The annual contract season is down to the final stretch in the trans-Pacific shipping market. U.S. import costs, liner profitability and service reliability all hinge on where contract prices settle in the next few weeks.
The plot twist this year is that the prior round of annual contracts were signed at historically high levels and the timing of the current contract RFP season coincides with a period of still-sinking spot rates.
Import demand remains weak due to bloated inventories, with inbound volumes reminiscent of spring 2020, when the culprit was COVID lockdowns.
The risk ahead: If shipping lines cannot obtain enough contract business at rates sufficient to cover costs as a result of weak demand and falling spot rates coinciding with the 2023 contract RFP season, the lines could take drastic action and cut much more capacity in the trans-Pacific, reminiscent of what they did in 2020.
If shipping lines cut more capacity at the same time import demand recovers in the second half after inventories wind down, spot rates would rise and shippers that secured cheap annual contracts starting May 1 may ultimately find their contract cargo bumped by carriers moving higher-paying spot containers, a replay of what happened three years ago.
The complexities surrounding the 2023 trans-Pacific RFP season were addressed by digital freight forwarder Flexport in a presentation on Thursday. For additional perspective, FreightWaves interviewed Nerijus Poskus, Flexport’s vice president of ocean strategy and carrier development.
‘Next two weeks are crucial’
“Most fixed contracts will have to be finalized by the first week of April,” said Poskus. “Some of the big BCOs [beneficial cargo owners] have already signed and I think we are going to be next.”
According to Anders Schulze, Flexport’s global head of ocean, Flexport currently predicts trans-Pacific contracts rates will be around 70% below 2022 base contract rates (not including premium surcharges) “and will settle around 30% higher than current floating levels.”
“Current spot rates are unsustainable because carriers have higher costs than pre-pandemic due to higher charter rates and bunker costs,” Schulze noted.
Poskus told FreightWaves, “I am hearing that the big BCOs are signing rates proposed by carriers that are higher than the spot market.
“The next two weeks are crucial,” he continued. While the final outcome of rate negotiations won’t be known until April, Poskus expects contract rates will be around $300 to $500 per forty-foot equivalent unit above current spot rates.
Inventories are still too high
The pandemic created unprecedented market dynamics in container shipping, leading to a massive spike in consumer goods imports.
The aftereffect of the COVID-era buying spree is a collision between sinking spot rates and high prior-year contract rates just as the current contract RFP season reaches its conclusion.
The surge in spot rates in 2021-2022 and the collapse in service reliability compelled U.S. importers to sign annual contracts at extremely high rates last year. It also convinced them to bring in far more cargo than they actually needed, leading to a massive “bullwhip effect” that has inflated inventories in 2023.
“We’re hearing cases of importers with enough inventory for the next six months who are only importing to keep their suppliers alive,” said Poskus. “There is also an extreme case where a client said it has enough inventory for one year.”
During Thursday’s presentation, Flexport polled shipper attendees on their inventories and 62% said they had too much. That’s effectively unchanged from December’s poll, when 63% said they had too much.
RFP backdrop: Falling spot rates
Excess inventories explain why trans-Pacific spot rates continue to fall. Carriers have already cut capacity, but not enough to offset lower import demand due to high inventories.
Freightos Baltic Daily Index (FBX) trans-Pacific spot assessments continue to decline. The FBX put Friday’s Asia-West Coast rate at just $1,017 per FEU, a new post-pandemic low.
FBX Asia-West Coast assessments are down 20% month on month, 26% year to date and 94% year on year (FBX included trans-Pacific premium surcharges in addition to base rates in 2022).
The FBX assessed Asia-East Coast spot rates at $2,129 per FEU on Friday, down 16% month on month, 26% year to date and 88% year on year.
Spot assessment in USD per FEU. Blue line: China-West Coast. Green line: China-East Coast. (Chart: FreightWaves SONAR)
The worst-case scenario for shipping lines was for the annual trans-Pacific contract season timing to coincide with a backdrop of falling spot rates — which is exactly what happened.
The conundrum for ocean carriers is that it does not make financial sense to sign annual commitments at current spot levels.
Xavier Destriau, CFO of ocean carrier Zim (NYSE: ZIM), said during a conference call on March 13 that shippers are pushing for “significant [contract] rate reductions compared to last year and we understand that,” but “we have set a limit in terms of where we are not willing to go, in terms of a floor.”
“If we don’t get the rates we believe make sense for us to continue sailing, we will stop sailing. And if we stop sailing, it may have a drastic effect on the ability of customers to secure their supply chains.”
Second-half risk to spot players
The current consensus is that imports will pick up in the second half as inventories come down, leading to at least some semblance of a traditional peak season. This should finally stop the bleeding for spot rates and push them upward.
Some importers are happy to take that future spot risk and forsake contracts in 2023 given what they’re saving in the spot market in the first half. Poskus said that around 60-70% of trans-Pacific volumes moved on annual contracts pre-pandemic and the ratio should be lower this year, with more on spot.
According to Kaitlyn Glancy, Flexport’s vice president of North America, “A number of our clients are playing the spot market and that is working really well. [Spot rates] are getting lower every day — almost concerningly low.
“There’s a risk that spot rates might go higher in the back half of the year, but for some clients, the priority right now is managing costs and maximizing margins where you can. If you’re still sitting on a lot of inventory and you paid a lot of money to get it here, cost is king and getting your costs under control in the first half is your top priority.”
Second-half risk to contract holders
Shippers that secure low contract rates for May 2023 to April 2024 face second-half risks if carriers make much larger cuts to capacity.
Poskus believes the most likely scenario is for contract rates to marginally exceed spot rates at the beginning of the contract period, then for spot rates to rise and reach more of an equilibrium with contract rates in the second half.
However, there is a possible scenario wherein spot rates jump higher than fixed contracts. “That can happen if carriers pull too much capacity out, and in that case, allocations under fixed contracts are at risk. This is not completely unlikely — it’s what happened in 2020.”
He told FreightWaves, “I am worried that carriers will take drastic action in terms of capacity and there is a comeback in volume in the second half.
“If contract rates are at unsustainable levels, carriers will just stop sailing. Service reliability will not be there anymore. It’s best for everybody if shipping lines are just slightly profitable because you’re still getting a great deal on rates and service is more or less sustainable.”
Poskus warned during the Flexport presentation, “Your service level is going to be considerably better if you’re paying [contract rates] that are basically the average of what carriers load on a vessel. If you’re paying under that, guess what happens? Your cargo is probably going to leave on the next sailing. If you’re paying $50 or $100 [per FEU] more, your cargo will be treated better.
“We’re not talking about what we saw in 2021-2022, when people were paying $20,000 or $30,000 [per FEU]. In this case, $100 can meaningfully change your loading priority. And at the end of the day, that doesn’t materially change your cost.”
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