For decades, ports reacted to changes in the maritime industry, expanding facilitates to accommodate trade. The shipping lines would order larger ships and the ports responded, expanding their terminals to serve their customers. If navigation channels needed deepening, the ports would seek federal dollars or undertake the work themselves. Ports made these investments and received a return on their investment over the life of a long term lease with a shipping line or a terminal operator with strong ties to a shipping line. It was an economic model that worked for the ports and their customers.

The global shipping line industry is an asset-intensive business, and the ocean carriers have been hard pressed over the past decade to sustain a profit. Unfortunately, it is an industry where carrier size (and perceived strength in the market) is determined by vessel capacity- how many container slots a carrier own on ships- not how much of that capacity is utilized. This has driven an oversupply of ships as ocean carriers ordered new ships despite a significant oversupply of vessel capacity.

Excess vessel capacity resulting in rate wars as shipping lines lowered their rates to fill ships. Characterized as a “race to the bottom,” these financial losses were really self-inflicted by the ship supply/ship capacity imbalance. The Journal of Commerce reported in November 2014 that the revenue per TEU for the world’s largest shipping lines has fallen over the past three years due to excess capacity in the shipping fleet, despite growth in container volume. Yet the companies survived by slow steaming, restructuring debt and government subsidies.

Rather than curb their appetites on ship purchasing, the shipping lines sought to restore profitability by doing three things: 1) ordering larger ships to achieve economies of scale; 2) rationalizing use of their assets by creating alliances with other shipping lines; and, 3) choosing the most efficient port terminals to call on with continual reevaluation of terminal selection. The “super” alliances created by the world’s largest shipping lines can control a significant share of trade in a trade lane, increasing their leverage in negotiating with ports and terminal operators.

The rate at which containership size increased over the past ten years has accelerated according to a new report released by the OECD International Transport Forum “The Impact of Mega-Ships.” According to the OECD, the average size of a containership between 2001 and 2008 was 3,400 teus, rising to 5,800 teus between 2009 and 2013. Today the average size of a containership is 8000 teus and the largest ships today are 21,000 teus. These large ships only achieve the benefits of scale economies if they sail full, reinforcing the benefits of shipping alliances.

Ports and terminal operators that seek alliance business have to significantly improve facilities and infrastructure in order to accommodate larger vessels. A port needs to continue to make ever greater financial investments to keep up. Deeper navigation channels along with efficient rail and highway access is a minimum to be in the “game.” But, ports that capture alliance business cannot be assured they will keep it. That’s because the shipping lines are negotiating short-term agreements with terminal operators with the flexibility to move their assets (the ships) from one port terminal to another. If the terminal does not meet the productivity demanded by the alliance, the alliance may shift their business elsewhere. That shift could mean that the public investments, such as dredging, terminal infrastructure and road and railway hinterland investments might be underutilized while creating a demand for similar public investments in another locality for the same business. Ultimately, this leads to port terminal overcapacity and a duplication of port infrastructure assets. This is a significant departure from the model ports traditionally used to finance their investments, locking in a shipping line’s business for 30 years. Now a port could make significant improvements to capture alliance business, lose the business and then be left with stranded assets and an inability to recover its investment. Similarly the federal government could fund a channel deepening project and find that the cargo has shifted to another port.

Today, ports and the federal government are often expected to make significant infrastructure investments without the safety net of a long term cargo volume commitment. That means investments in channel deepening and port improvements come with greater risk. If the savings to the shipping lines are becoming marginal in the latest round of vessel up sizing as the OECD report suggests, then should the federal government and ports continue to respond as if the business model of the shipping lines has not changed? The shipping lines are becoming more efficient by rationalizing their assets, using fewer but larger ships. Ports, however, are seeking to duplicate assets. While redundancy in the port system is important to ensure the US has the resilience to manage trade flows in the event of a major natural disaster or terrorist event, one has to question whether the economic benefits to ports and the their regions by being able to handle the largest containerships afloat are commensurate with the increased financial demands to provide the infrastructure. By being more selective in determining which channels it should dredge, the federal government can begin to articulate a long awaited national port policy that not only will protect its own investments but prevent some ports from making investments they might later regret.

Geraldine Knatz

Geraldine Knatz is Professor of the Practice of Policy and Engineering, a joint appointment between the USC Price School of Public Policy and the Sonny Astani Department of Civil and Environmental Engineering at the USC Viterbi School of Engineering. Dr. Knatz served as the Director of the Port of Los Angeles from 2006 to January 2014. She was the first woman to serve in this role and made a significant impact through the creation and implementation of the San Pedro Bay Ports Clean Air Action Plan She is an expert in seaport policy and management, maritime transportation, international trade, and seaport sustainability.