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Increasing environmental compliance costs provide wiggle room to hike freight rates

An intriging idea is doing the rounds on waterfronts of the world, and that is, increasing environmental compliance costs imposed on shipping may well contribute rate recovery out of China in 2024.

Even the Panama drought, which has restricted the size of ships transiting the waterway stands to contribute to boosting rates from last year's four-year low of US$1,000 per TEU.

Given the higher costs imposed, there is good reason to believe that rates will land somewhere between 25 and 30 per cent above those obtained in 2019, considered the last year of the "old normal". 

Rates below break-even “will not last very long,” says Hapag-Lloyd CEO Rolf Habben Jansen. “There are some indications that the market has bottomed out and short-term rates will come up.”

For 2024, Mr Habben Jansen said that container shipping demand will likely return to its single-digit growth rate of three or four per cent.

As some see it, rates will need to rise 25 per cent in 2024 to cover higher operating costs for carriers and new carbon emissions taxes on the shipping industry.

But the news is not as gloomy as one is led to believe. Container Trade Statistics (CTS) show container volumes through the first nine months of 2023 were only slightly below the same level as last year and space on ships is tight, forcing cargo to be delayed at origin. Carriers do not have more ships to deploy with idled vessels representing only one per cent of global capacity. There are also reports of boxes being rolled.

Thus, from all appearances, the threat to a supply and demand imbalance seems to be overblown.

The industry also must cope with the European Union’s emissions trading system (ETS) this year. Aimed at putting a tax on the carbon emissions of shipping to and from European ports, Hapag-Lloyd will tack on an additional $14 to $131 per TEU depending on the container type and the port pair. The silver lining in this cloud is the element of pricing elasticity.

Elasticity includes confusion with the ETS in relation to China exports with carriers  adjusting to Chinese regulations requiring that the costs associated with the European Union’s emissions trading system be included within the base freight rate of all China to Europe container bookings. This tends to counter the initial plan was to respond to the European eco-tax as a surcharge on the cargo.

While the preferred approach by carriers is to calculate exposure to the ETS and recover costs per container in a separate surcharge on top of the base rate, that will not be possible for Chinese exports to Europe. Which of course, represents the bulk of traffic to Europe from the Far East.

“In line with the Shanghai Shipping Exchange regulation, the EU ETS must be included in the freight rate only for exports from China,” Hapag-Lloyd said, adding that Chinese imports did not fall under the regulation.

Thus, surcharges are regarded by the Shanghai Shipping Exchange - established by the Chinese Ministry of Transport in 1996 to promote fair competition in the industry - as being temporary to cover additional increases in costs and not meant to be a permanent charge.

Maersk has also informed customers of changes in the way the ETS surcharge will be applied to Chinese cargo compared with other origins of European imports.

For all bookings from China, though not Hong Kong and Taiwan, Maersk decided to add the EU ETS cost to base freight rates instead as a surcharge to comply with Chinese authorities.

Adding confusion to attempts to forecast rates to come in the balance of 2024 is the number of new ships coming into service that will lead to oversupply with order book data showing 2.9 million TEU of new capacity joining the global fleet.

Counter balancing this influx of fresh tonnage is the relief expected from the increased volume of recycling of older ships as indicated by the UN's International Maritime Organisation’s (IMO) Carbon Intensity Index (CII). This went into effect this year, and forced the scrapping of older ships that do not meet the increasingly stringent standards for reducing their carbon dioxide output. 

Vessel speeds will also be reduced to meet the CII thresholds, which will also require more ships be put in weekly services to maintain schedules, adding that some vessel deliveries will also likely be deferred. 
Top 10 carriers' containership fleet and newbuild capacity on order.

So while new ships are coming, optimists expect to see recovery in demand. Scrapping, order slippage and CII rules will require people to deploy more capacity. So, if that turns out to be the case, and optimists are right, the market will be more balanced as retail inventories decline and return to normal levels.

Another factor contributing to the need for more tonnage deployed worldwide, the reduction in utility of the Panama Canal owing to a low water condition denying bigger ships and heavily laden smaller ships the ability transit the waterway without scraping bottom. (Ironically, the Upper Rhine suffers the reverse problem - too much water so the ships don't have the air draft to clear bridges.)

But the Panama water draft problem also plays a role in absorbing new supply. What's more, Panama's problem has revived interest in the Suez Canal where services have been rerouted from Asia to the US.

Optimists rule the roost at this juncture, but such an outlook may not be justified over time. It seems that factors tending to increase rates back to the old normal are created by conditions dictated by bureaucratic regulation to address problems like the "climate emergency" that may not exist. The 20th century rife with examples of central planners planning economies while divorcing themselves from the true dynamics of supply and demand with results having been repeated often enough for all to see.

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If freight rates are bumped up by dint of state regulation to levels enjoyed before the Covid crisis, will this lead to prosperity in world shipping or a less desirable outcome?

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China Trade Specialists