The maritime industry has had a remarkable run over the past five years, which I have chronicled in Proceedings' Naval Review issues. Last year turned out to be a watershed, and my analysis is replete with many unwavering signs of market uncertainty. Although the level of profitability in various shipping markets and sub-markets remains respectable compared with the lackluster 1990s, 2007 will go down in shipping annals as a turbulent year.
The maritime horizon today is cloudy at best. There is a serious concern about economic recession in the United States, and the European economy is only marginally better. Traditional trade growth patterns have been affected markedly, with the trans-Pacific liner trade, the most robust trade route for many years now, posting its weakest growth in recent memory. Compounding ship owners' woes, their operating costs, already rising over the years, are now escalating even faster. The cost of bunker fuel almost doubled in 2007, besides the rise in crewing, insurance, and lubricating oil expenses. Adding insult to injury, the industry gained considerable notoriety in 2007 with a series of accidents in sensitive areas that included the largest oil spill in South Korea, the second largest spill off Norway, and two major shipping accidents in the United States within a four-day span, one on the East Coast and the other on the West Coast.
Furthermore, although the industry has made major progress in complying with heightened environmental standards and is a substantially lower polluter compared with other modes of transportation, the perception that ports and shipping lag in their environmental stewardship gained momentum in 2007. There is an overall credit squeeze in the investment sector today because of the sub-prime lending crisis in the United States and the fraudulent activities of rogue derivatives traders in Europe. This has impacted even those banks that have a respectable investment portfolio in ports and shipping. Thus the marketplace is now riddled with considerable ambiguities, and uncertainties permeate the sector globally. The 2008 annual review includes a discussion of these and other related topics.
Market Developments
Dry Bulk Market
This market was unquestionably the star attraction in 2007. The Kildare, a 1996-built capesize bulk carrier, was fixed in mid-September at more than $200,000 per day for a time charter trip, reaching the records established for very large crude oil carriers (VLCCs). Currently there is an anomaly in the dry bulk market, with one- and two-year time charter rates exceeding the spot rates substantially. Figure 1 shows the annual trend in average dry bulk daily charter rates. Toward end 2007, the capesize index fell by one-third, and the trend is expected to continue in 2008, dropping another third. Although this will still amount to a respectable daily hire compared with earlier years, the escalating cost of operations and the anticipated new deliveries will diminish profit margin across the board.
Tanker Market
The rising cost of crude oil has affected oil imports to the United States, the largest driver of the world tanker market. Japan also cut back its crude imports by 2 percent in 2007. However, China and India posted 10 percent and 5 percent increases respectively, contributing to the 4 percent increase in worldwide demand for tanker capacity. This fell below the 5.3 percent growth in crude carrier capacity and, hence, there was an overall decline in tanker earnings in 2007. The industry remained profitable, and a brief late-year spike in daily hire rates (with VLCCs earning $220,000 per day) gave a major boost to ship owners.
Double Hull Tankers, a major crude tanker operator, reported a decline in average VLCC daily charter hire by $8,000. Top Tankers, another operator faced with increasingly adverse market conditions, diversified its operations into the dry bulk sector and even changed its name to Top Ships. The accelerated phasing out of single-hull tankers by South Korea in particular has adversely affected its demand, and many are being converted to enter the dry bulk sector. The ensuing capacity depletion is expected to help stabilize VLCC rates in 2008.
Liner Market
The current economic slowdown has precipitated a global industrial slowdown, directly impacting major liner trades and operators. A weakened dollar has made U.S. exports competitive, but the import volumes have stagnated. In the meantime, the containership fleet grew by 11.7 percent in 2007 according to AXS-Alphaliner, and will grow another 15 percent in 2008. All forecasters seem to be in agreement that the increase in container carrying capacity will exceed the demand growth and impact carrier profitability. Maersk, the market leader, has already started trimming workforce and operating costs, and entered into an unprecedented trans-Pacific vessel-sharing agreement with CMA CGM and the Mediterranean Shipping Company, allying the three largest liner operators in the world.
About one-half of the ships on order now will carry 7,500 20-foot equivalent units (TEUs) or more. A study released by DVB, the shipping finance bank, is questioning the economic rationale for building giant containerships. At the current cost levels, the building cost per slot for a 10,000-plus TEU containership is $12,800/TEU. This exceeds the cost per slot of an 8,000-TEU ship by $3,300. With the current level of port congestion and infrastructural limitations, it is unlikely that the bigger ships will be more productive than the smaller ones and justify the higher up-front costs.
Cruise Market
The cruise industry continued its upward stride in 2007 despite the broad macroeconomic woes. The top three players, Carnival, Royal Caribbean, and Star Cruises, strengthened their market dominance. About 70 percent of all cruise passengers now come from North America and 22 percent from Europe. A 2006 DVB Bank Research report found that the cruise-shipping industry has an annual economic impact of $60 billion.
The demand for cruising is forecast to increase consistently for the next five years. However, increasing ship sizes will play a role in determining the fortunes of cruise ports in future years. Until the 1990s, a cruise berth 250m long was all that was required to handle the largest ships. The new-generation Genesis-class ships are 360m long. Cruise ships 290m long or more will increasingly become the industry standard and dominate the market by 2014. Some of the current major cruise destinations will lose that status unless they make substantial improvements in their port facilities.
The U.S. Merchant Marine
For a number of reasons, 2007 was a historic year for the U.S. merchant marine. It marked the 100th anniversary of the Great White Fleet's departure from Hampton Roads, Virginia, when President Roosevelt sent a portion of the Atlantic Fleet on a world tour to earn goodwill and test the nation's naval readiness.
Although the current U.S. presence in deep-sea merchant shipping is far from enviable, remarkable developments in 2007 made the worldwide shipping fraternity take a good look at the U.S. maritime milieu.
Rejuvenation of the U.S. Maritime Administration
The appointment of Sean Connaughton as the new Maritime Administrator in September 2006 turned out to be the perfect prescription for an agency that was historically much misunderstood. The Maritime Administration underwent drastic changes under his leadership and elevated its profile globally, gaining accolades from the industry as well as from seafarers and labor unions.
In addition to salient organizational restructuring under four key program areas at headquarters, ten gateway offices were established at the nation's major ports, replacing the five former Maritime Administration Regions and Region Offices. These changes were introduced to facilitate seamless movement of commerce, and also to improve interaction with local shipping and trading communities.
Additionally, they complement the nation's military and national security capabilities. In early 2008, the agency released its "Vision for the 21st Century," seeking a leadership role in transportation-related matters. It strongly endorses a marine highway system to mitigate the intensifying congestion and infrastructural limitations in major trade corridors, supplementing the marine highway legislation that was signed into law in late 2007.
Emphasizing its role as an honest broker, the Maritime Administration has lent full support to the Jones Act and played a leadership role in promoting environmental initiatives. The administrator has strongly promoted and signed agreements with several foreign-flag shipping companies that will provide training as well as employment opportunities to U.S.-educated merchant mariners. The companies include not only LNG operators who stand to benefit from faster permitting for their U.S. terminals, but also tanker and liner operators.
The Jones Act Scenario and Cabotage Issues
A major Jones Act controversy erupted in the cruise sector related to the Passenger Vessel Services Act (PVSA) of 1886. As interpreted by Customs and Border Protection (CBP), the brief port calls made by foreign-flag cruise operators to Mexican ports while en route between Southern California and Hawaii do not comply with the spirit of the law and amount to intentional evasion of cabotage restrictions.
Some of these port calls, referred to as Ensenada visits, are made between 0100 and 0200, in the dead of night. The issue gained attention because NCL, the lone U.S.-flag Hawaii-based cruise operator and alleged victim of unfair competition, lost $227 million in 2007 in addition to its continuing string of losses that began in 2004.
NCL is now controlled by Apollo Management, the private equity firm that made a $1 billion equity infusion in 2007. Under the new owner, NCL has decided to re-flag two of its U.S.-flag cruise ships (Pride of Hawaii and Pride of Aloha) to the Bahamian flag and shift them, presumably, to the more lucrative European cruise market.
There is concern that the Pride of America, the remaining U.S.-flag NCL ship, will also be shifted elsewhere if operating conditions do not change. Hawaiian officials seem to be caught in the middle as their ports benefit from visits by both types of cruise operators. CBP has recommended a change to the PVSA, mandating that ships spend at least half of each cruise itinerary in non-U.S. ports, and that each stop be for at least 48 hours. These changes are opposed vehemently by all major stakeholders in the cruise sector except NCL.
Maritime Security
The Department of Homeland Security began issuing Transportation Worker Identification Credential (TWIC) cards in 2007. Anyone entering port premises will be required to have a card by 25 September 2008. It remains unclear whether everyone who needs a card will receive one by that deadline. Dock workers are also concerned about privacy issues and denied TWIC applications.
A University of Virginia study found that a majority of those enrolled in the Customs-Trade Partnership against Terrorism (C-TPAT) program find it useful despite the high cost of joining.
Benefits include improved workforce security and predictability in moving goods, along with enhanced supply-chain visibility. Study participants reported spending $38,400 annually on average to improve their physical security. DP World (of the 2006 Dubai Ports fame) became a C-TPAT member in 2007, the only international port operator so far with that status.
In general, the maritime sector has learned to live with the Safe Port Act enacted in late 2006. However, one of its provisions, the 10+2 program that was implemented as of 1 April 2008, received considerable attention in 2007. CBP states that it consulted the industry in developing the 10+2 rule, according to which importers will file 10 data sets at least 24 hours prior to loading cargo at the foreign port, and the carriers will file 2 additional data sets.
All carriers except those that carry only bulk goods are to submit a vessel stowage plan not later than 48 hours after departure from the last foreign port, or before arrival at the first U.S. port of call for shorter voyages. The program's main goal is to help identify at-risk cargoes, but it is facing resentment from many, including the European Union. The anticipated annual price tag of $100 million has not helped its cause, especially as its benefits are still unclear.
The Safe Port Act also mandated 100 percent scanning of all U.S.-bound containers in foreign ports by 1 July 2012. This is highly unpopular among major stakeholders in the United States as well as overseas. Opponents of 100 percent scanning include the CBP, the U.S. Chamber of Commerce, the World Shipping Council, and the European Shippers' Council.
Environmental Issues
An inter-island superferry service conceived for the Hawaiian waters as an alternative to air travel met with opposition from environmental activists. Subsequently, the Maui court ruled that extensive environmental impact studies be conducted prior to commencing the service. Faced with a weekly of loss of $650,000 and an eight-month or greater delay for proposed studies, the ferry operator began furloughing its staff. With strong backing from the governor, the state legislature voted emergency measures to override the court decision and begin superferry services.
In California, a proposed $30 fee on each import container was withdrawn after Governor Arnold Schwarzenegger (R) threatened to veto it. A state senator initiated the proposal to improve the state's air quality and environmental standards. The industry is more or less resigned to such taxes in the near future.
The Clean Air Action Plan was adopted jointly in late 2006 by the Southern California ports, whose goal is to cut port-generated diesel pollution by 45 percent over the next five years. A key action item is to replace roughly 16,800 old harbor trucks with newer ones that burn the EPA-mandated ultra-low-sulfur diesel fuel and meet rigid pollution standards. The initiative to replace old trucks will cost close to $2 billion.
Long Beach intends to subsidize 80 percent of the cost of buying a new unit, or to pay the full cost of refitting a 1994 or later truck model. It will impose a $35-per-TEU fee on cargo owners. Pre-1989 trucks will not be allowed to enter the port as of 1 October 2008, and by 1 January 2012, all harbor trucks will be 2007 or later models.
However, what began as an epoch-making environmental stewardship initiative has transformed into a controversial labor issue, with the two ports being on the antipodes. The bone of contention is who will own and operate the trucks, regrettably forgetting the central issue. Whereas Long Beach is in favor of traditional owner-operated trucks, Los Angeles is opting for unionized employee drivers and has the backing of the Teamsters union and others. The American Trucking Association has threatened legal action against the port of Los Angeles, and Long Beach is being sued by the Natural Resources Defense Council and the Coalition for Safe Environment.
The March 1989 Exxon Valdez oil spill continues to make headlines. Exxon has spent $3.4 billion for the cleanup, and the $2.5 billion judgment against the company is now under review by the Supreme Court.
There were many convictions in pollution cases in 2007. At least five chief engineers of U.S.-flag ships have pleaded guilty to magic-pipe-related federal charges (that is, their ships did something illegal to bypass oil-pollution regulations). Federal prosecutors are concerned about the high legal fees earned by some lawyers in these charges; in some cases, it has been a third of the reward given to whistleblowers.
End of the LASH Era
The year 2007 saw the demise of the lighter-aboard-ship (LASH) concept, with the last operating vessel—the Rhine Forest—heading to the breakers in December. It was invented by a New Orleans-based naval architect in 1967. Break-bulk ship owners of that era were concerned about the poor productivity of World War II-vintage ships, but did not look upon containerization as the panacea to their problems.
LASH turned out to be a very effective ship type for ports without deep water or the infrastructure to handle containerships. The Rhine Forest could carry up to 83 barges, each capable of carrying 375 tons of cargo. LASH operations are being discontinued because of the high cost of replacement tonnage, and also the increasing level of container penetration. This is an unfortunate end to what was once a proud symbol of American marine engineering ingenuity.
Ports and Terminals
A study commissioned by the American Association of Port Authorities found that seaports added $2 trillion to the national economy in 2006 and generated 8.4 million jobs. The new, highly automated APM Terminals facility in Portsmouth, Virginia, was officially inaugurated in September 2007. It is now the largest privately owned terminal in the country, and the environmentally friendly terminal cost $450 million for the first phase.
The agreement between Georgia and South Carolina to create a bi-state port agency and settle the dispute over the long-fought, proposed port in Jasper County (S.C.) is particularly noteworthy. In 1996, I highlighted the absence of such collaboration between neighboring ports despite the latitude provided in the U.S. Shipping Act of 1984. Similarly, the report that the new bi-state port authority will seek private capital, again as I advocated in 2000, is also a welcome development.
The American President Line has begun using 53-ft containers in its Los Angeles-to-South China service. It provides significant cube economies, two such containers replacing three 40-ft containers, and also offers superior intermodal vitality.
Longshore Issues
In mid-2007, John Bowers, president of the International Longshoremen's Association (ILA), stepped down after 20 years at the helm and was replaced by Richard Hughes Jr., former ILA executive VP. In November 2007, a federal judge ruled against the government's civil racketeering lawsuit implicating the ILA leadership (this was discussed in prior annual review articles).
The criminal racketeering charges against ILA had been dismissed earlier, in 2005. According to the judge, federal lawyers had not made a good case linking the broad union leadership and its operations to the Genovese and Gambino crime families. The Department of Justice was given two months to re-file a more focused case, which it readily did.
On the West Coast, the management's contract with the International Longshore and Warehouse Union (ILWU) is due for renewal in 2008. Unlike 2002, when a ten-day lockout of longshoremen resulted in major supply-chain disruptions, the 2008 negotiations between ILWU and the Pacific Maritime Association are expected to proceed smoothly. The quick and timely contract negotiations held in 2007, involving 14 terminal operators and the Office Clerical Unit of ILWU Local 63, is a good harbinger of the new negotiating environment that pervades the West Coast waterfront. Should there be protracted delays such as those in 2002, dock workers appear to be concerned about potential job losses to Canada and Mexico.
International Issues
Piracy
There were 263 reported maritime piracy incidents in 2007, a 10 percent increase from 2006. Furthermore, the severity of pirate attacks and personal harm caused to innocent merchant mariners rose drastically by 400 percent. African waters are increasingly becoming the nightmare of seafarers, with Somalia, Nigeria, and Tanzania becoming particularly piracy-prone. In Lagos, Nigeria, alone, there were 35 piracy attempts and 25 attacks. Off Somalia, pirates captured 154 hostages.
On a positive note, Malacca Strait, the traditional epicenter of maritime piracy, reported a significant decline in activities. This is attributed mainly to littoral states' efforts, which include implementing a Regional Cooperation Agreement on Combating Piracy and Armed Robbery against Ships Information Sharing Center. The International Maritime Organization (IMO) has recommended establishing similar centers in Africa. The Tokyo-based Nippon Foundation has established a fund to support navigational safety and anti-piracy initiatives in the Malacca Strait and will contribute one-third of the costs involved for the first five years.
The Combined Maritime Forces Coalition, which consists of 20 countries, is now playing an active role in piracy prevention off African waters. They conduct maritime security operations and provide humanitarian assistance and supplies to rescued merchant mariners. The coalition naval forces were directly involved in releasing six ships that had been hijacked off Somalia.
The Golden Nori, a Japanese chemical tanker loaded with 40,000 tons of highly explosive benzene, was captured by Somali pirates on 28 October 2007 while en route from Singapore to Israel. The guided-missile destroyer USS Porter (DDG-78) entered Somali territorial waters pursuing the ship under pirate control. The pirates threatened to kill the ship's crew (Myanmar, Philippine, and South Korean nationals) unless they received a million-dollar ransom. Two U.S. Navy ships effectively blocked supply replenishments to the pirates on board. The ship was finally released on 12 December, and the crew members were unharmed.
The issue of any ransom payment to the pirates remains unconfirmed. The U.S. Maritime Administration and Office of Naval Intelligence have warned mariners to be on high alert while transiting Somali waters.
Ship Operating Costs
These costs are rising at an extraordinary pace. For the past two years, the crew cost component has increased by more than 10 percent annually. The cost of bunker fuel doubled in 2007 and has tripled in the past three years. The proposed adoption of voluntary amendments to International Marine Pollution Prevention regulations (MARPOL) Annex VI will raise the cost of marine bunker fuel even higher, according to the International Chamber of Shipping. Whereas the bunker cost was typically about 20 percent of the total operating cost ten years ago, it may now exceed 50 percent for some operators.
All major cruise ship operators have introduced fuel surcharges in the range of $5-$7.50 per passenger per day. Container operators, the worst affected, are introducing floating surcharges to cover the added burden. Another trend is to reduce speed by 10 percent. This provides substantial fuel savings, and also a significant reduction in carbon dioxide emission. New 13,000 TEU ships are being built with propulsion units that were designed a few years ago for 8,000 TEU ships; they will have 20 knots' service speed.
Ship Recycling
There were a number of developments in the ship-recycling sector in 2007. Mexico is building a new recycling yard at the port of Lazaro Cardenas, and wants to compete for some of the dated U.S. Reserve Fleet ships on the West Coast. However, the Maritime Administration will not approve an overseas yard that is not EPA approved. The International Organization for Standardization (ISO) has made available a new series, ISO 30000, that details best practices in the ship-recycling sector and control of hazardous materials.
Colleagues and I conducted the first-ever econometric analysis of the ship-recycling market in 2008. Our analysis of 51,112 ships found very important results of relevance to ongoing deliberations at IMO related to a proposed ship-recycling convention.
Figure 2 summarizes the probable impact of the convention on the five major recycling nations. The three flag-based broad categories are "under EU jurisdiction," including Malta and Cyprus; "major flags" that include ships registered in Liberia, Panama, Marshall Islands, Bahamas, and China; and "not under EU jurisdiction," which is all others.
Figure 3 shows the probability of recycling for all major flags, including Cyprus and Malta.
Mariner Shortage
The shortage of qualified mariners worsened in 2007. A recent Lloyd's Shipping Economist study concludes that the world fleet needs an influx of 23,000 new officers every year until 2010, to safely operate the unprecedented new tonnage coming on stream. This will drastically alter the 2005 BIMCO/International Shipping Federation statistics that predicted a shortage of 25,000 officers by 2020.
In the LNG sector alone, 10,000 qualified individuals are required to crew the 138 ships to be delivered during the next three years, and at this point no one really knows how this demand will be met. In countries such as India, which has historically supplied about 14 percent of the well-trained global officer pool annually, macroeconomic conditions have changed. A career at sea is no longer a very enticing option for its youth. There is a serious concern today that some ships may be laid up in the near future because of a shortage of officers.
Adding fuel to this fire is the current impetus to criminalize mariners at the slightest pretext. The collision involving Hebei Spirit, a VLCC off the coast of South Korea that was hit by an errant heavy-lift crane barge in 2007, is a good illustration of the seemingly reverse-burden-of-proof standard imposed on merchant mariners.
The master of the fully loaded VLCC at anchor took every conceivable action to avoid a collision and behaved in a prudent, seamanlike manner. Yet he was indicted for criminal negligence and now faces monetary penalty and jail time.
The captain of the Erika, the infamous 1999 tanker casualty off the Brittany coast, was incarcerated immediately without trial but found innocent in January 2008. After nine years, he was finally released. It is refreshing to note the recent request from the U.S. Coast Guard Commandant Thad Allen to treat all seafarers with utmost respect and professionalism.
Crewing ships with poorly trained seafarers results, sadly, in more maritime casualties and pollution incidents. This is an unfortunate reality today, and one of its direct consequences is the sharp increase in marine insurance cost. It makes perfect market sense to invest in training or find other ways to engage skilled mariners. One speaker at the 2007 Journal of Commerce Conference in New Orleans referred to the worsening situation as a "world war on talent." The large number of cadet training agreements that the U.S. Maritime Administration has signed with various ship owners and operators is indicative of the global demand for well-trained junior officers.
The International Bargaining Forum reached agreement in fall 2007 to incorporate the ILO Maritime Labor Convention and other workplace and wage improvements for seamen. The ratings employed on the 3,500 open-registry ships will now have a traditional 40-hour, 5-day workweek. The Forum also agreed to establish a Developed Economy Ratings Fund that will be sourced with a $10-per-rating-per-month levy on the approximately 100,000 open-registry ratings covered by the agreement. The Fund's objective is to promote employment for seafarers from traditional maritime nations such as Australia, Japan, the United States, and Western European countries.
Outlook
Macroeconomic uncertainties make it very difficult to forecast objectively shipping market conditions in 2008 and beyond. However, all indications point to a change in market dynamics and shipping cycles for the worse.
Capacity utilization rate for the broader markets is expected to come down from the historic highs reached during this cycle, because of anticipated unprecedented increase in new tonnage. Ship operating costs will continue their upward surge, further affecting carriers' profit margin.
The demand for well-trained and educated mariners will become even more pronounced as new, more sophisticated ships are delivered. Interestingly, the only lifelines in sight emanate from China, India, and other fast-growing Asian economies.