Category Archives: Shipping Market Economics

Shipping IPOs

Capital markets and shipping IPOs are once again a hot topic in shipping; high prospects and expectations from a new crop of shipping companies, quite a few now sponsored by institutional investors. Hopefully, this new round of shipping IPOs will manage to bring to the public markets a more distinguished management style than the shipping IPOs of the last decade.

Interesting article in the Tanker Operator magazine, June 2014 issue.

2014-05may-to-shipping-ipos-timing-quality

Tanker Operator article on shipping IPOs – May 2014

Please feel free to access the article in pdf here!

Trireme_picture JUN2014

A watchful eye in shipping!© 2013-2014 Basil M Karatzas & Karatzas Marine Advisors & Co.  All Rights Reserved.


 

IMPORTANT DISCLAIMER:  Access to this blog signifies the reader’s irrevocable acceptance of this disclaimer. 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 of this website. Whilst every effort has been made to ensure that information here within has been received from sources believed to be reliable and such information is believed to be accurate at the time of publishing, no warranties or assurances whatsoever are made in reference to accuracy or completeness of said information, and no liability whatsoever will be accepted for taking or failing to take any action upon any information contained in any part of this website.  Thank you for the consideration.

 

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A Reflection on Posidonia 2014

In ancient Greek mythology, Posidon (also spelled as ‘Poseidon’ and known as Neptune in the Roman mythology) was a major god of the Olympian Pantheon protecting the waters and seas. Posidon, although not as temperamental as his more famous older brother Zeus, was known from time to stir the waters for fun or just to raise hell – so to speak; his weapon was the three-pronged trident which not only caused major storms in the sea but also could shake the earth and cause earthquakes.

It’s only logical that Posidon’s name is metaphorically associated today with shipping endeavors, and a biennial conference in Greece in named in his honor. This year’s Posidonia was consummated shortly ago, and the waves of Posidon’s trident have yet to settle.

Posidonia_logo14For once, the attendance according to un-official reports has set a new high and reconfirmed Posidonia as the premier event of the shipping industry, and by association, Greece as a major shipping cluster. Close to 20,000 attendees visited the Expo where 1,843 exhibitors from 93 countries presented their businesses and products. It can be said with confidence that there has been an equally impressive amount of guests who never made it to the Expo and tried to enrich their visit by staying at the south suburbs, attending the many corporate events, enjoying great food and libations and talking shop and massaging deals at the deck of a yacht or the veranda of a private bungalow at the Astir Palace complex.

The mood was positively optimistic as the bottom of the market has definitely been considered to be behind us. While at Posidonia 2012 were still doubts about having found the market bottom, now the debate has been centered on where on earth the expected recovery is! The buoyancy and improvement of the freight markets in the second half of last year have really convinced market players that the market definitely was not dead at all but a fundamental rally was underway. As a reminder, last summer freight rates for capes VLCCs were well below operating expenses and well below $10,000 pd while by the end of the year rates has bounced fivefold. If an anemic market can bounce that strongly, what else could be the cause besides a fundamental rally? Asset prices improved by 10-50% depending on asset class from summer till spring this year and newbuilding orders were placed by the dozen, like the good old days of 2008. The rally had been impressive and the market slowdown since Easter has not been considered menacing, just a ‘breather’ for the market. A few hopeful IPOs failed to obtain a listing in the spring as well, but that’s part of the game, no more.

However, given that BDI has dropped by about 45% since March 20th (at 1621) to date (906 at present), Posidonia’s optimism had to be qualified. Yes, there has been abundant optimism that better days are ahead of us, but … several shipowners, including high profile publicly traded shipowners, openly admitted at panel discussions their disappointment with the freight market  and confessed that they were not expecting such low rates at this time of the cycle. The fact that we are heading to the summer, which seasonally is a weak freight period, it means that there may be two more months of weak earnings before the market shows any improvements. And, the rally since last year has not been ‘money in the bank’ in the traditional sense: the strong cash generated in last year’s rally has partially been used to make current shipping loans or was deployed as down-payment for newbuilding orders, thus, no excess cash has been preserved for a prolonged weak market. There even has been mentioning that some shipowners may be hitting the ‘panic button’ if the market ends the summer in such a malaise. But again, there has been the argument that trading patterns have been shifting and most of the trade takes place in the second half of the year in the last few years – such as Chinese re-stocking of inventories causing last year’s rally– and thus that no need to write off 2014 yet as not a good year for shipping; optimism has been strong that the second half of the year will be another strong positive surprise for owners and charters alike.

The optimism for the market could be sensed in the expectations for strong capital markets as basically every investment banker from New York active in shipping was in attendance and lots of meetings were noted on and off premises with IPO hopefuls. Apparently expectations are high that strong freight will return soon, and given the environment of exceptionally low interest rates and $780 billion ‘dry powder’ by the institutional investors in North America, IPO hopefuls should be ready on the runway for take off. The few IPOs that failed to obtain listing in the spring are considered one-off events and not a trend.

Private equity funds have been focal during Posidonia for the deals they have done so far in the Greek market but mostly for the ‘noise’ without deals that have done. It’s always great to have a rich partner to bankroll a venture, but there has been abundant complaining that ‘funds do not get shipping’; on the other hand, curiosity has been high on whether funds are done investing in shipping and what may be the ‘next big thing’ they may be looking in shipping: a neglected sub-sector, a local market, possibly a service industry possibly?

The strange thing is that since Posidonia 2012, the BDI has been literally flat at just above 900 points, despite some volatility within this interval. However, despite the freight market moving sideways, about 3,400 vessels have been ordered since the last Posidonia, that is about FIVE vessels each single day in the last two years.  No much happened about freight as far the indices are concerned, but tonnage supply has made a great jump.

One has to be an optimist in shipping, whether for Posidonia or not!


 

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

IMPORTANT DISCLAIMER:  Access to this blog signifies the reader’s irrevocable acceptance of this disclaimer. 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 of this website. Whilst every effort has been made to ensure that information here within has been received from sources believed to be reliable and such information is believed to be accurate at the time of publishing, no warranties or assurances whatsoever are made in reference to accuracy or completeness of said information, and no liability whatsoever will be accepted for taking or failing to take any action upon any information contained in any part of this website.  Thank you for the consideration.

Newbuildings and the ‘eco design’ debate

So far this year, the newbuilding market has been exceptionally active. There are many reasons for that, primarily because shipping is entering a long-awaited recovery but also because ‘eco design’ vessels with their economic efficiencies are expected to send non-efficient vessels to the scrapheap.   No doubt that competitive markets always navigate toward efficiencies eventually (whatever they may be) and the ‘new’ render the ‘old’ obsolete (one of the inimitable truths of nature); however, the level of newbuildings placed on order in most shipping segments, not only this year, but ever since the market crashed in 2008, assumes that older tonnage will just disappear and will find some corner of the world where they would go and die off quietly.

There is no doubt that, during peak years of the cycle, owners were ordering vessels that they were expected to be delivered fast and start earning (big) money as soon as possible. Attention to detail for engineering and design and attention to workmanship were secondary priorities since any floating device with cargo carrying capabilities was making (big) money. Especially in the dry bulk market where there was and there is no ‘honor system’ of ‘major approvals’ (vetted and approved by oil majors) and in the market for smaller tonnage where a river bank and a crane were sufficient credentials to start shipbuilding operations (‘greenfield yards’), there is an unknown amount of the existing world fleet that will never reach their design life of about twenty-five years.  It is difficult to quantify the percentage of the world fleet (primarily dry bulk and containership vessels, and again, smaller tonnage) that will have to get scrapped much sooner than later, but our own shipbrokerage experience and also anecdotal evidence suggests that in certain, particular asset classes more than 10% of the world fleet – again for certain market segments, may have to be scrapped in the next five years.

However, does accelerated technological obsolesce combined with efficient modern vessel designs justify a world fleet outstanding orderbook of 17% across all market sectors when, in general, the world fleet is newer than five-years old?

Let’s follow the industry practice: a charterer at any given market rate and at any given geographic location and within short chartering window (laycan) will charter on the spot market the best (commercial) vessel possible, that is the vessel with lowest fuel consumption and largest cargo carrying capacity for any given trade available at certain location and timeframe.  Nominally, a brand new, efficient vessel with cargo maximizing holds would get the charter at such rate; it’s logic and good business sense. However, a vessel that is a tad inferior in fuel consumption or in cargo capacity but with a lower cost basis (was cheaper at acquisition time, or has been written down through good freight rate markets or the mortgage bank eased off on claiming timely payments) can afford to underbid the competition (the top notch vessel) and accept a lower rate, just because her owner can afford to or because the owner is desperate enough. Thus, the ‘bad’ effectively drives down the market and gets the business from the ‘good’; and, even if the good vessel manages to get the business (charter) at market rate, still, they have not earned any premium over the market to compensate for the savings that can generate for the charterer; they have earned the preference of the charterer to earn their business, but no much premium over the market. For period charter market where vessels are employed for longer periods of time where financial calculations can be more rigorous and market transparency lower (and also vessel delivery location and charter window can be known well in advance and thus there is sufficient time to be addressed vs. the spot market), the charterer will give more consideration and preference for the modern vessel, but never really will pay much premium above market and definitely will not compensate dollar-for-dollar for the savings they will earn from a modern vessel. Likewise, for charterers / traders working on Contract of Affreightment (COAs) where the cost is predominantly seen as $/ton or $/bbl (vs $/d for time charters), efficiencies are more important and stronger preference for modern vessels; again, there is never dollar-per-dollar to the owner for savings reimbursement; just the preference of doing business with modern, more efficient vessels, but never an ‘obligation’ or definite commitment.  And, there always will be an owner with a lower cost basis or desperate enough to undercut the competition and any competitive advantage, and thus the whole ‘preference’ argument goes out of the window. Shipping is an almost perfect competition market, and there are very limited opportunities to earn a premium over market rate by providing superior product; shipping is a commodity business, a ‘need’ business and not a ‘want’ business like Apple’s (ticker: AAPL) where they charge for their latest cool phone exactly what the market can bear.

Another Newbuilding!

Another Newbuilding!

In the tanker market and the containership market where chartering standards and fuel efficiencies are a higher priority than in the dry bulk market, poorly designed and maintained tankers and containership vessels will become obsolete sooner than dry bulk vessels, ceteris paribus.  However, it does not mean that overnight, older tankers and containerships will become obsolete and magically disappear off the market. After all, the MT „EXXON VALDEZ’ accident in 1986 brought into effect OPA 90 regulations that forced single-hull tankers out of the market only in 2010, a cool 24-year later.  Usually, the charter market and the $ sign are more effective at driving the market than regulations, but again, scrapping a vessel, especially a modern vessel, is hard thing to do; it’s easier to give hell to competition and underbid the market first rather than irrevocably sell the vessel for demolition and take the loss.  For the dry bulk market, where charter and regulatory standards are lower and where there is a very, very long tail of charterers, those vessels can be kept profitably in the market for many, many more years to come.

MEWIS Duct Propeller (Image Source: Courtesy Becker Marine Systems)

MEWIS Duct Propeller (Image Source: Courtesy Becker Marine Systems)

Our argument is not against efficiencies (and savings and transparency) in shipping; we are strongly for it. However, we think that the newbuilding story has been taken to the extremes and accepted at face value. There has been the argument that equally commendable fuel efficiencies can be achieved by modifying existing quality vessels (with ducted / MEWIS duct propellers, etc) at a relatively low cost ($1-2 million per vessel, depending on vessel size), proposals that have been suggested or already implemented by companies like Danaos Corporation (ticker: DAC), Ardmore Shipping (ticker: ASC) and Euronav (ticker: EURN).

A potential side effect of the present newbuilding wave may be that market recovery may be longer in the offing than many market players would care to wish …

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

IMPORTANT DISCLAIMER:  Access to this blog signifies the reader’s irrevocable acceptance of this disclaimer. 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 of this website. Whilst every effort has been made to ensure that information herewithin has been received from sources believed to be reliable and believed to be accurate at the time of publishing, no warranties or assurances whatsoever are made in reference to accuracy or completeness of said information, and no liability whatsoever will be accepted for taking or failing to take any action upon any information contained in any part of this website.  Thank you for the consideration.

‘Liner Business Models’ in Shipping

The first decade of this century has been characterized not only by the strongest shipping rates of a lifetime, but also by the rise of a new breed of shipowner who was financially literate (sort of the ‘MBA President’) and capital markets savvy and highly conversant on Wall Street values; while previous generations of independent private owners were going in to great efforts to design their house flags and insignia, modern shipowners were focusing on mission statement and shareholder value optimization hanging high from the yardarm of their ships and their roadshow presentations.

True to the spirit of the decade that made securitization of debt a very profitable alchemy in the financial industry by slicing ‘composite’ into different, distinct ‘trade-able’ tranches where certain investors would appreciate especially, the shipping industry was fast on catching up with the ‘divide and conquer’ strategy of its own.  While private shipowners stack to what had worked best for them in the past, usually by trial and error and exploiting their special trades and relationships, publicly traded owners devised business models that were appealing and sale-able to Wall Street and the institutional investors primarily rather than to the shipping markets.  There were formed companies whose business models were very distinct and ‘pure plays’ such as dependent on spot VLCC market exposure or Suezmax market exposure, companies with ‘yield driven’ strategies irrespective of underlying shipping market conditions, capesize shipowners with full spot market exposure positioned as ‘China play proxy’, dry bulk owners whose chartering strategy to reflect the ubiquitous Baltic Dry Index (BDI) given there is no liquid derivative market for an investor to play directly the BDI; there were even owners who moved into the ice-class products tanker market just to fill the ‘vacuum’ of despite having several publicly traded product tanker owners, there was none in the ‘pure’ ice-class segment. Public ship ownership become a very streamlined business where a financial owner identified a segment that was missing from Wall Street, used Other People’s Money (OPM) to secure the tonnage, involve liberally as much cheap debt financing as possible, engage a third-party vessel manager on a contract basis, and charter out the vessels in the open market.

‘Mono-line’ shipping business models definitely have their advantages.  They optimize economies of scale, operational leverage and cost savings, and they level sufficient critical mass of modern tonnage to entice major charterers and trading houses.  One additional benefit of such business models is that it’s easily understood and explained to the investment community, without undue complications and multiple layers and overlaps with inputs from other market segments and industries.  For example, for a VLCC owner of ten vessels trading on the spot market, the financial model could be sweet in its succinctness: capital requirements and financial expenses were known or easily projectable, operating expenses were contractually assigned to third parties and thus publicly known, and the assumption of expected future rates to be ‘plugged into’ the financial model was really the only big unknown. Modeling out a year or so was rather easy…and unquestionably worked time and again when the times were great.

Not Linear Enough Model? (Image source: courtesy AP Moller Maersk)

Not Linear Enough Model? (Image source: courtesy AP Moller Maersk)

Fast forward to the lower arch of the business cycle and taking another view at vessel ownership, it seems that shipping companies active in markets with a narrow focus that appealed to the investors in the past, have their fair share of problems.  This observation has been valid for both private and public owners who had overweighed exposure to one market.  After all, if the VLCC market is oversupplied, in a burning cash mode for some time and with unfavorable underlying economics, a narrowly focused VLCC owner has few options…the market is the market, and no much can change in shipping in the short term (sparing an exogenous shock like a geopolitical or macro-economic event or other event of unforeseen nature such as military action, embargoes, etc.)  Such an owner, a VLCC owner will suffer in a bad market, whether the capital structure is private or public; the market is the market, as we said.  However, a public company with a VLCC mandate has few options navigating the storm, unless the management or the ‘sponsor’ has the capacity to support the company directly or through their market clout.   Things would not be much better for a private owner, except that the private owner may have saved away some of the excess profits (dividends) from the good times, or had diversified away in less volatile or lightly correlated industries like in real estate those earnings; or even may have used the excess profits to enter other shipping segments that offer different (uncorrelated) characteristics and a better chance of survival when the headwinds hit.  Shipping companies with broader diversification to be considered ‘industrial conglomerates’ like AP Moeller Maersk or MOL OSK Lines with legs in many industries and segments had never had their survival questioned during the days of the absolute gloom.  Also, staying closer to home, without having to reach ‘industrial’ scale, it’s well commented that Dryships would had survival issues when the dry bulk (capesize) market collapsed if not for the management’s ‘thinking outside the box’ and entering heavily the drillship market with the acquisition of Ocean Rig.  The recent filing of private Greek owner for an LNG IPO is also another exhibit that diversification in shipping may pay better than ‘mono liner’ plans, possibly to the extent of making the difference between survival and going under.  Whether horizontal or vertical integration / diversification is best suited is debatable, however it seems that ‘lard’ rather than ‘leanness’ make better buffers in shipping…

This article is an adaptation from an earlier posting on November 5th, 2011, at The Captain’s Log blogspot.

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

IMPORTANT DISCLAIMER:  Access to this blog signifies the reader’s irrevocable acceptance of this disclaimer and other important information and terms. 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 of this and related websites. Whilst every effort has been made to ensure that information herewithin has been received from sources believed to be reliable and believed to be accurate at the time of publishing, no warranties or assurances whatsoever are made in reference to accuracy or completeness of said information, and no liability whatsoever will be accepted for taking or failing to take any action upon any information contained in any part of this website.  Thank you kindly for your consideration.

A New Way to Make a Million Dollars?

There was a saying about the airline industry that in order for one to become a millionaire, they had to start with a billion-dollar investment.   With the Airline Deregulation Act of 1978 in the US, the regulatory barriers to entry were not stratospheric anymore, allowing for new entrants, like Southwest, to enter the market with a clean sheet, no legacy entanglements (union labor, mostly) and set a business plan – mostly like thereof – to act opportunistically and expand selectively.  With an ever expanding fleet, route and plane offerings, the market grew, ticket prices came down, and once upon entering the internet age with its easy price comparisons and choices, competition became cutthroat, and airline companies were after survival by going after market share and covering variable cost.  It was a brutal business model with a constant round of bankruptcies where legacy airliners were trying to get rid of their legacy fixed costs, such as pension obligations or get out of leases for obsolete planes, etc.  Come the liquidity crunch of the financial crisis that caused the legendary ‘tit to go dry’ of easy lending combined with skyrocketing fuel prices, airline companies had to do a reality check.

In the first decade of the century, the seat mile availability (an industry metric of airline seats available for booking) exploding, while revenue per seat and the financial condition of the airline companies was deteriorating.   Once upon having to face reality and deal with a constrained option set, airline companies started shedding off inefficient airplanes, focusing instead on strategic routes and discontinue flying on marginal ones, and, to the detriment of passengers, started optimizing pricing and charging extra fees for luggage and almost anything else for that matter, and … and … In a rare Pauline moment for the industry, the airliners understood that collective, self-imposed discipline was required for survival, and shifting focus from market share (the typical ‘we lose money on the operations but we make it up in volume’) to revenue optimization and maximizing of profit.  And to make this clear, today’s Wall Street Journal reports that Thanksgiving-week typical airfare is about 9.4% higher than last year, and Christmas-week traveling higher by about 7.3% respectively; given that seat availability is tight, prices could increase further and no last minute madness sales are expected any more from airline companies trying to fill empty seats at the last minute.

Why one should care about the airline industry’s self-discipline about capacity?  As much as we hate such self-discipline as passengers, likely we would have loved it as investors.

Like a Passing Ship!

Like a Passing Ship!

In previous postings we have raised doubts about the shipping industry’s fundamental recovery based on the amount of newbuidings that were delivered in the last few years, and mostly about the newbuildings being ordered today. We appreciate the frustration of investors / shipowners from their market point-of-view as buyers being unable to find quality tonnage in the secondary market for purchase at market related prices, since there are few vessels available for sale given that the system is ‘propped up’ all around: central banks and regulatory authorities with their quantitative easing keeping propped up bad banks which in turn keep propped up bad owners which in turn are allowed to keep trading expensive vessels in default (having earned the banks’ tolerance for servicing properly their shipping loans), and thus expensive vessels have an efficient cost basis to compete with more modern and efficient vessels.

Ordering newbuilding vessels is still a rather tempting proposition: prices are still low, especially when compared to peak market pricing, payment terms for newbuildings are favorable and fairly backloaded, and more importantly, newbuildings are better vessels since they are more fuel efficient and may also provide operational efficiencies as well (usually bigger cargo carrying capacity for same dimensions / asset class vessel.)  The logic goes that a vessel that is 15% more efficient than an existing vessel, she will crowd out the less competitive vessel; whether the vessel were to be employed under a timecharter (where the charterer pays for fuel expenses) or a voyage charter (where the shipowner pays for fuel expenses), the more efficient vessel will offer a lower transport cost per cargo unit, and thus will have preference over the less efficient one.

Looking for Guidance!

Looking for Guidance!

That’s at least what we learned in Economics 101.  What happens when tonnage capacity doubles, as it has or expected to do for certain segments, and there is no sufficient demand for all the available tonnage?  Logically owners will have to accept any charter rate, whether it’s profitable, break-even or unprofitable. What happens when the banks have given up demanding loan servicing from ‘bad’ owners and now these owners – despite their early mistake of ordering peak-expensive vessels – have actually a low cost basis that can remain competitive (only operating cost)? What happens when the ownership and chartering activity is of a very long tail nature, as it is in several market segments in shipping, most conspicuously for the smaller dry bulk vessels? There are jurisdictions and charterers who would accept such vessels that can be kept profitably trading when they are well past their design lives (although clearly top, big charterers would prefer modern, economic vessels, for many reasons.)  What happens when shipowners refuse to scrap vessels when they become economically inefficient? (admittedly, selling a vessel for scrap is a very tough, irrevocable decision that never is taken with light heart).  Frontline, among others, has recently advocated for the early scrapping of relatively new VLCCs in order for the market to get rid prematurely of tonnage that has not yet reached its design life but could clear the way for more efficient vessels and higher freight rates.  As a gesture of setting a good example, Frontline has scrapped earlier than expected a few vessels, and Mitsui OSK Lines over the last year have opted to sell fairly modern capes (sixteen and seventeen year old) for demolition rather than in the secondary market where they could achieve a small premium over scrap. But Frontline has to be a responsible corporate citizen since they are now collectively one of the biggest shipowners in the world and Mitsui OSK Lines is an industrial conglomerate that can absorb losses from shipping; try to explain the logic of early scrapping to independent, trap owners, a long line of them in every sector and in every corner of this planet.

It has been said recently that shipping is not a ‘team sport’ and that certain companies have already been benefiting from the advantages of the ‘first market mover’. No doubt.  One of the ‘charms’ of shipping is the renegade attitude of a worldwide market of perfect competition.  But again, it’s said that shipowners are their worst enemies where self-discipline is an unknown virtue.  Time will tell!

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

IMPORTANT DISCLAIMER:  Access to this blog signifies the reader’s irrevocable acceptance of this disclaimer and other important information and terms. 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 of this and related websites. Whilst every effort has been made to ensure that information herewithin has been received from sources believed to be reliable and believed to be accurate at the time of publishing, no warranties or assurances whatsoever are made in reference to accuracy or completeness of said information, and no liability whatsoever will be accepted for taking or failing to take any action upon any information contained in any part of this website.  Thank you kindly for your consideration.

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.

‘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.

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.