Dry Bulkers Brace for Brutal Impact
If you own shares of any dry bulk industry stock, or for that matter any commodity exposure, you owe it to yourself to listen to Diana Shipping's Q1 conference call, and to consider the resurrected warnings from Diana's astute and seasoned President, Anastasios Margaronis.
Here is my article discussing the issue:
And here are some salient excerpts from the conference call transcript:
From the conference call transcript:
We feel that the signals emanating from the market are, indeed, confirming our very cautious expectations experienced as far back as May 2009 when we said quote, "Beyond the short-term optimism, it is difficult to envisage a scenario not centered on
a sharp freight market recession. The length and the depth of this recession will depend on the evolution of the global economy."
Later, during that conference call, we went on to say, "The challenge for most shipping companies will be to survive over the next two years or so, and then optimism will hopefully return to the industry. In the meantime, opportunities will present
themselves to acquire inexpensive assets with significant capital appreciation potential."
Truth be told, the unexpected strength of the economic recovery in 2010 and the delayed deliveries of several new building bulkers, not to mention the outright cancellations, resulted in 2010 being a pretty decent year at least after the beginning of
the last quarter. However, the inevitable cannot be indefinitely postponed regardless of the short- or medium-term factors which might temporarily at least influence the supply/demand balance of bulk shipping.
Let us have a brief look at the macroeconomic factors, which will have their influence on demand for bulk carriers of all sizes over the next few quarters. The IMF has recently lowered its forecast for US economic growth for 2011, predicting that higher
oil prices and the slow pace of job creation will restrain the pace of recovery.
US gross domestic product growth is now expected to expand at 2.8% this year, down from 3% predicted earlier on. This was confirmed by first-quarter growth figures coming in at 1.8% annual rate with government spending declining by the most since
1983 and bad weather leading to increases in food prices, which in turn has an adverse effect on consumer trending. Nevertheless, consumer spending which was up 0.7% during the first quarter grew more than had been anticipated. However, this cannot
be expected to continue going forward unless more favorable conditions return to the marketplace. In March Japan's manufacturing deteriorated at the fastest pace in at least nine years, underscoring forecasts for the economy to shrink in the aftermath of the earthquake and nuclear disaster. Factory output fell by 15.3% from February, and household spending declined 8.5% from a year earlier. (inaudible) Japan topped its growth estimates for the ending March 2012 to 0.6% from January's prediction of 1.6%.
In China the [12th] five-year plan lowers the target of GDP growth to 7% per annum over the next five years compared to actual growth over the last five years of 10.6% per annum. This implies that growth in the Chinese economy will be slower than at any
time in the last decade. First-quarter GDP growth in China came in at 9.7%, and growth for the whole of 2011, according to the economist intelligence unit, was predicted at 9%, while for 2012 the estimates for growth was 8.7%. Growth in Europe's services and manufacturing industries slowed in March after surging energy costs in Japan's earthquake clouded global growth prospects. The latest forecast for growth in the euro area, according to the economy's intelligence unit, stands at 1.75% for 2011 and the same for 2012.
Therefore, we see that overall world growth is expected to slow rather than accelerate, and unless energy prices come down fairly soon, it is logical to assume that more downward revisions of growth forecasts can be expected. And it is that omen, as
regards the market ability to absorb the anticipated increases in the size of the world bulk carrier fleet net of scrapping, which we will talk about later on.
Let's turn to bulk carrier demand. Starting with the most likely effects of the Japanese earthquake and the demand for raw material imports to that country, we agreed with the view asserted by [Galbraith] that more and more domestic production will be focused internally to aid in the rebuilding process. The power supply disruptions will affect manufacturing and production output, as well as the Japanese export trades. All the above will most likely create a drop in shipping demand for the next couple of quarters as industries and their logistical chains try to recover from the devastating effects of the recent earthquake.
Looking at steel production on a worldwide basis, the 64 countries reporting to the World Steel Association reported production of 372 million tonnes for the first quarter of 2011, which was 8.8% higher than the first quarter of 2010. Chinese steel production
has overcome pressures created by the surge in steel stockpiles during February and March and going forward is expected to increase modestly, thus supporting the overall growth figures referred to above.
As for iron ore, Clarkson predicts an increase in total world imports of 7% during 2011, bringing the expected total volume to 1.055 billion tonnes, a new world record. Very little growth is expected in the supply of Indian iron ore to China, and again, according to Clarkson, that would make it increasingly hard for Chinese steel mills to find greater export volumes from elsewhere. At the same time, according to Commodore Research, about 81 million tonnes of iron ore is currently stockpiled at Chinese ports, an increase of 1.4 million tonnes or 2% from just a week ago. Stockpiles have remained at near record levels since the end of January, which has caused Chinese iron ore pictures to fluctuate rather wildly during the last few months. Overall Chinese iron ore demand has remained very firm, however, as steel production has been maintained at a high level.
Coking coal exports are expected according to Clarkson to reach 255 million tonnes in 2011, an increase of 5% over 2010. Japan's coking coal imports are expected to reach 77.4 million tonnes during 2011, representing a year-on-year increase of 6%. Japan
is expected to use larger quantities of steel this year for its reconstruction efforts, but Clarkson does not believe that this will necessarily lead to importation of larger volumes of raw materials used in the production of steel. It is more likely that the
country's steel mills will export less steel than in recent years, giving priority to the domestic demand for steel in the construction of housing, roads and other infrastructure projects ahead of overseas demand. Obviously this will in turn means that Japan's
overseas clients will have to get their steel from elsewhere, so the net result on the overall transportation of raw materials is very difficult to predict.
According to Clarkson, thermal coal exports are expected to reach 686 million tonnes, which, if realized, will be 4% higher in 2011 than in 2010. It now appears that the number of coal-fired power stations in Japan were more seriously damaged than
previously thought, and therefore, the country's coal-fired power generating capacity will be adversely affected over several more months. This will have an analogous negative effect on steel coal imports to that country for the rest of the year. Thus, Clarkson's projection for Japanese imports of steel coal is 126.5 million tonnes, up just 1% from 2010. However, in the long run, the energy mix in power generation will change in Japan as a result of the damage to the nuclear plants. Thermal coal and LNG are according to Clarkson most likely to fill the immediate and longer-term gap.
According to Clarkson, overall bulk commodity shipments are expected to increase by 5% in 2011 compared to 2010 and come in at just under 3.5 billion metric tonnes.
Let's turn to bulk carrier supply. In looking at projections of the world bulk carrier fleet, it is inevitable to start by looking at the order book and try and make the reasonable guess on how many vessels will actually be delivered and when. The total bulk
carrier for the book stands at 260.8 million tonnes deadweight, which is a rather daunting 47.3% of the existing fleet. The 604 Capesize bulkers on order represent about 54.5% of the existing fleet, while the 928 or so Panamaxes are just under 54% of the existing Panamax fleet. According to the contractual delivery date, deliveries are fairly evenly spread out between 2011 and 2012 with the 2012 Panamax
delivery book looking the strongest of them all at over 33 million tonnes deadweight.
In our model, we have assumed that about 40% of Capesize bulkers and an equal percentage of Panamaxes will either never be delivered or their deliveries will be delayed. This will mean that about 30 million tonnes deadweight worth of capes and
around 16 million tonnes of Panamaxes will be delivered during 2011. These ships represent gross additions to the world cape fleet of about 14% and for Panamaxes an additional 12%.
Could possible scrapping come to the rescue? To date about [3.7] million deadweight tonnes of capes and only 800,000 tonnes deadweight of Panamaxes have been scrapped. If this trend continues for the rest of the year, the net additions to the cape fleet will be reduced to 16 million deadweight tonnes, bringing the net fleet increase to around 7.5%. It has to be kept in mind, however, that the average days of capes heading for the scrap yard during 2010 and so far in 2011 has been about 26 years. Considering that only 6% of the existing cape fleet is over 25-years-old and a further 10% of the fleet is between 20- and 25-years-old, the scope of further scrapping in that size range is fairly limited unless there is a total collapse of our earnings going forward.
Finally, as mentioned by Howe Robinson in their annual dry bulk review for 2010, never in the past has scrapping taken place ahead of the shipping recession on a sufficient scale to prevent it. Under the 40% slippage assumption for Panamaxes, the additions to the fleet net of scrapping in 2011 will be brought down to 13 million deadweight tonnes, an increase of 10% of the existing fleet.
New building contracting has been another cause for concern. During 2010 newly 90 million deadweight tonnes of new buildings were contacted according to [Morris Brokers]. This has been the second highest year for dry bulk new building contracts, the
highest being 2007 at around 128 million deadweight tonnes. So far in 2011, the trend is certainly more encouraging, but the 2010 orders if they get ordered will be delay the freight market recovery we all anticipate by several quarters.
The growth of the fleet this year has seen 20.1 million deadweight tonnes delivered during the first quarter alone. Clarkson allowing for late reporting and slippage projects that 79.7 million deadweight tonnes will actually be delivered in 2011, which
is more or less the same as the tonnage delivered in 2010. This represents an overall fleet growth of 12.6%, which is difficult to reconcile with the projected 5% growth in demand.
Even if our optimistic cancellation (inaudible) slippage figures materialize and only 6% of the fleet on order during 2011 is actually delivered, the numbers are still unpleasant. We should keep in mind that nearly all vessels scheduled for delivery this year have seen construction commence, so cancellation of their deliveries is highly unlikely. The most we would realistically hope for would be a delay of some deliveries into 2012. As we have seen in the past, this will just delay the noticeable further deterioration of the supply/demand balance.
One would have expected a rather dramatic slide in asset values given the drop in bulk carrier earnings witnessed so far this year. This has not happened. So far this year we have seen a relatively modest drop in the value of modern capes and a similar drop in the value of modern Panamaxes. At the end of 2010, a modern cape was worth, according to Clarkson, approximately $50 million, even though asking prices were considerably higher, and the latest value of a similar ship today is just under $45 million.
For a modern Panamax, the values have dropped from $36 million at the end of 2010 to just under $33 million today. However, the values of very old vessels have gone up with a rise in scrapped values, which is somewhat surprising because they still do command a significant premium through their net scrap values.
We agree with the view expressed by Howe Robinson that the dry bulk market continues on a long-term cyclical downswing as the cumulative effects of fleet growth outpaces cargo growth. These conditions are expected to continue through the rest
of the year and into 2012. The Capesize vessel is most vulnerable, while Panamaxes should suffer less. As far as this year is concerned, supply/demand balance for capes is less favorable during the first half compared to the second half, while for Panamaxes the situation is the reverse.
In this climate our Company intends to continue its acquisition strategy and acquire vessels with conservative leverage. This Forex policy will continue throughout the thrust of the shipping cycle, and we are confident that Diana Shipping will not only survive this downturn, but also manage to emerge a larger company with a much greater earnings capability and profit potential when the market starts improving.