Key Market Updates For Container Shipping

Quite some time ago, we noted the emergence of a bifurcated container shipping market: One where oversupply of ULCVs, which are confined to the Asia/Euro routes, would keep larger container shipping rates under pressure while the mid to smaller classes would benefit from a shrinking orderbook and a wider variety of trading options.

This proved to be the case for quite some time up till the impact of C19. It was at that point where demand destruction became the overriding market trend taking down all classes in an indiscriminate fashion.

Idle capacity rates are a key gauge for containerships and for a brief period we surpassed those horrific 2016 levels.

Source: Clarksons SIN

But things appear to be rebounding nicely with utilization rising sharply over the past months, bringing with it rising rates.

Source: Clarksons SIN

In fact, the Shanghai to US West Coast freight rate just hit a high not seen in well over a decade.

This is all welcome news, but is this trend sustainable?

For that, let’s turn to a brief update on the supply side followed by key demand side developments.

The ongoing oversupply of large container ships, specifically Ultra Large Container Vessels, which has been responsible for the vast majority of the segment’s woes, is poised to continue through 2022.

Source: Data Courtesy VesselsValue – Chart by Value Investor’s Edge

The pace of deliveries will drop off just a bit compared to recent years, however, the amount of capacity still hitting the water during this already massive supply glut will be an ongoing burden on the market even after deliveries slow.

In most segments and classes, the potential for vessel retirements would be factored into this equation. However, the 15,000+ TEU vessel is a relatively new phenomenon in shipping, which also means there are zero candidates for demolition. In fact, the average age is just 3.75 years, with a life expectancy of around 20-25 years. Not only are there zero candidates now, but it will remain that way well into the future.

But there are two bits of good news:

First, newbuild orders remain subdued which is paving the way for a supply side correction post-2022.

Second, there has been an interesting trade flow development regarding intra-Asian and intra-Europe trade. More on that when we get to the demand side of this report.

Let’s turn back to newbuilds then for a moment before moving on. Just eight orders for ULCVs have been placed so far in 2020. This comes in stark contrast to 25 just last year, 22 in 2018, and 27 in 2017.

While this is welcome news, it is still too early to celebrate. Typically, these large vessels take a minimum of two years to build, which means 2023’s low orderbook isn’t set in stone just yet.

Newbuild orders have been non-existent for the Post-Panamax class since November of 2018. This indicates a preference for New-Panamax tonnage, where modern vessels typically fall in the range of 11,500-15,000 TEUs. However, there has yet to be a single order in 2020 for this class following 20 orders in 2019 and 51 in 2018.

This slowing in orders is most welcome and will play into the ongoing trend of reduced newbuild capacity hitting the water for these two classes combined.

Source: VesselsValue

Unfortunately, like the ULCV class, these are relatively newer vessels and present very few scrapping opportunities. In fact, all potential scrapping candidates are found in the smaller Post-Panamax class.

Source: Data Courtesy VesselsValue – Chart by Value Investor’s Edge

While the lack of scrapping candidates is a bit disappointing, the low 2% approximate gross fleet growth (capacity) for the combined classes in 2020 and 2021 means that even the slightest bit of cargo mile demand growth will keep the market balanced, and achieving five year average cargo mile demand growth will actually tighten the market.

Looking at the next size down, Panamax vessels are likely to continue seeing negative fleet growth as the orderbook is non-existent while demolition opportunities are present.

Source: Data Courtesy of VesselsValue – Chart by Value Investor’s Edge

We find a similar trend extending through the smaller classes all the way to the Feeders, where we see potential retirement candidates matching up favorably with incoming tonnage.

Source: Data Courtesy of VesselsValue – Chart by Value Investor’s Edge

While the supply outlook tends to set the tone for the longer-term market, many are rightfully curious as to the rebound in rates. For that, let’s turn to some key demand side developments.

The recent rate upswing can be partially attributed to an organic demand side recovery, as a sort of backdrop, but it can also be attributed to pushed out demand now being fulfilled and seasonal strength. This would suggest short term caution as the rally in rates unfolds since some factors inspiring this move appear to be temporary.

While demand dropped during the initial months of the global lock down (year-on-year fall of 27% in the second quarter), not all that was destined to be destroyed permanently. Some of this demand was simply pushed out as consumers and businesses were temporarily pent up.

After all, that Q2 demand drop doesn’t correlate with the level of new unemployment, especially when we take into account financial demographics (who was impacted) and correlated consumption (what they spend).

Some recent data shows that July witnessed a massive snap back in port volumes into the West Coast of the US, as businesses responded to this May recovery.

The Port of Oakland saw a 33.4% increase in July, processing 291,082 TEUs, compared with 218,191 a year earlier. Meanwhile, the Port of Long Beach said July was the busiest month in its 109-year history, with 753,081 TEUs, a 21% increase over July 2019.  At the nation’s busiest facility, the Port of Los Angeles, July proved to be the strongest of the year with 856,389 TEUs processed.

Mario Cordero, executive director of the Port of Long Beach, believes that much of this rebound was “surge in cargo that was brought on due to pent-up demand by consumers.”

In addition to this pent-up demand, IHS Markit transportation economist Paul Bingham said many shippers are getting products into the supply chain now in anticipation of the holiday shopping season.

“This is classic peak season behavior,” he said. “Some of the numbers we are seeing are a pent-up demand from the shutdown in the spring and the recovery from the lower numbers earlier in the year.”

While these two factors played a role in the rebound, it’s important to point out another short term influence here that provided stability to the consumers and consequently the market, that of the US stimulus measures to citizens and the unemployed. These unprecedented measures provided significant disposable income to many while offering levels of unemployment income which were well above what many low wage earners with the highest marginal propensity to consume had earned prior to C19.

The waning support for these programs will need to be met with a transitional recovery of sorts if the market is to remain balanced from this perspective. Especially since, as of September 13, support for extending these programs and issuing pandemic related payouts is sharply waning.

Before we move on, a brief note on consumer psychology. I have read accounts, which led me to begin observing firsthand, how a lack of service options has potentially influenced the greater consumption of finished goods. This would play into greater demand for containerized shipping. However, as the service sector recovers, we should begin to see a shift back towards service spending with finished products taking a hit. Think of it again as a push/pull demand scenario. Service demand was pushed back and, in its place, finished product demand was pulled forward. As the economy normalizes this trend will be reversed for a brief period before normalization to pre-C19 consumption is seen.

Turning to another topic we should take note of is the ongoing expansion of ULCVs into various markets.

While the Asia-Europe route had been the focal point regarding these vessel introductions, we are seeing a greater amount of cargo being carried on these vessels for intra-Asia routes.

With Asia leading the way out of the C19 economic funk, we have seen cargo volumes rebound there with a greater portion being carried on ULCV for various routes in the region.

Intra-China trade has been a strong leader in this regard, as ULCV cargo quantity went from 5,773,944 TEU over July 1 to August 31 in 2019 to 7,623,000 TEU in 2020 over that same period – Representing a 32% YoY increase. To add further perspective, those July-August 2020 intra-China cargo numbers represent just over 20% of the total TEUs carried by ULCVs over that time.

Using this same time period, we have seen S. Korea to China cargoes increase by nearly 50% to become the second highest ULCV route in terms of TEUs, while China to S. Korea increased by 35%. Another key route, China to Singapore, grew by nearly 30% as well.

Now, these are all shorter haul routes, but taken together they contributed quite a bit to overall cargo mile demand. In fact, these intra-Asia routes composed roughly 15% of ULCV cargo mile demand in July-August 2020.

Looking at it from a regional standpoint, SE Asian trade alone grew from 3,075,475 TEUs (July-August 2019) to 4,543,847 TEUs (July-August 2020) while increasing cargo mile demand in that region by a whopping 28%. 

This trend in Asia is like what NW Europe experienced just a couple years earlier when trade lanes there filled out with ULCVs between the Netherlands, Germany, the UK, Belgium, and France.

However, this filling out is a temporary market move, though it does provide some permanent relief to the beleaguered ULCV class as these trade lanes are established for larger vessels. But two things this temporary market move has going for it that Europe did not are Asia’s more robust economic growth and a larger population. These factors will likely serve to prolong this move thereby absorbing a greater number of ULCVs.

It is expected this intra-Asia adoption of ULCVs will continue into 2021, just as OCED economies are expected to see the bulk of their progress. This will play a significant factor in balancing the incoming ULCV tonnage going forward.

In conclusion: The short run is still a bit dicey. The combination of a variety of factors paved the way for this latest rebound in rates. However, they could be temporary as waning unemployment support and stimulus measures are met with an end to seasonal strength. Furthermore, as the service sector reopens it is expected that consumers will shift a portion of their income to this sector.

For these reasons I wouldn’t be surprised to see a bit of a peak soon in rates and then possibly a small decline before we really begin to see the onset of an organically backed recovery.

Beyond that, the outlook for mid to smaller container shipping is set to improve in 2021 and 2022. This is not only based on the aforementioned supply outlook, but also a rebound in the global economy as government directed, employment oriented, stimulus measures which will really be felt in 2021.

But the lead here may be the ongoing diversification of routes for the ULCVs. The greater utilization of these vessels for regional trading purposes will help to mop up excess supply more quickly. Furthermore, due to the thin orderbooks for the classes below, the cascading impact won’t be quite as profound, allowing the market to more easily absorb displaced tonnage.

Due to this unfolding dynamic, along with the excellent job of managing available capacity by the three Alliances, my view on ULCVs is turning. This is no small shift, as many might recall that I have been bearish on ULCV fleet development since 2015.

Going forward I anticipate less bifurcation and an increasing bullish outlook – that is if the demand side can hold up its end of the bargain.