Sea Freight – Smoother Waters or Choppy Sailing Ahead?

As we concluded in our last briefing on this topic in June 2024, ongoing geopolitical situations in the Red Sea and elsewhere continue to create conditions of material uncertainty for shippers and carriers alike. However, worldwide volume has somewhat stabilised and new capacity has entered the market, the effect of which has softened rates across all trade lanes. Analysts are therefore predicting that 3Q24 will mark the peak of carriers’ earning cycle, as carrier revenues continue to inch down in 4Q24.

However, this newly acclimatised dynamic may again be disrupted if labour disputes continue in the US and elsewhere or if conflict escalates further in the Middle East. It remains to be seen how shippers will respond to an early Chinese New Year (CNY) and the outcome of the US presidential election.

Market performance to date

Earnings forecasts as at 1H24 indicated that carriers were understating their expected profitability figures in light of the uplift in earnings due to surcharges. These analyses have been partially borne out, as global carrier Maersk reported bumper earnings in 3Q24, with EBITDA at $4.8bn, twice as much as in 2Q24. While other competitors have yet to release their quarterly earnings, Hapag-Lloyd has revised its FY24 EBITDA outlook to between $4.6bn-$5.0bn (up from $3.5bn-$4.6bn).

Asian carriers have likewise reported bumper QoQ increases in operating revenue: Evergreen’s figures increased by 44% in 3Q24 compared to 2Q24, with Yang Ming and Wan Hai reporting increases of 39% and 43% respectively. These QoQ increases are the highest in two years (when the effects of the worldwide response to COVID-19 caused shipper demand to soar).

The strength of global carrier profit margins is so strong that some analysts are wondering if (or in France’s case, when) tax authorities may seek to increase levies.

4Q24 forecasts and trend spotting

The consensus among analysts is that 4Q24 will see the trend of record earnings reverse. Monthly revenues for Asian carriers have decreased, with Evergreen reporting an 18% fall in September compared to July and Yang Ming and Wan Hai respectively reporting a 15% and 26% decrease.

Ebbing earnings reflects the contraction of spot rates for transpacific routes, which is in part owed to newcomer carriers such as TS Lines and SeaLand Shipping Asia-US West Coast offering shippers lower rates to increase their volumes, forcing the mainstay carriers to follow suit. More widely, the annual peak arrived early in 2024 as shippers brought forward cargo shipments due to uncertainties over extended transit times via Asia-Europe routes and to avoid Transpacific disruption anticipated in response to the International Longshoreman’s Association (ILA) strike-action (which has since been called off for the time being).

The modest decline in carrier revenue which analysts are forecasting in 4Q24  reflects the softening of container spot rates: SCFI’s Shanghai-Los Angeles was down 19% as at 16 August 2024 compared to its peak at 5 July 2024. During the same period, SCFI Shanghai-New York rates were down 7% and SCFI Asia-Mediterranean down 14%. Similarly, Asia-north Europe reported a 9% decrease from 12 July to 16 August 2024.

Though the overall trend through to end of October remains a modest decline from the summer highs, rates have rallied in recent weeks, with the SCFI up 6% week-on-week as at 25 October 2024, likely in response to the general freight increase many carriers have sought to initiate from 1 November 2024. The Asia-Europe market has bolstered most of the surge, up 14% in the same period, whereas Shanghai-US east coast was up 3% and Shanghai-US west coast up merely 1%. Notwithstanding, analysts prior to the US election were sceptical that these rallies would stick in the medium-term, though the US election outcome may now change that (see below).

Taken in the round, the overall contraction in rates through to October 2024 from the summer highs reflects relatively healthy shipper demand as the market strives to adapt to the uncertainty poised by the interruption to the Red Sea and elsewhere. For context, Asia to Europe volume in TEU was up 14.5% YoY in August 2024, and Asia to North American routes were up 13.2% during the same period.

No doubt the ILA’s decision to call off the strike, which would have affected US East Coast and Gulf ports, has allayed retail shippers’ concerns about port congestion in a period where US import numbers remain relatively strong. While carriers had plans to implement surcharges in anticipation of the strike, as these would not have taken effect until mid-October 2024, spot rates were not affected. Indeed, after the strikes were postponed, container freight rates for east-west routes dropped by as much as 30% compared to the highs reported in July 2024 as large uncertainty was removed from the market.

Horizon scanning

The potential for another ILA strike planned for mid-January 2025 may arise if the ILA does not secure a favourable deal. This in conjunction with an early CNY is likely to result in importers pulling forward cargoes yet again, which would apply upwards pressure on rates to accommodate the change in demand patterns.

Given Donald Trump’s US presidential election victory, which has just been confirmed at the time of this bulletin’s publication, analysts now predict that shipping demand is likely to increase in the short-term in anticipation of the tariffs Trump has pledged to implement on Chinese imports. This is likely to magnify the effect of the early CNY and may result in a material crunch in capacity. It could also cause renewed upward pressure on freight rates, the inching up of which may now stick in the medium term.

Separately, the continued interruption in the Red Sea is forecasted to absorb capacity worldwide, the effect of which may operate as a floor preventing rates from falling much further. In terms of further horizon-scanning, the Houthis have pledged to widen their attacks on vessels further afield of the Red Sea including in the Gulf of Oman and Arabian Sea.

Moreover, the risk of a wider regional conflict as tensions worsen between Israel on one hand and Hezbollah and Iran on the other suggests that geopolitical uncertainty affecting the market will persist. It remains to be seen if spot rates will price in the risk of a full-blown conflict in the region which may have the effect of disrupting routes traversing the Persian Gulf, Gulf of Oman and Arabian Sea.  

But even supposing that tensions in the Middle East resolve, thereby enabling the Suez Canal to fully reopen, Maersk’s CEO has warned that there may be significant congestion and operational delays persisting for as long as two months following opening. Carriers including Hapag-Lloyd and Maersk have therefore indicated that they will continue to route vessels via the Cape of Good Hope in pursuit of stability and certainty irrespective of the Suez Canal’s operational status. Taken in sum, there are many external factors keeping freight rates elevated.

However, on the supply side, 2025 is expected to deliver an increase of 3m TEU in additional capacity. We also note that scrapping levels remain low, and carriers are not removing ageing tonnage in support of a more modern, energy efficient and less-polluting fleet. External volatility aside, while rates are unlikely to fall to pre-COVID levels, there are countervailing factors keeping rates subdued.

Contractual considerations

As the run-up to the anticipated US East Coast and Gulf port strikes demonstrates, carriers are likely to continue to use surcharges to offset increased operational costs from disruptions (as they did for the Red Sea disruption at the beginning of the year). In contrast to cases when surcharges often lacked contractual basis, many carriers have since incorporated mechanisms in new contracts to enable them to introduce additional surcharges. This means that shippers’ legal positions have been further restricted, though as summarised above, the commercial dynamics at play may offset carriers’ contractual advantage.

From a shipper’s perspective, however, the use of surcharges effectively undermines the certainty of otherwise fixed-rate contracts. Accordingly, we predict parties may reintroduce index-linked pricing mechanisms. This should give both parties some stability and tracking to spot market rate levels and negate some surcharges where appropriate indices are applied.

Force majeure and other clauses seeking to govern non-performance of obligations are also enjoying renewed scrutiny giving the impact of external forces. Watch this space for more on this…

Jake Rickman, Trainee Solicitor, assisted in the preparation of this briefing.