South Korean carrier Hyundai Merchant Marine (HMM) is back in the news with an impending order for as many as 14 Ultra Large Container Vessels (ULCV) of 22,000 TEU and for its intriguing re-entrance into the Asia-Europe market as a vessel provider. Reports suggest a new standalone service called Asia Europe Express (AEX) using 10 Classic Panamax ships of 4,700 TEU will commence in April. The AEX ships would be the smallest deployed on the route that is usually reserved for ULCVs, with faster transit times to Europe (Alphaliner indicated calls at Rotterdam, Hamburg and Felixstowe) being used as the carrot to shippers.

The two developments appear to be connected. HMM has two years left to run on a slot-charter agreement signed in 2016 with 2M carriers Maersk Line and MSC and presumably sees the new ships either as a bargaining chip to continue that partnership as it will have more to bring to the table, or to leverage full membership of another carrier group, or in the worst case scenario to have sufficient means to operate independently, building on the custom generated by the AEX service.

More importantly, is this new order the sum of HMM’s ambitions or does it signal the start of a previously expressed expansion game plan? The answer to that will decide the company’s hard-to-predict future.

In the midst of a shareholder-mandated restructure in late 2016 the company announced a bold vision to control five percent of the world fleet by 2021. That target was made more difficult when it was forced to relinquish a number of charter vessels to Maersk and MSC as a condition for sharing space with them, with the 2M carriers needing to appease customers fearful of a repeat of the situation when cargoes booked with Hanjin Shipping’s service partners were left stranded when that Korean line went bankrupt.

If HMM still maintains that vision the first batch of new ULCVs will just be the start. From its current position – operating approximately 1.5 percent of the world fleet – it will need a total of 1.2 million TEU based on today’s active fleet and orderbook to reach its target. To do so will require an additional 830,000 TEU (or 38 x 22,000 TEU ULCVs); more than twice what it currently has on the seas.

Frankly, that seems like a pipe dream. Firstly, the company lacks the financial resources – despite improving the debt ratio, it just reported a net loss of $1.1 billion for 2017 – and will be dependent on funds from the state-owned Korea Maritime Corp to even secure the first order. There is a high likelihood the company will benefit from further government support as part of a wider policy to support the flagging shipbuilding industry, but not to the extent that would propel HMM into the big leagues.

Secondly, and most importantly in our view, to follow such a rapid expansion plan would be ruinous for the container industry, inevitably leading to a vicious bout of rate discounting that would deepen HMM’s losses and once again raise fears of a collapse . Such a scenario is incompatible with what should be HMM’s primary objective; to restore trust and confidence in its brand. Its reputation took a hit when Hanjin failed, when many realized it could just have easily been HMM instead but for the whim of the Korean government.

Confidence in the market has improved significantly since Hanjin’s demise, so much so that the logistics firm Kuehne + Nagel has cancelled its carrier bankruptcy insurance policy, but another prolonged run of liner deficits would send shivers down the backs of shippers and freight forwarders once again. For its part, HMM has managed to grow its business quickly as annual volumes increased by 30 percent in 2017, helped by the pick-up of former Hanjin customers. At the time of writing Drewry hadn’t seen a breakdown of the company’s full-year volumes by trade, but after nine months of 2017 the two main growth markets were Intra-Asia (up 81 percent) and the Transpacific (36 percent). The focus on the Intra-Asia trade, where freight rates are notoriously low, saw HMM’s worldwide unit revenues fall by 9 percent when all other major carriers were seeing gains.

HMM appears to have been given the benefit of the doubt by Korean manufacturers, who were possibly emotionally motivated by nationalistic loyalty when transferring cargoes from Hanjin to HMM. They helped HMM’s quarterly volume growth soar to 30 to 40 percent between the fourth quarter of 2016 and the third quarter of 2017, but with comparisons becoming like-for-like in the fourth quarter of 2017 the growth rate slipped to seven percent, giving a truer impression of the organic growth and rising trust in the company.

The company has done a good job of stabilizing itself since the turmoil of late 2016, but much like Korea itself, it finds itself at the cross roads, not knowing whether to stick or twist to remain a shipping superpower. In our opinion, HMM needs to shed any grand ambitions it has and realize the competition has moved too far ahead for it to catch-up. To vainly try would be to risk everything. The proposed new order on its own is not evidence that it is being reckless, but it might be a wise move to signal what the long-term plan is. It has two years to secure itself a home with a carrier alliance and existing members would likely be wary of inviting a potentially destabilizing and financially risky line into the fold. Moreover, growing too big would very likely preclude it from becoming a full member of the 2M, given that group is already close to permitted capacity thresholds allowed by competition authorities.

Even before any confirmation of the HMM newbuild order, the containership orderbook has sparked back to life thanks to deals signed by CMA CGM and MSC late last year and more recently by Evergreen and Yang Ming, the latter only at the board approval stage. Assuming the Yang Ming orders go through, new orders placed in the first two months of this year are already over 50 percent of what was booked in the entirety of 2017.

Looking at the current fleet and orderbook for the five largest ship classes, there are clues as to who else might want to add to the newbuild tally. CMA CGM has an obvious numerical disadvantage in the ULCV class in relation to it nearest competitors, especially as we know that Cosco is building a $2 billion war chest to fund more of those leviathans. Reactionary moves by the two leading carriers, Maersk and MSC, to maintain their lofty position cannot be discounted.

Hapag-Lloyd and the new Japanese ONE carrier group also have a deficit of ULCVs, but the noises emanating from their respective boardrooms suggest they will look at smaller classes, possibly the VLCV Maxi neopanamax class that can sail through the expanded Panama Canal.

HMM is too far behind the leading pack, which will likely stretch their lead further with more orders, to play catch up without destabilizing the market. It should focus its energies on restoring its profitability and reputation, dull as those ambitions may be.

That container spot rates have increased since the start of year should not be a surprise to anyone. In every year since Drewry launched the World Container Index (WCI) spot prices on the key East-West corridors have increased during the lead up to Chinese New Year (CNY), which lands in and around the end of January/mid-February. The shutdown of factories during festivities means that shippers front load cargoes ahead of time, causing a demand spike that lifts prices.

As of February 8, the composite benchmark rate for the WCI that covers eight major East-West trades, was $1,512 per 40-foot container, a rise of 25 percent on the year-end 2017 figure six weeks prior. Similar increases were seen in both of the previous two years six-weeks out from CNY.

For carriers, it is imperative to cash in during this boom period, because the crash on the other side of CNY can be equally, or even steeper than the rise was. It spells danger to carriers if, as happened in 2013 and 2015, there is only a minor uplift in rates, as there is a much lower a platform for rates to fall from.

In 2013 it wasn’t such a problem as the post-CNY nosedive was less pronounced than the preceding increase, but in 2015 (the year of the sheep) lines were hit bit the double-whammy of a weak build up to CNY, followed by a steep decline. It was an even worse scenario in 2016 (year of the Monkey) when after a reasonable pre-CNY boost of 24 percent, rates crashed by 41 percent afterwards.

In both 2015 and 2016 that meant that the WCI composite lost nearly 25 percent of its value when comparing six weeks before and after CNY. The rise and fall of rates during this time window is especially significant to the Transpacific market as the prevailing rate at the end of the period helps set the benchmark for annual contract negotiations.

Last year brought some respite for carriers as the pre-CNY gains exceeded the post-CNY lull, which meant that the prevailing rates six weeks after CNY was around $100 higher than it had been six weeks prior to the festivities, giving a reasonably stable platform for contract negotiations.

What then are the prospects for 2018? Will the spot market downslide be as severe as it was in 2016, or will the recent trend be overturned and further gains achieved as happened in 2012, or something in between?

To try and answer this we have looked at the supply and demand conditions in the first quarters of each year since the WCI started. For this purpose we are using Drewry’s Practical Market Index, as published in our Container Forecaster report, which measures available world capacity and demand with the former being adjusted for vessel lay ups. A figure of 100 equates to equilibrium.

What we see is that in 2012, when rates increased before and after CNY, the supply-demand balance was the in the best shape. That was largely achieved through significant capacity adjustments, when lines adopted a greater focus on restoring profitability by removing surplus tonnage in the Asia-Europe and Transpacific trades to support the market. Having dwindled beforehand, carriers reactivated the idle fleet, which jumped to nearly five percent of the total fleet in the first quarter of 2012.

Drewry’s Practical Market supply-demand index for the first quarter of 2018 is only a forecast, but we expect conditions to be on a par with 2016. Therefore we expect the WCI to follow a similar trajectory, meaning carriers are in for fairly steep price reductions immediately after CNY.

That is not to say that we expect spot rates for the full year to be down against 2017. In fact, we anticipate a small increase. While there is a lot of potential new tonnage due in 2018 (around two-million TEU after slippage from last year) we expect carriers to suppress their impact with more deferrals, scrapping and if necessary by reactivating the idle fleet, which is now below two percent. Moreover, void sailings will remain a key part of the arsenal to prevent trade load factors falling precipitously in any given month.

Rates are likely to fall sharply after Chinese New Year, but will strengthen thereafter. Carriers are likely to have to make greater use of the idle fleet to approach supply-demand equilibrium.

The collapse of freight rates during the second half of last year, far out of line with the underlying supply and demand fundamentals, suggests that carriers have not yet rid themselves of certain self-sabotaging traits and that talk of a new golden age for carriers was perhaps exaggerated.

However, despite the recent developments, in the latest Container Forecaster report Drewry retains its view that the carriers are heading towards a brighter future, while also acknowledging there are several temporary factors that have created a bump in the road to recovery.

One area that might have been expected to have provided a more immediate benefit was the significant consolidation occurring in the market. The fact that M&A hasn’t so far materially changed anything is not that surprising on reflection. The latest consolidation wave has barely become operational, with most transactions either just concluded or still pending. Moreover, even after all of the latest deals are finalized, they alone do not have sufficient weight to move the industry all the way to being a non-collusive oligopoly, which we previously outlined as being necessary to herald a new era of ‘liner paradise.’

If anything, we perhaps overlooked the risk that the merger activity would make some predators more aggressive with their pricing, to minimize customer attrition.

Following completion of the outstanding deals that will see OOCL become part of Cosco, and the three big Japanese carriers merge their container operations to form the Ocean Network Express (ONE), the leading seven carrier groups (i.e. inclusive of all subsidiaries) will control approximately 90 percent of the active containership fleet as it stood on 1 October (see Figure 1).

Yet, even with such a large swathe of the fleet in the hands of very few lines the industry remains highly competitive by standard measures. Using the Herfindahl-Hirschman Index (HHI) method (see footnotes in figures 2 and 3 for details) the industry resides in the “competitive marketplace” zone if you count all operators either as single entities or group them within parent companies (see Figure 2).

The HHI readings in Figure 2 should be treated with some caution as we we’re unable to assign some ships to operators, meaning that roughly 1.8 percent of the fleet was not included in the exercise. Nonetheless, we believe the inclusion of the missing data would not drastically alter the findings.

Based on the known ship data series, remarkably there were 379 different vessel operators, all bar 31 of which garnered less than 0.1 percent market share. With so many operators on the water there is clearly a lot of potential for more M&A, but in reality the majors are unlikely to be interested in the small fry. More likely, the leading carriers will look to lines in the next tier down that have a little more substance.

To try to give a glimpse of the future, we ran two scenarios in which the top 7 carriers control 100 percent of capacity, again based on the October 2017 fleet. In the first case we evenly distributed the capacity from outside the top seven among the leading carriers, and in the second case we assigned it all to the current market leader Maersk Line. Interestingly, in both cases the level of market concentration does not surpass the 2,500 threshold that would signify a highly concentrated environment. The inference being that to reach that status there will need to be further M&A within the top seven carriers.

While the overall picture appears to indicate that shippers have nothing to fear from consolidation, the competition levels do differ markedly at the trade route level. The Container Forecaster keeps on top of the shifting market concentration levels for key East-West and North-South trades by applying effective capacity (i.e nominal capacity after adjustments for slow steaming, out of scope cargoes, deadweight restrictions and other factors) to the Herfindahl-Hirschman Index (see Figure 3).

The results of the analysis revealed that even after the latest M&A has concluded, the industry remains ‘competitive’ or ‘moderately concentrated’ in most of the routes covered, even if all bar one (the unchanged southbound Asia-West Africa trade) did move further up the HHI scale.

Two of the trades covered (northbound Europe-East Coast South America and westbound Europe-South Asia) do now fit the ‘highly concentrated’ description, but being relatively close to a HHI reading of 2,500, they are at the lower end of the definition (10,000 being a monopoly).

Three trades (the two Asia-Europe headhaul routes and the southbound Asia-East Coast South America trade) moved from ‘competitive’ to ‘moderately concentrated’, where they will likely stay without further consolidation.

The Transpacific, Transatlantic and Asia to Middle East and South Asia headhaul trades are all still ‘competitive’ on the HHI scale. The addition of SM Line to Asia-East Coast North America will see the corresponding HHI number come down next year.

Our view: The industry is heading towards a scenario whereby a small handful of dominant carriers dictate matters, but there is still healthy competition in most trades for now. Shippers will need to stay watchful for deals that impact their main routes.

The cost of operating cargo ships rose marginally in 2017 following two consecutive years of falls, but shipowners should prepare for higher costs led by a spike in insurance premiums, according to the latest Ship Operating Costs Annual Review and Forecast 2017/18 report published by global shipping consultancy Drewry.

After two years of marked decline, average vessel operating costs stabilized in 2017 as pressure on owners was lifted by a nascent recovery across most cargo shipping markets. Trends in ship operating costs are heavily linked to developments in the wider shipping market, external cost pressures notwithstanding.

But the recovery has not been uniform across all sectors, and risks remain. Despite a brighter economic outlook, the industry is still weighed down by excess capacity, poor profitability and high levels of debt and many owners are struggling to survive. Poor financial returns have kept the pressure on costs and we expect this to remain the case for the foreseeable future.

Drewry estimates that the average daily operating cost across the 44 different ship types and sizes covered in the report rose 0.9 percent in 2017, following a 7.5 percent fall over the previous two years (see graph below). Costs rose for most cargo sectors, with the exception of container shipping which achieved a third consecutive year of cost reductions.

The depressed state of shipping markets has forced operators to focus on cost reduction as a means of survival. In the past few years big savings have been achieved in stores and spares, while many owners have been forced to slash repair and maintenance spending, keeping any work to an absolute minimum. Meanwhile, falling asset values and excess capital for hull insurance have depressed insurance premiums. Finally, owners’ largest cost head, manning, has changed little in recent years as wage increases have been kept to a minimum.

“However, there are limits to how long cost cutting can be sustained,” said Drewry’s director of research products Martin Dixon. “This is evident from the uptick in spending on stores & spares as well as repairs and maintenance in 2017. Meanwhile, the recovery in crude oil prices from the lows of 2015 has forced up the cost of lubricants.”

These factors have helped to stabilize overall ship operating costs, while the early signs of a recovery in many cargo markets have given owners some breathing space.

Looking ahead, pressure to restrain costs will continue as many sectors remain overtonnaged and any recovery will rely on fragile fundamentals. Hence, Drewry expect costs under the immediate control of owners, such as manning, spares, repairs & maintenance and management & administration, to be tightly managed.

“But some cost elements are harder to control as they are driven by influences outside an owner’s control,” added Dixon. “Large losses being booked by reinsurers for a series of natural disasters this year will have the effect of driving up hull & machinery as well as P&I premiums in future years.”

However, given the more benign outlook for the remaining cost heads, overall ship operating cost inflation is expected to remain moderate over the next few years.