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. 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. By 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 virtually 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 during 2012, which by consensus was a very bad year, and into 2013.
A CNBC report on the sector in June 2012 pointed out that the Baltic Dry had dropped by around 40% by mid-2012. Charter rates for ships were down to around US$8,000 a day, by comparison with their pre-crisis peak of US$22,000 a day, and many ships were swinging empty at anchor, tying up their owners’ money, and generating zero income.
In an interview on December 12, 2012 with the BBC, 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, the group 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.
What makes matters worse is that many companies in the sector invested heavily in new shipping at the height of the boom in 2006 and 2007. By the time these ships were delivered demand for shipping had crashed, so the industry was left with a surplus of very modern, very large vessels, and a greatly reduced order book. Because of the long lead time in building ships, new ships were being launched into that glut for some time after it became apparent that there was insufficient demand to justify expansion. Unfortunately, at the height of the 2007 boom, just prior to the global downturn, the global shipping sector committed itself to 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, which take anything from 18 months to three years to build.
The bulk dry carrier sector, too, saw fleet additions picking up strongly in the period from 2004 to 2007. During 2004–08, the average annual growth rate for the dry bulk fleet hovered around 7%, significantly above the levels of previous decades. More recently, there has been a major step change in fleet additions. In 2009, the total dry bulk fleet expanded by 10% year on year, or 42 million deadweight tonnage (dwt), the strongest growth in the fleet’s history, ending the year with 460 million dwt of capacity. On top of that, the fleet grew another 12% in 2010, adding a further 55 million dwt, after accounting for cancellations, delays, and fleet scrappage.
By way of contrast to all the gloom and doom, the specialist liquefied natural gas (LNG) carrier section looks as if it is about to see real boom times. 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 have begun building LNG tankers in competition with established shipyards in Japan and South Korea. The first LNG carrier built by a Chinese shipyard was launched in 2008, out of Hudong-Zhonghua Shipbuilding, a subsidiary of the state-owned China State Shipbuilding. In January 2011, Hudong-Zhonghau Shipbuilding won a US$1 billion contract to build four LNG carriers for ExxonMobil and Japan’s Mitsui OSK lines, and, in September 2012, it won an order from a consortium that includes Australia’s Origin Energy, the United States’ ConocoPhillips, and China’s China Petroleum and Chemical Corporation (Sinopec), for four to six LNG carriers. In 2002, there were just 126 LNG carriers in the world. By 2015, the number is expected to rise to 485.
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 cargoes worldwide, 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 onto or off a ship. Using containers, that price comes down to US$0.16 (source: Wikipedia). The container was a huge step beyond the previous best “invention,” namely palleted 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 meters in length and 55 meters wide. They can carry 13,000 containers, or 50% more containers than the biggest ships in 2003–04.
In a penetrating analysis of the current state of the shipping market, Danish Ship Finance (DSF) points out that ship owners have stopped investing for the time being. Shipyard orders are contracting, and shipyards around the world are currently running at only 30% of capacity. Some 13 million compensated gross tonnage (CGT) has contracted. DSF predicted that around 4% of the world’s shipyards would close or go inactive in 2012. By 2013 and 2014, many yards will be running out of orders. By the end of 2014, DSF believes that global capacity will have retreated back to 2008 levels.
However, DSF points out that despite overcapacity in the container shipping market, in general shipping lines have been 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. DSF expects supply growth to continue to outstrip demand during 2013, which does not bode well for the sector, the main reason for this being the arrival of new ships already in the build pipeline.
There is also a large and growing oversupply of tonnage in the crude tanker market. “The outlook for 2013 is dominated by the challenge of absorbing both the previous overhang of tonnage and another large inflow of vessels,” DSF says. Freight rates and asset values are expected to continue to remain low in 2013.