Nail-Biting in Shipping
by: Hard Assets Investor June 16, 2009
Unlike, say, gold and oil, it's not often we get a detailed look at the prospects for shipping. When you talk shipping, specifically dry bulk shipping, you're talking about the supply and demand of ships as well as the commodities they carry, China, and finance - all interacting in often-unpredictable ways. Capital Link Shipping hosted a webinar on Friday to educate investors about the state of the shipping industry, and there were a few eye-openers.
Let's start with the Baltic Dry Index:
Ride The BDI
Historically, since 1985 when the BDI was first published, the index averaged around the 2000 mark. But as Ted Petrone, president of Navios Corp. and Navios Maritime Holdings (NYSE: NM) pointed out during the conference, since China entered WTO in 2001, the BDI sat at around a 4000-point baseline for a few years.
Taken in that context, the early December 2008 low of 663, as well as last June's high of over 9500 look like huge outliers. More recently, the index hit 4291 on June 3 and was at 3583 on Friday - pretty reasonable if you look at the long-term statistics - but given recent history, mainly December's low, the numbers have led to a lot of discussion. Not many indexes have risen 440% since Christmas.
Mr. Petrone explained the December low this way:
This was not a supply/demand issue. It was really a credit issue that brought the BDI to that level. There were no letters-of-credit. In the fourth quarter the financial world was coming to an end, so we thought. Those sort of term letters-of-credit were not available. There were ships anchored all over the place. Those days are over - no one expects to see these levels again anytime soon.
In fact, credit - a key to operating a shipping company - is no longer a factor, according to Akis Tsirigakis, CEO of Star Bulk Carriers Corp:
Credit has become available, in fact credit is not an issue anymore and is not affecting cargo volumes and freight rates anymore as it definitely did in November and December when the lack of it brought everything to a standstill.
And the recovery to current levels? "China, China, China," Mr. Petrone says, particularly Chinese iron demand.
Although China produces a lot of iron ore domestically, it's both lower quality and more expensive (roughly $85 to $90 a ton) than that which can be imported internationally - even including freight prices. With an estimated 72% of the $586 billion Chinese stimulus package going to construction, no wonder China gets the credit for pulling the shipping industry back from the brink. As long as international iron ore prices (Including the freight charge) remain lower than domestic, import demand, and therefore demand for ships, should do well.
There have been some questions as to whether the Chinese are just topping off their stockpiles, or if any of the iron ore is actually being turned into steel. And given the difficulty in obtaining data from China, nobody really knows for sure. Joseph Royce, CEO of TBS International [NASDAQ: TBSI], noted, "Even though we see the raw materials moving, the finished products are somewhat lagging behind."
Here's what we do know: Chinese ports are in bedlam. The popular large capesize vessels that are used to haul iron ore around the world are completely clogging the major import points in China. Lloyd's List reported that 10% of the global capesize fleet of 855 vessels was literally sitting dead in the water, waiting to be off-loaded at Chinese ports, causing the Baltic Capesize Index to jump 18% in one day. Just one example of how volatile the index can be.
With this in mind, there is widespread pessimism that the current, comparatively lofty level of the BDI will be maintained. Said Mr. Petrone: "I don't see this as a broad-based recovery, we're not seeing greater, better numbers out of the OECD, Japan or Korea."
Mr. Petrone went on to suggest that industrywide, a level of 2500 is probably needed for most shipping companies to remain healthy - which would put rates in the high $30,000 range for capesize and around $20,000 for Panamax (assuming the cape/Panamax ratio drops from its current value of over three back down to two or lower). He estimated that those were the rental rates that most companies need to cover their costs.
Supply And Demand For Ships
Congestion at ports is just one way the supply of ships can be limited, causing freight rates to rise. To bring supply up, shippers need to bring more ships online - increasing the supply and most likely reducing shipping rates. Right now the order book for new ships is large - but so far in 2009, only a few ships on the big theoretical list have been delivered and many have been delayed until the end of the year or even 2010 - delaying the time when the additional dry weight tonnage will come on board.
Dale Ploughman, CEO of Seanergy Maritime Holdings [NASDAQ: SHIP], estimated that if 40% of the current order book didn't come to delivery due to cancellations, delays, etc., that it would still mean that there would be a 26% to 30% increase in the global fleet in terms of dry weight tonnage. That's a huge jump in available transport supply.
But from there, it looks dismal to be a builder. The current order book is zero for 2012 and 2013.
"They (the shipyards) would like to see a more normalized picture instead of working to capacity in the beginning and having zero new building orders for later. They have an incentive now to normalize the order book and that might produce an opportunity for owners as well to kind of even out the order book into a longer period," said Mr. Ploughman.
If that happens, the rate of new tonnage coming online may be balanced with older ships being taken out of the fleet due to scrapping, lessening the supply shock that will otherwise hit the shipping industry.
The Takeaway
It's a dangerous time to be playing shipping. The Chinese demand situation is in tremendous flux, the order book is sketchy and even those deepest in the know aren't quite sure which way the way the wind is blowing.
If you want to invest directly in a shipping company, do your research and be very careful to pick companies with strong balance sheets and low operating expenses - you want to pick the companies that will be able to ride out the rough seas (sorry, couldn't resist) of the BDI swings.
Another interesting thing to note - the iron ore negotiations are still ongoing, and most analysts believe that the benchmark price will be set between 35% and 40% lower than last year - no surprise there because the spot market has actually priced that in to some effect. But, shipping is a volume-driven industry - low iron ore and prices may actually benefit shipping companies by boosting international trade. If you're pessimistic about the price of iron, going long shipping is one way to play it.
Lastly, with Rio Tinto and BHP announcing a joint venture, and China being left out in the cold, there is a possibility that China may approach Brazil for a closer relationship - something that could be very good for shipping. Brazil is a lot farther from China than Australia is, and shippers, like cabbies, are on the meter.
