"Oil And Water": America Only Has 178 Flagged Cargo Carriers Vs. China's 7,362
By Michael Every of Rabobank
Oil and Water
Today will be all about US inflation, as the market continues to give itself this year’s and next year’s generous Xmas presents in advance of its projected retreat. However, I am still focusing less on gift-wrapped data, and more on the lumps of coal that point to upside risks to 2024 inflation.
‘COP28’s watered down draft text criticised for omitting fossil fuel ‘phase out’’, screams one headline. “Phase out” was phased out as the COP28 draft text suggests “reducing” use of fossil fuels instead after heavy Middle East oil-producer lobbying, making it COP-OUT28 in the eyes of some. It remains to be seen what this means in terms of the outlook for energy prices.
Meanwhile, in the Middle East, it’s oil and water which matter. Especially as Yemen’s Houthis have officially announced they will attack Israeli vessels and any ships carrying cargo to or from Israel via the Red Sea or Arabian Gulf. Welcome to how the world used to work before British, then US, naval supremacy. This is what a multipolar world is going to look like, if we see one.
We are likely to get a US naval reaction. Combined Task Force 153 Operations was set up in 2022 to stop Red Sea piracy, but will need to be expanded from the US and Egypt: France already helped out last weekend by shooting down Yemeni drones aimed at Israel. Yet it’s still only reactive to attacks on shipping, not proactive at the source. That maintains the risk shipping diverts from Suez round the Cape of Good Hope: if so, global carriers would only be able to make 3-4 Asia-Europe roundtrips per year, not 4-5, a massive structural drop in supply capacity. The Financial Times warns ‘Global pre-Christmas Trade at risk from twin Canal crises’, including the drought in Panama cutting passages there. But it’s far more than just pre-Christmas trade at risk.
Indeed, we are likely to get an Israeli reaction to this Yemeni (slash Iranian) casus belli to stop it at source; and Israel is also close to establishing a fixed deadline for Hezbollah to retreat north of the Litani river, after which it will attack them south of it. In short, key dominoes could yet topple towards a regional escalation impacting both the Suez Canal and energy markets.
There are also other maritime developments of concern. In the South China Sea, China has used water cannons against Filipino vessels resupplying their maritime territory, which Beijing claims as its own: tensions remain high, yet the Philippines’ furious protests were just dismissed by the former editor of China’s Global Times as “blustering” by “an American minion”. This follows a recent dangerous sonar incident between the Chinese and Australian navies, and Chinese PLAN vessels entering a new naval base built in Cambodia, which Beijing had promised would not be for military use. Watch these spaces.
Moreover, the maritime logistics industry says ‘The shift of manufacturing out of China is shaking up shipping’. Indeed, “Container rates have collapsed. Logistics executives foresee a freight recession dragging into 2024... There is one bright spot, though: intra-Asia shipping. As manufacturers seek to diversify their supply chains by shifting certain production segments out of China, there’s been more demand for transporting raw materials and intermediate products within Asia.” The winners: Bangladesh; Cambodia; India; Vietnam. The loser: China. For example, in 2019, Vietnam had 13 direct shipping routes to the US, but in Q3-2023, that was 23. The US and China totals were 56 and 58. Echoing what the BIS showed recently, “Governments and companies are diversifying beyond China, but they won’t be fully substituting the world’s industrial powerhouse anytime soon. One effect is that supply chains are getting longer.” And no less risky – yet.
But that’s not the end of the story, as ‘Shipping giants Maersk and MSC are making different bets on the future of trade’ in a new era of reshoring and friendshoring. Back in January, Maersk and Mediterranean Shipping Co. (MSC), the world’s two largest shipping lines, announced their maritime code-sharing alliance accounting for one third of global capacity, known as 2M, would end in 2025. This may have a flow-through effect to the other two big global groups, the Ocean Alliance and THE Alliance. As experts see it, this “represent different bets on the shape of global trade in the decades to come - and on the forces of economic decoupling that will reroute the international flows of goods.” Maersk is shifting strategy from ships to a one-stop shop for all logistics including air, freight forwarding, trucking, and last-mile delivery, an integrated logistics bet on more reshoring and onshoring from China. By contrast, MSC will increase its fleet to try to capture market share anchored around China’s industry. One of them is going to be wrong.
The industry also notes China’s Cosco needs to decide if it is going to be a Maersk or an MSC. But Quartz thinks perhaps it will be both: “It could pursue more horizontal integration by acquiring more shipping lines, while also becoming more vertically integrated by acquiring ports --as it has done worldwide, including most recently in Germany-- as well as partnering with domestic carmakers and port operators.” Something for the Politburo to consider at its annual Central Economic Work Conference discussing 2024’s GDP target and plans (which ends today when nobody had even announced it had started until this morning!) But can you smell the geopolitical tensions of a one-stop logistics shop for Chinese firms in an expanding geography?
Belatedly --and very importantly-- the US Navy Secretary Del Toro now aims to reinvigorate US shipping to strengthen its fleet. The Navy now sees what we argued in 2021’s ‘In Deep Ship’: “A thriving maritime industry would mean more trained builders and maintainers the Navy could tap in the event of a crisis; more dry docks and construction facilities the service could leverage; and more investments in innovative tooling, technology and processes to build ships faster and cheaper. And, chiefly, it would mean a larger fleet of American-built ships the military could call into service if a war broke out.”
As the global merchant fleet asks for US protection in the Red Sea --again, why is it provided for free to rivals?-- America only has 178 flagged cargo carriers vs. China’s 7,362. In case of war, the US could lean on only another 160 from all sources. Worse, from 1953 to 2016, the number of US shipyards capable of building large military and commercial vessels declined from 30 to six, and their annual output from 60 to seven. In response, Del Toro is calling for US “maritime statecraft” that “encompasses not only naval diplomacy but a national, whole-of-government effort to build comprehensive US and allied maritime power, both commercial and naval.”
Financially, he has floated “construction differential subsidies” to incentivize the private sector to buy ships from US builders, a tool unused since the Reagan era which allows the government to pay up to half the cost difference of a local build if there’s a national security need. The US is also trying to get allied private sectors involved in US small- and medium-sized shipyards. Notably, D.C. is not going to repeal The Jones Act that calls for US-built, -owned and -operated ships to move goods between US ports: rather, they are going to build more US ships to fill the gap, which is how the legislation was always supposed to work.
Of course, this is going to cost a lot of money; and there is a desperate shortage of merchant mariners, and a shortfall of 7,000 in Navy recruitment due to the tight labor market. But if you think being hegemon is expensive, try not being one anymore.
So, this maritime policy shift was logical two years ago: and I suspect in another two, it will be sailing ahead. Contrast that with a WSJ article about Europe’s military incapacity nearly two years into the Ukraine War: the UK still has only 150 deployable tanks and 12 pieces of long-range artillery; France has 90 of the latter, which Russia loses on the field in any month; and Germany’s army has enough ammunition for two days of battle, and can produce all of three tanks a month.
Yes, let’s focus on US CPI today, and on the swings from the BOJ reportedly backpedalling on the need to raise rates, again. However, if you can’t see how this backdrop of ‘oil’ and ‘water’ changes fiscal, monetary, trade, and industrial policy, with flowthroughs to commodities, stocks, bonds, and FX, then, just like oil and water, the real world and your forecasts are sadly immiscible.