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Global Economics

Shipping Industry Fights for Survival

A brutal downturn in global trade has left shippers with idle capacity, billions in losses, and even facing potential bankruptcy

The Andromeda towers almost 40 meters (131 feet) above Hamburg's Burchard wharf, as countless feeder ships and container stacking vehicles bustle around it like insects around a bored elephant. Shipyard CMA CGN's new flagship container ship, one of the world's largest, boasts a 100,000 horsepower engine, can carry 11,400 containers, is 363 meters long and was delivered from South Korea only a few months ago—at a price of $160 million (€111 million).

The Andromeda was built for an economic boom that never seemed to end, at a time when more and more containers, bigger ships and ever-growing port facilities were needed.

With each passing minute, lift bridges hoist containers from the quay wall onto the deck of the 100,000-ton behemoth. When fully loaded, the vessel has space for containers arranged up to 18 wide, 86 long and 19 tall. In the end, the Andromeda is loaded to about two-thirds capacity. "That's not bad," says Captain Ivan Bozanic. "At least nowadays."

The next day, the CMA flagship leaves Hamburg for China, the point of origin of its 68-day round-trip voyage. The Andromeda travels exclusively between East Asia and northern Europe, a speedway of global trade. It steadily shuttles TV sets, mobile phones, T-shirts, and everything else China's factories are churning out, toward the West, and returns to the East loaded with finished parts, machines and empty containers.

Until not too long ago, shipping was both the greatest beneficiary and hammering pulse of globalization, moving goods around the world at an ever-increasing pace. The industry has been growing rapidly from year to year, ever since China became the world's factory. In 2008, roughly 500 million standard containers (TEU) were transported on the world's oceans—twice as many as at the turn of the millennium.

Year after year, new and ever more massive ships were built, ports were expanded and new scheduled service introduced. The cargo capacity of the world's combined container fleet increased from 4 million TEUs in 2000 to 12.5 million today.

Many became rich in the years of the boom, including ship owners, bankers and investors, particularly in Hamburg. In the last decade, the northern German port city became the world's leading center for the financing and operation of new ships. Germans own 35 percent of the container ships in operation worldwide, and close to 60 shipping banks and financiers are headquartered in Hamburg. Hamburg-based Hapag-Lloyd became one of the world's leading shipping line operators.

A Stifled Boom

But now the global financial and economic crisis has stifled the boom in container shipping, and it has happened almost overnight. For the first time in its history, the industry has stopped growing and, in fact, is shrinking. In the first six months of this year alone, the shipping industry declined by close to 16 percent.

The new giant ships are now much too big for the cargos they transport by sea, and often they sail half-empty—if at all. Billions are being spent to expand ports to handle a boom that no longer exists. Leading shipping line operators are on the verge of bankruptcy, as are shipping banks and charter shipping companies. The industry, once one of the biggest beneficiaries of globalization, now threatens to turn into one of its chief casualties.

"There has never been a crisis like this before," says Reinhard Lange, the CEO of Kühne + Nagel (KNIN.F), the world's largest sea-freight forwarder. Shipping line operators alone are expected to suffer combined losses of $20 billion in 2009.

Drewry Shipping Consultants, the world's top consultant to the industry, warns: "The industry is looking at the edge of a deep abyss." And industry publication Lloyds List writes: "Container shipping was thrown into a full-scale panic."

This sense of panic is more palpable in Hamburg than almost anywhere else in the world.

A Symbol of the Crisis

For more than a century, the Hapag-Lloyd headquarters building has dominated the Binnenalster, the lake that shapes the Hamburg cityscape. The inscription above the entrance of the magnificent structure, built in the Wilhelmine style, reads: "My Field is the World." The building symbolizes Hamburg's global importance as a port city and the 160-year-old, deeply traditional company's prominence as a world-class shipping company.

But now it has become a symbol of the crisis. Ironically, Hapag-Lloyd, consistently recognized in the industry as probably the most efficient among the major shipping line operators, is struggling to fend off bankruptcy. Its case has attracted the nervous attention of ship owners, banks and shipping company executives around the world. If a company like Hapag-Lloyd can't survive, they are asking themselves, who will be the next victim?

The traditional German shipping company lost €222 million in the first quarter, and it will need close to €1.75 billion to stay afloat over the next 18 months. "At current prices, we aren't making money on any route," Ulrich Kranich, the executive board member in charge of global operations, says, summing up the main reason for Hapag-Lloyd's financial woes. Shipping companies currently receive only about $500 to ship one container from Asia to Europe—about $300 less than they need to cover their costs. A year ago, shipping companies were still collecting more than $1,500 per container.

'There Was Never a Shortage of Cargo in the Past'

Although the shipping industry has always gone through cycles, shipping companies now believe that things have changed drastically, and for the worse. "There was never a shortage of cargo in the past," says Kranich. But that's no longer the case today. Because of declines in consumption in the West and production in the East, the global container fleet's enormous cargo capacity can no longer be filled. The resulting sharp decline in prices means that almost all shipping companies are generating substantial losses.

Efforts by shipping companies to raise prices have been as desperate as they are ineffectual. Officially, at any rate, shipping line operators recently raised the fees they charge for service between Asia and Europe by $500.

However, higher rates have little effect on consumers and producers, because the costs of maritime transport hardly enter into the calculation. It costs $10 to ship a TV set from Asia to Europe, while shipping a vacuum cleaner costs $1 and a bottle of beer 1¢.

The invention of the container made such prices possible in the first place. Nothing has advanced globalization more since the mid-1980s than the boom in these steel boxes. China's rise to global economic power would be inconceivable without containers. The more shipping costs declined, the more it made sense for Western companies to outsource production to faraway parts of the world. "Chinese factories rarely have warehouse capacity," says Kühne + Nagel executive Lange. "They often produce directly in the container."

In fact, shipping costs are so low today that it is even worthwhile to ship Spanish tomatoes to China for processing into tomato paste, which is then shipped back to Europe. Dutch tulip bulbs are shipped to New Zealand and then returned to the European market in the form of mature plants ready for flowering.

Cut-Throat Competition

In the current financial crisis, financially strong shipping companies are fueling the price war even further to gain market share, at least according to their less well-heeled competitors. "There is cut-throat competition going on," says one ship owner.

Maersk (MAERSKa.CO) CEO Eivind Kolding makes no secret of his view that the shipping industry would probably be in much better shape if only a handful of global shipping companies were to exist in the future. Many in the industry assign part of the blame for the disastrous situation today to Maersk.

Although Maersk also lost money—$373 million—in the first quarter, the Danish shipping company is owned by an oil and gas company that can more easily shoulder the losses in its shipping division.

None of the world's major shipping companies is currently turning a profit. Singapore-based NOL, for example, posted a $245 million loss, while South Korea's Hanjin lost $110 million.

Like Maersk, though, these companies have the backing of either financially strong corporations or their governments. NOL is owned by the Singapore state investment fund Temasek, which just approved a $1 billion capital increase. The Chinese shipping companies Cosco (600428.SS) and China Shipping (601866.SS) can rely on the support of their government. The same is true of Japanese shipping line NYK.

'Without Outside Help, We Won't Make It'

But Hapag-Lloyd appears to have been hit by the biggest crisis in shipping at the worst possible time. Because it was forced to transfer its substantial profits from previous years to its ailing parent company TUI (TUIGn.DE), the Hamburg shipping company was barely able to build any reserves. At the end of last year, TUI sold Hapag-Lloyd to a consortium of the City of Hamburg, local businesspeople and banks. At the same time, it burdened the shipping company with €1.3 billion in debt, creating an additional drain on a company already faced with operating losses. The consequences are clear for company management in Hamburg. "Without outside help, we won't make it," says an insider.

Initially, some of the company's own shareholders stepped in and, for €315 million, purchased Hapag-Lloyd's share of the Altenwerder container terminal in Hamburg. But Klaus-Michael Kühne, who had initiated the takeover last year, refused to play along, instead attacking the executive board and fellow shareholders, leading to heightened tensions at company headquarters in Hamburg.

To help shepherd Germany's leading shipping company through the crisis, the government is now being asked to provide a loan guarantee for up to €1 billion. In principle, the container business is still considered to be extremely profitable. Global trade is already on the rise again, and the hope is that prices will soon follow. "The load factor for ships coming from Asia has already increased," says Hapag-Lloyd executive Kranich.

A report by management consulting firm Roland Berger, which shipping companies have been putting to the acid test since early July, is intended to provide evidence of the future viability of Germany's biggest shipping companies. The Berger consultants conclude that Hapag-Lloyd's positioning and outlook are extremely positive, as the budget committee of the City of Hamburg confirmed two weeks ago. The same report was presented to the banks last Thursday. According to the presentation, "Hapag-Lloyd is well positioned and fulfills the key success factors of shipping line operators."

The report will be presented to the Hapag-Lloyd supervisory board this Tuesday. Once approved by the board, the request for a loan guarantee could be submitted to the government in Berlin early this week. Before that happens, however, all shareholders must agree to a capital increase of roughly €750 million, which the board has been struggling over for weeks.

Regardless, there will be substantial cutbacks at the Hamburg company. Job cuts and salary reductions will be unavoidable, say company officials.

Hapag-Lloyd is also getting rid of ships it leases. The company owns only about half of its fleet of 128 container ships. The other half are leased and, for this reason, are to be jettisoned more quickly. Hapag-Lloyd has already returned about 30 ships to their owners. Other shipping companies are pursuing the same strategy. Industry insiders say MSC, a Swiss company, does not plan to renew charters on close to 80 ships, while French company CMA which reportedly has up to 170 charter ships with charters about to expire.

This, in turn, is becoming an existential problem for many other Hamburg shipping companies suddenly faced with the return of ships they had been leasing to other companies.

Hard-Hit in Hamburg

Roughly 1,644 of the 4,619 container ships worldwide are German-owned. Largely unnoticed by the public, about a dozen Hamburg shipping companies, together with Hamburg banks and investment funds, became the world's leading force in the financing and construction of new container ships during the boom years. But instead of operating their own shipping lines, they have chartered out the vessels, often with crews included.

The boom of the last few years is also due in large part to an abundance of available cash at low interest rates. Spurred by tax savings models and the corresponding high yields, investors and banks pumped hundreds of billions into the industry.

And in Hamburg, with its traditionally cozy relationships between the financial market and shipping companies, plenty of people knew how to take advantage of the situation. A small elite of extremely tight-lipped Hamburg ship owners now plays the sort of dominant role in container shipping once played by legendary Greek tanker dynasties. One member of that elite group, Claus-Peter Offen, 65, bought his first ship at the age of 33 from a bankrupt estate and now operates more than 128 ships. Offen still has 20 contracts for new ships on his books, including one for the world's largest container ship, with a capacity of 14,000 TEUs. Another is Erck Rickmers, the son of a highly traditional family of ship owners, who has expanded his fleet from 46 to 118 ships in only 10 years. And ship owner Peter Döhle now operates close to 200 ships.

While keeping a low profile, the Hamburg ship owners have earned vast sums of money in recent years. "Even cleaning women drive Porsches," says an industry expert. Banks specializing in ship financing have also grown rampant, from barely a handful 20 years ago to almost 60 today.

The demand for container shipping seemed to be bottomless, given the seemingly unstoppable pace of globalization. Goods and commodities began circling the globe at an ever-increasing pace. But now ailing shipping line operators can hardly unload their ships quickly enough.

A Fatal Domino Effect

"The chartered ships will be returned in large numbers," warns a leading shipping manager. "Things will get very tight for many people in Hamburg." Another industry executive warns: "The big charter shipping companies will weather the crisis, but there will be a bloodbath among the smaller ones." Without adequate charter revenues, shipping companies will be unable to service their bank loans.

In past crises, shipping lenders and banks often simply allowed charter-shipping companies in financial straits to defer their loan payments, sometimes for up to 24 months, says an experienced Hamburg ship owner. But the financial crisis has made lenders more hesitant to issue credit. "Risk managers, not shipping bankers, are now making the decisions at banks," says a frustrated ship owner.

A fatal domino effect now threatens to strike the industry. The shipping line operators can no longer pay for their chartered ships, while the owners of the chartered ships and shipping funds can no longer afford to service their debts to the banks. Many of the banks, in turn, are also in trouble.

HSH Nordbank, the world's largest shipping lender, has outstanding ship construction loans worth €33 billion on its books. The bankers are seeking to allay concerns. "We already increased the equity ratio we require from shipping companies seeking financing 18 to 24 months ago," says Harald Kuznik, the head of the ship financing division at HSH Nordbank. The bank has also increased its risk reserves twentyfold—from 0.05 percent to 1 percent of credit volume.

Downturn Will Create Consolidation Pressure

This was the reasoning behind the move by Hamburg bankers and shipping company owners—most notably HSH Nordbank and Peter Döhle—to rescue the troubled Chilean shipping line operator CSAV two months ago. In return for shares in the company, the Chileans' loan payments were reduced by a third.

Hapag-Lloyd, in a letter it wrote in late June to the owners of the ships it charters—including Döhle and Rickmers—accused them of "distorting competition" and requested talks "on extending the charter contracts at reduced rates." The effort apparently paid off, according to Hapag-Lloyd, which says rates are now up to 30 percent lower.

A Glut of New Ships

But the real problems are still ahead for German shipping companies. The 1,550 new ships that were on order in mid-2008 are to be delivered in the next few years. The major Asian shipyards are unwilling to accept cancellations.

Some ship financiers have already decided to forfeit down payments already paid to the shipyards, which can amount to up to 40 percent of the total price, because they lack the additional millions needed to take delivery of the ships on order. Most others are trying to negotiate with the shipyards to at least delay construction, in the hope that the situation will improve significantly in a few years.

The orders for new container ships now on the shipyards' books represent a total capacity of 5.3 million TEUs, or about 50 percent more than current worldwide container fleet capacity. Even if global trade recovers by next year, this glut of new ships will create enough excess capacity to depress shipping prices.

To reduce loading capacity, ships are already being decommissioned today, and they now lie at anchor, unused, in ports, estuaries and bays around the world. Ironically, most of these idle ships are at anchor off one of the most important arteries for world trade: the port of Singapore.

A visit to this final resting place of the products of globalization involves a 45-minute boat ride into the waters off Singapore. The armada of decommissioned ships at anchor there—all classes of tankers and freighters, as far as the eye can see—is an eerie sight.

About 130,000 ships put into the Singapore harbor

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