The world maritime community has experienced many difficult commercial and operational challenges over the years, but nothing compares with the enormity or the scope experienced since spring 2019, with no immediate end in sight. The confluence of a series of epoch-making market disruptions—some planned and some not, and much to the industry’s agony—has been without parallel in recent history. While some transformational changes, such as the mandated transition to the new 2020 International Maritime Organization (IMO) low-sulfur fuel oil rule or a recalcitrant Brexit finale, were expected, the industry could not anticipated another tanker war off the Strait of Hormuz or the more recent crude oil price collapse. In addition, the outbreak of COVID-19 has had a crippling effect on shipping markets, just as they were attempting to fend off the aftereffects of U.S. trade sanctions and a decelerating Chinese economy.
The Global Shipping Market
Outcomes in the global shipping market are driven by the health of the global economy and the trade it generates among nations. Per World Bank statistics, global economic growth slowed from 3 percent in 2018 to an estimated 2.4 percent in 2019. Even prior to the COVID-19 outbreak, the World Bank had lowered its earlier economic growth forecast for 2020 from 3.5 percent to 2.5 percent, and because of lingering effects of trade tensions with the United States, the Chinese economy, which had been the main driver of shipping market growth for the past two decades, was projected to grow only 5.7 percent for 2020. Nevertheless, expectations for global shipping markets were improved in 2020. The 2019 U.N. Conference on Trade and Development (UNCTAD) Report, released in October 2019, projected a 3.4 percent compounded annual growth in 2020. Other analysts also predicted a 2020 recovery based on the recovering primary market conditions, relatively mild infusion of new shipping capacity, and improving market confidence as late as December 2019 (2019 BDO Shipping Confidence Survey). Little did anyone envisage a pandemic outbreak and the supply chain disruptions it would trigger worldwide, throttling the global economy.
The World Trade Organization has acknowledged that trade in goods will be affected noticeably during the first half of 2020. IHS Markit, the economic forecasting company, projects a 0.8 percent decline in global real gross domestic product (GDP) growth during the first quarter of 2020, followed by another 0.4 percent decline in the second quarter. Trade in dry bulk commodities and oil cargoes bound for China fell substantially in January and February 2020, and earnings dropped to less than 10 percent of their 2019 peak. Current estimates from the Organisation for Economic Development and Cooperation (OECD—an intergovernmental organization to stimulate the economy and world trade) show China’s GDP dropping 1.8 percent in 2020, and both U.S. and global GDP falling 1.5 percent.
China is not only a dominant exporter of consumer goods but also a crucial supplier of intermediate inputs for manufacturing companies abroad. Using an intra-industry trade index, a recent UNCTAD technical note calculates that 20 percent of the global trade in manufacturing intermediate products originates in China. The restrictions on movement of people and economic activities there to contain the coronavirus will affect the production of these intermediate goods and, even more important, disrupt the supply of critical components for manufacturing at many companies around the world. The most affected economies include those of the European Union, the United States, Japan, South Korea, Taiwan, and Vietnam.
Dry Bulk Market
Although conditions were ideal for a long-awaited recovery in this market in 2019, unexpected impediments to trade during the first half of the year—damage to the iron ore mining infrastructure in Brazil, tariffs on soybean trade, flooding in the Mississippi River affecting U.S. grain exports, and other localized developments—held back any substantial improvement. However, conditions improved during the second half of the year; in particular, Brazil’s iron ore exports to China. In addition, shipowners’ newfound self-discipline and success in limiting the supply of new ships, the temporary withdrawal of ships to equip them with scrubbers to meet the IMO 2020 fuel oil mandate, and increasing trade volumes contributed to partial market recovery. Conditions were so ideal at this point that Clarksons, one of the world’s leading shipbrokers, predicted growth in dry bulk shipping demand and supply would even out in 2020, as opposed to the 200 percent excess capacity that existed barely four years ago.
With the collapse of the China trade, however, by the end of January 2020, the Baltic Dry Index fell to 498, with all three commonly used categories of bulk carrier ships earning substantially less than their lowest in three years. The average daily earnings for Capesize ships (that carry 170,000–180,000 metric tonnes of cargo) fell to $4,081, and for Panamax ships (60,000–70,000 tonnes) to $5,351. With the deepening of the pandemic scare, steel prices have dropped and the futures market has sunk. The first quarter has been almost wiped out for the dry bulk sector, and there is a crisis in demand for the immediate future.
Although the tanker market also had been reeling under surplus capacity pressures for the past several years, 2019 turned out to be an extraordinary year. The same geopolitical factors that had held back the tanker market from its anticipated recovery in 2018 gave an unprecedented boost to the larger oil tankers in early October 2019.
To begin with, tanker owners, hurt by prolonged excess capacity in the market, finally began to cut back on investment in new ships. Simultaneously, there was an increase in the scrapping and recycling of older ships in 2019, which tightened the market fundamentals.1 Tanker supply also was affected throughout the year, as about 700 large tankers spent several weeks in shipyards for planned sulfur scrubber installation to meet the IMO 2020 fuel mandate prior to the 1 January 2020 deadline. Then came the attack on two oil tankers in May and June near the Strait of Hormuz, and the attack on Saudi oil facilities in September, worsening the geopolitical environment and U.S.–Iran relations. Those relations already had been at a boiling point since April 2019, when Iran claimed its right to block the Strait of Hormuz if U.S. sanctions were to choke its oil exports. Another political driver—as part of U.S. trade sanctions—was the shunning of tankers used in transporting Venezuelan oil during the previous 12 months. And then there were seemingly tit-for-tat tanker arrests by British and Iranian forces.
In the midst of these market disruptions, any one of which would have
had significant impact under normal trading conditions, in late September 2019, the United States imposed sanctions against two units of COSCO—a large Chinese government-owned shipping company—for carrying Iranian oil exports. More than 50 very large crude carriers (VLCCs) operated by the COSCO units suddenly became unavailable, and the daily hire rates, already inching upward because of tightening supply, could no longer contain the market apprehension. Concurrently, in early October, there was a missile attack on an Iranian tanker in the Red Sea. This led to a massive hike in tanker rates, with some VLCCs’ daily earnings exceeding $300,000, almost ten times the prevailing daily
hire rate. Clarksons estimated that at those rates, a ten-year-old VLCC costing $47 million could pay for itself in just two voyages.
Euronav, a big tanker owner and operator, reported average daily earnings of $67,700 during the last three months of 2019, almost twice its average daily earning for the whole year. The benefits of the rate increase spilled over to the other tanker submarkets, akin to a rising tide lifting all boats, and Euronav’s medium-size (Suezmax) million-barrel tankers earned $60,000 daily during the last three months of 2019 versus $40,800 for the whole year. The rates softened to about $45,000 per day by the year end, and with the onset of COVID-19, plunged more than 80 percent from the October peak, as cited by the International Chamber of Shipping.2
Liquefied natural gas (LNG) shipping also had strong growth in 2019, both in trade volumes and ton miles. Clarksons estimated annual global LNG trade was worth $150 billion in 2019. Prior to the COVID-19 outbreak, this trade was projected to grow in 2020 by 7.4 percent in trade volume and 12.3 percent in ton miles. In anticipation of this growth, more than 141 new LNG tankers, costing $17 billion, were slated for construction per agreements signed in the past two years. Small-scale LNG production and transportation are expected to be key aspects of the next phase in its development. Developments in the LNG trade are particularly noteworthy as the United States is projected to become the world’s largest LNG exporter by 2025.
Continuing trade tensions and lukewarm worldwide GDP growth muzzled any substantial pickup in container trade volumes in 2019. Early statistics show the increase in containerized global trade was barely 1 percent in the first nine months in 2019, which gave a GDP multiplier effect of less than half a percent compared to multiplier rates of 3.4 percent in the 1990s, 2.6 percent during 2000–2008, and 1.8 percent during 2010–18. Tariffs and trade tensions generally are believed to be the main cause for the drastic drop in liner trade. Interestingly, although mergers and acquisitions have escalated the market concentration, the competition among top carriers has only ratcheted upward. The carriers’ amalgamation into three domineering vessel-sharing alliances with a global network helps them control their operating cost and, more important, rationalize their advertised sailings.3 In addition, the carriers held off new ship deliveries to control their shipping capacity. Many ships also were taken off the market for several weeks to install sulfur scrubbers, per the IMO 2020 mandate, to continue using the traditional heavy fuel oil. All these actions affected the supply side and helped carriers make substantial gains in lessening the surplus capacity almost a year ahead of projections.
UNCTAD’s 2019 liner shipping connectivity index (LSCI)—which captures how well countries are connected to global shipping networks—is an excellent tool to analyze the potential reach of COVID-19 aftereffects in liner shipping. The LSCI for China—the nerve center of liner services today—has increased 51 percent since 2006, when the index was first published. The next four most connected economies in liner shipping—Singapore, Korea, Hong Kong, and Malaysia—are all located in China’s proximity. The extensive cancellation of liner port calls in China has created a massive container imbalance problem and will affect Chinese exports as manufacturing plants limp back to normalcy. Even without the current pandemic, the long-awaited market equilibrium in liner shipping forecasted for 2020 is unlikely to materialize, if the delivery of 1.2 million 20-foot-equivalent units (TEUs) in new shipping capacity goes ahead as planned.
The U.S. Maritime Sector
This was a year of mixed emotions for the U.S. maritime sector. On one side, there were some extraordinary successes, but there also were undeniable realities that drove home the ground truth on U.S. maritime preparedness and seapower capability. The successes must begin with the centenarian Jones Act for its dexterity in combating yet another year of coordinated political attacks against “build[ing] up and maintain[ing] an American Merchant Marine,” the fundamental premise of Section 27 of the Merchant Marine Act of 1920.
Other positives include reauthorization of the Maritime Security Program (MSP) until fiscal year (FY) 2035; the large investment in U.S. ports, waterways, and small shipyards; a program to facilitate transitioning veterans with sea experience earning civilian mariner credentials; and a firm commitment toward the education and training of the maritime workforce for both afloat and ashore jobs. Then there is the new Cable Security Program authorized by the FY 2020 National Defense Authorization Act (NDAA)—and modeled after the MSP—which will help fill a strategic gap in the nation’s ability to expand, repair, and maintain its critical submarine cable infrastructure. To cap it all, a long overdue National Maritime Goals and Objectives Report to Congress (MARGO), a project seven years in the making, saw the light of day in early March 2020 after multiple rounds of interagency deliberations.
While these developments are commendable and some even noteworthy, what deserves greater attention is a reality check on U.S. seapower and force projection capability. A September 2019 stress test of the Ready Reserve Force (RRF) and the Military Sealift Command sealift ships under simulated activation conditions revealed they could provide only 40 percent of the 10.5 million square feet of available military useful cargo capacity. From the 61 ships in the Organic Surge Fleet (15 managed by the Military Sealift Command and 46 by the Maritime Administration), only 39 were ready for tasking, primarily because of age-related mechanical issues, and just 32 were able to execute their mission. With an average age exceeding 45 years, that even 32 vintage ships could execute their mission is a testimonial to the skill and proficiency of the crews maintaining those vessels. This is a highly discomforting picture of U.S. sealift’s capability to adequately support its warfighters, especially while operating in a contested environment against a major adversary.
Furthermore, although sealift operations against any near-peer competitors will be carried out in contested waters, the capability to maintain, repair, and even build new ships for a resilient military supply chain has been depleted substantially, as noted in two recent reports from the Center for Strategic and Budgetary Assessments (CSBA). The Center articulates a strong case that the current U.S. sealift capability and maritime defense industrial base are inadequate to support the nation’s defense strategy against China and Russia.
Surge activation of all RRF ships would immediately require more than 1,300 sealift-qualified mariners ordinarily attached to U.S.-flag commercial ships.4 Assuming those civilian mariners are available and willing to serve, the next rotation of crew would require an additional 2,000 sealift-qualified mariners, at which point there would be an unavoidable impact on domestic shipping operations at what would be a vulnerable time for the U.S. economy. This would not have been an issue in the early 1990s, when the number of U.S.-flag commercial ships was more than twice the current fleet. Today, however, the number of sealift-qualified mariners employed on large U.S.-flag commercial ships is estimated to be about 1,800 short of the minimum required to sustain sealift mobilization beyond the first four to six months.
The flaws in U.S. seapower and force projection capability assumptions do not end there. Sustaining deployed ground forces and the Navy combat fleet will require consistent fuel supplies, for which the nation needs a fleet of internationally operable product tankers. The assumption that the “ensured access” for refueling will come from foreign-flag ships, including those under effective U.S. control (EUSC), is a red herring. Changes in tax law dating to the mid-1980s, obfuscating legal layers to avoid liability and ownership accountability, and other security-related developments, including lack of control over those ships’ crews in a post-9/11 geopolitical environment, effectively have made the EUSC an impractical, illusory, and unwise option for national security purposes. Of the seven internationally trading U.S.-flag product tankers, only two are in the MSP fleet and provide ensured access to the Department of Defense. It is estimated the United States will need more than 80 product tankers to meet refueling needs, far exceeding those currently trading under the U.S. flag.5
The 2020 MARGO Report distills four goals and 39 objectives for building a stronger maritime nation, all of which are commendable and appropriate.6 It is, however, bound to raise the skepticism of being “too little, too late, and too skimpy.” A major predicament with U.S. maritime policymaking stems from how the various authorities are dispersed among the more than two dozen executive departments, agencies, and directorates that have at least a tangential interest in the nation’s maritime matters. In contrast, U.S. maritime competitors, both traditional and new, have a streamlined and focused approach toward policymaking that makes their coordination nimbler and easier to execute. So, much as there is a compelling story to demand a resurgence of U.S. maritime capability, the key to getting it done is a national will and commitment, as observed by the Honorable Mark Buzby, the current Maritime Administrator.
As of 15 March 2020, all indications are for COVID-19 to continue disrupting global commerce over the next several months. What first garnered attention as a crisis in demand for raw materials in China has mushroomed into a global crisis in supply as well, affecting all aspects of world shipping and beleaguering all related markets, including the cruise sector. With the industry holding its collective breath, the long-awaited recovery in major shipping markets will remain elusive in 2020.
Domestically, the U.S. Merchant Marine is on an active recovery glide path and rising to its challenges in many aspects. Despite the obstacles that lie in its course and the gross misinterpretations of its perennial critics, there is a visible groundswell that may help propel a renewed national maritime commitment that has been missing for several decades. Perhaps the centenary year of the indefatigable Jones Act is the time to jumpstart a fresh sense of purpose for the nation’s merchant marine and implant a new ecosystem that blooms our maritime prowess.
More from Shashi Kumar:
1. As per Clarksons, 31 VLCCs were recycled in 2019, the largest number since 2002. See, “The Spike in Oil-Tanker Rates May Be Over, But a Boom Is Coming,” Bloomberg News, 13 November 2019.
2. It is on the ascent again, fueled by the price war between Saudi Arabia and Russia that began in early March 2020; many older, large tankers are being used for storing crude oil in anticipation of higher future price.
3. As per Drewry Statistics, liner operators canceled as many as 253 east-west sailings (compared to 145 cancellations in 2018), owing to lack of demand.
4. Sealift-qualified mariners meet all domestic and international requirements to operate ships of the size used for sealift. In addition, they hold a current security clearance, a valid Transportation Worker Identification Credential, and the U.S. Coast Guard medical certificate and have sailed at least once within the past 18 months.
5. The actual requirement in a major war will be much higher than the publicly estimated 80-plus tankers.
6. The four goals stated in the 2020 MARGO Report to Congress include strengthening U.S. maritime capabilities essential to national security and economic prosperity; ensuring the availability of a U.S. maritime workforce that will support the sealift resource needs of the National Security Strategy; supporting enhancement of the U.S. port infrastructure and performance; and driving maritime innovation in information, automation, safety, environmental impact, and other areas.