With the international shipping community gathered in Athens in early June for the biennial Posidonia Exhibition, the industry’s biggest event, there was a great opportunity to ‘talk shop’ and get an assessment of the state of the industry. While many of the formal discussions during the conference focused on the prospects of the industry for a quick recovery, most of the informal discussions at the party circuit and on shipowners yachts were about survival in the present downturn.
The shipping industry is an international business with more than 90,000 vessels of several types and sizes plowing our planet’s waters, transporting 90 percent of our world’s trade (approximately 9.8 billion tons of merchandise annually) and generating about US$380 billion annually in freight revenue in 2014, according to UN Conference on Trade and Development. There is no doubt that the shipping industry is the world’s crucial floating backbone which connects the continents the oceans divide, making trade possible.
Shipping is an industry at the crossroads of trade and trade policies, politics and strategy, macro-economics, fiscal and monetary policies worldwide, the banking and financial system, engineering and regulations. Once, a proud shipping analyst confessed that his firm had identified more than 1,000 variables to input into its shipping model. No wonder then, with so many variables, shipping is a tough industry to predict, and its volatility is just notorious. As a matter of illustration, capesize vessels (approximately 180,000 tons deadweight (dwt) dry bulk vessels that carry iron ore from Brazil to China) were earning close to $240,000 per day in 2008 and were costing close to $150 million to purchase; these days, same vessels earn $2,000 to $4,000 per day and can be acquired for as little as $30 million.
The Baltic Dry Index (BDI), the proxy index for the whole industry, topped at close to 12,000 points in May 2008; it was below 1,000 points by the end of the same year. After several failed attempts to recover, and having established an all-time low of 291 points in February 2016, the index presently stands marginally above 600 points. The volatility is nose-bleeding and fortunes can be made and lost within a business cycle, and at present, we are at the phase where fortunes are getting a downsizing by each trading day. Some hope that in today’s market fortunes can be made, too.
At the risk of being too simplistic and patronizing, freight rates in shipping are a matter of tonnage supply and tonnage demand: how many cargoes charterers have and how far they have to move them (ton mile) versus how many ships are available at any given time to undertake such “trade.” In 2008, China was growing at almost 15 percent annually, and could not buy soon enough iron ore and coal for their heavy industries. There were not enough ships at the time (less than 7 percent tonnage annual growth), and thus, the exorbitant freight market and an even more exorbitant appetite to build more ships. However, it takes one year to physically built a ship (and several years of shipbuilding backlog). Now that all those ships have come to the market – fleet growth is close to 10 percent overall – China and the rest of the world are growing by less than 5 percent. Just recently, the OECD updated the world’s growth to 2.2 percent from 2.6 percent for 2016.
The latest cycle of tonnage supply and tonnage demand has been amplified by several factors, and as a result, eight years after the market collapse, there are still many aftershocks, strong enough aftershocks to qualify as market shocks on their own right.
China’s unexpected strong growth between 2005 and 2008 was accompanied by a very strong credit expansion in the west. Banks and other lending institutions were going for market share and were throwing cheap money with loose covenants to inferior borrowers, who jumped on the wagon to build as many ships as their heart could be content with. It has been estimated that close to $600 billion in credit was extended to shipping by 2008, and only a couple of years later, close to $150 billion of that became non-performing loans. The cycle of tonnage expansion was highly amplified by the easy credit available, in this case.
Given that Chinese importers and exporters had to pay those exorbitant freight rates during the peak years of the cycle, both the Chinese entrepreneurial spirit and also formal Chinese government policy jumped on the bandwagon to expand tonnage supply by establishing new shipbuilding yards in China and also offering very competitive financing for shipbuilding orders to foreign and domestic clients alike, further stretching upwards the upper limit of the cycle.
In other words, in good times, ships were just too good by any measure.
The 2008 market collapse, kindled by the sub-prime market collapse in the U.S., saw a breakdown in trading and trading volume. This triggered charter defaults, which, in turn, led to the devaluation of shipping assets (think loan collaterals) and loan defaults. The collapse was fast and furious for the dry bulk, tanker and the containership markets and 2009 to 2011 were years to be forgotten by many shipowners.
However, few of the nightmarish scenarios became reality, as trade slowly grew again and life was bouncing back, largely on the back of monumental stimuli in the form of quantitative easing by central banks worldwide. Also, unlike in previous markets, shipping banks largely showed discipline (or ‘lack of backbone’ if you were to ask a free-marketer or buyer of assets) and did not put their distressed ships and bad loans up for fire-sale, to further depress the market. Many a shipowner, hand-in-hand with private equity, soon got impatient with lethargic shipping banks to sell cheap ships, and headed to China, mostly, to order more ships, on top of an already outstanding bulging order book. Back-of-the-envelope calculations indicate that more than $50 billion were injected to the shipping industry, most of which went into newbuildings. As a result, the cycle has been pushed to the limit in terms of tonnage supply. These orders were placed as the industry was trying to find its footing after the 2008-2011 precipitous collapse, and were made in the belief of a robust world recovery, mainly driven by China. Again, given the shipbuilders’ backlog, most of those vessels placed on order at the time only recently entered the market, as dark clouds seem to be gathering on the horizon.
The monetary policy of central banks does not seem to have worked, and growth has been laggard worldwide. Central banks had to ‘push the pedal to the metal’; Japan, Austria and Switzerland are among those that have adopted a negative interest rate policy (NIRP) and more than US$10 trillion of sovereign debt bears negative interest.
There is concern that central banks are running out of ammunition to further stimulate economies, and NIRP is a fiscal experiment that has never been tried on a world scale. Many educated people have expressed concerns on the outcome, which may have some severe negative implications on trade, and thus shipping.
While there is an obvious dislocation of tonnage supply and demand at present and the foreseeable future, there have also been additional headwinds for the industry. Most of the investments and co-investments with private equity that were placed in 2012-2014 are presently under water, and publicly listed shipping companies like Scorpio Bulkers (ticker: SALT) and Star Bulk (ticker: SBLK) have already realized more than $400 million each in losses by disposing of shipping assets. These are reference transactions in the public domain, but there are numerous more private transactions which are in default. There seem to be little interest to ‘double down’ by these institutional investors, and there is concern that given that investment horizon is getting closer, some of these funds will divest assets at a loss, further depressing the market.
On the banking front, new regulations have made asset-backed financing, such as ship mortgages, too expensive and cumbersome, and as a result, shipping banks have been avoiding the industry and new business. All along, shipping banks are holding several billions of dollars of shipping loans in varying degrees of default, which they quietly or actively are trying to sell. Thus, the traditional source of shipping finance – shipping banks – are gradually but persistently leaving the industry and they focus any remaining liquidity on large shipowners which are considered “corporates.”
The collapse of the price of oil in the last year has now caused major defaults with the offshore and drilling industries, which are not considered ‘shipping proper’; however, many shipping banks have been active with offshore as well, and now, the collapse of the offshore market further makes shipping banks more concerned, as their problems keep piling up in this sector.
While the collapse of the price of oil may be considered a boom for shipping due to lower bunker bills, the lower fuel price for vessels means that charterers can steam the vessels at full speed – incremental fuel consumption at higher speed is immaterial at lower oil prices – ships arrive earlier at their discharge ports and are available earlier to be in the market for their next cargo. It is estimated at present that dry bulk tonnage supply is artificially higher by about 15 percent due to faster speed. Higher oil prices would therefore actually bring some stability to the industry.
Apparently, the shipping industry is facing many headwinds, from many directions, some caused by the industry itself and some cause by complementary industries and developments. The mood has been very sober, as it is expected that more bankruptcies will get filed over the next year, barring a phenomenal recovery.
It is said that one person’s crisis is someone else’s opportunity, and frankly, as dark and ferocious as the sea looks at present, there are plenty of investment opportunities, in our opinion. First, there are pockets of opportunity in the industry that have been overlooked, as at present a blanket ‘do not touch shipping’ mandate seems to prevail. Shipping is a very volatile industry and actually it is about managing risk; making sure that downside risk is quantifiable and manageable, one can let their profits run. And profits will come for those who have the right advice and knowledge to make the right decisions.