Europe – a new reality

The development of demand at European ports has been characterised by fairly steady expansion, with this linked to general economic growth and (for containers especially) a period of globalisation driven primarily by China. As is considered by A J Keyes in the accompanying articles there is now a clear step-change in demand and, as the Covid crisis recedes, and its immediate fall-out is digested (a demand collapse followed by recovery), it’s clear that significant changes are underway. A simple reliance on increased demand to fund large scale port investment now looks increasingly misplaced. So how will the tension between investment and economic returns be squared?

WILL GROWTH BE SLOWER?
What is going on in the market and what will the major ports look like in five- or ten-years’ time? Essentially, major ports are facing pressures from two key sources. On the one hand, macro- economics is shifting the ground on which port investment is predicated and – at the same time – changes at the regulatory level are also forcing shifts in the sector. How these forces will interact, and modernisation and expansion still be delivered on a profitable basis, will be the main driver of future port development in the major European ports.

Since the early 1990s the emphasis on investment in the North Continent has been for providing increased capacity for containerisation, with a focus on market share considerations. With demand recording year-on-year increases this rising tide served to ‘lift all boats’ with increased volumes invariably justifying the pace of expansion. The rapid shift to larger vessels also resulted in investment being focused on the largest capacity terminals for both gateway and transshipment activities.

The European Seaport Organisation (ESPO) has suggested that European ports will require investment of at least Euro 80bn within ten years. How this can be profitably delivered in a climate of slower growth is far from clear.

MACRO-ECONOMIC DRIVERS
If we take a look at the key drivers here it is clear that things are changing. Most significantly, the pace of demand growth on the major Asia-Europe trade has slowed, with this impacting on both direct volume and transshipment volumes at the major hubs. This has been driven by uncertainties with regard to reliance on China and an only partially realised switching to alternative East Asian suppliers. The Covid experience and geopolitical uncertainties underlined the move towards ‘nearshoring’ at the expense of these deepsea trades. This is a global phenomenon but has been clearly manifested in the European port market.

The link between GDP and trade growth has also changed significantly in the past few years. According to broker Clarksons, between 2010 and 2020 the global link between GDP and trade volumes was placed at 1 : 1.02, with this representing a continuation of a well-established longer term trend. Indeed, the link for containerised goods was even stronger. The corresponding figure since 2020 has been 1 : 0.66. The major market drivers – slower deepsea growth, increased emphasis on intra-regional trade and increased annual volatility – are changing, but the sector will clearly need to adjust to a period of slower growth.

This will place further pressure on the major ports but will also offer opportunities in the sector. In the period since 2020, the pace of shortsea intra-Europe trade has increased more rapidly. The previously neglected shortsea terminal market is now receiving increased attention. The pace of demand growth in the Ro-Ro and Lo-Lo (containerised) markets has increased sharply and this process is still underway. Competition between these two modes has focused primarily on cargo value and overall supply chain costs but increased emphasis on environmental issues, carbon offsets and a lack of truck drivers have made the position complex.

Investment in these shortsea terminals will increasingly be driven by local trading relationships and service levels. Reliable delivery will be the key as much as overall transport costs. This represents a considerable change in perspective for both operators and investors.

CHANGING POLICY PRIORITIES
As if these shifts were not enough to digest, changes at the regulatory level make the outlook even more opaque. Environmental issues are now at the centre of port development in Europe. These are primarily driven by changing rules and priorities but – considered together – these will have far-reaching impacts. Specifically:

• Emissions controls will become central. Already, we are seeing moves to electrify port equipment and this will continue. At the same time regulatory requirements will insist upon the provision of shoreside power for vessels when cargo handling. There are major uncertainties in this sector with regard to standardisation, but the overall constraint will be the expense of provision of these systems.
• The shift towards hydrogen and other alternative fuels will see an increase in the amount of land required for the storage and handling of these commodities. In the North Continent port markets space is at a premium so the costs of this provision will be high.
• Similar considerations apply to land required for the construction and maintenance of wind farms, with this already driving up land prices in some key markets.
• Carbon pricing and the push for increased intermodalism will accelerate changes in port structures with this focusing investment on facilities serving immediate markets and also emphasising the importance of barging and other modal shifts.

A combination of these and other factors will change the structure of the European port sector as the emphasis shifts from expansion to environmental efficiency. The level of compulsion will is also set to increase sharply.

FUTURE PORT STRUCTURES
In the next few years port investment in Europe will be increasingly focused on meeting stricter regulatory requirements, with this entirely driven by environmental concerns. At the same time, the pace of demand growth seems certain to be significantly slower than has been the case. Indeed, recent heavy commitments in some of the major gateway ports could see a period of over-capacity as deepsea and transshipment volumes record slower growth.

In this situation, the level of profitability for terminal operators will be squeezed and this will coincide with significant investment calls. It is not clear that the established structure of port investment will survive this change. Governments (and their Port Authorities) will come under increasing pressure to provide the investments that will be needed to meet their policy requirements. In ten years’ time we can anticipate a European port sector which is less profitable and increasingly reliant on external funding to meet structural changes.

It’s far from clear that this is a positive outlook. Investors will need to factor in the impact of all of this on their profitability and asset values. This may drive away the more speculative groups as margins will become tighter and state interests exert increased control over the sector.