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Commissioner Khouri Addresses International Propeller Club of U.S.

October 30, 2014

Remarks of the Honorable Michael A. Khouri International Propeller Club of the United States Annual Convention Louisville, Kentucky

October 17, 2014

Good morning. My thanks to the International Propeller Club of the United States for the invitation to participate in this year’s Annual Convention and it is good to be home in Kentucky and to visit with old friends.
 
As standard preamble, my comments today reflect my personal views and opinions, and I do not speak on behalf of the Federal Maritime Commission or the federal government.
 
I will touch on four areas this morning that relate to the U.S. import and export trades, more specifically, the containerized seaborne trades, and how the FMC, as an independent federal regulatory agency, addresses these issues.
 
For those who may be unfamiliar with the FMC’s role, I will provide some background. Then I will touch on the significant reorganization and realignment that the liner vessel industry is currently going through. Third is the terminal and port community and their current issues. Last, will be container issues here in the heartland and the growing use of containers for export agricultural commodities.

FMC Background

As general background, the FMC is an independent agency with five commissioners, each nominated by the President and confirmed by the U.S. Senate – three are from the President’s political party and two from the loyal minority. The Commission’s original congressional charter dates back to 1916.
The FMC administers several maritime statutes. Primary focus is on the Shipping Act. Also, in the news over the last two years are financial responsibility laws for the passenger vessel cruise industry. 
The Shipping Act provides for the regulation of U.S. liner services in foreign commerce - our import and export trades. The statute directs as follows:
 
to establish a regulatory process that is free from commercial discrimination and with a minimum of government intervention and regulatory costs, 
to provide for an efficient and economic transportation system, 
to encourage the development of an economically sound U.S. flagged liner fleet,  and
to promote the growth and development of U.S. exports through such competitive ocean transportation by placing greater reliance on the marketplace.
 
The principal stakeholders in this regulatory world include container vessel operators, the ocean transportation intermediary community – the freight forwarders and the non-vessel owner common carrier community, and the marine terminal operators. Their activities are subject to the provisions and proscription in the Shipping Act and FMC regulations. 
All of our regulatory efforts are ultimately focused on protecting America’s import and export trades and the consumer public.
 
In the broadest sense, the Shipping Act requires these regulated stakeholders to not discriminate or use unjust, unfair, or unreasonable business practices in a number of different transportation scenarios – either individually or in collusion with others.
 
The Act does allow for competitors to meet and discuss certain business issues, but first they must file a written agreement with the Commission. We review these agreements using traditional antitrust law and economic models before they go into effect. We often read commentary that the FMC "grants antitrust immunity" to the ocean carriers. This shorthand phrase is convenient in its brevity, but is misleading and wrong in application. The Shipping Act is itself a federal antitrust law applicable to the industry of international liner shipping. It contains provisions similar to those found in the Sherman Act, the Robinson-Patman Act and the Clayton Act concerning various prohibitions of discriminatory or unfair business practices and standards regarding business combinations. The Shipping Act provides that, so long as the regulated entity complies with the statutory and regulatory proscriptions of the Act, then the other federal antitrust statutes do not apply. Conversely, if a regulated entity violates the Shipping Act, they would be subject to penalties set forth in the Act, and, further, they may be subject to investigation and prosecution under the full array of federal antitrust statutes.
 
The Commission is quite busy with its agreement responsibilities. There are 340 vessel carrier agreements, 275 operational agreements of different types, and over 150 marine terminal agreements currently in effect. Each agreement is routinely monitored by the economic staff with our Bureau of
Trade Analysis.
 

Vessel Operators and Carrier Agreements

Moving to the vessel carriers and the significant restructuring in that major segment of the industry – we need to touch on a particular type of agreement that the FMC regulates – the vessel sharing agreements, or VSAs. Of the 275 operational agreements, there are 136 VSAs in operation in U.S. trades. A good number of these are essentially joint venture operating agreements where two or more vessel operators will jointly contribute vessels to operate in a service loop within a trade lane – for example North Europe ports to U.S. North Atlantic ports.  The participating carriers book containers on the shared service and it does not matter if a box is loaded on its own vessel or one of its partner’s vessels. Costs are shared, but all marketing, sales, and revenues are maintained as separate – by operation of the agreement and operation of law.
 
The Commission reviews these types of agreements – again with recognized and established antitrust processes and standards. The Shipping Act requires the Commission to then continually monitor these joint ventures. Further, if monitored data suggests anticompetitive behavior, then the Shipping Act provides for a process to go into federal court, get an injunction and, if necessary, to unwind the joint venture.
 
Vessel Sharing Agreements have been used for decades. In the last few years; however, the VSAs have grown to include more of the major vessel operators and they began to operate on a fully global scale.
In June of last year, the top three carriers – based on ships and container capacity – announced a global alliance, named P3, to operate in the U.S. trans-pacific and trans-atlantic trades and in the Asia to Europe trades. Other existing loosely formed associations promptly followed suit with their announcements of more fully formed alliances.
 
After an extended review, the Commission voted to allow the P3 Alliance to begin operation. Unfortunately, the Chinese regulatory agency handed down a ruling that disallowed the P3 in their trade lanes and the agreement, as a whole, did not proceed.
 
Other alliances continued their agreement applications with the FMC. Then this summer, two of the former P3 partners refiled for VSA authority that covered a somewhat smaller global footprint. Last week, the Commission voted to allow the 2M Alliance of Danish based Maersk Line and Swiss based Mediterranean Shipping to go into effect.
 
Today, sixteen of the top twenty international liner vessel operators have aligned themselves into four global alliances. Two of these alliances are under pending filing and review.
 
Critics have characterized these operational joint ventures as "market dominate." They make sweeping allegations of capacity manipulation and freight price collusion. The managing director of a container index firm in London was quoted in the press as follows: "the carriers that belong to the four big alliances – will control 97 percent of container shipping capacity in the main east-west trades." An official with a European ship finance bank said: "the pricing power of the alliances is incredible."
 
However; there are no objective facts, no industry data, no relevant industry trend analysis and no economic or legal theory to support these critics or their charges. Not to venture too far into weeds, but consider the following as an example:
We begin with 5,000+ container ships globally, and total world capacity of over 18 million TEUs [twenty foot container].
 
The sixteen vessel-operating companies in these four alliances combined own or charter 2,900 ships with 14.2 million TEUs of capacity. That represents 58 percent of all container ships and 78 percent of world container vessel capacity. Sounds like significant market share and an ominous predictor for future pricing activity – until you break it down into the relevant truths.
 
Based on public data, the largest alliance by measure of total vessel capacity in the U.S. trades is the G6 with 1.24 million TEUs. That represents less than 7 percent of total world capacity. The 2M Alliance that cleared the Commission last week will have slightly less than one million TEUs in U.S. trades, representing just over 5 percent of total world capacity.
 
The four alliances – combined – are contributing slightly over 20 per cent of their respective vessels and 27 per cent of their total combined global capacity to the collective U.S. trades. That leaves roughly 75 per cent of their capacity serving other non U.S. trades throughout the world.
 
The bald allegation is that one alliance will decide to constrain vessel availability in a U.S. trade and thereby cause demand induced freight rate increases. The predictions in the press that these alliances will have dominate market power and will exert unbridled pricing power, such as those mentioned earlier, are not supported by fact or reason. However, at this point in the realignment of the global vessel operating community, the compelling market structure and historically proven market dynamics suggest that there will not be a ready path for any of these alliances to successfully implement any market distorting scheme. If you put simple numbers to the allegation, it becomes rather apparent.
 
Consider a simple hypothetical. If all six members of the largest alliance – the G6 – decided to pull fully one half of their vessels – that is, 600,000 TEUs of capacity – out of the U.S. trades in the hope of constraining capacity and thus forcing freight rates to rise, then what would be the market reaction? 
The other three alliances would have 2.6 million TEUs in the then current U.S. trades and, collectively, those vessel operators would also have over 8.3 million TEUs of additional capacity in other global trades that could be easily redeployed into this hypothetical newly lucrative U.S. trade. And historically, vessel operators have consistently moved assets from one trade to another whenever cargos with favorable freight rates were available.
 
More pointedly, transportation economists say that the market dominance - capacity restriction - freight rate increase scenario is just not plausible under any rational factual construction. With so much global capacity available to promptly move into any trade lane wherever and whenever freight rates rise above nominal competitive levels, there is simply no current basis for the concerns.
 
Granted, in any context where competitors are allowed to enter into joint commercial enterprises, the FMC must be judicious and diligent in both the initial review and approval process and, more importantly, in our ongoing monitoring duties. If evidence of market distortions does begin to appear in our relevant trade lanes, then we have plenty of regulatory tools to address such scenarios.
 
Each carrier will continue to separately market and price its service. Past market behavior has demonstrated that marketing, sales, and pricing competition between carriers within an alliance has continued. There is no current credible reason to predict a change in this behavior. And, again from past industry behavior, there is no articulated reason to presume that an alliance will act within the market as a unified entity in price competition with other alliances. To be clear, I remain open to all arguments and evidence that could point to improper or illegal conduct by any regulated stakeholder. While all are entitled to their opinions, the referenced objective facts remain persuasive.
 

Port and Terminal Operator Issues

Now, moving over to the port and terminal community – the gateways to and from America for our export and import goods. The ports face significant infrastructure challenges on a number of fronts. Their entrance and dock side channels need dredging to accommodate the larger ships that the alliances are now deploying in our trades. These ships require larger, taller and broader cranes for unloading, and they need more of the cranes so as to efficiently send such mega ships back out in a timely manner. The larger ships also place new burdens on the land side operation of the ports as more containers hit the port at one time causing congestion issues for the local truck community and chassis suppliers.
 
To add more challenges, the larger ships, being subject to more delays at one port, get out of sequence on their port rotation, resulting in missing their next normally scheduled berth window and thus "bunching" at the next port.
 
For containers coming inland, for example to Kentucky or Indiana, and many times by double stack unit rail cars; the larger slugs of containers coming out of the ports can exceed the capacity of the inland yards. I hear of examples where a train arrives with four hundred containers, but there are only three hundred chassis available to carry the containers out of the yard. The other one hundred containers must go to ground storage, resulting in further delays in container delivery and delay in train turn around.
 
As we all appreciate, the marine transportation system is, indeed, a SYSTEM that relies on all modes working seamlessly together.
 
The FMC has been holding listening and discussion sessions around the country to provide a forum where all parties can come together and give their views on port efficiency, infrastructure and congestion issues, and to share their thoughts and ideas on improvements and solutions.
 
Two forums have been held so far. Chairman Cordero held the first in the LA/Long Beach area in early September. Commissioners Lidinsky and Doyle held a session for the northeast ports late last month. I will host a session in Charleston for the South Atlantic ports on October 30th and Commissioner Dye will lead the Gulf Coast port session in New Orleans on November 3rd. All of you are welcome to attend and, more important, invited to participate.
 
To bring blue water container issues even closer to home here in the heartland, the availability of empty containers at inland load points has been a recurring problem. American exporters face constant challenges in finding containers. 
 
The U.S. Department of Agriculture issues a weekly report on Ocean Shipping Container Availability. Their data finds that the probability of a carrier not having sufficient 40 foot dry containers available for market requests in any given week is lowest in LA/Long Beach – no surprise – but highest in Chicago, Kansas City and Minneapolis, with the Twin Cities having a 55 per cent probability in any given week of not having sufficient dry containers for the demand within its market area.
 
There are several reasons for this equipment allocation problem. Highest on the list is the available freight rates for imported cargos, primarily Asian finished goods being imported to the U.S. The carriers are anxious to get the empty containers back to their high rate ports in Asia. Further, the typical U.S. export cargo has a far lower value and therefore does not support a high freight rate.
 
Now add in the trend of agricultural export products moving increasingly by container versus bulk transportation. From 2005 to 2012, grain exports moving in containers doubled from 6.2 million metric tons to 12.5 million metric tons. In that period, total grain exports increased by 11 million metric tons and the modal share for containers increased as well. In 2005, 6.3 percent of grain exports moved via container versus 11.4 percent in 2012.
 
Once again, there are several reasons for this market trend, but number one is an ever increasing market requirement for maintaining cargo identity for agricultural exports from origin to destination due to GMO concerns in foreign country destinations. There are no current indications that this concern is abating, and, viewing the current U.S. crop harvest, the demand for export transportation capacity can only increase. With underlying crop prices falling, the question is how to attract more containers to pause in the heartland long enough to be loaded and sent out as a U.S. export.
 
The Commission conducted an extensive fact finding investigation into the container shortage problems during the global economic slowdown. First, no improper conduct by carriers was found. But one positive result was the increase in awareness and information flow, such as the USDA weekly report mentioned earlier.
 
I doubt that grain exports via container is an existential threat to my many inland barge friends here today, but the trend is interesting.
 
With that, I will wrap up and thank everyone for coming today and for their kind attention.