Revenue structures shelter port ratings from tariff tit-for-tat

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Increased tariffs sparked by the U.S.-China trade dispute may result in decreased traffic at the largest U.S. container ports, but their revenue structures protect them in the short-to-medium term.

Those revenue structures will also shelter the ports' bond ratings, said Emma Griffith, a Fitch Ratings senior director for global infrastructure.

Long-term higher tariffs would result in lower U.S. consumer demand, which would reduce U.S. imports and curb trade volumes beyond 2019, according to a Fitch Ratings report Wednesday.

Griffith said she couldn't say how significant the decline in port volumes would be if a 25% U.S. tariff took effect.

"We would have to wait and see," she said. "People are still going to purchase sneakers, shirts and all these things. It is just going to cost more. It is hard to gauge how long, before it filters into consumer behavior. In the balance of 2019, I don't see a big impact."

The potential for economic havoc on state and local economies from the trade dispute goes beyond the impact on the ports.

“A failure of China and the U.S. to reach a trade agreement could have serious impacts on the California economy through several channels,” said Lynn Reaser, chief economist at the Fermanian Business & Economic Institute at Point Loma Nazarene University in San Diego.

Those channels include hits to supply chains from higher prices for California firms, efforts to switch suppliers to other sources, and disruptions if national security concerns are used to block imports of certain technologies. Tariffs could decrease the already low profit margins of retailers and raise consumer prices. California firms doing business in China like Apple and Disney could be adversely affected by the backlash against the U.S. by Chinese consumers, she said.

“Because of the potential severe damage to both the U.S. and Chinese economy, there still appears to be a 70% chance that a trade agreement will be reached, but a failure would have widespread negative effects on California,” Reaser said.

When the Trump administration failed to reach an agreement with China on May 10, the president increased tariffs from 10% to 25% on $200 billion of Chinese exports, including seafood, toilet paper, luggage, handbags and parts sold to U.S. companies, such as circuit boards and microprocessors. Trump has threatened to impose tariffs on an additional $325 billion in goods including cell phones, clothing and laptops made in China if an agreement isn’t reached.

China’s Ministry of Finance retaliated Tuesday saying on its website it will raise the duty on about $60 billion of U.S. goods on June 1. China already imposed tariffs up to 25% on about $110 billion of U.S. goods last July.

U.S. stocks have bounced up and down during recent weeks depending on the perceived status of the trade talks.

The strength of the stock market matters to California because of the state government's dependence on capital gains and personal income taxes.

“A major and sustained sell-off in stocks could quickly erode California’s fiscal surplus, because of the negative impact on capital gains,” Reaser said. "Personal income taxes account for more than two-thirds of revenues and capital gains are a major source of volatility.”

California’s wine and agricultural industries, particularly soybeans, took a hit last year when China instituted tariffs.

Volumes in loaded exports have leveled off or declined at most of the larger West coast, East coast and Gulf of Mexico ports, with the exception of the Port of Houston, since tariffs were put in place in January 2018, according to a Fitch Ratings report.

All Fitch-rated ports continued to see volume increases in loaded imports since tariffs were introduced in January, but California port officials attributed it to pre-ordering by retailers trying to get ahead of threatened tariff increases in December and March.

The U.S. imported $450 billion of goods from China in 2018, the vast majority of which arrived through seaports, according to Fitch.

“In the latter half of 2018, the warehouses were bursting at the seams,” said Mark Zampa, a Port of Oakland spokesman. “The ports in Los Angeles and Long Beach had congestion. The shipping lines put extra ships into rotation, because they had so much cargo inbound to the U.S.”

U.S. exports of waste materials like cardboard recycled into products in China have also fallen off, but Zampa attributed that to a change in Chinese environmental laws requiring a higher quality of recyclable materials, not the tariffs.

The Port of Oakland had its busiest April for import traffic in its 92-year history with containerized import volume jumping 7% compared to the same month a year earlier, according to the port. Imports were flat at Los Angeles and Long Beach, but experienced increased outbound traffic from sending “empties” or empty containers back to China for more goods, according to the ports.

Oakland import volume has increased 5.8% through the first four months of 2019. The port attributed the gains primarily to continued strong U.S. consumer demand. Oakland's total cargo volume, including imports, exports, and empty containers, is up 4.6%, so far this year.

“We entered this year with uncertainty over the trade outlook, so we’re gratified by the solid performance of import cargo, Port of Oakland Maritime Director John Driscoll said in a statement. “At the same time, all of us involved in global trade are concerned about what comes next.”

The 30-year leases that the twin ports of Long Beach and Los Angeles have with their tenant shipping companies protects those ports from revenue reductions should container traffic dive, Griffith said. They have long-term guaranteed contracts that provide a revenue floor, which helps to insulate port revenue from trade-related volume volatility, she said.

Bondholders of the Port of Oakland and the Port Authority of New York and New Jersey paper benefit from diversified revenue pledges as they both have other revenue streams, according to the Fitch report. The Port of Oakland receives 50% of revenues from port activities and the other half from Oakland International Airport. The New York/New Jersey port authority receives revenues from airport, road, rail, ferry and real estate holdings.

“We have been in the middle of this tariff debate for well over a year — the tariffs began with aluminum and steel and then moved into manufactured parts,” said Gene Seroka, executive director of the Port of Los Angeles. “What we have seen is an absolute roller coaster with people trying to get ahead of the heightened tariffs.”

A lot of companies advanced their inventories, and at the same time, exports were off as China retaliated, Seroka said.

“Imports are flat and exports have declined modestly, but we saw a 22% increase in the number of empty containers going back to China for the next round of imports in April,” he said.

“There is 1.4 billion square-feet of warehouse space within a 60-mile radius of the port and the vacancy is less than 1%,” Seroka said. “A lot of businesses have been using the shipping containers as warehouses.”

A container that would usually return to the port in three to four days is taking seven to eight days. The longer it takes the container to come back, he said, the fewer containers that are available to go out on a ship to China, which affects the supply chain.

Seroka’s take is that the trade dispute won't alleviate the trade imbalance between China and the U.S. that the president initially claimed as a goal.

Three things will happen, Seroka said: higher prices at the store; American companies importing goods will be forced to absorb the cost of tariffs; and trade patterns may shift to other countries, like Vietnam, which Seroka doesn’t think is likely, because there isn’t enough factory space in alternative countries.

“Part of what this industry wants is certainty, knowing the amount of imports coming in and being able to match that to exports,” Seroka said. “Shipping companies want certainty in the supply chain industry and that has not been the case.”

The Port of Los Angeles has had no major service failures and has been able to recover from bottlenecks. But it has not been easy, Seroka said.

“We are doing everything we can to maintain liquidity and it has been a 24-7 grind and it has been that way for 14 months,” he said.

Half of the imports that come through the port are component parts and peripherals that go into the manufacturing stream, like brake pads for cars and computer keyboards that are assembled into kits and sold at places like Best Buy, he said.

“We are slowing down that sector of the business, because the prices are higher and businesses are not sure when it will go up again next,” he said.

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