David Grinberg
December 18, 2023
Shipping's Quiet Recession
Pandemic-Induced Supply Chain Vulnerabilities
The COVID-19 Pandemic highlighted many systemic flaws in the global supply chain. Decaying infrastructure, political unrest, and geopolitical heating have created a market dynamic not seen since the 1970s. The combination of record low interest rates in the post-GFC world order, shipyard closures, supply chain backlogs, wartime uncertainty, and lack of operational infrastructure set the stage for the surge in container spot freight rates to 5x their pre-pandemic levels in 2021.
This was a four-standard deviation move above the 20-year average for supply chain pressure. The shipping industry faces incredible uncertainty as the United States commences a series of interest rate hikes in response to the dramatic shift in inflation as the global economy reopened. We now see a strong bullwhip effect playing out in front of our eyes where the combination of interest rate uncertainty, demand uncertainty, and ever-decreasing supply to defend against this demand uncertainty is the modus operandi of the decade.
Trade Policy Evolution and Market Response
As we enter 2024, the shipping industry must play defense and ensure they have the liquidity to weather through paying the 'time premium' of waiting for signs of a significant unified stance in Western trade policy. If we briefly re-examine the period since Trump's election and his initiation of the US-China Trade War up to December of 2018, the Containerized Freight Index (CFI), which trades on a contract for difference (CFD) model, rose from 795 points to a high of 976 points right before the pandemic (a 22% increase in the index in 2 years).
Prices rose as international tensions regarding Trump's tariff policies increased trade uncertainty. The Biden administration and its Western counterparts chose a softer approach where China is now exporting 50% more than it was to its partners during the Trump administration.
Infrastructure Constraints and Regional Dominance
It is crucial to consider the supply-side capacity to facilitate all this trade; with so many moving parts, we prefer to focus on the container shipping industry as maritime shipping facilitates more than 80% of all globally traded goods. Port infrastructure is notoriously underdeveloped globally, troubling all nations regardless of economic status. When considering the distribution of container throughput globally, Asia-Pacific is the dominating player, with about 60% of all handling. Europe, the Middle East, and Africa handle about 25% of all containers, with the United States only processing about 15%.
As a result, Asian countries dominate pricing power and can manipulate their prices due to the inelastic nature of port capacity. Additionally, from 2014-2022, shipyards closed down at a rate of 7%, whereas the average was higher between 2016-2019, with a closure rate of 11-19%. A 2021 survey of more than 600 logistics executives claimed that besides the pandemic, container capacity, shortages, and port infrastructure are the leading contributors to freight rates at a combined percentage of 37%.
Technology and ESG Regulatory Pressures
Storage, labor, equipment shortages, and technology disrupt trade on a routine systemic level. Shipping companies with the most advanced digitization process fully integrated with ports will experience a winner-takes-all effect. The ability to have advanced ship tracking, consumption, bunker costs, and more will create an implicit advantage in digital economies of scale.
To add fuel to the international fire, the industry is facing ESG headwinds. Carbon emissions from these container vessels increased by 4.7% between 2020-2021. Carbon taxes will likely increase, forcing many companies to hold off on ordering new ships as they adjust their strategy to balance these regulations by waiting for new developments in cost-efficient fuel and overall shipping technology. The average ship age is 21.9, with a carrying capacity of 11.5 years.
Market Consolidation and Competitive Dynamics
This puts the shipping giants in a precarious position where they must decide soon or pray that demand returns to at least pre-pandemic levels. Between 1996 and 2022, the top 20 carriers increased their share of container-carrying capacity from 48% to 91%, and over the past five years, we have seen four carriers control more than half the global capacity. Of the top ten largest carriers, two are Danish, three are Japanese, two are Chinese, One German, One is Israeli, and One is American.
A recent tariff by Dutch customs will tax 21% of the value of any good imported from China to the Netherlands. Germany has similar policies, and naturally, there is a unique advantage for the companies that can navigate these restrictions. China is a leading maritime benefactor with no concern for ESG and can squeeze Western shipping companies as a result of the conglomeration of the industry.
Current Market Dynamics and Supply Response
Despite governmental pressures, the shipping industry is uniquely positioned to profit from this sudden shift in international strategy. The continuous consolidation among shipping titans allows for a reduction in competition and more collaboration. Growth in TEU size for new container ships indicates a projected increase in demand for goods, especially from the digital marketplace, while cutting down shipping costs associated with maintaining a large fleet.
S&P Global's Purchasing Managers' Index (PMI) shows that global manufacturing delivery times in May 2023 were their fastest since April 2009. This speed is due to an oversupply of goods caused by the bullwhip effect the market experienced from the pandemic. Production of goods will likely drop in the coming year as market uncertainty regarding inflation causes international cooling.
Sector-Specific Demand Indicators
Chinese exports for lithium carbonate are down more than 50%, a metal crucial for making electric vehicles and other consumer products. The demand for electric cars has dropped, showing a consumer pushback against international ESG policy. We see this slump as a short-term pain to the EV industry as EVs inevitably take a mature position in the car market share. Additionally, the export volume of computer chips is down 22%, again depicting a slump in consumer demand for goods due to economic uncertainty.
We have food supply chain disruptions from the war in Ukraine, causing most commerce to shift to the slower form of land-based importation. All these factors imply that shipping is experiencing the brunt of its pain today for a better future tomorrow. Shippers pay a time premium for waiting when the market is unclear, and money is not moving. The companies with the best balance sheets to weather the storm will succeed and have more market share.
Strategic Positioning for Recovery
The shipping industry benefits from a robust payoff structure where if the economy runs into stagflation, investment into consumer staples and defensive consumable goods will increase, thereby increasing shipping volumes. If interest rates suddenly drop, demand for other luxury and technology goods increases. Any form of inflation also benefits the shipping industry as they can pass on costs to the consumer. Energy prices are a neutral factor in shipping because the cost is passed on to the buyer of goods.
Due to geopolitical uncertainty, contract cargo models will profit more consistently than spot-rate shipping models. The diversity of cargo across different regions will allow these companies to avoid pricing pressures, which affect more concentrated business models such as the spot business in the transpacific Asian-US market. Despite the oversupply, many Asian and European shippers are running close to total capacity, indicating a high demand at lower costs on the pendulum. As of today, we know the shipping industry continues to suffer in its recession, and we are also positioning ourselves for the inevitable recovery.
