OPTIMISM seems to be mounting in the dry bulk market, with forecasts for iron ore and coal looking relatively rosy, but no-one seems to be sure whether the rally is just a joyride or more of a sustained one.

China, which buys about two-thirds of global seaborne iron ore, imported 582m tonnes of iron ore in the first seven months of 2016, which is 43m tonnes more compared to the same period a year ago, Chinese customs data reported.

Another 67.5m tonnes of iron ore shipments from Brazil and South Africa are scheduled to arrive at Chinese ports in August this year, according to Thomson Reuters commodity research.

Although the figures exclude all shipments from top exporter Australia, given the shorter voyage durations, it paints a firm picture of the key steelmaking raw material demand in China.

At Friday’s settlement, the weighted time charter average of capesize bulkers — the workhorse for iron ore trade — was at $6,921 per day, a five-week high, on the Baltic Exchange.

For the coming months, Arctic Securities expects Brazilian iron ore exports to continue having a positive impact on the dry bulk market.

“We’re seeing early indications of influx from Atlantic to Pacific, which relates to positioning in hopes of higher volumes out of Brazil,” Arctic Securities analyst Erik Stavseth said in a note.

Italian brokerage Bancosta’s head of Asian research Ralph Leszczynski also said: “At this point, even if imports were to slow down significantly in the last quarter, this would still be enough to hit 1bn tonnes.” This would be an all-time high in terms of Chinese iron ore imports.

“I do expect the growth in imports to slow down a little in the last five months of 2016, to something like 4% year on year [down from 8% year on year in the first seven months],” Mr Leszczynski said.

“This would still mean that the total for the year should be about 1.01bn tonnes,” he added.

But most importantly, the near-term driver of this dry bulk renaissance is, of course, China’s steel production.

Output of the world’s top producing nation has been showing on-year gains since March, according to the World Steel Association.

And Chinese exports have shown little sign of slowing, rising to 67.41m tonnes in the first seven months of the year, up 8.5% versus the same period a year earlier, customs data showed. This is despite the protectionist moves against Chinese steel.

In addition, the world trade, one of the main determinant of demand for shipping services, is still growing moderately this year, despite worries on the macro front.

The World Bank has projected the global economy to grow at 2.4% in 2016, with relatively high growth in countries that are net commodity importers.

This implies there are fundamental reasons for iron ore price’s recent rally, which looks sustainable, with demand astonishingly on the upside and supply growth from major producers slowing.

However, the other side of the argument, presented by consultants at Hartland Shipping, is that China doesn’t actually need to consume 1bn tonnes of overseas iron ore, even if its steel output turns out to be higher than expected.

“Assuming Chinese steel output of about 800m tonnes in 2016, which would be above the level the market expected at the start of the year, about 1.2bn tonnes of iron ore, on a 62% iron content basis, will be required,” said Hartland Shipping in a report.

Having said that, if 1bn tonnes comes from the seaborne market, that leaves only 200m tonnes to be supplied by domestic mines in China.

However, China produced a total of 594m tonnes of iron ore in the first six months of 2016, according to official figures, suggesting it may reach about 1.2bn tonnes by the year-end.

Given Chinese ore is of a considerably lower grade than imported ore, this would probably equate to less than 400m tonnes on a 62% iron basis, Hartland Shipping argues.

“This means it’s still likely that China’s iron ore market will be oversupplied in 2016 when imports and domestic productions are put together,” it said.

Dr Adam Kent, director of UK-based markets forecaster Maritime Strategies International (MSI), finds himself a busy man – downturns tend to be good for his business.

MSI typically experiences a strong inverse relationship between the number of enquiries and the state of the freight market.

“When markets are strong owners are not as interested in understanding how and when they could earn a little more and financiers are not as concerned with market risk exposure. When markets soften the reverse is usually true,” Kent says.

Kent reckons the state of global shipbuilding has changed ship cycles forever.

Even if yards are wound down or are mothballed the general infrastructure tends to remain in place, he points out. The consequence to shipping is that the moment any single sector shows sustained improvement owners will be able to place orders at these underemployed shipyards, which will be hungry for new contracts, and these orders could easily be delivered in relatively short window, therefore curtailing any sustained market improvement.

“This paves the way for shipping market cycles to become shorter with lower peaks, as shipyard capacity no longer presents a limiting factor to timely provision of new supply,” Kent predicts.

The MSI excecutive thinks that the shake up going on at the moment among South Korean shipyards is long overdue. The industry was offered a lifeline in the form of huge numbers of offshore contracts that were placed during 2011-13.

“These offshore orders have, to some extent, been partially responsible for the treacherous financial position most of the Korean yards are now battling, given the low – or no – profit margins they provided,” says Kent.

Shipping investors have changed in character tremendously over the past few years, Kent observes.

“At the start of the decade investors wanted to enter shipping sectors which exhibited high liquidity, high visibility and a clear route for an exit strategy, today the reverse is true with investors looking to target sectors with high barriers of entry in a bid to protect their investments,” he says

MSI is forecasting demand growth in dry bulk to increase year-on-year until 2018 and, apart from 30 VLOC orders, there have been virtually no dry bulk contracts placed during 2016, while at the same time demolition volumes have been high.

“Once the current orderbook has hit the water the prospects for the sector should begin to improve, narrowing the current imbalance between demand and supply,” Kent reckons. He cautions however that with the capesize sector so reliant on the fortunes of China and with the peak in iron ore trade a distinct possibility within the next five years, the over capacity of the largest vessels will continue to be “an area of concern” for dry bulk shipping.

On ship finance, Kent notes that it has become increasingly difficult for smaller owners to secure new bank debt or to refinance existing facilities. The primary reasons for this are higher levels of non-performing loans, for which banks have had to make provision, coupled with having a more stringent regulatory framework. Banks that are still able to lend will therefore prefer to finance larger corporates where there is a potential for higher fees and cross-selling products. This is certainly the message MSI has heard from a range of banks, with many now only targeting the top 10 to 20 owners.

“This, of course, leaves a very long tail of shipowners that are currently struggling to find debt from traditional shipping lenders and are having to be more resourceful,” Kent concludes.

FOR asset markets, 2016 so far has been characterised by structural overcapacity, depressed charter rates and a lack of financing available for many dry bulk owners. Secondhand vessel prices have been hit so badly that the bigger ships in the dry bulk segment such as capesizes are worth less today than they were almost a decade ago.

According to UK consulting firm Maritime Strategies International, the first quarter of this year was marked by massive deterioration in bulker secondhand asset prices. On average, prices fell by almost 25% quarter on quarter in sharp contrast to the relatively minor deterioration in newbuilding contract prices. “Older ships saw the greatest value destruction, with 15-20-year-old prices dropping by almost 30% quarter on quarter, whilst zero-year-old ship values dropped by just under 20% quarter on quarter,” said MSI senior analyst Will Fray. “However younger ships have broken new ground with their current values — in net replacement terms, five-year-old vessels are now worth around 39% of the differential between contracting and scrap prices,” he said.

Against this backdrop, the number of secondhand bulker sales in the first quarter of this year reported by MSI stood at 168 vessels, the highest total since the second quarter of 2014. MSI’s first-quarter assessment of the value of a five-year-old capesize vessel was $22m, well below the previous record low of $27m in 2002. To place the scale of the recent value deterioration into context, the average fourth-quarter 2015 value of a five-year-old capesize vessel was $29m.

Despite secondhand prices being at all-time lows, owners have not been able to grab too many deals as the banking sector had severely tightened lending to the shipping industry. So the pool of buyers in the market remains limited to those with cash saved from the boom years. MSI expects the industry’s acute cash flow problems to persist. In addition to the scale and longevity of a freight market slump, the cost of finance will play a major role. Debt service provisioning is clearly a critical issue and restructuring is a key agenda for struggling shipowners and lenders alike, says MSI.

Meanwhile, MSI forecasts secondhand prices to recover from 2018. “We anticipate secondhand prices to recover from 2018 — this will be a slow and marginal recovery over the medium term, mainly due to expectations of weaker ordering of new tonnage and also as a result of massive redundant shipyard capacity in China that at times may be reactivated for specific projects,” Mr Fray said. “Dry bulk vessel values are right now at bargain basement levels but potential buyers must have access to sufficient capital to cover debt service for several years, and a robust constitution to bear the significant downside risks to a market recovery if they are to buy in at this point.”

Will Fray, a senior analyst at Maritime Strategies International, notes how asset values are now at all-time lows for many bulker benchmarks, but are set to increase.

The first quarter of this year marked a massive deterioration in bulker secondhand asset prices. On average prices fell by almost 25% quarter on quarter – in sharp contrast to the relatively minor deterioration in newbuild contract prices. Even so, the secondhand market remains very liquid – MSI recorded 168 bulker sales in the first quarter of this year, the highest total since Q2 2014.

Older ships saw the greatest value destruction, with 15-20 year-old prices dropping by almost 30% quarter on quarter, whilst 0 yr old ship values dropped by just under 20% quarter on quarter. However younger ships have broken new ground with their current values – in net replacement terms, five-year-old vessels are now worth around 39% of the differential between contracting and scrap prices.

Until Q1 this year, the lowest value recorded for this measure of five-year-old ships was 47%. Similarly, 10-year-old vessels are worth 18% of the differential, compared with a previous low of 22%.

Asset values are now at all-time lows for many bulker benchmarks. For example, MSI’s Q1 assessment of the value of a five-year old capesize vessel was $22m, well below the previous record low of $27m in 2002. To place the scale of the recent value deterioration into context, the average Q4 2015 value of a five-year old capesize ship was $29m.

There is little doubt that a significant proportion of sales have been ‘distressed’, ie sold in order to prop up company balance sheets and avoid financial collapse. A recent example of this has been Star Bulk Carriers, which has sold nine ships so far this year. Forced sales have resulted in massive destruction in the value of aggregate equity in dry bulk.

Looking ahead we anticipate an astonishing rate of recovery in aggregate equity over the next five years.

This theoretical calculation is essentially underpinned by:
• A prolonged period of low prices and low contracting resulting in less new debt required.
• A relatively strong recovery for second-hand asset prices from 2018.

In reality, the actual recovery in dry bulk equity will not be quite so dramatic. The assumption that all debt for every ship is paid off as the vessel reaches 10 years old is not entirely realistic, particularly given how weak earnings have been in relation to debt service costs.

As a result, restructuring of debt will have extended the payment schedule for a number of vessels and the sharp downwards slope of outstanding debt will not be quite so pronounced over the medium term.

Of course the need to refinance will have been abated for some vessels/owners through raising new equity, for example by Scorpio bulkers, which would have the opposite effect.

Nevertheless, dry bulk debt requirements peaked in 2012-13 and will fall on the basis of market developments in the interim – ie lower prices, fewer orders. Therefore, if the value of dry bulk assets increases as MSI expects from 2018, then the impact on aggregate equity will be effectively leveraged.

MSI expects the industry’s acute cash flow problems will persist. In addition to the scale and longevity of a freight market slump, the cost of finance will play a huge role.

According to MSI’s forecasts, earnings by quarter barely exceed (and indeed sometimes dip below) operating costs for most of 2016/17. However, taking into account finance repayments the picture is far worse: cumulative losses from the project inception to the end of 2019 amount to $9.6m.

Similarly, an investment in a capesize vessel today with the same loan conditions would be subject to cumulative losses until 2018 of a total $5.4m. In fact the same analysis for any capesize vessel built from 2008 onwards yields cumulative losses by 2018 of up to $25m.

Debt service provisioning is clearly an acute issue and restructuring is dominating the agenda for struggling shipowners and lenders alike.

But whilst changes in the finance/ownership of vessels as a result of restructuring can be dramatic, from the perspective of bulker market balances these vessels are subject only to a change in ownership and often remain in operation.

Theoretically, widespread financial restructuring (such as partial write-offs and repayment holidays) should take some of the pressure off vessel owners, meaning weaker sell-side negotiating pressure and therefore lower timecharter rates, but in fact, this influence is marginal.

Regarding the drivers behind MSI’s secondhand price recovery forecast, two key props underpin the recovery: newbuild contract prices and timecharter rates.

The former we anticipate will recover from 2018 – this will be a slow and marginal recovery over the medium-term, mainly due expectations of weaker ordering of new tonnage and also as a result of massive redundant shipyard capacity in China that at times may be reactivated for specific projects (likely under the operational oversight of larger builders).

Meanwhile, we anticipate a recovery in earnings slightly in advance of newbuild prices, from 2017. As outlined earlier, our outlook is for a reasonably strong recovery in timecharter rates from 2018, although this is subject to some significant and very real downside risks. In addition, our expectation of a reasonably strong positive response from prices to better earnings is partly due to expectations that as operating profit margins improve, there will be fewer distressed sales.

Dry bulk vessel values are right now at bargain basement levels but potential buyers must have access to sufficient capital to cover debt service for several years, and a robust constitution to bear the significant downside risks to a market recovery if they are to buy in at this point.

The dry bulk shipping outlook for the remainder of 2016 remains extremely negative with an unbalanced supply-and-demand equation preventing any meaningful rebound in pricing as too many vessels chase too few shiploads, according to a new report by AlixPartners.

The consultancy said uncertainties about overall global economic activity and trade, coupled with surplus capacity and reduced demand for iron ore and coal from both China and India had placed every company in the dry bulk shipping industry at risk. “Although vessel demolitions in 2016 are expected to hit a record high of 40 million dwt, that won’t offset the 50 million new dwt expected to enter the fleet,” AlixPartners said in its 2016 Dry Bulk Shipping Outlook report. “Despite a modest bounce in pricing at the end of the first quarter, the outlook for the remainder of the year remains extremely negative.”
After a stable 2013–14, the dry bulk shipping industry began a deep downturn in 2015. Industry financial performance declined markedly from 2014, and compared with 2013, the drop in operating performance has been staggering, the report said. “By 2014, the dry bulk sector appeared to have stabilised, and it looked like companies had positioned themselves to take advantage of any market rebound, protecting themselves against further market erosion. Unfortunately, that stable state broke down in 2015, when four companies filed for protection and many others sought out-of-court restructuring. “Market pricing – reflected in the Baltic Dry Index, which charts the costs of shipping raw materials globally – sank once again as increased industry supply met diminished global demand. These unbalanced fundamentals continue to hobble the industry in 2016 and show no signs of abating anytime in the near future.
The report said the industry-wide decline could be explained by a fairly straight-forward equation that few companies have managed to solve: Weak Pricing + Costly Operations + High Debt Loads = Distress. Shipowners’ financial performance in the past few years reflects the harsh proof of that. Even companies that were restructured a few years ago were struggling, and Alix Partners said the majority of companies surveyed for its dry bulk shipping outlook were at risk of bankruptcy.

The first part of the equation – weak pricing and costly operations – showed that industry revenues fell by more than a third from 2014 to 2015, with less than 15% of the companies surveyed in an AlixPartners study showing revenue growth during the period. Bottom-line operating performance was even worse, as overall EBITDA turned negative. “The declines in EBITDA margins and operating cash flow are especially troubling because few companies have been able to sustain positive results for either,” the report noted. “A majority of companies surveyed had negative EBITDA last year compared with less than 15% in 2013. In addition, two-thirds of companies in our study had negative operating cash flows compared with just over one-third in 2013.”

AlixPartners said the severity of the slide was best shown by comparing 2015 results with those of 2013, when dry bulk new ship contracting was on the rise. Industry revenue dropped 15%, but EBITDA slid 120% into negative territory. Income losses went from USD542 million in 2013 to USD2.8 billion in 2015. “The grim numbers illustrate the collapse and pinpoint the challenges the industry faces in projecting demand accurately enough to pace supply,” according to the shipping outlook.

The consultant’s report said China’s economic slowdown was the cause of reduced demand for dry bulk shipping because it makes about half the world’s steel, and iron ore and coal make up a majority of dry bulk shipping. The mix of larger stockpiles and reduced production mean it’s unlikely Chinese iron ore imports will grow enough in the near-term to make a material difference for dry bulk shipowners. Outside of core bulk steel inputs, the picture looks equally dim. The China Coastal Bulk Freight Index, a broad proxy for the country’s maritime shipping activity, is at all-time lows and even well off its 2011–15 average. This affects Capsize vessel operators more than other dry bulk shipowners with spot rates falling by between 65-80% between 2010 and 2016.

Valuations have been driven to all-time lows in the first quarter of 2016 by sales of distressed assets and a five-year-old Capesize vessel is currently priced at a discount of almost 50% of a newbuilding. Although ship recycler GMS said some of the numbers seen on ships sold recently suggested a cash buyer confidence was returning to the market. “While supply has slowed over this past month, certain owners have been compelled to sell their respective units at lower overall rates, unable or unwilling to pass surveys or even lay up their vessels in wait of the anticipated fourth-quarter resurgence,” GMS said in a note.

That resurgence may still be some way off with shipowners often their own worst enemies. Oversupply remained the greatest industry-wide problem and AlixPartners said it was a real-life application of the prisoner’s dilemma game theory problem: “The best outcome for the group as a whole is achieved when no one entity acts in its own self-interest, but it will happen only if everyone acts selflessly, with owners scrapping or at least idling a proportion of their individual fleets to rebalance supply so as to boost demand.” But shipowners would also have to stop building because even though new vessels may be more efficient and more desirable from a marketing perspective, the economics of adding capacity remained counterproductive in the current market.

“Practically speaking, we think it’s unlikely that enough owners will, of their own volitions, behave in the industry’s broadest interests to make a meaningful impact.” This gloomy prediction led to the report’s conclusion: “Three years from now, demand may come back, but shipowners should focus on the next 36 months and act as though depressed demand is here to stay.”

THE future of commercial shipping is dire in most of its conventional forms, according to industry veteran Ravi Mehrotra, as result of the “Fourth Industrial Revolution” which brings increases in domestic production through lower labour and energy costs via technological innovations.

The emerging term generally refers to the new manufacturing technologies merging digital and physical spaces, such as 3D printers, that are coming to light after the first industrial revolution in mechanisation, water and steam power in 1760-1820, the second in mass production, assembly and electricity in 1870-1947, and the third in information technology and automation in 1950-1992.

In the inaugural Tom Leander Memorial Annual Lecture, named after the late Lloyd’s List Asia editor-in-chief, the Foresight Group’s executive chairman will say the latest industrial revolution is hitting the main shipping sectors as robotics, artificial intelligence, 3D printing, digital and nano technologies are maturing.

“The main objective of Fourth Industrial Revolution is to lower the cost of labour and energy as we have got accustomed to it,” Mr Mehrotra will say at Cambridge Academy of Transport on Friday. “[This] changes the fundamentals of global supply chains.”

The new, innovative manufacturing methods would require less infrastructure in the developed and developing nations and a limited labour force, he will say. Conventional needs of manufacturing and energy will be reduced, with the emergence of sharing economies such as Uber, which would cut overall demand of vehicles and renewable energy. And 3D printing means manufacturing at the point of use, he will add.

But all those changes will have negative impact on conventional shipping. “One thing is certain: the long-term growth in manufacturing and shipping is over,” he will say.

“Manufacturing from low-cost labour countries flooding the developed world with cheap industrial goods is over.”

According to Mr Mehrotra, who derives his predictions from Clarksons and Danish Ship Finance data, the annual growth of seaborne import volume will decline to 1.2% in 2015-2030 from 3.7% in 2000-2015. On the supply side, he forecasts annual newbuilding deliveries range between 76m-102m gt in 2016-2021 and removals between 20m-26m gt during the same period.

Those numbers point to vessel oversupply. “We are under-utilising our fleet. Utilisation is only 80%,” he will say.

“Our capital employed in shipping is under-utilised and resulting in low or negative returns.”

“It is very difficult for the shipping industry to survive in its present form… the companies that will survive will be large, highly efficient, have access to funding and will probably be more corporate.”

However, the effect of changing ways of production will be uneven over the different shipping sectors. Mr Mehrotra will point out the container sector will be the hardest hit, with forecast increase of local production. Tankers will be relatively supported as consumption by China and India — where domestic reserves are limited — continues to pick up.

Moreover, with the world’s ageing population, especially in the developed world, Mr Mehrotra will predict the boom of cruise shipping. “As import and export of cargo volumes in the developed world reduce the existing port facilities will be free. They can easily be converted to cruise terminals.”

And as people’s leisure time increases, there will be more demand for sport shipping, he will add.

Mr Mehrotra will say the generally weak market conditions after the 2008 financial crisis were signals of prolonged weakness that many didn’t realise until recently.

“Until recently we looked at world GDP growth and its volume growth to find our clue for future growth in shipping and spent hundreds of millions in this belief,” he will say.

“We were living in our own cocoon without looking at the outside world and how it is changing around us.

“It is only in 2016 we started looking at the outside world to see if some other answers were there.”