Back in early 2021, Ryan Petersen was one of the first people we spoke to on the Odd Lots podcast about supply chain snarls and high shipping costs. The founder and co-CEO of Flexport has since gone on to become a go-to name in the world of logistics, making headlines after he tweeted about what could be done to fix congestion at the ports of Long Beach and Los Angeles. (A Bloomberg Opinion columnist called it the "tweetstorm that saved Christmas.") But fast forward two years and it seems like we're on the verge of a sharp reversal for the shipping industry, with freight rates now plunging and container traffic to the US down almost 20% last month. On this episode, we talk catch up with Petersen to talk about what he's seeing in the industry right now. This transcript has been lightly edited for clarity.
Key insights from the pod:
What did shipping companies do with their profits? — 5:11
Why manufacturing won’t move away from China — 7:38
Do spot rates matter for global trade and contract renewals — 9:08
The coming great recession in shipping — 14:03
Did shippers and logistics firm optimize? — 17:42
Ryan’s famous trip to Long Beach — 19:20
Unions and efficiency at the ports — 21:37
How do non-US ports operate? — 24:55
Shipping times and inventory build-up — 26:45
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Joe Weisenthal: (00:10)
Hello and welcome to another episode of the Odd Lots podcast. I'm Joe Weisenthal.
Tracy Alloway: (00:15)
And I'm Tracy Alloway.
Joe: (00:16)
So Tracy, it seems, it seems…
Tracy: (00:20)
You're going to jinx it.
Joe: (00:22)
I know, it seems like the supply chain, it seems like the supply chain ‘crisis,’ it kind of feels like that's over, in my opinion.
Tracy: (00:30)
I mean, I definitely think we're seeing some of the bottlenecks that we spent the better part of 2020 and 2021 talking about, those are starting to ease. Some of the import boom into the US seems to be easing. There is this general shift from consumer goods to services, but things are still relatively busy. But I think they've settled down enough that we can start to talk about what we have learned from this whole saga.
Joe: (00:57)
Absolutely. I think so too. I mean, there are definitely areas, you know, you still see occasionally specific products will be in shortage. There are certain types of equipment and if you read the surveys, the ISM or PMI surveys, you still see manufacturers talk about the difficulty of getting certain things -- electrical equipment seems to be up there. But the sort of like generalized shortage of everything, those like crazy lines we were seeing of boats at the ports and trucks at the ports and all that stuff, I kind of think that story is over.
Tracy: (01:28)
Right. And one of the, the few good things that tends to come out of crises in general is that they offer you this opportunity to look at what exactly went wrong and why were things designed poorly. Is there stuff that we can do better in the future? And so now that some of these supply chain issues and transportation and shipping and logistical issues are starting to ease, we can go back and, and think about what we've learned, what we can do differently.
Joe: (01:58)
Yeah, and you raise a really good point, which is that, you know, you have some crises and it’s always like, okay, what should we fix? What could be done better? But on the other hand, you know, what about maybe not fixing anything because, you know, [it was a] once in a century pandemic, is that a good reason to completely upend the way the world does business? To me it's like, let's just put it this way, it's not obvious to me that we won't eventually just return to 2019 pattern.
Tracy: (02:21)
Well, this is the other question I have because the industry that we've been talking about, the shipping and logistical industry, this is already incredibly cyclical, right? So do they just look at 2020/2021 and say ‘Well, that was a crazy cycle.Now we can get back to our normal cycles and just do what we were doing before.’
Joe: (02:38)
And well, you know, we're mostly talking about the pandemic and the Covid disruptions. You know, there are other developments globally. There's the ongoing war in Europe, there's heightening tensions between US and China politically. There’s the energy cost surge in Europe, which may not ease for a long time. So there are other things going on. Anyway, throughout the crisis. We've talked to this guest multiple times, so perfect time to get him back in. We are going to be speaking with Ryan Peterson. He is the founder and Co-CEO of Flexport. So Ryan, thanks for coming back on Odd Lots. And also, are we right? Is the crisis phase of this over?
Ryan Petersen: (03:16)
Well, it depends who you are. I think for the average consumer in business, yeah. It’s more or less passed now. If you own ships or planes, the crisis might just be starting right now. Really the prices of, well, just the price of planes came down 80%, they were all making a lot of money. And now, right, we speedran through one of those cycles that you're talking about that usually take 20 years. And we did it in two or three. And so right now I think we're looking at the opposite problem of excess capacity. There's too many, there's going to be too many ships and perhaps too many planes relative to the demand to ship things.
Joe: (03:50)
Tracy and I have been joking that maybe our Odd Lotses for 2023, it's just going to be take all the episodes we did in 2022 about how there's a shortage, a crisis, and then just flip the signal to negative. So, oh, plunging prices, overcapacity, we'll just do all the episodes over again and change the direction.
Ryan: (04:09)
I've seen gluts that don't lead to a shortage, but I've never seen a shortage that doesn't lead to a glut.
Tracy: (04:14)
So Ryan, you mentioned that the crisis might just be beginning if you are actually, you know, a shipping company and you see your freight rates start to plunge. And this kind of brings me to something I wanted to ask you, which is we have seen a lot of these shippers make absolutely insane amounts of profit for the past two or three years. I think the last number I saw was for the third quarter of this year, it was net income of $59 billion for the global shipping industry, which is more than the $48 billion they made the year before [in 2021] and up from like a fraction of that pre-crisis.
Ryan: (04:53)
Or from zero.
Tracy: (04:54)
Yeah. Up from zero or negative. So what do they do with all that money is my first question. Do they just buy a bunch of new ships? Do they start to put in like efficiency improvements or do they return it all to their long suffering shareholders?
Ryan: (05:11)
I think you've seen a little bit of each of those things, and it depends on the company, which one’s emphasized the most. So some, a few of the ocean carriers have gone been pretty aggressive in buying freight forwarding businesses or e-commerce kind of fulfillment, trying to go more end-to-end, own assets on land that can kind of connect their ships and be able to, yeah, really provide that full factory to consumers’ door experience. So you see that from CMA and Maersk in particular. CMA is the big French ocean carrier. ZIM is the large -- actually they're kind of small, but all these companies are big. That's an Israeli carrier and they've been pretty aggressive in doing dividends, returning cash to the shareholders, to the owners. And MSC, which is now the world's largest carrier, has done a little bit of all these things as well, but they also invested a lot in ships. And so they've become the largest carrier in the world by really investing in the fleet.
So all those strategies are being done. A lot of these companies are private, so you don't really get to see everything that's happening. And I think it's by nature because Wall Street really can't handle the cyclical, they want quarterly consistency. They can't handle these 10 years of losing money and then two years of printing money. It's just not something that sits well with public investors. So they tend to be private companies or in some cases state-owned or kind of quasi state-owned, and where there’s sort of some national interest in having ocean carrier capacity.
Joe: (06:42)
So, you know, obviously the big story, you know the pandemic disruptions, the insane amount of demand for sort of pure goods and the filling warehouses and filling ports, etc. But as I mentioned in the intro, there are some other pretty big things that have happened in the last two years, particularly the war in Ukraine, which remains ongoing. And just the clear ratcheting-up of tensions with China. And you see these companies start to wonder, well, what is the long-term future of trading between China and the US? And also, you know, related I guess to all of this is the surging cost of energy in Europe. Can you talk a little bit more about these other sort of non-pandemic macro factors and how much you see them like staying with us right now? Like how much are like businesses that you speak with every day, sort of like thinking about whether these are sort of deeper long-term trends?
Ryan: (07:38)
Well, the manufacturing in China has been a long-term trend. As China's gotten richer, their labor costs have gone up. It's probably a good thing for the Chinese people. But manufacturers are kind of always seeking out that lower cost labor. So that's a trend that's gone on for a decade or more. And the trade war’s sort of brought more attention to it and you know, the increase in tariffs probably caused some companies to reevaluate. And then the inconsistency of shipping and then kind of Covid where there's different, if your factory's closing down, it makes it a little bit less reliable. So that's probably had some marginal acceleration there. But I think it's a long-term trend driven mostly by labor costs. Now it's really the most important where labor is the limiting reagent or the hardest thing to find to execute these manufacturing jobs.
So that tends to be kind of lower skilled, simpler stuff like apparel, which has largely shifted out towards Southeast Asia and Sri Lanka. But some of the stuff like consumer electronics, it's just this whole ecosystem there that's in Shenzhen and around, that's very hard to move those factories. So I think it's kind of overblown some of the heat on this stuff. Like, we've traded more with China over the last couple years than ever. And so it's a nice narrative, but I dont' know that it bears out in the data.
Tracy: (09:08)
Can I ask a really basic question before we go any further, but when we talk about spot rates in shipping and, you know, we mentioned that they went up a lot during the pandemic and now they're starting to come back down. How much do those actually matter for global trade? Because my understanding is that if you're a big manufacturer or just someone who ships a lot of goods, you're probably going to have a contract in place that might be different to the spot rate and you're also going to be renewing that contract on maybe a yearly basis. So it seems like there's perhaps a lag in how long it takes the decrease in spot rates to feed through to actual shipping rates.
Ryan: (09:47)
Yeah, that's exactly right. I don't have the stat in front of me, but I want to say it's about 60% or 70% of containerized freight moves on annual contracts and 30% or 40% on the spot market. I'm not a hundred percent sure, but that's where my brain settles in on it. And so that, that spot rate, it doesn't flow through immediately to the P&L of the carriers. Sometimes people don't honor the contract. And a lot of people, if they, you know, see.. These contracts are kind of gentlemen's agreements, handshake…
Joe: (10:20)
Yeah, that's the impression we get.
Ryan: (10:22)
It's a repeat game. So if you don't honor your contract this year, people are going to really hesitate to sign a good contract with you next year or, you know, it's not something that, it's not necessarily legally enforced. People aren't really suing each other very often over these things, although with the level of price, you know, you've seen more probably lawsuits against carriers and freight forwarders in the last couple of years than than ever, because people are so upset about how things played out. But in general, people do honor their contracts even when the spot market drops below, but not always. And in any case, it is a lag. So it's putting a lot of pressure, contract renewal season in ocean freight for the United States, it's going to be in April or May each year, kind of March through May, and that's coming around the corner and people are looking at these spot markets and saying, you know, that's clearly going to be the driver and price of where the contract market settles in. So the pain for the carriers probably comes after this contract season and it's going to be really interesting kind of economic theory in practice to get to watch and see what plays out.
Joe: (11:22)
Hmm. Yeah, I believe, you know, we've talked to Craig Fuller from FreightWaves a few times. I think he, at least in trucking specifically, he sort of likened it to, you know, the deal you have with your babysitter where it's like, ‘okay, I'll pay you, you know, $150 every Friday’ or whatever. But if you change it, it's not like anyone's going to sue you, [you] just sort of like expect that that's like the arrangement. And so you just sort of keep it, but it doesn't necessarily mean that [if] the babysitter doesn't show up one day, it doesn't mean you're going to sue your babysitter.
Ryan: (11:51)
There's just a lot more babysitters in the world than there are ocean carriers
Tracy: (12:04)
As a former babysitter I do not approve of breaking contractual relationships.
Joe: (12:08)
There are a lot of parents in New York City who have a hard time finding a babysitter right now, so I think you really want to be careful about burning that relationship as well.
Ryan: (12:15)
Yeah. Okay. Okay. Maybe there's more similarity there. Okay. But yeah, there's only 10 or 12 ocean carriers that matter that have any real scale. They probably represent 95% of the containers moved in the world. And so, you know, you don't want to be breaking your contract because you do that once and, you know, you're down to nine. And there are a number of these big companies that come around and, basically when you get to be above about 5,000 containers a year that you're shipping, it makes sense for a company to contract directly with that ocean carrier rather than working with the freight forwarder to buy the freight. But there are some big companies that buy from freight forwarders and when you dig in you find out, oh, it's because they like dishonored all their contracts and no carrier wants to work with them anymore.
Tracy: (12:54)
Well, this is something I wanted to ask you, because I think one of the things we learned from our, our very first episode with you, where you were basically walking us through why I was having so much trouble getting half a container from Hong Kong to Los Angeles as an experiment in shipping congestion. But one of the things we learned was that a lot of this business is relationship driven. And we used to joke about like Sven in Sweden, right? You know, this Sven who operates some port somewhere and you can maybe get some extra room. But for the past couple of years, has the industry become more relationship-driven? Is it more important to have these direct relationships with the shippers themselves? Or has the crisis sort of opened up opportunity for that behavior to begin to change?
Ryan: (13:42)
I think in the last two years relationships probably mattered more than ever because when capacity is tight and there's no space on the ship, it's who's been a best customer for these people over the long term, who plays golf? It's not Sven in Sweden by the way. It's Lars in Copenhagen.
Tracy: (13:57)
Oh, I'm sorry. It was Lars in Copenhagen. Sorry, I'm getting my Nordic names mixed up.
Ryan: (14:03)
I'm just joking. But you know, I think when capacity’s tight, very little else matters in the world than what's your relationship? Are you a profitable customer? How long you been a profitable customer? What's your consistency? So being able to bring freight every single week and not cancel, those things start to matter a lot more. When space is wide open, if there's excess capacity, it’s sort of like, you know, you don't need a relationship. We need to sell some more cargo. So I think, that dynamic is going to shift. And, you know, we went through a real long period from 2015 until 2019, 2020, really at the beginning of the pandemic when it kicked in of just excess capacity in ocean freight. And then we had two years of extremely tight capacity and it looks like we're right in the midst of a great recession, call it, where there's less container shipping than really even before the pandemic.
Joe: (15:02)
Oh wow. Okay. There's our title for this episode, the great recession that's coming to container shipping. Thank you.
Ryan: (15:08)
In container shipping. Yeah. Now it might be great news for people who have to ship containers, like all of a sudden the price is way down and you can get space and you can have some sanity about it all.
Joe: (15:17)
But, okay, so we went from glut to extreme scarcity to glut again, and not just glut, but also sort of very poor demand. Can you talk about the energy component? This is like a fascinating thing, the gap say between how much it costs to manufacture goods in Europe versus the US due to the gap in electricity prices. Do you see that reshaping trade flows or has this become another one of these things where it's kind of a fun story and we talk about it in the media, but in the end, you know, the world doesn't reorient that fast and ultimately finds a way to sort of go back to the old normal?
Ryan: (15:55)
Yeah, I mean I think it's a little too early to say. It seems obvious just looking at the numbers, that manufacturing in Germany doesn't make sense at these energy prices. Does the government come in and subsidize the energy to allow them to maintain the manufacturing which has employed so many people and kind of been the engine of the European Union as a whole? I think they probably will. And so then it starts to be really hard to predict how things play out because once you have the government coming in and intervening in the market, then you know, a lot of the market theory kind of breaks down. And I don't really know what'll happen. But with those prices, manufacturing in Germany just doesn't make a ton of sense. The US has such an advantage on energy right now.
Tracy: (16:38)
So just going back to the past couple of years, I'm curious whether or not you saw either shippers or people related to the shipping industry and transportation and logistics more generally, whether you saw them do things that made the whole process more efficient? And I remember in our various discussions on this topic there, there seemed to be a lot of low-hanging fruit for the industry. And I think you had one figure when we first talked to you talking about how most container ships on average are only 70% full. So it would seem like just put more containers on the ship and we could maybe fix some of the backlog. But did stuff like that actually happen? Because all of these things, they seem so simple, but then when you actually go and try to fix them, my impression is it often ends up being more complicated than you expected.
Ryan: (17:29)
Well actually that stat is that the containers themselves are only 70%
Tracy: (17:33)
Oh, there we go.
Ryan: (17:34)
Ships are full, but the inside of the containers are not optimized.
Tracy: (17:38)
Did the containers get more full?
Joe: (17:39)
Yeah, did they get better at packing them?
Ryan: (17:42)
Surprisingly no. And if anything it might've gotten worse, which is a really interesting counterintuitive thing. But if you, but it sort of makes sense when you think about the psychology of it all, it’s like, okay, you're having a hard time getting a space on a ship, you finally get one, you're not going to sit there and try to optimize the inside of the container. Just whatever yo’veu got now, just throw it in there and let's go, which, you know, it's sort of counterintuitive because you think like,’ oh, this thing's really scarce, we've got to really optimize our capacity, but you may not have that luxury because you're just scrambling to get space on a ship. So no, we haven't seen a lot of progress on that metric.
We’re not seeing, I can't say that I saw material changes in the infrastructure in our ports to enable them to handle a surge incapacity if that ever happens again. The appointment systems haven't improved, the technology for picking up trucks, you know, for picking up containers for getting trucks in and out of there hasn't improved. We've got the West Coast Union, it's called the ILWU, International Long-Term and Warehousing Unions, they’re operating without a contract right now, so their contract expired this summer. Those negotiations are ongoing. I don't have any intel what's happening there, but I have heard that the main thing that they want is to not have more automation in the ports. So I don't see that kind of coming, that we're going to get a lot more automation to be able to handle the surge in the area. So in general, I would say the infrastructure isn’t is the same. It's not gotten any better.
Tracy: (19:20)
Wait, you famously went to Long Beach and I think you rented a boat so that you could observe how things were actually being loaded and unloaded at the port. And wasn't there a change as a result of that trip? Weren't they stacking, I think two containers on top of each other and you made it, or you suggested that they start stacking them higher and they ended up doing that?
Ryan: (19:42)
Yeah. So I went down there to explore what's really happening here in the ports? Why is this backlog of a hundred ships going out here? People are like, ‘Oh, you're so great.’ I don’t know what words they used, but really creative or something, going down there and like doing that. I'm like, it's kind of my job. I got all my customers’ cargo stuck there. I’ve got to figure out what's happening, you know?
And so what we figured out was that the trucking yards around the port were only allowed to stack containers too high. And then after that, they had to just leave the containers on the chassis. That's the trailer that hauls the containers around. So then we ran out of trailers, ran out of chassis to go pick up more containers. And so you had this huge backlog that that created. So the city of Long Beach, I did a tweet storm about that at 6:00 AM. [At] 3:00 PM the city of Long Beach changed the zoning law to allow stacking up to four high.
Tracy: (20:33)
That’s pretty impactful.
Ryan: (20:35)
I'm told it's the fastest response to a citizen action in the history of government, in all human civilization.
Joe: (20:45)
Didn't you also bring the workers tacos?
Ryan: (20:47)
That was the week prior. We brought the labor union tacos to try to interview these guys and learn what was happening. That's where we found out that the truckers are missing their appointments. And then we found out the reason the truckers are missing their appointments is because they don't have any chassis. They don't have the trailers to go pick them up. So that zoning law did have an impact.
However, it was only the city of Long Beach, and Los Angeles didn't follow suit. All the other Southern California cities didn't follow suit and Long Beach doesn't have that many trucking yards in it. So it kind of had a marginal benefit, but not dramatic. And I think it was kind of around the edges in the first place. What we really need is why do these truckers need appointments in the first place? There should be a system where they just show up and we give them the container and then the mobile app tells them where to go. So Flexport has implemented that in a couple of terminals for our own cargo. But for the wider industry, they haven't done anything like that.
Joe: (21:37)
All right. I'm not trying to blow up any future Ryan Peterson presidential ambitions with this question. You know, down there at the ports giving tacos to the workers, all things that could be a career in public service one day. But your honest take in terms of the difference between unionized versus automated ports, in terms of what you've seen around the world how. In your view, how costly is it from a sort of economic perspective, if at all, to have this sort of level of unionization that we have at the US ports versus what I believe are more automated ports elsewhere?
Ryan: (22:18)
You know, it's hard to unpack the effect of the union, whether it's automation or just like management style and the adversarial relationship between the union and the employers, and the managers. It’s a very strange, you know… My company's not unionized and it wouldn't work if it was because this idea that a person who manages people is like a different person, and can't, you can't relate to each other. And so very specifically what happens at the ports, on the West coast at least, is that the management, the companies have to say, the terminals say every day, how many employees, how many workers do they need the next day? And then the union furnishes that many workers, but they're different people every time. They move around between the different terminals.
And then the team has to reform every day and you're operating heavy equipment with new people doing new jobs without adequate training in many cases. And it's just kind of a crazy way to work, if you think about it. Like, the kind of the core element of running a company and running an operation is that you take the team and you go, ‘what did we learn yesterday? And what are we going to do better today?’ And you can't have those conversations because it's new people every day. And it's hard to unpack how much of the US port inefficiency is from just like a weird structure that's put in in terms of how the workers work with the management. And I'm not blaming the union for that by the way. It's like why? The management, I don't know. There's just this adversarial relationship between management and union that that needs to get worked through.
And now look, I'm an outsider. I haven't worked in ports so I'm sure these guys will criticize me and tell me, I have no idea what I'm talking about. But, then the automation piece is like a money saving thing for the operators. I don't know how much efficiency gains come out of it versus just like, Hey, the union workers are really well paid and if you didn't have any of them then you could make more money running a port, and lower the cost of shipping goods for sure. It costs about, the terminals charge about $600 to unload the container. And I don't know, it takes 30 seconds for a crane to go like that. So it does seem like a pretty high tax to put on the world. China is about a hundred bucks and some of that is because they have lower labor costs, but a lot of it's because they've got more automation.
Tracy: (24:45)
I was about to ask, can you talk to us about non-US and what they're doing there, just to give us a sense of what is possible here?
Ryan: (24:55)
Yeah. And what is possible, by the way, Rotterdam has been a fully automated port for something like 25 years, with self-driving trucks from 25 years ago, because they don't need that much – they kind of just follow a white line on the tape. There's no people to run into. So it's real, it doesn't need like really advanced AI or anything. And they're a worker friendly place. I don't think people are thinking like, ‘oh, the Dutch are this like terrible, you know, like fascist place where workers have no rights.’ I'm pretty sure that the workers in the Port of Rotterdam do okay. So it is, you know, there are other things that are other ways of working that are possible and people can get along with investments in robotics. And I think it's really important for civilization that we keep improving the efficiency of the way we ship stuff, globalization was really powered by the shipping container.
We lowered the cost of shipping things by 95% or more. We lifted something like a billion people out of poverty, largely in Asia. But the ability for anybody to trade with anybody's created huge economic benefit. And we kind of like, stopped there and went ‘ We don't need any more of that. We'll stop with the robotics thing and the containers, [it’s] fine. We don't need to optimize the inside of the container or the way the containers are picked up.’ So it's disappointing to me as someone who would like to see more growth in the world. I'm sort of a single issue voter on economic growth. I'd like to see, if we were all twice as rich, I feel like we'd be able to solve most of the other problems that are out there.
Joe: (26:21)
Going back to, you know, the struggles that you believe container shippers are going to face, what are they going to do? I mean, we talked a little bit about what they're going to do with all the money that they made in the last two years, but what do you see as some of the ways they're going to navigate if we go through this sort of,, you know, let's say 2023 is kind of a bust for them. Are we're going to see consolidation? What are we going to see out of that?
Ryan: (26:45)
I mean, it's a really fascinating thing to watch. I get to be kind of front row seated in the game a little bit. They did make a lot of money and yet nobody likes to lose money no matter how much they have. You don't want to sit there and lose money. So they've returned a lot of it to shareholders. They're investing in new business lines, but at the end of the day, if the price goes down below the cost, you know, below their cost, they start bleeding cash. How long do you bleed cash? What happened? You've already had a huge amount of consolidation during the prior glut. Like when Flexport started, there were 23 major ocean carriers. We’re down to 10 or 12 depending on how you count them today. So there's been a lot of consolidation. I don't know if there's that much room for more consolidation as weak players go bankrupt.
Maybe some of them get bought up. And there might be some bankruptcies. People might walk away say, ‘Hey, like we made tons of money. We don't, you know, let this thing go.’ But they also largely pay down their debts. So I don't know that they have a huge amount of debt to default on in the first place. So very interesting to see.
There are a couple of factors that might change this trajectory. One is that the consumer’s actually still pretty strong in the United States. Like container volumes are way down, but actually consumer spending has not gone down, even on goods. Services has gone way up, but the goods spending has stayed elevated. So maybe there's a world where the consumers continue to spend goods and those trade volumes will come back up.
One reason to think about why trade volumes have gone way down in the last quarter is that transit times improved, right? And so it was taking 120 days to get a container from China to the US at peak. I mean it used to be 40. We're back down to like 50 or 60 days. And so if all of a sudden, your ships go 60 days faster than you thought they were going to go, you're going to have two months of extra inventory in stock in the United States. And then you're like, ‘Hey, I don't need to order more stuff.’
But you're going to sell through that inventory if the consumer stays strong. So, you know, I think the carriers are really hoping that January, February, April, May, you know, the next few months, people start reordering. The factories start producing more and the companies start ordering more goods to get them into the country. So there's some hope there that the consumer stays strong and that all their recession talk is overblown.
They have another thing on the supply side that's coming down the pipeline, on the supply side, meaning the capacity for shipping, the number of ships that are out there and they're, sort of the big factors are how many ships are there, what's their capacity and how fast do they go? And under this thing, the International Maritime Organization -- that's the division of the United Nations that oversees, it's kind of the governance body for ocean freight -- they have a rule that kicks in on January 1st that the ships must reduce their carbon emissions by 13%. And the only way to do that for an internal combustion engine is to just go slower. And so all these ships are going to start slow steaming. We estimate that if they have to go 30% slower than their max speed in order to hit that target, now it turns out there a lot of them are already going slower in order to kind of rein-in capacity and lower fuel costs.
So our economists estimate this is going to be a 4% to 6% reduction in capacity. that that'll start in January. So that may, you know, that may rein-in some of it as well. On the counter side though, during this boom and in years prior, these ocean carriers ordered a lot of ships. So over the next three years you're going to see a 25% increase in container capacity as new ships come online and those orders were already placed and the ships are in construction. So from where I sit, it looks like the price has to go down a lot and the carriers will go back to the old world.
And I think, you know, there's a lot of hate spewed at these ocean carriers over the last few years, but those of us who’ve been in the industry know, hey, this was a ugly business. They lost money for a long time. They're going to, you know, they're going to fail if they can't make money. They made money. It comes in waves, as it turns out, they made a lot of money for a couple years. They may lose money for long time coming up. And hopefully, you know, they're in it for the long run as these kind of family businesses and national businesses that they're willing to ride out a downturn because they know the upsides can be so good when they come.
Joe: (31:16)
Tracy, I'm kind of fascinated by that point about environmental regulations as de facto capacity curbing mechanisms. It's like if all the rules are imposed at once, then they sort of can solve the game theory of limiting capacity.
Tracy: (31:30)
I just want to go back to that cyclical point, because we know that shipping itself is a very cyclical industry and it's gone from basically bust to a massive, massive historical boom. But you've spoken about this before, sort of the pressures of short-termism on the broader business cycle. So this idea that everyone's obsessed with making money, with generating return on equity, everyone moved to just in time inventory and things like that, which kind of contributed to the bottleneck because you don't have a lot of stuff on hand when suddenly demand starts to spike. Have you seen any progress from that perspective? Did anyone in business, in manufacturing, in retail, learn from the experience of 2020 and 2021 that actually maybe we want to move to some sort of more resilient model?
Ryan: (32:30)
I assume some people learned, a lot of companies have, you know, more inventory than ever right now, I'm not sure how much of that is planned versus like, hey, the transit time spread up and they've got more inventory than they want right now. There is a bit of a Darwinian function in economies, right? The people who played over the long game those people who do it right should come out ahead and win. But it's difficult because, you know, in the meantime, you have too many assets. You're not earning a return on assets as a CEO. You get canned, or you go bankrupt because assets are not free. And so can you even, you know, actually the great reminder here is Hanjin, which is a Korean ocean carrier that went bankrupt in in 2016.
And if they would've just held on for six more years somehow, they would've made like $25-50 billion in profit the last two years. And so, you know, they might have had the right strategy, they had the right assets, they were ready, but they couldn't survive to see the strategy through. So it's really difficult to just stand from the outside and say, oh, everybody should have more assets on the balance sheet. And yet and yet there are, there is a competitive advantage to doing that. Amazon has kind of proven this. Very interesting to see how eBay still 30 years later hasn't responded to Amazon opening up its own fulfillment centers and running a logistics network and kind of dominating an e-commerce. And eBay is still like, ‘no, we just like our marketplace for used, you know, junk.’ I don't know, it seems like there's an opportunity that that's missed in going to invest in assets that many, many companies are afraid to do.
Joe: (34:09)
All right, so the big lesson of the last two years is here comes another downturn and no one actually learned any lessons or are going to do any business any differently. Everyone's going to go back to just in time, manufacturing in China, it's all just same old, same old? That’s kind of like my takeaway from this.
Tracy: (34:27)
Wait, wait, wait. Just on this point. At a minimum, we've spent the past two years talking about supply issues and the sort of hidden plumbing of the global economy. Has that not translated into anything tangible?
Ryan: (34:45)
I don't know. I think never underestimate the ability of human beings to forget terrible things that happen.
Joe: (34:53)
We got some good episodes out of it all.
Ryan: (34:55)
I think there'll be more discussion of it. Like Washington has taken some action to do some things that actually are valuable. Now ocean carriers have to provide the date of when a container is made available which seems like, yeah, that's a reasonable regulation to require -- that they can tell us exactly when this container was available. Because remember, you only have seven days to pick up the container after it's available before you start paying daily fines.
Joe: (35:29)
Oh, right. I forgot about that.
Ryan: (35:31)
And if they can't tell you when it's available, it's precisely like how are they going to, what ground truth do you have to base those fines on? So that was one of the things that came out of the Ocean Shipping Reform Act that Washington passed. That one seemed pretty sensible. The rest of it, I haven't seen a big impact, but that one, it's a good rule in my opinion. But sometimes, you know, Washington wants to take action and action, you get a group of people in a room and say, ‘you have to do something.’ You will definitely do something, but whether that thing is valuable or not is a big, big question mark.
Joe: (36:02)
Ryan Petersen, co-CEO of Flexport, thank you so much for coming back on Odd Lots.
Ryan: (36:07)
My pleasure. Thanks for having me.
Joe: (36:21)
I thought that last point, Tracy, never underestimate humans’ ability to forget, that’s kind of bad and good. I think it’s kind of a neutral thing. Like, okay, we wish somethings got fixed, but on the other hand, all right, maybe just move on.
Tracy: (36:34)
I think it's kind of bad, Joe. I mean, I started this episode trying to be on an upbeat note, that maybe we have learned something from this crisis. But I mean, I don't know. Ryan had some examples of stuff that had changed, that he had actually affected change personally, like stacking containers
Joe: (36:53)
In one day. In one sort of modest-sized port, they did add an extra layer of stacking
Tracy: (37:00)
So some things are possible it seems, but it does feel like the cyclical nature of shipping means that a lot of people are just going to look through the past couple of years and just be like, ‘well, you know, it was an abnormal boom.’ But it's not unusual that we get these booms followed by these big busts.
Joe: (37:18)
And, you know, the fact that they all went out and made these big orders, did they start believing it too? You know something is going to be fundamentally changed, the permanent bust. And so it does seem like the over-capacity story is really staring us on the face for 2023.
Tracy: (37:32)
Yeah. It seems like the thing that that would help would be if there was some sort of floor put under some of these cycles?
Joe: (37:39)
I mean, when he said like, okay, the environmental regulations, they kind of do have that effect. Okay, if you mandate, if you put out some emissions mandate and the only way to hit that emissions mandate is for everyone to get slower, no one is going to sort of voluntarily get slower if there's no force. But you could see how these sort of curbs might have an effect of solving some of these capacity problems, solving some of the game theory that otherwise would automatically result in the race to the bottom.
Tracy: (38:07)
Yeah. All right. Well we've done our shipping bust episode. I guess maybe in two or three years we'll do another boom episode.
Joe: (38:15)
Yeah, hopefully not under global pandemic condition.
Tracy: (38:18)
Hopefully not, but we'll just keep marking all the turns in the cycle. Shall we leave it there?
Joe:
Let's leave it there.
You can follow Ryan Petersen on Twitter at @typesfast.