IHS Fairplay sat down with Robert Bugbee, president of Scorpio Bulkers and Scorpio Tankers, in the latest of a series of interviews on lessons learned from the shipping cycles of the past decade.

Bugbee began his shipping career at Gotaas-Larsen, then went on to serve as an executive under Craig Stevenson at OMI Corp. OMI sold out at the top of the cycle, in 2007, for USD2.2 billion. Bugbee came aboard at Scorpio after his non-compete agreement expired,  taking the group’s product tanker company public in New York in 2010 and its dry bulk company public in 2013.

The following interview was conducted in Scorpio’s Manhattan office on 13 December:

Greg Miller: Let’s begin with what shipping did right during the highs and lows of the past decade, the kind of actions that can be used as a guide for future industry strategy. What worked at the companies you were involved with?

Robert Bugbee: “It was a really right thing to sell OMI. It was a really right thing for Scorpio Tankers to trade its VLCC position, buying them in the 80s and selling them at 105 [thousand]. It was the right thing for Scorpio Tankers to trade out of its Dorian LPG position. And the thesis of Scorpio Tankers was the right thing, in terms of the development of the product tanker market from the demand side, as a result of the change in demographics of refinery capacity and environmental changes in countries like Australia, where they decided to import refined products rather than import crude and refine their own products.”

I’ve seen two conflicting theories on refinery developments and what they mean to product tanker demand. Several analysts, including Drewry, have said that refineries are being built closer to crude production, which is bad for crude tankers and good for product tankers. But OPEC  recently published a forecast claiming the opposite, that refineries are being developed closer to consumers, in China in particular, which is good for crude tankers and bad for product tankers.

“Well, one of the major contributors to OPEC, probably the most important, Saudi Arabia, has also come out and said that it is doubling its own refinery capacity, which would be contrary to that [OPEC forecast]. I also think China’s development of its refinery capacity is a good thing for the product tanker market, in the same sense that the development of the US and European refinery areas were. It will allow for more intraregional transportation. There will be more products shipped, whether it’s locally or across the ocean, so that’s fine.”

To go back to what you said about selling OMI, one of the criticisms of public companies is that management is averse to selling at the top of the cycle, because by doing so, management is out of a job. The OMI deal is a perfect counter-example, but in general, what do you think of this theory that there’s a managerial aversion to cashing out on the public side?

“I think that shipping is one of those industries where it’s much more fun to collect ships and to have bigger organisations, so it’s an industry that is prone to having better buyers than sellers. I don’t think there’s a natural tendency for any particular [shipping] management to give up its toys, whether the company is public or private.

“It’s a hard thing to do [to sell out] and it comes with a lot of social cost [to employees]. Fortunately, I’ve come from a background at Gotaas-Larsen, which was sold twice, and OMI, where the boards of those companies made sure that not just management but also staff were compensated for doing the correct thing for the shareholders. It doesn’t do any good to say to public companies, ‘You should always sell and consolidate’ if at the same time, you do not have the incentives alignment for the management and the staff to do that. When it comes to private companies, it’s their own money, so they can do whatever they want.”

Let’s move on to how the banking industry has behaved over the past 10 years. There was a tremendous amount of low-cost debt provided during the shipping boom through 2008, then we had the ‘extend and pretend’ and ‘kick the can’ practices in 2010–13, and then in 2016, we really saw a much sterner tone from lenders and we saw banks pressing borrowers to raise new equity. Where do you think we stand with the banks?

“We’ve now got some tremendously encouraging things going on for the shipping industry. I see five things that are encouraging. First, the banks are now allocating capital rationally. They’re no longer extending and pretending. They’re really dealing with their issues. There’s far more willingness to be discriminatory. If they are willing to lend to the top of the food chain in each of the shipping sectors, they are really being tough where the balance sheets aren’t there – and that’s a good thing.

“The second encouraging thing I see is that equity today is being more disciplined. We’ve got the re-emergence of the really good long-only value funds. Many of the people who are buying stock in Scorpio Tankers or Scorpio Bulkers today are people who bought into OMI but had not bought in during this last four- to five-year period because they were scared off by the free capital [coming into shipping] that was basically provided by private equity or quantitative easing, whichever way you look at it.

“The third element is something I’m seeing for the first time in my career: we now have a meaningful reduction in shipyard capacity. We haven’t had that discipline before. Just as we saw ‘extend and pretend’ from lenders, we saw governments prop up shipyards with no view towards revenue and costs. Now, they’re getting more disciplined.

“The fourth element is that we continue to ratchet up the environmental and safety compliance on vessels. And the fifth thing is that we’re actually getting benefits of scale not only through the capital markets, but through technology and software, whether it’s through electronically managing vessels, getting empirical data, the ability to follow customers, or accounting software. The larger companies with the larger access to capital will be able to afford more, programme more and keep more on the cutting edge of software and technology.

“At Scorpio, we effectively have all sister ships with sister engines monitored electronically, so we’re able to really know what’s wrong with the ship. It’s not a guess. And if an adjustment has to be made to one engine, it can be translated across the rest of the fleet within seconds. You also have much better degrees of control on your inventories, your wear and tear on parts, your records of crew going through different things, etc.”

When I listen to you talk about technology, it brings to mind the so-called ‘Smart Shipping’ paradigm, the concept of ultra-high-tech satellite-linked purpose-built fleets working as unified factory units for the manufacture of transport. I’ve never understood how we’ll make the transition to this model, given that the huge investment required and the integrated logistics would seem to necessitate a reversion to more industrial-style shipping and more long-term relationships with commodity shippers, versus the current spot model. But what I hear you saying is that we’re already seeing some of the benefits associated with Smart Shipping.

“I don’t think that has ever been a problem for the industry [affording new technology in a spot market environment]. I think our job in bulk shipping, if we really look ourselves in the mirror, is to provide safe bulk transportation that over time is really cheap, and we do that by this wonderful dynamic whereby supply is more inelastic than demand and every now and again we get these wonderful surges in the market where there are extraordinary returns that ultimately lead to tremendous overbuilding on the supply side.

“As the famous economic quote goes: ‘The cure for high prices is high prices’. Shipping is doing a great job of that and it has always managed to somehow afford whatever technical advancement there is.”

We talked before about what the companies you were involved with did right over the past decade. What about other examples involving companies you were not involved with?

“So many people got things right. There were the so-called ‘gods of shipping’ – the Ofers, the Paos, the Angelicoussises, the Fredriksens. These people were very clever in seeing this wall of money that came in from Wall Street three or four years ago, and this massive ordering of vessels, and they did the right thing and passed. They basically, as a group, said, ‘This is ridiculous.’ And they waited, and the market crashed, and they were able to scoop up a bunch of ships and assets. That’s one example of people who got things right.

“Another example is Golar LNG, in terms of technical innovation and complexity and taking things forwards in an industry that is massively changing. Remember, it was only a few years ago that we were building these LNG import terminals in the US [which has since switched to exports]. Golar is in an industry that’s much more complex than a normal bulk business, with huge changes, and they’ve just kept to their knitting – and I expect them to be rewarded for it.”

There are also lessons to be learned from the mistakes that have been made. Can you give me a few examples of what your companies have done wrong over the past decade?

“At Scorpio Tankers, I think we got the demand thesis correct, and we got the type of ships we were ordering correct. What surprised us, what I think we got wrong, was that we didn’t expect a whole load of people, including some of our own shareholders, to go out and give a whole lot of money to a whole bunch of other people to go out and order the exact same thing. We had shareholders with big positions in Scorpio Tankers who were funding start-ups ordering the very same ships they were investing in with Scorpio Tankers, for their own reasons. We didn’t expect that.

“I can tell you what we got wrong at Scorpio Bulkers. We didn’t expect the slowdown of China and the capital market change and the real deflationary environment surrounding commodities. Those things were surprising.

“At the same time, the wonderful thing about shipping is that if you stay humble for long enough, you’ll get some upside surprises too. So we’re now pleasantly surprised with dry cargo.”

Like what’s going on today with coal…

“Yeah, people were saying we were never going to need coal anymore – but coal is moving again. And China seems to be doing OK. And Trump [US president-elect Donald Trump] has come along and stimulated the US equity markets. The bane of all shipping is deflation and we’re seeing some tendencies now where you could have inflation, which is good.”

You’ve been in this business for decades and through many cycles. Do you think the tumultuous events of the past decade will actually change the way the industry behaves in the future, or will any lessons learned not sink in?

“Oh I hope not. I hope they don’t. The great thing about shipping – and the tragic thing – is that the lessons are always shown, they’re always the same lessons, it’s always the same syllabus, and yet the participants and capital providers just won’t learn. I’ve gotten even more cynical as time goes by. Ten years ago, I thought that Wall Street had at least some memory. Now, I know it has none at all.

“Only six months ago, they were saying that people were never going to invest in dry cargo again and it will be years before anybody will do a public offering or secondary offering. Well, a few companies are doing that as we speak.”

While we’re on the subject of Wall Street, where do you think we are on the spectrum of capital access and how does this affect your views on shipping prospects?

“I think capital at this moment in time is more disciplined and it’s clearly looking for value. It’s actually great capital. We’ve got really good value funds, really good long-only funds, good private people buying. It’s good ‘sticky’ money. If you combine that with lending discipline, we’re at a great point.

“But I still believe that the lesson isn’t learned, so the moment that the environment is great and the market is great, we’ll move into growth and ultimately we’ll move into momentum and we will become overcapitalised in a fraction of the time, again.

“I think the real lesson learned, if we are to learn a lesson and try to follow it, is that a company should use this next position [in the cycle] to become more self-reliant. I think that high leverage, either by will or by force, is now gone. That will be the difference from the beginning of the cycle. I don’t think banks are going back to 80% financing. I think all of the balance sheets will have to be stronger. I think investors are crying out for properly constructed balance sheets with some kind of gravity, some kind of capital size. So for the first time in my career, I do think we are laying the foundations now for proper consolidations.”

That would certainly be a positive development. OK, last question. What are the bellwethers you focus on? What are the indicators you follow to shape your views on where the market is headed?

“The very big bellwether is that the big long-only funds are taking in more money and they are swapping from risk-off to risk-on positions, and they’re more willing to invest in industrials. We would expect investible stocks to be much broader going forward. For the last year and a half or so, unless you owned six technology stocks including Google and Facebook, you just weren’t going to do very well as a fund manager. Now, we’re facing a situation where the bond market is being sold and money will be transferred into more industrials, which is good for building infrastructure and good for shipping in general. At a very high level, that’s what we’re looking at.

“At the lower level, what we’re seeing is that the world economy isn’t in bad shape right now and there is more movement [of cargo]. Despite the fact that the dry bulk market is still weak – it has just moved from terrible to not so terrible – the actual amount of cargo being moved has gone up, whether it’s cement, aluminium, wood chips, or logs. Everyone sees the big headlines – coal and iron ore – but underneath these, there is a market we’re not involved in, the Handysize bulker market, that is really ticking along quite nicely. And that’s a good indicator of the future of the world economy.

“It would not surprise me if we’re at the beginning of another super-cycle.”

Really? As in the 2004–08 super-cycle? People have repeatedly insisted that a boom like that will never happen again.

“This could be one of those that goes up very hard and then crashes very hard. Normally in shipping when anybody says that we’re never going to see something, we’re usually a short time from seeing it. You’ve got so much forced discipline right now. You’ve got this forced position across all shipping markets where capital is not willing to invest in newbuildings and shipyard capacity is going down. We haven’t had this before, this forced period for a while in a world that is growing.

“It’s almost never wrong to sell something when the market and all the analysts are saying that everything will carry on and be great forever. And it’s almost never wrong to buy something when it’s a mess. So it’s going to be a fun year [2017] for the industry, because with these dynamics, sometime in the next year or two, either we are going into an economic abyss or if the world economy keeps going, there will be a point where shipping literally just melts upward, because people haven’t been ordering ships for a while.”

I have to admit, I haven’t heard this one before, that there could be another shipping super-cycle anytime soon. But hey, you never know. If the consensus is usually wrong, as you say, maybe the contrarian view will come true…

“As Wilbur knows [shipowner Wilbur Ross, who backed underdog Trump during the election  and has been named US commerce secretary-designate], contrarian views have paid off well.”