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Commanders of the seas

Curious crowds gathered at quaysides in the United States this May to greet the largest ship ever to call at ports along the eastern seaboard.

The spectators were scanning the horizon for something familiar – the vessel was four times as long as the Statue of Liberty is tall, the local media had been marvelling – but the newcomer was actually Chinese.

Owned and operated by China Cosco Shipping, the 13,000-TEU vessel had just set a record as the largest to pass through the recently-widened Panama Canal and ports along the US east coast have been deepening their harbours in a bid to welcome more arrivals from China.

A quick survey of the shipping headlines for the same month shows that Cosco’s reach has been expanding as well. One of its vessels carried the key parts for a Chinese-designed nuclear reactor to Pakistan and another of its containerships made the inaugural call at Asia’s first fully automated terminal in Qingdao. There was another new high for container traffic at Cosco-controlled Piraeus in Greece, plus the launch of a multi-billion dollar fund promising to scoop up maritime assets around the globe. In another piece of news Cosco has even revealed that it is taking a stake in a trading zone in Kazakhstan, thousands of miles from the sea.

Headlines like these sound promising after a period in which Cosco’s fortunes were torpedoed by the global financial crisis and the subsequent slump in freight rates. But one of the results of the stormy seas was a mega merger with China Shipping – another giant – that will reshape the sector at home and overseas.

 

Merger mania

In another of the state-sponsored marriages in Chinese shipping China Merchants is taking over Sinotrans, bringing together the latter’s logistics kingdom with the former’s ports and tanker assets. The combination of Cosco and China Shipping, however, is launching a leviathan with well over a thousand vessels and it creates a stronger candidate for national champion.

The newly merged entity operates across most of the maritime industry. Cosco Shipping Bulk and Cosco Shipping Energy Transportation own the world’s largest bulk and tanker fleets, respectively. Cosco Shipping Holdings is the fourth-largest owner of containerships and Cosco Shipping Ports is the number two container terminal operator. Cosco Shipping Development, the group’s leasing arm, is the second largest non-operating owner of container vessels, while Cosco Shipping Heavy Industry is China’s third-largest shipbuilder.

The background to the bringing together of the two state-owned giants is a tale of weakness as much as strength. A disastrous run of losses had put Cosco in financial peril, forcing the sale of its dry bulk fleet to its parent to avoid its shares being delisted in Shanghai. Policymakers pushed hard for the combination with China Shipping as a way of reshaping the landscape and most of Cosco’s old guard were compelled to stand down (Wei Jiafu, the man most associated with the booms and busts of the earlier era, had departed in 2013: see insert).

The new leadership is wrestling with the challenge of coalescing the two companies into a single entity. “Our two firms had similar operations, we did not have many advantages in the various sectors we operated in, and we could not count on economies of scale,” explains Xu Lirong, the new boss.

Cosco now enjoys even greater scale as the owner of the world’s largest fleet in tankers, bulk carriers and containerships combined. The supersizing is supposed to steer it into profit, although some commentators have been sceptical about the restructuring that its executives are promising, noting that state-owned firms are reluctant to make radical changes, especially if they lead to lay-offs.

True to form, Xu has made public commitments that no jobs will be lost as a result of Cosco’s coupling with China Shipping, for instance.

Parash Jain, head of transport research for HSBC in Asia-Pacific, argues that there are still plenty of savings to be made, however. Taking the container division as an example, he says that larger lines offer more extensive services and that they should be able to achieve higher levels of efficiency. Consolidation helps further in creating a more stable industry, with greater predictability in pricing.

Cosco is looking first for synergies across its “hard infrastructure”, Jain reports. One of the more immediate benefits is more effective deployment of vessels across its network and another advantage is that it can return ships that were chartered too expensively in the past.

Shipping routes w

magnifying glass

After a $1.4 billion loss last year, Cosco has reported a profit of $39 million in the first quarter, fuelled by improvements in its container division. Cargo volumes increased by more than half compared to the same period last year, reflecting the addition of China Shipping’s fleet. The company said that cost efficiencies and improvements in freight rates had also boosted margins.

Cosco’s performance since the merger has been better than most analysts anticipated, although it is too early to tell how effectively it will transform its business. “The merger happened during some of the worst conditions in living memory and everyone else has rebounded over the last two quarters as well. It will take longer to determine whether the restructuring is going to result in long-term gains,” Jain reports.

 

China’s container shipping – still punching below its weight

One of Cosco’s advantages is that it is already aligned with some of the strategic priorities of the Chinese government. Its dry bulk division has locked in long-term contracts to ship iron ore from Brazil to Chinese steelmakers and its tanker group is spending $1 billion on new deliveries to carry more of China’s shipments of seaborne oil. Another area where profit and policy overlap is the Belt and Road Initiative, and Cosco announced in January that it had secured Rmb180 billion ($26 billion) in financing from state-owned China Development Bank for maritime investment under the banner of Xi Jinping’s signature plan.

Back in the world of container shipping, consolidation is a trend shaping the sector in general. Bleak trading conditions have spawned a survival of the fittest mentality and takeovers have reduced the number of leading lines from 20 to 12 over the last three years. The leading lines now control about 60% of the world’s fleet, or double their share in 1996.

Cosco is a member of the elite with about 8% of the market in fleet strength, although it trails AP Moller Maersk (from Denmark), MSC (Switzerland) and CMA CGM (France) in total carrying capacity. The arrival of new vessels over the next year and a half was going to see Cosco move close to third place, however, and a proposed takeover of Orient Overseas Container Lines announced in July will seal the move into third position (see final section).

But wresting more business from its rivals in some of the other main trades isn’t going to be easy. Jain gives the North-South route (Latin America related traffic) as a prime example, where Asian shipping lines have relatively small market share. Cosco’s claims on Asia-Latin America traffic have been minor, making it harder to build a profitable business from scratch.

Even in the trans-Pacific lanes the Chinese lines have punched below their weights, carrying a lower proportion of traffic than China’s share of international trade would seem to support. National loyalties seem a lot less pronounced than in Japan, for example, where local lines control about 8% of the world’s fleet but transport more than 40% of the country’s trade with the US.

Part of the reason is that Japanese brands such as Honda, Toyota and Sony have more sway in choosing their national carriers to transport their goods. More of the orders for Chinese exports are coming from American retailers and their logistics partners, who have less reason to be loyal to companies like Cosco. In bulk shipping and tankering the situation is different – more of the demand comes from ‘national’ customers, and China’s oil and steel giants can specify how the commodity should arrive. The country’s consumer goods firms need to secure a stronger foothold in overseas markets before they can set the same terms on how containerised freight should be transported. “If China’s phone and television brands get more popular with consumers the companies that make them will get more say about how the goods are shipped,” Jain says.

 

Container terminals: looking further afield

Chinese ports have been direct beneficiaries of the country’s export boom, with the emergence of a number of gateways along the country’s southern and eastern coasts.

Traffic through Chinese ports currently accounts for almost 30% of the world’s containerised trade flows and its terminals, including Hong Kong, rank in seven of the top 10 positions as the world’s busiest ports.

Somewhat paradoxically, the push from terminal operators such as Cosco Shipping Ports and China Merchants Ports to invest overseas is being prompted by slowing growth in container traffic, however. In the 1990s, container volume growth was 3.5 times global GDP growth; from 2000 to 2009 it was 2.7 times, and since 2010 it has been moving towards par. Flows through China’s top eight ports are now growing by less than 3% a year, significantly less than the previous decade. This slowdown has stimulated the operators to look overseas, with billions of dollars of Chinese investment in about half of the world’s top 50 container ports since 2010.

The outflow is backed by the Belt and Road blueprint, which prioritises spending on infrastructure that supports cross-border trade. With this kind of policy support, Chinese firms are in a stronger position to overcome their rivals when new projects come up for bidding. “Port operators from other countries might commit to building a new container terminal but they tell the host government that it has to provide the roads, the railways and the power supply around the port,” Jain explains. “The Chinese make a fuller offer than building a port alone. They are committing to roads and railways, power stations and special economic zones, and they bring the financing to make it happen.”

Strategists claim that port operators could be in a position to play the national card by moving Chinese cargo first or exploiting control of the terminals to influence how the shipping lines do business. And it’s certainly true that port ownership can benefit companies with a presence across the industry chain – shipping conglomerates can instruct their container ships to call at points where they control the terminals, effectively guaranteeing customers.

Yet Jain says that this strategy isn’t much different to European majors like Maersk and MSC, who own port terminal businesses alongside their container lines. More likely it’s the state backing for these deals that has been alarming China’s rivals, especially India, which is concerned by what it sees as encroachment into its traditional sphere of influence in the Indian Ocean. On the other hand, many of the newest projects are in parts of the world that are fraught with political risk, as China Merchants has discovered in Sri Lanka, where it has interests in ports in Colombo and Hambantota (see sidebar). There is no guarantee of commercial success. Jain is cautious about some of the investments by China Merchants Ports in particular, fearing that it has overpaid for some of its new holdings, and that many of them don’t seem to be tapping into the fastest growing markets.

Cosco Shipping Ports has done better by taking stakes in terminals that complement its container lines and bulk shipping businesses. The flagship is Piraeus in Greece and Cosco has strengthened its position in the Mediterranean with investments in the port of Vado in Italy, as well a majority stake in a Spanish company with port interests in Valencia and Bilbao, and two rail terminals in Madrid and Zaragoza.

Even so, few of these stakes are likely to deliver the same returns as the best of its port businesses in China. “The opportunities that you get as an incumbent in your home country can be difficult to replicate because you don’t know your customers as well and you don’t have the same relationships with the local regulators,” Jain explains. “China’s port operators have always enjoyed home advantages but they aren’t going to get the same assistance overseas, where they’ve got to beat the likes of DP World, Hutchison Port Holdings and Maersk in a profit-driven environment.”


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