Transportation & Logistics Analysis

Demand for container shipping regulation recedes

June 02 2022

The likelihood of the commercial and operational practices of the container shipping companies being subjected to tighter regulatory control is diminishing, at least in Europe. The fall in freight rates has comforted the position of the European Commission, which has never been very keen on regulation.

The sharp rise in freight rates for cargo leaving China, which began in April 2020, brought reactions in the summer of that year and again in 2021. The clients of the shipping companies made it a point of honour to alert their representative bodies and national authorities, directly or indirectly, each in line with its ability to command media attention.

In France, for example, hypermarket magnate Michel-Edouard Leclerc did a great deal to bring the increase in freight rates to public attention. Shippers' professional bodies also protested strongly over the situation. It has to be said, however, that these protests have done little to date to arouse the interest of the different authorities and regulatory bodies.

The protests were at least partly justified. Shippers' organisations rightly traced the link between the explosion in freight rates, future retail price inflation and the chaos in supply chains, which creates long-term tensions for buyers. This argument was relayed, moreover, by UNCTAD and other economic bodies.

It would be a great exaggeration, however, to accuse shipping of being the main cause of current inflationist trends. Thinking in this respect is in the process of changing direction, moreover.

1/ Ideal whipping boy

During the first year of the pandemic, most distributors took the strategic decision not to pass on the increase in their transport costs or, at least, not the bulk of it. Rather, they decided to absorb the increase in the belief that it would be short-lived or because they feared they would lose market share otherwise in a fiercely competitive sector. This affected their operating margins but was covered by the additional consumption generated by the government support measures introduced after the first lockdowns.

The turning point really came in May 2021 and, in the second half of the year, the situation became intenable. Retail prices soared, and energy prices with them. Inflation was generally expected, a little bit as if it was a side-effect of Covid-19 which was ultimately not very serious compared to all the other consequences of the virus on daily life. This change nevertheless took us into a new situation, economically speaking, which has not yet been brought under control.

Today, inflation is virtually out of control, even if France is one of the rare European countries which has at its disposal a dampener on energy prices, which enabled it to keep the official annual inflation rate down to 5.2% at the end of May, compared to a European average of 8.1%. Forecasts for the second quarter offer no improvement. The contrary is true, in fact, since they are now affected by the impact of the conflict between Russia and Ukraine.

The increase in freight rates has certainly made manufactured products more expensive but, in general, the increase has not added more than a few centimes per kilo to retail prices, which represents a fairly modest share of the overall increase. It would be unfair therefore, to blame the increase in freight rates for all the problems currently being experienced. Logistics costs generally, including storage and road transport, have shot up. Price increases are also being caused by major changes in cargo flow management strategy in a high-risk economic environment.

The whole chain is now following the example of the shipping companies and passing on the increases and restoring profit margins. Distributors are doing the same thing. This is an important point since it makes it easier to understand the relative embarrassent of some of those who called for action from regulatory bodies when freight rates began to take off. Some are now enjoying average profit margins higher than they were before the pandemic and, so, are less in a hurry to call for regulation.

2/ EU indulgence

CMA CGM, Maersk, MSC and Hapag Lloyd, which are the non-Asian leaders on the container shipping market which have been making record profits, help to make Europe look strong. As the spearhead of the EU's prestige and pride in a world of increasingly radical change, they are viewed with benevolence by Western governments and the EU institutions. As the advance guard, which kept the economic machine going during the Covid pandemic despite the dramatic living conditions experienced by their crews, the shipping companies have become so strong that they do not need to fear commission interference.

This deliberately caricatural analysis hides the reality of the daily joint decision-making made by the Western shipping companies and their mainly Asian partners. It partly invalidates the argument that the European merchant navy force needs to be defended. But the narrative is a good one, which is well presented, and clearly pleases Brussels, where "sovereignty" has made a noted arrival on the podium of fashionable concepts.

3/ A form of self-regulation

It is a fact that, whereas, last year at the same point, shippers were having to pay the big shipping companies FAK rates ranging from USD15,000 to USD18,000 per 40' container if they were to have any hope of getting it on to the first ship to leave, they are now "only" paying USD10,000-12,000. There has, therefore, been a big fall in rates. The big question now is to know whether the reduction is being totally or partially passed on or whether market operators have preferred to take advantage of the inflationary wave to maintain their first quarter prices as long as possible and keep their margins as high as possible. For the time being, the downstream market seems to have barely registered the fall in spot rates.

The matter will be decided by the level of recovery in China and, above all, in Shanghai. The world's leading container port has started to ease restrictions in preparation for a hoped-for return to normal at the end of May. We believe, however, that this will not lead to a demand in recovery as great as had been announced. European importers will think twice before ordering, given the uncertainty about the solidity of demand. Following "short circuit" logic as a means of avoiding delivery date and timetable problems, they have every interest in using up the stocks they reconstituted at high cost last year when uncertainty was at its high point.

The fall in FAK rates has strengthened the case for avoiding intervention by the regulatory authorities, which see the successive upward and downward movement of freight rates as an indication that the market is self-regulating. The European Commission is not enthusiastic about the idea of putting forward new legislation or modifying existing legislation without have a clear idea of the consequences it will have, as Magda Kopczynska, head of waterborne transport at DG MOVE said recently during a webinar organised by the European Logistics Platform on current shipping supply chain disruption. She nevertheless added that the commission was regularly in contact with the competition authorities in the United States and China and that it was in favour of pursuing dialogue with the concerned parties in Europe.

Its reluctance to intervene is understandable. If the European Commission had implicated itself last year in measures to control freight rates, would those who complained agree today to pay 12 for what is now 10 if the commission had guaranteed a floor rate of 12 for the shipping companies at the time. We have reason to doubt it! In short, there will be no attempt to change the liner block exemption regulation before it reaches its term or to create a European-style Federal Maritime Commission (FMC). On the other hand, the climate question is continuing to take up a lot of discussion space and to monopolise virtually all EU debate about transport.

4/ Warning shots in the US

On the American side, on the contrary, the FMC is showing its teeth. Hapag Lloyd and Wan Hai have been fined for having charged demurrage and detention fees without justification. The commission's power of investigation and sanction have been extended, moreover.

There is, however, a significant amount of message-sending in the apparent firmness shown by the FMC. There has never been any question of taking any fundamental action on market prices since that would be quite simply against the law. The aim is above all to improve application of the Shipping Act so as to protect the interests of American exporters. On this point, moreover, Europe could usefully take inspiration from the example of the United States, unless it wants to continue having to watch its trade deficit with China grow.

The FMC's announcement of its intention to tighten up controls on the rates charged by the shipping companies, on the other hand, can only be doubted…Since security measures were reinforced after the 11 September 2001 terrorist attacks, the American administration has known to the nearest centime the details of cargo operations and the freight rates applied to them thanks to the obligation to file service contracts for all goods entering or leaving the United States. It is difficult to see how the shipping companies could be more open than they already are. The FMC acknowledged that it had not identified any collusion between shipping companies at this stage.The question should therefore be to know whether the FMC had the means to process and exploit this data prior to the start of the Biden presidency. The answer is that it probably did not. In a country the size of the United States, the FMC is still far too small to be able to properly carry out a mission which has become vastly more demanding.

5/ China concentrates on managing the pandemic

At the Chinese Ministry of Commerce, no information has emerged regarding regulation. What is certain is that it has other preoccupations. The central challenge of the moment is managing the Covid-19 pandemic and its effect on production against a worrying background of high inflation and the risk of product shortages.

It is not impossible that the Chinese authorities will take a fairly directive approach on the purely operational front with the aim of boosting activity at port terminals as much as possible. The terminals will need to be at maximum operating capacity, moreover, when cargo starts to flow again as lockdown measures are progressively relaxed.

They will need to make up for lost time if growth targets are to be achieved and, if the shipping companies are slow to get their ships back to normal operating speed in Chinese ports, the authorities may well call them to order…

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Expert in Ocean shipping for 25 years, Jerome puts all his knowledge of the industry to contribution for Upply. Ship captain at heart, he has written the English-French Lexicon of Containerized Shipping (Paris: CELSE, 2001).
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