Backed by popular demand?

Why is it that analysts fail to grasp cause-and-effect relationships? Here’s a review we just read:

“Maritime transport is the backbone of international trade and an important enabler of economic globalization. If not for the significant gains in technical and organizational efficiencies achieved in shipping and international logistics, we would not be seeing the rapid expansion of international outsourcing and global production networks.

[Correction: If not for the demand on the part of employed consumers who have buying power, there would have been no “significant gains in technical and organizational efficiencies achieved in shipping and international logistics”, and consequently no “rapid expansion of international outsourcing and global production networks.”]

“According to figures published by the United Nations Conference on Trade and Development (Unctad), more than 80 per cent of the global merchandise trade by volume is currently carried by sea. The volume of world seaborne trade doubled from four billion tonnes in 1990 to eight billion tonnes in 2007, rising at an annual average rate of 3.9 per cent.

“Containerized freight accounted for 1.24 billion tonnes in 2007. Of the different modes of sea carriage, it has seen the highest rate of growth, of about 9.8 per cent in terms of TEUs (twenty-foot equivalent units) since 1990, largely through capturing the market share of break-bulk and bulk trades.

“While we see strong growth rates in the volume of cargo carried by ships, these do not bear a direct relationship with the commercial fortunes of the shipping business, which have been characterized by extreme volatility and unpredictability. This has to do with the unique and complex economics of the shipping industry.

[Correction: “… extreme volatility and unpredictability …” and “… the unique and complex economics of the shipping industry …” are the effects of either an increase in demand by employed consumers or a decrease in demand by unemployed consumers.]

“The demand for container shipping services is derived from the demand for imported goods and materials … [True enough.] … thus, changes in demand fundamentally influence the fortunes of shipping, but shipping itself cannot control the demand … [True]

“The supply side of shipping services, made up of the capacity of ships operated by the carriers, is no less problematic. While trade drives the demand for shipping services, the ability of ship operators to adjust their supply quickly in response to a change in demand is limited. There are long lead-times associated with adding and removing capacity.

[Correction: Trade doesn’t drive demand. Demand drives trade.]

“For example, if demand is growing at a time when capacity utilization is high, freight rates will climb and ship operators will start placing orders for new ships. However, it may be 3-5 years before the ships are delivered. By that time, the demand may have fallen and the freight rates will be further depressed when the new capacity enters the market. Shipowners can scrap their older ships, but the capacity reduction usually is not in line with the drop in demand. Laying up some ships may become a final option.

“An additional problem faced by container carriers is the directional imbalances on its major trade routes. This leads to asymmetric freight rates on services on the forward and return journeys on a route. In cases of severe imbalances, carriers may even have to charge higher rates to customers on the high-demand sector to cover at least part of the costs of the return trip, including that of repositioning empty containers.

“An extreme case of a mismatch between supply and demand in container shipping has been unfolding during the past few months. The global financial crisis in mid-2008 caused a sharp drop in imports at a time when new capacity was pouring in rapidly, prompting freight rates to spiral downwards.

[Correction: “The global financial crisis” began more than three years ago. Government economists recently admitted that the financial crisis officially became a recession back in December 2007.]

“The situation came to a head earlier this year when it was reported that some carriers were charging ‘zero freight rates’ in the Asia-Europe container trades in a desperate attempt to improve the utilization of their assets. The rationale is that if the ship is in service but is under-utilized, it is better to accept any cargo and at least cover the variable costs involved in the carriage.

“The total freight charge is composed of a base freight rate plus various surcharges. By zero freight rates, what is meant is that the shipper (exporter) pays only the surcharges which include the bunker adjustment factor (BAF), the currency adjustment factor (CAF), and the terminal handling charges (THC). In specific circumstances, carriers may impose other surcharges such as port service charges and insurance surcharges.

“The zero base rate, for the Asia to Europe trade, translated to a reportedly all-inclusive spot box rate of as low as US $ 200 per TEU in January 2009. Data from Unctad show that just 15 months before, this very sector was boasting one of the highest yields globally, exceeding US $ 2,000 per TEU.

“Apart from the variable costs, the carrier also incurs massive fixed costs such as the capital cost of the ship, repairs and maintenance, stores and consumables, crew costs, shore-based administrative costs and insurance. By charging zero base freight rates, these costs are effectively not being recouped by the carrier. Over the medium to long term, shipping companies can only survive if their total freight charges can at least cover their full average unit costs, including both variable and fixed costs. Zero freight pricing is not only unsustainable for the particular carrier. It also contributes to the further instability of the entire market. Fortunately, as noted in industry reports, the practice was applicable to a very small segment of cargo on the trade – less than 5 per cent.

“In more recent weeks, many carriers have decided to suspend some services and lay up more tonnage to cut their losses. According to AXS-Alphaliner records, the idle containership fleet surged to 453 ships for 1.35 million TEUs (10.7 per cent of the cellular fleet) in the first week of March. More and more carriers have also made announcements on rate increases on the Asia to Europe route.

“Some carriers have looked to other strategies to reduce costs on the Asia-Europe services. For example, the Journal of Commerce recently reported that Mediterranean Shipping Company (MSC) and CMA-CGM have joined Maersk in routing their ships around the Cape of Good Hope to avoid paying Suez canal tolls. The savings from not having to pay the canal tolls and higher insurance charges from moving the ship through the Gulf of Aden apparently exceed quite significantly the additional bunker and other costs incurred in the longer journey, at a slower ship speed of 20 knots.

[It wasn’t very long ago that we were being told that a higher ship speed was one of the distinct advantages mega-ships had over smaller vessels. It was one of the ways to guarantee “Economies-of-scale”, according to the bigger-is-better advocates. Remember that con job?]
“In the next few months, it is expected that more services on other routes will be suspended and additional ships laid up, as new capacity continues to come on-stream. According to data from AXS-Alphaliner, global capacity is forecast to increase from 13 million TEUs in December 2008 to 14 million TEUs in August 2009.

“A combination of service withdrawals and capacity reductions, coupled with the application of reasonable freight rates, may well bring the market back to equilibrium possibly by the end of the year or early next year. By then, hopefully, global demand will start to pick up and the industry can be gradually steered out of choppy waters.”

[This is the rationale that is difficult to grasp. It would have made much more sense if the writer had written: “A combination of service withdrawals and capacity reductions, coupled with the application of reasonable freight rates, may well bring the market … to its knees … possibly by the end of the year or early next year …”

Wouldn’t an eventual termination of operations be the logical consequence of “service withdrawals and capacity reductions”?

And instead of ending with the wistful, “By then, hopefully, global demand will pick up …”, the writer should have said, “By then … miraculously … global demand will start to pick up …”

Because only a miracle will prevent a worldwide economic disaster. We referred to such a miracle earlier this week in Article 32, and unless the authorities get behind our efforts to revitalize U.S. shipyards and create jobs for fifty or sixty million Americans, there will be no “global demand”. The government’s obsession with Wall Street, housing and credit problems is a waste of time and money.

Our biggest problem is that there are too many of “the best and the brightest” calling the shots being heard around the world.]