Boeing warns of supply chain constraints, carrier options are limited & the shipping cycle continues
Monday Morning Wake Up Call
June 7, 2021
Boeing CEO warns of airline supply constraints, U.S.-China trade
(Reuters) Boeing Co (BA.N) Chief Executive Dave Calhoun on Thursday said there could be “supply constraints” beginning in the summer after a “more robust” recovery than he expected from the aviation downturn during the pandemic.
Speaking at a Bernstein virtual conference, Calhoun also said he expects Boeing will be able to deliver the "lion's share" of roughly 100 787 aircraft sitting in inventory due to production defects and weakened demand.
With U.S. leisure travel going "gangbusters" and carriers needing to rehire and rebuild their networks and supply chains, Calhoun pointed to likely "supply constraints for a while
"I think that will mean it's a healthy recovery and they'll get back to former pricing levels sooner rather than later," Calhoun added.
Boeing is working to emerge from a safety scandal following two deadly crashes of its 737 MAX airliner and an air travel collapse during the pandemic.
It is also trying to decide the timing of its next new jet program, a multibillion-dollar dilemma that has sparked an internal debate and put the future of the largest U.S. exporter on the line, industry insiders say.
Calhoun said it would not be "all that long" before Boeing announces plans, but said the planemaker is not rushing the decision.
Regardless, Calhoun said efficiency gains on the aircraft would have to be found during design and assembly, as the next quantum leap in engine technology remains years away.
Separately Calhoun sounded notes of caution about the U.S.-China trade relationship, saying he could not predict when a "thaw out" would open up jet deliveries in one of the world's fastest growing aviation markets.
On Thursday, Reuters reported that Qatar Airways was weighing a potential order for 30 or more freighters, attracting interest from Boeing (BA.N), which has begun offering a freight version of its future 777X jetliner.
In April, the Gulf carrier said it was interested in a 777X freighter but had not been told by Boeing of plans to launch one.
On Thursday, Calhoun pushed back against uncertainty over demand and certification challenges for the 777X, saying there will “always be routes” for the mini-jumbo. But he added the Boeing board had not yet approved a freighter version.
To Read More: https://www.reuters.com/business/aerospace-defense/boeing-ceo-warns-airline-supply-constraints-us-china-trade-2021-06-03/
Where have all the carriers gone?
(FreightWaves) In 1977, Congress deregulated the nation’s air cargo industry, allowing all-cargo carriers to operate free of government economic fiat. Over the next 18 years, each U.S. transportation asset class was fully or mostly deregulated, effectively ending the industry’s more than century-old status as a public utility. The collective actions remain one of the watershed events in U.S. transportation and economic history.
Yet the world today looks very different from what deregulation’s advocates had envisioned. Deregulation is still in place, but the surge of new entrants and the innovative services and competitive prices expected to follow into perpetuity has instead given way to massive consolidations that have reduced the provider universe to microscopic proportions.
Canadian National Inc.’s (NYSE:CN) proposed $33 billion acquisition of Kansas City Southern Industries (NYSE:KSU) will remove the last U.S.-based north-south railroad and shrink the nation’s Class I carrier roster to four: CSX Corp. (NYSE:CSX) and Norfolk Southern Corp. (NYSE:NSC) in the east and Union Pacific Corp. (NYSE:UNP) and privately held BNSF Railway out west. The U.S. air travel market, the largest in the world, has only four national network carriers — Southwest Airlines Inc. (NYSE:LUV), Delta Air Lines Inc. (NYSE:DAL), United Airlines Holdings Inc. (NASDAQ:UAL) and American Airlines Group Inc. (NASDAQ:AAL) — for many travelers to choose from.
The U.S. parcel industry has two network carriers — FedEx Corp. (NYSE:FDX) and UPS Inc. (NYSE:UPS) — that large shippers can consistently trust. The LTL industry, which had hundreds of carriers at the dawn of truck deregulation in 1980, is now dominated by the 10 largest carriers that control about 70% of a $40 billion industry. Other than on domestic maritime routes protected by the 101-year-old Jones Act, there is no longer a U.S.-flag maritime industry 27 years after it was deregulated by the Shipping Act of 1984.
The two exceptions, and they are large ones, are the truckload industry and the brokerage sector that supports a good chunk of it. Both remain very fragmented, by-products of the very low barriers to entry for each. The largest truckload carrier, Knight-Swift Transportation Holdings Inc. (NYSE:KNX), has about 5% of the market. The largest broker, C.H. Robinson Worldwide Inc. (NASDAQ:CHRW), has a bit more than 10% of its market. Yet the truckload sector has its own unique battles with shrinkage, namely in drivers and equipment, that has put shippers behind the eight ball.
The consequences of these trends are potentially material for all stakeholders, which is essentially the entire U.S. population. Even after the massive supply chain disruptions spawned by the COVID-19 pandemic have ebbed, transportation buyers of all types will confront a stubborn shortage of asset-based providers. The result could be elevated pricing and a stifling of innovation for years to come.
The saving grace is that deregulation injected a large dose of adaptability into the transport system. Sensing voids ripe to be filled, new models — whether asset based or not — will join the fray and provide shippers and consumers with the levels of innovation at the core of the original deregulation blueprint.
For now, though, it’s hard to find anything of abundance on the supply side of the ledger. After digging a massive hole more than a decade ago with destructive price wars, the big LTL carriers have leveraged their market dominance by raising rates over and over again for the past seven years. Through difficult macro conditions such as industrial recessions and the pandemic, those rate increases have stuck, a reflection of the industry’s iron grip on its shippers. The railroad industry could not wait until a multitude of multiyear legacy contracts expired to replace them with much higher rates. Airfares, which had been steadily rising until the pandemic because above-deck capacity had shrunk dramatically, are likely to resume their upward trajectory once Americans start traveling again in great numbers and international markets open up.
Perhaps the poster child for the impact of market concentration has been the parcel delivery industry. For decades, FedEx and UPS have operated as a duopoly, particularly in the business-to-business (B2B) arena where the high-margin traffic could be found. The carriers would raise rates, impose add-on fees known as accessorials and change the rules of engagement in tandem and with impunity. DHL Express entered the market in 2002 but exited seven years later in the wake of billions of dollars in losses. The ruthlessness of FedEx’s and UPS’ behavior, and the wellspring of resentment from customers, long ago led to the coining of the term “FedUps.”
The U.S. parcel landscape has changed in recent years. Business-to-consumer (B2C) deliveries account for the bulk of the two carriers’ mix, a trend unlikely to reverse as long as e-commerce activity continues to grow. Here, FedEx and UPS face competition from Amazon.com Inc. (NASDAQ:AMZN), the U.S. Postal Service and the small but growing presence of regional delivery carriers that serve specific slices of the country. However, big accounts tend to shy away from the Postal Service, and regional parcel carriers, by definition, lack the national footprint that FedEx and UPS have. Amazon, for all its logistics capabilities, confines its offerings to companies that also do retail business with it. Only when Amazon rolls out a stand-alone delivery product unconnected to its retail business will FedEx and UPS feel the pressure of a third national carrier.
All of the deregulation bills were designed to benefit users of transport services, a reality that the carriers knew all too well. U.S. airlines had to be dragged kicking and screaming into deregulation, aware that their high fixed cost structure that had long been supported by tariffs would be brutally exposed in a free-for-all market to low-cost, nonunion rivals. LTL carriers, like the airlines beset with expensive infrastructures, high labor costs and weather issues, also saw the handwriting on the wall. Many unionized LTL carriers, especially in the Northeast and mid-Atlantic, went out of business, unable to compete with more nimble, low-cost competitors. The Teamsters union’s LTL-dominated freight division, which at its peak in the late 1970s boasted about 500,000 members, today has less than 40,000.
Deregulation wasn’t a pox on all sectors, however. The railroad industry, which was on the brink of insolvency exiting the 1970s, used the Staggers Rail Act of 1980 to get its financial house in order. Average rail rates, measured by inflation-adjusted revenue per ton-mile, are 44% lower today than they were in 1981, the year after the rail industry was deregulated, according to the trade group Association of American Railroads (AAR). This meant the average rail shipper could move much more freight for the same price it paid more than 40 years ago, AAR said.
In addition, the overnight air delivery industry, led by Federal Express Corp. (NYSE:FDX), didn’t have a legacy model to defend, so it was able to capitalize on deregulation’s benefits. However, other sectors struggled to convert from an environment of government-protected rates, routes and services to a no-holds-barred world of open markets and freewheeling pricing.
What is the shipping cycle — and can it ever be tamed?
A circa-2014 diagram of the shipping cycle by Marine Money. The timing of new orders is different this time (Photo: Marine Money)
(AmericanShipper) Talk about the future of ocean shipping and it always comes back to the cycle. When is this horrific tanker down-cycle going to end? Did investors buy the tanker stocks too early? How high can this crazy container-shipping up-cycle actually go? When will containerized cargo shippers ever get relief? Is this finally the start of the elusive dry bulk upswing?
And inevitably, the bigger question: Can shipping cycles ever be tamed or broken? Can it ever be the case of “this time it’s different?”
“Market cycles pervade the shipping industry,” wrote author Martin Stopford in “Maritime Economics,” widely considered to be the industry bible. “These shipping cycles roll out like waves hitting a beach. From a distance they look harmless, but when you are in the surf, it’s a different story.
“As far as shipowners are concerned, the cycles are like the dealer in a poker game, dangling the prospect of riches on the turn of each card,” wrote Stopford. “This keeps them struggling through the dismal recessions … and upping the stakes as the cash rolls in during the booms.”
The uncertainty of cycle timing
The shipping cycle is the pricing mechanism that adjusts vessel supply to cargo demand.
When vessel supply exceeds demand, freight rates and asset values fall, older ships are scrapped, and new ship orders decline. As the market balances, new ships are ordered (or, in the case of countercyclical orders, before the market balances). Traditionally, because it can take two years to build a ship, too many new vessels are built and by the time they’re delivered, vessel capacity exceeds demand and the cycle repeats.
A central question for shipowners, investors and cargo shippers is: Even if you know that what comes up must come down, and vice versa, what good is that if you don’t know when the cycle will turn? Being too early is the same as being wrong, particularly given opportunity costs.
In his book “Mastering the Market Cycle,” Oaktree Capital Management co-founder Howard Marks wrote, “The rational midpoint [of the cycle curve] generally exerts a kind of magnetic pull, bringing the thing that’s cycling back from an extreme in the direction of ‘normal’ [the secular trend].”
Marks believes that business cycles “aren’t as regular as the cycles of clock and calendar, but they still give rise to better and worse times for certain actions.”
Marks’ company happened to be one of the largest investors in equity and distressed debt of dry bulk and tanker shipping companies in the wake of the 2008-2009 financial crisis. Several industry sources speaking to American Shipper have opined that Oaktree came in too early.
Oaktree has spent much of the past decade waiting to monetize post-financial-crisis moves. It built up significant stakes in Eagle Bulk (NASDAQ: EGLE), Star Bulk (NYSE: SBLK) and TORM (NASDAQ: TRMD), among other shipping companies, and is finally starting to sell off more of its positions.
Oaktree has sold over $9 million in Eagle Bulk shares this year and sold $226 million of its Star Bulk stake in a block sale in May, according to Tradewinds. It has been a long wait. It invested in Eagle Bulk via distressed debt back in 2013, the same year it began building its stake in Star Bulk.
Oaktree’s early timing was the butt of a joke by Robert Bugbee, president of Scorpio Tankers (NYSE: STNG) and Eneti (NYSE: NETI), the company formerly known as Scorpio Bulkers, during a Marine Money conference in November 2013. Announcing his mock year-end awards, Bugbee said, “[The winner for] philanthropy has to go to Oaktree, again. Three-time winner.”
Ironically, Scorpio has had its own cycle timing issues. Scorpio Bulkers went public in December 2013, just a few weeks after Bugbee’s Marine Money speech, and lost money ever since. In December 2020, it announced it would sell its entire dry bulk fleet and focus on wind-farm installation ships instead, booking a $458.8 million write-down on its bulker fleet in Q4 2020.
Just a few weeks later, the dry bulk market sharply rebounded. The big winners have been the companies that bought the ships from Scorpio Bulkers, including Star Bulk and Eagle Bulk, companies backed by Oaktree.
Rough decade for cycle timers
There were some periods of profitability — tankers had a good year in 2015 and saw brief events-driven spikes in Q3 2019 and Q2 2020 — but no truly sustainable up-cycles. Countercyclical ordering by both private equity and public companies kept the supply-demand balance in favor of cargo shippers.
The cycle is less volatile in container shipping than in bulk commodity shipping because the former are liner (scheduled) operators using primarily owned and time-chartered ships whereas the latter are tramp (unscheduled) operators with a heavy focus on spot deals.
Sea-Intelligence CEO Alan Murphy told American Shipper, “Container shipping used to be cyclical prior to 2009. We had pretty high two- to three-year cycles. But since then, besides a fantastic year for liners in 2010, the market overshot because everybody ordered, which led to 10 years of oversupply [prior to the current upturn]. If you were a shipper, you could take a contract and use it as a free option, and if the market went down you could go into the spot market.”
Another way to describe the pattern would be: Container shipping is still cyclical, but it had shorter, more rhythmic cycles prior to its mass ordering of vessels in the late 2000s, leading to a decadelong down-cycle, followed by the current historically strong up-cycle driven by COVID-induced consumer spending on goods.
Is it different this time for bulk shipping?
Sustainable up-cycles in tanker and dry bulk shipping typically coincide with strong cycles in commodities, as occurred after the entry of China into the World Trade Organization in December 2001. There is now growing talk among analysts of a post-COVID commodity super-cycle, which, if true, bodes very well for dry bulk shipping and eventually tankers.
The “this time it’s different” argument for wet and dry bulk shipping cycles is that decarbonization has dramatically altered the vessel-supply equation.
According to this theory, speculative orders for tankers and bulkers are not only much lower in the current cycle due to economic uncertainty, but due to fear of future decarbonization rules on allowable newbuild propulsion systems. Ordering a ship with the wrong propulsion system would cause premature obsolescence.
Jefferies analyst Randy Giveans told American Shipper, “For dry bulk and tankers, you could certainly argue that this time it’s different. If you look at rates, you’re still not seeing a lot of orders. Clearly something is keeping orders at bay. It’s a combination of things: There’s less shipyard capacity, there are more orders for gas carriers and container ships [filling up slots], there is less access to capital from European banks, and there is real uncertainty over environmental regulation.”
Giveans doesn’t think this will break the bulk commodity shipping cycle, but he does think it will change the duration of the future up-cycle. “I think the cycle will be more pronounced and longer than it has been in the past, because we haven’t seen these [low] numbers on the vessel supply side in 20 years,” he said.
Is it different this time for container shipping?
Container shipping faces the same environmental-regulation risk as bulk commodity shipping, but this hasn’t stopped new orders.
New contracts signed in Q4 2020 and 2021 have brought the orderbook from a low of 8% of on-the-water tonnage in the second half of last year to around 18% currently. However, the orderbook remains manageable, given that a ratio of 15% is considered normal to replace aging vessels and that the ratio was as high as 60% in 2008.
The “this time it’s different” argument for container shipping is not as much about environmental regulations as it is about liner concentration.
Container liner operator operations are dramatically more consolidated than in bulk commodity shipping, with the main East-West trades now controlled by just three alliances. If there’s one thing that can tame a cycle, it’s extreme consolidation.
“The consolidation that has taken place is a game changer,” said Giveans. “Even four or five years ago, it was a much more competitive market. Now there’s really only five or six real players.”
The vast majority of container-ship orders placed in the past nine months have been signed by non-operating owners (NOOs) against long-term charter agreements or by liners themselves. In an interview with American Shipper in December, Stefan Verberckmoes, shipping analyst and Europe editor at Alphaliner, predicted, “Just as carriers have become more careful about managing capacity, they will also consider managing newbuilds as part of their plan.”
And even if there were a rise of speculative orders by NOOs, it may still not lessen liners’ market power.
The liner sector proved in Q2 2020 that when demand falls, it can manage capacity downward to support rates via the use of “blank” (canceled) sailings. If liners can continue to do so in the years ahead, it could temper the swings of the container freight rate cycle — to the benefit of liners.
On the last quarterly conference call of Maersk, CEO Soren Skou was asked about the recent wave of orders for ships that will be delivered in 2023-2024. Skou responded, “In the second quarter of last year our demand dropped 15% and we took out 20% of our capacity and kept our pricing flat. That’s the kind of operating modus we will continue in the coming years. On the question of the orderbook, what really matters to us is the capacity we deploy compared to the demand we have.
“It’s not really important how many ships exist in the world,” affirmed Skou. “It’s how many ships that are deployed that matters.”
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