Monthly Archives: September 2013

Shale Oil: Think Globally, Buy Locally!

Fresh on the heels of a recent marketing campaign of the most ‘forward thinking’ i-concept yet, some may wonder whether the Jones Act tanker market in the US is exhibiting one of its best ever performances yet based on the dislocations caused by the status quo and possibly hard-to-substantiate assumptions.  Although in the summer Reuters first reported that the MT „AMERICAN PHOENIX” Jones Act product tanker was sub-leased to ExxonMobil by Koch Industries for one year at a rate of $100,000 pd, a recent article in a shipping trade publication erroneously stretched that charter to a grand total of five years, still at $100,000 per diem.  (We happened to know the true charterers and rates, and it’s not what it has been reported beyond what it was written in the Reuters article). Basing investment calculations on rates similar to $100,000 pd for 5 years as exciting and attractive as they may be, they can only lead to mis-calculations, disappointment and undue attention.

Shale oil discoveries and production oil and natural gas liquids (NGLs) in the US and overseas are definitely a game changer for world geo-economics, and such development will definitely provide a strong competitive advantage to the US versus other industrially developed / developing countries.  The shortest and best telling exhibit of such an advantage can be seen in the price differential of natural gas between approximately $3.5 / MMBtu at Henry Hub (Louisiana) and about $15 / MMBTU at DES Japan / Korea Marker (JKM) with an approximate $4.5 / MMBtu freight cost differential between the two markets; in other words, the base cost of energy input in the industrial value chain is one-fourth in the US than in Japan; although slightly better in Europe, still it’s three times as high than in the US.

Jones Act Tanker MT „FLORIDA" (Image Source: Courtesy of Crowley Maritime Corporation)

Jones Act Tanker MT „FLORIDA” (Image Source: Courtesy of Crowley Maritime Corporation)

Oil produced in the US is illegal to be exported (on a commercial, sustainable basis), based on laws enacted primarily in the aftermath of the 1970 oil shocks (Mineral Leasing Act of 1920, the Energy Policy and Conservation Act of 1975, and the Export Administration Act of 1979, and the so-called short supply controls in the Export Administration Regulations (EAR) of the Bureau of Industry and Security (BIS) where the restrictions are duly defined.)  Therefore, based on the status quo, oil produced in the US has somehow to slosh in the US and that can only be done by rail cars, pipelines and tankers, Jones Act tankers that is. Ergo, the exuberance on the Jones Act tanker market. Since our last posting on the Jones Act market, there have been a firm order for an additional two tankers by clients of Seabulk Tankers at NASSCO, and a reported Letter of Intent (LOI) for additional four tankers by an institutional investor at the ailing Avondale  Shipyard (part of Huntington Ingalls Industries ) based in Louisiana. For those in the knowing, an LOI sometimes is worth as much as the paper it’s written on, but so far, the orderbook of firm orders for Jones Act tankers stands at fourteen vessels with production solidly filled till late 2016, with four more options plus the potentially four at Avondale.

Transporting Oil in the US (Source: Valero)

Transporting Oil in the US (Source: Valero Energy Corporation)

Domestic US oil production has increased from 5 million bpd in 2008 to 7.4 million bpd in 2012, while at the same time US imports of crude oil have dropped from 9.2 to 8.4 million bpd. All along, US oil consumption has dropped by 10% or 2 million bpd from 2008 till now. Major shale oil production came from the Bakken fields in North Dakota and the Permian Basin and Eagle Ford fields in west and southwest Texas, while the primary US ‘refinery corridor’ is lined up along the east part of the US Gulf Coast (USGC) and the US East Coast (USEC). According to a recent investment presentation by the world’s largest independent refiner Valero Energy (ticker: VLO), it costs about $15-17 /bbl to transport oil by rail from Bakken to USEC which is less or tantamount to the cost by rail / pipeline from Bakken to USGC and then by (Jones Act) tanker to USEC. All along, Valero estimates their cost of supplying oil from Eagle Ford to their Quebec refinery on foreign-flag vessels at $2 / bbl (crude oil exports to Mexico and Canada are allowed, and thus Valero’s ability to by-pass the Jones Act tonnage in this instance.)

The economics of transporting oil within the US whether by rail, pipeline or by sea (barges or tankers) are tight, and for now, the bottleneck / dislocation has caught many people by surprise.  However, there are strong efforts for the building of the TransCanada Keystone XL pipeline and expanding the railroad capacity from North Dakota (Bakken) to USEC (and elsewhere.) Given that US refineries are oriented for sour and heavy crudes, the economic argument has been made, some times vocally and sometimes discreetly but always against great criticism from many fronts, that in today’s economic world it would make more economic sense for the US to export its domestically produced high quality oil and logically highly priced (West Texas Intermediary (WTI) and Louisiana Light Sweet (LLS)) and import cheaper, lower quality crudes. Since the shale oil boom, the spread between WTI and Brent has been as wide as -$25 / bbl, meaning the better quality WTI is lower priced than lower quality Brent (compared to WTI.) While recently the gap has narrowed significantly and almost a month ago their pricing approached parity momentarily, the gap has widened again to -$6 /bbl.

Oh, the economics and the logic behind the world’s energy needs…but again, if there were no inefficiencies, there would be no opportunities for exorbitant profit whether in the international tanker markets in the past or the Jones Act tanker market at present… and again, we were told in Econ 101 that capitalism is about exploiting needs and efficiencies…just don’t make a bet that the market will be inefficient forever or before the payback period of a highly priced Jones Act product tanker newbuilding order…

© 2013 Basil M Karatzas & Karatzas Marine Advisors & Co.

No part of this blog can be reproduced by any means and under any circumstances, whatsoever, in whole or in part, without proper attribution or the consent of the copyright and trademark holders.

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China’s Raw Power and Steel Strength

The capesize market has kept enjoying a robust September so far with freight rates approaching the magical level of $40,000 pd (not seeing since 2011) for a round-voyage trip between Brazil and China. Given that rates were at about $5,000 pd in early June this year, the freight increase is phenomenal and most-welcome in an otherwise uninspiring shipping market, in general.

The increase in the cape market has been triggered by China’s elevated iron ore mostly (and some coal) import activity over the same period. This time however, more of the imports (proportionally) were originating from Brazil than the previous mini-peak of the market earlier this year; Brazilian imports usually absorb three times as much capesize tonnage as Australian imports do due to distance, which explains partially the freight increase.  It is not known yet whether the increased iron ore imports are purely for inventory replenishing purposes or due to increased iron ore production, as updated, reliable statistics are not available yet.  This differentiation between end-production and stock piling in general is useful as the latter explanation equates to ‘stuffing the channel’ improvement. It is known that Chinese iron ore stockpiles have been maintained at the 20-day mark this year (about 70 million tons), while in the last few years that mark was at about 30-to-40 days of demand. Also, the price of steel plate at Chinese shores increased from about $100/ton in late May to $130/ton at present after briefly setting a recent high of about $140/ton.

The recent rally in the cape market has not really spread proportionally to other asset classes in the dry bulk market, and the crude tanker market is definitely under renewed duress.  The big question then becomes whether the cape rally is sustainable and it can be an inflection point for the shipping market.

Iron ore and metallurgical coal are used for the production of steel, which to be used for infrastructure projects, construction, in heavy industries, etc In a sense, the steel industry and its health thereof is an integral parameter to the health of the of the iron ore trade (and capes.)

A recent article in Week in China, a Hong Kong-based insightful weekly publication about Chinese matters, about the steel industry got us thinking.  Here are few major points: there are about 21,000 steel mils in China according to the Research Center for Chinese Politics and Business at Indiana University, ranging from the heavyweights like the state-owned, publicly listed companies like Baoshan Iron and Steel (Baosteel) to start-up steel makers.  In 2012, about 715 million tons of steel was produced in China, and the industry overcapacity stands at about 300 million tons, for a total overall capacity of more than one billion tons per annum.  This is not a typo, Chinese steel production capacity exceeds demand by 300 million tons per annum; to put this into perspective, the whole annual European steel production stands at 150 million tons presently, so China’s spare capacity is twice Europe’s annual production.  Chinese steel mill utilization rate has remained in the 70-80% range in the recent past. [The European steel industry has tremendous overcapacity in its own right, in full disclosure, as capacity stands at 2008 levels of 200 million tons per annum].

So, how an industry with 40% overcapacity (much worse than that in shipping, actually) and a low utilization rate (again, lower than in shipping) gets to make money?  Glad that you asked!

In an article titled ‘In a precarious state,’ Week in China reports that Chinese steel firms have run a debt tab of RMB 3 trillion (US$ 490 billion).  About three-quarters of these loans are bank loans and in general have short maturities, usually less than one year, and thus they will have to be re-financed in the immediate future. Focusing on the established and most solid players, the largest 30 steel mills in China have outstanding loans of RMB 760 bln (US$ 125 bln). As we mentioned in previous posting, China’s ‘shadow banking’ is estimated at about US$ 2 trillion, so any way one slices the data, the steel industry has a significant share of it; some have argued that the steel industry may be of higher cause of concern than overstretched property developers and local government financing vehicles.  A recent study by Morgan Stanley titled ‘China Deleveraging, Can the banks tide out a financial storm’, ‘Ferrous metal smelting & pressing’ is the most underperforming industry and by far the highest risk of concern to their lenders.

steel plates

Chinese steel mills, without any government subsidies, in general lose RMB 100 – 300 per ton produced (about $15 – 50 per ton.) All inclusive, the industry’s margin is as thin as 0.04%.

China’s recent ‘rebalancing efforts’ have taken into consideration ‘excess capacity’, and officially the government has ordered 1,900 companies in the steel, aluminum and concrete industries to be shut down; about seven million metric tons of steel capacity to be taken out of the market by the end of September 2013 (about 2.5% of the 300 mil ton overcapacity.)  The curbing is rather mild, and as Reuters’ article emphasizes: “Beijing’s previous efforts to rein in “blind expansion” in some sectors have been thwarted by local governments that have offered cheap land, tax deductions, subsidies and loans to attract investment, the People’s Daily said on Tuesday, citing a spokesman for Ministry of Industry and Information Technology.” However, one cannot ignore the writing on the wall…

Chronic overcapacity may be interpreted that if/when the Chinese economy grows again at 15%, there will be plenty of ‘shovel ready’ plants to rev up production, which would be an immediate blessing for the iron ore and cape markets… But again, all this overcapacity will have to be kept alive until then, either by political will or at considerable destruction of wealth…

The recent cape rally has partially attributed to Brazil’s iron ore coming back to the market after an exceptionally heavy rain season earlier in the year and port facilities becoming available again. Chinese steel mills, especially the smaller ones and the ones with their debt financing coming due immediately, kept buying iron ore despite increasing prices of the commodity in an effort to ‘keep the bicycle moving’: once they stopped buying and producing, despite the government’s edict and the bad economics of their production, banks would be much more inclined not to re-finance loans coming due…

Far from us being ‘dragon slayers’ (pessimists on China) and would rather side with the ‘Panda lovers’ camp (optimists on China); and, no-one said that Chinese local politics and statistics are always translucent and that China does not have the magic to surprise. However, it seems that the Chinese steel industry, the cornerstone of any sustainable cape recovery, may just not be the rock where great fortunes can be build upon at present.

© 2013 Basil M Karatzas & Karatzas Marine Advisors & Co.

No part of this blog can be reproduced by any means and under any circumstances, whatsoever, in whole or in part, without proper attribution or the consent of the copyright and trademark holders.

Quotes and Expressions Inspired by the Sea

In Sea affairs, nothing is impossible, and nothing is improbable.’                                                                                                                     Admiral Lord Nelson, writing from HMS Victory in 1804

ὦκα δ᾽ ἐφοπλίσσαντες ἐνήσομεν εὐρέι πόντῳ.                                                                               When that ship has been made ready and is fit to sail, we’ll launch it out into the broad sea.                                                                      Homer, Odyssey, Book B, Line 295

Bundìn er bàtlaus mađur  (Bound is boatless man)                                                                                                                                               Norwegian (Viking) Expression

Twenty years from now you will be more disappointed by the things that you didn’t do than by the ones you did do. So throw off the bowlines. Sail away from the safe harbor. Catch the trade winds in your sails. Explore. Dream. Discover.                                                                                                                                                         Mark Twain

If you want discoveries to be made, let your ships sail a bit haphazardly on the high seas.                                                                             Harvey Sachs

We are tied to the ocean. And when we go back to the sea, whether it is to sail or to watch – we are going back from whence we came.                                                                                                                                                                        John F. Kennedy

But let there be spaces in your togetherness and let the winds of the heavens dance between you. Love one another but make not a bond of love: let it rather be a moving sea between the shores of your souls.                                                                                                                                                                                                        Khalil Gibran

If you want to build a ship, don’t drum up people to collect wood and don’t assign them tasks and work, but rather teach them to long for the endless immensity of the sea.                                                                                                  Antoine de Saint-Exupery

Men go abroad to wonder at the heights of mountains, at the huge waves of the sea, at the long courses of the rivers, at the vast compass of the ocean, at the circular motions of the stars, and they pass by themselves without wondering.                                                                                                                                                                Saint Augustine

When the seagulls follow the trawler, it is because they think sardines will be thrown into the sea.                                                                                                                                                                                                                                          Eric Cantona

There is a tide in the affairs of men, which taken at the flood, leads on to fortune. Omitted, all the voyage of their life is bound in shallows and in miseries. On such a full sea are we now afloat. And we must take the current when it serves, or lose our ventures.                                                                                                            William Shakespeare

Love one another, but make not a bond of love: Let it rather be a moving sea between the shores of your souls.                                                                                                                                                                                                          Khalil Gibran

Timid men prefer the calm of despotism to the tempestuous sea of liberty.                                                                                                     Thomas Jefferson

Fishes live in the sea, as men do a-land; the great ones eat up the little ones.                                                                                                 William Shakespeare

For life and death are one, even as the river and the sea are one.                                                                                                                      Khalil Gibran

Earth and sky, woods and fields, lakes and rivers, the mountain and the sea, are excellent schoolmasters, and teach some of us more than we can ever learn from books.                                                                                             John Lubbock

As different streams having different sources all mingle their waters in the sea, so different tendencies, various though they appear, crooked or straight, all lead to God.                                                                                                 Swami Vivekananda

As fire when thrown into water is cooled down and put out, so also a false accusation when brought against a man of the purest and holiest character, boils over and is at once dissipated, and vanishes and threats of heaven and sea, himself standing unmoved.                                                                                                       Marcus Tullius Cicero

The sea does not reward those who are too anxious, too greedy, or too impatient. One should lie empty, open, choiceless as a beach – waiting for a gift from the sea.                                                                                                           Anne Morrow Lindbergh

O wise man! Give your wealth only to the worthy and never to others. The water of the sea received by the clouds is always sweet.                                                                                                                                                               Chanakya

The sea, once it casts its spell, holds one in its net of wonder forever.                                                                                                             Jacques Yves Cousteau

We must free ourselves of the hope that the sea will ever rest. We must learn to sail in high winds.                                                                                                                                                                                                                   Aristotle Onassis

The fishermen know that the sea is dangerous and the storm terrible, but they have never found these dangers sufficient reason for remaining ashore.                                                                                                                           Vincent Van Gogh

When I was a boy the Dead Sea was only sick.                                                                                                                                                   George Burns

You can’t cross the sea merely by standing and staring at the water.                                                                                                               Rabindranath Tagore

God moves in a mysterious way, His wonders to perform. He plants his footsteps in the sea, and rides upon the storm.                                                                                                                                                                                                William Cowper

It is better to meet danger than to wait for it. He that is on a lee shore, and foresees a hurricane, stands out to sea and encounters a storm to avoid a shipwreck.                                                                                                                     Charles Caleb Colton

Following the light of the sun, we left the Old World.                                                                                                                                         Christopher Columbus

Ships are the nearest things to dreams that hands have ever made.                                                                                                                  Robert N. Rose

You can’t change the wind, you can, however, adjust your sails.                                                                                                                        Unknown

Hoist your sail when the wind is fair.                                                                                                                                                                          Proverb

I find the great thing in this world is not so much where we stand, as in what direction we are moving – we must sail sometimes with the wind and sometimes against it – but we must sail, and not drift, nor lie at anchor.                                                                                                                                                                                    Oliver Wendell Holmes, Jr.

The cure for anything is saltwater — sweat, tears, or the sea.                                                                                                                                Isak Dinesen

She sent him a warm and gentle wind,                                                                                                  and Lord Odysseus was happy                                                                                                                  as he set his sails to catch the breeze.                                                                                                    He sat beside the steering oar                                                                                                                and used his skill to steer the raft.                                                                                                                                                                                Homer

There is, one knows not what sweet mystery about this sea, whose gently awful stirrings seems to speak of some hidden soul beneath…                                                                                                                                                                   Herman Melville

If one does not know to which port one is sailing no wind is favorable.                                                                                                               Seneca

There are some things you learn best in calm, and some in storm.                                                                                                                        Willa Cather

To young men contemplating a voyage, I would say go.                                                                                                                                          Joshua Slocum

He that will not sail till all dangers are over must never put to sea.                                                                                                                     Thomas Fuller

That’s what a ship is, you know – it’s not just a keel and a hull and a deck and sails, that’s what a ship needs. But what a ship is,… really is, is freedom.                                                                                                                                            Captain Jack Sparrow

Men go back to the mountains, as they go back to sailing ships at sea, because in the mountains and on the sea, they must face up.                                                                                                                                                                         Henry David Thoreau

My soul is full of longing, For the secret of the Sea,                                                                             And the heart of the great ocean, Sends a thrilling pulse through me.                                                                                                             Henry Wadsworth Longfellow

Build a deck high up on it, so it can carry you across the misty sea.                                                     I’ll provision it with as much food and water and red wine                                                                  as you will need to satisfy your wants. I’ll give you                                                                        clothes and send a favoring wind blowing from your stern,                                                                so you may reach your own native land unharmed,                                                                               if the gods are willing, the ones who hold wide heaven,                                                                whose will and force are mightier than my own.                                                                                                                                                 Calypso to Odysseus – Homer

To be successful at sea we must keep things simple.                                                                                                                                         Pete Culler

Fortune brings in some boats that are not steered.                                                                                                                                            William Shakespeare


 

© 2013-2014 Basil M Karatzas & Karatzas Marine Advisors & Co.  All Rights Reserved.

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‘Royal’ sailing

Probably one of the greatest temptations and charms of the shipping industry has  been its extremely volatile nature and mercurial reflections of the underlying economics of the trading cargoes and their own market dynamics thereof. In statistics, volatility is expressed as standard deviation, but it’s hard expressing shipping in terms of standard deviations when in the last decade, in the VLCC and capesize markets – allegedly two of the most volatile sub-sectors on the industry, spot rates have ranged from zero to more than $200,000 pd, with an average rate below $50,000 pd, depending on the time window used for the calculations.

Fortunes have been made (and lost) in shipping for those who were perspicacious enough or audacious enough or lucky enough to make the right bets at the right time, usually bets on riding the wave of a strategic shift in the markets. Probably the most famous examples have been the success of the ‘Golden Greeks’ Aristotle Onassis and Stavros Niarchos building ever bigger tankers accommodating the huge discoveries of crude oil in Middle East and the rapidly improving standards of the middle class in the US and its exponential energy demands (think of the 5,000 cc Cadillacs, etc)

Besides the changing dynamics of demand for tonnage that can cause big waves in shipping, sometimes structural shifts in tonnage supply can have as much impact on successfully making bets.

While we were re-reading recently   ‘Last of the Cape Horners', a book based on firsthand accounts of seamen sailing on the last voyages of full rigged vessels around the Cape Horn, south of the Land of Fire and through the Drake Passage, we were reminded that every so often shifts in tonnage supply have also been a great wealth creator (or destroyer) in shipping.

In the middle of the 19th century, the ‘tea trade’ was the golden age of the clipper vessels, usually three-masted, square-rigged vessels that had relatively narrow beam for their length

Rounding the Horn, unknown date (source: Wiki)

Rounding the Horn, unknown date (source: Wiki)

and relatively small cargo capacity for their size and could ‘clip’ the waves. The clippers were the vessels of preference for the ‘grain race’ and ‘opium war’ trades with the East Indies, China, Australia and the colonies (the „Cutty Sark” at the National Maritime Museum in Greenwich, UK is an eminent sample of such vessels).  The introduction of steam and the steamship of the industrial revolution forced originally the evolution and building of barques and windjammers  (steel-hulled vessels with five or more masts and squared rigs) where cargo capacity maximization was more important than speed in an effort to compete with steamships.  By the first decades of the 20th century it became obvious that the steamship was the way of the future.  The technical obsolesce for sailing ships forced the sale of many of those vessels at scrap-related prices to ‘poor’ then Scandinavian countries (mainly, Norway and Finland) with maritime tradition; the windjammer „Parma” was sold in 1932 at scrap related pricing of $10,000 to Finnish buyers, but she made for them $40,000 profit in her first year of ownership.

Fast forward several decades later, and the introduction of double-hull tankers forced many owners to sell their fleets of single-hull tonnage; the move was pronounced by the publicly traded owners who wanted to present early to Wall Street their environmental credentials, about fifteen years ago, and well before the ‘drop dead’ deadline of 2010.  Most of these vessels were sold at scrap related prices, and their buyers (mostly independent Greek, Norwegian and Asian shipowners) made a killing when the market subsequently took off and there was little differentiation between single- and double-hull freight rates. The technical obsolesce of the single-hull tonnage was the fortune creator of many a modern shipping fortunes.  Again, the successful bet had been on buying good quality, fairly modern vessels with the ‘stigma’ of the single-hull, and not primarily buying the brand-new, double-hull vessels at elevated prices (elevated due to increased demand as the ‘herd’ shift was taking on, and also improvements in the freight rate market).

Since the collapse of freight rates in 2008, the mantra of the shipping industry (at least a section of it) has been about ‘eco design’ vessels and an ensuing program of heavy newbuilding (despite the continuous malaise of the markets).  In our humble opinion, many of these newbuilding orders are not justified, and the main effect will be keeping the markets oversupplied for years to come; although this will eventually force out of the market ‘bad’ vessels (and there are plenty of them, even some modern of them from ‘greenfield’ yards), it will keep vessel prices depressed indiscriminately even for modern, quality vessels. There will be sharp and astute vessel operators and managers who would make a fortune from such vessels.

The barque „Parma” in 1931 established the fastest sailing time by a sailing ship, reaching Falmouth, Cornwall, England from Port Victoria in South Australia in just 83 days when the ‘average’ time was about 120 days.  Between her sleek hull and the favorable weather, the vessel had spread its full suit of sails for most of the voyage, including the royals (light, usually fair weather sails set high on mast of square-riggers).  It was indeed a sailing deserving ‘royal’ appreciation in its own feat but also as a herald of her remaining trading life…

The stories old ships can tell…

Barque „Parma" (source: Wiki)

Barque „Parma” (source: Wiki)

© 2013 Basil M Karatzas & Karatzas Marine Advisors & Co.

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Shipping Paranoia

In one of the best business books ever written, in our opinion, ‘Only the Paranoid Survive‘ by the former CEO and Chairman of Intel Andy Grove, the then young executive Grove is agonizing with Gordon Moore, co-founder of Intel and brilliant engineer (of the ‘Moore’s Law’ fame in the semiconductor industry), about the price war ensued by the Japanese in the DRAM memory chip business and Intel’s precarious position.

Only the Paranoid Survive

Only the Paranoid Survive

Grove recalls early in the book:

“I looked out the window at the Ferris wheel of the Great America amusement park revolving in the distance, then I turned back to Gordon and I asked, “If we got kicked out and the board brought in a new CEO, what do you think he would do?” Gordon answered without hesitation, “He would get us out of memories.” I stared at him, numb, then said, “Why shouldn’t you and I walk out the door, come back and do it ourselves?”

This may seem like a casual observation, but Intel effectively invented the DRAM chips and Moore’s suggestion to get out the market was almost sacrilegious.  Intel did indeed move away from memory chips and into value-added ‘mother boards’ and laughed all the way to the bank for the next decade or so by riding the ‘Wintel’ infrastructure of the PC market. (Different times, different gadgets!)

It’s amazing how vested people become in a situation, whether job or company or industry. As long as one is on the ‘inside’, the never-ending cyclical path around the water well seems to be a purpose by itself. It takes often some stepping-back in order for one to get a better perspective of the right priorities, like Grove’s insightful question what would a new team with a clean slate and mandate do to solve a problem.  Apparently both Grove and Moore had intimate knowledge of the company, the industry and the engineering behind them and the answer become obvious instantly; a new team may have to spend time on consulting reports, take more time, do their own analysis and possibly could never see the ‘light’.

Shipping and maritime are integral industries in our every day lives, and no doubt they will remain important going forward. However, the dramatic drop in asset prices (compared to 2008 peak pricing levels) has induced a tremendous wave of newbuildings. It almost seems like a race to the shipyards (at least the ones that provide competitive pricing and lenient payment terms) to build more and more vessels in the mainstream markets; bit more fuel efficient than older vessels, bit bigger in cargo capacity within same asset class, bit better standards of workmanship than the ones from fresh yards a few short years ago.  However, in our opinion, the amount in newbuildings is not justified by the market economics and demand for cargo.

2013 09SEP PARANOIA B

We run two basic scenarios evaluating historic returns on major asset classes in shipping: under the first, long-term scenario (TABLE 1), the vessels were bought and paid for at the beginning of 2001 and were held till present; purchase price and residual price are real (nominal) prices and freight rates have been the average freight for the whole period; operating expenses (inclusive drydock) are shown in the table herebelow for each category; also, it is assumed 60% mortgage on the vessels at 6% interest rate. The IRR is calculated for each asset class, and the returns have been ranging from single digit rates (MR tankers with 8%) to highly respectable 37% for capesize vessels. It needs to be noted that historically, 2001 has been a good year for one to enter the market and the almost twelve years of this scenario include the best shipping cycle known to man.

Under the second scenario (TABLE 2), since the beginning of 2006 till present, the same assumptions have been maintained.  Returns however under this scenario range from negative returns to barely adequate of 14% again for capesize vessels.  In 2006 asset prices had already moved significantly higher than 2001 and since then, there has been ‘the best of times and worst of times’ in terms of freight rates with extreme example in early 2008 capesize and VLCC freight rates at $150,000 pd spot market and negative freight rates in 2009 and 2010 (‘back haul’ to reposition vessels).

We acknowledge that our scenarios are rather simplistic by presuming average rates and average financing terms and holding onto the assets, thus excluding any ‘asset play’ (capital gain from asset appreciation) when sometimes where most of the opportunity lies in a highly volatile industry like shipping.

Shipping and maritime are rather risky business and the cost of capital (discount rate) has to be rather high. The achieved historic returns really do not justify an investor being aggressive on acquisition pricing or one orderbook.

Going back to the newbuilding race, are investors are losing the trees for the forest? The vessels for the ocean? Revisiting Grove’s question, if one was not vested in a company or an asset class or the industry, what would have been the ‘right’ thing to do?

© 2013 Basil M Karatzas & Karatzas Marine Advisors & Co.

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The Cape Debate

The Financial Times recently had a lengthy article in their ‘analysis page’ titled the ‘Clash of the Cape Crusaders.’ People in shipping may be excused for thinking that an international, mainstream business newspaper was dedicating a whole page discussing at length the ‘Cape market.’ In the case of the FT however, ‘Cape’ referred to ‘Cyclically Adjusted Price Earnings’ ratio; according to the way PE is adjusted for cyclicality, the broader US stock market can be either undervalued or overvalued. Based on the same benchmark.

Shipping’s capesize market has been experiencing a resurrection recently that has got many industry pundits wondering whether the worst is behind us or just that the recent improvement in this market is a just another ‘false positive’ sign.  Thus, shipping’s own cape debate is whether the market is overvalued or undervalued in its own small universe. Not a small question, really.

First the good news: in the first ten days of September, average capesize rates moved from about $15,000 pd to $27,00 pd (up 80%), while the Baltic Capesize Index (BCI) climbed about 1,000 points to 3,243 (up 45%) and transport cost by 31% from West Australia to Qingdao (China) at $12.1 / ton and about 18% higher on the Tubarao (Brazil) – Qingdao (China) route to $ 23.5 / ton.   Given that this time last year capes, on average, were earning less than $5,000 pd, and that it costs about $8,500 pd in daily operating expenses to run such a vessel, the present rate of $27,000 pd is a most welcome development!  In long forgotten days, such rates may have been a cause to pop a champagne bottle.

As great the improvement in rates as it has been, we all sort of have seen this story before where rates improved seasonally / temporarily and then deflated rapidly again.  However, it seems that the increase in rates this time is driven by end demand and higher production of steel bars in China, which translates into higher demand for iron ore (while quite often in the recent past, increase in freight rates was driven by pure stock piling / replenishing inventories).  Bloomberg reported that steel reinforcement-bar futures in Shanghai have climbed to $613 per ton recently, while steel output has increased to 2.12 million tons in late August.  These all despite the fact that iron pricing is up about 25% in the last three months at $138 / ton and iron ore stockpiles stand about 22% lower than the year ago.

Thus, so far, the news is fairly encouraging, which is most welcome in a market that has been brutally battered by the storms of the weakening word trade and other market dynamic considerations.

Now, the bad news: Rio Tinto has announced an earlier than expected iron ore new capacity to 290 million tons (from 230 million tons previously) on an annual basis. This would have been ‘great‘ news, if not that most of this new production and also additional production coming to market by other miners is taking place in West Australia, which is much closer to China than new production in Brazil, which would had absorbed much more tonnage for the transport of same amount of cargo.

And more bad news: while in the last three months about six capes per month were entering the market via deliveries from shipbuilders (vs more than 15 deliveries per month in 2012), still more than twice as many capes delivered this year than got scrapped (about 70 deliveries vs 30 scrapings); year-to-date, about 130 newbuildings (plus 30 more options) were ordered.  Admittedly it’s tough sourcing rumor from fact on these ‘orders’ and still to be seen how many of these newbuilding vessels will eventually ‘hit the water’, but it’s almost incomprehensible that 10% of the world cape fleet has just been contracted anew in 2013 when on average, year-to-date, average cape freight rates ($10,500 pd) remained just above operating expense levels.  The overall cape orderbook stands at about 20% of the world cape fleet (depending on assumptions), while more than 50% of the world cape fleet is newer than five years old.

Looking at the forward curve for some guidance, while the physical freight market for capes improved and the paper market (FFAs) moved along to same levels for Q4 2013, the forward curve for the next three years stands sizably lower at about $18,500 (admittedly much higher than the level of $11,500 for CAL14 in early June but nowhere close to level covering cash expenses).

The recent developments in the cape market, as welcome and encouraging as they have been, still have not changed our bearish assessment in an earlier posting on this site. It will take more than a market rally to make us reconsider. It’s not that demand is not there…

In our opinion, the shipping ‘cape debate’ is bit clearer to award than the CAPE debate on the US stock markets, in our opinion …

© 2013 Basil M Karatzas & Karatzas Marine Advisors & Co.

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Small details that make a big difference for FMV in shipping

While most of the ink spent on debating valuation methodology in shipping is about the (coarse and fine) differences among the three primary valuation methods (please see previous note on our blog), no much attention is paid on the finer points of the Fair Market Approach (FMV). The FMV is the method used by default in loan agreements, and it’s supposed to be the only ‘real’ valuation method, as it reflects the price the market will pay for the asset, fair and square.

The point is that what is reported in the market place and what actually took place is not necessarily true or it doesn’t truly reflect reality.  Here are a few quick points to consider next time one ponders whether a new sale is above or below ‘last done’ and how the market is trending:

Finding a price of a 20 Oz. bottle of Coca Cola is very easy; one can do this by just walking in the closest convenience or grocery store and the price is posted right there for all to see.  One doesn’t even have to enter into a transaction to discover the price. Probably a store close-by will have a very similar price, again posted for comparison.  An upscale store or a store in an expensive neighborhood can be expected to have a higher price, and if one can wait till the weekend to buy in bulk at Costco, the price would be meaningfully discounted. There is a great deal of market transparency, which has become even more effective in the age of the internet and smartphones; there are even apps that allow for instant price checking while shopping.  Only if the waters were so clear for price checking in shipping!  A lot of the sale & purchase deals are bilateral and they may involve a broker (or a couple of brokers), thus only a handful number of parties know the intimate details of the transaction and the pricing. Maybe the second-best buyer (and their broker) suspect the real price (i.e they know they offered $X for the vessel, and they lost, so the actual price logically has to be at least $X+1); again, this is only a suspicion and again it’s based on the assumption that buyer and seller are rational (or it was an arm’s length transaction; however, precious little prohibits from the sale taking place at $X-1, but that may be found under the ‘agency theory’.) So, two or three parties really know the fine pricing point where title of ownership took place, and these parties perhaps do not have interest to divulge the exact details to the market for many reasons, ranging from privacy to protecting a competitive advantage. Thus, what is reported in the market (usually by way of broker reports) is not necessarily accurate, for legitimate or bad reasons; our background in sale & purchase confirms such point; a great deal of the reports of deals we were involved with were misrepresented to a certain extent, once or twice misreported to the extent of ignorance.

Then, besides the price, we have to deal with the subject market itself: we all can agree that a 12 Oz. bottle of Coca Cola is a very standardized ‘commodity’ in a certain geographic market, from content, to packaging, to labeling, etc  However, what is a ship?  It’s more than a philosophical or a poetic question than ‘what’s in a name?’ Even vessels built on the same design cannot necessarily be exact copies; some got more TLC from their owners during construction in terms of attention to detail and good craftsmanship and also more attention after their delivery. We do not mean necessarily vessels built on same design from different yards, but vessels built on same design by the same yard and have subsequent hull numbering. It has been known that many young yards (some of them ‘greenfield’ yards) were building vessels fast enough to just stay afloat for the next year. Yes, there is price differentiation between vessels coming from good and bad yards, good and bad owners, etc but again, the fine detail of specification, design and maintenance of the vessel is not widely known. In a market where even the name of the manufacturer is not much of solace for quality consistency ‘that which we call a modern bulker, by any other name would rust as fast,’ if we were to take the poetic liberty to have Juliet get involved in shipping. And of course, there is the point of the owner and vessel manager, where the standards of maintenance and spare parts onboard differentiate the ‘stable’ vessels come from.  You see, certain managers take at face value the old saying that vessels are referred to as ‘she’ because like women demand constant attention; and, the more the attention they attract, the better their standing in their social circle (market place).  It’s not a 20 Oz. Coca Cola bottle situation here, comparing apples to apples.

Vessels are required to be drydocked every five or two-and-a-half years at a cost that can range in the million dollar range.  In today’s market, consideration is given on pricing for the vessel’s ‘survey position’, that is when the vessel is drydock due.  However, an owner intending to sell the vessel right after her drydock, they may opt for the ‘lipstick on a pig’ treatment rather than more fundamental maintenance; and, a serious buyer may opt for a vessel purchase pre-drydock in order to have the opportunity for a thorough preventive maintenance schedule at a much higher cost.  In short, the ‘survey position’ adjustment can be opaque (one ‘had to be there’ to know for sure) or can be completely subjective based on the buyer’s trading and maintenance standards, and optimal points of competence and convenience.

Another consideration on the fair market value goes back to the gross and net price of the vessel; there are commissions that can make a big difference on the pricing; it could be that there are several brokers involved, or that there is a hefty ‘address commission’ where effectively the buyer or the seller or both are subsidizing their in-house brokerage business by adding another commission. There is a sizeable difference on the pricing of a vessel if the commission is just the ‘standard’ 1% or 5% including ‘address commission’ but market reports refer to the ‘gross’ number.

How about the location of the delivery of the vessel to her new buyer? A vessel delivered close to a loading port when she can immediately start earning freight revenue is a much more preferable location than a delivery closer to the discharge port.  For smaller vessels in the dry bulk market, the difference between ‘loading’ and ‘discharge’ ports may be as convenient as shifting the vessel from one berth to another in the same harbor; however, for bigger vessels like supertankers or capesize vessels, the ‘loading’ and the ‘discharge’ ports can be half-a-world apart (like Middle East and US Gulf Coast for VLCCs, or Brazil and China for capesize vessels); at today’s bunker pricing, repositioning a vessel on one of these trades can be one to two million dollars; plus, their  is the operational expense to reposition the vessel to the new loading port. According to NSF template (Norwegian Sale Form), it’s the seller that determines the actual delivery location of the vessel, but within a range of ports mutually pre-agreed between seller and buyer. So, two identical vessels (with our point above notwithstanding on exact duplicates) that are sold at two different locations could be apart a few million dollars; but when vessel sales are reported, location delivery is always ignored.

There is a standard definition for fair market value about willing seller and willing buyer, etc where market comparable valuations are based; the standard valuation methodology in shipping does not require an objective, physical inspection of the vessel, and also, as an industry practice, vessels of same size and design are assumed duplicates for valuation purposes. The fair market valuation methodology has often been ‘abused’ in our opinion; here, we went tangentially about a few of the points that routinely are ignored on the pricing and determining what’s really the market price; and, we have focused here on market transparency solely, and we have not touched at all the situation when the buyer or the seller, while both ‘willing’, can exert disproportionally more pressure on the other side and command higher control of the transaction and its outcome.

We wish that shipping was as poetic as Anne Sexton’s lines:

‘Water so clear you could

read a book through it.’

Well, that will be the subject of a subsequent posting …

© 2013 Basil M Karatzas & Karatzas Marine Advisors & Co.

No part of this blog can be reproduced by any means and under any circumstances, whatsoever, in whole or in part, without proper attribution or the consent of the copyright and trademark holders.