This week's Insight has come from one of our new colleagues and industry veteran Neil Dekker, formerly of Drewry and the Informa and Safmarine groups, who has covered the liner sector for over 25 years.
The way in which ocean carriers price their services has significantly changed in 2019 because of new IMO low sulphur fuel regulations due to be enforced on 1 January 2020. The companies are now more cost-driven and will focus on yield management in an effort to drive profits – after what will inevitably be a poor 2018 financial performance for the majority.
We feel it is time to focus less on predicting where we see overall freight “rates” going up or down by X% — which in itself is pretty meaningless, as there are so many trade lanes, all with different dynamics — and more on base freight rates and bunkers. Each of these aspects have many different drivers.
Many of the major shipping lines have already passed on additional fuel costs to shippers with effect from 1 January 2019 via a separate surcharge (primarily referred to as a Bunker Adjustment Factor, or BAF). If ocean carriers do not remain profitable, the very real expectation is that ships and services will be idled and suspended respectively, which will massively disrupt the supply chain. The last time this happened, in 2009, the ocean carriers realigned supply and demand, and it became a carriers’ market in 2010 with the idle fleet reaching 9-10%.
There are a number of operational issues to sort out for operators before the IMO low sulphur fuel regulations are effective from January 2020, but the commercial pricing arena is equally confusing at the moment. There should no longer be a debate on whether operators alone should pay for the increased costs, but the mechanisms and methods of charging need to be openly discussed between parties and become much more transparent. Ocean carriers have historically been scant with the facts when introducing different industry surcharges, but if ever there is a time to change this for the better, it is now. Those carriers that are the most open will surely benefit within the shipper community.
While most carriers are already implementing separate bunker surcharge mechanisms from this month (January 2019), there are a number of questions that remain unanswered or at least unclear:
- Currently, there is no recognised industry standard low sulphur fuel price index and there will probably not be a global standard grade, which in any case can be utilised by all market participants by January 2020. Argus and Platts are at least a work in progress to help the industry provide guidance, and some refiners are already giving information at major bunkering ports this month. Carriers will need to be very specific with which data they are basing their price calculations on.
- Fuel prices fluctuate across major bunker ports — so for many trades, which price and at which port will carriers base their calculations on?
- On certain niche trade lanes, carriers may need to deviate ships to bunker at specific ports – how or will these costs be built into freight rates?
- All credit to Hapag-Lloyd for producing a recent document that attempts to give market transparency on methodology. However, the inference is that average or general market data will be utilised (average size ships per trade, average fuel consumption, average fuel prices, etc.). If this is the case, the resultant bunker cost is hardly representative of Hapag-Lloyd’s specific costs, i.e. the bunker consumption of its own fleet. For some carriers this could be advantageous if they do not operate a fuel efficient fleet.
- For ocean carriers only providing slots on a particular route and that are not operating ships within the service — they are not responsible for fuel costs and pay the primary carrier an agreed rate — will they charge shippers an additional BAF on top of the freight rate? And if so, how will this be calculated?
- For operators using low sulphur fuel oil on given vessels on given trade lanes, calculations will surely be based on prevailing market prices. But, for operators opting for scrubber technology and utilising lower priced IFO380 grades, there are CAPEX costs of buying and fitting the scrubbers as well as ongoing maintenance. Unless there is transparency on these costs, the market will have no idea what they are and therefore how they should be fairly priced. These are surely very different to the price differentials between IFO and LSFO, and the pay-back time for the original CAPEX will differ.
- Where operators are chartering-in vessels with scrubber technology, these additional costs will no doubt be built into a higher daily charter rate for the agreed term. Carriers will no doubt seek to pass this on, but will this be built into the base ocean freight rate or a BAF and if so, how?
- For longer-term contracts, will shippers be allowed to bring their own BAF formulae to the negotiating table? Ocean carriers willingly let shippers do this when IFO 380 previously hit USD 600+ per tonne in the recent past and the carriers needed cost recovery.
- Very little if any discussion has been made on pricing within short sea markets such as intra-Europe. In addition, short sea feeder operators have traditionally found it extremely difficult to recover bunker costs from the main line operators when providing critical feeder services. If this practice continues, feeder operators will surely not be able to provide a service.
- After a period of time, will the industry naturally find a standard BAF formula across trades that is accepted by the market or will these remain separately priced by individual operators?
So what now?
The industry needs to find acceptable solutions — to be transparent and to have detailed and meaningful discussions with shippers if indeed they wish to achieve some meaningful cost recovery. Many European freight rate contract negotiations are being concluded about now, and shippers will want security to know how much more they will be required to pay for freight both this year and next. If the estimated USD 20bn in additional container industry costs are indeed to be recovered fairly, the industry owes itself to be transparent about the process.
Those ocean carriers that fail to make sufficient and clear provision via their new surcharges in the spot market or via clauses in mutually agreed longer-term contracts could struggle from late 2019 and into 2020 when fuel bills will significantly rise. We will be watching this trend closely as 2019 progresses, with particular focus on the more immediate negative impacts on short-term liquidity (potentially requiring new agreements with key suppliers) and bottom line profit.