Will ESG, Climate Activists, and Houthis Help Boost Containership Profits?

Will the actions of Houthi militants and climate activists inadvertently avert the widely anticipated financial fallout in the containership market set for 2024?

Editors Note: This narrative unfolds amidst a highly intricate and chaotic series of events. While we’ve strived to present this story in a clear and linear manner, it’s important to acknowledge that the actual situation is far from straightforward and tidy.

by John Konrad (gCaptain) Just before the Houthi attacks disrupted Red Sea shipping, top containership companies such as Maersk, CMA CGM, and MSC were facing formidable challenges. Coming off a period of COVID-induced record profits, the industry was dealing with an influx of new ship deliveries and unstable freight rates. This situation was poised to significantly reduce containerline profits by 2025, potentially leading to a level of bankruptcies among smaller carriers not witnessed since the downfall of Hanjin in 2016. Confronted with this uncertainty and the need to match growing fleet sizes with decreasing market demand, major carriers were compelled to branch out into other sectors, including logistics, data management, and aviation, to stabilize and diversify their business models. Everyone in the sector tightened their seatbelts for the coming downturn.

Nevertheless, two factors could play a pivotal role in rescuing the industry from the substantial financial losses anticipated next year: one predictable (new climate regulations) and the other unexpected (Red Sea militant activities). Comprehending the impact and shipping company strategies surrounding the new climate regulations could provide valuable insights into how the industry might effectively navigate and potentially capitalize on the challenges posed by the situation in the Red Sea.

A Perfect Storm Builds

Container shipping is a highly competitive and volatile industry. Ship owners often engage in overbuilding during times of favorable rates and strong cash flow, only to face steep downturns when new vessels saturate the market, leading to excessive shipping capacity.

This dynamic has been intensified by two key developments over the past two decades. Firstly, the introduction of ultra-large containerships, which began in 2006 with the launch of the 14,770 TEU Emma Maersk, underscored the cost-saving benefits of economies of scale. This trend was further emphasized in 2013 with the debut of the 18,270 TEU Mærsk Mc-Kinney Møller. Secondly, the resulting overcapacity in the market led to the financial strain and potential bankruptcy of smaller players, thereby reinforcing the dominance of the largest firms in the sector.

These factors resulted in record profits when stimulus checks and COVID-induced ordering flooded the market with freight. Profits skyrocketed higher when port congestion sidelined many ships thus reducing overall capacity in the system.

The Perfect Storm Nears

With these record profits, majors followed the usual playbook and ordered too many ships. Every major shipping analyst has predicted a downturn in 2024 as new capacity is launched from the drydocks of Chinese shipyards.

Maersk has already cut 10,000 jobs in response to the downturn. Analysts foresee further difficulties in 2025, with over 2 million TEU (Twenty-foot Equivalent Unit) in capacity expected to be delivered for the third consecutive year. Clarksons Research anticipates fleet growth rates of 8% in 2023, 7% in 2024, and about 5% in 2025. This rapid expansion may disrupt the balance of supply and demand until 2026.

Container xChange’s report on 2024 industry trends warns that mismanagement of the surge in deliveries could lead to intense competition and potential mergers and acquisitions. The current trend suggests both freight and charter markets will soften in 2024, although the charter market has fared relatively better in 2023.

Despite taking delivery of new ships, carriers have managed to use existing tonnage effectively, as indicated by Alphaliner’s data on low inactive fleets and limited spot tonnage. However, the industry faces additional pressures from the redelivery of vessels fixed for multi-year periods during 2021-2022, and the cascading effect of record deliveries could spread across sectors. The freight market has significantly declined from its pandemic highs to its current loss-making lows.

Major operators, including AP Moller-Maersk, CMA CGM, MSC, Hapag-Lloyd, and Ocean Network Express, are bracing for losses in late 2023 and early 2024, a result of falling freight rates below pre-pandemic levels.

A dark storm is nearing but environmental regulations, especially in Europe, are expected to play a role in managing capacity, as vessels slow down to comply with these rules. But, even with slow steaming reducing capacty, by the end of 2025 the fleet capacity is projected to be over 20% higher than at the start of 2023. Some analysts say that demolition rates could also rise in 2024, particularly if companies like MSC Mediterranean Shipping Company decide to scrap older ships with poor environmental scores.

Climate Activists

gCaptain has been at the forefront of environmental issues since our inception but, apart from the prevention of oil spills, the industry had very little interest. Today, however, it’s difficult to find an industry conference or trade publication that’s not dominated by the climate agenda.

The landscape shifted significantly with the introduction of the IMO 2020 regulations, which mandated ship owners to either switch to costlier very low-sulfur fuel (VLSFO) or fit their vessels with mechanical scrubbers to eliminate sulfur from engine exhaust. When these regulations were initially proposed a decade ago, there was a widespread expectation that ship owners would resist any legislation that increased their expenses. Contrary to these expectations, however, the new laws were successfully implemented, garnering the backing of the majority of large shipping companies.

Why would shipping companies agree to increased costs? Was it because they truly believed in saving the environment or did installing scrubbers make financial sense? The truth is probably both but the economic advantages to large shipping companies can not be ignored.

The IMO 2020 regulations had a dual impact on the shipping industry. Firstly, they universally raised operational costs for all ship owners. In such a scenario, increased expenses are typically transferred to customers through higher fees. However, the burden of these costs was not evenly distributed. Large shipping companies, benefiting from access to affordable capital, were able to invest in costly scrubbers and spread this expenditure over an extended period. On the other hand, smaller and independent shipping companies faced a tougher choice. They either had to secure capital at steeper interest rates to afford scrubbers or opt for the pricier and more volatile option of using low-sulfur fuel, which, despite being less expensive initially, entailed higher overall costs due to its price fluctuations.

Climate Agenda Picks Up Steam

The IMO 2020 regulations marked the beginning of a significant shift in the shipping industry. Leading companies, such as Maersk, started advocating for Green Corridor projects, which necessitate substantial investments from ports into alternative fuels like methanol. These new fuels demand the construction of specialized ships, which incur higher initial costs but offer long-term savings. big shipping companies support these initiatives because (at least in part) the port infrastructure for these systems will be funded by taxpayers and bankers that provide lower rates to companies that supports environmental sustainability initiatives as well as government and customer ESG (Environmental, Social, and Governance) incentives.

Like the earlier adoption of scrubbers, the move towards expensive future fuel powered ships increases the upfront cost of shipbuilding, further widening the competitive gap between large and smaller shipping companies. However, unlike scrubbers, a significant portion of the expenses associated with producing future fuels and developing the necessary infrastructure can be offset by public funding, rather than being directly passed on to customers.

These Green Corridors offer advantages not only to ship owners but also to port authorities. Ports can access government rebates and low-interest loans for green initiatives, creating an opportunity to secure long-term commitments from their biggest clients. Clinets like Maersk. Consequently, this strategy not only deepens the competitive moat for shipping companies but also strengthens the market position of participating ports by excluding ports that are too small to invest in future fuels.

Climate Agenda 2024

Future fuels and green corridors are a long-term strategy that are unlikely to save carriers from rapidly declining rates in 2024. They are, however, important to note because while every containership owner will suffer from decreasing freight rates as capacity enters the market, the independent ship owners are also facing higher environmental costs from purchasing VLSFO combined with competitive pressure to deliver future fuel ships and navigating new government regulations requiring things like green corridors.

What could help save all ship owners from financial ruin in 2024 however is new carbon index regulations that provide incentives and penalties based on emissions. These rules go into force in January. The implementation of the Carbon Intensity Indicator (CII) may lead to a reallocation of vessels across different routes, but experts are uncertain if they will have a direct impact on trade volumes. The Emissions Trading System (ETS) could influence trade dynamics, particularly if European imports are re-routed to circumvent associated taxes.

CII and ETS are deeply complicated regulatory systems that are way beyond the scope of this article. What is clear is the highly complicated set of targets and conditions give ship owners the incentive to build more environmentally friendly ships – again, deepening the moat against small and independent competitors with shallow capital sources – but those advantages will not be seen for years. In the short term owners can reduce penalties and increase incentives by reducing costs or rerouting cargo to more environmental routes.

The Red Sea

What do environmental regulations have to do with the Red Sea?

The lessons from the evolution of environmental initiatives are many but what’s critical in the context of the Red Sea is that the major shipping companies have grown incredibly in their ability to coordinate actions, affect politics, and operate via multiple narratives at once. So how does this all fit together?

If you look at the stock prices of large shipping container companies or listen to the interviews with shipping executives on CNBC, you may be led to believe that the operating costs of rerouting around Africa will deepen the losses for carriers. But seen in the context of the recent environmental push, it starts to become apparent that Red Sea disruptions could provide an opportunity for carriers to profit.

At the most basic foundations, shipping profits are a triangle with freight rates bringing in profits, operating costs driving expenses, and system capacity working to regulate both sides.

As we have seen from the climate agenda, carriers have become adept at pushing costs to customers and taxpayers. Insurance costs are rising rapidly due to the security concerns in the Red Sea, and getting naval support to protect ships reduces those costs. Operating costs will spike greatly with the added fuel costs of rerouting ships around Africa but several carriers have already announced additional customer fees to cover that.

Freight Rates And Capacity

The relationship between freight rates and shipping capacity is intrinsically connected. Rerouting ships around South Africa, for instance, leads to increased operating expenses. While these costs can be partially or even fully compensated for via customer fees, the total number of ships in circulation cannot be quickly altered. With the longer transit times incurred by such rerouting, these ships are unavailable for other shipments for an extended period.

This reduction in the number of ships actively transporting goods effectively decreases the overall system capacity. With fewer ships available, the total shipping capacity drops. In the context of supply and demand, this diminished capacity translates to a lower supply of shipping services. However, if the demand for shipping remains constant, this reduced supply inevitably leads to higher freight rates, as the balance tips in favor of demand over available capacity.

This is already proven to be true as the Containerized Freight Index Futures (Europe Service), have doubled since December 1st.

Environmentalism And Militant Activity Combines

As we have shown several headwinds were combining into a perfect storm that threatened to sink profits. New CII and ETS regulations were set to be the one life ring that could buoy profits by incentivizing some ships to slow steam (traveling slow reduces total availability and system capacity) while others looked to reroute cargo along less carbon-intensive routes. With all the news about the Red Sea nobody only a few analysts are talking about the potentially large impact of slow steaming combined with longer, round South Africa, routes. It could be a one-two punch for rates.

Deepening the problem it’s not just the Suez Canal that’s restricted but the Panama Canal. Remember those ESG incentives for rerouting ships? Those are a limiting factor on routes too. The combination of those three major restrictions could have a profound but difficult-to-predict impact on rates.

This problem could be solved by suspending the new CII and ETS programs beyond January 1st and not enforcing it until the Houthi threat is solved. But is that in the best interest of carriers? They certainly haven’t been vocal in asking for a suspension.

Politics And Shipping

In June of 2022 after port congestion ignited a global firestorm of inflation, President Biden commented on the political power and cartel-like behavior of the largest containership lines.

“I have to admit to you, a lot of us elected officials have been in office for a while. Every once in a while, something you learn makes you viscerally angry. Like if you had the person in front of you, you’d want to pop them,” Biden said from the Port of Los Angeles. “No, I really mean it.”

“There are nine major ocean line shipping companies that ship from Asia to the United States. Nine. They formed three Consortium,” the president continued. “These companies have raised their prices by as much as 1,000 percent. So, everything coming from Asia, they take 90-some percent of the stuff coming from Asia. They’ve raised it by 1,000 percent.”

Now the question is, are these consortiums working together to undually magnify and benefit from another crisis? Are they helping or hindering the military commanders working in the Red Sea?

“Operation Prosperity Guardian aimed to ensure that the main ocean artery between Europe and Asia, which carried 15% of the world’s trade, was safe for the major shipping lines,” writes Dr. Sal Mercogliano in a recent editorial. ” It was Maersk, along with Hapag-Lloyd that led the charge to abandon the route.  But now, after the successful convoying of Maersk Line, Limited vessels by the US Navy, it appears that Maersk may be resuming their trade, but Hapag-Lloyd is not.”

We have seen how large carriers like Maersk have used environmental imperatives to back Green Shipping lanes which give them a sizable advantage. Now in the Red Sea, we are seeing them use social cues to – the protection of seafarers – to divert ships. This alone isn’t worrisome because both the environment and the protection of seafarers are important issues and, regardless of the outcome, Green Coordiroes will reduce emissions, and avoiding the Red Sea will help protect seafarers.

The important question is whether they are being anti-competitive in their execution. On Christmas Eve logistics professionals and beneficial cargo owners rejoiced as Maersk announced they were getting ready to resume transits through the Red Sea. Yesterday CMA CGM announced a similar plan. When the stock markets reopened on Tuesday container shipping stocks fell sharply with the smallest carriers like $ZIM falling furthest.

Also Read: French Navy Escorts CMA CGM Ships While US Ships Remain Stranded

What Maersk failed to announce was that it’s resuming sailings on ships with special protections. This started when France bowed out of Operation Prosperity Guardian to convoy CMA CGM ships. Maersk followed suit with its US-flagged ships and now, according to a tweet by Flexport CEO Ryan Peterson, is also prioritizing the movement of Danish-flagged ships. Meanwhile, MSC tried to follow but its Liberian-flagged ship MSC United was targeted by the Houthis. Germany doesn’t have a Navy with enough spare capacity to send warships to convoy, and its largest shipping company, Hapag-Lloyd announced today the Red Sea is still too dangerous.

And why are Danish-flagged ships being prioritized if Denmark did not contribute any warships – just a single staff officer – to OPG? Did the Maersk or the Danish government make a deal with France or the United States to protect Danish ships?

Also read: Is Maritime Media Putting Ships At Risk In The Red Sea?

And why is the information being fed to shipping media powerhouses so different from what’s actually happening in in the Red Sea?

Political Pressure

This situation represents a highly fluid and risky environment, and Maersk’s increased protective measures for the safety of seafarers are unquestionably vital and beyond reproach. The issue at hand, however, is the conflicting messages being disseminated. According to multiple sources from military and government circles who have spoken to gCaptain, Operation Prosperity Guardian was initiated by the White House, seemingly in response to external pressures. This development emerged just a day after White House spokesperson John Kirby announced that the US Navy would not extend protection to Maersk ships, only for the White House to subsequently reverse its stance.

The French Navy similarly joined OPG with the intention of following the US Navy’s lead but then broke apart to convoy ships owned by the French shipping major CMA CGM.

It’s difficult to point blame because so much is happening so fast but gCaptain spoke with a senior US Navy official close to this operation who said the most difficult problem is not shooting down Houthi drones, but managing outside political pressure and dealing with the shipping companies. He specifically noted that the major tanker and bulk ship owners were not the problem, the problem was handling major containership lines.

Anyone who spends time in Washington DC or local Port Authority meetings in the United States can tell you, the major European containership companies make a lot of demands but rarely attend meetings or offer direct support when executing their demands.

As we saw with the green corridors and scrubbers… companies can often start with the right intentions – e.g. reducing carbon and protecting seafarers – but then use their size and political might to gain significant anti-competitive ancillary benefits.

Conclusion

The containership market stands at a critical juncture. It was heading into 2024 with significant headwinds. Those still exist but are now influenced by a more complex interplay of environmental initiatives, geopolitical tensions, and market dynamics. While the rise of environmental regulations like the IMO 2020, the introduction of CII and ETS, and the development of Green Corridors represent a seismic shift towards sustainability, their impact on the market is multifaceted. These changes offer potential advantages to larger carriers but pose significant challenges to smaller ones, deepening the competitive divide.

The situation in the Red Sea, compounded by political maneuvers and the strategic actions of major shipping lines, adds another layer of complexity. While the intentions behind Maersk calling for initiatives like Operation Prosperity Guardian are laudable, the resulting market fluctuations and political pressures highlight the intricacies of navigating the global shipping industry. This evolving landscape prompts a critical examination of the balance between competitive practices, environmental imperatives, and the safety of seafarers.

As we move forward, the industry must tread carefully, ensuring that the pursuit of environmental and safety of seafarers is rewarded but does not lead to anti-competitive practices. It is a delicate balance of safeguarding the environment, protecting the workforce, and maintaining fair market competition – a challenge that regulators like the Federal Trade Commission, Federal Maritime Commission and their counterparts in Europe need to watch more closely.