Maritime industry braces for sea-change

Ports and containership operators have turned the page on a challenging 2019 in which they persevered through a weakening global economy, slackening demand, shifting trade flows, trade and tariff battles between the U.S. and China, and a resulting pause in capital investment by the world's industrial and manufacturing companies as they wait to see how the battles play out. The one bright spot was the American consumer, whose strong consumption continued to buoy an otherwise tepid economy.

Going into the new year, maritime players are faced with many of these same macroeconomic as well as shipping-specific business issues. Notably, the maritime industry also enters 2020 dealing with perhaps its biggest challenge in decades: IMO 2020, the International Maritime Organization's global regulation to limit sulfur emissions from oceangoing ships, which took effect January 1st.

Under the new regulation, ships are required to use fuel with a sulfur content of 0.5% or less, down from 3.5%—or otherwise equip vessels with exhaust-cleaning systems, or "scrubbers," to meet lower sulfur oxide (SOx) emission requirements. (Alternatively, they can meet the mandate by investing in new ships powered exclusively by liquefied natural gas.) It's a sweeping mandate that affects all ship line operators and the approximately 60,000 vessels that ply the world's oceans moving some 90% of global trade.

The greening of ocean shipping is expected to have significant health and environmental benefits. Oceangoing vessels burn an estimated 3.9 million barrels of fuel per day, generating about 90% of sulfur emissions worldwide, according to an estimate by investment firm Goldman Sachs. The IMO projects that the changeover to low-sulfur fuels and scrubbers will reduce sulfur oxide emissions from ships globally by 77% from 2020 to 2025, reducing acid rain and avoiding some 570,000 premature deaths worldwide from conditions like strokes, asthma, cardiovascular disease, lung cancer, and pulmonary diseases.

But those benefits will come at a price. Two of the world's biggest containership operators, A.P. Møller -Maersk (Maersk) and Mediterranean Shipping Co. (MSC), have stated that their costs for compliance and changes to their fuel supplies due to IMO 2020 will likely exceed $2 billion annually—costs that will inevitably be passed on to customers. A number of ship lines have already put in place fuel-surcharge mechanisms for both short contracts (or spot rates) and long-term contracts to help recover the majority of the extra expense. As the added costs of compliance ripple through global supply chains, Goldman Sachs estimates the impact in higher shipping costs could be as much as $40 billion.

SWITCHOVER UNDERWAY

Ship lines have spent most of the last year getting ready for IMO 2020. Søren Skou is chief executive officer of Maersk, the world's largest container shipping company, operating 725 vessels worldwide that serve 343 ports in 121 countries. In the company's recent quarterly earnings call, Skou noted that Maersk is well prepared for IMO 2020. It started the fuel switchover in December, has lined up agreements with low-sulfur fuel suppliers globally, and will "mainly comply by using low-sulfur fuel in our vessels and scrubbers [on] a little more than 10% of our fleet," he said.

All this will cost Maersk a pretty penny. Although the total cost of its emissions-reduction efforts is unknown at this point, the company says the additional expenses likely will run into the billions of dollars. "We cannot pay this [increased cost] ourselves," Skou said, adding that Maersk has focused on structuring contracts and spot rates "so our customers will help us pay for this." He noted that the price adjustments had met with "good understanding" from customers and that the company continues to "work on getting our overall fuel consumption as low as possible, which is beneficial both for our costs, our customers, and not the least, the environment."

Similarly, Hamburg, Germany-based Hapag-Lloyd, which operates some 230 vessels worldwide, is putting the majority of its eggs in the low-sulfur fuel basket to achieve compliance, according to Pyers Tucker, the ship line's senior director of corporate development. "We expect that by the end of 2020, around 15% of our fleet capacity will be equipped with scrubbers," he says.

Hapag-Lloyd has instituted a "marine fuel recovery" mechanism to recoup the additional fuel cost. "While of course nobody is happy with increased prices, all understand and accept that this is a good thing for our planet," Tucker says.

He notes as well that Hapag-Lloyd this year is converting a 15,000-TEU (20-foot equivalent unit) vessel to liquefied natural gas (LNG) propulsion. If successful, that could pave the way for conversion of an additional 16 "LNG-ready" vessels in its fleet.

A QUESTION OF CAPACITY

The impact on shipping costs aside, efforts to reduce sulfur emissions by ocean vessels will also have implications for overall available capacity, service strings, transit times, and port calls, say industry watchers. In a 2019 report titled **ital{New Fuel Regulations for Ocean Carriers Raise Price, Capacity Issues for Shippers,} Gartner analysts David Gonzalez and John Johnson warn that capacity could tighten as vessels are taken out of service to be retrofitted with scrubbers. The report estimates that the scrubber installation itself could sideline a vessel for six weeks, while the entire process—including product selection, design, engineering, and procurement—could take as long as 12 months.

More than 2,000 vessels already have scrubbers installed, costing millions of dollars, the report said. It goes on to say that "estimates call for 4,000 vessels to be outfitted with scrubbers in 2020," adding that "the likelihood of temporarily removing 5% to 6% of the world's 60,000 ocean [vessels] could impact capacity and drive up costs."

Yet even with the prospect of up to 4,000 vessels being taken out of service for scrubber refits in 2020, there's some question whether, in today's market, that will have any influence at all on capacity and rates.

Maritime operators already face a low-growth global economy, slack demand, and stubborn market overcapacity. In this environment of flat to declining volumes, carriers are dialing back new-ship orders and aggressively cutting costs to maintain, and even improve, profits. That's evidenced by Maersk's 2019 third-quarter results, where earnings before interest, taxes, depreciation, and amortization (EBITDA) in its Ocean segment rose 13%, to $1.3 billion (U.S.), while revenues were "on par" with the same period a year ago.

And as new containerships get larger and larger, some are beginning to question whether the largest ships are a step too far.

"We are in a period of severe overcapacity," says Lars Jensen, CEO of SeaIntelligence Consulting, a consultancy based in Copenhagen, Denmark. "Right now, the order book [number of new ships on order] is historically low, at about 11% of capacity, down from 60%." The 10 largest carriers, Jensen notes, "basically have no order book of consequence," a market situation he called "unprecedented."

Hapag-Lloyd confirms this trend, stating flatly "We do not plan to add any ships in the near future." Maersk echoed a similar position in its recent investor call, saying "We have no intentions now to invest in large vessels."

Jensen cites only one carrier, Korea-based Hyundai Merchant Marine (HMM), as expanding notably, with a number of vessels in the 20,000- to 22,000-TEU range on order—with Korean shipyards. "Before they ordered, fleet capacity was about 450,000 TEU. Now, they're gunning to reach a million TEU," says Jensen about HMM. That's potentially a problem in itself, he notes. "If you can get the money [to build the ships,] you can grow your capacity, but that does not mean you can generate the cargo to fill those ships," Jensen says.

For vessel operators, who were accustomed to a market that for decades grew at some 9% annually, the slowdown in structural growth—now projected in the 2% to 3% range—has dictated a sea-change in strategy. Instead of pursuing volume at any cost to fill ships, "carriers have had to change their mentality [to one of] increasing the profit of the containers you actually move," Jensen notes.

BUILDING BOOM

Yet the slowdown in growth of global container volumes hasn't dampened the enthusiasm of U.S. port operators for expansion. They continue to invest in infrastructure improvements in an effort to drive efficiencies and more throughput—and become the port of choice for shippers. Some are seeing substantial growth even as the global economy cools.

"Volume has reached record levels at the Port of Oakland in each of the past two years," said the port's maritime director, John Driscoll, in late 2019. "Through October, [the port] was ahead again of last year's record pace. Loaded container volumes continue strong."

While uncertainty over global trade policy casts a shadow over the containerized trade sector heading into the new year, Oakland is pushing ahead with improvements and expansions.

Its International Container Terminal, operated by SSA, will install three new 300-foot-tall cranes in the third and fourth quarters of this year. The investment: more than $30 million. The first building in Oakland's Seaport Logistics Complex, a 460,000-square-foot distribution center, opens this summer. It's the centerpiece of a major logistics infrastructure redevelopment project at the former 200-acre Oakland Army Base. The investment: more than $50 million.

Driscoll adds that another major round of operational enhancements kicks off this year and will extend for three years, including grade improvements, road and rail track relocations to avoid congestion, and its "Freight Intelligent Transportation System," a collection of 15 technology projects designed to improve cargo visibility, send drivers on the quickest routes, and speed truck traffic through the port.

WOOING "BIG SHIPS"

Like Oakland, the South Carolina Ports Authority (SCPA)—which operates oceanside and inland ports in Charleston, Dillon, and Greer—experienced an uptick in activity last year. As of November 2019, SCPA had seen a 7% year-over-year increase in volume, moving 855,959 containers through its Wando Welch and North Charleston container terminals since July. It saw a 36% increase in automobiles processed through the port, with 79,238 vehicles moved thus far in its fiscal year 2020.

SCPA also is benefiting from shifting trade flows as more ships transit the expanded Panama Canal and call on Gulf and East Coast ports, which is a driving force behind its ongoing expansion and upgrade efforts. Those include retrofitting and upgrading the Wando Welch terminal, building out the first phase of the new Leatherman terminal, opening a second inland port in Dillon, and launching its harbor-deepening project.

"The name of the game in the port industry is to prepare for the big containerships," says Jim Newsome, SCPA's executive director. "We're locked and loaded as far as our cap-ex plan is going." By the end of 2021, SCPA will be able to handle four 14,000-TEU containerships at one time, Newsome says.

He adds, "We can't worry about trade wars; that's beyond our control. We have to focus on infrastructure and having it ready on time, so the ship lines see us as reliable."

A few hundred miles up the coast from Newsome's South Carolina port complex, the Port of Virginia has accelerated its efforts to become the deepest port on the U.S. East Coast. It has started the first phase of a commercial-channel dredging project to deepen the channel to 55 feet.

Launched in October, some two and a half years ahead of schedule, the project "tells the ocean carriers we are ready for your big ships," said John F. Reinhart, CEO and executive director of the Virginia Port Authority, in a release. When complete in 2024, the $350 million project will enable the port, unrestricted by tide or channel width, to simultaneously accommodate two ultra-large container vessels, which "is a significant competitive advantage for Virginia," the port said in the release.

LONG BEACH'S LONG GAME

Business is also relatively robust for the Port of Long Beach, which projects that 2019 will be the second-best year in its history despite a lukewarm global economy and the U.S.-China tariff battles, according to Executive Director Mario Cordero.

For Cordero and Long Beach, it's full speed ahead on a series of multibillion-dollar infrastructure improvement and expansion projects. Among those is the $1.5 billion replacement of the original 50-year-old Gerald Desmond bridge with a new, larger span, which will open to traffic this spring. "Fifteen percent of the nation's container cargo goes over that bridge," Cordero says.

The port also is proceeding with the third and final phase of the Middle Harbor project. Some 211 acres of this $1.4 billion investment in a state-of-the-art automated marine terminal are in operation. When fully completed in early 2021, it will have the capacity to move from 3.3 million to 3.5 million containers, which, Cordero says, would rank it as the sixth-largest marine terminal in the U.S.

Infrastructure aside, Cordero says the long game for the Port of Long Beach is an unwavering focus on operational excellence. "The American shipper has choices," he says. "We have a geographical advantage [as] the gateway closest to Asia, the most important trade partner for the U.S. But [the differentiator] is the way we move cargo in an efficient, predictable manner [with] the type of operation that, again, [ensures] the customer is well-served."

Cordero adds that the IMO 2020 mandate may have a silver lining for West Coast ports. Noting that fuel surcharges will be lower on shorter routes from Asia to West Coast ports versus longer routes to Gulf and East Coast ports via the Panama Canal, he says he's curious to see "whether or not the [higher] cost of fuel leads some shippers to now see the West Coast in a more favorable light."