Tuesday, March 9, 2010

MSC CEO Blames Shippers for Industry Crisis

The head of the world's second largest shipping fleet is placing much of the blame for the deepness of the recent shipping industry downturn on the ocean carriers' customers – the shippers. 

“Shippers are not that deep,” Gianluigi Aponte, chief executive of Mediterranean Shipping Company said during an exclusive interview with Robert Wright of the Financial Times. “They worry always who will ship for $50 less. The shippers are concerned solely by the price.”

While Aponte predicted that every major ocean carrier will survive the downturn, the worst in the shipping industry since the 1970s, he worried about instability brought to the system by the shippers – mainly through their efforts to repeal the conference system. This system, which was abolished in October 2008 just as the worst of the financial crisis was taking hold, was used by the industry to predict future capacity needs and help prevent devastating rate swings. 

It is worth noting that ocean carriers, by their nature, are creatures of long term planning. In the formula for financial success in the carrier industry, ocean carriers must maintain a fine balance between capacity, in the form of available space aboard vessels, and cargo rates, which provide revenue to cover operating costs.

Anytime the formula gets out of balance, the balance sheets of ocean carriers prosper or suffer accordingly. If capacity rises to a level that can no longer support the demand, you have overcapacity, and rates tend to drop, leading to reduced revenues for the carriers. On the opposite end is undercapacity, with the concomitant rise in rates and often a surge in the earnings of the carriers.

The problem for carriers is that their investment side of the formula, i.e., the vessels, does not encourage a quick response. It can take years for vessels ordered in good times and costing tens of millions of dollars to come on line. In some cases, as has been the case during the recent economic downturn, massive vessel orders came on line just as the bottom fell out of the industry.

However, carriers, faced with a sudden surge in overcapacity, are loath to lose any ordered capacity. It can cost them millions in deposits and they may have to wait years to get back in the purchase cycle with shipbuilders. So even in the worst of times carriers try to maintain their long-term investments in vessels – even if it means tying up the vessels in bad times and taking the loss on continued payments.

This situation imposes upon the carriers a lack of ability to quickly respond to changes in the rate side of the formula, especially if rates drop. And if rates fall too quickly, as they did in the past two years, carriers face monumental losses. Add to this the increase in operating costs over the past several years due mainly to fuel price increases, and the losses become staggering.

Complicating the matter, on the other end of the formula is the shipper – the customers of the carriers. By and large, shippers do not suffer from restraints due to long-term investments or high overhead costs. They can respond quickly to turbulence in the market simply by adjusting their rates. During a downturn, while cargo volumes slow, shippers can easily cut their rates to attract more business. However, this often leads to a race to the bottom. In the case of what happened in 2008 and 2009, the bottom literally was the bottom. Cargo rates that were above $2,000 per TEU before the global economic crises began fell to less than $400 per TEU in the early part of 2009. Bulk rates suffered an even worse collapse.

However, ocean carriers and their tremendous overhead require a certain rate level just to cover operating expenses. It was not until cargo box rates began returning to around the $1,500 per TEU level at the end of 2009, that ocean carriers even flirted with talk of a better 2010.

“I think that the big operators will come out very strong,” Aponte told the Financial Times. “We will all recover our losses in 2010.”