Beware 'Nasty Side Effects' If Government Targets Ocean Carriers

As skyrocketing rates squeeze importers and exporters scramble for containers, the push for government intervention is accelerating.

What if the U.S. government does move to rein in foreign carriers? What if carrier alliances are broken up, detention and demurrage charges are curtailed, export service is mandatory and — most hypothetically — spot rates are capped?

To answer these questions, American Shipper spoke with Lars Jensen of Denmark-based Vespucci Maritime. The consultant and former Maersk executive is considered one of the leading authorities on container shipping. The following is an edited version of the interview:

Skyrocketing rates, profiteering accusations

AMERICAN SHIPPER: In commodity shipping — tankers and bulkers — the rate is the rate. If shippers think the rate is too high, they don't charter the ship. If the tanker market spot rate is $300,000 a day, and a refiner can't make its margin paying that freight, there's no talk of price gouging. When enough shippers refuse to take tankers, rates fall back. In contrast, in container shipping, there's all this talk about the "fair price" and "profiteering."

JENSEN: "I completely agree with you there. It's just that a lot of the people in container shipping have never been used to this kind of volatility before. And for some, this quite literally means they have a business model that is no longer viable and that scares the living Jesus out of them."

AMERICAN SHIPPER: But is container shipping really the same as commodity shipping? If container freight demand exceeds effective capacity, as it does now, will rates just keep going up until enough shippers have their margins erased and the box ships can't fill their slots? Or is there more of a focus on customer relations in container shipping, where at some point, liner operators will say: "These crazy rates are too high for our customers?"

JENSEN: "If carriers were concerned about customer relations, you would have seen rates stop going up a long time ago. There is not enough capacity and there's no way in the short term to bring more capacity to the table. It's as simple as that. So, the only way you can balance this equation is by reducing demand. That's why prices keep going up."

AMERICAN SHIPPER: The shipping community is being very vocal about these extremely high freight rates.

JENSEN: "It's important to keep in mind that there is an enormous price differential now. The normal price differential between what you pay on contracts if you're a very large importer and what you pay on spot if you're a very small importer is in the hundreds of dollars [per forty-foot equivalent unit or FEU]. We're now at the point where if you compare the tip of the spot market to large contracts, this difference is more than $10,000. So clearly, shippers out there do not have aligned interests.

"If you're a very large importer that is still able to move a substantial part of your cargo on contract — and some of them definitely still have the ability to do that — you now have a massive competitive advantage compared to your smaller competitors that have to ship on spot. If I were a large importer, I would not be complaining about this situation. Sure, I would be somewhat frustrated that I have to pay three or four times more than I did last year, but my competitors are paying 10 times more. If I were a large importer, I would look at this as a strategic opportunity. I would eat that loss myself and not increase my retail prices, because I can afford to absorb this and my competitors cannot. I would basically drive my competitors out of business.

"I think the shippers that are really complaining loudly and emotionally, and I can understand why, are the ones that are more exposed to the spot market, because for some of them, this is life-threatening to their business.

"We had been in an environment for the past 20 years in which freight, at least over a long period of time, was noncompensatory from the container-shipping industry's perspective. Now, if your business model had relied on freight being de facto subsidized, it is not going to survive. Products that are too expensive to nearshore because production costs would skyrocket and that are also too expensive to ship are just going to fade from the market."

AMERICAN SHIPPER: There has also been a lot of criticism of liners not honoring the minimum quantity commitments in their contracts. The first complaint has just been filed with the Federal Maritime Commission.

JENSEN: "These contracts have always been unenforceable. There's absolutely nothing new about this. It's just that the shippers are at the opposite end of it now."

Alliances and consolidation

AMERICAN SHIPPER: Criticism of ocean carriers is gaining a lot of political traction in the U.S. Let's go through some "what-ifs," starting with carrier alliances. What if, at some point in the future when demand eventually drops, carriers again use blank (canceled) sailings to support rates, like they did to great effect during the Q2 2020 lockdowns, and some government authority, whether in the U.S., EU or China, breaks up the alliances?

JENSEN: "We have definitely seen the effects of consolidation. At least on the main trades, there is a de facto oligopoly, which means the carriers are able to somewhat better prevent the price wars we've seen in the past. And they were more actively blanking more sailings even before the pandemic. You saw it in January 2020, when demand growth was quite weak and carriers were able to successfully pass through the cost of low-sulfur fuel, demonstrating that they had much more market power than they had before. This is the logical end point of 20 years of gradual consolidation.

"If you start to toy with the idea of abandoning alliances, the argumentation on the shipper side would be that you'll have more competition because you'll have more individual players. The counterpoint — to which I definitely subscribe — is that if you sit down and actually do the math, you'll find that if you abandon the notion of the alliances tomorrow, this will also be to the detriment of the shippers.

"Alliances are there to give carriers flexibility. If I have 10 weekly services, I can change capacity in increments of 10%. If I have one, I'm pretty much stuck. If each carrier had to do its own network, they would have many fewer weekly services because the number of ships wouldn't change and the size of the ships wouldn't change.

"If you abandoned alliances, virtually every shipping line [in the Asia-Europe trade] would say, ‘OK, I will definitely have a service that goes Shanghai-Hong Kong-Singapore-Rotterdam.' But maybe only one or two would say, ‘I'll do a service from Qingdao.' That means a shipper who wanted to ship from Qingdao might suddenly have only one or two carriers to choose from instead of three alliances. If you look at it at the port-to-port level, you would very quickly run into a situation where most shippers would see less choice, not more.

"If you wanted to go down the path of ‘carriers should operate independently,' that decision should have been made 20 years ago, because the ships would likely not have grown above 12,000-14,000 TEUs [twenty-foot equivalent units]. The reality is that we now have over 100 ultra-large container ships in service and they are not going away. And carrier scale economics is about two factors: the size of the ship and also the number of weekly services and the number of permutations you can get in your network. If you disallow alliances, that will be to the detriment of all."

AMERICAN SHIPPER: But wouldn't you agree that as a result of this massive spike in rates and carrier profits, and the new political climate toward carriers, the future risk to alliances is greater than it was before the pandemic?

JENSEN: "Absolutely. On a rational basis, nothing in the argumentation has changed compared to two years ago. The mechanics and the mathematics are exactly the same. But politically, of course it's going to be somewhat of an uphill discussion if an industry that has suddenly made tens of billions of dollars of profits has to defend the position of ‘we need protection from competition law.' That is going to be a more difficult argument going forward."

Detention and demurrage abuse accusations

AMERICAN SHIPPER: Let's look at the next what-if? There is a major focus in the U.S. on detention and demurrage charges paid by shippers. These charges are designed to incentivize the return of equipment to carriers in a timely fashion, but critics argue that the system is being abused. What if the U.S. significantly restricts global carriers' ability to charge detention and demurrage?

JENSEN: "You could certainly see political intervention on detention and demurrage, not necessarily because it's a good idea, but because it's one of the few things that can be done, because it happens in the U.S. and it's under U.S. regulation.

"And I can certainly understand shipper frustration on detention and demurrage because there are delays in the system that are no fault of the shipper. But in some cases, they are also no fault of the carrier either. There are an enormous number of stakeholders involved and when something goes wrong they all tend to point at each other.

"From a carrier perspective, I would say, ‘If my equipment is tied up a lot longer than normal, that costs me money, and if I'm not allowed to charge detention and demurrage in the same way as before, there are two different ways I can address this.'

"I can say: ‘Industry practice for the last 60 years has been that when you book the freight you have free usage of the container within a given number of free days and if you keep it for more than that you have to pay [detention and demurrage charges]. If I'm no longer allowed to do that anymore, all well and fine. I will then set up something more to the tune of: I give you a freight rate but that only covers moving on a ship. Then you have to pay a daily rate for the usage of the container right from the time you pick it up all the way until I get it back.' So, it's not detention and demurrage anymore. Now shippers pay a daily fee for the usage of my container.

"If I am restricted from charging detention and demurrage and that happens overnight, then as a carrier, I would simply say: ‘OK, that's fine. I will only accept cargo CY-CY [container yard to container yard]. After that, you are going to have to come down, pick up your container at the port, strip it within a mile of the port and give me my container back.'"

Export service requirement?

AMERICAN SHIPPER: That doesn't sound like something shippers would want. The next scenario involves U.S. exports. There has been a lot of criticism of carriers sending containers back to Asia empty and leaving U.S. exporters short of the boxes they need. What would happen if carriers were mandated to ship U.S. exports?

"For the last 20 years, there has been a big trade imbalance and a lot more imports to the U.S. than exports. Since carriers have to return the containers anyway, they were willing to provide a low price to exporters. Exporters built their business models around the fact that freight was not free, but somewhere close to that, and that is what has worked fine for decades.

"It depends on what index you trust, but I ran a few numbers and if a carrier has a slot that goes round trip [on the trans-Pacific], only about 5-7% of revenue is paid by U.S. exporters, so there is a clear incentive to not tie up equipment for the exporter when the carrier can make much more money on the import side.

"If I, as a carrier, were now told that I have to provide the exporter with freight, I'd say: ‘That's fine. That will just be reflected in the freight rate.' And you would see export freight rates skyrocket.

"If, as a carrier, I am now forced to absolutely make sure I can take the cargo for the exporter, then export pricing would have to be much closer to what the importer is paying. The exporters would need to pay their fair share, which goes back to this whole discussion of fairness. The importers would be happy because their price would go down a bit, and the exporters would be out of business because there's no way they could export products profitably that way."

AMERICAN SHIPPER: Jacking up rates so high that American businesses can't export via container inevitably leads to the idea of price controls and government caps on freight pricing. This is the most hypothetical and most unlikely of the scenarios, but what if the U.S. government capped freight rates of foreign carriers serving the country's imports and exports?

"If you went down that path, you would find it extremely ineffective. Let's say for the sake of argument — and I know this is completely unrealistic — that the U.S. government won't allow you to charge more than $5,000 [per FEU] from China to the U.S.

"As a carrier, I would say: ‘OK, that means I'm not going to sell any freight to the U.S. importer. I'm only to give quotes to exporters over in China, because there's no cap in China and the U.S. cannot legislate what China does.' It's as simple as that."

AMERICAN SHIPPER: And carriers could use the same strategy to avert a cap on U.S. export rates, by only selling freight to importers outside the U.S. So overall, what you're saying is that all of these proposals on the U.S. reining in foreign ocean carriers would have unintended consequences.

"What I'm saying is be careful what you wish for. Because you might get what you want — but it will have very nasty side effects."

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