Dry Bulk Shipping Supply Side Improving

• Shipping often rides boom and bust cycles, and much of that can be traced to the supply side.
• A seemingly small increase or decrease in vessel availability can often have a large impact on the market.
• Here, we examine trends in the dry bulk shipping market supply side.

Overview

Matching up supply and demand isn’t always as easy as it sounds, especially on a global playing field like maritime trade which has many participants. Often the ups and downs in this industry can be traced to supply side imbalances.

Recently several segments have been experiencing a bit of trouble brought on by an oversupply of vessels with many more still set to hit the water. This oversupply has been a main culprit behind the disequilibrium in shipping markets lately and therefore low charter rates.

Background

It is widely accepted that currently the drybulk market is experiencing supply and demand disequilibrium. This was the result of too many ships being ordered prior to the 2008 crash to supply a commodity demand boom that was unsustainable in the long run.

The end result was a massive amount of supply that was ordered before 2008 and being delivered as late as 2014 due to the lengthy nature of the shipbuilding process and the backlog in many shipyards that spanned several years. Thus, the available supply soon outstripped post-boom demand.

This oversupply problem has been compounded by a return to average demand growth for the dry bulk trade which eventually led to a historic lows in the leading economic indicator for the segment known as the Baltic Dry Index, or BDI.

The Baltic Dry Index, or BDI, is a composite of the Baltic Capesize, Supramax, Panamax, and Handysize indices. It is useful in determining the cost to move materials by sea.

Introduced on January 4th, 1985, at 1000 points, this economic indicator had reached a record high 11,793 on May 20th, 2008 and a record low of 290 on February 10th, 2016.

The market is still dealing with a large amount of vessels but the orderbook is thinning and newbuild contracts have been scarce over the past year. This points to a badly needed supply side correction which has 2018 as potentially the first year in many where demand side growth could outpace fleet growth.

Sector Focus

There are several different segments in dry bulk shipping. For the purpose of simplicity, overlapping trading purposes, and maintaining the continuity of data obtained from Clarkson Research, we will group some of these segments together.

The Capesize, Newcastlemax, Womax, and VLOC’s (Very Large Ore Carriers) are typically involved in long-haul iron ore transportation such as Brazil to China or Australia to China. Capesize vessels also engage in large shipments of coal on long-haul routes. Together this collection of vessels of 100,000 dwt and above will be grouped together under the Capesize heading.

The Panamax and Kamsarmax vessels are primarily used for transporting coal, as well as grain, iron ore and some minor bulks. This collection of vessels, between 65,000-99,999 dwt, will be grouped together under the Panamax heading.

Handymax, Ultramax and Supramax vessels transport many minor bulks, in addition to some of the major bulk cargoes on relatively short-haul routes. These vessels range between 40,000-69,999 dwt and will collectively be referred to as Handymax.

Note: You may have noticed some overlap in the Panamax and Handymax range in the 65,000-69,000 dwt range. This is due to other ship specifications which determine it to be one class as opposed to another and they are not double counted.

Finally, we have the Handysize vessels which transport a wide range of minor bulk commodities on short-haul routes. Many vessels are equipped to transport specialized cargoes such as logs, wood chips and cement. They are typically between 10,000-39,999 dwt.

Supply Side

Let’s start with a snapshot of dry bulk vessels currently on the water by class.

Now, as noted earlier we experienced a massive influx of vessels in recent years which led to historic lows in the BDI. In order to put the magnitude of that disequilibrium into perspective it is necessary to breakdown the fleet a bit further. We will do so by year built for vessels on the water in each class.

Source: Data From Clarkson Research Chart By James Catlin

The Capesize class saw an extraordinarily high number of deliveries following the collapse of 2008/2009. Not only did these vessels face unprecedented competition from one another, but the backdrop of a fresh economic collapse, which took a major toll on commodity demand, worsened the situation.

Once again for a bit of perspective take a look at the Baltic Capesize Index, which was the catalyst for a record amount orders as owners attempted to capitalize on a hyper-bullish market by having as much tonnage on the water as possible. But this was followed by the economic collapse and many of these orders, due to a large backlog at shipbuilding facilities and the lengthy nature of the construction process, hit the water during the aftermath.

Source: Investing.com

Even when demand side trading patterns returned to historical averages, the oversupply continued to weigh on the market and has kept a massive amount of pressure on rates for the following 9 years.

This same trend held true for the Panamax group as well.

Source: Data From Clarkson Research Chart By James Catlin

As well as the Handymax…

Source: Data From Clarkson Research Chart By James Catlin

and finally the Handysize.

Source: Data From Clarkson Research Chart By James Catlin

To keep things in perspective, vessels built in the years prior to 2001 across all classes have experienced an extraordinarily high level of demolitions. So the 2001-2004 years, which have only seen a total of 31 demos across all classes over the past few years, are a viable indicator of what had been a normal amount of deliveries prior to a distorted market courtesy of an inflating bubble. Knowing this should help put the high level of deliveries from 2005 till now into context.

The Balancing Act

With demand growth in the dry bulk market expected between 2%-3% over the coming years and ton mile increases expected to average approximately 3%, the key to a market recovery rests in a re-balancing of the supply side.

This re-balancing can occur either through the scrapping of older tonnage thereby thinning out the global fleet, or for new orders hitting the water to slow which would allow the demand side to catch up. In the case of dry bulk both appear to be at work.

An unprecedented amount of demolitions since the oversupply crisis became apparent has already played a role in getting things back on track.

Source: Data From Allied Shipping Research Chart By James Catlin

Now there are a couples interesting things about this chart. First, the level of scrapping annually has increased significantly since 2010. It is noteworthy that scrapping activity was practically non-existent for a prolonged period of time up until November 2008 and then really began accelerating in 2010. More on the reason behind that in a bit.

Second, the average age of those being scrapped has seen a massive drop. The average dry bulk vessel can expect about 30 years of service. But in 2016, when rates hit their all time low we saw the average demolition age slip to just 23.68 years, down from 31.04 years in 2010.

Now, why has scrapping increased significantly with younger vessels being sent in for demolition?

As a vessel begins nearing the end of its service life, the current market and future projections can greatly influence the decision to retire early or perhaps extend operations. Rates are the deciding factor in this equation.

If rates remain very strong, we typically see vessels remaining on the water longer than usual as strong charter rates more than cover the increased OPEX for older vessels. This is what was happening in the mid 2000’s when scrapping activity was very low.

On the other hand, if a vessel is nearing the end of its life and charter rates are dismal, perhaps even loss-making, it may find itself in the scrap yard sooner than expected. This decision rests on the severity of losses, coupled with the projected duration of the downturn, all while considering the vessel’s age and financial needs.

For example, if a vessel is three years away from retirement, but currently operating in a loss making environment projected to last five years, the decision is easy. But if the vessel is eight years from retirement, with a five-year bear market on the horizon, owners must take into account the current projected losses they will suffer in the bear market, and whether the bullish upturn will negate those losses and perhaps turn a profit. Of course, that can all be highly speculative. Which is why in horrific markets we sometimes see vessels ten years away from retirement being scrapped early.

A side note on the speculation surrounding this downturn: This latest downturn in the dry bulk segment actually had many analysts confounded. Just for kicks here is one analyst who got it completely wrong in 2014 predicting a peak for dry bulk rates in 2016. Instead, we saw historic lows.

Let’s get back on track here. We have seen how demolitions have played a role, but do they have any further ability to contribute to restoring market balance? Turning back to the charts showing the different classes by year built currently on the water and taking into account the average scrapping age is now climbing, 24.79 so far in 2017, it becomes apparent that the role demolitions have played will be much smaller going forward, especially considering forecasts for an improving market ahead.

Out of the 11,076 dry bulk vessels currently on the water only 423 of them were built in 1992 or before which represents about 4% of the current fleet. So the demolition hand has been played to a very large extent.

That then brings us to the subject of how vessels hitting the water will compare with projected demand growth going forward?

For that we need to take a look at the orderbook.

Again, for some context, previous years have been included so we can see how future deliveries stack up to the recent past.

We’ll get to an individual breakdown, but the overall orderbook paints a very solid picture so we’ll start there.

Source: Data From Clarkson Research Chart By James Catlin

Now, let’s take a look at each class individually.

Here we have the Capesize.

Source: Data From Clarkson Research Chart By James Catlin

Followed by the Panamax.

Source: Data From Clarkson Research Chart By James Catlin

Next we have the Handymax.

Source: Data From Clarkson Research Chart By James Catlin

Finally, the Handysize

Source: Data From Clarkson Research Chart By James Catlin

Notice that in all classes, 2017 represents the final year for a significant amount of deliveries.

If all projected 2017 deliveries hit the water on schedule the total dry bulk fleet will consist of 11,335 vessels by the end of the year. In 2018 a total of only 228 vessels are projected to hit the water making for fleet growth of just 2%. This doesn’t take into account slippage or demolitions which could potentially bring fleet growth to just 1% or even lower.

Remember, this stacks up against a projected 2%-3% conservative demand growth estimate coupled with ton mile increases of approximately 3%.

In short, 2018 looks to be a turning point for the market where for the first time in several years we should see the demand side outpace the supply side. Ideally, this dynamic should lead to higher charter rates and signal the start of a burgeoning recovery.

But it’s not just higher rates which will help the companies engaging in the dry bulk trade. Recently we have seen a significant increase in vessel values across the entire segment.

Source: Athenian Shipbrokers

These increasing prices directly impact NAV which is considered a key component in how shipping companies are valued, as well as how they manage leverage.

Let’s put some actual numbers to this move. Asset values appeared to find a collective bottom around the end of March to early April of 2016.

Source: Allied Shipbroking Week 14, 2016

Below is a snapshot of current asset values.

Source: Allied Shipbroking Week 31, 2017

Let’s take a closer look at the Capesize class to highlight an interesting recovery trend and how it will impact companies based on the average age of their fleet.

Source: Data From Allied Shipbroking Chart By James Catlin

Notice that the older class of ships have experienced a much larger move to the upside. During the downturn these vessels bore the brunt of asset declines and NAV suffered as a result. This was because many feared their remaining service life would be marred by a prolonged and significant downturn in the market.

But as market prospects have improved owners realize that with a recovery on the horizon these older vessels may still have some very profitable life in them. Therefore they have been a main target of asset acquisition lately due to their initially depressed prices. This same trend holds true for all classes.

Source: Data From Intermodal’s Week 31 Report Chart By James Catlin

In fact, as the chart above points out, vessels between 12-17 years old are still being targeted by buyers even after the substantial gain in prices.

So while companies with newer fleets may benefit from slightly higher charter rates, companies with older fleets have seen a substantially larger increase in NAV. These higher asset values could potentially provide a bit of wiggle room for companies with older fleets to begin upgrading their fleet as leverage concerns dissipate.

Conclusion

A long awaited turn in the dry bulk market appears to be underway. 2018 looks to be a pivotal year with demand growth expected to outpace vessel deliveries for the first time in many years.

As the market comes into balance we should see rates as well as asset prices continue to improve. Companies may actually begin posting profits in the near future, taking into account items like debt servicing, G&A, and depreciation. For several years, many companies were lucky just to cover operational expenses which didn’t include the aforementioned items.

Back in 2014 I had predicted profitability returning to the dry bulk segment in mid-2017. In the middle of 2015 I had revised that recovery date to mid-2018 and I still believe this looks to be a fairly accurate estimate. We could see some profitable rates materialize before the end of 2017 but then we must again deal with the seasonal slowdown in dry bulk trade in Q1 of next year. Nevertheless, the trend from here on out appears to be higher highs and higher lows with 2018 presenting the possibility for the first profitable year for some companies after many years of losses.

While the BDI has improved to just below 1,100 as I write, which is far better than the triple digits we saw so much of last year and at the beginning of this year, 1,100 is still an abysmal number and there needs to be some improvement for that forecast of profitability to come to fruition.

Now, the key to this rebound rests on maintaining healthy demand for dry bulk goods as well as owners keeping the orderbook at an acceptable level. That second part is a main concern of mine going forward. With the prospect of a recovery on the horizon owners often place orders in an attempt to position as much tonnage on the water to capitalize on higher rates. The continuing low prices for newbuilds also present a bit of lure as well.

Already we have seen 93 new orders in 2017 which isn’t a concern. Nevertheless this is higher than the 51 placed in 2016, and not quite on pace with the 212 orders in 2015, which was seen as a positive step in correcting the orderbook. If owners can keep ordering activity on par with 2015 and 2017 we should see a healthy market begin to develop over the next few years.

Overall, the dry bulk market appears to be in a corrective phase and things are beginning to look up. But there is still quite a bit of work ahead.