The year 2018 was meant to be when the uncharacteristic self-discipline and wise investment decisions of shipowners during the previous two years finally yielded a world maritime industry recovery after years of agony. The first part of the year mostly lived up to that expectation. All necessary economic fundamentals were remarkably well-aligned for the industry to navigate out of its prolonged sluggishness. However, during the latter part of the year, renewed geopolitical tensions, trade disputes, and antiglobalization forces slowed the market. Those same forces are shaking the foundations of globalization, supply chain efficiency, and interdependencies that underpin world commerce. Shipping, often perceived as the world’s most globalized industry, appears to be in a quandary. The “Review of Maritime Transport,” published annually by the United Nations Conference on Trade and Development (UNCTAD), lists rising protectionism as the foremost trend shaping maritime transport. Maersk Lines, the dominant liner operator, predicts that trade restrictions in 2019 will erase 2018 gains in containerized freight volumes worldwide.
The Global Shipping Market
The International Monetary Fund (IMF) 2019 “World Economic Outlook” estimates gross domestic product (GDP) growth at a respectable 3.7 percent in 2018, but revised its projections for 2019 and 2020 to 3.5 percent and 3.6 percent, respectively. GDP growth in advanced economies is projected to drop from 2.3 percent in 2018 to 2 percent in 2019, and to 1.7 percent in 2020. In general, developing economies continue to be the major drivers of recent trade growth; they now account for almost two-thirds of all commercial cargoes, loaded and unloaded, worldwide. Collectively, developing economies now are net importers, with a trade deficit of 400 million tons in 2017.1 However, current trading conditions may cause 2019 to turn out quite differently if the IMF’s recent 0.4 percent downward revision of China’s annual GDP growth holds.
Business Performance Innovation’s November 2018 survey of 174 top-level maritime executives found them to be cautiously optimistic about the future, their biggest worries being protectionist trade policies and cyber vulnerabilities. A late 2018 Moore Stephens survey on ship operating expenses also cast similar concerns about the future based on increasing business costs. The survey estimated a 2.7 percent increase in operating expenses in 2018 and a 3.1 percent increase in 2019. These increases come after two consecutive years of declining operating costs (1.1 percent in 2016 and 1.3 percent in 2017). The estimated increases will come from rising costs of drydocking and other safety requirements, along with escalating environmental compliance costs, such as switching to low sulfur fuel oil starting in January 2020 and complying with the recently enacted ballast-water management convention provisions.2
A recent Det Norske Veritas (DNV) and Menon Economics report, “The Leading Maritime Nations of the World,” found China to be the world’s foremost shipping nation, followed by the United States and Japan. This report ranks maritime dominance using four criteria: shipping, finance and law, maritime technology, and ports and logistics. China dominates all four pillars, both in size and magnitude. Germany, Norway, and South Korea tie for fourth position, followed by Greece.
Dry-Bulk Market
The slow positive uptick that began in the dry-bulk market in 2016 gained momentum in 2018 and now appears to be on firm footing for strong returns. A significant increase in demand for dry-bulk shipping capacity during the past two years, as well as shipowners’ relative success in controlling their new ship orders, have contributed to the ongoing market turnaround. According to the industry consulting group Shipping Strategy, there was an estimated 6 percent increase in demand for dry-bulk shipping services in 2018. Remarkably, from the supply side, fleet growth was limited to 5 percent.3 The total dry-bulk fleet capacity at the end of 2018 was 824 million deadweight tons (dwt); this includes 47 million dwt of new capacity added during the year and 5 million dwt that was recycled.
Lloyd’s List cites three major drivers for the ongoing demand growth—China’s iron ore consumption and increases in the coal and agriproducts trades. In general, the dry-bulk shipping market is highly competitive and has relatively no barriers to entry; about 2,500 owners control the current fleet of 12,000 ships. Many owners endured tough market conditions during the past decade and now are reaping the benefits and renewing their fleet composition. Time charter rates are on the ascent in all submarkets, and freight earnings are forecast to grow.
A good example of the consequences of the China-U.S. trade war is the emergence of Argentina as a major soybean importer. Argentina, the third-largest soy grower, has picked up substantial volumes of exports to China and is importing lower-priced American soybeans for its domestic soy-crushing industry. The cutback in China’s purchase of other U.S. agricultural products also has impacted the demand for smaller bulk ships. Similarly, the demand for larger dry-bulk ships has been affected by a decline in China’s iron ore and coal imports (from a 5.5 percent annual growth rate in 2017 to 1.8 percent in 2018) and the January 2019 iron ore dam disaster in Brazil.4
Tanker Market
A tanker market recovery in 2018 did not materialize as expected. It was an exceptionally bad year for very large crude carriers (VLCCs) and product tankers in particular, despite the 1.4 million barrels per day (mbpd) increase in oil consumption in 2018 estimated by the International Energy Agency. Numerous geopolitical factors caused this, including ongoing political instability in Venezuela and Libya, U.S. sanctions against Iran and Venezuela, trade hostilities between the United States and China, and wild fluctuations in oil prices. The market also continues to deal with the consequences of the massive tanker building splurge that occurred in 2016. 140 large crude tankers were delivered in 2018, and another 160 are expected in 2019. The building orders have slowed since 2018, and the number of ships being recycled is rising. These are good signs for the industry. Also, even though the cessation of Iranian oil exports would technically deprive VLCCs of that trade, increased exports from the Middle East and Russia seem to be making up for the loss.
The strengthening U.S. oil exports and the long voyages from the U.S. Gulf Coast to Asian refineries are opening significant employment opportunities for foreign-flagged crude oil tankers. Export volumes have reached the equivalent of one VLCC load daily, or roughly two mbpd. However, as of late 2018, the trade conflict with China had affected this movement, and new crude oil export trade patterns are emerging in lieu of U.S. exports. Still, prospects of tanker market recovery in 2019 are tied to major oil consuming economies, such as those of China and India.5 At present, the market is generally bullish for VLCCs, Suezmax, and Aframax tankers, and an upward trajectory for freight rates is projected for 2019 and 2020.
The concentration
of industrial
shipbuilding in China,
South Korea, and Japan
should alarm U.S.
policymakers.
There is speculation that as 2020 approaches and the new International Maritime Organization (IMO) rule for using low sulfur fuel is in place, the excess supply of high sulfur fuel oil may be stored on board VLCCs. In 2018, the market for product tankers fared even worse than that for large crude tankers. However, this should improve in 2019 because of the expected surge in worldwide demand for low sulfur fuel oil starting in 2020.
In contrast to the traditional tankers, the specialized market for liquified natural gas (LNG) tankers was the most bullish sector in shipping in 2018, with a 9 percent annual increase in export volume.6 Current estimates from the International Energy Agency project a 43 percent increase in demand for LNG shipping from 2018 to 2023. The United States is expected to become the third-largest LNG supplier by 2020. LNG also is being used increasingly as a marine fuel, especially for newly built ships. There are 124 LNG-propelled vessels in operation now; 136 more are on order, and another 111 are LNG-capable.
Liner Market
The year 2018 began very well for liners, with the operators successfully restoring freight rates in all three arterial trade routes (trans-Pacific, trans-Atlantic, and Asia-Europe), only to be stymied later by the tariff threats that started during the second quarter. Although the early rate gains left operators with stronger market fundamentals to begin 2019, the level of uncertainty has escalated. The credit rating agency Moody’s downgraded Maersk Lines, the publicly traded market leader, to Baa3—one level above junk status.
Lloyd’s List estimates a 2 percent year-on-year growth in global container volumes in 2018, compared with 6 percent in 2017. The annual tonnage growth estimates for 2018 range from 4 percent (Lloyd’s List) to 5.7 percent (Alphaliner), adding to the excess capacity in the market. The mandated switchover to low sulfur fuel as of 2020 may expedite the market exit of some older ships this year.
Another likely benefit of the ongoing unpredictability is a shift in the operational philosophy of some top carriers, who now are seriously rethinking the wisdom of cost-based competition. Major operators such as Hapag-Lloyd and Maersk have expressed their clear preference for enhancing customer service rather than building ever-larger ultra-large container vessels (ULCVs). They are focusing instead on becoming global logistics integrators for their customers, optimizing the network and facilitating supply-chain services to reverse the decline in shipper satisfaction noted by several customers in a 2018 Drewry survey and the European Shippers’ Council survey. This trend is not universal; operators such as Mediterranean Shipping Company have ordered ULCVs that can load 23,000 20-foot equivalent units (TEUs), an unprecedented amount.
There has been a disturbing increase in the number of fires on board container ships. In 2019 there were two major fires on relatively new ships—one on board the APL Vancouver and the other on the Yantian Express. Investigations have traced previous fires to inaccurate or wrongly declared container contents that resulted in unsafe stowage. A review of 12 years of data by cargo insurers found the degree of mislabeling and inaccuracies in declared weights and contents to be 20 to 30 percent. Fighting a shipboard fire that starts in the cellular cargo hold of a large container ship is extremely challenging and often an exercise in futility. This is becoming a major concern for the operators, especially given the size of ULCVs. Going forward, Maersk Lines will randomly inspect all container shipments into or out of the United States for the accuracy of cargo descriptions. This likely will be the industry norm in future years.
Shipbuilding
There is intense competition between the yards in China and the Republic of Korea (ROK), the world’s two dominant shipbuilding nations. In 2018, the ROK government provided substantial support to its shipyards to help recapture market share lost to China, especially in building midsize bulk carriers and oil tankers. The broad-based ROK government initiative to prop up shipbuilding consisted of integrating artificial intelligence technology and lowering overall production costs. Japan filed a complaint against ROK shipbuilding subsidies with the World Trade Organization, with the European Union also signing. Regardless, immediately thereafter, the ROK announced additional support for its shipyards to help build 140 LNG-fueled ships by 2025.
Shipowners’ attempts to control capacity by holding back their new construction plans directly impact the shipbuilding sector. There has been an extensive consolidation of shipbuilding capability worldwide. As of January 2019, only 127 shipyards in the world are building at least one ship of more than 20,000 dwt (per Clarksons statistics), compared with 309 yards a decade ago. All but 20 of the 127 active shipyards are located in China, Korea, and Japan. The concentration of such critical industrial shipbuilding prowess in three nations (among which Japan increasingly is a minor player) should alarm U.S. policymakers.
The U.S. Maritime Sector
For the U.S. domestic maritime sector, 2018 showed more flashes of brilliance and harbingers of optimism than in recent years. The improving national economy helped lift all key players in the market, at least during the first half of 2018—before trade-related concerns began throttling back some of that optimism. The recapitalizing of the Jones Act fleet of big ships is mostly complete, and a surge sealift recapitalization strategy is in place, although when and where the Navy will find the resources to implement this is unknown. The Maritime Administration (MarAd) has begun efforts to acquire two used replacement vessels authorized by the 2018 National Defense Authorization Act. The Department of Transportation has endorsed an ambitious plan to construct the nation’s first-ever fleet of dedicated training ships to educate the next generation of Merchant Marine leaders. Congress has authorized funds for building two. The first is expected to be available for the State University of New York Maritime College in 2023. This is a remarkable commitment to maritime education, and brings to fruition the preparatory work that began well over a decade ago.
Commercially, the United States became a net exporter of oil in early December 2018. The U.S. Energy Information Administration (EIA) projects domestic oil production will rise to 12 mbpd in 2019, and crude net exports will increase to 1.2 mbpd. Several investments are being planned along the U.S. Gulf Coast to construct LNG export terminals and crude oil loading terminals that can accommodate very large tankers. The most recent is the plan for a $10 billion LNG export terminal in Texas by Qatar Petroleum and Exxon Mobil. Although oil exports have had limited impact on U.S.-flagged shipping, they have helped establish new and profitable trade routes for globally trading tankers and gas carriers.
The debate over U.S. maritime policy continues—the primary bone of contention being the Jones Act provisions from 1920 that prevent foreign competitors from entering domestic waters. This despite the findings of a 2019 PriceWaterhouseCoopers study that the Jones Act generates $100 billion in economic output and creates 500,000 jobs.7 A new Jones Act target is the shortage of about 1,800 sealift-qualified mariners, reported to Congress in 2018. These U.S. citizen mariners hold credentials to crew ships similar to those in the sealift fleet; in a time of national need, they would be called on to support sealift mobilization. Opponents see the declining pool of mariners as another testament to the failure of Jones Act provisions, the Maritime Security Program, and the Cargo Preference Act. Because they see these foundational pillars of a U.S. national maritime policy as artificial support mechanisms that have made the U.S. shipping industry noncompetitive with the rest of the world, opponents claim that the nation should open the domestic market to competition from foreign-flagged operators and discontinue promoting the U.S.-flagged international fleet.
Is there a fundamental market disadvantage for U.S.-flagged vessels? What is driving the national shipping policy of dominant shipowning nations today? If one were to rank nations based on the total dwt owned by citizens regardless of where those ships were registered, Greece, Japan, and China—in that order—would head the list, followed by Germany, Singapore, Hong Kong (China), and the ROK. Of these, China is the only country that has openly pursued maritime policies that go beyond the traditional arguments of domestic economic welfare and balance of payment. It should also be noted that, excluding Germany and Japan, all the dominant shipowning nations promote their national shipping and shipbuilding sectors aggressively.
Although the United States has for decades maintained a national security justification for promoting its Merchant Marine, policymakers face a thorny real-world dilemma. The owners of U.S.-flagged internationally trading ships encounter a fixed capital cost almost identical to that of every other foreign-flagged shipowner, as opposed to a variable (ship-operating) cost that has a semifixed component and a fully variable component. The fully variable component, also referred to as “voyage cost,” includes expenses such as fuel cost, fees for port services, canal transits if applicable, and tug and pilot services. Running cost (the semifixed ship operating cost component) covers expenses such as crew, including wages and victualing; ship maintenance and dry-dock; stores and supplies; marine insurance; and administration.
These expenses vary, depending on crew nationality and vessel registration. Crewing cost, the biggest component, can vary from 50 to 65 percent, or even higher, of the total running cost. The 2017 Drewry Manning Report did not analyze U.S. crewing costs for any mariner rank. However, the 2018 GDP per person employed (in constant 2011 purchasing power parity dollars) data from the International Labor Organization for China, the United Kingdom, and the United States are $29,732, $80,545, and $115,484, respectively. This places the 2018 U.K. GDP per person employed at 30 percent less than the U.S. wages, and the Chinese GDP per person at 74 percent less. This will invariably place U.S.-flagged ships at a cost disadvantage and affect their ability to facilitate sealift mobilization and sustenance.
Overdue for a New Approach
The arguments for and against Jones Act provisions have a long history, and their constant resurfacing has become painfully uninspiring as we approach the act’s centennial year. Typically, the antagonists argue that restricting domestic shipping activities to U.S.-built and -owned vessels operated by U.S. citizen crews has squashed competition in those trades and made those services highly profitable, much to the detriment of citizens at large, especially the inhabitants of noncontiguous states and territories such as Hawaii, Alaska, Puerto Rico, and Guam. Particularly after a weather-related disaster strikes, they argue that the Jones Act requirements from the mainland limit the scope of critical relief services and recovery efforts to these states and territories, although this has never been substantiated. Some have even attempted to blame every macroeconomic challenge faced by Puerto Rico on the Jones Act. The anti-Jones Act coalition tends to paint domestic operators as malevolent monopolies that extort shippers based on the neoclassical monopoly model in economic theory. If that were the case, the current Jones Act carriers would be making excessive profits.
According to the U.S. Department of Justice (DOJ), such allegations once were common against liner shipping companies (which operated under the once-dominant liner conference system). DOJ’s hypothesis was that the liner companies earned monopoly profits they dissipated by indulging in costly and unnecessary service competition.8 In the case of Jones Act carriers, there are no signs of excessive profits or profligate spending directed toward superfluous service competition.
Jones Act debaters on both sides must analyze this trade from new perspectives in economic theory. The theory of market contestability is an elegant, more realistic performance model with fewer behavioral assumptions than the dated neoclassical monopoly or oligopoly model.9 The new theory does not give much emphasis to the actual number of firms active in the market or to the rivalry among incumbent firms; what makes it plausible is the assumption of “costless reversible entry.”
In such a market, with no entry or exit barriers, the mere threat of new entry is sufficient to foster socially optimal behavior by incumbents, if the sunk costs are either absent or relatively low. Prices remain sustainable and the new entrants and incumbents are placed symmetrically in terms of operational capability.
While the Jones Act restricts direct foreign competition from one U.S. port to another, it does not dissuade domestic entrepreneurs from market entry, nor does it prohibit foreign operators from calling on a U.S. port from a foreign location. Although Jones Act vessels are higher priced because of the U.S.-build requirement, there is room for new market entry through innovation or acquisition of tonnage, either through the charter market or from those making market exit. Most of the cargo movements take place under annual service contracts; hence freight rates remain sustainable and not subject to retaliatory pricing. There is no proprietary technology in basic shipping services that would place the new entrants at an insurmountable disadvantage compared with the incumbents. While there are some sunk costs in Jones Act shipping, they are not overwhelming.
The Jones Act market is contestable, though not perfectly contestable. Its economic features, vastness of resources and trade volumes, entrepreneurial base, and new entrants’ track record in disrupting market inertia, along with the constant vigil exercised by its antagonists, will keep incumbents from abusing their market power. The market contestability theory has been used effectively during the past three decades to analyze the structure-conduct-performance paradigm of liner shipping alliances and other carriers, and its application should be extended to the Jones Act trades.10 Stakeholders should focus on eliminating entry barriers for U.S. companies and on promoting innovative market disrupters rather than engaging in jaded, unproductive diatribes.
From an overall perspective, the world maritime sector continues its economic recovery. Had it not been for geopolitics and tariff battles, 2018 would have been even better, despite the uncertainties caused by the ballast-water management system requirement and the fast-approaching 2020 low sulfur fuel oil mandate. The U.S. Merchant Marine is on the cusp of a resurgence. A strategic maritime industrial policy that leverages the newfound U.S. competitive advantage in energy exports could be the change agent. Perhaps a look at the experiences of other maritime countries such as Australia and the United Kingdom (in its anticipated post-Brexit status) can provide lessons in why a nation with the stature of the United States should protect its maritime prowess.
1. Developing economies had a trade surplus of 190 million tons in 2012. They became net importers in 2014. However, there is wide disparity among these nations, with developing economies in the Americas and Africa continuing their trade surplus, while those in Asia and Oceania have a deficit. See the United Nations Conference on Trade and Development’s Handbook of Statistics 2018, chapter 5, “Maritime Transport.”
2. This is a mandate from the International Maritime Organization (IMO). The International Chamber of Shipping (ICS) estimates low sulfur fuel oil to cost about 50 percent more than the residual bunker fuel in use today; at this rate, crude oil trading at $70 per barrel will result in a price differential of up to $400 per ton. See ICS 2018 Annual Review Key Issues, 15. The IMO Ballast Water Management Convention entered into force worldwide on 8 September 2017, 13 years after its original adoption. All ships are to retrofit a system between September 2019 and September 2024. As per ICS, the collective cost of installing the new treatment system for all applicable ships is estimated to be $100 billion.
3. In 2017, only 37 million dwt dry-bulk tonnage entered the market, while 12 million dwt exited.
4. The dam in Brumadinho—a Brazilian mining town controlled by mining giant Vale-—burst on 25 January 2019, killing at least 166 people; several hundred are still unaccounted for.
5. No VLCC with U.S. crude has called on Chinese ports since October 2018, whereas before the trade war the typical rate was 3–4 VLCCs per month. During the second half of 2018, U.S. export of crude and refined oil was one-seventh of what it was during the first half. See U.S. Energy Information Administration.
6. Drewry Maritime Financial Research.
7. The study was conducted for the U.S. Transportation Institute.
8. Department of Justice, 1990, Analysis of the Impact of the Shipping Act of 1984, 25.
9. For a thorough review of contestable market theory, see W. J. Baumol, John C. Panzar, and Robert D. Willig, Contestable Markets and the Theory of Industry Structure (New York: Harcourt Brace Jovanovich, 1982).
10. Shashi Kumar, “Competition and Models of Market Structure in Liner Shipping,” Transport Reviews 15, no. 1 (January 1995): 3–26.