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Should Container Shipping be exempt from Competition Regulation?

BRITISH CHAMBER OF COMMERCE IN HONG KONG

1 December, 2015

DR JONATHAN BEARD

VICE PRESIDENT, ICF INTERNATIONAL

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Should Container Shipping be exempt from Competition Regulation?PRESENTATION OUTLINE

1. Hong Kong’s New Regulatory Environment - What are the competition concerns in container shipping?

2. What would determine whether liner shipping agreements qualified for a Block Exemption?

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WHAT MAY BE A CONCERN FOR REGULATORS?THE COMPETITION ORDINANCE

Liner shipping industry features a variety of cooperative elements:

– Conferences – common tariffs and surcharges (no longer prevalent in the industry)

– Rate discussion agreements (RDA): no common tariff but provide a forum for members to discuss the trade and may provide recommendations for rates and charges

– Alliances: agreements between carriers to cooperate on space and capacity on a global or regional basis

– Consortia and Vessel Sharing Agreements (VSA): agreements which focus on a particular route

Such cooperative elements usually forbidden by competition law in other industries – but liner shipping industry has obtained numerous exemptions

Hong Kong Competition Ordinance Comes into effect on 14th December 2015

Process: Competition Commission (CC) investigates suspected anti-competitive behaviour, and brings enforcement action before the Competition Tribunal (CT). CT decides whether an infringement has happened, and imposes sanctions.

Concern focusses on the first conduct rule: “prohibits an undertaking from entering into agreements or engaging in concerted practices that have the object or effect of preventing, restricting or distorting competition in Hong Kong”

“Serious anti-competitive conduct” “Other contraventions”

Examples • Price fixing• Market allocation• Bid-rigging• Etc.

• Joint ventures/selling• Information exchange• Exclusive distribution• etc.

Commission response

Issue infringement notice or start proceedings in the CT

Must issue warning notice before bringing proceedings before the CT

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BLOCK EXEMPTIONS CAN EXCLUDE CATEGORIES OF AGREEMENTS FROM

THE FIRST CONDUCT RULETHE COMPETITION ORDINANCE

Current State of Play:

- CC recently announced it will not take any action against industry sectors that have applied for a block exemption until the applications have been reviewed

- Hong Kong Liner Shipping Association will submit an application for block exemption on behalf of all liner cooperative agreements covering Hong Kong

Offers a temporary reprieve, as longer term uncertainty remains for lines

There are cases where the block exemption has been partially removed (European Union) or is contested (Malaysia)

A strong case for a block exemption should consider the benefits for Hong Kong consumers, shipping industry, and the wider economy

Argument should be two-fold:

– Market impact: Theory of harm

– Wider economic impacts: Macroeconomic impact

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Should Container Shipping be exempt from Competition Regulation?PRESENTATION OUTLINE

1. Hong Kong’s New Regulatory Environment - What are the competition concerns in container shipping?

2. What would determine whether liner shipping agreements qualified for a Block Exemption?

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THEORY OF HARMTWO STEP APPROACH

We use economic theory and empirics to answer Q1

Burden of proof for Q2 mainly falls on the undertaking concerned

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IS AN AGREEMENT ANTI-COMPETITIVE?THEORIES OF HARM

Wording of the Competition Ordinance similar to that used in the European Union

– Object: is the agreement by its very nature harmful to competition

– Effect: agreement has the actual or potential effect of appreciably harming competition

Theories of harm follow a sequential approach:

Counterfactual

1

Loss of competition

2

Is there a material loss in competition (i.e. has the agreement reduced the number of suppliers in a given market)

Are consumers worse or better off from the agreement?

Response of rivals

3

Will other competitors counter the likely anti-competitive effects

Is a new entrant likely to restore competition

Presence of network effects

In the absence of the agreement, what would competition conditions look like?

Were parties prior to the agreement actually competing against each other?

Did parties to the agreement have the incentive to compete?

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CAN EFFICIENCY ARGUMENTS BE MADE? SEQUENTIAL TESTS

Efficiency gains?

1

Do consumers benefit?

2

Do consumers get a fair share of the gains (i.e. cost savings are passed on to consumers)

Indispensability?

3

How essential is the agreement to achieve efficiencies ?

Could the same efficiencies be gained with less restrictive agreements ?

Do they exist?

If they exist, how big are they ?

Can they be quantified?

4

Is there the possibility of eliminating competitionin the market?

Eliminating competition?

Decision to issue (or not issue) a block exemption

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Market Share (by Capacity), LH Axis HHI, RH Axis

CONTAINER SHIPPING – MARKET SHARES (I) MARKET CONCENTRATION IS LOW

Limited concentration of industry: top 5 operators account for about 47% of capacity; 86% for top 20 operators. Relatively little consolidation, but change underway?

Notes: Herfindahl-Hirschman index (HHI) is a statistical measure for market concentration widely used by EU Directorate General for Competition, U.S. Federal Maritime Commission (FMC) and U.S. Department of Justice. Calculated by squaring the market share of each firm competing in a market, and then summing the resulting numbers. If, for example, there were only one firm in an industry, that firm would have 100 per cent market share, and the HHI would equal 10,000 (100^2), indicating a monopoly. Or, if there were hundreds of firms competing, each would have nearly zero market share, and the HHI would be close to zero, indicating nearly perfect competition.U.S. DoJ considers a market with HHI <1,000 to be a competitive; 1,000-1,800 to be a moderately concentrated marketplace; and > 1,800 to be a highly concentrated marketplace. As a general rule, mergers that increase the HHI by more than 100 points in concentrated markets raise antitrust concerns

Herfindahl-Hirschman index (HHI) for industry of 767, well below the trigger point of 1,000

Market Analysis top 20 Carriers

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CONTAINER SHIPPING – MARKET SHARES (II) MARKET OVERVIEW – ECONOMIES OF SCALE VIA MEGA-VESSELS

Shipping lines are ordering ever larger vessels in order to reduce unit costs. Sizes more than doubled in 16 years.

“Herd mentality” – liners compete to order larger vessels

Latest order by OOCL: 6x 21,100 TEU for delivery in 2017

Economies of scale only realised with adequate cargo

Mega Vessel Specifications*

Source: Alphaliner*Latest Maersk class (on order) will have 16.5m draft

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CONTAINER SHIPPING –MARKET SHARES (III) MEGA VESSELS AND SURPLUS CAPACITY DRIVE MEGA ALLIANCES

Individual operators struggle to fill the mega-vessels Growth of “mega-alliances”:

- operational cooperation (i.e. joint operation of services, and sharing of vessel space, schedules, etc.)

- secure enough vessels that are of same magnitude of size to offer fixed schedule

- can share certain information (market data, forecasts and trade flows), but not commercial information

- mitigates the risk of introducing larger vessels in subdued market conditions, facilitates scale economies to reduce unit freight rates.

- High level of scrutiny (i.e. P3 Alliance blocked by China)

Source: Alphaliner

Far-East – N Europe Capacity Share by Alliance

Key alliances account for significant % of capacity…..

….HHI for this key trade lane is estimated at >2,500, but each alliance cannot be compared operationally or commercially with an individual line, hence the HHI should be treated with caution

2M: Maersk Line and MSCG6: Hapag Lloyd, NYK, APL, HMM, MOL and OOCLCKYHE: Coscon, K-Line, Yang Ming, Hanjin Shipping and EvergreenOcean 3: UASC, China Shipping and CMA CGM

1111

Port Operators

Relatively stable EBITDA

Very market / region

dependent

Liner Companies

Less successful

Still very fragmented – slow

pace of consolidation

US shale oil ‘buffer’ should at

least moderate bunker price

fluctuation

EU-Asia rates continue to

tumble

Supply / demand still drives

performance…and the failure

of the market to clear.

Source: ICF; Annual Reports

Notes: EBITDA / Revenue

-20%

-10%

0%

10%

20%

Mae

rsk

CM

A C

GM

Hap

ag‐L

loyd

AP

L

Han

jin

CO

SCO

N

MO

L

OO

CL

K L

ine

NY

K

2010 2011 2012 2013 2014

0%

10%

20%

30%

40%

50%

60%

APMT HHLA Eurogate DP World ICTSI HPH HPH Trust CMHI PSA

2010 2011 2012 2013 2014

EBIT

DA

Mar

gin

EBIT

DA

Mar

gin

CONTAINER SHIPPING – COMMERCIAL PERFORMANCE (I) LITTLE EVIDENCE OF MONOPOLY PROFITS OR RENT EXTRACTION

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CONTAINER SHIPPING – COMMERCIAL PERFORMANCE (II) LITTLE EVIDENCE OF MONOPOLY PROFITS OR RENT EXTRACTION

Airlines

Better EBITDA margin than

shipping lines, but still

struggling to generate

adequate returns on capital

invested

Source: Companies’ Annual Reports, SEC Filings, ICF AnalysisNotes: EBITDA / Revenue;

* Cathay Pacific does not separate out operating lease expenses from depreciation and amortization; Japan Airlines filed for bankruptcy and delisted on 2010 – no financial data was available for FY2010

-20%

-10%

0%

10%

20%

Mae

rsk

CM

A C

GM

Hap

ag‐L

loyd

AP

L

Han

jin

CO

SCO

N

MO

L

OO

CL

K L

ine

NY

K

2010 2011 2012 2013 2014

EB

ITD

A M

arg

in

0%

10%

20%

30%

40%

50%

CathayPacific*

SingaporeAirlines

JapanAirlines*

Air China AirAsia Delta AirLine

Lufthansa

EB

ITD

A M

arg

in

2010 2011 2012 2013 2014

Shipping

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CAN EFFICIENCY ARGUMENTS BE MADE? DO ALLIANCES REDUCE RATE VOLATILITY?

Lines’ customers seek lower costs, better services, etc. ……but also stability

China Containerized Freight Index (CCFI), 2006 to 2014 – Trade Lanes Compared

Notes: 1998 = 1,000. Not adjusted for inflation

Source: Shanghai Shipping Exchange; Drewry

Proponents of agreements cite greater volatility post conferences for China-EU. 2006-2008 the price volatility of the CCFI as standard deviation of the index values = 187 versus 305 2009-14.

Argue volatility on the China to Europe trade lane is now ~3 times China to WC America and China to EC America lanes

But is the variance all due to the removal of conferences?

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CAN EFFICIENCY ARGUMENTS BE MADE? THE MACROECONOMIC PERSPECTIVE

Ocean transhipment increasingly important for Hong Kong – “footloose” market where shipping lines can switch to alternatives hubs if Hong Kong loses competitiveness

Notes: TS refers to international ocean-to-ocean transhipment; OD

refers to origin-destination (or IE) cargo.

Source: ICF

Asia Transhipment Market

Hong Kong Port Container Throughput

2000

2014

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CAN EFFICIENCY ARGUMENTS BE MADE? THE MACROECONOMIC PERSPECTIVE

Success in the ocean transhipment market brings additional services & connectivity that would not exist if Hong Kong was purely a gateway port, since its import/export (‘HK Local IE’) volumes are so small

The additional connectivity benefits Hong Kong’s importers & exporters; the presence of large shipping companies benefits the Hong Kong economy: size of impact?

Exemption considered the norm in the region – if Hong Kong does not follow suit, liners might switch their transhipment calls to other competitor hubs: size of impact?

Unlike the US, EU or PRC, HK does not offer a major IE market that provides a compelling incentive for lines to call direct

If Hong Kong’s port declines further, what is the potential economic loss?

– Oft cited figure: ‘Trade and Logistics’ contributes 24.6% of HK GDP in terms of value added and 20.9% of employment: but much of the activity under ‘trade and logistics’ has negligible linkage to the port / shipping industry

– HK Port 2020 estimated direct contribution of port was 2.5% of GDP in terms of value added and 3.7% of employment in 2000.

Economics can be used to estimate the wider economic (multiplier) effects of the shipping industry on the Hong Kong economy

However, consideration should also be given to the counterfactual i.e. would all related economic activity be lost (c.f. London)? What is the +ve economic impact from use of the land for alternative uses?

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OVERSEAS COMPARATORSCOMPARISON WITH SINGAPORE

Like HK, Singapore is an ocean transhipment hub

Success in the transhipment market brings additional services & connectivity that would not exist if Singapore was purely a gateway port

The additional connectivity benefits Singapore’s importers & exporters; the presence of large shipping companies benefits the Singapore economy

Competition Commission has recommended extension of the block exemption for another 5 yrs to 2020, taking into account:

– Antitrust exemptions for liner shipping agreements remain the regulatory norm worldwide;

– Size of the Singapore economy;

– Singapore is not a major port of origin or destination (IE), mainly involves transhipment;

– Connectivity of liner shipping services available in Singapore generates considerable benefits to Singapore, including providing a higher degree of connectivity and choice for Singapore's importers and exporters; and

– Agreements between liners to share vessel space increases the utilisation of space, enables more frequent services, and may enhance competition with larger liners.

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Thank You Jonathan Beard

– Vice President, ICF International

– Managing Director, Hong Kong; Executive Director, Beijing

– Jonathan.Beard@icfi.com

Mark Peacock

– Lead Managing Consultant, Competition and Economics, Asia

– Based in Hong Kong

– Mark.Peacock@icfi.com

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ICF HONG KONG: SERVICES, SECTORS AND CLIENTSSUPPORTING OUR CLIENTS THROUGHOUT THE POLICY AND PROJECT CYCLE

Key ClientsOur Service Offerings:

Strategic and master planning

Economic analysis and business case development

Regulatory and competition economics

Independent market assessment and competitiveness analysis

Financial analysis, transaction advisory, due diligence and investment guidance

Governance, implementation and public private partnerships (PPPs)

Policy development and evaluation

Key Sectors: Ports, airports, transport and logistics

Public services and municipal infrastructure

Area-based developments and niche property products

Tourism, recreation, arts and culture

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ICF HONG KONG: COMPETITION AND REGULATIONOVERVIEW OF KEY STUDIES

ICF, formerly GHK, is a leading economic and public policy consulting practice in Hong Kong. We have been advising public and private clients here for over 20 years.

ICF combines:– Hands-on experience of competition issues:

• We have advised competition authorities, regulators and private clients in Hong Kong, Singapore, UK and European Union.

– Deep understanding of markets in Hong Kong:• We have conducted market and economic studies of many major transport, infrastructure, and property developments.

– Specialist knowledge across many sectors: • Transport (aviation, ports & shipping, bus, rail), utilities (energy, water), healthcare, retail, advertising, consumer credit

ASIA EUROPE

DEFINING AND

SCREENING

MARKETS

• Retail malls, Singapore• Container port operations, Hong Kong and

South China

• Private healthcare, UK• Tertiary education, UK• Classified directories, UK• Consumer markets, UK

ASSESSING

IMPACTS OF POLICY

INTERVENTIONS

• Airline Joint Ventures operating through Singapore

• Block Exemption Order on liner shipping agreements, Singapore

• Energy markets, European Union

• Rail industry, Hong Kong• Bus industry, Hong Kong• Ferry terminal market, Singapore

• Water industry, UK• Off-grid energy market, UK• Current account markets, European Union

ADVISING ON

BETTER

REGULATION