London, U.K. – Despite ongoing freight rate erosion, carriers are yet to announce any service suspensions for the slack season. Might this jeopardize any annual contract gains?
Drewry recently conducted a webinar that provided an overview of our outlook for the container market.
One of the cornerstones of our assessment that carriers will improve profitability next year in spite of a heavy burden of new ships is that we expected them to demonstrate the same level of capacity management skills as they have in the recent past.
However, even at this very early stage we are starting to be concerned that we might have given them too much credit. The reason for this hesitancy is that lines have for some unapparent reason suddenly eschewed some of their normal modus operandi. In particular, there has been a complete lack of service suspension announcements for the traditional shipping slack season in the fourth and first quarters.
That would be understandable if demand and freight rates were strong, but that isn’t the case now as spot prices on the East-West trading routes have been on a downwards spiral for a number of months. This situation is most significant in the Asia-Europe corridor where annual contract negotiations are already underway. Every weekly deflation to spot rates further weakens carriers’ negotiating position.
The curious fact is that rates are not falling due to any weakening to the supply-demand balance. As Figure 1 demonstrates, on the key westbound Asia to North Europe route, ship utilization has trended upwards since October last year. In contrast, spot rates, as recorded by Drewry’s World Container Index, have gone in the opposite direction. With that in mind, the chart above heavily implies that there is some element of undercutting occurring in the market. It could be that the strong fundamentals are what have made carriers more resistant to withdrawing services. They might be thinking: with ships close to full, where’s the need to stop services now?
If that is the thought process, that would miss the point: They have increased their exposure to the risk of locking into much lower prices for next year than they might have got had they temporarily removed some capacity.
Aside from the current malaise in spot rates, Asia-Europe carriers couldn’t pick a worse time to begin annual contract negotiations. It is an unfortunate legacy of history that the majority of long-term deals are struck in the trade’s second-weakest quarter, heading into the weakest. Figure 2 shows the seasonality of westbound trade since the start of this century.
In the past, carriers have bolstered their negotiating hand during the seasonal demand slide by pulling services. Until this winter, only once in the past nine years has capacity on the westbound Asia-North Europe trade not been trimmed in the final quarter of the year. However, for this year Drewry is currently forecasting that the number of available slots will rise by about 1% from 1 October 2017 to 1 January 2018.
Another key component in carriers’ tool-kit to manage capacity is the use of void sailings, but once again they have used this tactic relatively sparingly of late. There were a number of void sailings around China’s Golden Week holiday earlier this month, but prior to that they have hardly been a feature since the new alliance structure kicked off in April. Whether the two are connected we cannot say with any degree of certainty, but it does appear from the outside that lines have preferred to win customer loyalty to their alliance through consistent and reliable services, at the expense of adjusting capacity to support flagging rates. If so, that could be a decision that comes back to haunt them when the ink is dry on the 2018 contracts.