Ominous Signs From Dry Bulk

RDX : 说得好


by Charles de Trenck

Posted October 3, 2008

After the crack-up of the financial sector, the world is waiting to see what the effect will be on the world’s real economy. One negative indication is that market turbulence earlier in the year was soon followed by a drop in the Baltic Dry Index, a measure of dry bulk shipping prices that in late September was down some 70% from its May 20, 2008 peak. The BDI is often considered to be a leading indicator, since dry bulk carriers transport the raw materials that later become intermediate and finished products.

In a previous article in the REVIEW (“Shattering Shipping Myths,” June 2007), I pointed to elevated risks of a United States/developed countries’ consumer meltdown and how it would threaten the container-shipping industry: “Then not only will we have a few percentage points of overcapacity, we may have a bigger problem resulting from cumulative heavy ship orders from 2003 to 2007 to deal with.” In July 2008, in my piece “How Inflation Hits Asia’s Traders,” I showed how trade volumes had slowed more than expected when adjusted for inflation: “The question is when and how prices might fall as excess capacity forces shippers to compete for scarce customers.”

Since oil appeared to peak, we have been backsliding into a weird deflation rather fast. But some China production costs could remain structurally higher than a few years ago when combining a stronger yuan with higher labor and input costs. Is it a 21st-century twist on stagflation? Since we were on steroids for so long, I don’t know. But transport costs have been falling fast. Ex-surcharges, rates from Asia to Europe on container ships were actually negative. The shock will only register if the downturn lasts longer than a few months. Events in 2001 certainly constituted a shock. But the 2005-06 correction happened too fast. In many ways 2008 picked up where 2005-06 attempted a correction.

Some industry old hands believe the next two to three years for container shipping could be as rough as parts of the 1980s for shipping in general. We’ve learned that history repeats in strange ways; and, still, many of us continue to think it will get worse before it gets better. But I suspect a resolution will be more rapid if financing continues to dry up. And ships will not get delivered because there is no steel or no yard, as argued by many analysts in 2007-08. Ships may not get delivered because owner financing is in short supply.

Nevertheless, the long-term advantage of containers is they reduce transport costs and make globalization cheaper. As a result, as long as the trend of deepening the global division of labor through international supply chains is not derailed by a resurgence of protectionism, the container shipping industry should only suffer a temporary setback.

Bulking Down

The mood is not as sanguine in the dry bulk world. The tempo of corrections varies by subsector, and with more than 10 years of vessel demand equivalents waiting to be delivered to the dry-bulk sector over the coming few years, some shippers could be in for a big shock. Pain levels could be high for companies that agreed to pay 2007 top dollar prices for dry bulk ships, or who agreed to pay high long-term charters in parts of 2007 and 2008. The pain is produced by the calculation of returns on a project where investment costs are at levels of 2007, operating costs are higher, financing is high or limited, and demand growth is leveling off.




Consider a large Capesize vessel for iron ore or coal that may in the past have experienced $6,500 per day in depreciation costs. When delivered in 2009, a new ship may have to register around $14,000 per day in depreciation costs. And then add operating and debt service costs. The average spot charter-revenue equivalent per day on Sept. 26, 2008 was $42,000, as opposed to a very high average of $127,000 per day for 2008. Longer-term charter rates may run $60,000 per day. Many projects will in fact be fine because average costs will be lower than peak costs for many, and average revenues will be higher than prices achieved in the last few weeks. But the time factor on the decline will again be key.

The very best thing that could happen is mass waves of canceled orders for dry bulk ships due to insufficient funding, followed by a re-acceleration of China demand in 2009-10. This scenario is not out of the question, so we should remain open to its possibility. But as of late September the cautious course has been to stay on the sidelines.

For medium- and longer-term trading horizons, the best approach is to know your valuation targets and know your global growth indicators and what drives them. I would continue to be interested in cashed up, well-run companies, but be open to the likelihood of continued volatile trading as the starting point.

The BDI has fallen so far so fast for the second time in 2008. The first was the 50% correction of early 2008. The second followed the commodities correction after mid-2008, which has now clocked in at about minus 70%. Because the BDI fell so rapidly we need time to find correct reference points. Reference points will include steel and iron-ore prices, and bulk product demand volumes. And, of course, China and global growth will be key.

Bank Financing Shortage

A crisis in vessel finance is fast developing. This could be a great positive for shipowners with good credit standing, strong project profiles and good management track records, since the downturn could drive weaker competitors to the wall. In the words of one shipowner, “offshore oil and gas-related projects are prepared to pay libor plus 200 to 300 basis points, so shipowners will have to pay up.” The shipowners’ rough estimate is that only about half of ship loans will get done in the current market. And the equity market will not be in a strong enough position to handle issuances of new equity for most. This means many ships will not get built on time or at all. For me, this reduction in future shipping capacity is the silver lining for the industry once the process starts to occur repeatedly across yards in China, South Korea, Japan and other countries.

The U.S. dollar has been the first compass I look to when seeking guidance. As the dollar was being driven down, devalued and beaten up, many investors sought the refuge of other stores of value, such as commodities. Ships proved to be a great store of value as well during the strong demand/short supply phase of the last few years. And the steel from which the ships are made was particularly expensive in U.S. dollar terms.

The next few years will feature a different pattern, one of weak demand and plentiful supply. Although the dollar remains relatively undervalued in the long-term, my research has shown that a weak dollar is kinder to world growth than a strong dollar. So given all the current troubles we’ve already piled on to the world economy, seeing a continued weak dollar may help global growth find an earlier bottom. The U.S. government at the moment appears to be helping in this area. But a strong dollar rebound would be bad for shipping and global trade if it occurred in late 2008 or early 2009.

Charles de Trenck runs Transport Trackers, a Hong Kong-based consultancy service for investors, and has tracked shipping since the mid-1990s.