Supply squeeze trumps demand dip as shipping sector booms

The world’s biggest shipping lines are set for another hugely profitable year as freight rates along the busiest shipping lanes are expected to continue rising. Like mining and oil and gas companies reaping profits from exceptionally high commodities prices, shipping firms are rolling in cash while others down the supply chain fight to maintain margins. 

The demand for physical goods that began during the pandemic highlighted infrastructure shortcomings that could take years to fix, experts say. And although shipping lines are facing much steeper fuel, vessel and insurance costs, rate increases have swelled the revenues and profits made by the industry’s giants. Their combined earnings before interest and tax will reach a “frankly incredible” $300bn (£240bn) this year – a 40 per cent uplift on the $214bn made in 2021, said Simon Heaney, senior manager of container research at maritime consultancy Drewry.

Last year's profits “dwarfed anything the industry has ever seen before”, Heaney said on a webinar last week. 

AP Moeller-Maersk (DK:MAERSK.B), the world’s most profitable shipping company, last week increased its guidance for the cash profit it expects to generate this year by $6bn to $30bn, citing a better-than-expected first quarter as the rates it charges customers increased by 71 per cent year on year. 

Orient Overseas Container Line (HK:0316), the Hong Kong-based carrier owned by China’s Cosco Shipping, reported a 71 per cent increase in its first-quarter revenue, to $5.16bn.

There has been some softening of spot rates in recent weeks as lockdowns in Shanghai – a city which generates about 6 per cent of China’s GDP – meant fewer goods have arrived at the city’s port. 

The port remains operational but temporary factory closures and difficulties in getting drivers onsite mean vessels have left the port underutilised. This has led ships to then seek more cargo from other ports in Asia, leading to negative pressure on spot rates, Lars Jensen, chief executive of Vespucci Maritime said in a webinar organised by Citi.

The key trans-Pacific route from China to the US West Coast saw rates drop for six successive weeks before levelling off at $15,552 per 40-ft equivalent unit (FEU) by 28 April, according to the Freightos Baltic Index (FBX). But this is still 162 per cent higher than the same tariff a year ago. Rates from Asia to northern Europe, which have been dropping since January, fell by a further 7 per cent week on week to $10,836 per FEU and are now just 40 per cent higher than a year ago.

New year, same problems

Jensen said much of the decline in rates can be attributed to the time of year. The container shipping market typically experiences a lull in the wake of the Lunar New Year holiday before activity picks up again in mid-summer as retailers begin placing orders for the Christmas trading period. He believes that carriers could benefit from a “surge” of cargo once lockdowns in Shanghai ease. This could place vessel capacity under pressure and cause rates to spiral once more, he said.

There is enough global turmoil to make this kind of seasonal forecasting tough, however. Marc Zeck, an analyst with investment bank Stifel, also thinks seasonality has played a part in the recent weakening of spot rates but is not sure how much – particularly to a European market where demand has been weakened by Russia's invasion of Ukraine and higher inflation expectations. 

“Normally, China-EU freight rates come down by anything between 20 and 40 per cent. We are within that range,” he said. Freight rates have dropped by 27 per cent since the end of January, but during the same period last year only fell by 12 per cent, according to Freightos.

Zeck agrees with the assessments by Maersk and Swiss logistics giant Kuehne & Nagel (CH: KNIN) that freight rates will begin to ease in the second half of this year but could take years to normalise.

“Our base case is that in 2025 freight rates will be 15 per cent above pre-pandemic levels, but we will see a gradual decline,” he said.

Even as spot rates have weakened, contract rates paid by the biggest shippers for longer periods have continued to climb – up 11 per cent in April and more than doubling year on year, according to the Xeneta Shipping Index, which crowdsources data from shippers.

Contract rates between Asia and Europe remain above $10,000 per FEU. These typically act as a floor to spot rates, Xeneta’s chief product officer Erik Devetak said.

“It would not be in the interest of any carrier to push the spot [rate] much lower than this. At that point, you’d have some of your biggest customers wondering why they’re locked into contracts that are significantly higher than the spot,” he said.

Drewry’s most recent forecast, which was carried out after Russia’s invasion of Ukraine but before Shanghai faced widespread lockdowns, forecast a further 39 per cent increase in average global freight rates (a mix of spot and contract rates) for 2022, following a 110 per cent hike in 2021. This is despite the fact that it lowered its forecast for shipping container demand growth to 4.1 per cent this year (from 4.6 per cent three months earlier). Its growth forecast for next year was also lowered to 2.8 per cent (from 3.5 per cent previously).

“Slowing growth prospects are going to be of concern to carriers, but we think so long as there is any form of growth and a sharp contraction can be avoided, the party should keep on going from a carrier point of view,” Heaney said.

The dominant driver of freight rates – and therefore carrier profits – since the onset of the pandemic has been the capacity constraints faced at many ports. Lower port productivity has meant the effective capacity of container shipping lines was 17 per cent below potential last year and is expected to remain 15 per cent below this year, according to Drewry's forecasts.

“In today’s stressed container market, such are the capacity constraints it is entirely possible for freight rates to stay extremely high at the same time that headline demand growth is falling,” Heaney said.

Although the demand outlook for Europe is softening, “it’s definitely the US consumer who has been driving the freight market”, Stifel’s Zeck said.

Trade volumes into Europe have been “pretty much flat” over the past two to three years but have increased by 20-30 per cent to the US, he added.

The ships roll in

Large-scale container purchases solved the problem of boxes being in the wrong places and over the next two years the number of ships able to carry them is also set to surge. Orders for new vessels hit a record $43bn last year, adding a further 4.3mn 20 foot-equivalent units (TEU) of capacity, said Stephen Gordon, managing director of research services at Clarkson (CKN). Orders totalling $11.6bn for almost 1mn TEU have been placed in the first quarter of this year.

This has meant the current backlog for vessels currently stands at 6.6mn TEU, or about 26 per cent of fleet capacity. This is an increase from just 8 per cent in mid-2020, Gordon said.

Vessel capacity is one of just three significant bottlenecks faced by the industry, though. The other two are capacity at US ports and the required handling capacity to move goods inland, according to Zeck.

“All of these three bottlenecks need to be solved in sync,” he said.

Ports on the US West Coast – especially the neighbouring Los Angeles and Long Beach container ports – remain the key pinch point.

Although there is some hope that capacity improvements could be made through automation, this will depend on how the latest round of negotiations between West Coast terminal bosses and the International Longshore and Warehouse Union fare. Talks begin this month to replace an existing deal that expires in July.

Already, pressures on West Coast ports have led to some liners shifting traffic to Gulf and East Coast ports, but these are already more expensive and rates have now risen by 176 per cent year on year to $17,148 per FEU, according to the FBX. This, in turn, has had a knock-on effect on transatlantic rates, Xeneta’s Devetak said.

Shares in Maersk are up 184 per cent over the past two years, while European competitor Hapag Lloyd's (DE:HLAG) shares are up 202 per cent. Earnings forecasts for the pair have also soared, though, meaning that they trade at just 3.1 times and eight times FactSet consensus forecast earnings, respectively. Taiwan’s Evergreen Marine (TW: 2603) and Wan Hai Lines (TW:2615) trade on similarly lowly values of 3.3 times and 3.5 times forecast earnings.

Every Lidl helps

The boom clearly can’t last forever and additional capacity will provide some relief in the years ahead. For the time being, though, importers seemingly have few choices other than paying up or cutting inventory levels.

One company looking to tackle the problem head-on is German discount chain Lidl. It has chartered three Panamax containerships and is buying a fourth as it builds its own line, Tailwind Shipping.

The company will “partially use our own capacity” to secure supply chains and access to goods, a spokesperson confirmed, adding that it will also continue to work with existing partners.

Whether this strategy would be suitable for everyone is “debateable”, said Drewry’s Heaney.

A desire for predictable shipping capacity and costs is understandable, but “by the time these things are set up and delivered the problem may no longer exist and you’re left with some very expensive assets that you need to spend a lot of money maintaining and operating”, he said.