Friday, 11 March 2016

As shipping freight rates fall; what does the future hold?

What is the similarity between oil prices and shipping freight rates? Of course, the first similarity is that the prices of oil and shipping freight rates have been consistently falling for the last two years. Both oil prices and shipping freight have another similarity. Both have been hit by a global economic slowdown which has resulted in contraction in demand. But the most important similarity between oil prices and shipping freight rates has been the build-up of excess supply. Like oil companies invested heavily in shale capacity when oil prices were at above $100/bbl, similarly shipping companies also built up tremendous capacities during the last 3 years when the CCFI Freight Index was quoting in the range of 1150-1200. Today the index is down to 735 and, with more capacity coming up by the year 2019 it is doubtful how much the freight rates can increase from here.
Consider this simple example. Today it costs less than $300 to move a 40-foot container from Shenzhen in China to Rotterdam in the Netherlands. This is not even sufficient to cover the cost of fuel and handling. Even if we do not consider the exorbitant Suez Canal fees, the entire trip is unviable to begin with. But cargo is still moving at these cheap rates, before ships cannot afford to idle. Remember, both oil extractors and shipping companies have taken on tremendous debt to fund this expansion and hence they will have to continue to supply, irrespective of low prices.
Falling Freight Index...

As the above chart suggests, Shipping Freight Index has fallen from a high of 1150 in 2014 to as low as 735 in March 2016. For a very long time, the large shipping companies could manage to maintain the price at profitable levels due to their control over the shipping lines. But then, enormous shipping capacity has been built up in the last 3 years. Shipping capacity grew from 15.4 million TEU in 2011 to 19.6 million TEU in 2015. Hence, the luxury of managing price is not there with shipping companies any longer. The immediate mandate is to run all ships at full capacity and focus on market share instead of pricing.
So, is it all about a global slowdown in trade?
There has been a slowdown in trade worldwide over the last one year, including in China. But weak trade does not tell the whole story. For example, China’s annual imports are at $1.95 trillion and annual exports at $2.4 trillion. At a total trade value of $4.35 trillion, China is still contributing a lot more to global trade than it was doing 3 years ago. Ironically, the CCFI freight index was at a high of 1200 before 3 years. Therefore, the fall in volumes does not entirely explain the sharp fall in shipping freight rates.
It is actually about overcapacity in shipping:
We have already seen how Global Container Ship Fleet has increased its capacity by 27% in the last 4 years. The demand has simply refused to keep pace with this massive overcapacity that was initiated back when the CCFI Freight Index was at a high of 1150-1200 range. In fact, global consultancy firms like the Boston Consulting Group (BCG) expect another 30% increase in container ship fleet capacity by 2019 before the overall supply will plateau out.
The road ahead for container ships:
The scenario described above is hardly a sustainable scenario. But the bottom-line is that this situation is unlikely to change for the next couple of years till the time supply does not plateau and demand does not pick up. Both are unlikely to happen immediately. Broadly, there are a few key strategies that global shipping freight companies are adopting to overcome this supply glut:
·        The fist strategy has been to keep their cost of operation at optimal levels to stem losses for the next few quarters. One example is of container ships moving oil via the Cape of Good Hope instead of the Suez Canal. Due to cheap crude oil prices, shipping companies can afford to do the same. This also enables them to save on the Suez Canal fees and also make profit out of trading in oil in the midst of volatile prices.
·        Some shipping companies are trying to kill excess capacity to ensure that this supply disruption will impact prices positively. For example, Maersk A/S, the world’s largest shipping company has recently cancelled orders for 6 Triple-E class ships. Such cancellations may become more common as shipping fleets will try to move towards supply disruption.
·        Shipping of freight is a highly commoditized business and the scope for differentiation is quite limited. Hence some of the larger shipping fleets are trying to diversify towards other higher margin businesses like port terminal operations, marine maintenance services and supply chain management.
·        There is likely to be a major shakeout in the shipping freight industry. Many large fleets have invested hugely in creating economies of scale. Smaller and medium sized companies in this space may now become acquisition targets as supply gets automatically streamlined and rationalized. Normally, such tough times get to see synergistic alliances where competitors tend to complement each other. For example, two of the largest shipping companies, Maersk A/S and MSC have already formed alliances to share routes and costs. Similarly, four of the largest Chinese have also formed a national alliance to create virtual scale in the shipping industry to tide over this situation.
Future lies in Uberization of Shipping Fleet:

We believe that the future of the Shipping freight industry lies in a kind of Uberization. Today the Shipping industry is vastly demarcated between the large fleet carriers and the small & medium sized carriers. The small and medium carriers are already finding it hard to survive in this tight freight market. With the larger names forming formal and informal alliances, the effort will be to squeeze out the small and mid-sized companies from the shipping freight business. The major drawback in the global shipping freight industry is that there is no scientific methodology for aggregating demand and supply and matching them. Once this is done the entire shipping freight business can become a lot more democratic and competitive. That is probably the best answer to the woes of the shipping freight industry today. 

Wednesday, 2 March 2016

FDI in Logistics industry and the major challenges ahead...

A clear cut FDI plan for the logistics sector in India becomes critical considering that the logistics sector in India is currently in the growth stage. China and the US where logistics cost as a percentage of cost of manufacture is much lower, Indian companies still spend nearly 14% of their cost on logistics. This is substantially higher than the 6-7 % that most developed countries spend on logistics due the fact that the logistics infrastructure is much more matured and fine-tuned in these countries. That is where FDI in the logistics sector along with the strategic, procedural and technical know how can be a great value addition.

FDI in Logistics sector
Currently, the foreign direct investment (FDI) in India is allowed thorough 2 routes viz. Automatic Route and Government Approval Route. Most of the key logistics related services are covered under the 100% automatic route for FDI. Hence, there is no specific approval required from the Foreign Investment Promotion Board (FIPB) or the Cabinet Committee on Economic Affairs (CCEA). Current FDI regulations permit 100% FDI via the automatic route in areas like Transport services, Transport incidental services, Rental and leasing of transport vehicles, rental of transport equipment, storage services and warehousing services. While FDI has not yet been permitted in the transport operator service, there is still sufficient scope for the FDI to add value in the support services space. Some of the mega logistics management companies in the world like NYK Line, Hitachi Transport Systems, Sembcorp Marine, Kerry Logistics, TNT and FEDEX are already present in India and have already acquired stakes in Indian companies through the M&A route.

It is interesting to note that nearly 35 out of the top-50 global logistics companies already have a presence in India. Their presence could either be through the M&A route, subsidiary route, JV route or liaison route. The tax incentives are also quite attractive. For example for the cold chain and warehousing facility, there is a 100% deduction on capital expenditure incurred during the year (other than acquisition of land, goodwill and financial instruments). The question then is why is FDI not coming into India in a big way? The answer has partially to do with policies and partly with the ease of doing business.

Challenges to FDI in Logistics sector in India...

There are some key challenges to the inflow of FDI into the logistics sector in India and here are a few that the sector faces to attract FDI:

  •          India still ranks 133rd in terms of ease of doing business. China is ranked 89th. This ranking has improved marginally after the efforts of the present government but there is still a long way to traverse.
  •          It is not just about ease of doing business. Even in terms of starting a business, enforcing contracts and winding up a business, India ranks way behind other emerging market economies like China, Russia and Brazil.
  •          Although logistics FDI is defined as under Automatic Route, there are Ministry level clearances that need to be obtained. Additionally, there are environmental clearances which can be quite a cumbersome task.
  •          There is also the risk of rehabilitation and relocation clearances. If your project displaces the local population or impacts their livelihood, then the businesses need to focus on how to relocate and offer alternative livelihood to those displaced. More often than not, such activities acquire political and activist overtones and global business houses may want to avoid getting embroiled in such matters.
  •          Adjacent infrastructure development is a key risk for many such projects. For example there may be a projection of revenues based on traffic and demand which will be based on certain assumptions. If the adjacent infrastructure, on which you have no control, does not keep pace, then such projections can go awry negatively impacting the financial viability of the project.
  •          Time and cost over-run is another risk that FDI in India faces. In India activities like land acquisition, rising cost of material, rising cost of equipment can result in time and cost over-runs. Since many of these activities have regulatory implications, the investor is not in control of many of these things.
To cut a long story short, the challenges for FDI in the logistics sector in India are many. But then so is the opportunity. Logistics is already a $400 billion industry and is likely to be a $1 trillion industry in the next 5 years. This is the one area that can promise humongous growth for foreign investors. Secondly, logistics is the missing piece in catapulting India’s GDP growth from 7.5% to 10%. We have seen in China how infrastructure and logistics can combine to give a major thrust to growth. India is in a similar sweet spot. Thirdly, there is a fairly FDI-friendly regime as far as the logistics sector in India. There are challenges on the ease of doing business but the current government is moving on a war footing to make India more competitive and friendly to foreign investors. It is more a question of when; rather than whether!