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Plunging spot rates drag down container shipping contract rates

Shipping lines are still posting billion-dollar quarters despite a precipitous plunge in spot rates, courtesy of high-priced annual contracts signed by cargo shippers at the peak of the boom.

But the reprieve is only temporary. Record rates on existing annual deals are being renegotiated lower mid-contract. Many shippers are not delivering previously agreed-upon contract volumes. And the next round of annual contract negotiations is looming, promising a huge step down in rates and volumes for 2023.

To get the latest on the deteriorating market, American Shipper spoke with Patrik Berglund, CEO of Xeneta, a Norway-based company that tracks both short- and long-term container shipping rates.

This question-and-answer interview was edited for clarity and length.

When will spot rates hit bottom?

AMERICAN SHIPPER: Spot rates continue to sink. The mantra has been that carriers will “blank” (cancel) sailings to bring capacity in line with demand and stop the spot-rate bleeding, just as they did in the second quarter of 2020 amid COVID lockdowns. But isn’t it a different situation now? In Q2 2020, there was an incredible sense of urgency. There was an “end of the world” feeling at that time. Plus, carriers are now historically flush with cash. They face none of the bankruptcy risk they did two years ago. Do you believe carrier capacity management will play out the same way?

BERGLUND: “I think it was obvious in 2020 what carriers had to do in order to survive. It must be obvious now what they have to do to replicate that. It is almost irrational to not believe they will be able to jack up the market again. I believe they will remove more capacity, for sure.

“Nobody anticipated the drop in short-term rates to come this quickly and this heavily. I have never seen a rate reduction of this magnitude in the 15 years I’ve been in the industry. I think we’re going to see the end of the drop in the short-term market in the next couple of months. Then there’s going to be an upward moving spot market as new long-term contracts are negotiated in the first and second quarters.

“Otherwise, the carriers have played this market really badly and they’ll be in a position where they’ll really have to do something drastic.”

Demand falling or just brought forward?

AMERICAN SHIPPER: On the demand side, there’s a question about what’s causing the much-lower container volumes. One theory is that it’s economic weakness and inflation. Another is that demand just got displaced. Importers brought foward Christmas cargoes and also faced a “bullwhip” inventory effect as warehouses filled up too quickly. In the latter case, it’s a timing issue, not a loss of demand. Any indications on which theory is correct?

BERGLUND: “We run monthly polls with our customers, who have tens of billions of dollars of procurement spend. We asked them last week how they thought ocean volumes in 2023 would compare to 2022, and hardly anyone expected an increase in volume. Thirty-nine percent said they expected volumes to decrease by 10% or more.

“So, not only will carriers have to adjust to the current reductions in volume, they will face significant volume reductions in the coming quarters as well. That means it’s going to be hard for them to hit that equilibrium between supply and demand in 2023.”

AMERICAN SHIPPER: You’re saying that it’s not an import timing issue. It’s an economic weakness issue?

BERGLUND: “Yeah, that’s what we’re saying.”

Carriers lower annual rates mid-contract

AMERICAN SHIPPER: Turning to the annual contracts, carriers like Maersk and Hapag-Lloyd have claimed that contract rates are holding but volumes are down, whereas Zim (NYSE: ZIM) acknowledged that it is renegotiating rates lower mid-contract to preserve volume. What are you seeing in your data and what are your customers saying?

BERGLUND: “We are definitely seeing rate reductions. Quite a few BCOs [beneficial cargo owners] have already received significant drops in their long-term contract rates.

Xeneta CEO Patrik Berglund (Photo: Xeneta)

“We hear everything from carriers proactively going to shippers and proposing they should renegotiate — before the shipper even asks — to shippers saying that carriers didn’t respond the first time or the second time, but the third time they came asking for a rate reduction, carriers were willing to listen.

“There’s a clear sentiment among our customers that it’s possible to achieve rate reductions in existing long-term contracts. They’ve also told carriers: ‘We’re not going to be able to deliver the volume commitment on our contracts.’ That’s a frequent message.

“In our data, if you look at the trans-Pacific westbound [Asia-West Coast], the average spot rate has dropped 80% from a peak of $9,681 [per forty-foot equivalent unit] — not including premiums that were up to $10,000 per FEU — to $1,912 today. That’s the average rate. The lower end of the spot market is at $866 per FEU.

“The average long-term rate is at $6,413. But the low end of long-term rates is at $2,415, almost half of the peak of around $4,000.

“The spread between the low end of the long-term market and the average of the long-term market has just exploded. This means that quite a few BCOs have already obtained significant drops in their long-term contract rates. But the data also shows that there are BCOs still paying very elevated contract levels.”

AMERICAN SHIPPER: In other words, the increasing gap between the average contract rate and the low end of contract rates points to renegotiations mid-contract. The fact that the low end of contract rates is getting close to average spot rates shows how some shippers have been able to alleviate the pain. And the fact that the average contract rate is still more than three times the average spot rate points to shippers that are still on the losing end.

Shippers ‘stick it to the carriers’

AMERICAN SHIPPER: This must be really painful for the procurement people who signed those original contracts. When we talked back in January about the massive increases in 2022 annual contract rates, you said procurement people could end up “looking like fools” if spot rates plunged. That is exactly what happened.

BERGLUND: “This has created a lot of friction on the BCO side because the news is filled with all these stories about rates plummeting while a lot of them are still paying elevated long-term contract rates. Also, BCOs still have fresh wounds from the challenges over the last few years. They still have vivid memories of what they went through.

“There is a lot of internal pressure on any procurement person when spot rates collapse 80% and your contract rates are still high. It is very, very hard to accept paying a premium in this kind of falling market. It does not make for a good relationship with the carrier. The carriers have an incentive to help that procurement person who faces internal pressure and needs to deliver savings. It boils down to individual emotions about whether your job is safe. 

“Some of the shippers have been waiting to stick it to the carriers and now they have a golden opportunity. They are not only looking for significant reductions [in existing contracts], they are switching more volumes into the spot market with other carriers in parallel, and they are also simultaneously running new RFQs [request for quotations for new long-term contracts even before existing contracts expire]. They’re looking to get as much of a reduction as they can as quickly as they can.”

‘Lack of trust between buyers and sellers’

AMERICAN SHIPPER: Shippers have filed complaints alleging that during the boom, carriers did not honor their Minimum Quantity Commitments (MQCs), bumping the contract cargo and instead filling their slots with higher-paying spot cargo. If shippers don’t honor their own MQCs in the current year, wouldn’t carriers have the same complaint?

BERGLUND: “It’s not enforceable. And if the carriers tried to force customers [to honor MQCs] and penalize them, it’s hard for carriers to treat their customers that way after all they’ve gone through in 2021 and parts of 2022.

“There has been a lack of trust between buyers and sellers in this industry for decades. This is something that’s systemically wrong with our industry and I don’t see it changing in the next several quarters.

“Year after year, there are episodes where each side treats the other badly. This goes both ways. In 2021, one of our big automotive customers renewed one of its contracts with one of the biggest shipping lines. It did a full RFQ and just two weeks after allocating and signing the full volume, the carrier came back and said, ‘We will not move your boxes at the rates we agreed to two weeks ago.’ This went all the way up to the C-suite level. The BCO threatened a lawsuit. The carrier said ‘feel free’ and stopped moving the BCO’s boxes the day after that meeting. What happened was the BCO accepted all the additional surcharges from that carrier because shutting down the plants was way more expensive than agreeing to the rate increases.”

AMERICAN SHIPPER: But there are so few carriers left due to consolidation. The top 10 carriers now control 85% of global capacity. If I renege on an apartment lease in New York City, my leasing company will never rent me an apartment ever again. Isn’t there a concern among shippers that demand will ramp up down the road, or there will be another supply chain disruption, and the bridge will be burned when they need that carrier again?

BERGLUND: “It’s true that the market has fundamentally changed in terms of the number of suppliers to choose from. But the people will be different. People move on to new jobs. It happens all the time. There will be different people at carrier A and BCO B. And the conditions will be different. So, they will decide to do business again because they need each other.”

Lower rates, volumes for next contract round

AMERICAN SHIPPER: We’ve been talking about renegotiating and breaking existing contracts, but there’s a whole new round of annual contract negotiations coming up, with Asia-Europe contracts mainly renewing on Jan. 1 and Asia-U.S. contracts mainly renewing on May 1. Not only are existing contracts resetting lower and some MQCs not being honored, but this upcoming round of new contracts will reset lower. That sounds like a big negative for carriers’ average annual freight rates in 2023.

BERGLUND: “First, keep in mind that there are companies tendering throughout the year. It’s not just the traditional January and May cycles. There are companies that tender off-cycle, so we have new data coming in on a weekly basis.

“We’re seeing rates come down and we can already see long-term contracts being signed for next year at less than half the volume that was agreed to in the middle of this year, so there are definitely reductions in both rates and volume.

“Whether it’s a 50% rate reduction or even more that’s needed for carriers to get large volumes from BCOs, it really depends on what the short-term rate market does over the next few months. I think shippers are going to see substantial cost reductions on their long-term contracts compared to 2022 and also somewhat compared to 2021, but I believe rates are still going to be up in 2023 from 2019 and 2020 contract levels.”

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