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Brian M. Conrad Deputy Executive Director Transpacific Stabilization Agreement (TSA) before the March 9, 2006 / Costa Mesa, CA I’d like to begin by thanking WIT for the invitation to speak today. We saw remarkably strong cargo growth in the transpacific market during 2005, but not without operational and cost challenges. Container traffic grew 13.2%, from 5.2 million 40-foot containers (FEU) in 2004 to 5.9 million last year. At the beginning of 2005 TSA took a very lonely position, forecasting 10-12% growth. Most industry analysts forecast 7-8% and some predicted even slower growth – China’s economy would overheat… either its currency would collapse or protectionist sentiment in Congress would boil over… energy, steel shortages and domestic unrest would halt production… U.S. consumers would hit their credit limits, the housing bubble was about to burst, high fuel prices would keep them home, sitting around their heaters over the holidays. China exports to the U.S. have slowed – in 2005 they totaled a “mere” 3.7 million FEU, roughly 63% of the total transpacific market. Shipments this year were up “only” 23.5% from 2004. Foreign direct investment in China hit a plateau last year, as Beijing imposed restrictions on new plants and imports of raw materials and manufacturing inputs tied to exports, and shifted focus to infrastructure spending and spurring domestic consumer demand. That “plateau”, however, amounted to $60 billion in new direct investment, and it created 44,000 new businesses, many of them in export-related sectors. And despite a slowdown in new plant approvals at the national level, approvals at the local and provincial levels remained strong. Foreign manufacturing investment in China is now valued at $819 billion. Admittedly, the American consumer could look better on paper. The nation’s savings rate is minus 0.7%. Combined U.S. household debt is $11.4 trillion, almost 19% of total household income. The government isn’t doing much better, with a $318 billion budget deficit that’s 2.6% of GDP, and a $726 billion trade deficit that’s 5.8% of GDP. The U.S. trade deficit with China alone in 2005 reached $202 billion, and China holds an estimated $247 billion in dollar-denominated debt. This makes the U.S.-China relationship a long-term strategic partnership, politics notwithstanding. There is a bright side, however: January retail sales were up 2.3%, the largest monthly increase since 1999. Consumer confidence is up. Unemployment, interest rates and inflation remain low. Rising home prices and low interest rates prompted homeowners to extract more than $600 billion in equity during 2004 and 2005, through refinancing. They only spent about a third of that, however. And when they spent it was on second homes… on improvements and expansions that added value to their existing homes, including home furnishings, consumer electronics, building supplies and other major imports from Asia… and on paying off higher interest credit cards. From all indications we’re seeing, consumers are slowing down… they’re looking for value… they’re paying cash… but they’re not necessarily finished. On top of that, the long-awaited cycle of business spending may be here. Imports of computers, telecommunications equipment and peripherals took off in 2005 and we expect the trend to continue in 2006. Computers and electronics jumped sharply in the cargo figures for Japan, Korea, the Philippines and Vietnam. U.S. car sales soared last year, and despite discounting by GM and Ford, auto and parts imports from Japan and Korea posted big gains. Southeast Asia is finally rebounding, in a few of important respects. They’ve taken over some low-end manufacturing, from barbecue grills to household appliances. They’ve moved into apparel making after quotas were eliminated and then selectively reapplied by Europe and the U.S. against China. And they’ve taken advantage of hardwood and petroleum resources to increase furniture, plastic plumbing fixtures and other products. Malaysia’s exports to the U.S. grew by more than 13%; Indonesia cargo grew by 9%; Vietnam was once again the fastest-growing market, up nearly 38% to 120,000 FEU. Asia as a market is maturing – but with plenty of room for sustained growth in the foreseeable future. That is why China is planning and building port capacity to handle 130 million TEU by 2020, and has completed or is now building 55,000 miles of new highway. It’s behind the consolidation and intense global competition among port terminal operators in Asia, the Indian Subcontinent, Panama, Mexico and the U.S. Gulf Coast. And it’s why global container carriers are adding significant new ship capacity for the future. A relatively small number of ships in the 8,000-TEU range have been delivered so far, with more to follow over 2006-2008. All will be deployed in the east-west trade lanes, mainly the transpacific and Asia-Europe. Some analysts and press reports have suggested the potential for considerable overcapacity in the Pacific. To get to that assumption, you have to believe first that cargo demand will slow markedly, and second that an 8,000-TEU ship can – and must – sail close to full for the sailing to be profitable. That is not the case. Most U.S. ports do not yet have the 50-foot channel and berth depths to receive an 8,000-TEU ship fully loaded today. In fact, only about four ports have that capability at present. A second constraint is rail access: Class I railroads in the U.S. have not allocated the locomotive, crew and rail car capacity needed to meet current intermodal growth trends. The margins are lower than for their coal, agricultural and other product lines that are also seeing growth; the volume of containers into and out of port corridors already creates network imbalances; and they don’t have the redundant track yet – what we might call the “passing lanes” – that would enable efficient sharing with other types of passenger and freight trains. What we’ve seen instead are temporary rail embargoes out of port centers on both the East and West Coasts, in both the U.S. and Canada. We’re also seeing longer lead times, even where there is on-dock rail, to load containers onto a train for movement inland. And where railroads have adopted strategies of building longer intermodal trains to save on fuel and lower their per slot costs, that usually means a second stop at an inland rail ramp where there are longer loading and support tracks, and where more domestic and international cargo is waiting. In the meantime, rail intermodal traffic overall grew 5.6% during 2005 but international container rail traffic grew by more than 7% on top of more than 10% in 2004. Nearly 8 million ISO marine containers moved inland via rail last year – 58% of total rail intermodal lifts. The intermodal supply chain in the U.S. is now so tight that any inland service disruption due to bad weather, a derailment, even a crew change in a remote area, can add days to the end-to-end transit time. The network effect of these delays is an effective capacity reduction. Ocean carriers are not going to bring in 5,000 containers on a single sailing, only to have a large share of those loads sit at the dock accruing detention charges, or at some local depot or yard paying storage charges. Even if a line could and did bring the vessel in fully loaded, the potential delays would in turn jeopardize later sailings and back up subsequent ships in Asia. I might add that the congestion situation at U.S. ports is not necessarily over. True, there has been significant productivity improvement at U.S. port terminals, industry still has a long way to go before matching the 12,000-TEU per acre – or greater – throughput capacity of Asian ports. Terminal operators have successfully introduced automation and process changes, bringing productivity up to more than 7,000 TEU per acre in the best cases. But we have additional limitations at the destination end. For example, receiving terminals need the flexibility to store priority or “hot” cargo on chassis for pickup, rather than running a fully grounded terminal as is done in Asia. They need to prioritize and sequence loads coming off the ship for inland transit and distribution. On the other side of the Pacific the cargo imbalance is outbound, and the pressure is largely to move everything out the door as quickly as possible. New deepwater terminals, a wider Panama Canal, and expanded rail and highway access will ease these stresses over time, but that level of physical expansion is still at least two years off. Asia is going to be putting cargo on ships bound for the U.S. faster than U.S. ports can receive it for some time. Conditions have eased and we hope they stay that way, but the reality is that a sharp peak season spike in cargo demand could still easily cause severe backups in the transpacific supply chain in the next few years. The bottom line: We see cargo demand and effective vessel capacity tracking more closely than might be imagined during 2006 and 2007, within 3-4 percentage points. Global carriers are looking for two advantages in the Pacific right now – scale and integration. We’re in the midst of a cycle of consolidation, whether through mergers and acquisitions or through reconfiguration and strengthening of alliances. This in turn is bringing about consolidation of terminal operators on a global scale, with a few large mega-carriers operating their own terminals to their own specifications, while large third-party operators may dedicate “common user” terminals to members of a particular alliance or other affiliated group of carriers. Shippers can expect real benefits from this consolidation and from the new capacity coming onstream. Carriers have already made important productivity gains through load planning and sequencing… diversification of West Coast gateways, and expansion of all-water services… and participation in DC bypass and transload strategies to expedite inland cargo, lower shippers’ costs and better manage marine equipment. They’re working with accounts to offer new 10-day express service strings from more China ports, and to spread out shipments to off-peak times – of the day, of the week, of the year. These improvements will likely, over time, form the basis of a new service standard for container shipping. They will provide the transit times, reliable schedules, assured equipment availability and supply chain transparency shippers have wanted. But they will not come cheap. Transpacific container lines are looking at a minimum 7% increase in overall operating costs in 2006. That includes a 25% increase in inland rail and truck costs, and an 11% increase in equipment repositioning costs. Ocean carriers, as lead logistics providers and customers of the railroads and motor carriers, will be directly exposed to much of the cost associated with inland intermodal transit – locomotives, crew, rail cars, new track and switching, tunnel and bridge clearances, fuel surcharges, truck replacements and retrofits, rising truck driver salaries overall plus higher costs from hours of service rules, and so on. They will also be paying to reposition record volumes of empty containers in a trade that is approaching a 3-to-1 imbalance in traffic favoring inbound cargo and equipment. Of the 20.6 million containers that moved through West Coast ports alone during 2005, more than 6 million of those were empty units. Most entered the U.S. loaded, from Asia. After delivery of the cargo, returning equipment incurs handling, local inland and port drayage, maintenance and repair, long haul rail transport and other costs. During the peak season, the overall volume of cargo and equipment spikes, as it did in 2005 by 28%. That in turn triggers sharp increases in repositioning costs when equipment is needed most. In recent years it has also triggered rail and truck embargoes, as empty returns were competing for space with West Coast export and domestic bookings. The delays incur costs as well, if stranded containers must be stored, and new or leased containers be arranged in Asia. While vessel charter and equipment leasing costs have leveled off in recent months, many container lines remain locked into three-year deals, at high rates and terms agreed to during an emergency situation. Finally, after securing chartered ships and leased equipment to meet customer demand for all-water services, carriers saw an immediate 37% jump in their roundtrip sailing costs through the Panama Canal last year. Last May the Canal Authority began assessing the same fees for westbound empty return equipment transiting the Canal as for eastbound loaded containers. Further fee increases are scheduled for May 2006 and May 2007. Cost issues have been the primary focus of TSA lines during the past two years. Last year we charged a committee of the member lines to analyze cost trends in the transpacific, and we used the committee’s findings as the basis for an announced set of rate increases that varied by route segment. This year we went a step further: We ran a new analysis for 2006-07, and reported our estimate of minimal average cost impacts per container by route segment – $150 per FEU for West Coast and Group 4 shipments, $350 per FEU for intermodal moves, and $400 per FEU for all-water East Coast service. We wanted to make it very clear that these dollar figures represented the known costs carriers would be facing in the coming year, before any profit – not a target general rate increase that is seen as a maximum to be bargained down. We also wanted to make the point that a number of unknown costs are on the horizon, such as the long-term costs of fee-based night gate programs at multiple ports, and future funding of large, public freight transport infrastructure projects. The transpacific supply chain is in a critical transitional phase. The flexible, integrated, efficient network we all envision is projected to be up and running late in this decade. Ocean carriers expect to play a key role in building and funding this network, but the cost must be equitably shared. Stay tuned. Thank you.
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