Infra cover story Feb 2022

Global supply chains have been beset by covid-19 outbreaks, shortages and geopolitical crises over the past two years. But amid booming demand for goods, the sector has proven its resilience. Lessons from the pandemic, along with automation and decarbonisation, have laid out a busy agenda for the industry and offer plenty of investment opportunities.

Covid caused global trade to fall by 8.9 percent in 2020, according to the Bank of England. However, as this disproportionately hit services, the trade in goods only fell by just over 5 percent.

Meanwhile, lockdowns and related cash stimulus packages have been the main factors driving consumer demand, says John Manners-Bell, chief executive of Transport Intelligence, a research firm specialising in logistics. “This overwhelmed the port infrastructure,” he says. “Even if it had received two or three times the investment, it would still have been overwhelmed… Demand for goods had an enormous impact.”

He adds that there has been a “longer story of underinvestment in the global port network” that caused “saturation in the supply chain and led to goods containers sitting around for weeks, sometimes months”. A secondary factor is that Asian suppliers struggled with covid-19 outbreaks.

“The trend for increases in the size of ships, both in average fleet size and for larger ships, seems to have flattened off over the last few years”

Sundeep Vyas

Sundeep Vyas, a partner and deputy chief investment officer, infrastructure, at German infrastructure fund manager DWS, notes that since ports were classified as essential infrastructure they operated throughout lockdowns, albeit with covid-related measures.

“The last two years have been pretty good for the ports we manage, largely because they are very well diversified in terms of commodities,” he says. “We should be close to double-digit percentage growth in earnings for the financial year.

“But this won’t be the same in every port. If there are additional costs, we will ask our customers to pay their fair share where necessary.”

Willem Jansonius, a partner at Netherlands-based DIF Capital Partners, believes a clear distinction needs to be made among transport sectors. “Airports, ferries and passenger trains suffered very significant losses in volume, and very likely EBITDA, in the early days of the pandemic,” he says. “At the outbreak of covid-19, the transport sector froze for a couple of weeks, but then picked up massively. DIF had decided a few years before to focus on transporting goods, which proved to be a good choice. Our transport assets did extremely well during covid-19, with very high rates and utilisation.”

Seeing through the cycle

High shipping rates, shortages and supply chain disruptions are likely to be temporary. Jansonius says heavy manufacturing was “in a soft patch” entering the pandemic and that factory lockdowns compounded the problem: “It will take time to resolve, but heavy manufacturers and participants along the supply chain are working hard to create as much capacity as possible.”

Leisel Moorhead, a partner at QIC Global Infrastructure, expects disruptions to unwind as restrictions loosen. “We expect delays only to occur in the short term, until consumers are free to spend their money on services and [begin] travelling once again,” she says.

Although the coronavirus is likely to stay with us, it need not continue to be as disruptive.

“The sector has learned to work with covid-19,” says Jansonius. “Most metrics dropped sharply during the first lockdown – but not as much in more recent ones. Over the next six to 12 months, we should see a gradual easing of congestion and disruption.”

Manners-Bell adds: “In my view, Q1 2022 will stay really congested, with lots of problems, while Q2 will see improvement. And then during Q3 and Q4 we may see a return to more normal shipping rates and better service and reliability, with supply chains starting to work as they should.”

“We are positive about regional ports – we may be going into a direction where ‘smaller is better’”

Gianluca Minella

Extremely loose monetary policy during the pandemic directly pushed up valuations across many asset classes. Even in the most impacted infrastructure sectors, investors are looking to long-term strength. “Passenger restrictions had a big impact on airports,” says Moorhead. “But there’s still very tight pricing on the large ones – just look at the Sydney Airport transaction.” Sydney Airport Holdings accepted a A$23.6 billion ($17.5 billion; €15.1 billion) acquisition offer in November 2021 from the SAA consortium, comprising IFM Investors, QSuper, AustralianSuper and Global Infrastructure Partners.

“There’s a huge wave of capital looking at infrastructure, so there’s a lot of competition for assets,” Moorhead continues. “People were cautious during 2020 but M&A activity over 2021 has been really strong.”

Containerisation continues

One of the big underlying themes that has transformed shipping over the last half century has been containerisation. The biggest container ships have increased five-fold in the past 25 years from 5,000TEU to 25,000TEU, according to Willis Towers Watson, and this has had a knock-on effect on port infrastructure.

“It makes really good financial sense to go to huge ships,” says Manners-Bell of Transport Intelligence. “It’s a lot more efficient in terms of carbon emissions to load 22,000TEU on a ship than lots of smaller vessels.”

Supersized ships have led to a lot of stress being placed on port infrastructure. “There’s been a huge surge in the requirements for offloading on those terminals, which puts a huge amount of stress on the port operations and also rail and road services,” he says. “It’s also led to this consolidation of shipping lines’ schedules around major gateway ports into Europe and North America.”

However, Vyas believes we may have reached a plateau as the big shifts have already taken place. “The trend for increases in the size of ships, both in average fleet size and for larger ships, seems to have flattened off over the last few years,” he says, noting that average vessel size statistics have been distorted by the retirement of smaller ships over the last decade.

QIC’s Moorhead adds that although larger ships are more efficient “they are also contributing to the supply chain disruption”.

Rise of the superports

In recent years, the volume of global trade passing through the world’s biggest ports has continued to grow. China hosts seven of the top 10, according to the World Shipping Council, led by Shanghai at 43.5 million TEU in 2020 – up from 37.13 million TEU in 2016. Singapore has the second largest throughput at 36.6 million TEU, and the leading European and US ports are Rotterdam (14.35 million TEU) and Los Angeles (9.2 million TEU).

However, superports are not necessarily in competition with their smaller peers. “It is important to understand the location of the customer and where goods are destined,” says DWS’s Vyas. “If a commodity is needed, it needs to get there whether through a single port or a major port, and then a trans-shipment feeder. It is crucial to figure out the right logistics chain to satisfy each requirement.”

A hub-and-spoke model has emerged, with Rotterdam clearly one of the European winners. Supersized vessels arrive there first before containers are trans-shipped to smaller ports, for example in the Baltics.

Gianluca Minella, head of infrastructure research at DWS, believes that, over the medium term, trade may move away from the centralised model. “Rising trade barriers and re-shoring of production from Asia to Europe will potentially see decentralisation playing out,” he says. “We are positive about regional ports – we may be going into a direction where ‘smaller is better’.”

The supersizing of ships and consolidation around a small number of hub ports has increased risk, according to Manners-Bell. Beyond covid-related shutdowns, there is risk around industrial action and weather events such as typhoons. “Putting all your eggs in one basket does not count as a good insurance policy,” he says.

“Building an expensive container terminal where there is insufficient volume quickly becomes a very expensive hobby”

Willem Jansonius
DIF Capital Partners

Nonetheless, the trend will affect locations that do not have the scale to accommodate the largest vessels. “It’s a volume game,” says DIF’s Jansonius. “Building an expensive container terminal where there is insufficient volume quickly becomes a very expensive hobby.”

Automation is critical to optimising the efficiency gains from supersized ships. Best practice involves removing large numbers of people from port operations, completely automating cranes and using robots to move containers from stacks, according to Manners-Bell.

Stevedoring has already been automated at many ports and the trend is expanding across other areas. “We are seeing automation across the freight supply chain, particularly warehousing, distribution and the last mile of deliveries,” says Moorhead. “Technology will play a key role.”

Decarbonisation delays

Automation will be even more important in the age of covid. “It reduces the need for manual labour – which is a good thing during a pandemic – and improves health and safety,” adds Jansonius. The downside of automation is job losses and the associated likelihood of industrial action, which seems likely to follow the Port of Los Angeles negotiations of 2022.

Shipping carries approximately 80 percent of world trade, according to the UN. But the International Maritime Organization calculates that it is also responsible for just under 3 percent of global greenhouse emissions, and it is among the hardest-to-abate sectors.

The IMO set its “initial” GHG strategy in 2018. It “envisages” reducing the carbon intensity of shipping by 40 percent by 2030, compared with 2008 figures, and by 70 percent by 2050. However, it contains no legal requirement to decarbonise.

Nevertheless, according to Vyas, participants are already acting. “There is certainly greater awareness, particularly among end-customers,” he says. “This is encouraging use of alternative fuels and reducing emissions, whether in LNG ships or replacing port estate vehicles with electric vehicles.”

Moorhead notes that Australia Post is shifting a large chunk of its light commercial vehicles fleet to EVs: “I expect port fleets will be electrified over the next 10 to 15 years – hopefully sooner.”

The size and weight of batteries would be prohibitive for container ships and recharging times would also eat into profitability. LNG is a leading contender to replace bunker fuel in the medium term, with biofuels a possibility, while hydrogen has the greatest net-zero potential.

“If investors are willing to put capital into green ships, that may well lead to them being able to charge higher rates,” says Minella. “Infrastructure investors are starting to think about it as a viable thematic fund strategy.” He notes that the IMO 2020 sulphur regulation drove freight rates during that year.

Lower-carbon fuels would require a new supply chain of production, transportation and bunkering, at least across the major ports of Algeciras in Spain, Sri Lanka, Suez and Panama.

“LNG will be the interim fuel for heavy transport in [the] next two to three years – shipping, ferries, cruise ships and maybe heavy trucks – before the switch to no-carbon fuels,” says Jansonius.

He expects hydrogen to appear in the North Sea in the late 2020s or 2030s, before it expands to the Mediterranean, the US and Southeast Asia.

“Decarbonisation is one of our priority areas,” he says. “We have already made our first investments in LNG. We invest along the whole intermodal value chain, with the aim to also get trucks off the road and arrive at cleaner and more efficient solutions.”

Decarbonising shipping was discussed at COP26. “One thing I really like is the Clydebank Declaration,” says Moorhead, referring to the 22 countries that signed up to developing green shipping corridors and having at least six operational by 2025. “No single entity can ‘green’ the whole freight supply chain but there is movement as end-customers are demanding zero emissions.”

Manners-Bell is less optimistic about securing collaboration among the shipping companies, port operators and governments across global routes. “The IMO held a meeting the week after COP26 – but no agreement was reached,” he says. “There were so many different competing political priorities that there was no consensus whatsoever… There are no agreed targets, let alone a coherent strategy to meet them.”

Some shipping lines have come out against LNG as it would not lead to full decarbonisation. Manners-Bell notes that whether LNG, hydrogen or another solution will win out is “the million-dollar question… Investors are wary about backing the wrong horse”.

“During Q3 and Q4 we may see a return to more normal shipping rates and better service and reliability, with supply chains starting to work as they should”

John Manners-Bell
Transport Intelligence

He adds that if agreement is reached on hydrogen it could be an enormous opportunity, from building new ships to constructing a new refuelling network. “Ports are also a good place to manufacture hydrogen,” he says, noting that the ports of Rotterdam and Antwerp are near offshore wind farms, pipeline networks and the German industrial heartlands.

Investment opportunities

Which entities will bear the costs of development to accommodate larger ships is an open question. “Shipping lines currently benefit from the efficiency of larger vessels and shipping rates are up 200 or 300 percent,” says Moorhead. “Port costs are 2 to 3 percent of the total freight cost, yet ports are bearing the capital costs. We are working through the challenges in the ports we are exposed to and looking at the funding model before making significant investments.”

Manners-Bell says investing in emerging market ports “has got to be a really good bet”. “The port infrastructure in Africa is dire and needs really heavy investment,” he says, and development is also needed in Southeast Asia. “Emerging markets are in need of investments if they’re going to be connected to the global trading community.” He notes that there is an increasing realisation that Chinese investment comes with political strings attached, so countries may be more amenable to investments from Europe or the Middle East.

Trade patterns are likely to continue shifting with the pandemic. “Quite a lot of juggling has gone on and I expect that to continue,” says Vyas. “If you can adjust your business model to shifting trade flows, and can adjust your cost base, you are in a better position to take advantage of the situation.”

Although supersized ports and ships concentrate the covid-19 disruption risk, Jansonius says their wider benefits should not be forgotten: “There’s a reason for the shift to containerisation – efficiency. This is driven by the fact it’s modular and very easy to operate and automate. It has drastically reduced the cost of shipping and provided certainty for goods being delivered. There is no way back.”

The coronavirus has highlighted the Western world’s dependency on imported goods and the essential role of the entire supply chain. “The pandemic has only made the sector more interesting to invest in,” he says. “The mix of automation, containerisation and decarbonisation means that it remains a very attractive sector – even if there will be a few bumps along the road in the next 18 months.”