The global shipping crisis and the consolidation pressure on Liner Companies

Introduction

As the global shipping crisis goes into its 12th year, the light at the end of the tunnel still seems to be far away. Years of overcapacities and a destructive price war left some bankrupt and others merging to survive. The crisis has its roots at its underlying economic processes resulting from low product differentiation, long-term investment cycles and high capital intensity. While shipping crises are nothing new, the current one is particularly grave and reshapes the market of container liners completely.

While crises in the past saw freight and charter rates increase again after short shock waves, the current one is far from over regarding the persistent overcapacities and the peculiar appetite of owners to order tonnage in years of crisis. The race what liner is going to come out of the crisis as the winner has begun.

The Economic Roots of the Crisis

Shipping has always been a volatile business. The reasons for the high market volatility can be broken down into three factors: low-product differentiation, long-term investment cycles and the high proportion of fixed costs.

Low Product Differentiation

It is very difficult for a shipping company to have a competitive advantage in the market. When a client ships a container from location A to location B, he usually has a number of liner companies to choose from. The client wants the container to reach its destination reliably and within a certain amount of time. Liner companies do that job more or less equally well. The client’s liner of choice is therefore mostly determined by the price. This means that unfavorable market conditions lead to price wars, as liners start fighting for the existing cargo. It could be compared to the airline industry: security regulations are internationally standardized, planes are supplied by the duopoly Boeing and Airbus and travelling times as well as customs are the same. Here again, the customers airline of choice will fore mostly be determined by the price. Furthermore, liner companies form consortiums to serve standard routes more regularly. This means that four liners might have eight vessels that are constantly rotating between Hamburg and South Africa. While each company owns two vessels, the parties agree to fill up a proportional share on all eight vessels. The container a client booked with e.g. Maersk or MSC might therefore be on the same vessel, facing the same travelling times, customs, port terminal handling charges, bunker charges, etc. A competitive advantage is difficult if not impossible to achieve.

Long Investment Horizon

Due to the relatively long investment horizon of the shipping industry the tonnage follows a pattern similar to a pork cycle. The cycle was first described in 1925 by Mortdecai Ezekiel on the market prices of livestock in the US. When market prices are high producers invest as current prices indicate high profitability. After a time lag these investments lead to overproduction. The oversupply causes prices to fall and production is cut down. This in turn leads to higher demand and rising prices until the cycle begins again.

Ships have delivery times of around three years. Once an order is placed it is difficult to cancel it. This further increases the risk as market conditions can change within that period. The tanker crisis in the 1970’s is a good example. At the beginning of the six-day war in 1967 the Suez Channel was closed. Oil that was shipped from the middle east to the west had to travel around the African Cape to reach its destination: As a result, the transport time was significantly increased leading to an undersupply of tonnage, creating fortunes for current tanker owners like e.g. Aristotle Onassis. High rates encouraged orders of new tankers to fill the undersupply. In 1973 OPEC decided to cut oil production as a result of the Yom Kippur War. In 1975 the Suez Channel reopened. Rates fell rapidly leading the tanker segment into a deep crisis. Many of the ships that had been ordered before had to be wrecked without even being used once.

High Proportion of Fixed Costs

The high proportion of fixed costs make owners more reluctant of taking ships out of the market. Fixed costs make up roughly two thirds of expenditures. Sailing with a half loaded vessel is therefore almost as expensive as with a full one. Owners will decide to sail as long as the rates are above operational costs, even if this implies a loss. While freight rates are volatile, charter rates are even more. Once a vessel is purchased, variable costs are close to zero. He will therefore be willing to charter the vessel out for any price above zero. Time charter rates for Cape Size Vessels (dead weight tonnage above 100’000) fluctuated between 233’988 $/day in 2008 and 311 $/day in 2015 while fixed costs where estimated to be above 12’000 $/day. In unprofitable market conditions owners have three options: Either wreck the ship and lose the initial investment, sell it, which will be difficult, or keep it in hope of recovering market conditions. In any case the owner will always be reluctant to wreck his ship, as this realizes the loss.

The Current Crisis

In the years previous to the crisis freight and charter rates sky rocketed. World trade had been growing at a high pace and many new vessels were ordered.

The Role of External Financing

The beneficial market conditions as well as the scarce shipyard capacities led many owners to finance their orders through debt capital to ensure fast completion. The role of ship financers like the German banks HSH Nordbank, the Nord LB and the Commerzbank played a crucial part. Germany is the biggest owner of container ships, while most of them are chartered out to other liners. Ship funds became another popular financing method. Fund managers collected money from smaller private investors to buy a vessel. As long as rates where high this strategy would pay off. Banks gave out loans all too easily and as soon as rates dropped it became evident that excessive risks had been taken. Paying off the vessel and the interest would no longer be possible. Until February 2013 German banks had given out ship loans of over 100 bn. €. By 2007 the industry was already highly leveraged and a card house that would only need a breeze to fall apart. That breeze came in the form of the financial crisis in 2008.

Reshuffling of the Company Landscape

Ever since the industry has been in crisis. The HARPEX Index measures time charter rates for containerships around the world and is one of the most useful tools in assessing the rate development in container shipping. Globally collected information from shipbrokers, owners and charterers calculate the Index on a daily basis.

(Harpex Index from 2000 Until Today)

Due to the low demand and the overcapacity of tonnage in the market rates began to fall. German Liner Hapag-Lloyd alone recorded a loss of over 350 Mio. € between January and September 2009 and had to be saved by the state. While the market situation bettered in 2010 and 2011, Maersk ordered twenty 18’000 TEU (container capacity) vessels. The maximum capacity of VLCS (very large container ships) has been doubling approximately every ten years in the past decades. Although large vessels can access fewer ports, they promise higher economies of scale by cutting unit cost on staff and bunker (ship diesel). The desire of the global players to have the best cards at the end of the crisis lead to increased numbers of ship orders, which worsened the market situation further. Until the autumn 2014 over 450 funds ships went bankrupt representing a damage of over 10 bn. €. In 2008 the HSH Nordbank had already 40 bn. € of ship loans in its books and had to be saved several times by the city of Hamburg. While global trade volume is above the pre-crisis level, tonnage on the market grew even faster.

Due to the dire situation of the industry, owners are now more than ever forced to cut costs: This has led to a global consolidation process: Out of the twenty biggest liners before the crisis almost half of them have disappeared. In 2009 Senator Lines filed for bankruptcy. So did Hanjin in 2016, the sixth biggest liner shipping company. CMA CGM took over American President Lines and China Shipping Container Lines merged with China Ocean Shipping Company. In 2017 Hapag-Lloyd merged with United Arabian Shipping Company, Maersk acquired Hamburg-Süd and the three largest Japanese liners Nippon Yusen Kabushiki Kaisha, Mitsui Osaka Shosen Kaisha Lines and Kawasaki Kisen Kaisha merged their container segment. Traditional German Shipping Companies like the Rickmers Holding filed for bankruptcy after almost 2 centuries in business. The surviving liners formed alliances to increase their market power. Nowadays over 70% of the trade is controlled by the ten biggest players:

Conclusion

Although cargo volumes are increasing the crisis is far from an end. While smaller liners find it increasingly difficult to stay in business the global players continue to increase their market share and try to scratch along break-even level. Smaller operators still have more room in niche markets and on less common routes as they can reach smaller ports with their vessels and enjoy higher flexibility. Whether a normalisation will be reached in the next years depends largely on the appetite of owners to order tonnage and on the banks willingness to finance that appetite. In any case the former fragemented market is moving towards an oligopoly.

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