Global downturn leave costly empty vessels

The global shipping industry is associated with huge internal economies of scale and where demand is closely tied to the fortunes of industries such as iron ore, oil and coal but also to the world economic cycle. Things are looking grim for shipping operators who have bet hundreds of millions of dollars on expanding a fleet for which there is now substantially less demand.

Stacking

Containerisation is an idea which developed from an idea developed by the US entrepreneur Malcolm McLean. Stackable steel boxes have been at the heart of the phenomenal growth of world trade and the process of globalisation. But as the world economy weakens, the global shipping industry is facing a deep-rooted problem of excess capacity. In the airline industry, there are air fields where unused planes go to rot. Now there are hundreds of huge ships anchored around the world moth-balled and waiting for economic conditions to improve.

This industry is a good example of what can happen when there is a lengthy time lag between changing demand for container vessels, their construction and the new capacity coming on stream. Huge investments in new ships which looked a sure fire bet just a couple of years ago are now albatrosses around the necks of some shipping giants.

Falling demand

Container trade between Asia and Europe is shrinking for the first time in history according to some estimates. Fleet capacity is forecast to expand rapidly by more than 10 per cent per year from 2008 – 2012 – the result of a huge rise in capital investment in new container ships

But annual container growth has collapsed due to the global economic downturn in general and the steep slowdown in Chinese manufactured exports in particular. The Financial Times reported this week that Singapore, the world’s biggest container port, suffered last month its first fall in throughput traffic since 2001 due to a slowdown in global exports.

The early signs came from a sharp reduction in shipping costs for dry carriers shipping iron ore and coal around the world. We can see this graphically using the latest data from the Baltic Exchange Dry Freight Index. After years of continuous expansion, China’s imports of iron ore have fallen by more than 20 per cent this year.

Fixed costs and profits

Now the container shipping industry is witnessing a meltdown in the charges for moving a standard 40 foot container – the price has fallen by more than 90 per cent. This has had a drastic effect on the profitability of the container shipping industry – many operators are now cutting services, merging operations, encouraging pilots to slowdown to save fuel.

Giant container ships appeared highly attractive in an era of rapid globalisation when world trade expanded year-on-year at a fast pace. Many of the operating costs of the shipping industry are fixed – container ships operate to fixed timetables in a similar fashion to airlines. So when they are full, the average fixed cost of transporting products around the world falls, improving the profit margins of container operators.

Conversely in a falling market, not only is there excess capacity which drives fright prices lower, but the average fixed cost of each container carried rises. Suddenly the economics of smaller dry bulk and container ships looks more attractive. When demand is weak, it is much harder to reap the cost advantages of economies of scale.

The outlook for the international shipping fright industry will not be helped by the recent decision by OPEC to cut crude oil production by more than two million barrels per day.

What price the scrap value of some of the gleaming new vessels that have only just been launched into the industry?

Suggestions for further reading

BBC news: Stormy waters for moving freight

Financial Times: Dead wait