Demand for Space on Cargo Ships is Surging Ahead of Anticipated Tariffs on China
As over 300 witnesses present testimony in Washington, DC this week and next on the impact of proposed China tariffs on their businesses, uncertainty hangs in the air. Following the hearing process, committee review and publication of tariff schedules, new tariffs could be imposed as soon as late July or August, which means the cargo shipping rush is on to beat the potential hikes.
Don’t Miss the Boat
The prospect of tariff hikes acts like an “early bird” registration rate as companies are incentivized to lock in better prices now. Many retailers are competing just to find space for their goods on an ocean carrier. Air shipments are an alternative, but far costlier. The shipment surge has resulted in massive congestion at ports and warehouses that are bursting at the seams.
This scenario is familiar. Retailers scrambled last year to book cargo to get ahead of tariffs. Importers front-loaded holiday merchandise shipments to beat the 10 percent tariffs on $200 billion of Chinese imports in the fall of 2018, and then front-loaded spring 2019 merchandise imports late in the year when they anticipated the tariffs would go up from 10 to 25 percent on January 1, 2019. That threat temporarily subsided when President Trump extended the negotiation deadline with China, but reemerged in May 2019. This time, the tariff threat materialized. Goods would remain at 10 percent only if they were exported from China to the United States prior to May 10, 2019 and entered into the United States before June 15, 2019.
New Tariffs, New Shipping Surge
The President has said he will make a decision after the June 28-29 G-20 meeting whether to impose 25 percent tariffs on an additional $300 billion in Chinese imports, meaning a tariff on nearly everything the United States imports from China, including the kitchen sink (yes, kitchen sinks are on the tariff list).
Retailers generally import most of their holiday goods in August and September, but many are moving up this timetable in anticipation of higher tariffs, accelerating the traditional holiday peak shipping season. If major importers all do the same, advancing the shipment of months of inventory, how will shipping lines manage the demand and allocate vessel space? Where does all this volume sit when it arrives? What is the impact on costs for shippers?
All of this can add up to some choppy trade waters.
Hold My Spot
Retailers, who are the “shippers” of goods, may negotiate service contracts with ocean carriers under which the shipper commits to provide a certain amount of volume over a given period and the carrier commits to a certain rate schedule and set of services. Typically, the greater amount of volume, the better the rates will be. The alternative to contracts is the less predictable spot rate market. Usually valid for only one shipment, the spot rates fluctuate with market conditions.
Larger established shippers are more likely to have service contracts, while small- and medium-sized businesses are likely to be more at the mercy of the spot rate market. Because retailers generally require more pricing certainty and service guarantees, they may opt for contractual arrangements and lose out on the chance to capitalize on weak spot markets. Spot rates can dip below contract levels, for example, if carriers add too much capacity into the system or volume slows. Some businesses play it both ways, confirming some volume under contract and turning to the spot rate market for the rest.
There can also be price-based competition to secure slots on a particular vessel during peak periods, with carriers able to demand surcharges to protect shippers from being rolled onto a later vessel departure. When tariffs are imminent, shippers are often more willing to pay these surcharges to get space on the next available crossing.
Rather than contracting with an individual shipline, a shipper may choose to work with a common carrier, like UPS, that offers ocean transportation, but does not operate the vessels. These Non-Vessel Owning Common Carriers (NVOCCs) differentiate themselves by pointing to their ability to offer a diversified carrier mix and flexibility in cases of unexpected circumstances, such as a strike at the dock a particular carrier uses. The NVOCC negotiates with ocean carriers for a number of slots on particular trade lanes, in effect negotiating as the shipper, and then offers ocean shipping service to customers.
Seeking A Port in a Storm
In theory, changes to service contracts must be agreed upon by both parties – carrier and shipper – before taking effect. In practice, however, shippers and carriers sometimes treat service contracts more as guidelines than binding agreements. Import surges have caused some carriers to hike previously agreed rates, and if the shipper won’t pay, the cargo might sit in Shanghai.
Various organizations are developing innovative solutions to address these contract challenges, including through the use of technology to record contract terms and track shipments’ conformity with those terms, financial security tools to ensure penalty settlement, and requirements to pay collateral at the time of contract, unlike the current spot market where no money is exchanged until goods are on the water and either party can cancel at any prior point without an enforceable penalty.
As the race to get goods to shore heats up, shippers not only face cost increases at sea. With ports struggling with containers stacked six or seven high, shippers also face extra charges to get their goods off ships, onto trucks and into warehouses. As one example, the onslaught of containers also means a surge in demand for chassis, the steel frames that allow trucks to carry shipping containers. If sufficient chassis are not available, truckers have to delay deliveries, incurring costs that are passed to the shipper.
With thousands of retailers moving tremendous volume, the issue of warehouse capacity also becomes a challenge. According to Los Angeles Times reporting, Southern California’s warehousing and distribution complex, the largest in the world, has a less than one percent vacancy rate. Some retailers have resorted to storing pallets outside, while others face hefty fees for exceeding storage windows.
Are China’s Neighboring Ports Ready?
What about sourcing from countries other than China to avoid the tariffs? That’s easier said than done, at least in the short term to beat a looming tariff deadline. Switching to new vendors and manufacturers takes money and time. New vendors must be trained to meet retailer standards and be able to meet needed lead times. Factories must be vetted for quality standards, social welfare conditions and security factors. China also has superb logistics and other supply chain advantages that other countries cannot match.
In a recent piece in The Hill, the Cato Institute’s Dan Ikenson pointed to trade data showing that, as U.S. imports from China fell by 12 percent in the first four months of 2019, imports from Vietnam grew by 32 percent over the same period. However, Vietnam’s transportation infrastructure is reportedly overwhelmed with the new volume, straining the country’s roads and ports. And, Vietnam is facing pressure to adopt more rigorous measures to ensure that Chinese products do not get transshipped through the country and into the United States, merely to avoid U.S. tariffs.
“The Port of Los Angeles and the Port of Long Beach together comprise the San Pedro Bay Port Complex…On the import side, our most recent analysis estimates the current and proposed tariffs directed at China will impact roughly 66% of all imports by value at the San Pedro Bay.”
– June 17 letter to U.S. Trade Representative Robert Lighthizer from Eugene Seroka, Executive Director, Port of Los Angeles
Rough Waters Ahead
Despite the current shipping boom as producers and retailers build inventory to get ahead of tariffs, the shipping industry is concerned about the future impacts of an inevitable falloff in volume, even if the U.S. economy remains strong. When import volumes soften, dockworkers are not called to work, and the demand shrinks for logistics workers, warehouse workers and truckers. The surges and variability caused by tariff threats – some enacted and some not — have generated a boatload of uncertainty across the wide range of industries that make up the supply chain.
That uncertainty affects not only the users of shipping infrastructure, but sometimes the infrastructure itself. The Massachusetts Port Authority (Massport) owns and operates the Conley Container Terminal in the port of Boston, which serves 1,600 regional import and export businesses. After avoiding tariffs last fall on ship-to-shore cranes to service larger container ships, Massport finds the cranes back on the proposed tariff list. The imposition of 25 percent tariffs would add at least $10 million in costs for three new cranes it plans to buy. Currently, there is no U.S. manufacturer for these cranes and the only experienced manufacturer is in China.
The President and CEO of the American Association of Port Authorities is among those testifying at the hearings this week. He will make the case that tariff increases would negatively impact ports’ ability to make investments in infrastructure that are needed to handle significant growth in trade volumes in years to come. Modern transport infrastructure and a return to greater trade certainty will add up to smoother sailing for ports, consumers, and workers across the supply chain.