Major Industry Trends
Before the global downturn began to cause export volumes across the world, particularly in China, to contract sharply, the global shipping sector had placed some of the biggest bets in the sector’s history. These bets took the form of billions of dollars spent on a new generation of extra-large container vessels. If developed countries manage to shrug off the present deep recession and return to growth by the end of 2009, then all may yet be well for the shipping-line owners who placed these large orders. However, in March 2009, that is far from a given.
Nor is it just the huge container lines that are suffering. Bulk dry carriers, accustomed to an endless stream of orders to bring iron ore and steel from commodity-exporting countries to feed China’s massive building boom (the country was, before the downturn, committed to building 200 new cities), are now also faced with collapsing demand.
Niche business sectors in shipping, a sector that is rich in niche opportunities, are faring better, but they, too, are under pressure. LNG (liquid natural gas) carriers looked like an excellent investment at the height of the boom, back at the start of 2007. The world was hungry for gas as a cleaner alternative to oil, and a major global power production program based on newly built gas-generation power plants fueled demand for security of supply.
However, by January 2009, Lloyds List was reporting that some 30 LNG carriers from a tradable fleet of about 287 were sitting idle. According to Lloyds List, this wasn’t the end of the matter because advanced orders for new LNG carriers, placed in the boom times, meant that another 48 LNG carriers are due for delivery through the course of 2009. This creates a tremendous volume of spare capacity, driving shipping prices down to new lows.
For this sector, there is some hope in that cities need power, even in a downturn, and new gas-generation plants provide a greener alternative, whatever the state of the economy. Moreover, there are several major LNG projects due to come on stream in 2009. Lloyds List cites projects in Qatar, Russia, and Yemen, all of which are due to start shipping LNG to customers before the end of the year.
Lloyds List quotes Lorentzen & Stemoco analyst, Steve Engelen, who commented that “market utilization of LNG shipping capacity in 2008 was only 60%, which is extremely low.” Engelen thought that LNG carrier owners would fare better in 2009 as the new projects came on stream. Qatar alone is scheduled to increase LNG capacity by about 24 million metric tons, which should push the global LNG carrier fleet capacity to about 75% utilization by the end of 2009.
Interestingly, the total of 30 or so idle LNG carriers at present does not include an additional 20 or so older LNG carriers which could still find demand in a buoyant market, but which are now rusting in ports around the world. In 2008, the global LNG fleet was swollen by some 50 new LNG carrier deliveries, so the scrapping of the oldest and smallest ships in the global fleet “failed to dent tonnage,” according to Lloyds List.
The main drama, though, is being played out in the container market. Containers were the invention of the North Carolina entrepreneur, Malcom McLean, back in 1956, and they have completely revolutionized the transport of goods and cargo worldwide. In fact, many credit containerization for the globalization of trade, as containers make it very easy for many manufacturers to ship their specific products as part of a large, general shipment. When McLean invented the container, it cost almost US$6 a ton to hand-load a ton of cargo on to or off a ship. Using containers, that price comes down to 16¢ (source: wikipedia.org). The container was a huge step beyond the previous best “invention,” namely palletted goods in break bulk cargoes.
The novel element in McLean’s approach was the idea of a sealed, steel box that was never opened in transit, and that could be speedily loaded, unloaded and transshipped, or switched from rail to ship to road freight. The transformation of the whole process of shipping goods around the world was immense. Instead of having to unload ships by hand (or, in more modern times, by cranes swinging pallets of goods onshore to be checked, then warehoused until they could be freighted out), containerized goods take very little time to shift from ship to shore, or vice versa, and there is no checking of goods because the containers are sealed.
From there, the shipping industry slowly but surely moved in the direction of economies of scale. The fixed overhead costs associated with shipping a container come down when the number of containers being shipped goes up. When the world is booming, and the demand for container shipments is huge, this approach provides a fast route to superior profits. The largest of today’s container ships are some 400 metres in length and 55 metres wide. They can carry 13,000 containers, or 50% more containers than the biggest ships in 2003/2004.
Ironically, in a downturn, huge container vessels lose their appeal. Instead, it is the despised, “high cost,” smaller container vessels of yesterday that suddenly look much the better bet.
Market Analysis
According to the Financial Times, the spot rate for moving a 40-foot container from Hong Kong to Rotterdam stood at US$2,700 in fall 2007. By December 2008, that price had fallen to US$200. Container trade between Asia and Europe has grown year on year, and the volumes for 2007 were 16.5% higher than in 2006. However, for the first time in its short history, analysts expect container traffic on this sea route to contract. For an industry accustomed to double-digit growth over the last seven years—ever since China joined the World Trade Organization (WTO)—this is a cataclysmic fall. It has placed the future of entire shipping lines in jeopardy.
The Financial Times quotes the view of Nick Sjoberg of Braemar Shipping Services, a London shipbroker, that, in total, ship owners around the world need to find some US$500 billion to pay for new ship purchases to which they are irrevocably committed. These ships are currently being built in shipyards around the world, and the builders will expect payment. Unfortunately for the shipping line owners, the credit crunch and the downturn have hit them with a double whammy, as both make banks and other sources of funding, including private equity, much more reluctant to finance ship purchases. Not only do the banks not have the capital to make the loans, but such loans now also look much more risky and much less compelling. There is no particular logic in investing simply to build up spare capacity that no one wants, or is likely to need for the next few years.
What is bad news for the shipping lines could be a silver lining in the current downturn for exporters, assuming they can find some demand for their goods. Shipping is now so cheap that it is probably more competitive, in many instances, for them to send containers of their goods half way around the world to new markets, than it is for them to truck their goods a few hundred miles to their own cities.
One of the peculiar features of containerized sea traffic is that it has developed as a cooperative play among shipping lines, who collaborate to ensure that ships run a week apart on a circular route. With the ships running at a good speed, it takes 56 days and eight ships to achieve the desired frequency. However, in the downturn, shipping lines are instructing their ships to lower their speed to conserve fuel, easily the single biggest overhead for a shipping line (apart from the ship itself). According to the Financial Times, Asia-Europe round trips utilizing fuel-saving measures take an additional week and require an additional ship. The net result for shippers is fewer options when it comes to picking sailing times, and probably fewer ports to pick from. It also means that their goods will take a week longer to get to market. On the plus side, competitive pressure has, as we have seen, pushed the rates right down.
This has become a source of concern to the industry. The chief executives of a number of shipping lines are members of an organization, a “research and discussion group,” called the Transpacific Stabilization Agreement (TSA). They met in Tokyo in March 2009 to thrash out an agreement to ensure that service contracts between shipping lines and shippers are not struck at the unsustainable rates that developed as a trend during the 2008 off-peak winter season.
According to a press release issued by the TSA, ship owners agreed to ensure that the damaging practice of not charging shipping clients the full rate for fuel consumed on the journey was ended. “Lines have also indicated their intention to ensure that progress made in 2008/2009 contracting, which produced an improved level of fuel-cost recovery, continues,” the TSA said.
The group represents 14 TSA carrier CEOs, and all 14 agreed that any short-term rate contracts struck over the four to five months prior to March 2009 would be terminated at the latest by 30 June 2009, giving lines a chance to reintroduce sensible pricing.
However, the TSA faces a very similar problem to OPEC, the organization of petroleum exporters, in the oil world, in that when conditions become this tight, survival becomes the name of the game, and individual owners, just like some petroleum exporters, have a tendency to break rank and strike whatever deals they can. TSA chairman, Ronald Widdows, admitted that despite an earlier, similar announcement by TSA, the behavior of carrier owners had contributed to further erosion in pricing. This had eaten into a number of different cargo segments, and affected what the industry calls “non-compensatory rates” (i.e. loss-making rates have crept in).
“Everyone involved in this trade faces the certainty of significant losses, if quick action is not taken to approach the upcoming round of contract negotiations, with a renewed focus on rates that will support continued servicing of this market. It will be evident shortly whether member lines individually can rise to the challenge,” he commented.
There are some signs of potential life, however. The Baltic Dry Index is an index of freight shipping maintained by the Baltic Exchange, based in London. It provides a measure of the daily average cost of shipping bulk dry commodities such as iron ore, coal, and grain. As global growth is the major driver of increased shipping of bulk loads around the world, and as these contracts are struck months in advance of the goods actually being shipped, the Baltic Dry Index offers a very good window into whether the world’s trade is contracting or expanding. In basic terms, the higher the demand is for bulk freight around the world, the higher the index rises. If it falls away, then that is a sign that trade will contract sharply some months hence. In the fourth quarter of 2008, after a near-continuous climb, the Baltic Dry Index chart plummeted, taking shipping volumes back two decades. By the end of the year, the index had dropped by more than 90%. However, the latest chart for the index in March 2009 showed substantial activity. One reading of this is that manufacturers around the world are gearing up for what they hope will be an upturn in the fourth quarter of 2009.
The Baltic Exchange’s own magazine, The Baltic, ran an article in March 2009 titled “Light at the end of the tunnel?” on the state of the bulk dry carrier market. It pointed out that, in February 2009, “for the first time in several months, the dry-bulk market appeared to be showing signs of growth.” The index itself, the article points out, recorded the biggest one-day rise in 24 years, with a 14% leap on February 4, 2009. This was not sufficient to restore the market to its old levels from its record fall, but it was encouraging. There is considerable optimism in the sector that the stimulus package that the Chinese government has put in place, amounting to close to US$1 trillion, will add an additional 1.5 percentage points of growth to China’s GDP this year. That should ensure that Chinese demand for iron ore picks up again, and that will be good news for shipping lines. However, the sector badly needs global export activity to pick up, and Japan’s exporting falling by 50% and more in the fourth quarter of 2008 was not good news.
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