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Trouble on the High Seas

Budgets are breaking and shipments are delayed as demand for ocean container transport from Asia outstrips supply.
Vincent Ryan, CFO.com | US
April 21, 2010

The rise in manufacturer and retail inventories marking the end of the great "destocking" has been good news for the U.S. economy as a whole, but it's causing problems for companies transporting goods by ship from overseas, particularly from Asia.

Heavier demand for space on container ships has pushed spot rates up by sixfold to as much as $2,000 per 40-foot equivalent unit in a year's time, and some companies are seeing their goods languish on docks due to the shortage in container supply.

"If you ship 100,000 boxes a year, the [price] spike is huge," says David Barnes of Clarkson Securities Ltd., a brokering firm for shippers. "But even in terms of long-term budgeting, a movement of $200 is quite considerable and can have a great effect on margins." Clarkson is developing a derivatives product so that companies can hedge their exposure to volatile container freight rates.

A year ago, demand in the ocean container freight industry dropped by 15%, causing carriers to lose as much as $20 billion in 2009. But while it may be impossible to turn an ocean liner around quickly, the same doesn't hold true for the cost of transporting goods on that liner.

Carriers wised up in a hurry and attacked their problem head on. First they started to consolidate schedules and lay up ships to remove capacity from the market. Then a group of large carriers implemented "emergency recovery surcharges" from $400 to $1,000 to recoup the losses sustained last year. And carriers got a boost in mid-February as U.S. and European companies began replenishing severely depleted inventories, leading to a surge in demand.

The confluence of events has put container freight carriers in the catbird seat in their yearly contract negotiations with shippers. "Carriers are implementing general rate increases and keeping the emergency surcharge in place, and they have not yet put any capacity back into play," says Valerie Bonebrake, senior vice president of global supply-chain services at Tompkins Associates. It takes about 60 days to bring a ship out of drydock and back into service, she says. While carriers may start bringing mothballed ships back into service slowly, it will be highly dependent on the rate increases they get in contracts.

Adding to the uncertainty for CFOs and their logistics departments is the practice of "rollovers" — cargo being bumped to a later sailing due to constrained capacity. U.S. shippers are claiming that as much as 30% of their volume is being rolled. "Ocean container companies will prioritize loading of a vessel based on revenue per container," says Bonebrake. "If you have patted yourself on the back because your purchasing agent negotiated really low rates, your products could get rolled over and delayed."

Carriers are also doing a lot of "slow steaming" — reducing vessel speeds to save fuel, extending the time goods spend in transit, says Jimmy Crabbe, vice president of ocean freight services at UPS.

Crabbe says there are several things companies can do to counter the cost and logistics challenges. The first is to become a more attractive customer to the carriers. That means planning shipments better and not overbooking containers due to fears of supply shortages. Companies can also spread the risk, contracting with multiple carriers in case one is running tight on space. Eliminating emergency shipments and seasonality also smoothes relationships with carriers.

Crabbe says the industry could go as far as to force shippers and carriers to cooperate better by making carriers guarantee space under threat of penalty and fining shippers if they overbook container space.

But for now, companies just have to bear the higher pricing. "As you're doing your budgeting, be realistic," counsels Bonebrake. "You need to go back to the rates two years ago [not 2009] to set realistic expectations."

 




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