The impact of increasing container ship capacity

- wider implications

Global Liner Shipping conference

London, 18-19th April 2013

Mike Garratt and Antonella Teodoro

MDS Transmodal

212079_presentation_8

1. Our paper

• Brief review of long term trends in world trade

• Recent relationship between supply and demand in the container sector

• The current containership order book:

- explained on the basis of cost competitiveness

- how capacity may be redeployed

• Lessons and opportunities for shippers

- using the market for a given product as an illustration

• A view on the longer term opportunities to mitigate risk in the industry

- is hedging really the way forward?

- should ‘benchmarking’ by rates be the basis for the long- term relationship between shippers and lines?

• All informed by a model we are launching today.

2. Overview

• Global container trade grew by approximately 4% in 2012

– and fell marginally on the busiest route (Far East to Europe)

• Yet world container fleet capacity expected to expand by 24% by 2015

– the capacity of the fleet of >10,000 TEU ships to grow by 88%

• Explanation self-evident

– rising bunker prices from 2006 incentivised lines to build larger ships to reduce energy costs/TEU

– competitive advantage to those whose scale made such investments easier to digest

• In practice medium sized operators have also invested in larger ships…to survive!

• Consequential severe impact on supply/demand relationships unless smaller ships ‘withdrawn’

- to happen because falling rates will make them uncompetitive

• Global international trade (by tonnage) +110% (all goods inc. energy)

- +5% per annum and 1.4 times growth of GDP

- excludes intra-regional trade

• but that growth anything but steady!

- +80% from 1996 to 2008

- -6% from 2008 to 2009

- +17% from 2009 to 2011

- but now settling down to just 4% p.a.

• Underlying containerised goods growth has been rapid:

- ex Far East +240%,

- to Africa +221%

- to the Gulf +357%

- OVERALL +174%

• Expectation of continuing growth endemic in the industry!

- disguising many errors!

3. How we got here: Global trade growth: 1996 – 2012

4. Global trade (tonnes) v. Global GDP

• Growth in trade by tonnes consistent with GDP growth 1996 – 2002 • Acceleration post 2002 reflected trade liberalisation: - a continuing aspiration

5. Global trade (tonnes) by main sector

• Minerals and unitised sectors have grown fastest.

6. Global trade by importing region (excl. intra-regional trade)

• Gulf/ISC fastest show growth from 2009.

- recovering most rapidly post crash

7. Global capacity by ship class

• Underlying demand grew +22% 2008 to 2012

• Global capacity grew +18% 2008 to 2012

- so until recently a gentle upward pressure on rates

8. Global order book by capacity (2015)

TEU Class Extra TEU by

2015

increase over 2012Q3

base (%) 15000-19999 493,400 397%

12500-14999 926,950 70%

10000-12499 299,548 60%

7500-9999 857,990 34%

5000-7499 308,250 9%

3000-4999 499,140 14%

2000-2999 143,037 10%

1000-1999 98,851 6%

500-999 30,816 5%

< 500 5,968 2%

• Overall newbuilds to increase fleet capacity by 24%

- for ships > 10,000 TEU increase is 88%

• But (our) forecast demand growth is only 17%

- excess demand can only reduce rates

9. Demand, supply, freight rates and charter rates – Global

• Clear evidence that drop in utilization reduces freight rates

- evidence of the last few years irrefutable.

• Smaller ships will lose viability!

10. Case study: all trade lanes crossing Suez Canal by ship size class

• 8% of global capacity on trade lanes passing through Suez Canal

• Capacity grew by 25% between 2009 and 2012 v. demand +23%

- but forecast growth to 2015 only +13%

11. Utilisation level for all trade lanes passing through Suez Canal

• Given most of the larger ships intended for Suez routes

without withdrawals would fall from 74% to 60%

12. Potential impact on freight rates for trade lanes passing through Suez Canal

• Based on recent experience, at 60% utilisation level freight rates might

fall by 30%

- self-evident market forces will shift ships to other routes

• But rates will not fall at that rate…shipping industry will only retain ships in the market if:

– operating costs are covered

– owners can charter ships for sufficient days per annum

– medium term repair bills can be met

– returns exceed the alternative of scrapping

– freight rates allow profits to be made and risks covered

• The larger the ship (less marginal its viability) the more days it is likely to be on hire

• Chartering Panamax ships at $15,000 per day clearly not sustainable in medium term!

13. Ship owners and shipping lines reaction

• Important for the lines to better balance supply/demand. - now recognised by their behaviour • Industry will seek to avoid the experience of the last few years!

14. Shipping Line performance since 2006

• Is this in part a consequence of shippers and lines failing to

communicate?

15. Falling utilisation on freight rates reduce net earnings/ship day versus costs (Suez)

• Just withdrawing 3-5,000 TEU vessels only cuts capacity by 7%

- many 5,000 – 7,500 TEU vessels also cease to be viable as rates fall

• But larger ships profitable at lower rates.

• Over half larger ships with leading three lines

• But middle ranking lines have played ‘catch-up’

- fleet adjustments can therefore be across the board

Top 15 operator (2012) 2006 2010 2012

MSC 3,564,816 9,459,614 18,691,161

Maersk 6,234,846 11,503,966 12,688,884

CMA-CGM 1,662,635 5,410,486 9,466,915

Cosco 1,103,796 2,240,320 4,911,843

CSCL 1,012,958 2,610,479 4,399,325

Hapag-Lloyd 1,598,673 3,023,187 3,627,884

Hanjin 1,213,145 1,789,349 3,233,259

OOCL 1,703,649 2,194,218 2,617,479

UASC 2,096,315

Evergreen 702,964 1,537,970 1,714,469

APL 633,591 1,701,883

Hyundai 948,776 1,665,489

K-Line 51,890 1,113,383 1,476,641

NYK 1,320,697 1,400,007

Yang Ming 94,481 1,130,091 1,381,270

All others 655,579 1,419,879 2,480,666

Grand Total 19,599,431 46,336,007 73,553,490

Share of top 3 operators 58% 57% 56%

Market share for ships >=7,500TEU

over total fleet 8% 16% 22%

16. Deployed capacity – ships >=7,500TEU

• Top 10 operators (based on 2012 data) account for more than 63% of total route capacity (62% of ship capacity).

17. Allocated capacity by operator – total fleet

18. Allocating new ship capacity: methodology

• Identify current deep-sea global capacity: 198m TEU in 2012

• Project capacity for 2015 based on demand and service viability

• Account for new-building and scrapping based on age

• ‘Withdraw’ older (+25 years)tonnage (mainly 2000 – 7500 TEU)

- to achieve global supply/demand equilibrium

• Allocate new tonnage based on ship size classes to global routes

• Re-allocate/cascade ships (mainly in 2000 -7,500 TEU range) to match supply/demand on individual routes.

Global service capacity by ship TEU Class

•To reach mean utilization of 65% versus 74% in 2012

- freight rates falling to render smaller ships less viable .

- otherwise utilization would fall to 60%

•Absolute reduction in ship capacity provided by ships < 7,500 TEU

TEUClass 2012

2015 (with cut in capacity)*

market share Absolute change

in capacity

<3000 22% 19% 90%

3000-4999 26% 20% 81%

5000-7499 24% 18% 78%

7500-9999 17% 22% 134%

10000-12499 3% 4% 157%

12500-14999 7% 13% 185%

15000-19999 1% 3% 451%

TOTAL m TEU 197.8 203.5 102.9%

19. Global ship allocation

20. The Far East – Gulf/ISC – Europe fleet composition revised

Capacity by ship TEU Class for all routes passing Suez

•Capacity share of ships >15,000 TEU rises from 2% to 7%

•Significant cut in ships 3,000 – 7,500 TEU capacity

•Remaining ships < 3,000 TEU serving niche markets

TEUClass 2012

2015 (with cut in capacity)

Share by ship size

Absolute change in capacity

<3000 6% 5% 99%

3000-4999 13% 8% 79%

5000-7499 22% 13% 78%

7500-9999 29% 29% 133%

10000-12499 9% 10% 154%

12500-14999 19% 27% 181%

15000-19999 2% 7% 447%

TOTAL m TEU 26.4 34.3 130.0%

TEU Class Demand 2013 Q1

TEU

Capacity 2013 Q1 TEU

Utilisation 2013 Q1

Capacity 2015 Q1 TEU

(A)

Demand 2015 Q1 TEU

Capacity 2015 Q1 TEU

(B)

(A) minus (B) TEU

Total 3,415,544 4,185,486 77% 4,928,581 3,827,514

<2000 80,947 86,449 88% 88,061 77,558

7500-19999 2,739,563 3,321,648 78% 4,747,838 3,683,229

2000-7499 595,034 777,389 72% 92,682 66,727 823,357 -730,675

• Assuming capacity for ships <2,000TEU and >7,500TEU grows in line with ships on order, need for ships between 2,000 and 7,500TEU falls heavily.

• These ships could be reallocated to other trade lanes, mainly to: – Far East to Gulf & ISC (deficit for this class of ship of c330,000TEU)

– Far East to Sub Saharan Africa (deficit c112,000TEU)

– Far East to Latin America (deficit c103,000TEU)

Capacity

forecasted on

the basis of

ships on

order

Capacity left

21. Reallocation from Far East-Europe (2015Q1) available for redeployment elsewhere

22. Excess and deficit of capacity for ships globally 2,000 - 7,500 TEU between regions

Region to Region (dominant direction)

Change in Demand (all TEU class)

2013 Q1 - 2015 Q1 TEU

Excess / deficit of capacity for ships between 2,500 and

7,500 TEU

Far East to Europe & Med 411,970 -730,675 North America to Latin America -48,037 -190,899 North America to Gulf & ISC -80,741 -122,247 Far East to North America 275,686 -62,934 North America to Australasia & Oceania -31,956 -52,895 Europe & Med to Australasia & Oceania 12,097 -9,075 Australasia & Oceania to Latin America -1,687 -2,909 Australasia & Oceania to Sub Saharan Africa 665 1,684 Australasia & Oceania to Gulf & ISC 3,035 6,999 Latin America to Sub Saharan Africa 6,967 14,523 North America to Sub Saharan Africa 12,443 15,762 Latin America to Gulf & ISC 12,435 16,089 Latin America to Europe & Med 17,836 43,324 Gulf & ISC to Europe & Med 46,042 50,286 Gulf & ISC to Sub Saharan Africa 26,645 59,577 Europe & Med to North America 38,668 65,999 Europe & Med to Sub Saharan Africa 64,459 83,503 Far East to Latin America 194,100 102,161 Australasia & Oceania to Far East 43,312 108,451 Far East to Sub Saharan Africa 121,158 112,027 Far East to Gulf & ISC 299,739 329,125

FROM TO

23. Potential impact on supply demand relationship: implication for shippers

• Deep-sea unit costs will continue to fall as larger ships employed

• Utilization will continue to fall as new ships delivered

- and equilibrium can only be restored IF low freight rates cascade (higher unit cost) smaller ships onto secondary routes

• These routes should then also enjoy falling rates

• Challenge for shippers to relate such supply/demand relationships to freight rates

- impacts are medium term rather than based on short- term volatility, which can only cloud judgement.

• Opportunity to relate impact of higher bunker prices on shipping line/ship owner behaviour to impact on individual commodity markets

• For shippers a challenge to relate the reaction of higher bunker prices on line behaviour to the impact on individual product markets, for which shipping tariffs are simply another input cost

24. Impact on shippers: example of the tyre industry

• Global deep sea traffic in tyres has been growing

• But does a freight rate change reflect falling unit costs?

• Those changing unit costs combine

- fuel costs which are independent of the industry

- the reaction to those falling fuel costs by trading off against an emerging surplus of shipping capacity (slow steaming)

- the return of capital in fewer but larger ships

• Freight rates (on the other hand) reflect market forces in a market that is inevitable oligopolistic and imperfect

• What should be the shipper’s approach?

- to follow the freight rate roller-coaster or

- negotiate on the basis of shipping cost structure

• Market dominated by TransPacific Eastbound – in 2012 world share was 24% (down from 27% in 2006)

25. Tyres analysis: trade lane shares

• Largest increase estimated for routes where use of larger ships further reduces costs:

– North America to Gulf/ISC

– Far East to Africa

– Far East to Latin America

– Far East to North America and Europe

• Fastest increases estimated for

– North America to Middle East/ISC

– Far East to Africa and Latin America

Trade Lane ‘000s 2006

‘000s 2012

CAGR 2006-2012

TransPacific-EB 672 948 6%

Asia Europe-WB 425 629 7%

FE/MEGISC-WB 219 422 12%

FE/LAM-SB 152 350 15%

Intra-Asia 230 318 6%

FE/AFR-SB 60 148 16%

FE/ANZ-SB 80 135 9%

NAM/MEGISC-EB 20 112 33%

TransAtlantic-WB 72 107 7%

IET-Intra 9 106 2%

Others 447 665 7%

Grand Total 2,477 3,946 8%

26. Tyres analysis: highest increases between 2006 and 2012

• Overall trade in tyres increased by 60% between 2006 and 2012 (8% p.a.)

• Tyres follow economic cycle – Far East expanding market share

– A very large market: 4m TEU out of 125m TEU globally (3%!)

• Demand stable in 2013

• Inevitable pressure to reduce all production costs, including shipping.

• In 2006 we estimate freight rates ex Asia represented 14% of imported values

27. Tyres analysis – Global trade,immediate future forecast

28. Interpreting trends for the shipper: tyre value and freight rates ex Asia

Cargo $ value per TEU

Freight rate $/TEU

Destination Region 2006 2012 % change 2006-2012

TEU Value/TEU TEU Value/TEU TEU Value/TEU

Asia 230,597 10,747 295,792 14,527 28% 35%

Australasia & Oceania 80,242 12,362 121,033 16,260 51% 32%

Gulf & ISC 219,353 9,679 414,284 11,568 89% 20%

Latin America 152,191 7,358 338,925 9,616 123% 31%

N Europe & Med 425,939 11,575 617,831 13,361 45% 15%

North America 672,705 9,295 947,131 11,128 41% 20%

Sub Saharan Africa 60,322 10,162 144,728 11,657 140% 15%

Grand Total 1,841,349 10,052 2,879,726 12,084 56% 20%

Destination Region 2006 2012 % change

2006-2012

Australasia & Oceania 1,604 962 -40%

Gulf & ISC 1,043 1,389 33%

Latin America 1,819 1,630 -10%

N Europe & Med 1,542 1,595 3%

North America 1,782 1,729 -3%

Sub Saharan Africa 1,950 1,241 -36%

Weighted average 1,416 1,405 -1%

• Market growth of 56%

• Cargo value/TEU up 20%

• Freight rates fall by 1%

- despite bunker prices

more than doubling

29. Asian trades modelled (excluding intra

services): all commodities 2006 2012

Adjusted for

bunkers and

inflation

Actual Change

Demand (outbound) million 30.3 43.1 43.1 +42%

Modelled costs ($ billion)

Bunkers 13.3 40.3 21.7

Other costs 43.3 72.0 59.0

Total 56.6 112.3 80.7

saving 39%

Cost/TEU $1868 $1871 0%

Surveyed revenue/TEU

Mean tariff $1416 $1405 -1%

Contribution from backloads $675 $739

Round trip revenue $2091 $2144

Consequential profit/TEU $98 $85 -13%

Profit as % turnover 5.0% 4.4%

Freight rate as % of tyres value 14.0% 11.6%

30. Lessons for shippers: 2006 to 2012

• Deep-sea volumes moved in this product (tyres) rose by 56%

- increased competitiveness of Asian producers

• Shipping costs form a significant proportion of delivered prices and therefore a key element in exporters’ success

• Mean shipping tariffs/TEU absolutely stable and associated shipping costs fell by 1% despite bunkers prices more than doubling

• Without radical investment and change in practice model suggests shipping costs would instead have been 39% greater

• Every reason to suppose that use of even larger ships will lead to further falls in freight rates given a competitive environment

- as smaller ships driven out/cascaded to maintain load factors

• So what does benchmarking on rates achieve?

- by definition half will be ‘losers’…and the other half lucky!

• Surely better to reduce volatility and uncertainty through long long-term relationships based on transparency

31. Summary • Container market is continuing to grow

- but the supply side is growing faster

• That growth is driven by competitive pressure to deliver lower cost solutions through scale:

- which in a competitive environment can only result in falling rates and cascading of ships to smaller routes

• Market forces will therefore further reduce rates

- a scenario unlikely to be accepted by the lines

- creating uncertainty that cannot encourage trade!

• Opportunity available to address that uncertainty by analysis of shipping line cost structures

- regarding shipping as just one more input in the production process.

• A more informed approach than hedging!

For more information visit our websites

http://www.boxtradeintelligence.com

http://www.mdst.co.uk