Major Industry Trends
The shipping industry has basically been at stall speed since the global economic slowdown, apart from a brief but illusory flurry of positive activity in 2010. The outlook for 2014 is at best mixed, and the probability is that overcapacity in the container sector, in particular, will accelerate the trend toward lower rates signaled by Maersk, one of the biggest global shipping lines, in its third-quarter 2013 report.
Shipping relies heavily on global trade flows and growth in emerging markets to generate demand for tankers, bulk ore carriers, and container ships to ply from East to West and back again. As soon as trade slackens or the infrastructure build-out in the developing economies of China and India slows, the shipping industry is in trouble.
The industry has its own, highly accurate barometer of demand in the shape of the Baltic Dry Index. This 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. Shipping contracts are struck months in advance of the goods actually being shipped, so the Baltic Dry Index offers a very good window into whether the world’s trade is contracting or expanding. The higher the demand for bulk freight around the world, the higher the index. If the Baltic Dry starts to fall away, that is a sign that trade will contract sharply some months hence.
In April 2010 the Baltic Dry Index had risen by 58.5% over the previous 12 months and there was considerable optimism that the world had moved into a recovery phase, with strong emerging market growth pulling advanced markets out of their slump. However, by mid-2011 almost all that optimism had faded in the face of the European sovereign debt crisis and persistent weakness in the US economy. Inevitably, the shipping industry suffered as a result and its woes continued through 2012, which, by consensus, was a very bad year, and after some initial pick-up in 2013 things are once again looking tough for the sector.
According to an article in the December 22, 2013, edition of Drewry Maritime Research’s Container Insight, a large pool of surplus giant container ships—those able to take 8,000 to 10,000 standard containers (teu, or 20-ft equivalent unit)—is building up, with shipowners ordering a number of large vessels while shipyards are busy completing earlier orders. All of this adds up to still more overcapacity in the sector unless, as the journal puts it, “unusual service developments” are in the pipeline. The shipping industry is notoriously secretive. So it is possible (though unlikely) that ship owners might have been given a “heads-up” on developments about which the rest of the world knows little or nothing. Overcapacity is pretty easy to spot and its impact on freight costs is huge, which is good news for shippers and terrible news for the industry. As Drewry’s Container Insight points out, by the end of 2013 some 55 vessels averaging 8,600 teu will have been delivered, expanding the sector’s capacity by 18%, which is way ahead of global cargo growth. On top of this, another 40 are due for delivery in 2014, increasing capacity by a further 11.6%, with 45 more due for delivery in 2015, adding the same again. To make matters worse, the journal points out, three of the industry’s biggest shipping companies, Maersk, Mediterranean Shipping Company (MSC), and the French company CMA CMG S.A., are planning to merge their shipping operations on routes between North Europe and Asia, and on the North South route in the second quarter of 2014, which will render another 20 large container vessels surplus to requirements. Maersk for its part regards the coming merger as extremely positive and a rationalization of trade operations on the route that will maximize efficiencies and improve profits despite lower freight rates.
In a BBC interview in December 2012 Thomas Riber Knudsen, the Asia head of Maersk Line, said that the shipping industry suffers enormously from the fact that over the last few years it has only been able to generate a 1% or 2% return on its investment. “For an industry like ours this is simply not sustainable,” he told the BBC. In common with a number of major players in the industry, Maersk Shipping’s parent company, the Maersk Group, has made some very substantial investments over the last few years in E-class container ships, the largest of the current container ships. However, Maersk has no intention of making any further investments in its shipping arm for the foreseeable future, Knudsen says, citing the low return on investment and the fact that there are other businesses in the group that are able to generate a better return. There could hardly be a clearer indication of the predicament the sector is in.
History of the Container Market
The main drama, however, is being played out in the container market. Containers were the invention of the North Carolina entrepreneur Malcom McLean back in 1956. They have completely revolutionized the transport of goods and cargo worldwide, since 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 cargo on to or off a ship. Using containers, that price comes down to US$0.16 (Wikipedia, “Malcom McLean”). The container was a huge step beyond the previous best “invention”—palleted goods in individually packaged and loaded, or “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 which 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 and 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 meters in length and 55 meters wide. They can carry 13,000 containers, or 50% more containers than the biggest ships in 2003–2004.
On the positive side, the specialist liquefied natural gas (LNG) carrier section looks as if it is about to see real boom times. LNG is a cost-effective way of shipping natural gas, because when supercooled to liquid form the gas occupies 1/600th of its gaseous volume. Demand for LNG is expected to increase by 50% by 2030, according to a June 2013 briefing from the law firm, Jefferies. The sector had a false start at the height of the boom in early 2007, when investing in LNG tankers looked like an excellent idea. 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 March 2010 there were reports that freight rates for transporting spot cargoes of LNG had dropped by at least 20% since December 2009. In a briefing note to clients, the Japanese broker Nomura warned that “the sustainability of very large crude carrier (VLCC) and chemical tanker rates looks less than clear, with vessel overhang risks remaining.”
Since then, however, the rising excitement over the extraction of natural gas from vast shale deposits in the United States and China has created a real buzz in the sector. Chinese shipyards are building LNG tankers in competition with established shipyards in Japan and South Korea. According to Reuters, freight rates for LNG are likely to be high but volatile right through 2014. Reuters reckons that the handful of shipyards that can build the highly specialized LNG ships have order books stretching right through 2014, with deliveries through 2015. New-build orders are being constrained by tight bank financing, though the cost of a new-build tanker has stayed steady for the last few years at US$200 million.
“The new vessels on order will be barely enough to handle output from a slew of LNG production projects either coming on line or up for final investment decisions,” Reuters says. It also points out that up to one-tenth of the existing global LNG fleet is antiquated and no longer fit for purpose, which will allow owners to take capacity out of the market relatively easily if demand slackens. In 2002 there were just 126 LNG carriers in the world. By 2015 the number is expected to rise to 485.
In its “Shipping market review” of April 2013, Danish Ship Finance (DSF) pointed out that— despite overcapacity in the container shipping market—in general shipping lines were being very disciplined about keeping rates up and simply resting overcapacity instead of getting into price wars. Slow steaming has been a feature as well, which cuts fuel burn and keeps utilization rates higher than would otherwise be the case.
There is also a large and growing oversupply of tonnage in the crude oil tanker market, but rates are holding up in this segment according to DSF’s review. In total, the crude tanker fleet grew by 5% in 2012, while demand grew by 6%. However, when the final figures are in for 2013, DSF expects demand to have shrunk slightly over the year, as both Europe and the United States are importing less oil and from shorter distances. “Asia is the only major region expected to show positive growth in 2014,” DSF notes. However, balancing new deliveries against the general trend of declining tanker deliveries and the increased scrapping of older tankers by the industry, the global crude tanker fleet is expected to show growth of around 4% for 2013 as a whole, creating additional pressure on margins if there is no pick-up in demand.
Dry bulk demand has been insufficient to stop rates and ship values from continuing to fall, creating a double whammy for ship owners, according to DSF. At the same time, delivery of dry bulk vessels was at a record high in 2012, with 98 million deadweight tonnes added to the fleet, creating overall global fleet growth of 10% as against a demand increase of just 4%. However, DSF expects that 2013 and 2014 will show a return to more normal levels of business, with a record high level of scrapping of ships in 2013 helping to remove excess capacity. To get all the way back to normal, however, the sector is going to have to bite the bullet and go in for still more scrapping of vessels to take capacity out of the market.