Forwarders already buffeted by protectionism and bearish freight markets could take a hit later this year as new low sulphur fuels are introduced by shipping lines ahead of new IMO regulations that become mandatory at the start of 2020, according to one leading analyst.
Stifel views the current freight forwarding environment as “soft” with geopolitical uncertainty continuing to weigh on the industry. However, while most forwarders have been able to compensate for sluggish demand with better unit yields from lower capacity pricing, the potential cost implications of low sulphur shipping fuels which will be passed on by container shipping lines from later this year onwards is still not being fully recognised.
“One risk that we believe has not been sufficiently encapsulated is IMO 2020,” said the analyst in its latest market report. “We think the impending low-sulphur mandate could drive significant gross margin compression for many of the forwarders as early as Q3, but more likely in Q4 2019.”
According to Stifel, the IMO 2020 low sulphur regulations could produce anywhere from $10-30bn in direct ocean freight costs. “The container lines have historically done a poor job of passing costs through, but given the scale involved here, we believe there is no alternative,” it said.
“Those touched by the first derivative impacts have been planning appropriately, but second and third derivative affectees have not, in our view, and could see a 30% or greater increase in surcharges on major lanes.”
The analyst describes the current ocean freight market as one defined by tepid volumes and facing a potential gross margin squeeze in H2 2019 as IMO 2020 looms.
“Global ocean volumes continue to decelerate in line with global GDP,” the analyst firm said. ”At least part of the slowing is related to the absence of tariff pre-shipping activity, which was evident in North American container import volumes.
“Ocean yields for freight forwarders have been ‘neutral to improving’ as underlying capacity pricing has been under pressure. However, IMO 2020 could take capacity rates up significantly as early as Q3 2019, which would squeeze forwarder gross margins, all else being equal.”
Stifel believes that tariffs - real and threatened - are now creating direct costs for imports and driving uncertainty amongst shippers. “If antagonistic trade relations persist, we believe we could start to see more significant effects on fundamental demand as costs are passed through to consumers,” it said. “The direct, negative modal impact is most acute in ocean freight forwarding due to volume loss. But customs brokerage and 3PL/supply chain planning operations tend to benefit as shippers seek expertise in finding workarounds.”
According to Stifel, production sourcing shifts by manufacturers are not the answer to tariff woes. “Contrary to popular belief, sourcing shifts cannot be effected quickly, and sometimes, they cannot be effected at all,” it said. “Some operations are too complex to move elsewhere - shippers must consider product complexity, batch size, production capacity, distance from intermediate suppliers, proximity to raw material locations, and lack of logistics infrastructure. Sourcing shifts may add lead time and thus risk to the supply chain, for example, in India, it can often take up to two weeks to move goods from an inland facility to the port. And sourcing shifts may come with other costs that negate the savings on duties relative to the status quo. For example, more use of feeder capacity to and from hub ports.”
However, despite the bearish outlook for forwarders mergers and acquisitions activity remains “hot”, said the analyst. “Lane-level scale is becoming more important as shippers become more surgical with their supply chains,” it said. “Also, freight forwarders are looking to niche specialization to drive high-margin value-added services. Competitive pressure continues to form around the fringes of the industry – for example, container lines expanding into broader logistics functions. And, finally, while the digital disruption threat has matured and mellowed, the need to innovate and invest significantly in technology is strong as ever. We believe these trends will drive a continuation of the current, elevated pace of M&A.”