Trade & Supply Chain

Sailing into uncertainty

Published: Sep 2023

The container shipping industry, responsible for transporting 90% of traded goods globally, posted record-breaking profits during the pandemic but shipping groups face more challenging years ahead. From rolling out new strategies away from pure container plays to deciding when to invest in green ships or anticipating the impact of geopolitics on trade flows, treasury teams have much to navigate.

Lighthouse surrounded by rough sea, big waves crashing

Michael Kastl, Managing Director, Treasury, Finance and Investor Relations at Hapag-Lloyd joined the container shipping giant in 1996 but in all his 25-years in the industry, he’s never seen today’s abundance of cash.

Prior to the pandemic, Hapag-Lloyd had a typical liquidity reserve of US$1-2bn, topped up when needed with fresh funds drawn from financing assets or raising money in the capital markets.

After the pandemic – and before the company paid bumper dividends of US$12bn earlier this year – treasury had around US$20bn sitting on the balance sheet. Such largesse has turned Kastl from liability manager to asset manager, switching his treasury focus to areas like counterparty risk and the best places to assign liquidity.

That means low risk MMFs, investing in overnight repo transactions and a new allocation to a special investment fund outsourced to external asset managers that doesn’t sit on the group’s balance sheet as cash or cash equivalent, he tells Treasury Today in an interview from the group’s Hamburg headquarters.

“With interest rates at current levels, if you have US$9bn sitting on your balance sheet you can earn a lot of interest,”he says. “We currently have a net cash position of US$3.9bn, something I’ve never seen before.”

Elsewhere Hapag-Lloyd has invested in new terminals in North and South America and India via an acquisition of SM SAAM’s terminal business and related logistics services, and a 40% participation in Indian terminal operator J M Baxi Ports & Logistics, respectively. The company is also pouring money into the energy transition. It’s begun taking delivery of 12 new dual-fuel vessels, using long-term green financing and paying the equity portion off in cash, and is spending money on refitting ships to increase carbon efficiencies.

The pandemic transformed the container shipping industry, showering the sector with unprecedented riches that operators like Hapag-Lloyd are unlikely to ever see again. Lockdown-fuelled demand for goods sourced from China and Asia coupled with a reduction in supply chain capacity and labour shortages, turned container shipping (never much of a money spinner) into one of the pandemic’s biggest winners. Not every company publishes its financials, but Simon Heaney, Senior Manager at shipping consultancy Drewry Maritime Research estimates between 2020 and 2022 the industry made a collective profit of US$500bn. “This equates to as much profit in a two-to-three-year window as the industry has made in its entire history previously,” he says.

Kastl isn’t the only treasurer for whom the amount of cash washing around has led to a different kind of approach. As well as buying new ships and doling out dividends, many groups used their liquidity to pay down debt, repair their balance sheets, boost creditworthiness and deleverage. Danish giant Maersk has invested in broader transport activities, buying airfreight and logistics infrastructure to become an overall logistics provider and French competitor CMA CGM has bought a stake in Air France-KLM as part of an air cargo partnership.

But today the industry is coming down from its pandemic-induced sugar rush. The latest earnings reveal margins are shrinking with analysts predicting companies will lose money in the coming years as global demand for container goods falls. It’s a tougher trading backdrop for companies also facing strategic challenges like moving away from a pure container play, judging when to invest in green ships or how shifting trade patterns might impact on their business.

New ships

A bulging order book for new vessels commissioned during the pandemic and up for delivery in the coming years, is set to create overcapacity and push freight rates lower. Drewry estimate 890 new ships coming into the market, equivalent to 28% of current global capacity, and deliveries this year alone are expected to add 1.75 million TEUs (20-foot equivalent unit) or about 6.6% of the total fleet. Rodolphe Saade, Chairman and Chief Executive Officer of France’s CMA CGM Group recently warned that market conditions are set to deteriorate with new vessel capacity “likely to weigh on freight rates.”

Freight rates will also come under pressure because of state-owned actors in Asia like China’s giant COSCO Shipping wanting to keep freight and supply chain costs low to support exports and aid the recovery. “Sometimes, state-owned industries are the most aggressive when it comes to pricing and bringing the prices down because they want to support their exports,” explains John McCown, a New York based shipping expert.

But shipping groups have strategies to support their businesses if freight rates sink lower without eating too much into cash reserves. They can reduce capacity by stepping up the pace of getting rid of their old ships, suggests Heaney. “The container industry has been good at ordering more efficient, and greener ships, but it has not been so good at clearing out the old clunkers.”

In another approach, operators can slow down crossings so that ships consume less fuel and save money. This approach also includes running additional ships, explains Peter Sand, Chief Analyst at Xeneta, the ocean freight rate benchmarking and market intelligence platform. “During times of overcapacity, operators can extend transit times and add another ship into circulation to prevent rates and earnings from falling.”

Another way of reducing cost is to go round the Cape rather than through the Panama Canal, he continues. “You may burn more fuel going round the Cape, but you will save money by not going through the Suez. We are seeing a number of providers seeking to save the US$700,000 fee for a one-way ticket through Suez.”

At Hapag-Lloyd, strategies to deal with capacity increases can now include better access to terminals thanks to its recent acquisitions. Shipping groups often run ships at speed to secure access to terminal slots – only once a ship has arrived at a terminal does it have a commitment to berth. Owning terminals helps solve the problem, allowing the company to run ships slower and better manage the imbalance between supply and demand, explains Kastl.

In another strategy, industry experts say freight rates might find support if the sector transports more goods that used to travel in bulk carriers or specialised ships, like refrigerated vessels. Although grain is still moved in bulk carriers, commodities like bagged flour and coffee can go in a container, offering new business opportunities to container groups, says McCown. Container ships also have an advantage over bulk and specialised carriers because they are less likely to travel back empty since their customers are scattered around the world. “Container ships operate at 75% of their total loads and this is an inherent advantage over cargo,” he says. “I think we will continue to see the transition from other types of ships to container ships.” But it’s not an argument that holds much water with Kastl. He believes containerisation has reached its height apart from headroom in some markets like India. “The market has already shifted a great deal here.”

Timing the transition

Timing the transition is perhaps one of the biggest risks for container shipping groups ahead. Some of the new ships coming off production lines are dual-fuel, able to run off conventional bunker fuel, a diesel bi-product, LNG and methanol. However, in a sign that operators are also waiting for more progress in renewable fuels before they sink billions into their next generation of vessels, not all the new vessels are green. “The whole maritime sector is heading towards decarbonisation, but not all these new orders are green,” says Sand.

Operators are delaying decision making because of unknowns around which fuel will lead the transition, its availability and price developments. Hapag-Lloyd will use LNG as well as biofuels until the market in green fuels becomes easier to read. Although green hydrogen and ammonia has potential, the legislation around ammonia is unclear, and Kastl is convinced bio and e-methane will most likely become a key driver of the transition. “This is the way to net zero,” he says. Only now access to biofuels remains complicated by its scarcity, particularly as other sectors like trucking and airlines jostle for share of the renewables market.

Analysts warn that new green ships starting to come online are relatively small, and say methanol-powered ships are still expensive to build and operate. “Methanol is four to eight times as expensive as traditional fuel,” says Sand. “Being a first mover in the shipping industry is rarely rewarded.” McCown suggests that investing in green ships too soon could put western groups (facing more pressure to decarbonise from stakeholders and regulators) at a disadvantage to Asian competitors who will catch up once clean fuels are more readily available and today’s pricing dynamics have played out. “Operators don’t want to pick the wrong team when they are investing for the next 20 years,” he says. But as legislation tightens and consumer and stakeholder pressure grows on the highly polluting industry that emits almost 3% of global greenhouse gases, choosing not to invest in green ships could be even more risky. New ships running on fossil fuels with a commercial life of 20-30 years could quickly become stranded assets when the regulatory noose tightens.

For example, the industry regulator the International Maritime Organization has set new emission reduction targets, although they still need to be enshrined into individual country policy. Elsewhere, under the EU’s emissions trading framework, shipping groups will have to buy respective emission allowances for each tonne of carbon emitted in European waters from next year. “We are reflecting this into our price calculations and how to pass onto our customers,” says Kastl.

Add to this shipping companies meeting their own targets. Hapag-Lloyd targets net zero by 2045 supported by strategies like integrating KPIs around emissions into a 2021 sustainability linked loan.

Perhaps most pressure on shipping groups to invest in green ships will come from their corporate customers, given these emissions count in their Scope 3. Companies including IKEA, Amazon and Patagonia have signed a 2040 ambition statement for zero emission ocean shipping through a collaborative platform, Cargo Owners for Zero Emission Vessels. Today, the transport of IKEA products from suppliers to warehouses and stores around the world accounts for approximately 5% of the company’s total carbon footprint. “There is a lot of money at risk and a genuine fear amongst ship owners with older ships that they won’t transition in time and will have stranded assets if regulation prohibits them from manoeuvring,” warns Sand.

Hapag-Lloyd has launched a green shipping product that offers its customers the ability to ship their goods on a carbon neutral basis, explains Kastl. “Biofuels are available in limited quantities at the moment, but we are very active on purchasing them to be able to offer our customers less carbon emitting transportation.”

Like the energy transition, shifting geopolitics also hold opportunity and risk. Shipping routes between Asia and North America and Europe represent around 50% of global shipping lanes but new China +1 strategies characterised around friend-shoring as MNCs diversify their supply chains suggest changes ahead. Research from Xeneta finds that 56% of all containerised goods imported by the US from the Far East in 2022 came from China, down 10% from 2017. The biggest winner of this shift is Vietnam, which has seen its market share almost double, from 6% in 2017 to 11% in 2022.

Emerging manufacturing countries still lack port infrastructure compared to China which boasts four of the five biggest container ports in the world. But as manufacturing operations take off in countries like Vietnam and India, it will create more opportunities for shipping groups around intermediary trading. “If a company sources from China to consumption centres in the west, that is just one shipping voyage,” explains Heaney. “The number of journeys will increase because manufacturers in, say, Vietnam or Thailand, will source goods from China, and then ship their final products to Europe. There will be more shipping because of diversification,” he predicts.

Moreover, a shorter journey from “friendly” new manufacturing centres in countries like Mexico to consumers in North America, doesn’t necessarily mean a dramatic fall in shipping costs, says McCown. “The cost will remain high because less goods are being shipped and they won’t use the same big ships. Even though it is one third of the distance it doesn’t mean it is one third of the cost.”

Kastl concludes by reflecting on his treasury priorities ahead in the notoriously cyclical business. Since 2020, when the new IMO regulation said that ships could only use low sulphur fuels, the company adjusted its pricing mechanism in its contracts from bunker adjustment clauses to a more holistic marine fuel recovery formula. It means the company’s risk from ups and downs in fuel pricing can be passed on to customers. “Our hedging activity on fuel prices is now less than what we hedge in FX or on the interest rate movements in our debt positions.”

Inflation will dampen global trade, and he says weakness coming out of China will mean lower volumes, and the industry will have to adjust capacity. But higher interest rates are boosting returns on the company’s cash pile and the sector has firepower at the ready, whatever the challenge. “Whatever cycle is ahead, the shipping industry is sitting on robust cash positions and is better equipped than in the past.”

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