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As expected, with rising interest rates dampening demand, container freight rates (the cost of transporting one 40-foot equivalent container) have declined significantly from peak rates in September 2021 (which were approximately 730% higher than 2019 freight rates), though they are still about twenty percent higher than pre-pandemic levels. See Drewry, World Container Index – 06 Apr,&nbsp;<a href="https://www.drewry.co.uk/supply-chain-advisors/supply-chain-expertise/world-container-index-assessed-by-drewry">Drewry – Service Expertise – World Container Index – 06 Apr</a>. Similarly, charter hire rates for container ships have also stabilized much lower than peak rates in March 2022, but still at levels much higher than before the pandemic. As demand has declined, port congestion in the United States also has eased.

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Yet, two competing drivers will weigh on container carriage over the next few years. The first is that considerable container-carrying capacity is coming online starting in the second quarter of 2023 at a time when consumer demand is declining, which will have the effect of creating too much capacity and driving down both container freight and charter hire rates. The second is that air emissions regulations issued by the European Union (EU) and the International Maritime Organization (IMO) will commence in earnest in 2024.

The EU will require vessels transiting within, to or from the EU to participate in its Emissions Trading System (ETS). One hundred percent of GHG emissions from vessels transiting within the EU will be taxed under the ETS’s cap-and-trade scheme, while 50% of GHG emissions from vessels transiting to or from the EU will also be taxed. As well, the EU has adopted a new Fuel EU Maritime regulation, which will gradually introduce lower GHG-emitting bunker fuel to power vessels with the goal of reducing GHG emissions in bunker fuels by 80% by 2050. The EU’s near term goal is to reduce GHG emissions by 55% by 2030 from 1990 levels.

IMO regulations will require each existing merchant ship above a certain size to meet an energy efficiency existing ship index (EEXI) standard, which presently correlates with the energy efficiency design index (EEDI) for new-build ships. The EEDI has been in place for over a decade, and has already imposed standards that will improve operational efficiency for new ships by as much as 20%, with stricter standards implemented every five years. Both EEDI and EEXI are calculated for a particular vessel based upon its installed power, designed speed and cargo-carrying capacity (also known as deadweight tonnage). The expectation is that the vast majority of the world’s fleet of existing ships will not meet the new EEXI standards, which will require remedial action (e.g., reduced speed operations and/or power limitations placed on vessel engines with override functions for use in case of an emergency). The second IMO regulation will require each merchant vessel above 5,000 gross tons to be measured for a carbon intensity indicator (CII) rating of A (least emissions) through E (highest emissions). The emissions data collection process is taking place this year. Vessels rated D will have three years to improve to a C rating, and vessels with an E rating will have one year to do so. The failure to meet EEXI and CII standards may prevent a vessel from trading internationally, though presently there is no enforcement mechanism built into the IMO’s regulatory scheme. The IMO’s current goal is to reduce GHG emissions by 40% from 2008 levels by 2030, and 50% by 2050. The organization expects to finalize its GHG emissions reduction goals at the Marine Environmental Protection Committee (MEPC) 80 meeting scheduled for this July.

ETS, new bunker fuel requirements, EEXI, EEDI and CII will increase vessel owners’ operational costs, which they will pass along in higher freight and hire rates to shippers and charterers, who in turn will do the same with their contracting partners and they with theirs to the eventual end users. Time charterers are actually the parties who buy bunker fuel for merchant ships, and so their costs will rise as will vessel owners’, who may have to adapt their vessels to burn cleaner fuels. The EU’s new bunker fuel requirements likely will spread globally as merchant vessels transiting in international commerce will need to adapt. GHG emissions standards in the maritime supply-chain will drive up transportation costs and may create inflationary pressure. Certainly the cost of transportation within, to and from the EU will rise, which will drive the cost of that bloc’s goods higher. EEXI standards will slow voyages (slower speeds reduce emissions) resulting in supply-chain delays and longer lead times for the manufacture of goods comprised of parts from around the globe. The expected increase in transportation costs and voyage time may prompt manufacturers to rethink just-in-time manufacturing practices and look to geographically closer suppliers. We can expect a marked alteration in the merchant fleet’s composition over the next two decades as stricter emissions standards sideline older vessels that can no longer compete in the marketplace, and considerable financial pressure on vessel operators whose fleets fall below EEXI and CII standards.

Meanwhile, spot rates for very large crude carriers (VLCCs) transiting from the Middle East to China just topped $100,000 per day. See Greg Miller, Crude Shipping revs up; supertanker rates top $100,000 a day, Freight Waves,&nbsp;<a href="https://www.freightwaves.com/news/crude-shipping-revs-up-supertanker-rates-top-100000-a-day">Crude shipping revs up; supertanker rates top $100,000 a day (freightwaves.com)</a>. With China reopening after the COVID-19 lockdown and the passage of the Chinese New Year holidays, manufacturing activity there is spiking the demand for tankers. It is amazing how swiftly the VLCC market has shifted. As recently as January of this year, VLCC rates were as low as $38,000 per day. Tanker-market capacity is tight, and the order book for new tankers is thin.

The tanker market will face the same air emissions and bunker fuel drivers discussed above, and we can expect that higher tanker freight and hire rates will increase the cost of crude oil and refined products. The tanker trade is also buffeted by geopolitical headwinds, which will keep freight and hire rates volatile for the foreseeable future. Russian sanctions have removed the availability of Russian tanker tonnage from the markets of countries honoring those sanctions. The world’s tankers are now divided into two separate fleets: those carrying Russian oil and refined products (via a shadow fleet of some 600 tankers, whose ownership is opaque), and those not. See Julia Horowitz,&nbsp;<a href="https://www.cnn.com/2023/03/01/business/russia-oil-shadow-fleet/index.html">A mysterious fleet is helping Russia ship oil around the world. And it’s growing”</a>, CNN Business (Mar. 1, 2023). Russia’s oil continues to flow to China and India in ever-increasing volumes aboard these rogue vessels. The total quantity shipped to Asia nearly matches the pre-Ukraine War quantity Europe received from Russia. The shadow fleet is growing because Russia needs greater tanker capacity for the long hauls to China and India, rather than the short hauls previously employed to the EU. As this fleet grows, it may alter the capacity of the world’s legitimate tanker fleet and drive rates higher.

In sum, while the pandemic’s supply-chain impact has subsided, new drivers will influence merchant vessel freight and hire rates: GHG emissions and fuel requirements that take hold in 2024 on the one hand, and over-capacity in the container trade and under capacity in the tanker market on the other.

“Big Changes, Challenges Will Affect Maritime Supply Chain,” by Keith B. Letourneau was published in the&nbsp;<a href="https://www.law.com/texaslawyer/2023/05/08/big-changes-challenges-will-affect-maritime-supply-chain/">Texas Lawyer</a>&nbsp;on May 8, 2023.

Reprinted with permission from the&nbsp;May 8, 2023,&nbsp;edition of the&nbsp;Texas Lawyer&nbsp;© 2023 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited.

Big Changes, Challenges Will Affect Maritime Supply Chain

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