The carrier industry is now entering a period of managed decline; capacity management will be key to deciding how much of the super-cycle gains the carriers hold on to, says Drewry in its latest Container Forecaster report. Carriers didn’t really have to do too much to fall into the profit bonanza of the past two years. The upsurge in demand combined with chronic supply chain congestion guaranteed their windfalls – since 2Q20 the industry-wide EBIT profit is running at over $400 billion through 2Q22.
However, now that the market is in a tailspin with high-inflation sapping consumers’ spending power and spot rates in a seven-month funk, liner bosses are going to have to work much harder to keep the profits flowing. In the latest Container Forecaster, Drewry asks the question: do carriers have the tools to mitigate the upcoming supply and demand shocks?
Now entering a period of managed decline, what they do next will go a long way in determining how much of the gains of the super-cycle they get to keep. Failure here will mean that the industry will be doomed to return to the low-margin pre- pandemic trend. A golden opportunity to reset expectations will be lost, possibly forever. Lines face an enormous challenge taming the one thing they have control over – supply. The problem is – there is a lot of it and they are being attacked on multiple fronts.
Firstly, there is the latent capacity that has been “lost” due to supply chain/port congestion that is returning to the market as the bottlenecks ease, a process that might well be expedited by an ailing demand curve. As congestion fades, capacity will increase inversely and for 2023 we see bottlenecks on their own only stripping around 7% of effective capacity from the market.
Secondly, ship owners (independent and operators) have spent a lot of their profits on new container ships. Some 2.6 million teu of newbuild capacity is expected to arrive next year, before any adjustment for delays to delivery (slippage) or cancellations. The task in front of carriers has been made even harder due to a weaker outlook for port handling. Drewry has lowered its demand outlook for 2022 to 1.5%, and to 1.9% for 2023 on the back of heavily downgraded GDP predictions.It is the speed with which the market has turned that has led us to believe that carriers will fight back with more proactive capacity adjustments than previously envisioned.
In our analysis we argue that following consolidation and alliance restructuring carriers are better placed now to tackle the “danger” years than ever before, and that they will pull the right capacity levers to ensure a soft landing for the market. The fact that carriers have not halted the precipitous decline in the spot market (that has run for 31 weeks at the time of writing), might suggest otherwise, but it must be remembered that rates are still very profitable, even at their recently diminished values.
Carriers will have accepted that prices and profits were unstainable and a correction was inevitable at some point. In our view, the group-think has been to milk those profits for as long as possible, but start cutting back when rates sink close to a level that would be acceptable in the long run. Recent news of more East-West service suspensions, including a 2M Transpacific loop, indicates that time is now.
In our view, carriers will not sit idly by as spot rates tumble. To maintain profitable business they will look to offload as many older, more polluting ships from the market as quickly as they can. Our base forecast includes provision for a near-record level of demolitions in 2023. This capacity reducing lever will be pulled along with others, namely pushing back deliveries of newbuilds and greater idling, effectively calling on shipbuilders and independent owners to share some of the supply burden.
Assuming carriers do exactly as we expect, those combined actions will still be insufficient to fully bridge the supply- demand gap next year, with an estimated net increase in effective capacity of 11.3%, way above the projected demand growth of 1.9%. Adding in missed sailings will, however, get them closer and should be enough to keep freight rates and profits above 2019 levels.
By over-ordering in the boom years, carriers have set themselves an enormous challenge to shuffle and make capacity magically disappear. If they succeed next year they will need to rinse and repeat for 2024.