Chief China Strategist
The most recent geopolitical wave impacting the global economy, particularly international trade, began with Yemen-based Houthi militia’s missile attacks on commercial vessels transiting through the Red Sea in November last year. These attacks targeted vessels regardless of their national flags, prompting significant changes in global shipping routes. Since mid-December 2023, commercial vessels have largely avoided the Red Sea and the Suez Canal, opting instead to sail around the Cape of Good Hope at the southern tip of Africa. This rerouting has added 10-14 days to the shipping duration from Asia to Europe, bringing the total journey time to approximately 33-47 days.
For a 20,000 TEU (twenty-foot equivalent unit) container ship, this rerouting adds around USD 700,000 in extra costs, primarily due to 30% higher bunker fuel consumption. The increased voyage time has caused a sharp reduction in the capacity of global container shipping. Additionally, the disruption to scheduled arrival times and rerouting has led to port congestion in Singapore, Dubai, the Mediterranean and some European ports, resulting in longer waiting times for loading and further reducing global container shipping capacity by an estimated 2%. The lengthened voyage time has also delayed the return of container boxes from their destinations to exporting ports in Asia, creating a shortage of container boxes and further impacting shipping capacity.
Contributing to the lengthening of voyage time is a drought that resulted in low water levels in the Panama Gatun Lake and the Panama Canal, forcing container ships to unload some cargo to reduce the vessel’s draft, which is the maximum depth of the hull below the waterline when transiting the Panama Canal. Recently, water levels have improved but the disruption has yet to be completely resolved.
Simultaneously, strong demand from shippers aiming to replenish inventories ahead of peak seasons and avoid supply-chain disruptions experienced during the Covid-19 pandemic has led to an earlier rise in demand for container shipping, typically observed in Q3 peak seasons. Consequently, container liner companies have been able to pass on increased fuel costs and benefit from reduced global capacity and robust demand, significantly increasing freight rates charged to their customers.
The World Container Index (WCI) by Drewry, which is a volume-weighted average of the spot freight rates for eight major container shipping routes to/from the US, Europe, and Asia, surged 241%, rising to 4,716 on June 6 this year from 1,384 on November 23 last year (Figure 1). The Shanghai Containerized Freight Index (SCFI), a weighted average of the spot freight rates of 13 container shipping lines embarking from Shanghai, increased by 220% to 3,184.87 as of June 7, 2024, from 993.21 on November 24, 2023 (Figure 1). The China Containerized Freight Index (CCFI), a weighted average of freight rates, including spot and one-year charter rates, of 12 container shipping lines embarking from one of the 10 major Chinese ports, increased by 82.6% to 1,592.57 on June 7, 2024, from 871.28 on November 24, 2023 (Figure 1). Annual charter rates, which are less affected by near-term supply and demand fluctuations in the spot markets, are less volatile than the spot freight rates.
The global container shipping order book, which represents the number of vessels and their TEU capacity contracted to be built in shipyards, currently stands at 20% of the existing capacity of the global fleet. This level is not excessively high by historical standards and is much lower than the bubble levels of 40%-60% seen in the mid-2000s. This situation provides some additional support for a constructive freight rate outlook.
In May, China’s exports in USD terms grew 7.6% year-on-year (Y/Y), much stronger than April’s 1.5% and exceeding the median forecast of 5.7% in a Bloomberg survey. The growth in exports to ASEAN economies was notably strong, rising 24.8% Y/Y and accounting for 3.7 percentage points of the overall 7.6% export growth, representing 17.5% of China’s total exports by value. Exports to the US grew by 4.7% Y/Y, accounting for 14.6% of China’s total exports, while exports to the European Union contracted by 0.4% Y/Y, making up 16.9% of total exports.
As illustrated in Figure 2, China’s exports to the US and the EU have seen modest growth of 12% and 24% respectively over the past five years, compared to the 42% overall export growth for China. This slower growth reflects the geoeconomic trend of derisking from a China-centric global supply chain. Figures from Aiyar, Presbitero, and Ruta (2023) show that government-imposed trade restrictions have increased sharply (Figure 3), and mentions of “reshoring,” “onshoring,” and “nearshoring” have risen in corporate earnings reports (Figure 4).
A report from McKinsey Global Institute indicates that between 2017 and 2023, China reduced its geopolitical distance by 4% while increasing its geographic distance in goods trade by 6% in value. For the US, the McKinsey report estimates a 10% reduction in geopolitical distance and a 3% reduction in geographical distance during the same period. This emerging pattern supports observations by Gopinath et al (2024), suggesting that the surge in trade frictions between the US and China has replaced direct trade links between the two countries with indirect trade links via "connector" countries in Asia, such as Vietnam, and in Latin America, such as Mexico. As shown in Figure 2, over the past five years, China’s exports in USD terms to Vietnam, ASEAN, Mexico, and Brazil have grown by 74%, 75%, 108%, and 156% respectively. At the same time, US imports from ASEAN have surged by 75%.
The rising geoeconomic fragmentation tide has shifted the configuration of international trade by replacing direct trade links between the U.S. and its allies on one side, and China on the other, with indirect links via connector countries. This geoeconomic fragmentation has not exerted notable downward pressure on container shipping. Arguably, the rerouting and more complex logistic networks required to move intermediate and finished goods through connector countries may have increased the total voyages needed. This fragmentation tide, coinciding with the surge of the geopolitical wave of the Red Sea disruption, has created a perfect storm, pushing up container shipping freight rates.
However, it is appropriate to factor in the potential resolution of the Red Sea disruption and the return of vessels to transit through the Suez Canal over the medium to long term. This is also why term charter rates are lower than the elevated spot freight rates. The longer-term prospects hinge on how far geoeconomic fragmentation will go. In a scenario where massive tariffs on goods from other blocs are levied, McKinsey (2023) estimates that the geographic distance of global trade will fall by 4% by 2035. However, in an alternative scenario where fragmentation occurs more through non-tariff initiatives to diversify and reduce supply chain concentrations at the product level, the geographic distance of global trade increases by 3%, which will benefit the container shipping industry.
The two largest shipping stocks listed in Hong Kong, whose revenues predominantly come from the container liner shipping business, are COSCO SHIPPING Holdings (stock code: 1919) and Orient Overseas (International) Limited (stock code: 316). Investors need to be cautious not to confuse these with COSCO SHIPPING Development (stock code: 2866), whose main business is container manufacturing, or COSCO SHIPPING Energy Transportation (stock code: 1138), which operates 154 oil tankers and 43 LNG carriers but no container vessels. While container manufacturing, tankers, and LNG carriers also face supply reductions due to longer voyage days resulting from the Red Sea disruption, their business dynamics differ substantially from the container liner business. For instance, COSCO Shipping Energy Transportation is a stock that investors bullish on crude oil tanker or LNG freight rates may consider. Relevant indices for these sectors include the Baltic Dirty Tanker Index (BDTI), the Baltic Clean Tanker Index (BCTI), and the Spark Commodity LNG Freight Rates.
Another popular Hong Kong-listed shipping stock is Pacific Basin Shipping (stock code: 2343), a dry-bulk ship owner and operator that transports bulk commodities but has no exposure to container shipping. Its fleet consists of smaller vessels, Handysize (10k-40k dead-weight-tonnes) and Supramax (40k-70k dead-weight-tonnes), which transport minor bulk commodities. The relevant markets and freight indices to follow for investing in Pacific Basin are the Baltic Dry Handysize Index and the Baltic Dry Supramax Index, rather than the more widely reported Baltic Dry Index (BDI), which primarily reflects freight rates for larger bulkers that Pacific Basin does not operate and certainly not container freight rates.
In the table below (Figure 5), we outline some key metrics for the two Hong Kong-listed container liner stocks for reference. For comparison, we include two leading European container liners, Germany-based Hapag-Lloyd and Denmark-based AP Moller-Maersk A/S. It is important to remember that container shipping is highly cyclical and asset-heavy, causing profitability and earnings to fluctuate substantially through the cycle. The PE ratios using trailing 12-month earnings or consensus estimates for the current year are for reference only, as future earnings may vary significantly. Many investors also consider Price to Book or Price to Tangible Book ratios, which require adjustments for more rigorous research, such as using fleet value. Annual reports of shipping companies usually list vessel names, capacity (TEU for container vessels, dead-weight-tonnes for tankers and bulkers), and the year of build. Investors can either value vessels individually or use a shortcut by examining total owned capacity, average fleet age, and market prices for used vessels of similar age and from similar shipyards. The company’s order book is also important as it indicates both upcoming fleet capacity and additional financial obligations. For example, COSCO SHIPPING Holdings has an orderbook-to-fleet ratio of 20%, while Maersk and Hapag-Lloyd are at 9%.
Investors should also consider shipping companies’ lease obligations when assessing their leverage and financial strength. Additionally, the mix of shipping route deployments and relative exposures to the spot market versus term-charters (fixed-price freight rate contracts between liners and shippers) are crucial. The average voyage costs per TEU and bunker fuel consumption are also significant factors. Furthermore, investors should review the notes in companies’ financial reports for details on swaps or other derivatives used to hedge bunker fuel costs. Therefore, the PE, PB, and other ratios in Figure 5 are for reference only and should not be relied upon solely for making investment decisions, which require further research on other factors.
As investors are highly interested in the Japanese stock markets, it is worth noting that Japan has three large shipping companies: NYK (stock code: 9101), Mitsui OSK Lines (stock code: 9104), and Kawasaki Kisen Kaisha (stock code: 9107), which have pooled their container liner business together to operate jointly under One Trust. However, these three Japanese shipping companies generate most of their revenues from car carriers (roll-in/roll-out vessels), energy (tankers and LNG carriers), and dry bulk shipping, not container liner business. While they may be appealing investments, they are not driven by container shipping.
The container shipping industry is navigating waves and tides shaped by geopolitical tensions and geoeconomic fragmentation. While the Red Sea disruption has provided a short-term boost to freight rates, the long-term outlook hinges on the persistence of these disruptions and the broader trends of geoeconomic fragmentation.
As the operating environment continues to evolve, staying informed about geopolitical and geoeconomic developments, trade patterns, and supply chain shifts will be crucial for making informed investment decisions in this dynamic sector. Investors should carefully evaluate factors such as shipping routes, exposure to spot markets, fleet composition, and lease obligations when considering investments in container liner stocks.
Additionally, monitoring relevant freight rate indices, such as the World Container Index (WCI), the Shanghai Containerized Freight Index (SCFI), and the China Containerized Freight Index (CCFI), can provide valuable insights into the supply-demand dynamics and pricing trends in the container shipping market.
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