Friday, January 22, 2016

Transshipment, and the financing and pricing of container terminals

30 years ago, forecasting port capacity was a fairly straightforward exercise, and a popular one at that, among young students: population, GDP and trade data, together with a simple regression model, would easily do the trick with some excellent results. It should be remembered that, in those days, demand for port services was more or less captive and a cargo destined for, say, Italy would in all likelihood land at an Italian port, as close as possible to the final consignee.

Two things changed this picture since: containerization and the ‘through transport’ concept on the one hand, and the development of extensive land transport infrastructure on the other. Europe, dilapidated by a ruinous war, was being rebuilt, and what better way of doing this than developing your roads and railroads before anything else. If one were to take a cursory look at Europe’s map today, what one would see wouldn’t differ much from a nice dish of Italian spaghetti. Roads and railroads, together with European economic integration, free trade, and the abolition of national borders, opened up the market for port services. Before we knew it, any Asian cargo could in principle reach any European destination, passing through any gateway port around Europe. Port demand was no longer captive and ports started to compete for survival.

To do so, ports had to modernize and develop new capacity; often much more than what was needed. In the 1990s, I remember well, the northern range European ports (from Le Havre to Hamburg) had a collective excess capacity of about 40%. Usually, port capacity is developed in big chunks, each time far ahead of existing demand. A combination of factors can explain this, ranging from the availability of easy and cheap public finance, to managerial egos and port managers’ heartburning desire to leave their footprint in history... One more reason, of course, is economies of scale in port construction: apparently, it’s much cheaper to build two kilometers of quay rather than one.

Excess port capacity, over and above national demand requirements, is created for three more reasons. First is the economies of scale mentioned above, as well as the infamous economic law of Jean-Baptiste Say according to which supply creates its own demand. In other words, once the port is there, the customer is bound to arrive. Unfortunately, this is not always so. The second reason is the footloose nature of the container and its carrier, which may switch ports at the whim of a moment, whenever capacity is scarce and, as a result, the ship may have to wait. Finally, excess capacity is developed in order to capture transshipment traffic; i.e. somebody else’s cargo! As a matter of fact, most of the competition taking place among ports today is for this type of cargo; to capture it, ports often underprice concession fees agreed with terminal operators, and terminal operators, in their turn, underprice terminal handling charges (THC) they charge to carriers (often through hidden or opaque discounts). [by underpricing I refer to port dues and concession fees below the opportunity cost of port land].

Moreover, especially in ports where the management is responsible for its bottom line, more often than not the management tends to cross-subsidize footloose transshipment traffic with captive domestic traffic. In other words, domestic (national) cargoes are penalized through relatively higher prices, compared to transshipment cargo,  in the management’s anxiety to capture more of the latter. In a number of cases, some of which already heard in front of a judge (cf. Sarlis vs. MSC at the port of Piraeus) , the preferential treatment of transshipment cargo goes beyond price and it involves other terms of service, such as berth allocations and time-windows. For a number of reasons this is not right and I have always advised affected local shippers to present their case at the national competition authorities or, in case of complacency, directly to the Competition Directorate General of the European Commission.

And here is why this type of cross-subsidization, or price discrimination, between domestic and transshipment cargo is not right:

If sufficient domestic demand for port services does not exist, developing port capacity for transshipment purposes is risky business just because of the footloose nature of the container. Before you know it, you could find yourself with a ghost port in your hands, as it happened recently, for instance, at the Italian port of Taranto, when Evergreen decided to move to Piraeus, in spite of a 60 year-long concession at the Italian port. Years back, I remember quite vividly the crisis that developed at the great port of Singapore, when Maersk decided to move just around the corner, to the Malaysian port of Tanjung Pelepas. The graph above shows that, in the northern range of European ports, transshipment represents, wisely, no more that 40% of their throughput, vis à vis transshipment ports like Malta, Singapore, Damietta or Kingston.

In comparison to the economic impacts of domestic traffic, transshipment creates relatively less (local) value added. To draw a parallel, a port handling domestic cargo resembles a city-center hotel, where the visitor will most likely spend money on a number of activities (museums, restaurants, etc.), thus creating considerable value added for the city, vis à vis a highway motel (transshipment), where the traveler would stop there just for a sleep. I often hear my friends in Antwerp telling me that the port of Antwerp, as a result of its multipurpose/labor-intensive character, creates four times more value added than Rotterdam, the latter port being a highly automated/labor-saving one. Thus, I am told, the Belgian taxpayer is much happier to pay taxes for port development than his Dutch counterpart, who has often questioned the social utility of developing more port capacity at Rotterdam. Exceptions to the above do of course exist, and Rotterdam is a good one: the port’s value added is not created simply by the port itself, but by its port cluster, encompassing 50% of Europe’s Asian and North American European Distribution Centers (EDC); a city 50% of whose inhabitants are holders of a foreign passport, just because of the port. But not all ports can realistically aspire to such an enviable situation, developed not today but over a period of 70 years of hard work.

Finally, publicly funded ports are developed exactly in order to have these domestic impacts on business and employment, rather than to steal (transshipment) traffic from their neighbor, particularly in economically interdependent geographical regions such as the European Union. The problem is aggravated when some countries spend public money on port development, while others finance ports privately (UK) and both compete in the same market.

Development of container terminal capacity, including its transshipment potential, will continue unabated; this is normal and, in the long-run, port capacity follows international trade growth.  But with one caveat: this infrastructure should be priced (through the appropriate concession fees) in such a way so that investment costs are eventually recovered, irrespective of whether the proceeds from the concession remain with the port, or are returned to its financiers, the latter including also the government. In this way, it does not really matter who finances the investment, i.e. the public or the private sector, as long as the private investor principle applies; i.e. the terms of the financing are not very different from similar private arrangements and, as said, this means that pricing should aim at cost recovery.

Competition on infrastructure is indeed wasteful and governments, like recently that of Italy, have often argued in favor of centralized port infrastructure planning: something we used to do half a century ago, through the various National Port Councils [I remember an advocate of this policy, Francesco Mariani, the President of the Port of Bari, telling me recently that if a global carrier would like to come to Italy, he should only talk to the Minister and it should be he to tell him at which port he should call !]. In today’s Europe, however, something like this wouldn’t only be wrong but, euphemistically, it would be unthinkable: To my mind, the best planners of all are the (well-regulated) markets themselves, together with transparency in the financial flows between port and government.

The role of the public sector in financing container terminals should therefore be limited, and where it exists, or is necessary, it should take place on more or less commercial terms. In this way, limited would also be the risk assumed by the public sector. Competition by neighboring ports, excess capacity and similar concerns should lie only on the shoulders of the concessioners (terminal operators) who should themselves assume such market risks. It doesn’t in this way matter if excess capacity is created. To put it bluntly, if things go well, we will all be raising a glass; if not, well, bad luck. But the national taxpayer should not be bearing the costs (and risk) of private investments, benefiting private users.

The above is easier said than done. If the terms imposed on a private terminal operator, carrier or other, are too onerous, in all likelihood he would be knocking on your competitor’s door. And this is where public policy intervention is necessary. This can take only one form: an understanding that, no matter how terminal investments are financed, container terminals are private goods and their costs should be recovered through user charges; otherwise underpricing is not much different than dumping, sanctioned in many other sectors, including shipbuilding.

But the story doesn’t end at the financing of the container terminal itself. The ship must be able to approach a berth at the terminal, and the container needs to eventually reach the motorway from the container yard. Who should pay for these investments? Is a 16-meter deep approach channel and turning basin a public or a private good? Is a road that connects the terminal with the motorway system a public or a private investment? My views on these aspects are quite clear: these are private investments benefitting identifiable users and, thus, cost recovery should apply here too through user charges.

It seems the European Commission, in its forthcoming State Aid Guidelines, may be thinking differently, under pressure from powerful EU member states and ports requiring considerable dredging (e.g. river ports). We will soon know the outcome. HH