limited.

Now we look at the Shanghai US West Coast route and carriers are failing to implement the whole amount of the recommended TSA PSS earlier last month. This results in carriers trying to make up for the shortfall through their base rates. But, with peak season looking more like a bleak season, base rates are starting to slip. Forwarders cited that carriers are desperate for cargo bookings after Golden Week, offering long validity periods and spot rates and two week rate offers. In a normal year, the negotiated rate would stick and spot rates offered by carriers are a rare occurrence. However this is not a normal year and the only contracts actually performing at the agreed level are the container derivatives.

The CLX service operated by COSCON, Hanjin Shipping, PIL and Wan Hai recently announced the suspension of the service during the upcoming winter season. All four carriers will continue to serve the Transpacific trade through their other loops and the suspension will take out 3,584 teus worth of weekly capacity in the market. Looking at the end of the year, we expect that the standard ‘Winter Program’ (reduced Winter services, that normally starts in late November), could be implemented a month earlier. The big question is if that has much influence on the Supply Demand balance. All depends in the end on the actual Christmas spending of the American consumer. The stock levels at the retailers are relatively low and retailers are working with a lean supply chain. Therefore the million dollar question is whether we will see serious restocking happening before the Chinese New Year. We are not so sure, and the falling derivatives market confirms our expectations.

To lay up or not to lay up, that is the question. The story of the day is that things in the container industry will have to improve because current freight rates are unsustainable. If only things were that easy. After all, common sense does not always prevail in the industry. Let’s summarise some of the reasons why we don’t see any serious lay-ups happening anytime soon:
1. Maersk is having a huge advertisement campaign claiming daily sailings.
2. Maersk is telling the press, “we are not going to lay up”
3. Maersk has been telling the whole year the previous downturn did not last long enough
4. Maersk wants to achieve consolidation in the industry.
5. MSC is currently the cost leader, and is still taking in tonnage.
6. CMA CGM prefers to generate income by disposing their assets
7. COSCO is state owned, and might have other priorities than just making money
8. Hapag Lloyd is still making profits
9. Evergreen is still making profits
10. APL / CSCL / Hanjin are all part of an alliance, and therefore not the quickest decision makers
11. CSAV has no serious exposure on Asia Europe or USWC

As you can see, it isn’t likely that the top 10 carriers will be laying up vessels. Meanwhile most of the container lines have post-panamax vessels (i.e. those of over 10,000 teu) on order and we read in the press this week that Seaspan is about to order some 18,000 teu vessels on behalf of one of the alliances. The last thing carriers want to do is send their customers temporarily to their competitors. After all they know very well that the only way to make money is by having a high utilisation.

Returning to the the sustainability of the current freight rates, we have to conclude that the current rates are not sustainable. However, laying up is no option.The majority of the container lines have the financial strength to survive the current down turn, and why would they lay up vessels for the sake of helping their weaker competitors? Meanwhile the container liners lacking the financial strength, and please bear in mind that implied yields of some liner bonds are trading above 27%, simply can’t afford to lay-up. Laying up might make economic sense from an income perspective, but history has shown many times it is not income that forces a company to default. Normally defaults are caused by cash flow problems, and laying up vessels is most likely going to have a short term negative influence on the cash flow situation.

That leaves us in a catch 22 situation. From a macro point of view the whole industry would be better off by laying up 20% of their fleet, however the cost leaders are smelling blood. Cost leaders rather see a consolidation through defaults, and we fear it is only a matter of time before that will happen. Currently we notice that a lot of the liner companies are trying to book as much freight as possible for the remainder of the year. This is just another sign showing that these liner companies don’t want to withdraw capacity from the market. From a carrier’s perspective we can understand the reasoning behind booking physical forward freight. However, we would like to point out to shippers that it makes more sense to use derivatives for fixing forward freight rates. For healthy container lines it should not be a problem to index link their forward freight, while fixing it through cleared derivatives. Meanwhile shippers have to ask themselves: “Do I want to agree to a long term contract with a weaker carrier that is so badly capitalised that it can’t pay for clearing?

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