The current legal framework exempts container carriers from the generally applicable EU competition rules prohibiting anti-competitive agreements between companies. The European Union must decide whether it extends the Consortia Block Exemption Regulation (BER) for the liner-shipping sector for another five years from 25 April 2020.
Since asking for comments on the current legal framework, there has been much discussion about whether or not to continue the BER. Shippers advocate the termination or at least the major adaptation of the BER, while carriers argue that the BER remains necessary in order to be able to pursue a healthy sector. Although not all the objectives set at the time of establishment are achieved and the BER – due to the increase in scale and shifting market power that it indirectly encourages – also has a number of disadvantages, a decision to abolish it now may be premature.
The Block Exemption Regulation for Liner Shipping
The BER, introduced in 1995, but that has since been amended several times, makes it possible for container carriers to enter into collaborations under certain conditions. This takes the form of alliances, vessel sharing agreements (VSAs) or slot sharing agreements. Conditions for this type of collaboration are that the alliance may not have a market share over and that no price or capacity agreements are made.
The reason for setting up and maintaining this scheme at the time was that 'consortia generally help to improve the productivity and quality of available liner shipping services by reason of the rationalisation they bring to the activities of member companies and through the economies of scale they allow in the operation of vessels and utilisation of port facilities.’ The EU also states that: ‘If consortia face sufficient competition and are not used to fix prices or share the market, users of services provided by consortia are usually able to benefit from improvements in productivity and service quality. The Commission has therefore exempted such agreements from the prohibition of anticompetitive agreements in Article 101 of the Treaty on the Functioning of the European Union (TFEU).’
The previous renewal question in 2015 stated that these reasons were still valid and the decision was taken to continue the scheme. But are these reasons still valid today? Questions that arise are: Does the scheme lead to increased productivity and higher quality? Is there still sufficient competition? Is there an issue of market power towards customers and/or suppliers who are being abused or may be abused? Are there other factors that are important and should be taken into consideration?
Liner Shipping Industry, Structure and Development
The liner shipping-sector characterises by relatively high fixed costs and by established shipping routes on which regular services are offered in fixed schedules with sufficient frequency. At the same time, demand is volatile and seasonal. Therefore, there is a risk of underutilisation of the vessels, with negative consequences for the profit margins. In order to reduce the risk of bankruptcies and hence instability in the sector – see the dramatic collapse of the Korean shipowner Hanjin – some protection against destructive price competition can be justified. In addition, container transport is an activity where differentiation is hardly possible. Competition takes place on price, which means that the focus is on cost savings. This also has a clear impact on the profit margins.
An additional feature of the sector is that it can easily make use of economies of scale. Larger vessels lead to significantly lower costs. In combination with the strong focus on cost reduction, which is the main opportunity for carriers to gain a competitive advantage, this has led to continuous investment in larger vessels. Between 2008 and early 2019, the average vessel size on the Asia-Europe route increased from 7200 to 15,800 teu. By September this year, the largest ship on the route will have grown from 15,500 to 23,000 teu. In 2018 there were 26 ships larger than 18,000 teu, the highest number so far delivered to the carriers (total 525,500 teu). For 2019 and 2020 an approximately equal increase is expected with respectively 460,000 and 620,000 teu of capacity in the order books (Drewry, 2019). The increase in scale of the vessels has gone hand in hand with consolidation in the market.
In order to fill the larger vessels and to be able to deploy the capacity properly, the individual carriers are (or were) often of insufficient size. Takeovers have taken place, alliances have emerged and many VSAs and container slot agreements have been concluded. Concentration has increased. In 2018, 67 inter-regional container carriers with fully cellular vessels were active in the market, with the top ten controlling more than 87 per cent of the capacity. The East-West trades have seen alliances emerging, serving almost the entire market. The table below shows how dynamic the formation of alliances has been since 2000. The table below that gives an overview of the shares of the alliances in the capacities on the individual East-West trades.
Development of alliances in the deepsea container trades between 2000 and 2016 (source: Drewry, 2018). In April 2020 HMM will become a full member of The Alliance.
Capacity shares of alliances on the main East-West trades (source: Drewry).
The Ocean Alliance (Cosco, CMA CGM/APL, Evergreen Line) has the largest capacity share of 36 per cent on these trades, followed by 2M (Maersk and MCS) with 32 per cent and The Alliance (ONE, Hapag-Lloyd, Yang Ming) with 26 per cent. The share of "non-alliance members" on these trades together is six per cent. Thus, the BER – enabling these collaborations – has a strong link to the development of consolidation and economies of scale. However, major point is that both scale increase and consequent consolidation are primarily a result of the market structure and the way in which this market functions. The second important point here is that on East-West trades, in some cases the shares already exceed the set thirty percent ceiling and are thus subject to self-assessments, as prescribed by the general EU competition rules.
Improvements in the Market?
Over the past two decades, rates have fallen substantially. Although there are different rate developments on the different trades, between 2010 and 2018 the rates have decreased by between forty and sixty per cent (Murphy, 2018). Shipping lines have apparently (partly) passed on the efficiency benefits of larger vessels and rationalised networksto the shippers. This is also logical in view of the fact that there has always been competition in the market.
At the same time, a number of service attributes have not improved or have even declined in quality. With ships growing in size, they have slowed down and transit times have increased. The total end-to-end duration of services in the Asia-Europe trade increased from 8.7 to 11.3 weeks because of slow-steaming (Murphy, 2018). In addition, port stay times have increased significantly in order to handle the larger vessels. This entails costs, especially in terms of inventory costs. On the other hand, slow steaming results in less fuel consumption and therefore fewer emissions.
However, the choice for shippers has declined. There is a reduced number of direct port connections and frequencies are lower. At the very least, reliability has not increased. The question is whether this is a consequence of the BER and should be attributed solely to the carriers. Reliability is partly determined by (for the carriers) external factors. In addition, a more reliable product may be more expensive, for which it is necessary to find a willingness in the market to pay. Shippers themselves also have a role to play here. The answer to the question of whether the BER has brought about the intended improvements is therefore ambiguous.
Towards an Overly Concentrated Market?
The question then is whether there is still sufficient competition and whether there is not too much market power towards customers. It is clear that the formation of alliances has led to continuous increase of concentration in the market and that other forms of cooperation can also have a restrictive effect on competition. At the same time, we see that carriers have continued to compete with each other within alliances. Profit margins have not risen, they fluctuate strongly, but generally remain low. In 2016, for example, they were still predominantly negative. If we look at the Herfindahl index, an index that indicates the degree of concentration in a market,we see that there has been a sharp increase over the past ten years. However, the values of the index are still such that it is not (yet) possible to speak of an overly concentrated market.
An issue that applies here is the determination of market share. The BER states that this may not exceed thirty per cent, but how can this be determined? First, the relevant market must be determined. For globally operating carriers that operate on different shipping routes, serve geographically different markets and vertically integrate in the chain, this is not unambiguous and simple. Market shares should be determined based on transport volumes and not on capacity, as is currently the case because of a lack of data. Thus, although calculated Herfindahl indices do not yet show an overly concentrated market on most shipping lanes, the first question is whether this analysis can be carried out correctly. In addition, there is the question whether – given the increasing development of this index – this does develop into an overly concentrated market on certain trades in the coming years.
Market Power Towards Ports
The developments in ship sizes, in the number of ships, but also in the number of carriers, the size of carriers and the number of containers transshipped per port all influence demand and, therefore, the operations of all parties involved: port companies, terminals, maritime service companies and hinterland modalities. To what extent are all these parties affected by consolidation and an increase of in scale in the market?
In the case of ports, the ever larger ships require adjustments to the facilities and ask for an increase in efficiency. This is necessary to be able to handle the larger vessels and the larger number of containers they carry. This also applies to the connection with the hinterland, where congestion is a persistent factor. The competition between ports – partly fuelled by national interests – combined with the stronger position of carriers and their alliances, ensures that ports continue to make the necessary investments, which not always shows directly in their revenues.
The terminal operators definitely face greater market power of shipping companies. Terminal companies – coming from a reasonably protected market with relatively high margins that are (still!) substantially higher than the margins of container carriers – are now experiencing stronger pressure on their rates. This is partly due to increased competition and partly due to the consolidation on the part of the carriers. In addition, consolidation brings greater risks for the terminals: if an alliance shifts its complete cargo package from one terminal to another, this can have a major impact on the occupancy rate.
The maritime service suppliers in the port also experience these effects. By bundling purchases, the carriers have more market power through their alliances, which they can use to put pressure on rates.
Continue or repeal?
The structure and functioning of the liner shipping market calls for some protection against destructive price competition, which is a real risk and can lead to market instability. The possibility of cooperation and capacity sharing is a logical instrument for this. However, the formation of alliances seems to have gone perhaps too far on certain trades.
Very large parties have emerged on some trades and – especially from a chain perspective – an excessive ship size development has taken place. In addition, the quality of service has not improved and greater market power towards suppliers has arisen. Yet, whether this logically implies the abolition of the BER, remains questionable.
First of all, the BER has already partly ceased to be applicable for the East-West trades, while for the other trades different forms of cooperation allow for better capacity utilisation and can prevent instability. Secondly, overly concentrated markets do not yet exist and shipping lines do not make excessive profits. Thirdly, the vicious circle of cost savings, larger vessels, overcapacity and pressure on margins is a major concern, but rather a consequence of the structure and functioning of the market; the abolition of the BER will not eliminate this. Finally, the reliability and quality of service is also a concern, but at the same time also a demand feature for which there must be a willingness to pay in the market.
Concluding: while this author would not recommend the repeal of the BER right now, it is suggested to accurately monitor the development of the degree of concentration in the various relevant markets in the next five years. In addition, attention is needed for preventing the potential abuse of the increased market power (that is, purchasing power) of shipping lines over suppliers.
This article was originally published in SWZ|Maritime’s port special of June 2019 and was written by Dr Larissa van der Lugt, director of the Erasmus Centre for Urban, Port and Transport Economics (UPT). Subscribers can download the June issue online.
References
- Drewry (2019), “Have We Reached Peak ULCV Delivery?”, Drewry Shipping Consultants, Container Insight Weekly, 20 January 2019
- Drewry (2018), “Will Alliances Be Blocked?”, Drewry Shipping Consultants, Container Insight Weekly, 18 November 2018
- Alan Murphy (2018), “Containerliners Are Holding Their Breath", presentation Havendebat Rotterdam, 12 December 2018
Picture (top): A ship belonging to the UASC shipping company that was taken over by Hapag-Lloyd in 2017, which is part of "The Alliance".
