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The Hidden Causes of the Crisis

Hanjin Shipping was South ’s largest maritime container carrier. It was the seventh largest shipping company in the world. The company handled more than 7 percent of the trade volume between Asia and the United States, and 3 percent of all the shipping containers in the entire world. And on August 31, 2016, Hanjin Shipping filed for bankruptcy in its home country. Two days later, it did the same thing in the United States.

This unprecedented collapse continues to reverberate throughout the global supply chain, leaving its mark on every step of the fulfillment process. Ports were the first to take the hit. Stevedores and tugboat operators at every corner of the Pacific refused to unload Hanjin containers, fearing that they wouldn’t be paid.

To make matters worse, dozens of Hanjin ships lay at anchor just outside nations where they had yet to secure bankruptcy protection. If they docked, they might be seized by creditors. That concern was not unfounded; in the two weeks following the company’s initial bankruptcy claims, at least eight high-capacity ships were seized.

All told, Hanjin stranded about US$14 billion worth of merchandise at sea. Ports felt the sting of the withheld cargo immediately. The busy U.S. saw a 16.6 percent drop in container volume in September compared to the previous year. Imports dropped by 4.2 percent at Oakland, the U.S.’ 10th-largest port.

Reverberations Through the Inland Supply Chain

Next, railroads and trucking firms began to feel the effects of the merchandise shortage. After all, there was a US$14 billion hole in demand. Many transporters refused even the Hanjin containers that found their way ashore; again, it remained unclear who would pay for their services.

Warehouses in Europe and North America, the leading recipients of Hanjin’s once-robust trans-Pacific trade routes, may soon see throughput dropping right at the peak of the holiday shipping season. That could reduce demand for forklifts and material handling equipment, passing some of the pain on to manufacturers and dealers.

Finally, retailers are deeply worried about merchandise shortages. Many of them have orders languishing at sea on anchored Hanjin ships. Besides, the abrupt spike in shipping costs during the busiest season of the year will eventually be passed on to consumers. Sticker shock could still depress holiday shopping in North America and Europe.

As Hanjin leadership, South Korean courts, and rival shipping firms scramble to find solutions to the crisis, it’s worth taking a moment to ask the obvious question: How did this happen in the first place?

The Rise of Megaships: Setting the Stage for Disequilibrium

At the dawn of the third millennium, global supply chain business was booming. Economists estimated that the demand for container shipping would rise at a rate of 2.2 times global GDP growth. Between 2000 and 2008, that growth averaged 4 percent. Clearly, major shipping firms would need to boost capacity. Cue Roy Scheider in Jaws: “You’re gonna need a bigger boat.”

The Orient Overseas Container Line (OOCL) unveiled a ship called the Shenzhen in 2003. With a capacity of 8,063 twenty-foot containers (or TEU), the Shenzhen was the marvel of the shipping world. At the start of 2004, the average ship only boasted 2,126 TEU. Analysts had to coin a word to describe the Shenzhen and the super-high capacity ships that would follow in its wake: megaships.

Orders for new vessels spiked in the years leading up to 2008, creating a massive increase in capacity. That would have been fine if demand kept pace. But while shipping companies were investing in huge new container ships, U.S. banks were handing out subprime mortgages like candy. In the summer of 2007, the housing bubble burst, plunging global financial institutions into chaos.

Hanjin Bankruptcy’s Roots in the Financial Crisis of 2008

The financial crisis hit supply chain providers hard. The Journal of Commerce estimates total losses of US$15 billion for the global shipping industry in 2008 and 2009 alone. Hanjin Shipping itself hemorrhaged more than US$1 billion in 2009. That was the start of the company’s descent into a that, by 2016, topped US$5 billion.

But there was another damaging result of the Great Recession that followed the 2008 collapse. Remember the formula shipping executives used to predict demand? It was highly dependent on strong growth in the global GDP. Many companies expanded capacity based on the then-common 4 percent growth rate. Since 2010, though, global GDP has risen at an average rate of just 1.1 percent per year.

Unable to foresee the looming financial crisis, shipping companies overestimated future demand by nearly four times.

Megaships Return, Boosting Capacity and Driving Down Prices

As the global economy began its sluggish return to form, interest rates on capital assets declined. Meanwhile, fuel prices rose. That created a perfect set of incentives for shipping companies to invest in a whole new fleet of megaships.

Container ships didn’t stop growing at the Shenzhen’s roughly-8,000 TEU capacity. By 2015, the Shenzhen was right in the middle of the average ship size. The true megaships of the 2010s offer capacities of up to 20,000 TEU, or even higher.

So why would companies continue buying bigger ships when there was already a noted excess of capacity in the market? Larger ships offer dramatic savings of fuel, a serious cost for shipping firms. Besides, financing barely cost a thing in 2015. From an individual perspective, there was no downside to investing in megaships.

Collectively, though, the trend proved disruptive. The result was a record global fleet capacity of 20 million TEU, reached in 2015. The supply side had completely eclipsed demand. Freight prices plummeted, sometimes dipping below even the cost of fuel for a trans-Pacific journey. It was becoming nearly impossible to make a profit in the global shipping business.

By Spring of 2016, the cost of shipping a container from Asia to the West Coast of the United States hit a historic low of just $728 per spot.

Efforts to Save Hanjin from Bankruptcy

Facing rising debt and no relief in sight, Hanjin management took the dramatic step of handing control of the company over to their largest creditor, Korea Development Bank (KDP), in April 2016. By summertime, Hanjin officials were in talks with ship owners to reduce charter costs.

Tellingly, Hanjin wasn’t the only South Korean shipping company to pursue this strategy. Hyundai Merchant Marine, who would later take over shipping routes from the floundering Hanjin, signed a conditional debt settlement deal in March.The smaller shipping line would also pursue lower charter fees with ship owners, with the goal of a 20-30 percent reduction.

Loss of Creditor Confidence Precipitates Hanjin Bankruptcy

Hanjin Shipping’s parent company, Hanjin Group, was tasked with developing a plan to rescue the business. If KDB accepted the plan, they would continue to fund the struggling firm, hoping for more profitable days ahead.

On Aug. 25, Hanjin Group filed its rehabilitation plan for the shipping division. The plan would produce US$440 million through increased capital, reduced charter rates, and a capital reduction in the Hanjin Group-owned Korean Airlines.

There was just one problem: KDP estimated that Hanjin Shipping would need more than US$880 million to survive. Creditors rejected the plan.

“The self-rescue plan stops far short of expectations and it is hard to get approval with the creditors,” KDP representatives told the Korea Economic Daily that August.

The KDP demanded a new, more-robust rescue plan. Instead, on Aug. 31, Hanjin filed for bankruptcy in , and in the days that followed, other nations as well.

Could the Hanjin Bankruptcy Have Been Prevented?

One moral of this economic imbroglio is that individual economic actors have a hard time gauging the effects of collective action. With the benefit of hindsight, it seems clear that Hanjin’s fate was sealed during the industry’s transition to megaships.

Low fuel costs and rock-bottom interest rates made megaships a rational investment from the perspective of each individual shipping company. It wasn’t until the aggregate effect of these perfectly sound decisions became apparent that anyone in the industry could see how damaging the rapid expansion of capacity would become. BHS1GLOBAL.com In short, Hanjin Shipping is, like every enterprise, subject to economic forces beyond its control. Something had to happen to restore equilibrium to the global shipping market; when demand won’t grow, supply must shrink. If Hanjin’s bankruptcy hadn’t removed a great deal of shipping capacity from the Pacific Ocean, another company, perhaps many, would have collapsed. In a sense, Hanjin was the sacrifice that may return profitability to the crucial shipping routes between Asia and the West.

References:

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Fitzgerald, Patrick. “South Korea’s Hanjin Shipping Files for U.S. Bankruptcy Protection.” WSJ. Dow Jones & Company, Inc., 4 Sept. 2016. Web. 15 Oct. 2016.

“General cargo and container shipping.” ISL. Institute of Shipping Economics and Logistics, June, 2004. PDF. 15 Oct. 2016.

“Hanjin Shipping’s 500 Bil. Won Self-rescue Plan Rejected on the Spot.” Hankyung. The Korea Economic Daily, 26 Aug. 2016. Web. 15 Oct. 2016.

Jablon, Robert. “Hanjin bankruptcy causes global shipping chaos, fears.” AP. The Associated Press, 2 Sept. 2016. Web. 15 Oct. 2016.

Lubben, Stephen. “Lack of Planning Hampers Hanjin Shipping Bankruptcy.” NYTimes. The New York Times Company, 15 Sept. 2016. Web. 15 Oct. 2016.

Morris, David. “Why megaships suddenly dominate the ocean shipping industry.” Fortune. Time, Inc., 2 Feb. 2015. Web. 15 Oct. 2016.

Phillips, Erica. “Hanjin Bankruptcy Hits West Coast Ports.” WSJ. Dow Jones & Company, Inc., 13 Oct. 2016. Web. 15 Oct. 2016.

Young, Angelo. “That sinking feeling: Why the bankruptcy of shipping giant Hanjin has so many companies worried.” Salon. 12 Sept. 2016. Web. 15 Oct. 2016.

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