The next stage of “Moral Hazard?”
The amount it costs to ship containers from China to ports around the world has plunged to historic lows. As container carriers are sinking deeper into trouble, whipped by lackluster global demand and rampant oversupply of container ships, they’re escalating a brutal price war with absurd consequences.
Maritime research and advisory firm Drewry (emphasis mine):
Recent news stories, backed up by anecdotal stories told to Drewry, report that carriers have quoted zero dollar freight rates to some forwarders on certain lanes out of Asia. Whether these are merely isolated cases or something more widespread is difficult to judge at the present time, but whatever the exact quantum, there is no denying the container rates are now close to the historic lows as seen in 2009.
The World Container Index, an average of spot freight rates on 11 global East-West routes connecting Asia, Europe, and the US, plunged last week to a record low of $666 per 40-foot equivalent unit container (FEU), down 73% from mid-2012!
The China Containerized Freight Index (CCFI) tells a similar story. It tracks contractual and spot-market rates for shipping containers from major ports in China to 14 regions around the world. On Friday, the index dropped 1.6% to 659.19, its lowest level ever!
It has plunged 39% from February last year and 34% since its inception in 1998 when it was set at 1,000:
Shippers and their customers are rejoicing for the moment. But the collapse in shipping rates – to “zero” in some cases, as Drewry reported – is taking its toll on the industry.
The risk of carrier bankruptcies – with the awkward side effect of stranded cargo – increases, according to Drewry, “the longer rates remain non-remunerative, while carriers will likely intensify practices such as void sailings in order to minimize the chance of that eventuality.”
In 2009, when shipping nearly came to a halt, carriers relied on other people’s money to keep going:
[C]arriers have a history of shaking off the threat of bankruptcy. In 2009 when the situation was even more precarious than it is now, carriers found ways to survive, calling upon shareholders, governments, and new investors for financial support. Terms with banks, shipyards, and charter owners were renegotiated to limit the immediate cash drain and many needed to sell off assets such as ships, terminals, and some non-core units to repair their balance sheets.
But that was the Financial Crisis. It was followed by a V-shaped recovery of shipping volume and freight rates that soon hit new highs. This time, there is no official Financial Crisis. The Fed isn’t engineering any bailouts. The world economy hasn’t come to a standstill, and there won’t be a V-shaped recovery. This will be a long, drawn-out process.
But the first national bailouts are already underway:
While the industry at large has not (yet) reach the same precipice [as in 2009], individual carriers are careering to that point much quicker than others. The most obvious case is South Korean line Hyundai Merchant Marine (HMM).
On 17 March bondholders rejected HMM’s debt rescheduling proposal and as of yet there has been no agreement from shipowners to reduce their charter rates in return for equity. The next day HMM Chairwoman Hyun Jeong-Eun resigned her position and a takeover invitation to Hyundai Motors, run by Chung Mong-Koo, who had previously fought for control of HMM, has been rejected, which suggests that government support might be its only hope.
The Korean government is already setting up a $1.2-billion fund to bail out carriers HMM and Hanjin (one of the ten largest by capacity in the world). State-owned Korea Development Bank will also chip in: it agreed, effective March 29, to give HMM a three-month extension of the principal and interest on its debt.
“The most important thing is each company’s possibility of revival,” Oceans and Fisheries Minister Kim Young-suk explained in an interview with The Korean Economic Daily on March 20.
But both would preferably survive as independent companies, he said. “If the companies get merged, file for court receivership, or are sold to a third party, they will be completely dropped out from their global alliances… it would be a huge loss for the Korean shipping industry if we lose one of them that has maintained its hard-won membership.”
So they will be bailed out. Korean taxpayers and some creditors get to eat the losses. Because in the end, there is no “free” ocean freight. And governments around the world are getting ready to shanghai their taxpayers into bailing out their carriers.
Carriers have idled about 1 million TEU (20-foot equivalent unit containers). But they have also put new ships into service, including the new mega-ships with around 19,000 TEU capacity each. And overall industry capacity continues to rise.
But taking a ship out of service for longer periods and then returning it to service is costly, according to Drewry: “In one example, the total bill for a 10,000 TEU ship in six-month cold lay-up (including shutting down most of the ship’s operating systems, repatriating most of the crew and dry-docking) came to just under $1 million.”
A big bet that higher freight rates down the road will make up for these costs. But given the current status of the industry and the global economy, those bets look risky. So far, all of them have backfired. Which leaves Drewry to conclude:
Offering zero freight rates implies a lack of self-regard for their services and an arrogance that they will be bailed out if the worst was to happen.
And this would be the next stage of “moral hazard” that was created with such fanfare, beginning in the US and then around the world, via the bailouts during the Financial Crisis.
But this wasn’t part of the rosy scenario. Read… World Trade Collapses in Dollars, Languishes in Volume
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“… rates remain non-renumerative, …” Ouch, that hurts. Where the hell are we in this global economy?
Waiting for Godot…
off topic for a second but still revolves around China. i keep reading articles like the following.
http://www.safehaven.com/article/40923/china-boasts-most-billionaires-in-the-world-and-makes-for-a-great-long-term-investment
China is printing money hand over fist so is it any wonder why they are creating more (fake) millionaires than any other country? But why doesn’t
the author (and most never do) comment on that aspect? All these “China is going to rule the world” cheer leaders only seem to look at one side of the balance sheet, and why is that? Talking up their book?
and i personally see just as many problems in China as i see in the west, but then again i’m not that bright.
The US has the ability to impose value on the US dollar world wide through military might. China can also impose its economic ideology through military might. An army that can march thru Asia into Russia and Europe numbering the hundreds of millions has the ability to change whatever it wants. This is the truth that they dare not speak of out loud. It is just easier to keep calling them a great country with a lot of potential.
Yes, maybe, but no. You forgot about nuclear weapons. Feet on the ground has no relevancy anymore. Military might is no longer measured using this metric.
I didn’t forget about nuclear. The reality is if and when we all nuke each other, they have a better chance of survival just playing the numbers. One point two billion of them all over the world… and you can do the rest of the math.
Of course, you guys know what our dear CB/economist cabal is going to say: “Everything is contained.”
“A big bet that higher freight rates down the road will make up for these costs. ”
AHAHAHA, looks like somebody never looked at the Android handset business where a massive price war started in 2013, where 99% of manufacturers are breaking even at best or losing money for years. All of them had the same idea too, price wars for marketshare in hopes that competitor would exit eventually to raise prices…except they vastly underestimated that there will be always somebody else ever more desperate.
You mean they didn’t see Chinese manufacturers such as Huawei and Xiaomi coming on developed markets, and coming aggressively?
In short, if I got this right, European, Japanese, Korean etc smartphone manufacturers expected not only that their price wars would be rapidly won, but that the Chinese, who can undercut any competition thanks to their ability to sell at a loss for long periods, would not jump into the fray?
And, if I got this right again, these firms employ graduates from the best business and economics schools where I think it’s taught that price wars are not only notoriously dangerous, but that may last far longer than one can imagine in low interest rates environments, as companies bleeding money all over the place can continue raise capital by selling bonds at favorable rates to yield-starved investors… until the bottom falls off the market?
What kind of business model is that?
Remember the Wintel PCs days where PC makers are quickly relegated to being profitless slaves who are nothing but a mere conduit to sell Microsoft software and Intel chips?
Android is fundamentally the same business model where the only party left standing is Google, yet all the handset makers still willingly drank the Android Kool-Aid because “it would be different this time!” despite a clear-as-day living example staring them right in the face.
“And governments around the world are getting ready to shanghai their taxpayers into bailing out their carriers.”
That phrase is pure gold. Despite its implications it has put me in a good mood for the day.
By definition this is deflation. The global economy is stuck in a deflationary morass. We are truly in uncharted waters (pun intended) given the scale of the economic predicament we find the whole world in these days. Countries continue to devalue their currencies relative to the dollar in an effort to promote economic activity but it is having the reverse effect. I can see the day very soon where currencies will be worth nothing and it is still too expensive to profitably engage in business activity. Governments can continue to print money to bail out private business but this only forestalls the eventual day of reckoning where inefficient businesses need to be purged from the economic system.
I’d surely like some of that deflation, thank you.
…and our “uncharted” waters may soon become “unchartered” waters.
Market economy with Chinese characteristics: Subsidize a industry and kill off all competition.
Don’t forget that the Korean industries got to be the tigers they were with help from the government. What they’re trying to avoid is that this shakeout gets followed by a shakedown — that if a new world economy makes it worthwhile to export, they won’t be paying other people extortionate prices to get their goods out.
It assumes that Korean shippers are somewhat patriotic, so that they won’t be paying “local” people extortionate prices to get their goods out. We’re so used now to global operators picking their nationality depending on what they’re doing that day. Or vice versa: “Ah, ’tis Saint Paddy’s Day. Sure, me buchail, and let’s do our taxes today! Begorrah. Heh heh heh heh heh.”
I’m starting to think that capitalism, while the best of systems, might have some unperceived structural flaws that, unaddressed, slowly cause an unseen rot at the edges it fails to cover. This has now exacerbated to the point where we get all these mystifying phenomena pop up and experts run hither and thither claiming the future holds hyper-inflation while others cry massive deflation. The experts can’t agree and the problem looms ever larger as everyone desperately tries to pin the blame unable to see the root cause.
And to those who say we don’t have real capitalism, I would say that’s true but it’s damned near enough. The problem is not the amelioration of capitalism’s harsher edges.
If you ask me, the root cause is we are trying make people growing ever-more dependent on each other in our global economy that leads to unnecessary conflicts and asymmetrical control relationships favoring powerful selfish interests when we should be striving for the opposite to make the average individual more self-sufficient and resilient.
The problem with Free Enterprise Capitalism is when debt (bonds) are used to finance the operation. This has to be paid back, eventually. If the industry is financed through equity (stock) then, in theory, it does not have to be paid back, just make enough to pay operating expenses and hopefully a profit to the original investors.
That is why we had all the problems from 1865 to about 1915. As industry became more efficient (for many reasons), prices went down, since that was the point in newer and better systems. BUT, the earlier investors, using bonds, were going under.
The initially solution was “agreements” to fix prices. Didn’t work since everybody cheated. Next solution was consolidation into larger and larger firms, but still prices were bidded down (State Capitalism does not have this problem since there is no competition)
The final solution was “Monopoly” where one company ran it all and the price wars stopped. Standard Oil, US Steel, etc.
These Shipping companies need to combine into ONE company and keep all others out. This can happen with either Fascism where all the countries who need trade agree to allow one “Company” to control it, OR a Single State Corporation, owned by the Countries does the same thing.
If they don’t do this, there will be a lot of pain.
Just some layman’s thoughts here. A few years ago, when iron ore was riding high, there were ships in SE Asia looting sunken WW2 warships for the scrap metal. Today, probably not so much. With scrap metal prices following iron ore into the toilet shipping lines may be constrained in their ability to even scrap old ships and excess capacity. Lenders may be loath to take possession of ships they can’t even sell for scrap too.
Then there is the problem of floating oil storage. As contango decreases there is less and less incentive to keep oil on tankers as the cost of storage exceeds any profit to be made. This is, at some point, going to free up a lot of oil tankers looking for new cargo.
Now you guys figure out that there is structural problem with capitalism, but it doesn’t come from its inefficiency –
If you all had read your Marx and your Das Capital, instead of say, that useless bloviatrix Ayn Rand, you would understand what the Master of the British Central Library figured out all those musty years ago.
He realized Capitalism’s EFFICIENCY was its central fault.
Marx is shouting from his grave right now that, here it is, China is the great Deflationary Monster that will destroy the World, because of its ability to OVER-produce almost every product needed by man right now.
But without a consumer class anywhere to buy the products…. we will get the true definition of Free Trade. The containers will be FREE to stuff full of…. Stuff, but no demand for it.
Marx would have delighted in that end-game conundrum.
More efficiency is always good, however that clearly isn’t in our current “get-a-job to be a consumer to buy mass produced goods” economic model.
BTW while Karl Marx was right about elites oppressing the common man, he was wrong about the means of production. Ideally, it should firmly lie in the hands of the individual, and not to any collective group regardless of composition or class. The latter would just perpetuate the same old destructive cycle again and again.
This was why Morgan worked so hard in creating a US Merchant Marine and the Blue Water US Navy.
The War of 1895 was necessary to create American colonies, which, made it necessary to have a Navy. Why is that good for business? Naval ships needed a lot of Steel and Carnegie Steel produced most of it. Since Morgan was consolidating the Steel Industry (to stop the price wars), he needed a market. What better market than a US Navy.
World War 1 was necessary to use up the excess. Andrew Carnegie wondered how the hell Morgan & Rockefeller where going to make good on the 450 Million, 5%, bonds they “gave” to Carnegie. Easy, A nice big war to sink all those ships and new ones have to be built. World War 2? Rinse and Repeat.
This is why Carnegie took HIS bonds as “GOLD BONDS” where the 5% was paid in GOLD, only. He knew what was coming.
does seem to be a great wall of stuff, and it’s coming out of china, cheaper by the minute, shipped on the cheap.
and, since when do insurance companies load up on luxury hotels? how do you liquidate a luxury hotel to pay a claim?
I’ve said it before and Ill say it again. Nothing is going to put these guys out of business. Their countries of origin will twist arms, go door to door, soak the tax payer, and pressure bankers to give them free money if need be.
The problem here is the management and the general detachment from reality. Our SVP once said that “economics will not play a role in our pricing and we wont allow the business to become commoditized”. At this time the business has been commoditized for 40 plus years so I guess he was living in a time warp. Clearly this gentleman was out of his mind and he still is. Of course he still has a job and perhaps this delusional thinking is the reason these guys are in the straits they are in. We also had a VP whose wife would call if he used his debit card to buy a hamburger since the guy could not manage his own personal finances and therefore was at risk of overdrawing his account with the monumental purchase of a Big Mac Value Meal. Of course everyone knows that top managers who cant manage their own money are the best candidates to manage the companies. Right? If you not smart enough or just flat out greedy enough to watch your own dough then who in creation thinks he will manage someone elses?
So the nuts running the asylum are once again responsible for their own demise. Shippers don’t have the protections and the ability to collude on prices like the liner industry has historically. STILL these liner guys cant make money. However the top management still rapes the sales team and lines their filthy pockets while drumming out the producers.
So the pity party continues for a group of people who are nothing more or less than street level criminals. It couldnt be happening to a more deserving group of people.
Sorry to be harsh but I know of what I speak Wolf. I lived it.
Capitalism in it’s current form at least is based on a false and deadly premise. That we can have infinite growth with finite resources. Of course this is ludicrous but you wouldn’t think so listening to our politicians. They have no other solutions other than growth. More people = more jobs = more growth. Simple. This is how these idiots think. They can’t think another way. The capitalist system doesn’t allow it. It is quite literally the Doomsday machine and has no off switch. Collapse isn’t coming anymore. It’s arrived and we are rapidly heading towards the cliff. We are not smarter than yeast. If we controlled ourselves and our populations we could all be living very comfortable simple lives. Introduce greed (which our system worships) and all that goes out the window.
Japan is a good example where GDP is falling because people are choosing to increase quality of life rather than work themselves to death. The government (still lost in the age of Brylcreem and the Red Menace) is panicking and massively loading up debt to goose the economy but they fail to understand there’s nothing wrong with a minus figure. More strolling and less bar drinking reduces GDP.