Global Container Shipping Outlook 2017: Capacity discipline is needed to support & lift freight rates; increased industry concentration helps

8th March 2017, Global - On paper, 2017 and 2018 look like another two challenging years for the global container shipping sector given the sizeable scheduled newbuild vessel deliveries this and next year, pointing to another 2 years of industry oversupply before we see any glimpse of sector recovery from 2019.

However, we believe that after incurring huge losses in 2016, the liners will be more determined to implement disciplined capacity management this year, at least until they start making money again and the ambition to increase market share returns.    

Chart: Global container shipping demand and supply growth, containership idle fleet ratio and freight rate movement (2007 to 2020)

Global Container Shipping Outlook 2017

The chart above shows our projected global container shipping demand and supply growth from 2017 to 2020, in addition to the historical container shipping demand and supply growth and global idle fleet ratio trend. We have also included the movement in freight rates using the China Containerised Freight Index as a proxy to illustrate how freight rates have moved in relation to changes in the global container shipping industry’s demand and supply growth. Overall, we believe that much capacity discipline is still needed to support and lift freight rates in 2017. What has changed compared to historical years is that the industry concentration has increased from the recent slew of M&A activities and this will help improve the liners’ ability to manage actual deployed capacity better going forward, reducing the probability of free-falling freight rates and gradually driving freight rate recovery.

KEY DOWNSIDE RISKS

+ We are not out of the woods yet on the supply side

Based on the newbuild vessel orderbook and delivery schedules, the global container shipping capacity is expected to grow 8.4% in 2017, followed by 5.9% in 2018, 1.2% in 2019 and 0.01% in 2020 on a gross basis, compared to only 1.2% net capacity growth in 2016.

This level of gross capacity growth would far exceed the global container shipping demand growth which has been trending 3.1% per annum in the past 5 years. We have seen an up-tick in global trade demand in recent months with the global container shipping volume rising 5.3% y/y in November and December 2016 (source: Container Trades Statistics). However, it is still too early to ascertain whether this pace of growth is sustainable.

There could be some front-loading of imports into the United States which will boost the Transpacific trade near term in anticipation of potentially more protectionist trade policies in the longer term, in our view.

+ The higher rate of vessel scrapping and vessel delivery slippage in 2016 needs to continue this year, in order to achieve industry demand-supply growth balance in 2017

The global container shipping industry experienced a higher than expected level of newbuild vessel delivery slippage of 22% and vessel scrapping of 3.3% in 2016. In addition, 6.5% of the global container shipping capacity is laying idle.

Based on our projected global container shipping demand growth of 3.4% in 2017, the newbuild vessel delivery slippage and vessel scrapping will have to be maintained at the high levels we saw in 2016 of 22% and 3.3% respectively (or in some alternative combination), in order to bring down the global net capacity growth to 3.3% (versus our global container shipping net capacity growth forecast of 3.7%) which will be more in line with our expected global container shipping demand growth of 3.4% in 2017.

In addition, we still need to take into account the container shipping capacity in excess of demand growth accumulated in the historical years. We estimate that the cumulative surplus capacity has grown to 12%. The implementation of slow-steaming has helped to absorb around 6% of the excess capacity while another 6.5% of the global fleet has been idled.

+ The idle ships risk being reinstated

Globally, 6.5% of the global shipping capacity is laying idle as the operators have withdrawn services to cut losses and returned chartered-in vessels when their leases expire.

Our concern is that once freight rates return to more profitable levels, the operators are likely to reinstate their idle owned capacity. Fortunately, only 21% of the global idle vessel fleet belong to the operators. 79% of the global idle vessel fleet belong to non-operator owners who are finding it challenging to lease these vessels out even at low time-charter rates. However, if freight rates improve meaningfully, some operators may also be tempted to charter in some of the idle vessels given the low ship charter rates.

Reinstating these “ghost ships” without a corresponding rise in container shipping demand could worsen the industry oversupply again.

+ Corporate bankruptcies do not necessarily help to remove capacity from the shipping market

The bankruptcy of shipping lines does not necessarily result in the complete removal of their capacity from the shipping industry. This is because the ships that are seized from the bankrupt carrier by financial institutions and ship lessors are likely to be put up in the market for sale or charter again.

For instance, new entrant SM Line plans to launch 9 routes this year with a fleet of 12 containerships (some of which are Hanjin Shipping’s former vessels) and has plans to order newbuild vessels as well. SM Line also mentioned that it plans to operate 25 routes in 5 years, according to (source: Yonhap, Shipping Watch). Maersk is already chartering some of Hanjin Shipping’s former vessels. Other liners that are operating HJS’ former vessels include CMA CGM, MSC, PIL, Yang Ming (source: Reuters). Around 70% of Hanjin Shipping’s vessels have not found new employment yet but there are no indications that these are slated for demolition in the near term.

+ The natural rate of vessel scrapping is insufficient to offset the industry oversupply

The global container shipping fleet is still relatively young at 10.5 years. Only 4% of the global fleet is more than 20 years old and approaching the natural age of being scrapped. The natural rate of vessel demolition is likely to be around 2% per year, especially if fuel prices remain low. This level of natural scrapping will not be sufficient to offset the industry oversupply unless the global container shipping demand growth picks up to +4% and above.

KEY POSITIVE DRIVERS

+ The multiple M&A activities in the global container shipping industry in the past 1 year is raising industry concentration and will empower the liners to manage their actual deployed capacity better, preventing their freight rates from free-falling

Freight rates are ultimately driven by the level of actual capacity that is being deployed on each trade lane and the freight volume.

Historically, the global container shipping industry was highly fragmented. Only the top 3 liners, Maersk, MSC and CMA CGM had a meaningful market share in the global container shipping industry. The remaining liners, which are mostly Asian companies, only have a small market share each and limited pricing power and influence on their container shipping rates.

However, the market structure of the global container shipping industry has changed significantly. The industry concentration has risen, with the top 10 carriers providing 75% of the global container shipping capacity compared to 62% back in end 2011. Notably, Maersk’s global market share will rise 3ppts to 19% when its acquisition of Hamburg Sud is completed and retains its #1 position globally. The world’s third largest carrier CMA CGM’s market share has risen 2ppts to 10% in the past 5 years, helped by its acquisition of NOL/APL. Hapag Lloyd and UASC’s combined market share will be nearly 8%, ranking the fifth largest globally.

The industry’s higher market concentration will enable the carriers to limit the magnitude of the downside of their freight rates as the merged entities and alliance partners can coordinate their capacity allocation and deployment with one another.

+ The Asian liners’ dominance will increase

Apart from the above incumbent European carriers, we expect the Chinese and Japanese carriers to play a more dominant role in the container shipping industry going forward. The integration of China Cosco and CSCL into COSCO Shipping has resulted in a combined market share of 8% and it has become the fourth largest carrier globally.

The merger of the container shipping segments of Japanese carriers NYK, MOL and K-Line will catapult them to the 6th largest carrier ranking with a combined market share of nearly 7%. Evergreen, Yang Ming, OOIL and Hyundai Merchant Marine are ranked 7th, 8th, 9th and 10th largest with market shares of 5%, 3%, 3% and 2% respectively.

+ The establishment of the new carrier alliances will make a difference, with the 3 alliances controlling 75% of the global container shipping capacity

If we take into account alliances, the three carrier alliances that have been formed – 2M, OCEAN and THE alliances would control 75% (or 77% including Hyundai Merchant Marine) of the global container shipping capacity with 32% (or 35% including its vessel sharing agreement with Hyundai Merchant Marine), 26% and 17% market shares respectively.

Their dominance is even more pronounced on the two major trade lanes Asia-Europe and Transpacific. On the Asia-Europe trade, 2M, OCEAN and THE will have 40% (including its vessel sharing agreement with HMM), 35% and 23% share of the market, raising their total market share to 98%.

On the Transpacific trade, OCEAN, THE and 2M will have 41%, 29% and 19% share of the total market, raising their total market share to 89% (source: Alphaliner). We believe that carriers that are not part of the above 3 alliances are likely to be crowded out of the market over time.

When the implementation of OCEAN and THE alliances are in place from 1st April 2017 (in addition to 2M alliance), we expect improved coordination in capacity deployment among the carriers which should help reduce excess capacity allocation on routes where demand is soft. This should help support and stabilize freight rates.

In addition, following Hanjin Shipping’s bankruptcy, shippers are also more concerned about the risk of cargo transport disruptions and are likely to be more willing to pay more for service reliability and sustainability, in our view.

+ Conservative weekly capacity schedule in January and February 2017 reflect the liners’ discipline on capacity and strategic aim of securing higher freight rates in the run-up to their rate contracting season

Looking at the January and February 2017 weekly sailing schedules, the global liners’ capacity on the Transpacific trade lane was 2% lower y/y while their capacity on the Asia-Europe trade lane rose only 1% y/y in January and February combined.

+ Global container shipping trade demand growth has ticked up which is encouraging

The global container shipping trade demand growth has ticked up which is encouraging. The global container shipping volume rose 5.3% y/y in November and December 2016 (source: Container Trades Statistics) versus less than 3% for the full year 2016.

The Transpacific container shipping trade volume rose 4.5% y/y in January 2017 (versus the 4.3% growth for the full year 2016) but we will have to wait for February data to make a more reliable inference of the growth trend given the different timing of the Lunar New Year holidays this year versus last year.

The Intra-Asia container shipping trade volume rose 7.6% y/y in November and December 2016.

Only the Asia-Europe container shipping trade volume was still rather anaemic, flat y/y in 4Q16.

+ There is no better alternative mode of transporting massive quantities of semi-finished and finished goods than container shipping across continents and even within the region; the launch of more freight train services is unlikely to supplant transcontinental container shipping services in the next 10 years

The freight trains’ current operating capacity is miniscule relative to the global trade volume and it will take many years to build enough capacity to displace shipping as the main mode of international cargo transportation globally.

Moreover, although the rail transit time is shorter than container shipping, the freight rates are much higher. Rail transport is more likely to be a threat to the air cargo operators than to shipping in our view unless its unit cost can be significantly lowered.

+ The earlier than expected demolition of mid-sized containerships can help significantly improve the global container shipping industry’s demand and supply balance

27% of the global idle vessels are 3,000 to 5,099 TEUs in size which are too small for the larger trade lanes and too big for the shorter sea trades, especially after the widening of the Panama Canal. The current charter rates for 4,000 TEU vessels are 36% lower than the rates for 1,700 TEU vessels (source: Alphaliner). If these ships cannot find employment and are scrapped earlier than their useful lives, it could help restore the industry demand and supply balance much more quickly.

Globally, this vessel segment amounts to 19% of the global shipping capacity and 58% of them are chartered-in vessels. However, it is painful to write off and scrap these vessels due to their young age. The average age of this vessel segment is only 10.3 years with only 5% of the fleet above 20 years old.

The implementation of the Ballast Water Management Convention from 8 September 2017 could potentially drive some ship-owners to scrap their older vessels when weighed against the cost of complying with the new regulations.

TRADE LANE CAPACITY OUTLOOK

+ Asia-Europe trade lane

The Asia-Europe trade is likely to face the most severe capacity and freight rate pressure from newbuild vessel deliveries. However, the other trade lanes will not be spared due to the cascading of vessels. The historical excessive ordering of mega-sized vessels will continue to impact the global container shipping industry’s capacity deployment in 2017 and 2018.

78%, 86% and 89% of the gross capacity growth in 2017, 2018 and 2019 will be driven by the delivery of newbuild vessels above 10,000 TEUs in size. The top 5 carriers driving these mega ship investments are COSCO Shipping (33 such vessels on order), Maersk (20), MSC (22), Evergreen (16) and CMA CGM (15). The major ports and trade lanes that can handle the mega-sized containerships will be inundated with new capacity.   

71% of the global containerships that are above 10,000 TEU in size are already deployed on the Asia-Europe trade. 90% of Asia-Europe’s capacity are operated using these mega vessels. The 1.3m TEUs of mega vessels tonnage that will be delivered in 2017, 1.1m in 2018 and 0.2m in 2019 far exceed the 10% or 0.4m TEUs of Asia-Europe capacity that are currently served using vessels below 10,000 TEU in size. If capacity deployment is not tightly managed when the new ships are delivered, Asia-Europe freight rates are likely to remain under pressure. Asian liners with the largest capacity exposure to the Asia-Europe trade are Yang Ming (34%), Evergreen (29%), Hyundai Merchant Marine (29%), COSCO Shipping (28%).

+ Transpacific trade lane

The smaller trade lanes are not totally immune as the vessels displaced in these trade lanes are likely to cascade into the other trade lanes, except where there are port infrastructure and/or cargo constraints.

We expect the larger vessels to displace the smaller ships on the Transpacific (which is dominated by 7,500-9,999 TEU sized vessels), Latin America-related (dominated by 7,500-9,999 TEU vessels), Middle East/Indian Subcontinent (dominated by 5,100-7,499 TEU vessels) and Sub-Saharan African (dominated by 3,000-3,999 TEU vessels) trade lanes over time. Asian carriers with the largest capacity exposure to the Transpacific trade are K-Line (51%), NYK (43%), Mitsui OSK (37%), Evergreen (34%) and OOIL (30%).

+ Intra-Asia trade lane

The smaller displaced ships are likely to cascade into the other route regions where infrastructure is not a constraint and/or potentially scrapped. The Intra-Far East and Intra-Europe trade lanes are dominated by 1,000-1,999 TEU size vessels while Europe-North America and Oceania related trade lanes are dominated by 4,000-5,099 TEU vessels. Asian carriers with the largest capacity exposure to the Intra-Asia and Oceania related trade lanes are SITC (100%), KMTC (71%), Wan Hai (49%), COSCO Shipping (20%), and OOIL (12%).

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