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OECD warns against shipping industry bailouts that offload risk to public

OECD warns against shipping industry bailouts that offload risk to public
Ports are already seeing volume reductions Source: ITF

The International Transport Forum (ITF), part of the OECD, has cautioned governments against bailouts of container shipping lines that create a “moral hazard”, externalise risks to the public and generate a “race to the bottom” on regulation, subsidies and tax exemptions.

In a new report, the organisation pointed out that container carriers are “ill-prepared” for the impending economic shock from the COVID-19 pandemic due to their high debt levels.

Cumulative debt of 14 major container carriers reached US$95bn by Q3 2019, up from US$76bn in 2010 and the ITF believes it is likely that they will seek more government aid in the coming months.

However, it claims that a bailout will increase the likelihood that a bailout will increase risk-taking of firms to levels that would be considered unsustainable if there would be no bailouts.

It noted: “Government policies have encouraged this risk-taking. Favourable fiscal arrangements, such as accelerated depreciation regimes for investments have stimulated over-investment in ship capacity, often with borrowed money.”

The report added that shipping lines pay fixed “tonnage taxes”, which do not smooth out cyclical investment behaviour, in contrast to corporate income taxes, which reduce room for investments during booms but enlarge it during busts.

“These fiscal arrangements tend to increase risky corporate investments,” it added. “Government bailouts for container shipping companies also risk being unfair vis-à-vis shipping companies that have low debt levels.”

The OECD’s transport body believes that there is a chance that bankruptcy risks will be externalised to the public sector, while climate change risks, health risks from air pollution and financing risks of public infrastructure are also significant.

Citing carriers which are rerouting vessels via the Cape of Good Hope to avoid Suez Canal charges, it argued that the longer distances involve burning more fuel, increasing greenhouse gas emissions and pollution while affecting the cost coverage of the public investment in the Canal.

The report noted: “Such externalisation of risks have been facilitated by tax exemptions of ship fuel, lack of inclusion of shipping in carbon pricing initiatives and generous exemptions of infrastructure charges by infrastructure managers – like canal and port authorities – in order to be more attractive than the competitor. The shipping firm can reduce its costs, but in the process increases the costs for society.”

Its third concern is a “race to the bottom” where governments’ desire to protect their container fleets causes a vicious cycle of regulatory competition for the most generous subsidies and tax exemptions.

In this scenario, temporary support to weather a crisis can become permanent as one country’s support measures invite others to match or outdo them; and some countries will expand their support measures to increase their shipping sector’s competitiveness.

The ITF described the shipping sector as a hybrid sector which accrues public sector support but without aligning public policy priorities such as “creation of employment, generation of fiscal revenues and improvement of environmental performance because few conditions are attached to government support”.

This can lead to paradoxical situations where shipping companies ask for government support despite registering their ships in other countries to avoid taxation or labour regulations.

It can also provide container shipping companies with unfair advantages when they compete in other markets like terminal handling, logistics and digital freight transport platforms, said the ITF.

The report called for governments to use the economic leverage of the COVID-19 crisis to close tax loopholes, reduce exemptions and introduce carbon pricing for shipping.

“Governments could also halt the unfair competition of tax-exempt carriers with non-tax-exempt companies with regards to logistics activities.” It added. “They could stimulate a more crisis-resilient container shipping model that includes clear conditions regarding the value the sector creates for society, embraces environmental sustainability and internalises external costs and risks in the price of containerised ocean transport.”

Potential bailouts are under scrutiny as the COVID-19 pandemic looks likely to cause chaos within the sector over the coming months. Global container trade volumes declined by 8.6% in February 2020, largely caused by a 17.5% drop in Far East volumes. However, greater reductions are expected in figures for March.

Carriers have responded to falling demand by reducing supply through idling vessels and cancelling services, which have helped them to avoid price reductions for container shipping services.

Blank sailings totalled 188 in February and March, of which 85 were on the Asia – North America West Coast trade lane and 49 on the Asia – North Europe trade lane.

Upcoming cancellations will affect up to 30% of Far-East – Europe service capacity and up to 20% of trans-Pacific capacity. The share of idle container ship capacity reached 2.5m teu or 10.6% of capacity in early March 2020.

The report noted that the current oversupply of vessels could become even more problematic, as container ship supply is set to increase 5% in 2020 and 3% in 2021 while demand for container freight, however, could fall by 10% to 30%.

If global container trade volumes were to contract by 11% in 2020 in line with International Monetary Fund projections of an 11% contraction of global trade, even an all-time high container ship idling rate of 15% would not be able to bridge the gap with the reduction of demand.

Some ports could see up to 30% reductions in container cargo while blank sailings will likely result in rationalisation of terminal networks and increase the bargaining power of carriers vis-à-vis terminals, added the ITF.