Today’s Wall Street Journal article “With Big Ships Come Bigger Risks” (page B1) reminds me of a lesson that I learned 20 years ago while managing supply and distribution to the West Coast for a major gasoline blending component of the time, MTBE. Our counterparts in the ARCO Transportation Company (since absorbed by BP in a 2000 acquisition) desperately wanted us to commit to a ‘contract of affreightment’ for a vessel called the ‘ARCO Texas’. The name is suggestive of its size, and they were proud that this vessel could carry more bulk product through the Panama Canal than any other Jones Act ship on the seas. The only problem was that it could only be loaded at one dock in the Houston area and offloaded at one dock in Los Angeles. The pipeline fees involved in the last 10 miles of product distribution to the various West Coast refineries erased all of the benefits of scale on the water. Fortunately, my savvy colleagues found another ship, the Keystone Golden Gate that had a slightly smaller payload but a substantially shallower draft that could deliver to all the West Coast refineries. We enjoyed over two years of very profitable operation with the Keystone Golden Gate. The low costs allowed us to take the risk of a time charter structure that we could convert into low cost, reliable deliveries to customers and profitable trades from the ship’s flexibility.
Let’s contrast this with today’s WSJ revelations about the risks of large vessels. The lesson nearly jumps out of the article’s text. “Since the economic downturn, shipping lines have sought to stay competitive by running larger, more fuel- efficient container ships in major shipping lanes, reducing their cost of container”. But the list of risks not accounted for in this pro-forma cost analysis include:
– The cost of demurrage and other underutilization penalties associated with delays on these capital-intensive beasts. Demurrage hourly rates increase as the size of the largest container ship increases from a payload of 12,000 TEU’s (twenty-foot containers) to 18,000 TEU’s.
– Ship groundings are among the most prominent insurance losses associated with these large container ships. Larger vessels with deeper drafts and a shortage of talent to operate these vessels will only increase the risks and consequences of events like these. At some point, the larger vessels will be too large for some portion of the marine infrastructure, causing bottlenecks and delays if the large ship stalls or collides with something.
– “There is an element of uncertainty about how the new generation of container vessels will behave at sea……..”. Whether or not these concerns translate into more incidents, the value at risk for an 18,000 TEU vessel is greater than for 12,000 TEU or 5,000 TEU vessels. Make sure to understand the risks you are signing up for when you ‘lock in’ lower freight costs.
When supply chain operators adopt a single-minded focus on cost (particularly freight), surprises and complexities are sure to follow. The Panama Canal is an interesting example of this. It is only large enough to handle ships carrying up to about 5,000 TEU’s and has been in the process of constructing new locks that can accommodate the larger container ships (construction began in 2007 and completion estimates have been delayed from 2014 to 2016, by which time the largest container ships will likely be too large for what was designed ten years before). At the current time, the larger ‘post-Panamax’ vessel (anything above 5,000 TEU) must unload in Long Beach, California. Containers continue east via intermodal rail into the continental US.
Reminiscent of my ARCO Texas example, though, none of the U.S. East Coast ports are large enough to handle these larger container vessels once they pass through the expanded Panama Canal in 2016. This has set off a fury of public works studies and proposals from Miami and Jacksonville to Baltimore and New York. Whereas the Panama Canal expansion involves an approximate capital cost of $5 billion, each of these cities is looking to spend sums ranging from $0.65 to 1 billion to resolve some sort of bottleneck in its port (raising the Bayonne bridge in NYC, a new intermodal terminal in Baltimore, expanded trucking access in Miami).
What’s not clear is whether the full total cost to bypass the Long Beach/Los Angeles ports will be lower, or whether the total transit time will be faster. In either case, I am not sure it matters. When we observe what is happening right now at the West Coast ports with a labor force that has accurately assessed that they are the only option for owners of large container ships, perhaps the increased flexibility associated with expanded unloading and delivery options will be exactly the agility that ship owners (and the global supply chain) need, regardless of whether it is ‘lower cost’.