Early Lessons from Shipping's non-Recovery
The Baltic Dry Index (BDI) is the news as it keeps setting new old-time lows recently; on Friday February 13th, 2015, the index settled at 530 points; hard to fathom that on May 20th 2008, the index reached an all time high at 11,793 points, dwarfing the present reading to just 1/25th of its previous glory.
The market consensus is fairly bearish at present; unlike the drop of the markets post-Lehman Brothers that was fast and furious, the present decline is excruciatingly slow and painful, almost like torture. No-one has been claiming that shipping had worked out the problems of the super-boom years of the cycle, but frankly, most of the problems were concentrated in the containership market, mainly with KG ownership and mainly financed by German banks, with the rest of the market doing marginally well for most of the time, give or take the typical ‘animal spirits’ of the volatile industry getting out of control on occasion. The ‘pain’ of the (bad) market was contained; however, dry bulk vessel ownership is widely distributed both geographically and also in terms of shipping-owning companies. The BDI is considered a proxy for the overall shipping industry for the reason that the dry market is bigger and broader than any other segment of the industry.
The consequences of the low market are expected to present themselves in the market place sooner or later. Already, the Danish vessel operator Copenship A/S was forced to file for liquidation and return their chartered-in fleet to their owners. Publicly listed dry bulk owners are reporting diminishing cash reserves, fast draw downs on their lines of credit and continuous negative cash flows from operations. The weak state of the dry bulk owners and the prospect of bankruptcies add to the headaches of the shipping banks, thinking that the worst was behind them and only containership problems remained before moving forward. Dry bulk owners with an eye for long term prospects and value-priced vessels have completely withdrawn from the sale & purchase market, at least until they see a bottoming of asset pricing, further pulling asset prices lower and jeopardizing any shipping loans with strong asset-value covenants. Shipowners with strong dry bulk orderbook and imminent deliveries are facing the prospects of employing their brand-new ships at charter rates well below their operating break-even; and, just last week, Scorpio Bulkers (ticker: SALT) announced the conversion of three capesize newbuilding contracts to product tankers and an immediate write-down of $22 mil from the transaction.
What has gone so wrong? Looking at the demand side, world economic growth is not remotely close to that in the late 1990’s or ten years ago (2004 – 2007) when the economies of developed countries were growing by several hundred basis points annually, and the economies of developing countries, BRICs and all, were leapfrogging forward at rates well in excess of 5%. Over the last couple of years, it has become apparent that the lost decades of the Japanese economy are not over yet, Europe has been dragged back by political and monetary concerns, China has been slowing too much even by their own standards in their efforts to shift their economy from investment to consumption (and get rid of corruption in the interim) while only recently the US economy has been a bastion of growth (mostly driven by consumption and boosted by plummeting energy costs) at rates moderately above 1%. In the interim, since January 2010, the world’s dry bulk fleet has increased from approximately 460 million deadweight to 760 million deadweight, that is 65% over five years, and more than 12% average annual growth. In terms of number of vessels, the world’s dry bulk fleet moved from 7,350 vessels in January 2010 to approximately 10,500 vessels in January 2015, almost keeping pace tantamount to the deadweight growth. Given the minimal level of demolitions, tonnage supply outstripped demand by a league.
What brought such exuberance, irrational or not? In the dark days of the business cycle, the debate was on whether the recovery was going to be ‘L-shaped’ or ‘W-shaped’ or ‘V-shaped’. As per above graph with the Baltic Indices, by 2010 there was a picture of optimism for a market recovery, strong hopes indeed that this was going to be a V-shaped recovery and that those were the times to go long. The market had stabilized and capesize vessels on occasion managed to reached impressive freight levels, boosting even more hopes for a ‘V’ as in Victory. Shipbuilders lowered their prices, the ‘magic of the eco-design ships’ promised to make newbuildings money makers from the day of their delivery, and institutional investors rejected by the banks to buy ‘cheap ships’ found solace by piling up on orders at the shipyards. All along, shipowners keen to prove the adage that shipowners are their worst enemies did their own piling up on orders, whether with sweat equity, co-investments or sponsored by institutional investors, on the premise that ‘shipping is not a team sport’ but rather a ‘zero sum game’, thus orders of efficient vessels do not matter if they increase supply as long as fuel efficient ships crowd out existing tonnage (whether good, bad or indifferent).
Hindsight is perfect as they say, and the purpose of this article is not to assign blame on how and why the orderbook got out of hand. However, looking around, one has the sense that history teaches little over the cycles. Still, one can see lots of money on the sidelines waiting be to be invested, in shipping or not. And, as long as interest rates are low, it takes little for potential investments to look profitable on the drawing board. The outstanding orderbook has dropped by a lot over the last year given the state of the market, and there is even talk that shipyards will be going out of business. We opt to see the low outstanding orderbook as a concern causing more headaches to the markets rather than solving the current market slump. In less than a year, the shipbuilders will be very low on their forward book and will be dropping margins and prices to get new orders; and shipbuilding capacity in the dry bulk market is very elastic, especially for smaller tonnage. There is plentiful supply of iron ore and coal as the miners have invested exorbitant amounts of money to bring big projects to market (and thank for shipping, it will be dirty cheap for a while to bring raw commodities to the shipbuilders). Thus, there is money to be invested, there is shipbuilding capacity available and plentiful and cheap commodities to keep the shipbuilding assembly line going.
So much for the V-shaped recovery.
The opinions expressed herein are the author's and not necessarily those of The Maritime Executive.