Transportation & Logistics Analysis

Our second half container shipping scenarios

July 05 2022

The slowdown in demand is starting to affect freight rates. The shipping companies are still very much in charge but the party lights have started to fade.

The slowdown in economic growth was expected after the exceptional progression seen in 2021. We knew that the catch-up effect, which boosted consumption following the lockdowns caused by the Covid-19 pandemic, could not last. No one could have foreseen the scale of the return to earth which is currently taking place, however. The time seems right to review our three scenarios for 2022 in the light of the new economic and geopolitical parameters which can now be detected.

Growth forecasts in free fall

At the start of the year, the World Bank forecast that growth would be 4.1%, while the IMF and the OECD were even a little more optimistic. The World Bank suggested that growth would be 3.8% in advanced economies but, in early June, these forecasts were revised markedly downwards. Global economic growth is now expected to peak at 2.9% and in advanced economies at 2.6%.

Europe, which has been particularly affected by Russia's invasion of Ukraine, also expects lower growth. The European Commission, which had been expecting GDP to grow by 4% this year, is now predicting 2.7% growth. Production growth, on the other hand, is expected to fall from 2.1% to 0.8%.

Inflation, which was underestimated in 2021, is now taking off. In Europe, the rate of inflation rose from 4.6% year on year in the final quarter of 2021 to 6.1% in the first quarter of 2022. New records are being set by the month in the euro zone. In May, the inflation rate stood at 8.1%, while, in its 2022 spring forecast, the commission indicated that it expected a general inflation rate of 6.8% in 2022, compared to 2.9% last year.

The surge in inflation is having a devastating effect. It is clearly affecting household purchasing power but is also causing an increase in interest rates and debt. Some countries, like Italy and Portugal, are already facing their first major alerts in this area. Action to try to stop the upward trend is now the order of the day. The US Federal Reserve and the European Central Bank have both raised their key interest rates. Difficult times are to be expected, therefore.

The end of an economic model

Until April, the financial markets remained confident. There was a cascading share-out of cost increases and everyone took advantage to increase their profit margins. Consumers, who are at the end of the chain, have finally reached the limits of their capacity to absorb these extra costs. This could have a serious impact on spending habits, which are clearly going to be directed towards new priorities, like daily transport, food and heating for the winter. Those least affected might seize the opportunity to travel again, however, after two years of forced isolation because of the pandemic.  

The situation promises to have serious consequences for China, which is very dependent on its exports even if, in the last two years, it has been making great efforts to develop its domestic market. Chinese producers, who are already faced with the double challenge of the pandemic and disorganised, more costly supply chains, are now having to deal with a reduction in Western orders. China might fail to reach its 2022 growth targets, since the world economic slowdown risks undermining its hopes of a catch-up in the second half, following the effect of the lockdowns in the first half.

Our economic system, which is based almost entirely on the consumption of products, the majority of which are increasingly of Asian origin, was already worn out before the pandemic and the revelations it brought with it. Following the recent end of the first half of 2022, Europe looks to be torn between the temptation to prolong the "old world" system a little longer and the wish to move towards a new economic model. It remains to be seen what will be the new system and what energy sources it will use.

A soft landing still possible

These profound economic changes having an impact on container shipping, which can be seen in the three scenarios we envisaged for 2022.

Scenario 1: the shipping companies continue to lead the dance

This first scenario we put forward in January envisaged a tripling of shipping company revenues in 2022. At the time, it seemed to be the most likely one of the three to be realised, such was the position of strength in which the shipping companies began the year, with long-term contracts offering much higher rates.

In the first half, the shipping companies have largely come up trumps. The slight reduction in FAK spot rates for goods imported from Asia to Europe was very largely covered by the increase in contract rates and the continuing increase in rates on the westbound transatlantic market. The companies should continue to enjoy strong profit levels in the second half and, thanks to exceptional results in the first half, average results should stay well up on the record levels recorded in 2021. Profits in 2022 could be double those of 2021 and we think, therefore, that our number one scenario is still the most likely of the three to be realised.

  • Warning signals

A number of clouds have nevertheless started to appear on the horizon for the shipping companies as the second half gets under way. The purchasing decisions of the major business groups have been affected by the slowdown in demand and the general uncertainty caused by the ongoing pandemic and the deterioration in the geopolitical climate as a result of the war in Ukraine.

Goods are more expensive, not always available, and, most importantly, there is a lack of visibility on transoceanic delivery dates. Since Western distributors have abundant stocks which are costing them more with every month that passes, they are drawing on these stocks before placing new orders. This reticence to place new orders is now palpable, although it is more marked in the Asia-Europe than the Asia-US trades.

This does not mean that import volumes from Asia have begun to collapse but we are not seeing the container tsunami that some pundits predicted would follow the end of the lockdowns in Shanghai.

  • FAK rate menace

The summer will be difficult for the shipping companies if FAK spot rates start, as they already have, to get close to contract rates. Shippers will inevitably ask for a renegotiation their contracts, which the shipping companies will not be happy about, since it would mark the start of a return to the demand-side market control which they want to avoid at all costs.

Whatever market conditions apply, it would be illusory to think that rates for shipping containers from Asia could return to pre-pandemic levels. The shipping companies' operating costs have increased sharply, mainly because of fuel prices, which have quadrupled since the start of the pandemic.

On the other hand, there could also be a sharp increase in demand in the fourth quarter in the event that there is a significant decline in inflation rates in the West, even if this seems highly unlikely.

  • Choices harmful to quality of service

The blank sailings and general disorganisation of so-called regular line services, which proved such a financial success for the shipping companies in 2021, have continued in 2022. They have caused the same pressure on rates, as well as the widespread port congestion which is now recognised as its corollary. 

It is interesting to note that some port terminals are now more congested than they were before the pandemic even though are handling less ships and cargo on a monthly basis. This feels like the final insult for shippers, even if it is the result of the widespread breakdown in the organisation of shipping service schedules.

The shipping companies, which prefer for now to preserve their revenue levels rather than to improve service quality at the expense of cargo volumes, are increasingly coming under fire from the authorities in the United States. They have even been accused of being the sole cause of the wide-ranging difficulties cause by inflation, which is of course very excessive.

Scenario 2: the global supply chain seizes up

This was our catastrophe scenario, according to which too many grains of sand were blocking the workings of the worldwide maritime economies. It has to be said that, with the latest lockdowns in China, we came close to it. The threat has gone away for the moment but the breakdown scenario could still become reality in the second half, taking account of the geopolitical situation and the possible evolution of the pandemic.  

The situation is all the more tense for the fact that the shipping companies are not making any effort to restore the regularity of their services and thus increase regular line capacity. Ships are moving so slowly, services so irregular and commitment to loading dates and transit times so uncertain that the notion of supply chain management has lost all meaning. Shippers are forced to switch from "just in time" to "just in case", which wipes out 30 years of improvement in international logistics.

Transport professional initially got angry over their inability to change the situation. Today, they are in a state of disillusioned resignation. Shippers have lost control but still have to pay more and with no guarantee of obtaining the quality of service they want.

At Upply, we estimate that 20% of additional hold and container capacity would become available immediately on each service and in each port if all services returned to their originally weekly fixed day, fixed time routine. Clearly, it is not in the shipping companies' interest to reactivate this dormant capacity, however, given the immediate deflationary effect if would have on freight rates.

Scenario 3: the smaller operators gain market share

This scenario was based on the hypothesis that the lower ranking members of the big shipping alliances would drop carrier discipline and lower their freight rates. This phenomenon was marginal in the first half, however. For the time being, no operator has dared to take the plunge, given the high level of profitability still generating by the collective pricing policy.

The situation is starting to change, however. If FAK spot rates fail to increase over the summer and reverse the rates trend for goods leaving China for Europe and the United States, that would mean that demand has dropped. This would encourage the smaller companies to try to increase their share of the declining market by reducing rates. The leaders of the different alliances are keeping a close eye on developments, however, and, in practical terms, they are already managing the cargo allocations granted to their minority partners.  

If a leading operator decides to reduce prices with the idea of obtaining a short-term increase in market share, however, we could see a spot price tsunami, followed by a glut of attempts to renegotiate long-term contracts. This extreme hypothesis should not be totally ruled out. China's need to catch up on lost production and exports is a key factor in world trade in 2022. A reduction in freight rates could be an option it could encourage, particularly since it is now clear that, with or without nearshoring, China has become an essential part of global production capacity.

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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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