How Global Shippers Are Dealing With a Worsening Red Sea Crisis

25:41But wait a minute, the Houthi are there. Now I got to head around Africa. And so what you're seeing is a lot of surcharges and extra charges and most importantly delays in the movement of goods that were not planned on. I want to talk a little bit more about the military response, but I imagine we could do like a 20 episode series about the history and founding of the U.S. Navy, but we are just doing, you know, we have a 35 minute podcast. Can you just zoom out? you know, I've heard that the U.S. Navy is sort of originally created in part to, you know, to secure shipping against pirates, et cetera.

26:18Can you talk a little bit about, you know, the history and just the expectations globally for what the Navy is expected to do anywhere when there is either a military threat or a piracy threat to world trade? Yeah. I mean, 230 years ago this year, 1794, the Navy will basically create itself with the Naval Act of that year, where they build six frigates, one of which is still in commission today, USS Constitution up in Boston. Those ships were built specifically because the state of Algiers had seized 11 American ships and were holding them hostage for basically tribute for an agreement with the United States.

26:59So literally the birth of the US Navy is founded on an anti piracy and defend commercial shipping. Now, ironically, those ships aren't built in time to fix it. What we go do is basically negotiate out a treaty with Algiers and they release the vessels and we have an agreement. But then fast forward a few years later, 1801, the Shah of Tripoli announces war with the United States by having his men march down to the US consulate in Tripoli and chop down the flagpole. And for five years, Thomas Jefferson has got to wage a war against the Barbary pirates. We try an overwhelming military force. It doesn't actually work.

27:39We try an overland military operations, which the Marines immortalize to the shores of Tripoli in their hymn. But in truth, what we wind up doing is paying off the best shore. We give him $30 ,000 and we get a deal. He releases some captured Americans, including the crew of an American naval vessel, and we get peace. Fast forward 100 years, German U-boats start sinking American ships on the high seas. 10 vessels, 64 crew members killed. That's the reason Woodrow Wilson goes before Congress on April 2nd, 1917, and wants a declaration of war. And so the U.S. Navy has historically been a protector of trade, but usually it's a protector of U.S.

28:22flag shipping. But that all changes after World War II. After World War II, when the Germans and the Japanese are vanquished, the seas become this great open medium, this great blue ocean of commerce that takes place. And one of the things that we see happen beyond technological changes, super tankers and containerization, is we see the birth of open registries, the Marshall Islands, Panama, Liberia, so that you can have lower shipping costs because those countries don't require a huge amount of overhead and taxes. And they don't require it because they don't have to pay for navies because no one is threatening the ocean commerce.

29:02Now, 2023, here come the Houthi and they are threatening ocean commerce. But you don't have the Panamanian, Liberian, Marshall Island navies show up because they don't basically exist. It falls upon the U.S. Navy, the Royal Navy, and these other navies to defend the commerce because we move commerce differently now. We don't move it on national ships. We move it on international ships. Do you think you could see more of a reordering, a shift away from flags of convenience? I think the thing you may see is not so much that, I would argue, because I think those ships are getting the protection that they need.

29:40What I'm concerned about with the Houthi and what they're doing is breaking up the idea of this international blue water where you can move goods freely. And what we start to see is something that Bruce Jones talks about in his great book, To Rule the Waves, where we start seeing the breakdown and creation of regional shipping because people don't want to ship long distances. They want to ship local distances. We're seeing that right now, for example, in the LNG trade, where you have three big players, Australia, Qatar, and the United States. But now we're really seeing that shift take place where the U.S.

30:12is providing most of their LNG now to Europe. Vice Asia, Qatar is not shipping to Europe as much. They're moving to provide their LNG to Asia. So my concern is that if we can't handle a threat like the Houthi, and again, we've seen multiple issues happen in the supply chain. Remember, the big difference you have now today than ever before is not just the volume of trade. we've gone from moving half a billion tons of cargo on the world's oceans in 1950 to 22 billion tons today it's the velocity and when you have something moving as fast and as large as that all it takes is a little you know sand pebble on the runway and you create a bump

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32:17Need AI to turn 100 pages of market research into five insights with a click? Do that with Acrobat. Need templates for a sales proposal that'll close that deal? Do that with Acrobat. Need an AI specialist to tailor the tone of your market report to sound real smart in real time? Do that with the all-new Adobe Acrobat Studio. Learn more at adobe.com slash do that with Acrobat. So when you're thinking about comparing this crisis versus, say, the Somali piracy that people talked a lot about a decade ago, how much more is the, basically, as you say, the increased velocity of world trade since then?

32:56I assume it's continued to grow, basically magnifies the degree of disruption? oh i mean even since 2000 you've seen a massive increase but the somali piracy was very limited remember what somali piracy was it was an issue ashore drove the somalis to sea and then what they were doing was seizing vessels and holding them for ransom it was basically ransomware you know what they were doing and they would seize a vessel bring it in somali waters and wait for a bag of money to fall from the sky and then they would release the vessel and you could interdict that by moving ships further at sea. We saw Navy patrols come up.

33:32And the only time you saw the US Navy, for example, take direct action was when an American flag ship was captured, when Maersk, Alabama was captured and Captain Phillips was taken. Then the US interseas, because you have to save Tom Hanks. He's a national treasure. You can't allow him to fall into the hands of the Somalis. But what's different now is the Houthi aren't doing this for monetary reasons. They're they're able to affect the trade on an international level. The Somali piracy was a blip on the radar. It didn't really affect world trade at all. You didn't even see rates go up very much because of that.

34:10This is much different. You mentioned that the Indian Navy has gotten involved, which sort of raises the question in a multipolar world or rising other superpowers. And the other big one is China. And of course, they're a major beneficiary of the trade through this route. What is your expectation in the future? Will there be more sort of regional shipping police forces de facto? Would you expect to see an expectation that other larger countries that benefit directly from this type of trade have more resources in the area? So I was very surprised, for example, that the U.S. and other nations didn't put together some sort of UN element here to go in and do this.

34:57Basically, there was an argument that the US waited for a UN action before they struck. The fear you have here is that nations will act unilaterally. So talk about the Indians for a second. Indians are greatly impacted by this. India has seen a growth of trade to Europe. And India trade to Europe goes right through the Suez Canal. And now if you've got to go around Africa, that's like three, four times the distance for Indian trade to go. It's a massive change for them. Plus, Indian crews represent a big majority of the world's crews out there. And one of the things we've seen is the Indian Navy come to the rescue of their crews.

35:31The ship that was just hit, the Marlon Wanda, had a largely Indian crew on board, and it was an Indian Navy destroyer that actually came on board, fought the fire, and helped save the vessel. And you can see an issue where we saw during the piracy issue where India, when they encountered pirates, did not really use a lot of restraint in their force. They were pretty clear of using overt force to convince the Somali pirates not to mess with ships with Indians on board. And the fear is you can see that again. You also have the issue with China. China has a overseas squadron based down at Djibouti.

36:08We haven't seen much from them. They're escorting their vessels in and out very low key. But if there's an issue with a Chinese ship. Will China intervene? We've already seen a couple of Chinese ships come under attack with no action by China. But the fear is that you'll see regional navies, especially navies that have a big impact on shipping one. And India, I think, is the big player to watch right now. They're really interesting. They've come out in force after the attack on a ship in the Arabian Sea, pretty close to Indian territorial waters. I just want to press on the U.S. military point a little bit more because you did a fantastic job of laying out the historic importance of protecting trade to the U.S.

36:50Navy. That was sort of the whole raison d 'etre in many respects. However, we have seen this sort of reluctance or at least a debate right now to engage further with what's going on in the Suez. Is that unwillingness on the part of the U.S. to get involved in yet another thorny military conflict? Or is it, I guess, inability in the sense that there are limits to what nation military forces can actually do against what is essentially guerrilla warfare? Yeah, this represents a historically common threat that the Navy has faced in the past, but not one recently. And so the Navy, I would argue, has not done a great job of articulating what they're doing in their mission.

37:36They haven't put a lot of press on this in many ways. So I don't think they're doing a great job in conveying exactly how important. For most Americans, they see this as a European-Asian conflict. This is where the trade is. They're not contextualizing how this impacts the United States. And my argument, I will keep saying, is it's going to. It just takes time to work its way through the supply chain system. And by the time you feel it, it's too late to react. And that's one of the issues here. I do think that the U.S. Navy and the military in some ways are being hamstrung by the resources given to them.

38:12I think they were delayed in doing anything when the Carney had this very visible intervention and saved three ships back in early December. I think about December 9th. That should have been a key moment there. That should have been a moment of where a decision was made about whether or not to do a large scale protection. It took several weeks after that to really announce it and then to get it into full force. But this is a historic mission for the U.S. and other navies. And the other element is really the slow reaction the U.S. has gotten from other allies. You've seen the British Navy, you've seen the French and the Italians, but not a lot of other navies coming in.

38:49I mean, the Indians are kind of doing this separately. You haven't seen Asian navies, the Japanese, the Koreans come in. This really should be a unified effort because this is an attack not on just American shipping, but on world shipping. And to me, this is the context of why this needs to be better articulated. And again, the concept seems to be handed off to the military. Let the military solve this problem when the root cause of this problem goes back to what is happening in Israel and Gaza. And until you fix that situation, until there's Mideast peace, then you have a problem with the Houthi.

39:26And how do you exert pressure against the Houthi? There was a story a few weeks ago about the shipping companies trying to buy off the Houthis. I don't think you buy off the Houthis because they're not in this for money. However, there is leverage that can be exerted either through Iran or some other forces at play here that maybe you can convince them to push back on the Houthi or talk to the Israelis and have them back off and see if you can get the Houthi to kind of diminish it. But it's really hard to make that argument because you're seeing lives lost in Palestine, whereas in the Red Sea, all we're seeing as of now is the loss of money.

40:05Well, I mean, I'm glad you mentioned that because it struck me when you were giving your excellent two minute entire history of the U.S. Navy that even when you mentioned some of the key moments, it was actually some sort of political resolution and not the show of might itself that solved it, including the original pirates and the Shah of Tripoli. It sounds like it's something other than the force which announced it. So ultimately, it sounds like this is going to be a problem as long as the underlying tensions in the area, the ideological issues, the ongoing war are there. Yeah. The Navy just recently had their Surface Naval Association meeting where, I mean, there was a lot of congratulations on the role of the Navy destroyers, which have been doing a phenomenal job.

40:49Again, I talked to mariners. They love the Navy for what they're doing. The problem is, again, you're not convincing the Houthi about this or the ships. It's the insurance companies. And the insurance companies are going to use the line from Dumb and Dumber. As long as there's a chance of them getting a hit, that means that we're going to have higher war risk insurance. And therefore, it's going to make it cost prohibitive to go through. What we're seeing, for example, up in the Red Sea right now with the rebirth of this new trade going into Ukraine after the death of the Black Sea Grain Initiative, we're seeing ships going up and back to the Ukraine, and that's seeing an escalation or a de-escalation in the war risk from 3 % down to 1.25, but that's still high.

41:31But you're dealing with bulk ships and smaller ones, which the cost isn't as much. Plus, you have the Ukrainians working with insurance companies to underwrite that. We don't see that right now. And that's another element that could be done. But again, to underwrite war risk insurance for ships, they have to be of your registry. The US isn't going to underwrite ships under the Marshall Islands, under Liberia probably, although most of those ships can trace ownership back to Western companies in US, Europe, or even East Asia. How long until the slowdown and I guess the additional complexity that you've been talking about how long until that makes its way to U.S.

42:11supply chains? Because so far, you know, most people are talking about this as a Europe or Asia specific problem. But as you point out, it just takes some time to reverberate. Well, I mean, you're seeing that right now in Europe, you've had a very kind of high visibility, some manufacturers, Tesla and a few others, had to shut down production because they're waiting to get parts to them. And you're seeing the impact of that also in the fact that, well, we'll just throw them on airplanes and send them over. Well, 33 % of the world's aviation fuel goes through the Suez Canal and now it's being diverted.

42:45And so now even aviation has issues associated with it. It tends to be weeks. And where we're going to see it is right after the beginning of February, because what has happened here is a lot of empty containers, which is the most unsexy topic you can talk about is empty containers. empty containers have not been repositioned back to Asia in time to be reloaded and put on ships to leave Asia before the Chinese New Year, before the second week in February, which means that goods that should have been sailing across this week and next week aren't going to be there, which means now you're going to see them about a month later.

43:23So we're going to see some delays. And again, we're not going to see shortages. We're not going to have the great toilet paper run that we had during 2020. But what you will see is a little bit of a spike in inflation in terms of transportation costs, a lot of disruptions. One of the things that we did learn from 2020 and a lot of freight forwarders and smart people who went with companies that do this professionally did was diversify how their goods come in. So there was a lot of companies who saw what was happening with the Houthi and sat there and said, hang on, let me get my goods on a container ship and I'll go into LA and Long Beach right now because even though I hate it, I'll go in there because I know they're going to arrive and I can get them in there and I'll pay the rail because rail is looking for cargo right now.

44:09So a lot of people began to make movements, but some didn't. And the ones who didn't see this coming ahead of time, they're the ones who are going to see it. We're already seeing backlogs of ships, for example, start to pile up off of Savannah and some of the East Coast ports. You mentioned that empty containers were not the sexiest topic, but I disagree. I think the very first episode Tracy and I ever did on supply chain disruptions at the end of 2020 was sort of related to this phenomenon of the ships coming from China to the US, dropping off their stuff, not having anything to ship back. So they immediately turned around and then there were no more empty containers and that was sort of the seed.

44:46So that's a big deal. All right. I just have one last question, which is that I'm a dad and I'm well into my mid forties. And so by nature, I have this sudden impulse to read more military history books. What is a good book about the history of the Navy that I should read? Well, I would recommend Ian Toll's Six Frigates, which literally talks about the birth of those six frigates. I think Ian Toll does a great job. It is kind of must reading because it covers that early period, the birth of the U.S. Navy. But it's also about trade because you learn about, okay, I learned about that issue with Algiers.

45:20But then you learn about the French attacking our commerce in the Caribbean during what calls the Quasi War. Then the War of 1812, which is all about commerce and the impressment of Americans, because the U.S. wants to trade with everybody because that's who we are. So we were trading with the British and the French during the French Revolution and the Napoleonic War. Thomas Jefferson tries to avoid this by passing something, the worst act ever passed in the history of the U.S., the Non-Intercourse Act, which doesn't deal with what you think it does, but it deals with shipping and not trading with both Britain and France.

45:56So I love Ian Toll's book. I think he is one of the best. And then the last one I'd throw in there is one on U.S. shipping that I think is really, it's a wonky one. It's not a great read, but I think it's really an important one called Abandoned Ocean, which talks about U.S. maritime policy. I am conscious that we only have a few minutes left. So I just have one more question. What do you think of the Jones Act?

46:25Somehow, somehow this is all going to be blamed. Somehow the TV attack is going to be blamed on the Jones Act. And I just knew I wasn't going to get out of the show with you guys. Tracy is a masochist. No, that was a joke. We have been meaning to have you on for a Jones Act specific episode for literally years now. We got to get that done in 2024, Joe. We will definitely do a proper Jones Act episode one day. Well, I appreciate it. And actually, you may hear about the Jones Act with this because as diesel ships bringing diesel out of Asia heading to Europe are going to take longer to get there.

46:59There's going to be a real big desire to pull diesel out of New England and send it across. And if you start stealing diesel from New England to send to Europe, you're going to have to get that diesel to New England some other way. And that's either by pipeline, which is jammed, or those infamous Jones Act tankers. All right. Sal, thank you so much for coming on. That was great. We really will do a proper Jones Act episode. But this was an excellent context and details about the current crisis. So thank you so much for coming back on Oddbox. Can't be clear. John Conrad said, whatever you do, don't bring up the Jones Act.

47:30He said, don't bring it. Just try to get through it without talking. Well, you stayed true to your promise. I brought it up. Tracy was the up, yeah. You pivoted. And I told John, I said, there's no way it's coming up. There's no way they can bring it up. There's none. And then Tracy would bring it up right at the end. That's funny. I can't tell you how much I was laughing. Mute the mic for a second.

48:04I love talking to Stan. We got to make that Jones Act episode happen, Stan. I know. I feel bad that we keep touting it and it never happens. It's so funny because we've never done it. The Jones Act comes up all the time. I almost feel like we're associated. It's like that and Onion Futures. We've never done an episode on it, even though we talk about them all the time. I think the problem is the stakes are now so high because they have come up repeatedly for years now. We got to nail it. Right. If we ever do an episode, we want to do it in a big way or we want to do an event around it. And we just haven't been able to make that happen yet.

48:38But there are so many interesting things to pull out of that conversation with Sal. I thought his pinning of the time frame in which you might see some impact on U.S. shipping, I thought that was really interesting to actually get a firm time period and the idea that, well, things might be messed up because containers have been going empty again and Chinese New Year is coming up. So we'll definitely be watching that. And then I guess his explanation of just how the insurance actually works, wartime insurance, and how quickly it seems some of those decisions are made. Yeah, I thought that was really interesting in this idea that on each route, you buy the insurance and sometimes it's up to 1 % and eventually it can jump to the point where just the math says, no, between this, it's too much and the added fuel costs of taking a much longer route are worth it.

49:32and how quickly that adjusts and how there's this club of insurers and they're always sending. I thought that was really interesting. I also did think it was really interesting that in his history of the Navy, like all of those sort of key, many of those key moments he described, like in the end, it was the political solution that ultimately took care of the problem. Right. And not a military solution. Yeah. That ultimately you need to address the underlying diplomatic crisis. So peace in the Middle East? Right. We're not going to. Well, this also, I mean, this broader phenomenon where the Houthis, like the small military that Saudi for years attacked and wasn't able to eliminate their force.

50:12And this idea that he brought up that since World War II, there has been this generally stable expectation of global trade. But this idea that it could refragment, particularly if small militaries are able to stand up to large militaries is like a really interesting long-term question. The regionalization of shipping, that was really interesting because again, you think about shipping, obviously it's the sort of global industry, but it's global in very specific ways, including those flags of convenience where you can sail under a Liberian flag or something like that because you enjoy the benefits of other governments that are going to protect strategically or commercially important waterways.

50:57Yeah, that was great. And, you know, I think people talk about deglobalization or, you know, bifurcation or whatever it is. But look, if you don't have this expectation anymore of and maybe, you know, it's not dead or anything, but if this idea that it's getting easier and easier for small military forces to disrupt trade due to advances in weaponry and drones, et cetera, like that, then that does seem like implicitly a force for deglobalization. Yep. Shall we leave it there? Let's leave it there. This has been another episode of the Odd Lots podcast. I'm Tracy Alloway. You can follow me at Tracy Alloway.

51:32And I'm Joe Weisenthal. You can follow me at The Stalwart. Follow Sel Mercogliano. His handle is Mercogliano S and check out his show, What's Going On With Shipping, that's on YouTube. Follow our producers, Carmen Rodriguez at Carmen Erman, Dashiell Bennett at Dashbot, and Kale Brooks at Kale Brooks. Thank you to our producer, Moses Andam. For more OddLots content, go to bloomberg.com slash OddLots. We have transcripts, blog, and a newsletter. And you can chat 24-7 with fellow listeners in the Discord, discord.gg slash OddLots. We have a defense channel in there. We have a transportation channel.

52:09So there should be plenty of conversation about this episode. And if you enjoy OddLots, if you want us to finally do that Jones Act episode or event, then please leave us a positive review on your favorite podcast platform. And remember, if you're a Bloomberg subscriber, you can listen to all our episodes ad-free. Just connect your Bloomberg account to Apple Podcasts. Thanks for listening.

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