Is the Dry Bulk Tramp Trade at an Inflection Point?
As punishingly brutal as the shipping industry can be in bad times, it’s fulfillingly rewarding in good times. Who can forget the days from a decade ago when Capesize bulkers were earning $250,000 per diem and the ships themselves were changing hands in excess of $150 million?
We are a long way from those good old days, but memories of and even hopes for the prompt arrival of great times keep many a shipowner persevering in this business. It’s well-known that sweet memories and often hopes have on occasion been used to spruce up many an “investment thesis” in investor presentations.
The dry bulk tramp trade – whereby ships do not sail on a fixed schedule or published ports of call – has long been considered a textbook case of perfect competition in economics with its low barriers to entry and exit, minimal government and regulatory interference and taxation, an international market of price-takers for an undifferentiated product where no individual player – whether shipowner or charterer – has controlling influence on the market.
In such an individualistic market environment, fortunes have been made – and occasionally lost – when independent shipowners took timely risks and positioned their companies favorably on the dramatic upswing of the business cycle. Now that the dry bulk market is closer to the bottom than the peak of the cycle, there are calls to take risks for a market upswing.
Probably the timing is opportune for buying bulkers in expectations of an upswing in the market, but one has to consider whether the tramp market still adheres to the rules of a perfectly competitive market. The last decade has seen so many fundamental changes that one has to wonder whether the old playbook is still working.
Barriers to Entry
The greatest barrier to entry in the shipping industry has been capital, given that this is a capital-intensive industry. However, in past times shipping banks were providing generous financing in terms of financial gearing (leverage) and covenants, and there have even been cases of “name lending” and financing agreed on a handshake.
Now that shipping banks have been departing the industry and capital markets veering away from project finance and commodity shipping, private equity and other institutional investors have been depended upon to provide capital to shipping – but at a much higher cost of capital, tighter terms and covenants, and often for a share of the economics. In this respect, the barriers to entry in terms of accessing capital have definitely been affecting the industry in an adverse way.
In reference to government interference and regulation, for vessels having open registries (“flags of convenience”), the burden is still low in comparison to other onshore industries, but one can see the writing on the wall of higher regulation (and higher costs). Emissions and the quality of bunker fuel have been making headlines in the last year, resulting in both a higher financial component to the business and also technological and regulatory risk.
Likewise for ballast water treatment plans, already past the official deadlines, technology and approvals only now are getting sorted out. Likely, there will be higher risks for safety and security and ensuring that ships and the seaways supply chain are supported by hack-free systems (ransomware “NotPetya” cost Maersk a few hundred million dollars in losses in its last quarterly report, while the possibility of “hacked” ships became a prominent scenario in a recent wave of collisions involving U.S. Navy ships in the Pacific).
And while offshore registered vessels are subject to the so-called “tonnage tax” system, many revenue-challenged jurisdictions and taxpayers have been taking a second look at the substantial differential in taxation compared to domestically registered shipping companies and the potential loss of revenue. Taxation is a risk routinely mentioned in the prospectuses of all publicly listed companies in the U.S. capital markets, and the current favorable treatment by the IRS cannot always be considered “a sure thing.” Thus, in an increasingly burdensome era of regulations (environment, safety, security, etc.) and taxation, another of the legs of perfect competition seems challenged.
In theory, the “product” that dry bulk shipping companies “sell” is a “commodity” and “interchangeable” since they all offer the service of transporting cargoes in bulk over the sea. It’s as simple as that. And although there are many charterers who only care about the benefit of cheap transport, an ever-increasing number of quality charterers are demanding more than that: They want quality ships and proper management systems and real-time reporting and accountability, not to mention solid shipowners and managers free of the financial risk of default.
A New Business Model?
Thus, the “product” of tramp dry bulk shipping is becoming less commoditized and more of a “service” whereby now ships and shipowners are not exactly interchangeable. Quality ships run by quality managers are preferred by charterers, but they still earn market price. And in order to be profitable at market prices, a critical mass of ships is required in order to access capital and spread the overhead among a larger number of vessels. Thus, another tenet of the perfect competition model that dry bulk is a “commodity” good is slowly challenged.
At the end of the day, dry bulk shipowners in the tramp trade are “price-takers” and will take what the market pays as they have little pricing power – again, a perfect competition characteristic. However, the case of just buying cheap ships and waiting for the market to recover will not necessarily hold true in this new environment. One has to wonder whether the tramp dry bulk market, as a precursor to other asset classes, is slowly approaching an inflection point where “value-added” services become a differentiating factor.
“Hope is a good thing, maybe the best of things, and no good thing ever dies,” the quote goes, but one has to think that hope alone for a market recovery similar to recoveries in previous business cycles may not be enough this time around. – MarEx
The opinions expressed herein are the author's and not necessarily those of The Maritime Executive.