COVID-19 logistics market situation report: sea freight

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Container Shipping

Container Shipping was an early casualty of the COVID-19 crisis, following behind airfreight surprisingly closely but reacting differently. Not only has demand fluctuated wildly, but the supply-side has ‘deformed’. This ‘deforming’ has been quite different from the dynamic seen in airfreight and reflects the different operational profile of container shipping.

In such a situation container shipping’s ‘networked’ profile is laid bare as the relationship between different container lines, container fleets, container-terminals and land-side transport requires some degree of equilibrium. When this is removed the system has a tendency to malfunction. This has been central to the experience of China over February and March of 2020 and maybe the experience for parts of the rest of the world.

Prior to the Crash

The container shipping market was emerging from a period of depressed demand and depressed prices at the beginning of 2020. 2019 had seen some recovery in the first two quarters of the year, with both demand and freight-rates drifting upwards, however this petered-out in Q4. That said the underlying trend in the market seemed to offer some support, with the global container shipping fleet-size constrained both by scrappage but also by the needs to convert to low-sulphur bunker fuel. The COVID-19 crisis hit what was a gradually improving market.

China and the whiplash.

The trajectory of container shipping out of China has been one of violent contraction followed by some form of bounce-back. Estimates and numbers from the sector strongly suggest that volumes being shipped into and from China fell by 30% from the end of February to the third week in March.

What happened in China was complex and distinctly different from the bans on services seen in the passenger air transport market. Shipping services were generally permitted to continue, however, the transport into the port and terminal operations were crippled by the inability of staff to leave their homes, whilst demand for shipping services from both importers and exporters in China fell violently; although it is important to note that it did not stop with important flows of goods such as food, energy products but also items required for the maintenance of infrastructure continuing. This fall led to the ‘blanking’ of services into China.

The recovery took place in the third week of March with employees returning to areas such as trucking and container port operations. Demand also recovered, particularly from larger State-Owned Entities although by the end of March it had not returned to pre-crisis levels.

The market response was also complex. Although initially freight rates crashed, the subsequent widespread blanking of services led to the freight rates for the consignments still being moved increasing enormously. Indeed, it briefly became quite hard for shippers to gain reliable quotes for some services into China. In effect, the market ceased to function temporarily. Relationships with shippers with agreed contracts become complex with ‘rollovers’ becoming an issue. In addition, acute congestion began to appear both within China and at ports outside China. This was particularly the case with containers, with a mal-distribution leading to a mix of shortages and oversupply.

By the last week in March, the situation was beginning to partially reverse, with services into China attempting to recover but destinations in Europe and North America coming under pressure with falling volumes and some constraints on vessels entering port, with Italian vessels, for example occasionally being refused permission to dock. It is also notable that other regions, such as the Middle East are already well advanced in terms of quarantine measures although so far the crisis has been an economic rather than epidemiological one.

Again, at present estimates of the impact are just that, estimates. However, the opinion of shipping lines and others is that global container shipping will see a 20% shrinkage in volume in the second quarter. Obviously, some routes will be hit harder than others. The timing of this may be difficult to assess as certain countries, such as Italy, have progressed with the epidemic and may be past the halfway point. Others may not be as advanced. This will have implications for the level of demand.

Container shipping lines

A wave of consolidation in the sector has made container shipping lines more robust over the past 5-7 years. Nonetheless, this will be a considerable stress on all container shipping finances. A major issue will be servicing debt. The sector has traditionally been characterised by high-levels of gearing although this is complicated by the nature of ship-ownership. In such an environment capital asset utilisation will determine the viability of any business. However, unconventional monetary policy and related fiscal instruments are likely to be important here.

Maersk Far more robust financially after its restructuring, AP Moller Maersk has a strong balance sheet and has good margins for the sector. Although debt is significant its credibility with equity markets is high and it is perceived as well managed and open. This could be a critical strength in the immediate future.

CMA CGM is much more under pressure than its rivals, with a considerable debt burden not least as a result of its purchase of CEVA. On March 30th it announced that that it had sold assets to a joint venture it has with China Merchants, providing US$815m of cash. This was part of a previously announced plan to sell assets in order to reduce debt.

Hapag Lloyd announced a leap in profits for FY2019, with clear headroom above its debt-servicing requirements. This should give Hapag Lloyd the strength to survive all but the worst scenario.

MSC is not characterised by a high degree of visibility, however, it is believed to have a substantial level of debt. That said in the past MSC has shown both agility and an aggressive approach to cost control although, being privately owned its debt-to-equity issues may limit its options. It is also believed that MSC cruise operations were highly profitable and provided considerable support to the company. The crisis is likely to have hit this business hard.

Others: The Chinese State-Owned Enterprise, COSCO, is likely to have suffered badly from the crisis in China, however, its position as a state-owned enterprise all but ensures it continued liquidity. The question here is whether it will attempt to use its huge credit lines for purchases either of a shipping line or container terminals. ONE must be experiencing a degree of frustration as its results has improved considerably after a bumpy start. Although Japan has not yet been so badly affected, its key Chinese and trans-pacific trades must have been disrupted. ONE may be obliged to address further M&A issues in this climate. Smaller Asia Pacific lines face real issues of survival. Previous to this intra-Asia trade was comparatively robust however the future may look very dark for many of them.

Container Shipping: Summary

Do not assume that freight rates will simply collapse, the market is more complex than that. The container shipping lines are engaging in survival strategies of considerable savagery and this has already had an impact on the supply/demand balance. Rather than just a collapse in the market, extreme volatility is likely to be the markets main feature. Whiplash effects are also likely to be important in the short- to medium-term.

In this market, cash is likely to be king. This is amplified by the geared nature of the business. The ownership structure of ships is also important. The familiar issue of the risk of holding physical assets may become a vital part of any losses. During the financial crash of 2007-8, these were huge.  

In the not so long-term consideration has to be given to a major restructuring of supply chain geography and thus shipping patterns. This could upset many calculations around capacity and corporate strategy in the sector.

Finally, politics is likely to enter the calculation. Chinese state investors are unlikely to be too popular with anyone outside China.

Other Trades

The nature of the markets for other trades is often distinctly different to container shipping. For example, both car carriers and LNG carriers have very different relationships with their customers with car carriers in particular dominated by long-term relationships with key clients. The car carrier market was already struggling with soft demand in major markets so the near-halt to car sales in China, Europe and North America has led to savage retrenchment in the leading carriers. Governments are very likely to make significant efforts to boost car sales, however, do not assume that this will revive traditional trade patterns. The car carrier market could restructure for the long-term with some M&A activity.

Even the LNG carrier market, which has seen steadily growing demand over a number of years in key economies in Asia is under pressure. Even though LNG is a fundamental of a number of economies demand has fallen sharply, so much so that China’s energy purchasers declared ‘force majeure’. What the short-term holds is unknown, however, the LNG carrier market looks to be more stable in the longer-term due not just to the importance of its cargo but also the stability of its high capitalised logistics infrastructure. There may be a need for refinancing but such sectors are likely to be at the head of the queue for state-backed liquidity facilities.

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Source: Transport Intelligence, March 31, 2020

Author: Thomas Cullen