Notes on Capital Link Shipping Dry Bulk Shipping Sector Forum
Today, I found a webinar from Capital Link Shipping that hosted a panel of dry bulk executives. It's from 7/22/10, but I found a lot of information quite useful. My interest in dry bulk shippers stems mainly from my ownership of shares in GNK and BALT. However, I find that following shipping provides useful insight into global steel/electricity consumption and emerging market growth.
One should be mindful in reading this blog that the information is from July 2010, so it was around the time Q2 earnings were coming out. As Q3 earnings start to come out, this information will likely need to be updated. I do know that DSX reports on Tue 10/12/10, and I'm sure other shippers will report soon as well. Luckily, some of the themes in this blog are longer in nature and will remain relevant beyond 2010.
As always, I encourage input and comments. This blog post is an amalgamation of the comments of the participants and my personal commentary, so one should use this as the starting point for discussions and should not take any of this as concrete research. I'm merely sharing my thoughts as I learn more about the global dry bulk industry.
Link to webinar: http://www.capitallinkwebinars.com/2010/drybulk_july/main.html
Babis Mazarakis, COO of EXM
Michael Bodouroglou, CEO of PRGN
Akis Tsirigakis, CEO of SBLK
Joseph Royce, CEO of TBSI
Michael Webber, senior shipping analyst at Wells Fargo Securities
Demand Side Fundamentals
Iron ore is the major driver in dry bulk trade. It represents the highest percentage of total dry bulk goods shipped. Lower iron ore prices lead to increased tonnage shipped while higher prices lead to decreased tonnage shipped.
In Q2, we've seen higher iron ore prices. Q3 is expected to see high iron ore prices as well. This has meant less buying of iron ore. I remember from Lakshmi Mittal's comments in the MT Q2 earnings call that iron ore prices have risen and they were trying to pass on the costs to customers.
With iron ore contract negotiations now being quarterly instead of yearly, the higher iron ore prices cannot stay forever. China is a major buyer of iron ore and often exits the iron ore market for prolonged periods of time when spot rates are higher than contract rates. When the spot rate comes down, China comes back in and replenishes stock piles. This leads to inherent lumpiness in iron ore demand.
It's worth noting that various entities in China increased their iron ore stockpiles in Q2 from 40 days to 72 days. Despite China's insistence on opportunistic purchases of iron ore, it will not always work out. China will have to make some purchases in the spot market from time to time anyway. This likely will cause major fluctuations in freight rates, as they will slump and rise as China enters and exits the picture.
As you can imagine, iron ore prices seem likely to come down a bit. China has slowed its steel production a bit in the midst of the housing boom and has slowed its purchases of iron ore. China is the major consumer of iron ore, as it produces more steel than the US and Europe combined. The current consensus is lower iron ore prices in Q4.
Even with China slowing its economy, long-term fundamentals remain strong. The dry bulk trade is not dependent on consumers, but more on infrastructure and energy needs. That means dry bulk executives care more about global steel and electricity consumption than about Chinese GDP or other factors. The main players are Asia, India, and other emerging markets.
Here are some interesting numbers: China accounted for 45% of seaborne iron ore and 4% of coking coal trade in 2005. The 2010 estimates for these numbers are 70% and 15% respectively. Moreover, China is expected to account for 8% of seaborne thermal coal trade in 2010. This is important because China was historically an exporter of thermal coal. We're seeing important structural changes in iron ore, coking coal, and thermal coal imports into China. This works to increase dry bulk trade.
I read an article recently posted by walt373 here about China's infrastructure being almost complete and a shift to consumption being in the cards. I'm not quite sure how complete China's infrastructure stands, but shipping and steel industry executives seem bullish long-term on China anyway. Even in a shift towards consumption, steel production will not suffer. The steel industry serves construction (infrastructure), automotive, and appliance markets primarily. While construction steel demand may cool down, automotive steel will be in high demand over the next few decades and beyond, along with demand for appliances and such. It is my believe that the shift towards consumption and away from infrastructure will not hurt the Chinese steel producers drastically.
India is also worth mentioning. There were interesting comments about construction of many new coal-fired plants in India. Coal-fired plants produce very cheap electricity, although they are very environmentally unfriendly. India is rapidly increasing thermal coal imports. Also, there is a lot of work being done in Indian ports that will further facilitate thermal coal imports into India.
While China has slowed down recently and is also being selective in purchasing iron ore, demand is likely to be strong from the rest of the emerging markets. This bodes well for demand. Vale and other ore producers have even considered buying their own fleets of ships. The favorable outlook is likely a factor.
In general, iron ore, coking coal, and thermal coal make up 60% of global dry bulk demand. Iron ore and coking coal are the major inputs needed to produce steel. Thermal coal is used in coal-fired power plants. I also happen to know that manufacturers consume far more electricity than consumers. This is why following steel production is so important when following dry bulk industries, since steel companies drive a very high percentage of global dry bulk trade.
Grains and agricultural products account for another 15% of dry bulk trade. I look mostly at steel production, manufacturing in general as manufacturers are the main customers of utilities, and the global grain trade. Since these factors account for 75% of total dry bulk trade, you can see why I focus my attention on these.
Supply Side Fundamentals
It's no secret that there's a major supply overhang in the dry bulk industry. It was noted that the current dry bulk order book is 52% of the total fleet. There were no ships ordered in 2009 and I don't think too many ships have been ordered in 2010. In addition, there was considerable slippage in 2009 on the order of 31% (37% according to Michael Webber's own calculations). Slippage and cancellations have been lower so far in 2010, but it's still there.
Shipyards have been running at lower utilization rates in the past few years compared to the boom years, which supports the idea of some slippage in the order book. This has likely contributed to much of the 2011/2012 order book coming from renegotiated orders from 2009/2010.
The average ship age is 15 years. Some companies have new fleets with average ages of 10 years or fewer (EXM, GNK, DSX, etc.) and some companies have relatively old fleets (TBSI especially). There's major supply coming online, but a portion of that was necessary. The other portion was likely from faulty boom-time thinking.
Orders from here on will likely be due to solid fundamental analysis, not rampant and speculative buying. Ship acquisitions are currently less debt financed than in years past. In addition, bank capital has been more expensive for shippers in general. With banks being more careful to lend, it's also important to build relationships with banks, which doesn't happen overnight. This supports the idea of fewer orders going forward in the short-term.
It is my personal view that as all of these ships come online, those with older fleets will suffer. New ships are safer, more fuel-efficient, and require less maintenance. Look up major shipping accidents and they mostly involve old ships. Shippers with new fleets will be able to maintain higher utilization and shippers with old fleets will suffer. Once the old fleets are laid up and companies are paying money to do nothing with their ships, I believe scrapping will accelerate. There are no rules on when shippers need to scrap their ships; it's completely an economic decision.
I was glad to see that one of the panelists pretty much agreed with my view that scrapping will accelerate in the near future.
In the past several months, we've seen pretty pathetic Capesize rates. If you recall from my earlier blog on the dry bulk industry, these are the big ships. The lower rates are likely to due high current supply and very high Capesize ship orders. It seems like rates will not fully recover due to the new higher supply level.
This means Panamax, Supramax, and Handysize vessels have seen higher levels of profitability due to higher rates and lower relative vessel operating expenses.
Lower rates in general lead to lower asset values. This means that slumping rates create buying opportunities for ships. It seems that new ship values fell more than second hand ship values. Shippers didn't want to sell their ships with rates so low, so those ship prices held up a lot better than new ship prices. I'd like to happily note that Genco Shipping and Baltic Trading purchased new ships when rates were terrible, obtaining excellent prices opportunistically by watching the market prices.
Lastly, port congestion is not as bad as before, but is still pretty bad. This has helped the supply side, since ships must idly wait around and aren't available to ship goods. There are port infrastructure projects going on around the world that will hopefully ease some of the congestion. Look at China and India and how quickly they're increasing demand. With increased ship activity comes increased need for port infrastructure. These are necessary projects and are in the works.
There was a question about the Eurozone debt crisis. The panel didn't expect anything drastic to come of it. While bank capital from Europe is now expected to be scarce, there have been signs that Asian banks will offset that loss in lending. I know there are major shipbuilding institutions in China, Korea, and other places and I know that the banks from those countries would be interested in getting deals financed.
Another question was about the Panama Canal expansion that is to be completed in 2014. If I heard correctly, the Panama Canal will be expanded to fit Capesize vessels. I wonder if that's why Capesize vessels have been ordered far more than Panamax vessels. It's interesting to note that Panamax vessels will no longer be the largest vessels that can pass through the Panama Canal, rendering the name for that class of ship rather useless.
Anyway, more capacity through the Panama Canal is likely to decrease shipping rates for Latin American countries in the area. This is likely to boost some products coming out of Latin America, as the demand for those products should increase as they become more competitive with their product pricing in the face of lower transportation costs. It is worth examining the supply and demand of certain goods from this region.