Time to sort port sector

A recent report by Rockpoint Corporate Finance on the port sector highlights its rather poor state, buffeted by the demand of shipping lines and exporters and the brutal economics of shipping goods anywhere by sea.

A couple of weeks back I commented on the lamentable state of the airline industry as an investment option. While the port sector is not in the same league in terms of negative investment returns, there are similarities that investors in the four listed port companies need to bear in mind.

One might have thought that ports, being infrastructure, would have been a lot less risky than airlines. However, it's more that ports are just "less risky" than a "lot less risky".

The problem for ports is that their main customers, the shipping lines, are busily changing and re- changing schedules of calls at New Zealand ports in response to rising costs (think oil prices) and changes in demand for shipping routes.

Also, only one major exporter, Fonterra, has the clout to direct its export trade and can in some cases play one port off against another in terms of driving down prices and extracting greater concessions.

The shipping lines aren't playing cute with the ports; they are just trying to make a profit.

As Rockpoint notes in its report, most of the big international shipping lines are either barely or not profitable. Changing schedules is the shipping industry's answer to cutting out excess capacity and managing costs better. The airlines are doing the same, with most major airlines announcing schedule changes or reductions to better match supply and demand.

The problem with the ports is not so much that they are finding the shipping lines moving services and port calls around, it's that they have invested significant amounts of capital to develop their ports to attract trade.

During the past 12 years the ports have invested in new cranes, dredging channels and other developments at twice the rate of depreciation. Over the same time, return on assets has fallen as the marginal return on each extra dollar invested has fallen.

To make matters worse, all ports are controlled by regional councils – not a group renowned for sound commercial thinking.

Ports have been all too keen to invest in new assets either to carry out the direction of their political masters or attract new business. The Port of Taranaki spent $20 million deepening its channel to accommodate the ships that would carry coal from Pike River to the world's markets. The plan was for the coal to be barged from Westport and then put on large coal ships at Port of Taranaki.

The trouble was that at the time the Port of Taranaki made the investment decision, it and its partners did not have a contract signed with Pike River. Subsequently, Pike River elected to ship its coal through Lyttelton, leaving the Port of Taranaki with a deeper channel that it didn't need.

That anyone would go ahead with a $20 million investment without first securing a long-term contract to support the investment is beyond belief.

One suspects that the regional council that owns Port of Taranaki decided to go ahead in the name of regional development, trumpeting the deepening of the channel as opening up the port to all sorts of new opportunities.

Well that may be, but for the present the port has, quite literally, sunk $20 million into a hole in the ground.

The other, wider problem with the "build it and they will come" model adopted by some ports and their political masters is that a return is still needed.

Have a big asset base and high fixed costs to service, like a port? The answer is simple: predatory pricing. Any business with a big asset base and high fixed costs will seek to predatory price to cover their fixed costs. And a number of ports have done this.

In many respects, the port reforms that were launched nigh on 20 years ago have been a failure. All the ports are still controlled by politically appointed bodies and over-investment is rife. Returns are poor and there is the ever-present risk of assets being stranded – like Port of Taranaki's newly dredged channel. The problem with a stranded asset is that it is worthless.

Rockpoint doesn't say what it thinks will happen next – attempts at bringing some commercial rigour and rationale to the sector have failed, due mostly to parochial regional self-interest.

The outlook then for the sector doesn't appear to be that encouraging. Some ports, such as the four listed ports are doing better than the others, but overall the sector seems in need of another shake-up.

The traders (importers and exporters) are ruthlessly commercial in their approach because they have no choice.

Likewise, the shipping industry has to be ruthlessly commercial to make at least some semblance of a profit. Stuck in the middle are the New Zealand ports, which while not quite away with the fairies, are nevertheless down in the garden looking for them.

The one major reform needed for the sector is to allow ownership consolidation. There is no legal impedient, but it does require the port sector, or more particularly, the major port owners to put aside parochialism and work out what is better for the businesses operating in their regions.

Rockpoint has suggested that some of the smaller ports should focus on developing regional trade and acting as links in the chain to major international ports rather than trying to compete for international trade in their own right.

However, the idea that CentrePort in Wellington should act as a regional hub for Ports of Auckland or Port of Tauranga will probably have the political level of the Greater Wellington regional council choking on their morning toast.

The very idea that the port in Wellington should be a feeder port for Auckland would send these people into fits of rage.

From a commercial perspective that is probably what should happen, and the benefits to the businesses of the Wellington region would be likely to far outweigh the short term swallowing of some local pride.

However, there is about as much chance of that happening at the moment as the Government realising that buying the "train set" back was a bad idea.

* Bruce McKay is an Auckland investment banker.

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