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Hong Kong / November 28, 2006 Good morning. My thanks to IBC for organizing this event and for inviting me to participate, and thank you all for joining us today. As many of you are probably aware, I’m nearing the end of my tenure as Executive Director with TSA. I’ve held that position since 1999, and before that had served with various transpacific agreements, including the ANERA and TWRA rate conferences, going back to 1986. I was based in Hong Kong with ANERA and, initially, negotiated joint service contracts for the Asia-U.S. trade lane on behalf of as many as 21 carriers representing over 90% of the market Much has changed since then. At the point wiscussing my retirement with TSA, members saw an opportunity to re-examine the way the entire Agreement operates. Rather than use the Agreement as an intermediary between themselves and the market, as had been the case previously, they saw a growing need to become more directly involved with their various “audiences” – their customer base, government agencies, the trade press, the analyst community, and so on. I personally like to think that the members realized, after all these years, that I’m irreplaceable. Whichever view you choose to take, beginning January 1, 2007 TSA is to be run by an Executive Committee of CEO-level representatives from four member lines – initially APL, N.Y.K. Line, Evergreen Marine and Hanjin Shipping – and a line chairman selected from among the four, beginning with APL chief executive Ron Widdows. Both the committee membership and the chair position will rotate on an annual basis. This change is significant. It represents the urgency with which carriers view their position in the transpacific trade in recent years, and the potential value they see in TSA and agreements like it to give carriers a forum for addressing operations, service, asset allocation and pricing issues. Ours is a trade marked by strong, double-digit cargo growth in four of the past five years… ever increasing operating pressures to deliver state-of-the-art, time-definite supply chain services… rapidly escalating costs in developing and maintaining those services… and a vicious cycle of flat or declining revenues over three or four years, and a single, sharp increase driven by a service crisis. It is imperative that carriers break that cycle, beginning this year. In my presentation today I will walk through some of the key trends shaping the Asia-U.S. cargo market today, followed by a look at rising carrier operating costs – in particular for fuel. These provide a context for the guideline revenue and cost recovery program put forward by TSA for its members’ 2007-08 contracts. The equation is really quite simple: Sustained double-digit cargo growth + severe cargo imbalances + terminal and inland rail infrastructure constraints + high fuel prices = reduced network capacity and steadily rising costs, even to maintain basic service levels. Let’s begin by considering the Asia-U.S. cargo market – the world’s largest container trade lane, in which China dominates with nearly a two-thirds share. In five short years, China’s share of the transpacific container market has grown from a negligible amount to more than 60%. China’s entry into the World Trade Organization in 2001 opened the doors to foreign trade and investment on an unprecedented scale. Each year since 2000, foreign investment in China has increased, and by a rapidly accelerating rate since 2002, with WTO membership. In 2001, annual foreign investment in China was just under $47 billion; by 2005 it was more than $72 billion. Cumulative FDI is more than $941 billion – much of it tied to export manufacturing. U.S. imports from China grew from $46 billion in 1995 to $102 billion in 2001. Last year they were valued at $243 billion. One more figure of interest: 60% of China’s exports worldwide are inter-company transfers, meaning that they are not indigenous Chinese exports made by Chinese companies; they are made by, or under contract with, foreign firms – including U.S. firms – for sale overseas. There’s an important point to these numbers. China does not have a trading relationship with the U.S. – it has a long-term supplier relationship. China and the U.S. may have the two most closely interconnected national economies in history. China needs a minimum 8% annual GDP growth to provide jobs for a floating workforce of 140 million people that have migrated from farms to major cities. Most of those jobs will necessarily be in factories, producing goods most Chinese still can’t afford. Average per capita income in China is about $1,700 per year, with most of the country’s 800 million rural residents still earning a third to a fourth of that. Up to 40% of average annual income is savings set aside for health care, retirement, college for at least one child and so on. Thus, China remains under intense pressure to manufacture for export, and a major appreciation of the yuan is unlikely. Since it was re-pegged to a basket of currencies in July 2005, the yuan has risen less than 4% against the dollar. Lastly, China has 99 cities with populations of 1 million or more. Its transportation and logistics markets have been opened to foreign 3PLs and warehouse operators. A “Go East” program of incentives is gradually luring foreign investors north and west. The labor supply in a nation of 1.3 billion people – half a billion of them in cities – is for all intents and purposes inexhaustible. So China trade isn’t going away anytime soon. This is why container lines have embarked on aggressive construction programs that have seen ships begin to fill up as soon as they are delivered and deployed. It is why Shanghai and Shenzhen suddenly jumped to the number three and four positions among world container ports in 2005, behind only Singapore and Hong Kong, and China plans to double port capacity by 2020. And it is why China is hard at work doubling its national highway system to 55,000 miles… building 48 new international airports… and expanding its freight-carrying railroad capacity. How about the rest of Asia? When we see declining or very slow growth in shipments from major Asian markets – Hong Kong, Taiwan, Japan – a lot of that traditional business is still strong, it’s just showing up on the manifests as coming from China, which is now the final point of production or assembly. Southern China cargo now moves directly out of Shenzhen instead of Hong Kong. Conversely, some lower-end manufacturing is beginning to spin off from China to other parts of Asia. Several Southeast Asian countries – Vietnam, Malaysia and Indonesia in particular – have seen tremendous growth in apparel, footwear and leather accessories manufacturing, for example, growing in part out of the temporary textile and apparel quotas reimposed on China by the U.S. and European Union. Oil producing countries make and ship petroleum-based exports like tires, plastic toys, household items and PVC pipe. Containerized exports from Korea to the U.S. are up more than 12% so far this year. Household appliances and toiletries shipments have tripled over first half 2005. Glass products have doubled. Shellfish and furniture are up by 40% or more. High-end fabrics, yarns, synthetic fibers, apparel, construction equipment and kitchenware are all sharply higher. Japan fits a very similar profile, with growth in those products as well as motorcycles, aircraft and parts, computers, industrial machinery and GDSM. Now to the U.S. We know that, at some point, the double-digit growth we’ve seen is unsustainable. There’s been an uneasy feeling that consumer spending, which account for two-thirds of U.S. GDP, is headed full-speed toward a brick wall; that consumers have overextended themselves, first on credit cards and then refinancing homes to cash out equity. Traditional middle-class manufacturing jobs are being replaced by a mix of very high-skilled, high-paying tech and professional jobs, plus lower-skilled, lower-paying jobs in financial services, health care and other sectors. How much longer can they keep spending? A while longer, apparently. Right now we’re looking at about 2.5% GDP growth for 2006, which is healthy for a $13 trillion economy. Pick an indicator: Unemployment is at an all-time low 4.4%. Average weekly wages in September were $569, up from $545 a year earlier. Personal incomes have risen from $10.4 trillion to $11.1 trillion from August 2005- 06. Consumer spending has grown steadily from $8.9 trillion to $9.4 trillion during that time. Retail sales rose from $352 billion in September 2005 to $366 billion in September 2006. The consumer confidence index was 104.5 in September, up from 86.6 a year ago. Inflation has fallen from 4.69% to 3.82% in the past year. The Fed has left its funds rate at 5.25% since June, after raising rates 17 times since 2003. The Dow Jones Industrial Average topped a record 12,000 on October 18.
Bottom line: Consumers are slowing down; they’more cautious in their spending, looking for value, but they haven’t stopped. We shouldn’t take the U.S. economy for granted in 2007-08, but as we meet here today the news is overwhelmingly positive. Vessel load factors bear out the good economic news. Among TSA carriers, vessel utilization has been 90% or higher for most weeks this year since March, in all four market segments – Southern California, Pacific Northwest, all-water via the Panama Canal and all-water via the Suez Canal. Since July, load factors have consistently been 95% or higher, in some weeks passing 100% and resulting in some Asia cargo being rolled to later sailings. Now let’s turn to supply and demand. This year TSA has been working with Drewry Shipping Consultants in London to develop better trade-specific capacity information, and they have provided us with monthly capacity updates and forecasts – for TSA and Non-TSA lines – to help our members with their fleet planning. In the first 10 months of 2006, slot capacity in the Pacific, adjusted to exclude out-of-scope and wayport traffic, rose 15% from 299,000 TEUs to 344,000 TEUs. Drewry’s forecast for 12-month capacity growth in the Pacific during the April 2006-April 2007 period, however, falls to 12.8% as fewer new ships are introduced into the trade in 2007, services are rationalized and replaced ships are cascaded out. The largest new ships that we keep hearing about, in the 11,000-TEU and 13,000-TEU range, have not been ordered for the transpacific. Few U.S. ports currently have the 50-foot channel and berth drafts, terminal size and equipment to efficiently handle 8,000+-TEU ships. U.S. terminal operators can’t move to fully grounded operations and otherwise optimize throughput capacity because terminals still do not have full visibility and communication across the yard. Carriers will be pushing for increased terminal automation in the next West Coast longshore contract, which they will begin negotiating with the ILWU later in 2007. Labor is expected to push back or, as before, agree to productivity improvements in principal and then challenge each one procedurally, terminal by terminal, slowing progress over years. Railroads are making the needed investments and are moving as fast as they can to add locomotives, crews, track, tunnels, switching and inland intermodal yard capacity. But we are still seeing slow train speeds and high dwell times – including delays at the dock in assembling trains and getting them to the ramps to build the longer inland trains. There are still anywhere from 2-5 extra days in the intermodal supply chain. I should add, too, that references to an 8,000-TEU ships deceptively suggest a ship capable of carrying 8,000 containers. The shipyard-rated slot capacity of most vessels typically includes some “slots” that are unusable because of their configuration. As the ship is loaded for balancing, and sequenced for unloading at destination, not all usable slots end up being used. Add in network capacity constraints and an 8,000-TEU ship, 90% full, might be carrying fewer than 3,500 containers. These factors in combination knock 2-3% off the rated capacity of a ship, and give us a 2-3% reduction in effective capacity in the Pacific. Thus, our 15% capacity increase to date becomes 12-13% for all practical purposes, and the 12.8% April 2006- 07 growth forecast becomes 10-11%. As was mentioned earlier, cargo demand for all of 2005, and continuing through the first half of 2006, has been a little over 13%. Even with a lackluster peak season that tapers off in November and gives us 10-11% cargo growth for 2006, we’re looking at a 2-3% supply-demand gap at yearend, with supply and demand in line by Spring 2007. A brief word at this point about the winter season. Even though the traditional “slack” season has hardly been slack for the past few years – except for the period during and shortly after major Asian holidays like Lunar New Year and Golden Week when factories are closed – the December-March period is still the slowest part of the year. Increasingly container lines and vessel-sharing alliances are using that period to scale back sailings and lay up ships for scheduled maintenance and repair, or simply to save money. You may have seen some of their announcements in the trade press recently. Carriers are more efficiently managing their fleet assets, and it should not be assumed that they will suddenly be desperate to fill empty vessels in early January. Our forecasts have not always matched up with those of the major data services and securities analysts in the market. Our experience has been that, to the extent that these firms rely on economic modeling that predicts cargo demand based on country GDP growth, and supply based on pubic announcements of shipyard rated capacity, they consistently underestimate demand and overestimate supply. A GDP growth model designed to measure indigenous exports could not anticipate China’s emergence as a global manufacturing platform. A supply model measuring mythical TEU slots without taking into account equipment size and infrastructure constraints is bound to miss the mark. Models borrowed from other industries to translate the supply/demand gap into freight rate fluctuations, then, are by definition meaningless. In the supply-demand context I’ve described, let’s talk about costs. Assuming that growth continues more or less through the rest of this year as it has to date, the eastbound transpacific trade will pass the threshold of 6.5 million 40-foot containers – or, if you prefer, 12 million TEU. That’s nearly double the volumes seen in 2001. As was mentioned earlier, eastbound traffic has been up 13% so far in 2006; rail intermodal traffic grew 6% overall, and more than 9% for marine containers completing international moves. Intermodal, particularly related to international trade, is the fastest growing segment of the four Class 1 U.S. railroads’ business. It has also historically been their least profitable. Other product lines – coal, chemicals, agriculture – are also seeing strong growth, but intermodal volumes and schedule requirements have been the tipping point creating network congestion and an urgent need for systemwide rail investment. At the same time, ocean carriers’ long-term rail intermodal contracts are approaching their expiry dates. Rates in the renewed contracts have been as much as 30-35% higher than before. Not all shipping lines have taken the hit; some have been able to pay less, others have time left on their previous contracts. But beginning last year, the writing was clearly on the wall. The trucking industry is consolidating, as independent operators find themselves squeezed by low rates and weak pricing power on one side, and higher fuel prices and driver safety and environmental regulations on the other. Larger regional and national carriers are exerting their bargaining leverage – in part to raise pay and attract drivers back into the business – and raising their rates as much as 25% over time. Cargo handling costs have continued to rise at the U.S. end, under existing longshore and terminal contracts. Furthermore, negotiations will begin in late 2007 toward a new six-year agreement. Carriers will be looking for further technology and efficiency improvements at the terminals, labor will be looking for better pay, benefits and job security. Either of those objectives, and all of the potential compromises in between, cost money. At the beginning of this decade most China cargo was manufactured goods trucked or barged out of Southern China to Hong Kong for transshipment. Now carriers make direct calls at a long list of ports along China’s southern and eastern coasts, picking up cargo that often originates great distances inland along the Pearl, Yellow and Yangtze Rivers. The overnight shift of capacity and services to China traffic, and from traditional Asia transshipment hubs to multiple ports within China, has not been easy, and has not come without cost. Asia’s combined trade surplus with the U.S. in 2005 was around $320 billion, accounting for half of the total U.S. global trade deficit. The result: Nearly three loaded containers of cargo leave Asia for the U.S. market, for every one loaded container that returns to Asia with U.S. exports. What’s more, terminals in Hong Kong, Singapore, Shanghai, Shenzhen, Busan and Kaoshiung push their export traffic out the door faster than U.S. ports are able to receive it. Their throughput capacity is 12,000-18,000 TEU per acre per year; ours is 6,000-7,000 TEU per acre per year even with recent improvements. That means congestion at the ports, congestion at the railhead and at inland terminals, and a lot of empty boxes inland that have to be retrieved and delivered to inland shippers premises for export loading or transported as fast as possible back to the nearest coast and put on a ship back to Asia. For major U.S. container ports it means that one in four – or even one in three – containers crossing the docks is an empty reposition. That’s a lot of truck and rail trips, handling charges and documentation costs with zero offsetting revenue. A special Cost Committee of TSA, tasked with assessing carrier costs in the eastbound market, identified eight major cost components that together make up about 55% of West Coast base rates and 60% of intermodal and East Coast all-water base rates: - Container handling - Land transport - rail - Land transport - truck - Local empty repositioning - Inland empty repositioning - Maintenance & repair - Variable feeder - Miscellaneous These costs alone increased by 8% overall in 2006, and are expected to increase another 7% in 2007. The Cost Committee next studied additional costs relating to the imbalance of cargo and equipment in the Pacific, and congestion-related costs such as: - Demurrage costs paid at discharge ports due to delayed train departures - Costs to shift from “on-wheel” to “decking” operations at discharge ports - Trucking ‘hot’ cargo to rail ramp or final destination to meet delivery deadlines - Added per diem container and chassis costs - Added administrative costs Remember, too, that with reductions in port free-time allowances, and daytime premium charges to encourage pickups during off-peak terminal hours, carriers are under intense pressure to push containers out the terminal gate whether they have someplace to go or not. Often that means paying a trucker or an off-dock storage provider to keep the cargo overnight. But even these elements don’t get us to a full accounting of costs. Transpacific lines have committed significant resources to building and expanding end-to-end services demanded by customers. That includes new investment in IT systems… C-TPAT and CSI compliance for increased cargo security… and “green” improvements such as cold ironing of ships, use of cleaner fuels aboard ship and in the terminal yard and emptying of bilges. And yes, it means return on investment in capital assets like ships, at $80 million to $120 million each… containers and rail equipment… terminal expansion... and administrative functions like branch office networks, back office documentation functions and customer service call centers. Peak season costs are a reality. Conventional wisdom in the eastbound transpacific trade is that there is no longer a peak season – that shippers have spread out their shipments over the year and diversified gateways to avoid congestion, and it isn’t a peak season if cargo isn’t being rolled in Asia or ships aren’t waiting at anchor for a berth on the West Coast. We went back and compared first and third quarter cargo volumes from 2001 through 2005, and found that the difference in cargo demand averaged 26% annually. Last year it was 28%. Actually, utilization has passed 100% several times in recent months, and some cargo has been rolled to later shipments. Just as important, peak season demand drives asset deployment. If carriers come up short, there is a scramble to redeploy and charter ships, lease equipment and adjust rotations and schedules. Congestion and equipment management issues add network costs. In off-peak periods lines face added costs as they lay up assets. Finally, we can’t forget about last year. Carriers were very specific in focusing on cost recovery minimums in their 2006-07 contracts, rather than on a GRI target. Most took home a lot less than they’d hoped for in the way of cost recovery last year, but those costs didn’t just evaporate. In fact, when we compare revenue trends in a monthly internal TSA index that uses 2003 rate levels as a benchmark against cost trends identified by the Cost Committee analysis, we see rates up about 30% in 2003-04 contracts, and then hitting a plateau slightly below that for 2004-05. Costs, meanwhile, rapidly eroded that initial gain in rates during 2005 and, by the beginning of 2006, exceeded revenues. Fuel is truly in a category all its own as an operating cost element. CS 380 bunker fuel, marine diesel oil and highway diesel fuel account for 40-60% of voyage costs. Fuel prices fluctuate weekly – often by large amounts – driven by factors over which carriers have little or no control. Bunker fuel is a lower-end distillate that refiners aren’t always interested in producing relative to other fuels, and does not track with gasoline, heating oil or jet fuel price trends. It is costly to store and difficult to hedge with futures contracts. Few carriers, if any, in the transpacific trade, are even close to recovering true fuel costs through surcharges, particularly the bunker surcharge. An internal cost analysis done by TSA’s Bunker Committee, using actual consumption data and dollar figures from the member lines bears this out. Let’s walk through some numbers: At the beginning of January 2005 the benchmark world price for bunker fuel was $198 per ton; by May 2006 it had nearly doubled to $385. The highway diesel fuel price rose from $1.96 per gallon at the beginning of 2005 to $3.06 in August 2006 – up over 50%. Bunker has by far the greatest impact on operating costs. A typical containership deployed in the Pacific today burns close to 130 tons of fuel per day. A typical eastbound sailing runs about 22 days to the West Coast. So in January 2005, the average per sailing fuel cost per vessel was about $566,000; by May 2006 the cost had risen to $1.1 million. Divide by, say, 3,000 containers and you get an increase in per slot cost from $189 to $367. Add to those numbers by 50% to recover the pro rated westbound share of empty repositions and the cost rose from $284 to $550 – not an unreasonable calculation, since empty repositions are part of the price of assured equipment availability, and many westbound rates barely cover headhaul costs. If we then adjust for variations in individual carrier fuel consumption, routes, sailing speeds and weighted average fuel prices paid at 12 load ports worldwide, we come pretty close to actual surcharge levels – and sometimes over, such as in the case of East Coast all-water services. We can debate the calculation formula at the edges, but it hardly matters: As of June 1, 2006 TSA carriers’ combined weekly fuel costs had increased since just the beginning of this year by $6.5 million to the West Coast and another $2.5 million for East Coast all-water services. Actual surcharges collected did not even remotely keep pace: An internal survey of member lines revealed that, after capping, fixing and other mitigations, bunker surcharges this year were recovering a third to a fourth of actual costs. That brings us to the overall 2007-08 revenue and cost recovery program. As most of you know by now, its elements include: - A general rate increase of $300 per FEU to the West Coast and Group 4 Western states; $650 for IPI and minilandbridge intermodal; and $500 for East Coast all-water and reverse IPI via the Panama or Suez Canals. - A $400 per FEU peak season surcharge, effective June 15-October 15, 2007. - A $90 increase in bunker surcharges that are capped, fixed or otherwise mitigated in existing contracts – up to, but not exceeding the guideline bunker charge in effect – with the combined folded in charge and the increase to float with world fuel prices subject to the formula, and with no offsetting base rate adjustments. The GRI reflects real inland transport, equipment, cargo handestion and imbalance costs expected in 2007-08, as well as revenue left on the table in 2006-07. The peak season surcharge, as always, covers the costs of volume surges and contingency planning in the coming contract year. The $90 bunker surcharge increase, and a return to floating surcharges broken out from base rates, is an incremental improvement that will begin to reverse huge carrier losses due to fuel price increases. Carrier organizations are committed, from the CEO level down, to achieving meaningful revenue and cost recovery in the coming round of contracts. I’m sure you all have seen the news reports detailing the declines in carrier quarterly financial reports – among TSA and non-TSA carriers. A lot is at stake in the negotiations ahead. Carriers are telling us they are prepared to take tough positions and, if necessary, forego cargo to achieve revenue goals. Clearly, some interesting times lie ahead. |
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