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March 2 2020

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48 The Journal of Commerce | March 2 2020 Commentary Lars Jensen ANY DISCUSSION PERTAINING to rate levels tends to draw multiple oppos- ing views, depending on whether the issue is seen through the lenses of carriers or those of different ship- pers, especially as we near the annual contract negotiation season for the trans-Pacific trade. Nonetheless, it is of interest to look into an aspect of head- haul rates versus backhaul rates, as the discrepancy deviates significantly from the structural market imbalance. In essence, the data shows that backhaul shippers are de facto being partially subsidized by headhaul shippers. For the Pacific backhaul, this is in the ballpark of $1.6 billion annually. Whether this implies that backhaul shippers should pay more or is simply a result of differing sup - ply and demand equations between headhaul and backhaul is a subjective discussion. But is it true that such a de facto subsidy exists? And how would one measure it? The heart of the matter is quite simple. More containers are shipped eastbound than westbound on the trans-Pacific. The vessels, as well as the containers themselves, naturally have to be moved for a full round trip. Therefore, this opens up discussion of who should "pay" for the cost of the empty slots, as well as empty contain- ers, on the backhaul. With more cargo moving east- bound than westbound, it's also logical that eastbound cargo pays a higher share of the full round-trip revenue. Over the past year, headhaul volume accounted for 71 percent of the full round-trip volume from Asia to North America. It would therefore also appear logical that it should account for 71 percent of the revenue. But this would not be seen as reasonable, as the headhaul volume gives rise to empty container move- ments which, logically, also should be paid for by the headhaul shippers. If the empty container volume is taken into account and assigned fully as additional volume to the headhaul shippers, the result is that the head- haul shippers should account for 79 percent of the full revenue. This split can be tested by calcu- lating the revenue received in either direction based on the spot rate indi- cations from World Container Index (WCI). Using this as a data source, it turns out that 89 percent of the round-trip revenue comes from the headhaul cargo and only 11 percent from the backhaul cargo. It's therefore clear that the price being paid by the headhaul shippers covers significantly more than their own cargo, as well as the return of empty containers and vessel slots, whereas the backhaul shippers are not — proportionally speaking — covering their full shipments. It is then possible to calculate the difference between the theoretically balanced split — a revenue share of 79 percent — and the actual split of 89 percent. This yields a result of $1.6 billion annually, meaning head - haul shippers do, in fact, subsidize backhaul shippers by that amount each year under current market conditions. At this point, there are a number of caveats to note. First, this analysis is based on spot index rates, as they are the only credible index rates available on a comparative basis in both trade directions. Contract rates can deviate from spot considerably, calling the specific number into question. But this argument is equally valid in both directions, and while calcu- lating the number based on contract rates might yield a slightly different result, the conclusion itself appears unlikely to change. Significant rate differences abound, especially among different backhaul shippers, and hence the conclusion is an overall average, not necessarily applicable for each shipper. That this is the state of affairs in the market isn't surprising in itself, but it should give rise to some reflec- tion on market dynamics. As headhaul shippers account for a disproportionately large share of the round-trip revenue, this naturally also leads carriers to increasingly optimize their commercial and opera- tional processes around this fact. This in turn leads to operational decisions, such as inland equipment availability, that are detrimental to a range of backhaul shippers. Although such a development is clearly not in favor of backhaul shippers, it also can be seen as the logical outcome of a market struc- ture wherein revenue is coming disproportionately from the head- haul market. For some backhaul shippers, a substantial increase in their freight rates might undermine their profit- ability, as their commodities often aren't nearly as valuable as the headhaul commodities. And, while this is indeed a valid concern for some, the mathematical reality is the rates they are currently enjoy- ing are only possible due to the de facto subsidies achieved from the headhaul. As such, they should anticipate that future operational efficiencies from the carriers will con- tinue to favor the headhaul cargo and not the backhaul. The theoretical — and completely unrealistic — way to change that dynamic would be for the backhaul carriers to collectively increase their freight payments by $1.6 billion a year to be on an equal footing with the headhaul cargo in terms of freight contributions. Incidentally, the same type of calculation can be performed on the trans-Atlantic trade, with the con- clusion being that backhaul shippers are de facto subsidized by $1 billion annually. JOC email: Lars.Jensen@SeaIntelligence- Unfair share? For some backhaul shippers, a substantial increase in their freight rates might undermine their profitability.

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