An industry of 50,000 merchant ships that travel across international waters to deliver every form of cargo was fascinating. Registered in over 150 countries, this fleet of ships has been under its biggest attack this year with no place to hide even in the vast expanse of the ocean. The world’s top shipping companies have fallen prey to red ink on balance sheets and tumbled down much like the pins in bowling. The high roller ball responsible is composed of overcapacity and slowing world trade.

Let me introduce you to the ‘butterfly effect’ coined by Edward Lorenz to further comprehend the deep waters we are in. The theory states that it is ‘the phenomenon whereby a minute localized change in a complex system can have large effects elsewhere.’ You must be familiar with the metaphorical example of this effect where a hurricane can be affected by minor perturbations such as a butterfly flapping its wings weeks before. There are just  minor adjustments to make to compare this to our sea freight situation here. We need to replace the butterfly with a let us say….an elephant. The international shipping industry is responsible for the carriage of around 90% of world trade and red ink in this sector is not good news for any industry or country aspiring to gain from world trade. In 2015, for the first time since they were invented in the 1950s, (apart from the 2009 recession), global GDP grew faster than worldwide box traffic.

In a game of hide of seek, South Korea’s biggest shipping line Hanjin Shipping Company took the first big hit when it filed for court receivership on 31st August. The news shook the markets and people sitting on competitor boards for it was the beginning of the end. Hanjin was facing a massive debt of 6.6 trillion won (S$8.2 billion) on the day it filed for court receivership. This left its ships, crews and cargo worth 16 trillion won stranded at sea on fears of being seized. Its massive fleet of 66 ships  stranded with over $14.5 billion of electronic goods headed to Americas and Europe has not been since allowed to anchor at ports for the fear that the company will not be able to pay unloading charges. The effect has since spilled over to other important ports such as Singapore, where companies with cargo have been forced to look for alternatives.

This splash of red ink is a result of overcapacity. Container freight rates have sunk to historic lows in 2016. Too many container vessels have been built without disposal of an equal amount since the Great Financial Crisis. An earnings index compiled by Clarksons, a research firm, covering the main types of vessel (bulk carriers, container ships, tankers and gas transporters) reached a 25-year low in mid-August. The average of the earnings index is 30% lower compared to last year and as much as 80% below the peak of December 2007. In addition to that, as export volumes from China and South Korea have contracted, the cost of sending a shipment from China to Europe has decreased by 50%. The Baltic Dry index, a measure of freight rates for bulk carriers that carry commodities like coal and iron ore, has plummeted by 95% since its peak in 2008. Currency fluctuations in emerging economies in the past year have also resulted in massive losses. The value of goods that crossed international borders last year fell 13.8 per cent in dollar terms, the first contraction since 2009 — according to the Netherlands Bureau of Economic Policy Analysis’s World Trade Monitor.

In an industry that is already bleeding, firms are taking on additional debt in order to cover the present debt. According to Drewry, a consultancy firm, the shipping industry is set to lose $10 billion by the end of this year alone. Of the biggest 12 container lines that have published results for the past quarter, 11 are running huge losses.

World trade has also plummeted due to the changing trend of companies to produce locally to avoid transportation costs. Since 2001, hourly manufacturing wages in China have risen by an average of 12% a year. Rising wage rates in emerging economies and improved manufacturing techniques have forced companies to produce locally. In addition to that, recent political developments and sentiments across the trade platforms have threatened world trade. Protectionist policies supplemented with concentrated trade blocs have stalled world trading and shipping. Akashi Masuda, chief economist at Toray Corporate Business Research in Tokyo, said Mr Trump’s protectionist economic policies would aggravate slow trade, if they are implemented.

Amidst all the chaos, creditors are forcing boards to find solutions to survive these cut-throat times. One of the options available is M&A with many players opting for it. Germany’s Hapag-Lloyd finalised a deal to merge with United Arab Shipping Company. Japan’s three biggest shipping groups – Nippon Yusen, Mitsui OSK Lines and Kawasaki Kisen Kaisha – agreed to combine their container operations after striking a deal in October. French shipping giant CMA CGM’s has bought Singapore’s own Neptune Orient Lines (NOL) for $3.38 billion. Maersk Line, the world’s No. 1 container line, has confirmed that it will buy German carrier Hamburg Sud for US$4 billion (S$5.8 billion).

Companies have exhausted almost all lifelines ranging from diversification to debt. Major companies such as Maersk had diversified their businesses by investing in energy and container businesses so for the times when high oil prices squeezed container profits, energy provision made up for the loss. However, since 2014 oil prices and freight rates have fallen together. Maersk Line, the industry leader, and the largest firm within A.P. Moller-Maersk, lost $107m in the first six months of the year. With a decrease in the prices many of the small players are not able to survive. Analysts estimate that the break even price for shipping is $1,400 per container per month. Freight rates have been averaging less than $700 per container for more than a year on the Asia-Pacific route.

Shipping lines have to streamline their businesses much like the majority of energy firms today. Even if their intended M&As are undertaken successfully, they will not be able to realise the economies until a couple of years with all the impending legal work to be completed. According to Reuters survey, the global shipping confidence is at an all-time low with Brexit and other unfavourable events. Scrapping ships to reduce available storage seems to be a herculean task for smaller companies. A solution would be to take over the smaller firms and trim the available capacity as soon as possible. A world desperate for growth will need to rectify this industry in order for anything material to happen. Until then, it remains to be seen what financial wonders do the banks and accountants come up with in order to keep the ships and companies afloat.

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