International transport and logistics executives using container shipping are facing the biggest shift in their ocean provider base for 20 years and must adapt their procurement and contract strategy, according to ocean freight procurement consultancy Drewry Supply Chain Advisors.

In the last five years, beneficial cargo owners (BCOs) [ed.: a.k.a shippers] have been able to secure large reductions in freight costs by running traditional competitive bids with numerous providers in an over-supplied, fragmented market.

“Today’s business environment is starkly different, so we are now pro-actively advising our BCO customers that last year’s contract strategy will simply not work as a blueprint for the forthcoming annual ocean tender,” said Philip Damas, Head of Drewry’s logistics practice. “Things will be different and organizations must be prepared.”

“Rapid consolidation in the supplier base, changes in supplier behavior, huge reductions in vessel orders and new developments in tender technology will bring real change and uncertainty to the ocean transport procurement environment,” he added.

For example, on the Asia-North Europe route, the number of containership operators (excluding slot charterers) will decrease from 15 in July 2016 to 11 in July 17 to just 8 in July 2018. Globally, in 2016, orders for new containerships decreased from $17 billion in 2015 to $2 billion in 2016. On the other hand, the capacity of new containership deliveries is expected to increase from about 900,000 teu in 2016 to 1.1 million this year. The bankruptcy of Hanjin Shipping in 2016 has highlighted the performance risks of some financially weak providers and some BCOs and ocean carriers are experimenting with new contractual models.

Annual contracts being renegotiated on the Asia-North Europe and Asia-US West Coast routes are typically seeing container annual freight rate increases of about 50 percent (although from a low base).

In such a market Drewry believes that BCOs will need to re-think their contract negotiation strategy and believes that, by incorporating benchmarking and e-sourcing best practices in their tender management process, rate increases can be mitigated. Use of big data and optimization can also help find the best combination of bids to meet the intended balance between cost and service for the BCO’s many different lanes or supply chains.

BCOs could also face more frequent potential issues from roll-overs and canceled sailings in the medium term. In early 2017, European exporters suffered shortages of export shipping capacity to Asia, at a time when quarterly volumes to China were running 18 percent higher than in the first quarter of 2016.

Having been dormant for over 18 months the containership orderbook could be about to jolt back to life as CMA CGM is reportedly on the verge of signing an order for nine 22,000 TEU ships.

One of the two conditions for sustainable liner industry profitability that Drewry only last week laid out in a whitepaper is already in danger of being compromised. Despite a long period of sobriety it appears that carriers’ addiction to big new ships still remains in the blood stream, with news that CMA CGM is preparing to order up to nine 22,000 TEU units.

As first reported by Daily Splash and then Lloyd’s List last week the French carrier is in the final stages of negotiations for six firm orders, plus three options. If confirmed, the ships would become the largest of their kind, overtaking the 21,413-TEU OOCL Hong Kong (and its five sister ships still on order) that was delivered earlier this year. According to the media reports the ships are likely to be LNG dual fueled with China’s Shanghai Waigaoqiao Shipbuilding (SWS) and South Korea’s Hyundai Heavy Industries (HHI) in the running for the contracts, either solely or partly.

Given the chronic (and ongoing) overcapacity problem that has blighted carrier profits in recent years what could have tempted CMA CGM to risk undermining the still very fragile recovery?

To answer this question we have to remember that first and foremost carriers make decisions and investments with a view to their own standing; the potential impact to the wider industry being a secondary consideration, if at all. From CMA CGM’s point of view it is faced with demotion in the carrier rankings post Cosco and OOCL merger, while it was also short of top-end ships compared to its nearest rivals.

Add in the fact that the underemployed shipyards have probably offered a sizeable discount (admittedly we do not know the terms of the potential order) then it is easy to see how CMA CGM was convinced to make the splash. An improvement in cash flows linked to higher freight rates may also have given the carrier more confidence in making large capital investments.

In some ways this deal is all about the company playing catch-up. Its largest active ships are six (three owned) units of between 17,772 TEU and 17,859 TEU, while the biggest ships in the orderbook are three 20,600 TEU units that were originally due this year but were deferred to 2018. In comparison, Maersk Line has a total of 31 (all of which are owned) units above 18,000 TEU, either active or on order. Adding all nine ships will nearly double CMA CGM’s current orderbook to about 423,000 TEU and will help close the gap to its nearest rivals, although not by enough to reclaim its third place ranking.

As compelling as the individual case may be no carrier operates in a bubble and should this order become reality there could well be some hidden costs that CMA CGM and all of its cohorts will have to bear. From an industry perspective there is simply no good reason to add these ships to already overcrowded oceans.

We don’t know when (if at all) these ships will hit the water, but the existing orderbook is already close to three-million TEU due by the end of 2020, to add the active fleet that recently passed the 20 million TEU milestone. The bulk of new deliveries will arrive before 2019 and are heavily skewed at the top end of the range with 18,000+ TEU units (that have very limited deployment options) taking up nearly 40 percent of the orderbook. Adding even more ships to this top-heavy pool will make the task of deployment and cascading harder than it already is.

How much damage these ships might do to the supply and demand balance will depend on the prevailing conditions at the time of their delivery. We assume they will arrive after 2019 when the orderbook will have mostly played out, while increasing cargo flows and greater scrapping could also mitigate their impact. Yet, while these ships on their own will not significantly alter the supply-demand dynamics, it will become more of a problem for the industry if herd mentality kicks in and others follow. Will Evergreen, ONE, and Hapag-Lloyd, for example, now follow with orders for 22,000 TEU to play the catch-up game or will they remain more cautious in managing their balance sheet?

This unconfirmed order suggests, for some carriers at least, that growing market share remains their driving principle, when the recent trend has been to pay off debt. How many lines share that view will determine whether the industry can stay on the path towards sustainable profitability, or slip up and repeat the arm’s race and the over-capacity tendency of the past.

The path towards oligopolization in container shipping took another step forward with the proposed $6.3 billion sale of Hong Kong-based Orient Overseas International Ltd. (OOIL) to Chinese state-owned Cosco Shipping Holdings Ltd. (Cosco) and Shanghai International Port Group Co. (SIPG), announced a couple of weeks ago.

On completion of the deal, Cosco will hold 90.1 percent while SIPG will hold the remaining 9.9 percent stake in OOIL. The joint buyers said they will keep the OOIL branding, retain its listed status and maintain the companies’ global headquarters in Hong Kong along with all management. Employees will retain their existing compensation and benefits, and none will lose jobs as a result of the transaction for at least 24 months after the offer close.

OOIL and its container unit OOCL have a good track record for above-average profits in a challenging market and a reputation for being a very well-run company, earning the moniker The Perfect Bride by Drewry Maritime Financial Research. This was reflected in the substantial price-to-book premium of 1.4x, which is a fair bit above OOIL’s historical average P/B of 0.8x. Retaining the management team, processes and systems is a wise move and could be of enormous value to Cosco, in our opinion.

The deal also contributes to the shift in some of the previously entrenched liner fundamentals that have made consistent profits so elusive for carriers. In a new spotlight report (Two steps away from liner paradise?), Drewry Maritime Advisors, argues that with the total system (liner and ports) benefits from economies of scale being exhausted and in a less fragmented market, carriers can finally reach the nirvana of sustainable profitability.

To assess the evolving state of market concentration in liner shipping Drewry has used the widely-respected Herfindahl–Hirschman Index (HHI), which is used to measure the size of a company (in this case liner operators) in relation to the industry they are in, and can indicate the amount of competition between them.

To be able produce the HHI score, a value for market share is needed. Drewry has used liner capacity as a proxy for market share. A higher HHI score indicates lower levels of competition with an increased market power; a low HHI score indicates high levels of competition, high levels of fragmentation and less market power.

The chart above indicates that for the industry to move towards lower fragmentation the number of major competitors need to come down. Even with 10 competitors the industry remains highly fragmented on the HHI scale.

As things stand, upon completion of the latest M&A (the Ocean Network Express, or ONE, merging of the Japanese companies’ container units is expected to become operational in April 2018) and taking into account future newbuild deliveries, there will only be 10 carriers with a minimum two-percent share of global capacity by start of 2021, which between them will control approximately 82 percent of the world fleet. As recently as 2015 there were 17 carriers with at least a two-percent share.

Shippers are getting used to consolidation in the container industry. That doesn’t mean they have to like it. As their pool of carriers shrinks they are more likely to lobby anti-competition regulators to step in. Recent container M&A such as Maersk Line’s recent takeover of Hamburg Süd and the proposed ONE merger of Japanese carriers have all encountered minor regulatory issues so any future deals may have to contend with conditions being applied that make them less attractive to conclude. The onus will be on carriers to disprove any form of collusive oligopoly is occurring.

There are risks that could spoil the party for carriers, but if these two developments (falling scale economies returns and further industry consolidation) were to coincide, the pressures arising from structural overcapacity and market structure would greatly reduce. Sustained liner profitability would no longer be an unattainable dream but a solid reality.

Having been one of the few (unwanted) fast-growing segments in the containership industry until recently, the idle containership fleet has since gone on a crash diet. This is welcome news for carriers as it means that the industry is getting healthier, with fewer unwanted assets draining costs.

Drewry’s latest Container Forecaster report highlights how the idle fleet (defined as inactive for at least 14 days) has shrunk from 1.7 million teu in November 2016 to under 500,000 teu as of June 2017.

There are a number of reasons for the sudden slimming down. First, a large proportion of former Hanjin Shipping units that were parked up almost overnight in the aftermath of its untidy bankruptcy have since either been scrapped or picked up by other owners and operators. When the Korean line abruptly exited the stage it left about 100 ships (owned and chartered) without gainful employment and added around 600,000 teu to the idle fleet, pushing it to a record level (when measured in teu as in 2009 it was higher as percentage of the total fleet).

By early June 2017 only 13 of the original Hanjin idled ships had not been redeployed, leaving approximately 100,000 teu idled. In the short time since we compiled the research for Table 1, five of the listed ships have found employment. Maersk Line has taken the SM Norfolk, SM New York, Athos and Adamastos, while MSC has fixed the SM Savannah.

Another factor that helped to shape a leaner idle fleet was the number of formerly inactive ships that were scrapped. From early December 2016 to the mid-March Drewry counted some 23 ships aggregating 76,000 teu that were scrapped out of idled positions. The level of scrapping has since slowed down as demand was suddenly rekindled for previously redundant ships (reducing the idle fleet further – temporarily at least) as carriers sought to fill gaps in their networks as they hurried to implement new alliances from 1 April, while demolition prices also softened.

From March to the end of June some 133 idle ships were reactivated with the majority (74) being deployed in the core east-west trades, primarily the transpacific. Another 30 vessels moved into the secondary east-west trades, with many placed on the Asia to India and Middle-East trades. Only 18 ships have moved into the north-south trades, but MSC has been active in taking the largest ships possible – including a couple of 9,400 teu ships that have been put into the ECSA routes.

Table 1 shows a clear preference for the bigger (and younger) ships, which again helped to lower the idle teu count. As of June there were just 12 ships of 8,000 teu or more idled (see Table 2), of which as previously mentioned five have since been reactivated. In early March there were 68 ships of 8,000 teu + at anchor. The least desirable ships tend to be in the smaller size segments with 152 of the total 178 idle ships below 5,000 teu. The outlook for these ships is grim – most likely they will either stay at anchor or wind their way to the demolition yards.

While the idle fleet is a good barometer of the overall health of the industry it is important to remember that last year’s peak and the recent toning down were skewed by one-off events i.e. Hanjin’s collapse and the alliance restructuring. It was never as bad as it looked last year, but the recovery has been aided by the temporary demand for filler ships that won’t last.

The short-term fixtures for previously idled ships means that they will once again soon become candidates to re-join the great unwanted, while the slowdown in scrapping will see more ships stay in the idle ranks. We expect the idle fleet to remain at about two to three percent of the total containership fleet throughout the summer, before rising slightly during the slack season that comes into play in the final months of the year.

The idle fleet will likely plateau for the rest of the year as some short-term fixtures are parked up once again, mitigated by some scrapping. This tells us that the industry is close to recovery, but is not quite there with still too many assets that are simply unviable.

In April the boards of Maersk Line and the Oetker Group approved the sale of North-South trades specialist Hamburg Süd to the former for a sum of $4.06 billion. Under the terms of the agreement, the two brands will continue to be run separately with Hamburg Süd staying in Germany and keeping its existing management.

Following completion of the transaction, expected by the end of 2017, Maersk Line said that it expects to realize operational synergies in the region of $350 million to $400 million annually over the first couple of years. The cost savings are expected to come from integrating the two networks with more direct port-to-port calls and less need for transshipment. Additionally, APM Terminals, Maersk’s terminal operating sister company, will benefit from extra volumes, particularly in Hamburg Süd’s Latin America stronghold.

“By keeping Hamburg Süd as a separate and well-run company, we will limit the transaction and integration risks and costs while still extracting the operational synergies. The acquisition of Hamburg Süd will therefore create substantial value to Maersk Line already in 2019,” said Søren Skou, CEO of Maersk Line and A.P. Moller – Maersk.

When complete, the transaction will see the combined entity control approximately 19 percent of the world’s container fleet capacity, putting further distance between the Maersk group of carriers and MSC in second place (with 15 percent).

As it grows ever larger, Maersk Line’s ability to consume its competitors in one bite is reducing as the likelihood of regulators around the world intervening to put some brakes on that growth increases. The takeover of Hamburg Süd was unconditionally cleared by the US Department of Justice in March, but the European Union Commission felt obliged to place conditions that will restrict capacity in some trades, before it also approved the transaction.

The EU conditions will see Hamburg Süd withdraw from four services connecting Europe/Med with the Middle East and with Latin America. The German carrier can continue to operate these services during an unspecified notice period to ensure an orderly exit and give its partner carriers time to find alternative solutions.

The European Commission explained that without these conditions the proposed transaction would have resulted in anti-competitive effects. However, analysis of the two-capacity in the affected trades shows that even after these conditions are applied the combined entity will still exert significant influence.

For example, Hamburg Süd’s share in the Europe-East Coast South America trade—based on two-way capacity as of April 2017—will be trimmed by about seven percentage points, but even after you add what’s left to Maersk’s existing share that would give the combined carrier half of the trade’s capacity. A bigger loss will occur in the Europe-West Coast South America trade where the EC conditions will remove all trace of Hamburg Süd, although Maersk Line will maintain its market leading 28 percent share.

The EC’s decision to ask Hamburg Süd to exit the Europe-Middle East trade is perhaps the most puzzling as it only has a very small two-percent share, but it must have been felt that Maersk’s existing leading share of 30 percent was already bordering on the upper-limits of acceptability.

Away from the deep-sea trades, Maersk Line has decided to offload its Brazilian cabotage operator Mercosul Line—acquired in 2015 as part of the takeover of P&O Nedlloyd—to appease regulators in that country. Together with Hamburg Süd-subsidiary Alliança the share of the Intra-Brazil market controlled by the combined entity would have been an estimated 80 percent without the sale.

The attractiveness of Hamburg Süd as a takeover target was always obvious. The German carrier has turned itself into one of the most recognizable North-South trade specialists in the industry; delivering exceptional growth rates fostered by a keen appetite for M&A. The company made itself a relatively easy fit for any major line that was looking to expand its North-South horizons, while its virtual absence from the East-West markets avoids the need for scrutiny by competition authorities as far as those routes are concerned. While it flirted with moving into East-West trades, its owners clearly decided that the investment required to make the step up was too rich.

The Oetker Group has only ever published the most basic of information about Hamburg Süd’s performance—namely annual sales and lifts—but even these demonstrate the remarkable ascent of the company. Since 1996 container volumes have grown on average by 16 percent per annum to reach 4.4 million teu last year. Sales in the liner division have dipped marginally in each of the past three years, but they remain consistent, averaging $6 billion pa in the 2010-16 period. Having inspected the books more closely than we are able, Maersk Line clearly believes even better is yet to come.

It is an inevitable consequence of the concentration occurring in the container sector right now that each new transaction will come under closer scrutiny by competition authorities. The concessions forced upon Maersk are not so harsh as to prevent them being the market leader in the majority of trades shared with Hamburg Süd.