A cartel is defined as an organization of producers designed to eliminate competition amongst its members, usually by restricting output.*
In an article by International Freighting Weekly, John Lu, Chairman of Asian Shippers Council said, “…the shipping lines have started to work more closely and, in my view, this is the action of a cartel which has pushed shipping rates and surcharges artificially high.” Mr. Lu has a point. Profits in the shipping industry have turned 180 degrees over last year.
This week A.P.Moller-Maersk announced that profits would be much better than expected earlier this year. The company expects to book a profit of over $2 billion against a loss of over $1billion last year. Most of the profit will come from the container shipping sector. Other carriers are expected to follow suit. CMA-CGM’s declared a profit of $380 million in the first quarter of 2010; a $640 million turnaround from the same period last year. But how much of these profits are simply being at the right end of the market? Was the bounce back in the first half of 2010 so good that no one predicted, or could have planned for the additional capacity necessary? How much of the behaviour was actually “cartel-like”?
Conferences and talking agreements are common in the box shipping industry. In fact, one could make a fairly reasonable argument that the dismantling of conferences by the European Union made a significant contribution to the liner losses in 2009. At the very least, it didn’t help that lines could not publicly discuss capacity issues. But did that stop them?
There are certain industries where the formation of cartels (or cartel like behaviour) is rewarded. OPEC of course is the most famous cartel. OPEC tightly controls the supply of oil produced, and by doing so most of us are paying much more today for a litre of gas than we were even five years ago. Economics Explained* discusses the conditions necessary for cartels to thrive.
1) In a perfectly competitive industry, profits will increase if producers enter into an effective agreement to restrict output.
Carriers have successfully restricted output by first idling ships and, then slowing them down. In the aftermath of the 2009 bloodbath, and the abolition of conferences in the Asia – Europe trade, the industry had to do something to ensure the market was not over supplied. While there is no evidence of collusion, many long time industry observers mentioned that the collective laying up of ships was the closest the industry had ever worked together. There is a plausible argument to be made that carriers would have had an agreement to reduce capacity as so many would benefit from the reduced supply.
2) To achieve and retain the benefits of monopolization requires more than just agreeing to restrict output. An effective cartel must be able to police and enforce its output quotas because it is in any one producer’s interest to cheat.
While the carrier’s may have worked suspiciously tightly together to restrict supply, there is no evidence whatsoever that they had anything that related to a policing or enforcement mechanism.
3) An effective cartel must be able to control entry into the trade.
Due to the high cost of capital, there are numerous barriers to entry in container shipping. In fact, global carriers have all of the major and medium sized trades covered. New entrants are rare. The newest The Containership Company started a transpacific service this year with four ships serving only one port in China and one on the U.S. West Coast. Globalization has forced carriers to expand or get bought out. The dozen or so truly global carriers can effectively keep new companies out of the market by swapping slots, covering multiple ports and taking up ship building capacity by constantly ordering new ships.
4) In the short run, the demand curve must be fairly inelastic for the cartel to be successful.
The only real demand elasticity in container shipping is that of commodities that can be switched from break bulk to containers and back. In this case, the price point for container shipping against break bulk is relevant. However, in the merchandise trade a 5% drop in price does not result in a 5% increase in aggregate volume. Despite the wild fluctuation of shipping prices, volumes have risen steadily (2009 the exception) for decades. Most retailers’ supply chains are in one way or another entrenched in globalization. Even if importers wanted to change their sourcing due to higher shipping rates, they might be hard pressed to find adequate suppliers close to their markets. And they will likely find that many of their old local suppliers are also outsourcing. This is certainly the case in North America.
The top 10 carriers in the world control half the global fleet. Moreover, they also control half of the new buildings on order in the next three years. This group alone could keep prices high for many years to come despite fluctuations in the economy. But the test whether this group is running in a cartel-like way appears to be coming.
This year and next shipping lines will add about 20% to the fleets of the top 20 carriers (see table on link below). Uncertainty in the American economy continues with sluggish employment growth and a depressed housing market. While Europe’s difficulties with Greece appear to have subsided (resistance to reforms over the $134 billion dollar payout is losing steam), growth is still expected to be anaemic in 2011. If box shipping supply suddenly outstripped demand, as could plausibly happen, in the last quarter of 2010 and first quarter of 2011, how will the carriers react?
The real lesson for the shipping lines in 2009 is that they are able to effectively control supply. The mechanisms to manipulate the market by choosing to keep ships out of service or slow steaming are now firmly in place. The question is not whether they will do it again, rather how quickly will they react to the downturn next time?
* Economics Explained fourth edition, Linsday/Pervis/Sparkes/Steiner pp 314-320 (Harper & Row, copyright 1982)
Top 20 Liner Carriers and their Order Book (OB) 2010 to 2012