Archives for category: Investment

On 14th August 1948, Don Bradman, Australia’s greatest cricketer of all, walked out for his last test match innings, at the Oval in London. Over 52 test matches, his average score was an astonishing 99.9 runs. All he needed was 4 runs for a test match average of 100 (sorry non-cricketers, you’ll have to check it out on Wikipedia). But he was bowled out second ball by leg spinner Eric Hollies.

Two Simple Rules

The moral of this sad story is that however experienced you are, two basic rules apply. Keep your eye on the ball and watch out for spinners that behave erratically. That seems to apply pretty well to today’s tanker market. The fantastic revival of tanker earnings started in October 2013, was interrupted by the summer dip in 2014, then picked up in October 2014. Since then it has not looked back, with crude tanker earnings generally averaging $40-$50,000/day. There is a little weakening right now, but sentiment appears to be confident for the winter.

Demanding Wicket

Against the background of a 2% fall in seaborne crude oil trade in 2014, US fracking and a lacklustre world economy, this earnings surge was a surprise. But there were some mitigating factors. Low oil prices are boosting demand and the IEA has revised up its forecast for growth in global oil demand in 2015 to 1.6m bpd.

Growth on long-haul trades has also helped. Between 2011 and 2014 Caribbean tonne-mile exports increased by 36%, largely due to increased shipments to China and India. That sounds good, but many VLCCs repositioned with a backhaul e.g. West African crude for Europe, and maybe a Transatlantic fuel oil cargo. Although handling fuel oil is time consuming, especially when it involves STS (ship to ship), this undermined some of the “tonne-mile” effect. And so did cargo-leg speeds, which appear to have edged upwards over the last year. But while the part played by demand may not seem entirely clear, there has still been a notable improvement in crude trade volumes this year, with seaborne shipments to major importers estimated to have increased by 4% year-on-year in 1H 2015.

It’s Supply, Stupid?

When we turn to supply, the picture becomes clearer. Until the summer of 2013, the crude tanker fleet was growing at 15-20m dwt pa. That’s about 5-6% per annum growth, well above demand growth. But by October 2013 growth had fallen to 2%, producing a nice year-end spike. The tanker supply slowdown kept on going and by July 2014 the crude tanker fleet was declining. Admittedly the growth has
edged up so far in 2015, but only to around 1-2% per annum.

Nasty Spinner In Sixteen?

So there you have it. Tanker investors have scored well in the last year, but, like Don Bradman, they must remember rule two and watch out for the spinners. Although fleet growth is sluggish, the crude tanker orderbook for 2016 could produce a “googly” as it pushes fleet growth back up to 6% (depending on demolition). Even with positive demand, tanker investors are going to have to keep their eye on that ball and hope it breaks the right way. Have a nice day.

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Bulkcarrier owners could be forgiven for feeling just a little bit dizzy at the moment. The unprecedented growth in China’s steel industry over the last decade has for years provided an adrenaline-infused experience in dry bulk trade. But with both Chinese steel production and iron ore imports registering a decline in the first half of 2015, is the playtime over?

Down To Earth With A Bump

It’s no surprise that the recent wobbles in China’s economy have been leaving dry bulk’s thrill-seekers with a nasty headache. Construction activity has slowed, and total steel use dropped by 5% y-o-y in the first five months of the year. Steel production has declined by a less severe 1% y-o-y, but this is still an unpleasant change of direction for those accustomed to average output growth of more than 10% per annum over the last ten years.

Round The Roundabout Again

Yet these worries over China’s steel industry are not new. According to China’s annual estimates, steel output growth in 2014 slowed to 1%, from 14% in 2013. However, iron ore imports increased in 2014 by a massive 15% to 914mt. Almost heroic growth in Australian iron ore production flooded the global iron ore market with cheap ore, displacing some higher-cost domestic Chinese ore production. Ambitious production expansion in Australia is still underway, and exports from the country are up 9% so far this year, but total Chinese seaborne imports are down 1%. So what has changed?

Balance Shifts On The See-Saw

This year seems to have proved a tipping point in the iron ore market. Weak Chinese demand is contributing to record low iron ore prices (dipping below $50/tonne in April). In 2014, the rapid drop in prices boosted China’s overall import demand, but no such positive effect is visible this year. Instead, the extent of the price drop has squeezed out a number of small iron ore miners across the world, and Chinese imports from many smaller suppliers have been depressed this year. And while Chinese miners have clearly reduced domestic production, there are questions over how much more capacity (particularly state-owned) will be cut.

Swings In Need Of A Push?

The unsettling thought for the dry bulk market is that the excitement of the Chinese ride could be coming to an end. Despite the price drop, most major ore miners are forging ahead with expansion plans. If China’s steel usage has peaked, miners will be fighting for market share in a shrinking demand arena. And if Chinese ore output proves resilient to price pressures, this could leave those expecting a resumption of firm iron ore trade growth with only a severe case of vertigo.

While global growth in low-cost ore production could still boost imports later this year, there is certainly no longer a consensus that China’s steel industry has considerable long-term growth potential. Faced with this ominous scenario, bulker owners will be hoping that the current weakness in China’s iron ore imports is only a temporary downward swing. Time will tell, but for some the playground which once spurred great excitement might be starting to lose its appeal.

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Shipping investors have to cope with violent swings of sentiment. Today tankers are enjoying a precarious euphoria, whilst bulkers embrace manic depression. A year ago it was the other way round. These sentiment swings are bad enough, but when you factor in the future things get even worse. Last week’s Economist leader was entitled “Watch out…it’s only a matter of time before the next recession strikes”.

Reality Or Disorder?

So, the real concern for investors is what lies ahead. Somehow they must separate reality from sentiment and today that’s tricky. The Economist thinks that while the world economy is in better shape, governments and central banks have stretched their policy instruments to such an extent that there is not much left to deal with another crisis. With interest rates hovering around zero there is little scope for dealing with future problems. But, says the Economist “sooner or later, policymakers will face another downturn”.

The Parallel In Shipping

Shipping investors face much the same quandary. Seaborne trade has recently been commendably positive, growing by 4.2% in 2012, 3.4% in 2013, and 3.3% in 2014. Estimates for 2015 suggest around 3% (though it has to be said there are plenty of question marks, so this could be subject to some downside). With heavy scrapping and fewer deliveries, the world fleet looks set to have grown by around 1.5% in the first half of 2015. So supply may be growing roughly at the same rate as demand. But many of the least attractive ships have been scrapped and shipyard output is edging up, so any sort of trade slump would be difficult to manage.

Spiky Sea Trade

Since 1970 there have been seven slumps in world seaborne trade, each initially triggered by a crisis in the world economy. The first three slumps in 1975, 1980-82 and 1986-87 were due to the oil crises of the 1970s. Between 1979 and 1985, crude oil trade fell by one third. The next four were mainly financial. No. 4 was the financial crisis in the US. No. 5 was the Asia Crisis and No. 6 was the “dot-com” crisis when overheated IT stock values collapsed. No. 7 was the 2007-08 Credit Crunch.

Dire Warnings

That works out to a crisis close to every 6.5 years. It is now 6.5 years since the Lehman Brothers collapse, so the Economist’s case for caution makes sense. And shipping faces some additional structural risk. China now imports over 2 billion tonnes of cargo and coal and ore trade may be peaking out. Meanwhile, energy (over 40% of seaborne trade) is back on the agenda, with the phasing out of fossil fuels under discussion and plenty of energy saving technology in the pipeline.

On The Beach

So there you have it. Like waves at sea, crises are just part of shipping scenery. Serious seafarers take them in their stride, and smart shipowners make sure their companies can navigate whatever big waves they meet. But it’s never easy, and the holidays provide a good time to reflect on the balance of shipping sentiment and reality, ready for whatever the Autumn brings. Have a nice day.

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Price ratios are a classic indicator used in a range of industries where assets depreciate over time. In the shipping sector, they can often tell us something about the perceived health of the market, and in particular about what investors are really willing to outlay to get their hands on assets that are on the water today compared to investing in a new vessel.

A Classic Ratio

One classic shipping market indicator is the ratio of the 5 year old price of a ship to the newbuild price of a similar vessel. On the basis of a 25 year lifespan, a 5 year old ship, depreciating on an even basis, would be worth around 80% of the newbuild price. However, if investors feel that the market is strong enough, they may be willing to pay a premium to get their hands on a secondhand vessel to operate in the market today. Conversely, if the earnings environment looks weak, investors may take a more negative view of the value of the existing asset.

The graph shows the 5yo/Newbuild price ratio for a VLCC tanker, a Panamax bulkcarrier and a 2750 TEU containership over time. Immediately apparent is that during the boom shipping market of the mid to late 2000s, the featured ratios stood well above the 80% line, and at times above 100% for all three vessel types, with the Panamax bulker ratio as high as 170% in late 2007. Since the downturn in 2008, the ratios have fallen. From one angle, it could have been worse; there was a period when all three ratios exceeded 80% (Mar 10-Jun 11). However, in general the ratios have been depressed, and there have been clear phases (Oct 08-Mar 09, Aug 12-Apr 13) when they have all been below 80%.

Ups And Downs

So what do the ratios tell us today? Tanker earnings have had a strong run since late 2014 but even so the VLCC price ratio stands only a little above 80%, maybe indicating that investor positivity is mixed with caution. Meanwhile, the bulker market is in severe recession and the Panamax price ratio has fallen from 95% during 2014 to 65%, showing how investors’ optimism has drained.

Lower Levels

The containership ratio, however, is on the up, with earnings recently improved. But it still stands at just 54%, perhaps indicating investors’ caution and relative preference for new tonnage. At boxships’ higher speeds, the difference in fuel efficiency between new and older tonnage is more marked, though the ratio was higher in the 2010-11 period when fresh interest arose in a sector that ‘looked cheap’.
Reading The Classics

So, price ratios are classic indicators, and as if it needed emphasising, today’s ratios show that the shipping markets aren’t perceived by investors to be close to full health yet. Overall sale and purchase volumes in the year to date are a little way behind last year’s levels, and the price ratios today might give an indication as to investors’ actual feelings about assets on the water. But markets change quickly, so just like classic cars which get taken out once in a while, it’s the same for classic indicators – and market watchers should probably take another reading soon. Have a nice day.

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In the last four months dry bulk orders have fallen to 0.4m dwt per month, the lowest level since the 1990s. This is a massive 98% reduction from the 23m dwt peak in orders in December 2007, and probably the sharpest decline in recent decades. Not really a surprise in a market where Capesize bulkers are struggling to earn $4,000/day, but a timely relief to investors with ships on the orderbook.

Investment Fever

This investment collapse marks the end of a remarkable phase of bulkcarrier history. During the last decade, 724m dwt of new bulkers have been ordered, around 70m dwt/year. Just to put that in perspective, during the previous decade ordering averaged about 20m dwt/year.

The 5 years from 1996 to 2001 were disappointing to investors, who ordered only 1.2m dwt/month. At the time this was seen as normal, and included a spike in 1999, when investors snapped up Panamax bulkers for $19-$22m. These were probably the most profitable bulkers ordered in the industry’s post-war history. Upon delivery they sailed straight into the bulk shipping boom. Proof that “crazy investors” are not always crazy.

Softly, Softly

The next phase from 2002 to November 2006 was quite restrained, considering the rise in freight rates. Ordering edged up, averaging 2.8m dwt/month. As earnings eased in 2006, many assumed the boom was over, but they were wrong and what happened next was unprecedented. As earnings escalated owners threw caution to the wind, and the big bulker cash machine drew investors from outside shipping. In December 2007, ordering peaked at 23m dwt, and in 2007 to 2014, investment averaged 6.8m dwt/month (81m dwt/year), an astonishing number for a period mostly in global recession.

Carry On Investing

Despite the onset of the global downturn in 2008, two more bulker investment spikes followed in 2010 and 2013. With surplus bulker capacity, and China’s growth engine easing off, it’s hard to explain this investment on strictly economic grounds. Easier, perhaps, to understand the change in expectations. The memory of spectacular bulker earnings had been fresh in the minds of some investors, but a decade later and that dream is fading.

The collapse in bulkcarrier investment is a particular problem for shipyards. Many builders in China and Japan surfed the wave of bulkcarrier investment and bulkers still account for around half of tonnage on order globally. In today’s sluggish world economy, that is going to be a difficult gap to fill. The fact that bulker prices are around 5% down this year, and ordering has virtually stopped tells its own story.

Big Bulker Investment Boom

So there you have it. The spectacular run of dry bulk investment which kicked off in early 2003 has finally ended. Then China’s imports were growing at 27% a year, a big difference from the 3% growth in 2014. This is disappointing, but as serious shipping investors know, in good markets and bad, there’s still an awful lot of cargo that has to be moved around the world – it’s just a matter of who moves it. Have a nice day.

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The level of ‘forward orderbook cover’ is one indicator of the state of global shipbuilding. When times are tough, yards can find the race for the limited amount of ‘cover’ available difficult, but when times are better ‘forward cover’ can seem very supportive. In the face of slowing ordering volumes, the shipbuilding industry might take a look at this indicator as part of its regular health check.

Medical History

‘Forward cover’ shown in the graph (see graph note for the exact calculation) reflects the number of years ‘work’ yards have on order at recent output levels. In the 1990s yards averaged 2.5 years cover but following the ordering boom of the mid-2000s forward cover rose to over 5 years. The onset of the global recession saw ordering levels decrease significantly and orderbook cover had dropped below 2.5 years by 2012. But with yard output having adjusted downwards, a pick-up in ordering in 2013 helped cover expand to 3.5 years. However, investment slowed again in 2014, instigating a downward trend, and by early 2015 orderbook cover had adjusted to around 3 years.

Chinese Check-Up

Chinese yards have seen the most dramatic reduction in forward cover. As capacity created to meet boom demand came online between 2009 and 2011, output doubled. But investment levels decreased, the orderbook declined, and China’s forward cover briefly fell below that of its competitors in Korea and Japan in 2012, as Chinese yards were not as able to attract the increased ordering in the more specialised sectors. However, cover has since increased as active capacity has adjusted downwards and Chinese yards have regained the majority share of orders, slowly diversifying their product mix. Although overall cover has returned to pre-boom levels (3.6 years today), the situation varies substantially. Whilst state owned yards and a handful of private yards have a strong orderbook cushion, the vast majority of smaller local yards have limited cover.

Offshore Emergency

South Korea and Japan did not expand shipyard capacity to the extent as China, and their industries are much more consolidated across fewer yards. As such their forward cover did not swing so dramatically. The largest Korean yards responded to the downturn in merchant vessel ordering by entering the high value offshore market (the ‘big three’ Korean yards grew their offshore orderbook to around two-thirds of the value of all units they had on order). Yet whilst this provided relief for yards in 2011 and 2012 the downturn in offshore ordering in 2014 has contributed to forward cover at Korean yards (2.7 years today) falling below that of Japanese yards (3.0 years) for the first time. Japanese yards have been slowly improving forward cover partly due to a revival in export ordering backed by the depreciation of the yen against the dollar.

Today, whilst a long way from boom time highs, ‘forward cover’ looks more comfortable than two years ago. However, that’s not the only part of the health check and global shipbuilding has been through a period of immense turmoil and financial pressure. Moreover, with output stabilising and ordering currently suppressed, builders could well be checking their orderbook cover closely once again.

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According to Warren Buffett, the best way to become rich is to “close the doors. Be fearful when others are greedy. Be greedy when others are fearful”. Since dry bulk investors seem to be having a fearful fit of nerves at the moment, maybe it’s a good time to start getting greedy. But what exactly does that mean for shipping?

Two Tier Strategies

Actually this pithy advice bundles up two investment strategies. One is not to let your judgement be swayed by sentiment, especially when the market is at an extreme high or low. The other is to be contrarian. This is good advice for shipping, but it leaves investors with the problem of deciding what constitutes “being greedy”.

Bulkers Back To Basics

Recent secondhand price data provides a neat illustration of the issues. The Bulkcarrier Secondhand Price Index, based at 100 in January 2000, has recently dipped and is now almost back to where it was 15 years ago. In the meantime prices have been through a heroic cycle. After staying at around 100 points for the first three years, the price index took off, climbing to 500 points in 2008, before collapsing in 2009. After a brief recovery in 2010 the index is now back around 100. So investors who were not greedy and sold in 2007-08 have a nice warm feeling. But was selling really the right strategy? Let’s dig a bit deeper.

Patience Is Golden

Take a new Panamax bulker delivered in 2000 as an example. The inset table shows how things worked out for “non-sellers”. The ship cost $25.5m, and at 15 years old was worth $9m in March 2015, so the ship depreciated by $16.5m. But in 2000-15, assuming the ship trades 330 days a year, it would have made around $96m trading spot (boosted by strong earnings in 2007-08). Deducting depreciation and rough operating expenses ($32m at around $5-6,500/day) leaves net earnings of around $48m, generated over 15.25 years. That is $3.2m a year. On an original investment of $25.5m that is roughly a return of 12% per annum.

Safe As Ships?

That’s not exactly a top-end equity return, and punters might wonder if all that volatility is only worth 12%? But the net cash flow (revenue less OPEX) shows that in this example, if the ship was funded with equity and well insured, there was fairly low risk. There were a few months when earnings could probably not cover costs, but a modest working capital would cover these (although for some longer periods, net cash flow was tight). And of course it’s a very different story if the ship was funded with debt (another sort of greed?).

The Right Perspective

So there you have it. The shipping market looks unbelievably volatile and exciting. But if you “close the door”, focusing only on the numbers, for “greed” you could read “leverage”. With great patience; decent management; and lots of equity, shipping is a business where you can, if the timing is right, get a fair commercial return and an even better night’s sleep. Or you can get greedy, it’s your choice. Have a nice day.

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