Silver Linings in a Cloudy Shipping Landscape?

The precipitous decline of the Baltic Dry Index (BDI) and the multiple readings of all-time lows earlier this year have brought the abysmal state of the dry bulk market to the front pages of the international business press. Effectively, all dry bulk vessels afloat, irrespective of age, size and trade, were making $3,000 per day at the beginning of the year, if and when they could manage to find a cargo.

Three thousand dollars a day is below operating breakeven for all types of dry bulk vessels, well before taking into consideration financing costs and drydocking provisions. For any business covering only its variable costs, the future cannot be very bright.

While low freight rates will prove too painful for many shipowners and lenders, we are of the opinion that the miserable state of the market is actually its greatest hope as well. Indeed. Here’s why.

Lessons Not Learned

The market collapse in 2008 was too fast and condensed to leave any survival agony. Coming after the good years of the super-boom cycle with many owners still in a very good mood and with piles of cash in the bank, the impact and the lessons of the collapse were fast ignored.

Shipowners and institutional investors alike, failing at sourcing cheap ships from the banks, went to the shipyards and ordered massive numbers of vessels in almost every segment. While the world fleet was fairly young in 2010 (slightly over ten years of age on average), buyers of new orders were aiming at building fleets with a lower cost basis (lower shipbuilding prices than the boom years, often also subsidized with export credits) and better fuel consumption (think “eco design”).

As a result, by the end of 2013 the outstanding dry bulk orderbook had ballooned to 22 percent of the world fleet, with certain asset classes (35,000+ dwt. Handies, 80,000-dwt. Panamaxes and Newcastlemax/Capes) topping 50 percent of the existing fleet. Given the required couple of years’ lead-time for the delivery of a vessel, the present implosion of the BDI is partially the result of the newbuilding wave of 2012-2014.

However, in the present crisis, new orders for dry bulk vessels placed in 2015 dropped to approximately 18 million dwt. from approximately 67 million dwt. in 2014, an almost 75 percent decline. We see this as a silver lining in the world of dry bulk.

Fewer Newbuilds, More Scrappings

Covering only variable costs entails hard management and trading decisions, and none is costlier than drydocking a vessel and having soon to see it on a beaching yard. The low dry freight environment saw a largely expanded demolition schedule in 2015 with close to 31 million dwt. scrapped vs. approximately 16 million in 2014, an almost doubling of demolitions courtesy of the continuously weak freight market.

Checking the flip side of the coin, about 49 million dwt. was delivered in 2015 vs. 48 million in 2014, a miniscule increase courtesy again of the weak freight market, cancellations, slippage and other market retardants. Taking a combined look at deliveries and scrappings, in 2015 the world dry bulk fleet increased at a slower rate than in 2014, by 18 million dwt. in 2015 vs 32 million in 2014. A decelerating rate of supply growth is another silver lining in an otherwise cloudy sky.

Taking a longer look at the tonnage supply picture, there has been a shipyard consolidation in China in the last year with many yards, admittedly many greenfield yards, going out of business. Accurate data out of China are always hard to find, but we estimate the dry bulk shipbuilding capacity shrunk by a third in 2015. There is always the danger that these simplistic shipbuilders can easily come back to the market, but we are encouraged in the silver lining of decreasing shipbuilding capacity.

A great deal of the outstanding orderbook has been fueled by China’s credit boom of the last years, including subsidies and export credits for newbuilding orders placed in China. Again, news about China has to be taken with a grain of salt, but it seems that easy credit and/or export credits will not be available any time soon for those ordering more newbuilds. Besides, it’s difficult to extend credit in a cash flow negative market. Just another welcome silver lining on the horizon!

The Decline of “Opportunistic Money”

The collapse of the market in 2008 attracted for the first time many institutional investors to shipping, who invested in second-hand vessels, shipping equities and bonds, but mostly ordered vessels to their hearts’ content.

Opportunistic money bears part of the blame for the present state of the market, but such blame has been very expensive too: In general, most investments by institutional investors are under water at present, figuratively speaking. It’s hard to quantify the losses for the overall market, but for publicly listed companies calculations can be made with a certain degree of accuracy.

Lloyd’s List, for example, recently published that Scorpio Bulk, backed by institutional investors, realized a $400 million loss from the ordering and disposal of 28 Capesize vessels, an approximately 30 percent value destruction on the original investment. Anecdotal evidence suggests that 30 percent represents the present losses across the industry, realized or not by institutional investors in shipping.

Based on the estimate that $30 billion was invested in shipping post-2008, $10 billion is now in the bottom of the ocean. One can be sure that, after such losses, not many institutional investors want to hear about newbuilds, which in our opinion is the “silverest” of linings in this bad market because it keeps opportunistic investors away from expanding market capacity.

Catharsis and Rebirth

The present cycle is truly painful, and it’s unavoidable that many shipowners will file for protection or bankruptcy. Many investors and lenders stand to realize more losses in shipping in the coming year. It’s a pity, really, but that’s life.

We are of the opinion that a protracted and extremely bad market is actually a good thing for the market in the long term. Owners will default; banks will get aggressive with owners; ships will be forced to be scrapped sooner or later; and, hopefully sooner rather than later, investments will start taking place on fundamentals and not on gut feelings and investment themes (“eco design” has to be one for the ages). Fewer people will be around in shipping when the bloodbath is over, but they will be bigger, better capitalized, better organized and managed, and better positioned for a changing future.

We view the present pain in the market as growing pains that are necessary to make one strong. The BDI is bad, yes, but not cause for despair. There is good to come out of this ugly mess. – MarEx