Consolidation and Capacity Reduction in Motion, but Probably Unlikely to Have Big Impact on Rates in 2017, as Concerns about Service through the Alliances Grows

2016 will go down as one of the most eventful years in the history of container shipping, which dates back to 1956. Some in fact regard 2016 as the most momentous year the container shipping sector has ever experienced.

The level and pace of alliance forming, mergers, acquisitions, failures, and restructurings was indeed perhaps unprecedented.

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"The liner shipping industry is undergoing the most dramatic restructuring in its history," World Shipping Council President and CEO John Butler says in a commentary submitted for the 2017 Journal of Commerce Annual Review and Outlook.

Key events include the formation of two new alliances – the Ocean alliance and THE Alliance – and the resulting breaking apart of existing networks; a series of acquisitions (Maersk-Hamburg Süd, CMA CGM-NOL, Hapag-Lloyd-UASC, and NYK-MOL-'K' Line); and the complete bankruptcy of South Korea's Hanjin Shipping Company, which caused huge supply chain disruptions when containers it had couldn't move for weeks, while the failure ended the notion that container carriers would somehow always be able to somehow literally stay afloat no matter how bad the financial times became.

And carrier economics remained bleak, with rates hitting historic lows in 2016 and the red ink piling up. As the graphic below from Drewry Shipping shows, aggregate losses in the sector were more than $800 million in each of the first three quarters of 2016, and were above $1.6 billion in Q2 alone.

In desperate reaction, 18 major ocean container carriers declined to just 10 in 2016, and the sector has further consolidated into just three alliances, arrangements in which groups of carriers share capacity and schedules while maintaining their own sales, marketing and pricing operations.

So far, all these moves by the carriers have had little impact on rates and profits for the carriers. But is that finally going to change in 2017?

Possibly. For example, capacity is finally starting to be withdrawn in the face of slow container growth and tremendous over supply of TEU availability in the market. To highlight the changing dynamic, the youngest-ever ship to be scrapped, Rickmers India, at just seven years old, was sold in December for less than $6 million, though it was purchased new for $60 million in 2009, according to IHS Markit Data. That big loss on the scrap sale shows just serious providers have become about reducing capacity.

"I expect that we will see continued high levels of both scrapping and idling," Maersk Group CEO Soren Skou said in November during the company's Q2 earnings call.

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Eventually, the capacity reduction will be felt, and serve to push rates higher.

Beyond just rates, the consolidation and alliance arrangements have been worrisome for shipper groups since the action started a few years ago.

"It means larger ships, less competition operationally, fewer sailings for exporters to select from, and more stress on terminals and labor," says Peter Friedmann, executive director of the Agriculture and Commodities Transportation Coalition, as quoted by Peter Tirschwell, IHS Maritime & Trade senior content office, in a recent column on the Journal of Commerce web site.

In fact, despite the brutal year for carriers that was 2016, "The planets appear to be aligning to usher in a new golden age for container line profitability," Drewry wrote in late December, adding "Can anything stand in their way?"

Drewry answers itself by saying that Yes, several developments could keep a lid on rates for shippers and profits for carriers.

One is in fact potential new entrants to the container shipping market, such as the recent formation of the new Korea Line from the ashes of Hanjin. There will likely be others, Drewry says: "So long as there is a surplus of vessels that keeps charter rates down, and fuel prices are manageable, there are almost no barriers to entry" to the container shipper market.

To quickly gain share, new entrants tend to keep rates well below market, putting a price ceiling on other carriers.

What's more, governmental action by countries across the globe to gain market share for container carriers flying their flags could also keep rates down.

For example, the state-owned Islamic Republic of Iran Shipping Lines (IRISL) has recently ordered four 14,500 TEU ships from South Korean's Hyundai Heavy Industries and has previously expressed a desire to buy much more new capacity to become a global player. The order was financed by a South Korean government desperate to resuscitate its ailing shipping industry, which in the last year lost Hanjin and saw Hyundai Merchant Marine shrink in stature as it fights to repair its balance sheet.

Government intervention in the market "could push back the date when supply and demand finally align," Drewry notes.

All told, Drewry concludes that "Consolidation will assist carriers on their path to becoming profitable, but conditions will still not be ideal for making huge sums until the overcapacity situation is dealt with and the barriers to entry rise to deter competition," which appears unlikely to happen yet in 2017.

Another possible bit of good news for shippers, IHS's Tirschwell says, is that fewer, stronger carriers may be able to make the investments that will benefit shippers. He cites the newly created transportation business of Maersk Group, where terminals, logistics and liner businesses are being combined into a new, digitally driven business unit that envisions a customer experience akin to that of UPS or FedEx.

But although the Maersk game plan is ambitious and forwarding-thinking, it remains to be seen, "whether such an approach can break the commodity cycle and set up a scenario where value is created for the customer, which then is willing to allow the provider to share in the spoils," Tirschwell observes.

What customers truly value, he adds, is reliability, and "that can't be digitized."

For that to be achieved, the fundamental carrier-customer relationship has to change. Tirschwell writes that Cosco Shipping North America president Feng Bo is correct when he recently said that "Shippers and carriers should have serious discussions about how they contract and agree to rates and contract terms that are fair and keep disasters at bay."

The Bottom Line from SCDigest: Consolidation and related alliance moves are likely to create rates above the rock bottom levels the sector has seen for a couple of years, but not enough to pinch shippers too much in 2017, nor restore much luster the bottom lines of carriers. That could happen in 2018 and beyond, but only if carriers can maintain capacity discipline and new entrants don't emerge, a real unknown at this point.

What's your take on developments in the container shipping industry? What do you think will happen to rates in 2017? Let us know your thoughts at the Feedback section below.

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