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Bracing for changing seas
Ports and container ship operators turned the page on a challenging 2019 in which they persevered through a weakening global economy, slackening demand, shifting trade flows, and trade and tariff battles between the U.S. and China. They also weathered the resulting wait-and-see attitude toward capital investment among the world's industrial and manufacturing companies. The one bright spot was the U.S. consumer whose strong consumption continued to buoy an otherwise tepid economy.
Going into the new year, maritime players will be dealing with many of these same macroeconomic and shipping-specific business challenges. In addition, the industry faces perhaps its biggest challenge in decades: IMO 2020, the International Maritime Organization's (IMO) global regulation to limit sulfur emissions from ocean-going ships, which will take effect January 1. This effort to "green" the ocean shipping supply chain is expected to have significant health and environmental benefits, but it also will incur significant costs for ocean carriers. Meanwhile in spite of the economic tailwinds bedeviling the rest of the industry, ports in the United States are continuing to expand at an astounding rate in an effort to attract and retain customers. Savvy shippers will keep a close eye on all of these trends and assess what impact they may have on their supply chain costs, capacity, and strategy.
The cost of going green
Under the new IMO 2020 mandate, ships are required to use fuel with a sulfur content of 0.5 percent or less, down from 3.5 percent—or else equip vessels with exhaust-gas cleaning systems or "scrubbers" to meet lower sulfur oxide emission requirements. It's a sweeping mandate that affects all ship line operators and the approximately 60,000 vessels that ply the world's oceans moving some 90 percent of global trade.
Container ship operators have three viable options for meeting the mandate:
- Switch vessel operations to more expensive, compliant fuels with ultra-low sulfur content.
- Continue using higher sulfur-content fuel but install scrubbers on existing ships to reduce emissions to compliant levels.
- Invest in new ships powered exclusively with liquified natural gas (LNG).
Ship lines have spent most of the last year getting ready. Soren Skou, chief executive of A.P. Møller-Mærsk (Maersk), said during a recent quarterly earnings call that the container shipping company is well prepared for IMO 2020. The Danish business conglomerate—which operates 725 vessels worldwide serving 343 ports in 121 countries—started the fuel switchoverin December. It has lined up agreements with low-sulfur fuel suppliers globally and will "mainly comply by using low-sulfur fuel in our vessels and scrubbers [on] a little more than 10% of our fleet," Skou said.
Similarly, Hamburg, Germany-based Hapag-Lloyd, which operates some 230 vessels worldwide, is putting the majority of its eggs in the low-sulfur fuel basket to achieve compliance, according to Pyers Tucker, the ship line's senior director of corporate development. In addition, Hapag-Lloyd is in the process of converting a 15,000-TEU vessel to LNG propulsion. If successful, that could pave the way for conversions of an additional 16 "LNG-ready" vessels in its fleet, Tucker said. Furthermore, Tucker noted that by the end of 2020 around 15% of the company's fleet will be equipped with scrubbers.
But these changes won't come cheap and could end up impacting the bottom line of every supply chain. That's because containership operators can't absorb all of the increased cost from the changeover to more expensive ultra-low sulfur fuels and the installation of scrubber technology. Two of the world's biggest containership operators have already sounded the alarm. Both Maersk and Mediterranean Shipping Company (MSC) have stated that costs for compliance and changes to their fuel supplies due to IMO 2020 will likely exceed $2 billion annually.
"We cannot pay this [increased cost] ourselves," Skou said.
As a result, operators are putting in place fuel-surcharge mechanisms for both short contracts, (or spot rates), and long-term contracts. These fees are designed to help recover the majority of the extra expense. Skou noted that Maersk has met "good understanding" from its customers on the issue and that the company is continuing to "work on getting our overall fuel consumption as low as possible, which is beneficial both for our costs, our customers, and not the least the environment."
Tucker from Hapag-Lloyd—which has instituted a "marine fuel recovery" mechanism to recoup the additional cost—agreed that customers are for the most part onboard with the effort. "While of course nobody is happy with increased prices, all understand and accept that this is a good thing for our planet," he said.
Indeed, it's estimated that 3.9 million barrels of fuel are burned per day by ocean-going vessels. A Goldman-Sachs estimate pegs consumption of standard bunker fuel as generating some 90 percent of sulfur emissions in the world. The IMO projects that the changeover to low-sulfur fuels and scrubbers will reduce sulfur oxide emissions from ships globally by 77 percent from 2020-2025, reducing acid rain and avoiding some 570,000 premature deaths worldwide from conditions such as strokes, asthma, cardiovascular disease, lung cancer, and pulmonary diseases.
But those environmental and health improvements will come with a price. Once fuel surcharges are imposed and the added costs of compliance ripple through global supply chains, the impact in higher shipping costs could be as much as $40 billion, according to investment firm Goldman Sachs.
Indeed, Gartner analysts David Gonzalez and John Johnson say supply chain leaders will have to be on top of their game to minimize ocean freight cost increases. In the recent report "New Fuel Regulations for Ocean Carriers Raise Price, Capacity Issues for Shippers," they estimate carrier costs could increase between 40% and 60% to accommodate the new fuel.
Efforts to reduce sulfur emissions from ocean vessels may also have implications for overall available capacity, service strings, transit times, and port calls, say some industry watchers. The Gartner report notes that capacity could tighten as vessels will be out of commission while they are being retrofitted with scrubbers. The analyst group estimates that the scrubber installation itself could sideline a vessel for six weeks, while the entire process—including product selection, design, engineering, and procurement—could take 12 months. The Gartner report estimates that more than 2,000 vessels already have had scrubbers installed, costing millions of dollars. It goes on to estimate than an additional 4,000 vessels will need to be outfitted with scrubbers in 2020. "The likelihood of temporarily removing 5 to 6%of the world's 60,000 ocean [vessels] could impact capacity and drive up costs," the report says.
Given market conditions and existing capacity, however, it's unclear exactly how big that impact will be. Maritime operators already face a low-growth global economy and slack demand. In this environment of flat to declining volumes, carriers are dialing back new ship orders and aggressively cutting costs to maintain profits. That's evidenced by Maersk's 2019 third-quarter results, where earnings before interest, taxes, depreciation, and amortization (EBITDA) in its ocean segment rose 13 percent, to $1.3 billion, while revenues were "on par" with the same period a year ago.
On top of that, the market is currently in a period of "severe overcapacity," according to Lars Jensen, chief executive ofSeaIntelligence Consulting of Copenhagen, Denmark. "Right now, the order book [number of new ships on order] is historically low, at about 11 percent of capacity, down from 60 percent," he said. The 10 largest carriers, Jensen noted, "basically have no order book of consequence," a market situation which he called "unprecedented."
Only one carrier, Korea-based Hyundai Merchant Marine (HMM), is expanding notably, according to Jensen. HMM has a number of vessels in the 20,000 to 22,000 TEU (twenty-foot equivalent unit) range on order. "Before they ordered, fleet capacity was about 450,000 TEU. Now they're gunning to reach a million TEU," Jensen said. But Jensen is skeptical about the move. "If you can get the money [to build the ships], you can grow your capacity, but that does not mean you can generate the cargo to fill those ships," he said.
For vessel operators, who were accustomed to a market that for decades grew at some 9% annually, the slowdown in structural growth—now projected in the 2 to 3% range—has dictated a sea change in strategy. Instead of pursuing volume at any cost to fill ships, "carriers have had to change their mentality [to one of] increasing the profit of the containers they actually move," Jensen noted.
The slowdown in growth of global container volumes hasn't, however, dampened the enthusiasm of U.S. port operators for expansion. They continue to invest in infrastructure improvements in an effort to drive efficiencies and increase throughput—and become the port of choice for shippers. Some are seeing substantial growth even as the global economy cools.
"Volume has reached record levels at the Port of Oakland in each of the past two years," said the port's Maritime Director John Driscoll. "Through October, [the port] was ahead again of last year's record pace. Loaded container volumes continue strong."
While uncertainty over global trade policy overshadows the containerized trade sector heading into the new year, Oakland is pushing ahead with improvements and expansions. Its International Container Terminal, operated by SSA, will install three 300-foot-tall cranes in the third and fourth quarters of 2020. The investment: more than $30 million. The first building in Oakland's Seaport Logistics Complex, a 460,000-square-foot distribution center, opens this summer. It's the centerpiece of a major logistics infrastructure redevelopment project at the former 200-acre Oakland Army Base. The investment: more than $50 million.
The port will also kick off another major round of operational enhancements in 2020, including grade improvements and road and rail track relocations to avoid congestion. Additionally, Oakland will be implementing its Freight Intelligent Transportation System, a collection of 15 technology projects designed to improve cargo visibility, send drivers on the quickest routes, and speed truck traffic through the port.
Like Oakland, the South Carolina Ports Authority (SCPA)—which operates oceanside and inland ports in Charleston, Dillon, and Greer—also saw growth this year. As of November 2019, volume had increased by 7% year over year, and 855,959 containers had moved through its Wando Welch and North Charleston container terminals in Charleston since July. Charleston also saw a 36% increase in automobiles processed through its Columbus Street Terminal, with 79,238 vehicles moved thus far in its fiscal year 2020.
On the East Coast, port growth and expansion are being driven partially by shifting trade flows (as more cargoes transit the expanded Panama Canal and call on Gulf and East Coast ports) and by the need to service bigger ships.
These trends fueled SCPA's ongoing expansion and upgrade efforts, which include: retrofitting and upgrading the Wando Welch terminal; building out the first phase of the new Leatherman terminal in Charleston; opening a second inland port in Dillon, South Carolina; and starting the Charleston Harbor deepening project.
"The name of the game in the port industry is to prepare for the big containerships," said Jim Newsome, SCPA's executive director. "We're locked and loaded as far as our cap-ex plan is going." By the end of 2021, SCPA will be able to handle four 14,000-TEU containerships at one time, Newsome said.
A few hundred miles up the coast from Newsome's South Carolina port complex, the Port of Virginia continues its own preparations to be able to accommodate bigger container ships. It has accelerated its efforts to become the deepest port on the U.S. East Coast, and started the first phase of a commercial channel dredging project to deepen the port to 56 feet.
Launched in December 2019, some two-and-a-half years ahead of schedule, the project "tells the ocean carriers we are ready for your big ships," said John F. Reinhart, CEO and executive director of the Virginia Port Authority. When complete in 2024, the $350 million project will enable the port, unrestricted by tide or channel width, to simultaneously accommodate two ultra-large container vessels, which "is a significant competitive advantage for Virginia," the port said.
Some, however, wonder if IMO 2020 could lead shippers to reexamine their shift toward East Coast ports. Mario Cordero, executive director of the Port of Long Beach in California, thinks the mandate may have a silver lining for West Coast ports. He said he's curious to see whether or not the higher cost of fuel will lead some shippers to see the West Coast "in a more favorable light," as fuel surcharges will be significantly more for longer routes transiting the Panama Canal to Gulf and East Coast ports.
In 2019, Long Beach did see a drop off in U.S.-Asia trade volumes due to a lukewarm global economy and the U.S.-China tariff. Yet the port still projects 2019 to be the second-best year in its history, says Cordero.
As a result, the port is going full speed ahead on a series of multibillion-dollar infrastructure improvement and expansion projects. Among those is the $1.5 billion replacement of the original 50-year-old Gerald Desmond Bridge with a new, larger span. The bridge, which connects the port to downtown Long Beach and surrounding communities, is a key artery for freight flowing out of the port. "Fifteen percent of the nation's container cargo goes over that bridge," Cordero says. The bridge will open to traffic in the spring of 2020.
The port also is proceeding with the third and final phase of its Middle Harbor project to upgrade and connect two older container terminals. Currently 211 acres of this $1.4-billion state-of-the-art marine terminal is in operation. When fully completed in early 2021, it will have the capacity to move from 3.3 million to 3.5 million containers which, Cordero says, would rank it as the sixth largest marine terminal in the U.S.
The continuation of expansion efforts across the country, shows ports taking the long-term view when it comes to investment. "We can't worry about trade wars, that's beyond our control," says SCPA's Newsome. "We have to focus on infrastructure and having it ready on time, so the ship lines see us as reliable."
With container ships bracing for the impact of IMO 2020 and U.S. ports investing heavily in expansions and upgrades, ocean shipping is guaranteed to experience some sea changes this upcoming year. Shippers would be wise to take note. With rising fuel costs and new port facilities coming online, a company's optimal trade route in 2020 might be different than it was in 2019. It might be a good time for supply chain executives to reassess shipping strategies and supply chain network design.
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