Tag Archives: cape

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.

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.

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.

Between an Australian (Iron Ore) Rock and China’s Hard Place

China’s intended policy to ‘rebalance’ their economy with a greater focus on consumption rather than investment logically could have a negative impact on shipping, especially for large vessels that transport raw commodities to China such as capesize vessels. As more money is being spent domestically on consumer products and services, including either domestically procured or imported luxury goods, where there is more ‘value added quality’ than rudimentary processing of raw materials such as for real estate and infrastructure, big dry bulk vessels may be set for a tough few next years.  A recent article in the New York Times on the ‘credit crunch’ and curtailing some of the ‘shadow banking’ may be an early precursor of what is to be expected.

The price of iron ore, the commodity with the highest seaborne trading volume after crude oil, over the last decade has increased threefold, primarily due to China’s insatiable demand due to urbanization and infrastructure-building spree. Iron ore with 62% ferrous content delivered to Tanjin has been quoted presently at about $130 per ton, a 20% improvement since May alone, when China embarked on a buying spree of the commodity in order to primarily replenish inventories.

Mining companies have been planning a $250 billion investment in order to expand capacity; most of the investment is planned by the industry’s major (and most bankable / competent) players, like Rio Tinto Group (RIO), Vale SA and BHP Billiton Ltd. (BHP), which implies a high degree of diligent execution and delivering of the projects on time. Given the lackluster world economic growth and China’s decelerating economy, most analysts expect a glut in the iron ore supply with prices set for a decline to levels around $100 per ton, on average, over the several years; some analysts even expect that temporarily iron ore may dip well below the $100 / ton mark, meaning rather bearish prospects for the commodity. As a general rule of thumb, bear commodity markets imply bear shipping markets, correspondingly, since there is a very high degree of correlation.

Just to re-ascertain the point of a bear iron ore market may not be good for the capesize vessels, most of the investments and the planned investments for increasing iron ore capacity are taking place in West Australia. In a recent report produced by Goldman Sachs, seaborne supply of iron ore is expected to grow from an estimate of about 1,150 mtpa in 2013 to approximately 1,500 mtpa in 2017, for an overall 30% increase. However, during the same interval, seaborne iron ore supply from Australia is expected to by 44% while from Brazil by ‘only’ 30%. Nothing shabby with these growth rates – as long as you are not a mining company, but, really not a cause to pop a champagne bottle for a shipowner.

Chinese Iron Ore Imports & The BCI

As anyone can quickly ascertain by taking a look at a world map, Australia is much closer to China than Brazil, and it takes three times more ships to transport the commodity from Brazil than from Australia to China. On August 16th, the Baltic Exchange in its daily report was posting the ‘C3 route’ Tubarao-Qingdao at $20.73/ton while the ‘C5 route’ W Australia-Qingdao at $9.01/ton.

The Balics

While over the next five years seaborne iron ore supply is expected to grow by 30%, the supply of capesize vessels (about 180,000 dwt) and Very Large Ore Carriers (VLOCs) (>200,000dwt) is expected to grow by 13% in the next three years, based on firmed, confirmed orders by bankable players (and thus high certainty of actual delivery of the vessels). This again is the firm, known supply, and with the shipbuilders with plenty of spare capacity and desperate need of new orders, it could easily be revised upwards. Not to mention that if iron ore gets cheaper, so it will be the case with newbuilding vessels, which could lead to another round of increased newbuilding frenzy. And, this, at a time when capesize vessels have been averaging $9,000 pd in the freight market, barely sufficient to cover their daily operating expenses (the less said the better on their financial cost, since some such vessels were bought for more than $100 million, and an ‘average’ term amortizing mortgage would presume more than $25,000 pd payment).

It has been said that you never appreciate a friend or ally until you are really in need. China in the last decade has been the cause of ‘irrational exuberance’ in shipping and its excesses thereof, and many other industries of course, such as the mining industry and their ‘commodities super-cycle’. Now that China seems to be slowing down, still to levels that many developed countries only would dream of, the ‘decoupling’ for many industries seems to be messier than expected. But again, China is full of surprises and broken projections …

© Basil M. Karatzas 2013 All Rights Reserved

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