By Bill Smith, Vice President Business Development & Sales, CV International
The Abyss, The Bullwhip, The Recovery, and A New Global Shipping Paradigm Emerges
2020 started with modest expectations in the ocean shipping industry. Carriers were predicting slight volume growth, a stable economy, and fewer trade policy changes during a U.S. election year. After nearly twenty years of industry consolidation, the shift to a seller’s market was nearly complete, leaving those ocean carriers remaining in a stronger position to exert pricing power through increased strategic cooperation. Three Alliances composed of 10 main carriers now controlled the Trans-Pacific Eastbound (TPEB) ocean freight market, and they had become very adept at quickly adjusting capacity via “Blank Sailing” programs to keep rates at compensatory levels.
Then the COVID-19 pandemic hit, putting the economy and global trade into a deep freeze as countries went into lockdown, millions filed for unemployment, retailers slashed orders, and supply chains battened down the hatches. The massive drop in Q2 GDP was terrifying, with charts showing the economy falling into an abyss and no real assurance on when the recovery might occur. The ocean carriers responded by issuing a record number of blank sailings, to prepare for a significant reduction in cargo volume.
Blank sailings are a useful tool in the ocean shipping industry whereby regularly scheduled weekly service can be cancelled, due to low demand. They serve an important purpose in slack periods, since the fixed cost of each voyage is quite high, so carriers need a certain minimum threshold of cargo on each vessel to breakeven. Blank sailings have been particularly successful over the last 1-2 years, allowing carriers to avoid price wars and rate crashes, which have historically plagued the ocean shipping sector. The net effect is a short-term reduction in capacity, which can prop up and sustain rates during periods of lower demand.
Import volumes fell dramatically throughout the spring, given high unemployment and economic uncertainty kept consumers on the sidelines. Carriers extended their aggressive blank sailing program, canceling over 100 voyages between April and June. This translated into an overall reduction of 25 percent of total capacity to the U.S. west coast, and 20 percent to the U.S. east coast. The economic outlook for the remainder of 2020 looked bleak, and carriers began to plan for depressed volumes for the long haul.
Then something incredible happened, as new pandemic-fueled shopping trends emerged. With spending on services, travel, dining, and entertainment curtailed, consumers began focusing on home improvement and started buying domestic goods. Sectors like flooring, furniture, outdoor goods, and recreational equipment started to not just thaw out, but boom as consumers upgraded their homes to make the most of the inordinate amount of time they were spending there. By summer, new orders were flowing in these pandemic-friendly sectors, with overall ocean shipping demand increasing dramatically, given so many of these goods are imported. At the same time, carriers also realized a significant uptick in the volume of personal protective equipment (PPE). A perfect storm was developing in the ocean shipping market, with growing consumer confidence from the U.S. stimulus package and various States beginning to lift lockdown restrictions.
It is important to note that modern supply chains are optimized to run at low inventory levels, with predictable replenishment schedules and just-in-time deliveries, that yield lower carrying costs. Complicating matters further, global sourcing and imports translate into long lead times, so interruptions in supply can disrupt fragile product pipelines that span halfway around the world. As sales declined early in the pandemic, companies drew down inventories to conserve cash and weather the storm. Then when demand rebounded, suppliers did not have enough inventory on hand. In Q3, importers in pandemic-benefitting sectors placed outsized orders to restock empty warehouses. This rush created a “bullwhip effect,” which is a distribution channel phenomenon whereby demand forecasts yield supply chain inefficiencies (Wikipedia). Also known as the Forrester effect, it can be described as “the observed propensity for material orders to be more variable than demand signals and for this variability to increase further upstream a company is in a supply chain.” This resulted in major stress on global transportation networks struggling to keep up with already surging cargo volumes.
Ocean rates rose steadily during the second half of 2020, given higher demand and the pending economic recovery. Carriers were even able to implement priority loading surcharges, beyond their usual “peak season” fees. Carriers were firmly in control, exerting their pricing power given unprecedented market conditions.
Ocean carriers historically sign annual contracts with major shippers and transportation intermediaries, so a significant portion of vessel tonnage is occupied by fixed-rate cargo. This provides shippers with a predictable weekly allocation and stable rate, along with assurance from carriers to supply needed vessel space and equipment in a timely fashion. The spot market exists beyond this realm, a reflection of the remaining uncontracted space available on vessels each week, and what the current open market is willing to pay for it.
To handle increased demand, the ocean carriers deployed more capacity in Q3 and Q4, effectively hitting maximum fleet utilization. Even with the increased tonnage, demand outstripped supply and the spot market took off, with shippers willing to pay “premium” levels (well above already high spot market rates), to ensure their desperately needed cargo was loaded on ships. By early January, these premium levels reached their apex, given the runup in demand with shippers trying to load prior to Lunar New Year. For guaranteed loadability shippers from Asia were paying as much as the following premium (port to port) rates for 40’ and 40’ HC equipment, compared to market levels for long-term fixed contract rates signed in May 2020.
|40’ & 40’ HC||May 2020 Contract rate*||Jan. 2021 Premium*||Difference||% Increase|
A typical 20’ container of wood flooring is packed with approximately 600 cartons on 20 pallets, with a cost of merchandise at approximately $45,000.? Given the transportation spend as a percentage of cost of goods sold jumped during this recent period from 6 percent to nearly 20 percent (to the U.S. east coast), you can readily see how the wild shipping market of 2020/2021 is hitting home.
A New Global Shipping Paradigm Emerges
As the 2021/2022 ocean contracting season approaches, which runs on a May through April timetable, shippers are facing a very challenging set of variables, including a weaker negotiating position. The traditional model of guaranteed space for a predictable (fixed) rate will be harder to obtain, with carriers now favoring the spot and premium market sales channels. Current contract discussions and feedback indicate that ocean carriers’ interest in traditional fixed-rate structures is waning, with an unusual push for lower minimum quantity commitments (MQCs) amongst shippers. This allows the carriers to handle more cargo in the spot and premium markets, which is proving to be quite lucrative.
In the year ahead, it is extremely important for ocean shippers to have a multitude of booking/carrier options across various ocean alliances. Non-Vessel-Operating Common Carriers (NVOCCs) provide such a platform by contracting with a variety of carriers and Alliances, enabling a wide range of competitive service options. For most small to medium-sized shippers, the NVOCC solution has always been the best route, given the value-added role such partners play. A new paradigm is emerging though for larger shippers, who traditionally sign their own direct contracts with the carriers. Loading priority is increasingly being given to shippers that are willing to pay a higher price, so historical fixed-rate shippers will need a reliable channel to arrange and handle the increasing number of containers that will move outside of their direct service contracts. In these uncertain times, best-in-class shippers are adapting their ocean freight programs to accommodate more spot market moves and as such, it is clear the NVOCC value proposition is now stronger than ever.