ITF Roundtable on Future Maritime Trade Flows

Roundtable held in Paris, April 15-16 2019. Note: Chatham Rules apply, so content is not attributed to an individual.

By invitation of the OECD/IFT, I took part in a roundtable that included about 30 members of government, industry and academia. The two days were divided in five sessions covering selected topics, including the changing demand for maritime trade, costs and trade flows, maritime business strategies, infrastructures and the Northern Sea Route. A large array of issues were discussed and the following represents what retained my attention.

What drives maritime trade?

Maritime transportation is the standard expression of a derived demand since it exists to support trade and supply chain interactions. GDP per capita remains the core driver of this demand, but the multiplying effects have been declining. This is particularly the case for dry cargoes, namely containers, that have one of the strongest associations with GDP per capita.

It was underlined that maritime freight costs do not affect much the demand, particularly since they account for such a low share of the final price of goods; between 1 to 5%. There is thus an inelastic relationship between transportation costs and trade, which is paradoxical since trade is so highly dependent on transportation. There is a physical necessity for the support of trade, but once this support is established its costs has a marginal influence on trade structure.

The above raises the question as if it is relevant to invest in long distance infrastructures such as ports, but this question must consider the context of declining marginal return of investments. The issue of unmet capacity is relevant in the multiplying effects of maritime shipping on trade and as capacity increases the emphasis shifts to connectivity. Benefits are less cost-based, but increasingly linked with the capabilities to reach markets in a timely (and reliable) fashion.

The relevance of the TEU as a unit of measure is being questioned, particularly because of empty movements. It is argued that the conventional ton-km unit of measure remains more accurate. Irrespective, the value of what is being carried in containers is difficult to account.

A glimpse at the future

Most forecasting models are indicative of expectations since the forecaster always has some form of bias about how the future may unfold. It is therefore important to see forecasting from a set of scenarios that try to contradict some expectations. A particular future was discussed, which implied ongoing efforts towards the decarbonization of maritime shipping.

First, the industry will be decarbonized for the simple reason that there will be less demand for fossil fuels. The potential decrease in oil and coal consumption due to the energy transition is a distinct possibility for the coming years. This could have a substantial impact of the maritime bulk shipping sector, since energy products account for a high share of the ton-km carried by maritime shipping.

However, it was underlined that the industry is not well placed to handle decarbonization. For instance, the 2020 sulfur rule takes place in an industry in a situation of over capacity and unable to transfer additional costs to its customers. This lead to a paradox where a simple 1% cost increase in operations (likely to be grossly underestimated) could lead to substantial turmoil in the industry. There is a concern that national subsidies to carriers to install scrubbers to meet the new sulfur emission rules could change the competitive landscape, and could even force some shipping lines into bankruptcy.

The commodification of shipping

Maritime shipping has become a commodity, implying that there is little differentiation between product providers; each is technically interchangeable. The setting of alliances has reinforced this trend since carriers are incited to have similar operations.

Economies of scale, an important driver, have been about unit costs and their reduction have reached a limit. The average global rate used to be around $2000 per TEU, but this figure has reached about $1000 TEU; unit costs have flattened out. Further pushes towards economies of scale are becoming counterproductive since the operational benefits are unclear and likely not sufficient enough to justify the additional capital investments.

Economies of scale have been a double-edged sword for the industry. They push towards commodification since in view a large capacity, the industry will subcontract bookings (ship slots) to logistics service providers. Shipping lines have outsourced some of their capacity with the hope to get more cargo. Logistics service providers get a fixed rate while trying to maximize the revenue from their customers. The shipping lines are therefore not directly knowing the requirements of their customers and what value it is possible to extract from this cargo.

New trade routes: Potential or hype?

China's Belt and Road Initiative (BRI) was extensively discussed. The portfolio of the related investments is impressive, but the profitability of most of these investments is subject to debate. It was noted that the BRI is used to negotiate separate agreements with EU countries, which is undermining European regulations, particularly over the environment and over rules of procurement (European contractors).

Very few large infrastructure investment projects have been subject to more hype than the BRI, with so far more than 10,000 papers published on the subject. The true relevance and profitability of the endeavor is largely unknown. What could be perceived as a strategy could turn out to be ad hoc interventions taking advantage of opportunities (e.g. port of Piraeus). The Nicaragua Canal, which could be considered as a sub element of BRI, has failed to be realized because of excessive capital requirements in light of potential return on investment.

The Northern Sea Route (NSR) is technically an international route. The only fees that the Russian government can levy is for ice breaking services, which can be mandatory for many parts of the passage and according to the time of the year as well as the level of ice certification of the vessel. At this point a comprehensive climate model for the arctic cannot be provided, implying that the nature and extent of future navigation (e.g. 2050 timeframe) cannot be properly estimated. Traffic using the NSR is increasing, but most of it is to service Russian ports, with true transit traffic only accounting for a small share. It was noted that the Chinese are actively involved in investing in the arctic. Still, at this point the NSR cannot be considered as a serious option for global shipping.

From globalization to regionalization?

The issue of trade regionalization, as opposed to globalization, is a salient question concerning the future of maritime trade flows. Maritime shipping has been the main beneficiary (and support) of globalization. If trade becomes more regional in character (e.g. intra-Asia), even if the volumes remain the same (or increase), this could have a strong impact on the ton-km carried by maritime shipping. This could also impact the configuration and the dedicated capacity of shipping services.

Changes in technology and the rise of protectionism raise serious questions about the future of trade. I advocated that we could go back full circle in terms of the nature and composition of trade. Prior to globalization (before the 1970s), trade was more a necessity than a convenience, implying that the majority of what was being traded was resources, energy and agricultural goods. With globalization, trade became more a matter of convenience allowing to exploit cost arbitrage such as land and labor. With automation and rising labor costs, it remains possible that the share of trade accounted for resources will increase in the coming years, changing the demand composition for maritime shipping; reverting to trade being more driven by necessity.

In such an environment where technology, the price of labor and resources are all unstable and uncertain, a salient question is where to locate and how to allocate production and distribution capabilities. Port-centric locations remain attractive as a risk mitigation strategy since they maximize connectivity to market and sources of raw materials and intermediate goods. Thus, the more uncertain the macroeconomic environment is (particularly its input factors), the more attractive are locations with high maritime connectivity.

The digitalization wildcard

An uncovered issue at the roundtable remained digitalization, which is likely to transform maritime shipping. With the introduction and diffusion of intermodal transportation (containerization), and later with forms of terminal automation, the velocity of trade has improved to the point that in many cases it has become faster than the transactional capability to support it. Supply chain management relies on massive information flows that must be managed in real time, which has also placed pressures on the managerial capabilities of ships, terminals, inland transportation and distribution centers.

In the past, the compilation and processing of documents such as bills of lading and letters of credit was complex and time consuming, but since the underlying trade flows were also slow; transactions were not impairing intermodal flows in a substantial manner. Trade facilitation has relied on improving national trade policies to reduce the transactional complexity of trade. The growth of trade, its liberalization, its facilitation and its related information flows has created managerial challenges. Therefore, digitalization becomes a strategy to make sure that the velocity of intermodal flows are better synchronized with the velocity of transactions, including financial transactions. Once digitalization has reached a phase of maturity, it will be possible to manage in real time global freight distribution according to its capacity and velocity capabilities.