Unprecedented collapse

by Michael King
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Baltic Dry Index
The prolonged downturn of the bulk shipping market continues as rates plummet.
 
The Baltic Dry Index is used as a “canary in the mine” for the global economy as well as a measure of how much it costs to ship dry commodities around the world. On both counts its recent performance bodes ill. Indeed, such is the nature of the prolonged downturn of bulk shipping markets that grain counterparties should be wary.

 

In late May a bulker operated by Hanjin Shipping was released from Richards Bay in South Africa after being held due to unpaid charter fees.

“Both Hanjin Shipping and the relevant parties agreed that successful financial restructuring of Hanjin Shipping correlates to everyone’s interests and hence decided to resume the sailing of the vessel and to resolve the arrears issue through further discussion,” the Korean conglomerate said in a press release.

The troubled shipping giant is currently restructuring after a succession of dire financial results. It is not the only bulk carrier owner or operator to be struggling in the current market, but it is one of the largest. Many expect Hanjin to eventually merge with fellow Korean shipping line Hyundai Merchant Marine in a bid to avoid bankruptcy. Both carriers have been hit by awful returns from their container fleets, with overcapacity and poor demand hitting rates across the globe. But their bulker arms have proven just as problematic over the last year or two. The reasons for this are not difficult to discern and they also hold huge relevance for those in the grain industry that might be looking at counterparty positions with shipping companies.

Where has it all gone wrong?

In late 2013 the Baltic Dry Index peaked at 2,330. “Peaked” is a relative term considering that back in 2008 the BDI was approaching 12,000 and in 2010 it passed 4,000. But the 2013 surge was as good as it’s been for the world’s beleaguered ship owners and operators for much of the current decade. In 2015, the 1,000+ mark was only passed briefly during a short summer bump and in 2016 matters have gone from bad to worse. In January this year, the BDI hit just 290 – the lowest mark since the Index was established in 1985 – before recovering to 601 in late May.

According to the IGC Grain Freight Index in late May, this translated over the last year into a 52-week low of $16 per tonne on Brazil-E.U. routes compared to a 52-week high of $29 per tonne. On the USA Gulf-E.U. lanes, the Index dropped as low as $8 per tonne earlier this year and was at $20 on May 24, while on the USA Gulf to Japan lane the 52-week low was $20 per tonne versus a high of $38 per tonne. On May 24, it was $27 per tonne.

The BDI is a composite rating of the different ship sizes used to carry bulk cargoes – see charts for the individual performance by vessel size. But as a rough guide, most analysts believe the break-even mark for vessel owners and operators is around the 1,500-3,000 BDI mark, depending on ship size, fuel efficiency, crew costs and purchase price. So the last two years have been catastrophic for owners of bulk carriers and their investors, a fact that shippers and transporters of grain and other commodities should be aware.

Even the biggest can topple

The owner-operators at most risk at present are those that invested in relatively small fleets at the height of the newbuilding pricing boom – high fixed asset costs and poor returns are, of course, not a good mix. But even some of the world’s largest shipping conglomerates with diversified fleets and asset mixes are now struggling to remain solvent.

Hanjin said in its first-quarter 2016 results that it had suffered from the “lowest ever freight level triggered by low iron ore and coal demand during the first quarter,” adding that it hoped rising vessel demolitions would help offset the imbalance in capacity demand and supply as the year progressed.

K Line, another Asian shipping giant, also felt the pinch in the first quarter as rates slumped. It said the freight market slump came despite the increase in cargo movement for the winter season, which had “almost no impact amid plateauing iron ore import volumes due to stagnating iron demand in China.” The Japanese line also said that in the small and medium vessel size sector of most interest to grain shippers, the freight market had slumped as the “vessel supply and demand balance collapsed, mainly due to the slump in transportation of coal to China and easing demurrage for loading grain shipments in South America.” K Line responded by disposing of vessels and cutting operating costs to offset losses and revenue declines.

NASDAQ-listed Globus Maritime Listed was forced to renegotiate agreements with two of its lenders this April to relieve the pressure face in the current market. In March, Mitsui OSK Lines, one of Japan’s biggest shipping groups, said it would restructure its dry bulk business to cut costs including paring operations and selling vessels, while Norway’s Bulk Invest filed for bankruptcy in the same month. A number of companies including Goldenport Holdings and Hellenic Carriers have delisted to cut the cost of maintaining public listings, while Lithuanian Shipping Company is being liquidated.

Earnings suffering

Given the dire state of the bulk carrier supply-demand balance and the extended years of poor returns, it should come as no surprise that owners and operators are struggling. In a recent presentation, Jayendu Krishna, director of Drewry Maritime Advisors, noted that over the last five years the earnings of modern dry bulk vessels had been below break-even on a time charter basis, and for the last year returns had been lower than the average operating cost, a combination that threatened the financial viability of many in the industry.

“Several dry bulk shipping companies are battling with bankruptcy cases,” he said. “Though low freight rates are beneficial for cargo owners against the backdrop of low commodity prices, this is a very clear risk.”

Krishna also looked at the market dynamics that had produced the low rates. He spoke of a new era of low bulk shipping demand growth with the expansion in demand for coal and steel tapering off against a backdrop of key Asian economies such as China and India growing less quickly than anticipated, and with less emphasis on imports of commodities. This will see the global dry bulk trade grow by a CAGR of 2.7% over 2015-20, versus 4.8% over 2010-15.

“The era of the commodity boom seems to be disappearing,” he said. “The latest trends in terms of falling steel intensity and energy intensity suggest lower dry bulk growth in the next five years.”

The problem for owners is that even though vessel demolition rates have accelerated and the age of ships being scrapped has fallen, CAGR fleet growth of 8.1% over 2010-15 has left a huge surplus, and low fuel prices have encouraged some owners to speed up ships to capture cargoes, effectively adding to global supply.

Krishna said he expected the fleet to grow by a CAGR of 1.6% over 2015-20 as the orderbook dried up after heavy deliveries this year, but added that this lower level of growth would not address the fact that the “the dry bulk market is oversupplied by more than 30% versus total demand at present.”

2016 grain rally

BIMCO
Peter Sand, BIMCO Chief Shipping Analyst.

Peter Sand, BIMCO Chief Shipping Analyst, said that the rally of the BDI since the horrors of hitting 290 in February was aided by higher rates for smaller vessels and prompted by the strong South American grains season. A later increase in Chinese iron ore and coal demand also offered a boost. But to sustain the recovery, he said scrapping of ships needed to increase.

“The fundamental market balance is still very much off,” he explained. “Overcapacity is serious. The current lift in freight rates is not a result of evaporated overcapacity. The prospects for the dry bulk market are one that spells out a multi-year recovery. If we can keep demolition levels high – at around 40 million dwt per annum – for the coming three years while not placing any more new orders, we will bring back a sustainable market, even at low demand growth. We all know what needs to be done, but doing it is still a bit difficult.”

As for this year, he said BIMCO was worried that the recent bounce back in freight rates was unsustainable. “The demand side seems unable to buoy profits as both Chinese and Indian growth cools off and the rest of the world is still importing smaller volumes than before the financial crisis of 2008,” he explained. “However, we have been positively surprised by the way the market has developed during March to May with coal and iron ore into China and Chinese steel exports both featuring heavily. But before we get carried away, we also have to admit that these fairly positive trade volumes have failed to bring decisive support to freight rates.”

Supporting Sand’s analysis, Philippe Louis-Dreyfus, BIMCO President, described the current bulk carrier market as “terrible” but said that if owners could hold off from placing new orders – enticements on pricing and design will be tempting considering the empty orderbooks many yards are now staring at – and continue scrapping so that supply growth was held at zero, then it was possible the market could return to profit in 2019. “We cannot expect to be helped by growth in demand. The recovery of the market is wholly and exclusively in the hands of us, the shipowners,” he said. “The medicine is not going to be easy to take. Zero supply growth has been achieved only three times in recent history, during the 1980s and 1990s. The task ahead of us is huge and must be sustained year after year.”

In the meantime, for customers of the stricken bulk shipping sector, caution is advised. “Counterparty risk is an issue for all involved in dry bulk shipping at the moment, and that includes grain shippers,” said Sand.

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