Rate Outlook 2020: Fortune Favors the Bold

The old Chinese proverb about “living in interesting times” has never been more appropriate as a way to describe where we find ourselves at the onset of 2020. There’s much turmoil in the world on many levels, from economic challenges to energy uncertainty to social and political issues, right down to the fundamental activities of moving the world’s freight.

The North American economy remains strong, despite predictions of a recession on the horizon. In the meantime, some of this apparent strength is belied by the significant decline in freight volumes across a number of sectors. With that in mind, the key question we’re seeking to address is how all of this will influence the cost of North American freight management in 2020.

On the one hand, freight volume is static or declining, which bespeaks an economy heading into at least a slow-down, if not a recession. On the other hand, there are so many moving parts and indecipherable variables that predictions are in lock step with the old adage that “forecasts are either lucky or lousy.”

Having interviewed more than a dozen industry experts across all the modal segments, one common emergent theme is “uncertainty is certain,” and everyone’s crystal ball is significantly murkier than usual. Virtually all believe that the first half of 2020 will be tepid, with softness in the economy, excess capacity and no major changes in pricing.

There’s also the notion of—or hope for—a rally in the second half of 2020. While that’s a common thread across the board, it may be more wishful thinking than grounded in sound economics.

So what’s a shipper to do? Many we’ve spoken with have said: “We will wait and see what happens, but we expect to pay more.” As we’ve learned over history, passively waiting for something to happen is not a winning strategy.

What, then, is the alternative? Boldness, or at least proactivity, may be in order. Every shipper has a definable network of freight flows, inbound, outbound and usually inter-facility. Looking at the network holistically and optimizing modal choices is always wise, but never more so than now, with the economy in a confused state and the uncertainty that the new IMO-2020 regulations will have on the domestic cost of fuel, getting a good handle on network spend, capacity needs and evaluating modal choices is a very sound step.

The unstable market conditions with respect to price, capacity, service and cost means that it’s simply not possible to maximize network effectiveness and performance with traditional methods. Looking ahead at each of the key modes, our team of experts offers a series of observations and recommendations as we launch into 2020.

Fueling uncertainly

There are cross-modal storm clouds on the horizon relating to the implementation of the new IMO-2020 regulations January 1. While directly affecting the 51,000+ vessels in the global fleet not already equipped with exhaust scrubbers, the shift away from heavy fuel oil (HFO) to low sulfur alternatives is expected to ripple across supply chains worldwide. Goldman Saks estimates the impact at about $240 billion globally.

According to Derik Andreoli, principal at Mercator International and a frequent contributor to Logistics Management, the oil market is currently oversupplied, and it is likely to remain so over the first half of 2020 as global demand is expected to rise by 1.2 million barrels per day (bbl/d), while total non-OPEC supply alone is likely to grow by at least 1.6 million bbl/d.

Andreoli believes that this will pressure OPEC to keep oil production cuts in place, but it seems unlikely that OPEC will agree to pull oil production back any more than it already has. So, shippers should expect oil prices to remain bearish.

“This weakness in the global crude oil market has allowed us to dodge a bullet—so far—in terms of IMO-2020 impacts,” says Andreoli. “Under a high economic growth scenario, IMO 2020 would result in a rapid rise in distillate prices, which would drive up oil prices and, in turn, all other petroleum product prices with them. Instead, we’re looking at relatively low economic growth matched with an oversupplied oil market. As a result, we have seen oil prices remain low. More importantly, high sulfur bunker prices have plummeted while distillate prices have remained relatively flat, a pattern that we expect to remain in place over the first half of 2020.”

Andreoli makes one final point that’s germane to shippers. Ahead of IMO 2020, ocean carriers instituted new formulas for calculating bunker surcharges. While there are minor variations between these formulas, all of them pass the full cost of fuel on to the shippers. Hence, most of the shippers he has talked to expect that the bunker surcharges will end up being roughly equivalent, regardless of which carrier they choose.

Consequently, Andreoli recommends that, during contract negotiations, shippers ask each carrier to provide a bunker surcharge estimate that assumes bunker prices remain what they are today. This way, the shipper should avoid paying too much for the service.

True sea change is upon us

Ocean carriers will be challenged significantly to deal with what has been billed as the greatest ever change in energy policy, as will their customers and virtually all other modes of transport. Philip Damas, director and head of the supply chain advisors practice London-based Drewry, says he expects continued over-capacity in container shipping in 2020.

“Carriers have become adept at hiding over-capacity by using cancelled sailings and idling ships,” says Damas. “We expect carriers will continue ensuring load factors do not fall below 85% on the trans-Pacific route in 2020.”

Drewry expects that the key trans-Pacific eastbound route (Asia to North America) will see base freight rates (excluding fuel) decline in 2020 after having increased in 2019. In the spot market, spot rates have at times dropped below contract rates, while recent data from the Drewry Benchmarking Club shows that contract rates have already started to decline.

The key pricing theme of 2020 is the impact of the IMO-2020 low-sulfur regulation, which will increase the fuel portion of freight rates by 30%+. So, 2020 will be a combination of lower base rates and higher fuel charges, in Drewry’s view. It will be very important for logistics executives to ensure that they’re not over-paying for fuel costs in ocean transportation this year.

“Service levels from ocean carriers was poor in 2019,” says Damas, “with a higher-than-normal incidence of roll-overs and late shipments and a negative impact from front-loading of shipments pushed by shippers to avoid tariffs. While there will be more focus on carrier performance indicators in 2020, there’s no guarantee that service levels will actually improve for most shippers.”

Drewry is advising shippers to include new service performance clauses in their contracts with carriers in an effort to help keep costs in line. “We estimate fuel costs globally will increase by $11 billion in 2020 due to the IMO regulation,” says Damas. “This is a huge risk for vessel operators, as this amount is three times the aggregate profits of ocean carriers in 2019. It increases the risk that some financially weak carriers will discontinue some of their services.”

For most shippers, the impact of the new regulation will depend on their network, choice of carriers and services as well as contractual clauses. Cost impact quantifications made by Drewry showed that the impact for medium-sized shippers to be at least $2 million a year per company.

With he January 1 implementation of IMO-2020, Damas still sees a lot of uncertainty for many shippers concerning its impact on freight costs and, possibly, on slow-steaming and transit times.

“None of Drewry’s customers has received information from their ocean carriers on whether they will change their vessel speeds or transit times after the implementation of IMO 2020,” he adds. “This is an area to watch very closely during 2020.”

Trucking’s trying times

While the maritime business wrestles with the way the business will need to operate going forward, the trucking industry is in a no-man’s land of rising costs and downward pressure on price. Trucking bankruptcies soared as pressures mounted, and there does not seem to be any relief in sight.

“People have been shocked by how quickly we went from too little capacity to too much,” says veteran trucking analyst John Larkin. “They’re also reluctant to be too aggressive with so much in flux, including a trade deal that’s incomplete, political disruption and a potentially slowing economy leading to preparations for a downturn—which can be a self-fulfilling prophecy. There are just too many moving parts to take out a divining rod and understand what is likely to happen.”

Larkin adds that many believe that it will be soft through the middle of the year and then pick up, which could pile rate increases on top of increases caused by rising fuel cost. “Capacity could begin to tighten again as ELDs go fully into effect and cheating becomes much more difficult,” he says. “However, the cost of diesel may well have shippers rethinking their supply chains and modal choices. It may also accelerate a shift to alternative fuels—electric, hydro-cell, CNG, LNG. But the bottom line is that 2020 is a bit of a crap-shoot based on variables the industry doesn’t control.”

According to Ben Hartford, a senior equity research analyst overlooking transportation and logistics at Robert W. Baird & Co., the trucking market has basically done a 180-degree turn since 2018—and all price increases have been given back and then some. He also cautions that the second-half strengthening in the economy may be illusory.

“There are elements in play today that just weren’t there a few years ago,” says Hartford. “There’s more transparency and visibility into supply chain behavior; there’s lots of volatility; and the momentum is favoring the shippers heading into bid season.”

Hartford adds that he does see the back half of 2020 shaping up to be a bit stronger, although there’s always bias toward back-half recovery. “Growth rates are expected to be better in the second half of 2020, although manufacturing remains under recessionary pressure,” he says. “However consumer demand is an even bigger driver, and lagging here would have an impact on second half growth. In an election year, you can expect the current administration to pull out all the stops to make the back half look as good as possible and promote growth.

Pale rail

The rail industry has been suffering through sustained declines in carload volume, with volume down 3.3% through the first 33 weeks of the year. In the meantime, the carriers are striving—and succeeding—in taking out operating costs and maintaining reasonably good profitability, with operating ratios reflecting improving efficiency, despite losses of volume in virtually every commodity group except petroleum products.

Oliver Wyman veterans Bill Rennicke and Jason Kuehn watch the rail industry closely. Rennicke says that in the short-term, price changes will vary by commodity, rates will reflect market conditions and to expect modest increases in certain areas. Kuehn sees the level of uncertainty to be quite high, and says shippers should be prepared to stay the course for 2020, at least in the second half, with fairly static pricing and maybe small increases. Service, on the other hand, should hold up well due to fluidity in the network.

“Earnings per share going down will put more pressure on volume and price, while railroads are generating cash and doing share buy-backs to improve earnings,” says Rennicke. “That pricing improvement is likely to be undertaken cautiously to see what will stick, with the notion that improved service under precision scheduled railroading will justify increases.”

In the meantime, intermodal volume has been anemic for most of the year. Despite earlier predictions that the bottom was reached this past summer, third quarter volume dropped 4.6%, the steepest third quarter decline since 2016.

Larry Gross, president of Gross Transportation Consulting and long-time industry veteran who reports on the intermodal business, has called the current situation “unprecedented, not a normal cyclical event.”

According to Gross, pricing will be subject to what’s going on in the truckload sector, although a contributing factor is railroad “pricing discipline” where carriers are seeking to hold rates at present levels or even improve them. “This is difficult because intermodal is a minority mode and is a price-follower rather than a price-maker,” he says. “If intermodal doesn’t offer a price discount of 5% to 15% against truck, it isn’t going to get the business.”

A very key question is what will happen with truckload contract volumes, which represents about 90% of the source volume for intermodal. Truckload pricing is still under pressure and still in favor of the shipper. “I don’t see anything on the horizon that will dramatically alter that, although increasing driver wages and rising cost of fuel may help intermodal.”

Aerial gymnastics

Air cargo volumes declined for the 12th month in a row through October, with general cargo down 8.2% over the prior year. Chuck Clowdis, managing director of the consulting firm Trans-Logistics Group, says that 2020 won’t be another 2018, but it could be a boom for air cargo, as a lot more product may have to fly if slow-steaming lengthens supply chains five days to seven days.

According to Clowdis, consumer confidence and spending will have a lot to do with what sort of peak happens; however, present capacity is abundant and schedule reliability has been pretty solid. “Shippers will see air cargo prices to rise moderately in 2020, so my advice to shippers is to negotiate with forwarders early so you can take time and employ a methodical approach,” he says. “Air shippers need to be proactive. Don’t wait for your suppliers to come to you and don’t roll over with their first announcement of increases.”

Clowdis cautions that if consumer confidence continues to stay strong as predicted in recent surveys, then those moderate rate increases will become greater with a possible mid-year rate increase on the horizon. “Air shippers always need to keep an eye on consumer confidence and spending numbers,” he adds.

Parcel peculiarities

Both UPS and FedEx recently announced their increases for 2020 and, as expected, came in at slightly under 5%. As the saying goes, however, the devil is in the details.

Brian Broadhurst, vice president of transportation solutions at Spend Management Experts points out that actual cost will depend on the shipper’s parcel profile, their lanes and shipment sizes. Whether the shipper has some form of price protection in their contract will also play a role.

Broadhurst also points out that FedEx and UPS have two reasons for increasing pricing: covering cost and affecting behavior. FedEx shipments that exceed 150-lb/108” length will increase from $675 to $875 effectively price matching the 2020 UPS rate. UPS will also be assessing $875 in 2020, with the key difference being that the UPS rate was $850 in 2019. At this point, it’s clear that the carriers don’t want these size shipments in the parcel network.

“It’s now important for parcel shippers to look at contract rate increases and review contracts,” says Broadhurst. “It’s also a good time to examine shipment profiles, and on large packages, negotiate a better deal, evaluate re-sourcing or consider mode-shifting. Large shippers should also consider splitting volume in some proportion across both carriers.”

Jerry Hempstead, president of Hempstead Consulting and a veteran player in the world of parcel shipping, points out a number of the not-so-obvious sand traps and land mines. All prices are going up slightly less than 5% (DHL 5.9%, but from lower base). He reports that he fuel surcharge is between 7.0% and 7.25% of revenue and is a significant profit contributor, rather than a pass-through of an uncontrollable expense, as originally intended.

“Shippers need to be aware of other surcharges and negotiate them, too,” adds Hempstead. “Because everything is negotiable.”