We compare the container freight market to the bond markets. Scary? Oh yes…By james tweed • Nov 18th, 2011 • Category: Containers
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Thank you for downloading the container market report from Coracle Online and GFI for November 18th 2011. This report will look at the derivative and physical markets.
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We start this report with a look at the paper market and the Shanghai NW Europe route where the forward curve keeps chasing the spot market lower. What is interesting though is the fact that the international markets are trading at a steep premium to the Chinese markets. The brokers at ACM/GFI are still working $700/teu buying interest for Q1, which is at a significant premium to trading levels in China. Likewise there is still good buying interest for the year 2012 at $900. This is much better than the levels seen for physical contracts , which are more like $600. For a liner company that expects rates to fall even further, it would make more sense to sell derivatives for the Calendar year of 2012 at $900/teu, then fix a physical contract at $600/teu. Apart from the better rate in the derivatives market, the second benefit is the additional guarantee that your derivative contract will actually perform.
On the Shanghai USWC route the fear of a $400 GRI implementation announced by the TSA for January 1st caused the paper market in Shanghai to increase significantly. Interestingly the international markets are not pricing in this GRI. Without being able to say if one market is right and the other is wrong, we can only say, it is most likely that this spread will shrink. The international paper markets could go up, but we can also see the physical liner companies adjusting the supply. Cascading vessels from the Europe trade to the US trade makes a lot of sense, as price levels in the Pacific are much more lucrative.
Now we look at the physical markets and following the successful inaugural Container Derivatives Forum hosted by the CFDA in London this week, it further confirmed expectations of a dark and stormy outlook for the coming months.
Consider the Asia Europe route first and one of Winston Churchill’s famous quotes was: ‘All men make mistakes, but only wise men learn from their mistakes.’ We saw rates fall to an all time historical low of $353/teu in March 2009 and with spot tariff rates at $540 this week, rates only need to fall by $31 each week if that level was to be reached by the last week of 2011. It seems that there is no end to the downward spiral of rate declines on the Asia – Europe route. Carriers are freely giving spot tariff rate quotes as low as $475/teu and with a bit of haggling, a small shipper could easily attain a rate of $400/teu. As outlandish as it sounds, freight forwarders and shippers keep seeing rates fall with every passing week. Shippers no
longer want to book two weeks in advance, because they know that rates will plummet in under a week’s time. And if we take the year to date average change in rates of -$19/teu, then we will see the SCFI publish a rate of $425/teu by the end of 2011. We won’t see the big three carriers pull capacity out on the Asia – Europe trade lane any time soon. Some shippers have managed to negotiate 6 month contracts until May 2012 for $620/teu. Even at this level, carriers are making a loss. As history shows, especially 2009/2010, many shippers were caught out and had their contracts reneged only to find themselves having to pay 2 to 3 times more in the spot market as their ‘fixed’ contracts were no longer valid. If history is of any guide, shippers are going to face a similar situation. Negotiating index-linked contracts right now and hedging your price risk through container derivatives is a solution to this uncertainty and a tool that is readily available in the industry.
The situation on the Transpacific trade lane is slightly more positive. Eastbound utilization rates are hovering above 90% currently and exporters are citing an abundance of equipment availability. Capacity for December looks more promising, but it appears that it won’t be enough to warrant the full
implementation of the $400/feu GRI as proposed by TSA.
There are quite a lot of similarities between the bond and the container freight market at the moment. Effectively, Italy can pay for its debt provided lenders don’t require a high interest rate. However, once investors start to worry about Italy’s ability to repay its bonds, the interest rate rises. A rising interest rate makes it harder to service Italian debt, and therefore lenders require an even higher interest rate. If nothing is done, Italy simply has to default on its debt, because nobody trusts them anymore.
So, can the same happen in the container industry?
Are there liner companies who have breached their debt covenants before?
Is one of the liner companies going to breach on its loans this year?
Most likely, yes
Do we see carriers selling assets in a distressed market to raise cash?
Do we see the first signs of customers losing trust in some of the container lines?
The major concern for the industry is that some companies will lose more money than the industry average, due to a combination of higher debt servicing costs, lower volume growth and lower utilisation rates. Once their customers fear their company might default, they will allocate less volumes to these weaker carriers, making it even harder for them to service their debt. This might result in a self fulfilling prophecy. Once the market starts worrying about a country’s ability to service its debt, the ECB will step in to buy its debt. Unfortunately we doubt that the ECB will step in to rescue liner companies. As we have continued to mention, a default of one of more liner companies will lead to a supply shock, and rates will potentially shoot through the roof. For those shippers who fear this will happen, it might be good to learn a lesson from the mistakes of not hedging the downside, of the carriers. Make sure you manage your upside risk through the available risk management tools in the industry. We suggest freight derivatives.
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