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The demise of Hanjin — the world’s seventh largest line — killed the comfort blanket assumption that the world’s largest lines would always find a way of surviving irrespective of financial performance. Neither its creditors nor the Korean government were willing to foot any more bills after so many losses. Further consolidation of the container industry has since followed.
Well, the similarities between the bulk and container shipping sectors have been eerily similar for some time. Excessive vessels orders have created a huge supply-demand imbalance of both bulkers and box ships resulting in huge losses for owners in recent years. Bankruptcies have followed and the pressure to consolidate has rapidly built up.
Bulking up?
But while the consolidation process has gathered huge momentum in the container sector — the number of global carriers has fallen to just 13 from more than 20 over the last six years — the bulk shipping sector is a different beast. The current industry model in dry bulk shipping is characterized by fragmented ownership of the 10,800-plus ships in the global fleet. This means that each individual owner has little influence and bargaining power with its customers, and this often is reflected in low levels of mutual trust. Indeed, there are only four companies that own more than 100 dry bulk ships and on a DWT basis; the largest owned fleet represents less than 4% of the total fleet. By contrast, if Maersk’s purchase of Hamburg Süd is passed by regulators, the combined line will operate almost 750 vessels and boast a global market share of 18.6%.
As shipping association Bimco recently noted, many bulk carrier owners have highly leveraged fleets and are focused on the asset play — buy low, sell high — rather than acting as logistics providers focused on generating returns on capital employed.
“The asset play is a high-risk business model, especially when it is combined with a high proportion of ships on the spot market,” Bimco said. “There are owners who are more conservative and had a strategy of running many of their ships on long-term charter. They have been caught out by the length and severity of the downturn with most, if not all, of their long-term charters now expired.”
The problem facing bulk shipping owners and operators is that consolidation is coming — but from customers, not their peers.
“While dry bulk ship owners remain highly fragmented, their customers are ever-increasing in their influence and bargaining power,” Bimco said. “Right now, many dry bulk customers are spoiled for choice in the shipping market. There are too many ships to choose from and, as a result, freight rates are firmly in the gutter. Dry bulk shipping is, in fact, a good example of what economists call an oligopsony: a market with a limited number of buyers and a large number of sellers.”
Bimco forecasts that larger bulk carrier owners will seek to develop long-term direct relationships with major customers who will want to work directly with fewer ship owners able to offer more encompassing logistics solutions. In the future, Bimco believes this will mean the emergence of larger dry bulk ship-owning companies focused on providing logistics services to commodity giants with a focus on risk management and Return on Capital Employed (ROCE), not the asset play. This will make the industry more demand-driven with most ships purchased against long-term charters by large and sophisticated businesses that are better able to forecast future market demand.
“This will ensure that supply and demand are much more closely linked in a mature market where large and unforeseen trade fluctuations are rare,” Bimco said. “Ultimately this will mean a less cyclical industry where the peaks and troughs are dampened, leading to steadier and more predictable ROCE for the larger companies.”
All of which should be good news for the global grain industry in the long run: low freight rates are all well and good, but the risk associated with the financial stability of ship owner counterparties is a cost in itself. However, getting to this point will take some time.
What now?
In the meantime, the freight pricing and counter-party picture for grain shippers is complex, not least because since the last iteration of this column in the summer, the world has been turned rather upside down by Donald Trump’s surprise win in the U.S. presidential election. This also has been accompanied by an improving demand outlook.
The Baltic Dry Index, which gauges shipping rates for dry commodity goods, had bottomed out earlier this year at a record low of 290 due to sluggish global trade. That forced most shippers to idle ships while several operators filed for bankruptcy. But the BDI then surged to 1257 on Nov. 18.
The demand side of the shipper equation and the reason for the improving strength of the BDI as the year has gone by is essentially a result of core demand growth, especially linked to support from Chinese steel production, which increased marginally to 672 million tonnes in the first 10 months of the year against the expectation of a sharp reduction in output.
“Since it is more productive to use the ore with higher iron content with the costlier metallurgical coal, imports of iron ore increased in the country,” explained shipping analyst Drewry. “Meanwhile, imports of thermal coal in China have been driven by increasing thermal-based electricity production and reduced availability of local coal because of environmental regulations.”
Overall in 2016, China’s demand for commodities has remained firm and has in turn supported the dry bulk market. In 2017, according to Drewry, “the long-haul voyage of iron ore from the new S11D project in Brazil and the increase in bauxite exports to China and the Middle East from West Africa augurs well for the dry bulk trade, especially on larger vessels”.
‘Trump-ed’ up
Source: Baltic Exchange
What a Trump presidency will really mean for the global market is impossible to know at this stage, and investor ardor will no doubt subside, not least because the fundamentals of the bulk market still look rather poor. Roger L. Martin in his book, “Fixing the Game,” probably best explains the mismatch between investor views of the bulk shipping market and reality.
He defines the “real market” as the world in which factories are built, products are designed and produced, real products and services are bought and sold, revenues are earned, expenses are paid, and real dollars of profit show up on the bottom line. By contrast, the “expectations market” is the world in which shares in companies are traded between investors, in essence, the stock market. In this market, investors assess the real market activities of a company today and, on the basis of that assessment, form expectations as to how the company is likely to perform in the future. The consensus view of all investors and potential investors as to expectations of future performance shapes the stock price of the company.
In terms of explaining the share price surges of bulk companies in recent months, it is probably fair to assume that many investors may have over-bought on Trump’s promises to boost infrastructure spending and investment, and under-bought on the impact increased protectionism is likely to have on long-term demand. Many also seem to have under-estimated the continuing poor vessel-supply demand balance and what the fragmentation of the ownership of bulk vessels means for the ability of the industry to stabilize rates in the long term.
Peter Sand, Bimco’s chief shipping analyst, offers a sobering counterpoint to stock market enthusiasm.
“The 12 consecutive days of a rising BDI in November only brought Capesize ships back into profit — profits meaning a freight rate level that can cover OPEX (operational expenditure) as well as financing costs,” he told World Grain. “Panamaxes almost made it into profits, while Supras, Handymax and Handysizes remained in the red. After losses toward the end of November, all are back at loss-making freight rate levels. This is very important to make a note of. A short-term spike isn’t saving anyone. At worst it may bring around false expectations of a recovery around the next corner.
“Bimco estimates that the industry may turn profitable in 2019, if supply side growth is zero during the coming years and demand grows by 2% per annum. Owners have done the right thing as they have placed only a very limited number of new orders. This will benefit them in a few years. In terms of scrapping, the job was done in the first half, not the second, which doesn’t bode well.
“If scrapping stops even as rates are not profitable, sustainable freight rate levels will not be achieved in 2019. Owners have got their work cut out and they have to rely on demand growth.”
The lesson is that counter-party risk has not gone away on stock market expectations and Trump-ed up hope. Instead, expect rates to fluctuate at continued low levels for at least the next year, prompting a slow but inexorable consolidation of an overly fragmented bulk shipping market.
