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Thoughts on why the current container market is unsustainable. Report Nov 11

By • Nov 12th, 2011 • Category: Containers

The Coracle Container market podcast for Nov 11, 2011 in association with GFI

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Thank you for downloading the container market report from Coracle Online and GFI for November 11th 2011. This report will look at the derivative and physical markets.

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We start with the paper market and the Shanghai North West Europe route where both the spot index and the prompt months lost a good chunk of value over the past seven days. This resulted in a further steepening of the already steep contango situation (remember, contango means that the future price is more expensive than the prompt periods) To our surprise, we see several spread traders entering the market with the idea to sell prompt and buy the deferred periods, which is effectively selling cheap and buying expensive. Our intuition tells us that this should create opportunities for carriers. This allows them to take a profit on their short prompt positions (physical contracts) and hedge the future periods at a better rate. It’s a strategy we think would be worthwhile considering

On the Shanghai USWC route the Chinese trading community expects to see a big rise in the index in the coming weeks and this resulted in the SSEFC curve being at a significant premium to the international markets. Given the fact that the index is coming off, we think it is more likely that the Chinese markets will go down, rather than the international markets going up…

Looking at the physical market for Shanghai Europe and we note that the Chinese version of chess is otherwise known as ‘Weiqi’, which literally means ‘to surround/to encircle’ + ‘chess’. Compared to international chess, Weiqi has far fewer rules and is not a difficult game to learn. One of the main objectives of Weiqi is to obtain more territory than your opponent and as long as your territory is more than your
opponents, you win the game. A game can also end if one player surrenders, in which case the opponent will automatically win the game.
There seem to be a few similarities between Weiqi and the container industry at the moment. The larger carriers are in a war to gain market share through the deployment and ordering of larger vessels. According to some of our contacts in Asia this week, with carriers already making a significant loss everytime they ship a container on the Asia – Europe route, they are continuing to undercut each other by offering lower rates in the market. As low as $475/teu if you can haggle like the Chinese for small spot volumes. Additionally, carriers are also at the mercy of the larger freight forwarders who continue to use their bargaining power to negotiate lower than spot market rates as they know that vessels are running on below 85% utilisation levels at the moment.

Recently, Nils Andersen, the CEO of Maersk Group, was quoted in Lloyds List as saying: “We have a very sensible order book compared with the expected volume growth going forward, and we expect to keep all ships sailing,” He added “We hope rates will stabilize as the weaker competitors in the market decide to leave the industry. But that might still take some time.”
So it seems like the largest carrier is trying to obtain more territory than their opponents and in the running to win the race to the bottom and until one of their opponents surrenders, then the current situation will only deteriorate further. With the Eurozone crisis, many industry participants have also cited demand to have stagnated.

On the transpacific route, industry sources are citing that vessel utilisations are running at above 85% levels and the demand outlook appears to be steady. Despite the marginal rises in the index the past two weeks, it was merely a dead cat’s bounce and rates are continuing to fall on the Asia – US West Coast trade lanes as ships are not sailing full. Carriers expect volumes to increase in December and have announced that they will be implementing a PSS in December, as well as a GRI extension from the 1 Jan 2012. On the US East Coast routes, utilisation levels are now running at approximately 70% as bookings seem to have fallen off a cliff. The fall in volumes on the US trade lanes are also reflective of the decline in air freight volumes.

It’s currently reporting season for Q3 results by the carriers and so far we haven’t seen any of them publish black figures. For now, the reaction to losing money is either ordering more and bigger vessels (e.g. Yang Ming) or doing nothing (e.g. most liners, as they have already ordered too many ships). Our humble opinion is that the industry needs a reform, so let’s explain in some examples why the current situation is unsustainable:

1. Risk management
This is the second quarter in 2011 that Maersk has reported a loss on their liner business. It’s not a great surprise and this is more or less in line with the rest of the industry. What is a surprise is the attitude of Mr. Eivind Kolding , the CEO of Maersk Lines. When Maersk had a record year in 2010, he was the biggest combater of freight derivatives by comparing the derivatives industry to a casino. Even this year when the liner business was losing money, he was telling the world, “We, as Maersk Line, have no need for the derivative market – and,
on a philosophical level, we think it is sending the wrong signals”. “It is the wrong direction for the industry”. His attitude can probably be best explained by a Danish car driver refusing to buy winter tyres, and openly telling his mates it is a waste of money. After all, the winters can be cold in Denmark, but he has not had a serious accident during the last 12 months. Bear in mind the last time Maersk lost money was in 2009. Now imagine this Danish driver bringing his kids to school and the car does not break properly during a freezing morning. By accident, he injured a few kids on the sidewalk. I think this driver has a lot to explain. Unfortunately we haven’t heard any explanations from Mr. Kolding. Is he still thinking that applying risk management is the wrong direction for the industry? How he will make Maersk Line profitable in the near future?

2. Return on capital invested
There is too much debt in the world and no appetite to increase lending at the moment. Several countries are suffering from the consequences and so are liner companies. For example, a liner company’s debt in the market is currently best bid at 41.5 cents to the Euro, giving an implied yield of 27.5%. Such a yield is in excess of the historic return on capital invested. Meanwhile we see some problems on the horizon for heavily indebted liner companies:
– Asset prices are much lower than book value, and the assets can not be sold
– Hedging income requires margining and not every carrier can afford to pay this
– Laying up vessels, in some instances, costs more than continuing services, and some carrier can not afford to lay-up.
We can all agree that current rates are unsustainable, but as John Maynard Keynes once famously quoted: “Markets can remain irrational longer than it can remain solvent”. Given the very low spot rates, it might still make sense to hedge a percentage of the future exposure at a nice premium to today’s spot market.

3. New service contracts
In the last Alphaliner, it was reported that the traditional carriers had approximately 72% direct business with shippers on the transpacific trade lane and 38% of their business done through NVOCC’s. Quite a lot of the business will trace the spot market, especially NVOCC business. However there are still shippers in this world that honour their service contracts. These shippers are probably the cork that keeps the liner business afloat. However, every time new service contracts are negotiated, both parties will look at the spot market and last year’s historic rates as a reference to finding an acceptable level for next year’s contract. Both the spot market and the one year historic rates are much lower than the rates seen in Q1 2011. As a result, we fear that next year’s service contracts will be concluded at a level lower than 2011. If you have the same fear for 2012, then it is worth pointing out that freight for 2012 can be hedged at a nice premium to today’s spot market.

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