Date: Wednesday, April 26, 2023
The signals have been flashing curiously green in container shipping of late. Spot rates are up. Charter rates and durations are up. Secondhand ship sales are brisk and asset prices are rising. Idled tonnage is down. Carriers are not sending many older vessels for demolition. The warning Tuesday from leading container shipping consultancy Drewry: Those signals won’t be flashing green much longer.
“We would be confident if the foundations for recovery were in place but we just don’t see them,” said Simon Heaney, editor of Drewry’s “Container Forecaster” report, during a presentation on his company’s latest sector outlook.
“Without those building blocks in place, we view the uptick in spot rates and charter-hire prices as a transitory illusion.
“Volumes remain very weak. The orderbook for this year and next is vast and will start to land with more vengeance very soon,” he said. “The bill is due on the ordering frenzy we saw in 2021. The timing [of deliveries] couldn’t be much worse, coinciding with a slump in volume.
“And as the newbuilds flood in, pressure on both markets [freight and chartering] is going to become an irresistible force that owners and operators are not going to be able to bat away.”
What’s bad news for shipping lines is good news for U.S. importers — at least, in terms of freight costs. Drewry is now predicting low rates through 2024.
“The problem for carrier executives is that demand is not going to be sufficient to offset the capacity surge. Hence, we remain unconvinced that freight rates have bottomed out,” said Heaney.
Failure to scrap
Drewry currently estimates that global throughput will increase 1% this year, far below capacity growth. It expects net fleet capacity growth (including the effect of ship demolitions) to increase 4.7%.
“But when you take away the comfort blanket of port congestion, with ships turning around quicker, the rise in effective capacity is going to be far higher — at 25% year on year. That’s why we see the market tipping so heavily,” Heaney said.
Shipping lines could have made the supply-demand balance much more manageable for themselves by scrapping more of their older ships more quickly. The theory going into the downturn was that older vessels that were only kept in service because of boom-time rates would be quickly banished to the scrapyards when rates collapsed. It hasn’t happened yet.
“Scrapping is way below what we were expecting,” conceded Heaney.
In December, Drewry predicted 900,000 twenty-foot equivalent units of container-ship capacity would be recycled this year. It has now drastically lowered its forecast to 300,000 TEUs. And even at this level, recycling would have to skyrocket in the second half for that much-reduced target to be met.
Virtually no ships were demolished during the rate boom: only 28,000 TEUs in 2021 and 2022 combined. Drewry estimates that 31,000 TEUs were scrapped in the first quarter of 2023. That’s “on par with the whole of 2021 and 2022 but still way off from our current target,” said Heaney.
Fuel-efficient ships in, non-fuel-efficient ships still in
He noted that 81% of newbuildings ordered from January 2022 to mid-March 2023 were for dual-fuel designs.
“I don’t think that anyone could sensibly argue against the requirement from a moral and financial perspective to make the fleet more fuel-efficient and less damaging to the environment. Where owners are falling down is with the other side of things: They’re simply not removing enough of the older, more heavily polluting ships the orderbook should be replacing.
“We just can’t think of a justifiable reason for owners to persist with some of these old clunkers, other than they want to keep sweating them while they’re still making drips of money. The failure to get them off the books is just going to press down charter rates and asset values in the long term. We think this is short-termism at its worst.
“At the moment, lines and owners are still making a tiny bit of money without seeing the bigger picture. That’s got to change. You have such a weight of newbuild deliveries coming that to ignore the problem is just building the problem for the future.”
‘We got it wrong’
In October, Drewry predicted that carriers would ultimately make the right capacity-management choices to engineer a “soft landing.” Heaney issued a mea culpa Tuesday.
“I’m never afraid to put my hand up and say we got it wrong and this is why and we’ll try to do better in the future.
“We misjudged the fact that even though the market was more concentrated and alliances seemed more streamlined, [it was still about] prioritization of short-term gains as opposed to the longer-term picture in terms of the market balance. That’s what we got wrong. It’s a lesson to us that the market generally doesn’t learn too much. [Carriers] had a great run and they’re milking it, for sure. Ultimately, they reverted to type and we should have seen that.
“The hardest part of any container forecast is trying to get into the minds of carriers, which are not a monolith,” he noted.
Forecast for weak rates through 2024
Beyond not scrapping enough older ships, carriers have not “blanked” (canceled) enough sailings to manage capacity downward in line with demand to support freight rates.
“I think we can grade carriers’ capacity-management performance to date as suboptimal,” said Heaney. “By not acting sooner, they’ve allowed the collapse we’ve seen in the spot market to infect the contract market.”
Drewry now projects that freight rates — the mix of both contract and spot — will fall 59.8% year on year in 2023 on a global basis. It expects average rates to drop 68.4% on the mainline east-west trades (which include U.S. imports).
This average accounts for the positive effect of annual trans-Pacific contracts signed last year that expire in the coming weeks. Carriers will replace expiring contracts with new ones “at much lower rates,” Heaney said.
This positive rate “overhang” in the first half of this year won’t be there in 2024. Furthermore, “the same pressures will weigh down the market next year. You’ll still have relatively weak growth on the demand side and a heavy orderbook coming. So, rinse and repeat.”
Drewry now estimates that average freight rates including contract and spot will fall 13.7% globally and 24% on east-west trades in 2024 versus 2023. Its 2024 east-west rate forecast — the focus of U.S. importers — is now below pre-COVID 2019 levels.
Shipping lines projected to sink into red
Add it all up and the consultancy sees severely reduced earnings for the ocean carrier sector in 2023 and losses in 2024.
Drewry’s methodology focuses on earnings before interest and taxes, not net income. The container liner industry earned aggregate EBIT of $296 billion in 2022, “a staggering sum” and up 37% versus 2021, said Heaney. The industry’s operating EBIT margin (the percentage of operating profit versus revenue) was 49% last year versus 45% in 2021.
Drewry expects the industry to earn EBIT of $16.5 billion in 2023, a decline of 94% year on year. That’s “still very good by historical standards but way down from those huge towers we saw in 2021 and 2022,” Heaney said. Gains will be front-loaded to the first half due to contracts signed last year and “results are likely to get progressively worse as this year develops.”
Next year should see carriers in the red on an EBIT basis, according to Drewry. Its newly introduced forecast for 2024 is for an industrywide EBIT loss of $10 billion.
“Liners are going to be able to cope with those losses because they’ve built up very significant cash buffers,” said Heaney. “But it’s going to be a harder landing than it might otherwise have been had they acted sooner.”