Tag Archives: tonnage oversupply

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.

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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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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.