In this article, part of a series in which we cover commodities, energy, shipping and technology, media and telecom, we look at the shipping sector and asses the sources of volatility and uncertainty it faces.
Shipping: dramatic volatility
Over 90% of world trade is carried by sea, so the state of the industry is widely seen as a barometer of the global economy. Shipping capacity expanded vastly in the decade before the financial crisis as the global economy grew and structural shifts took place, such as the growth of offshoring and the massive expansion of China’s economy. The slowdown in global growth and setbacks in China’s economy have consequently hit shipping hard.
“Shipping is clearly dependent on global trade and has therefore suffered as GDP growth has slowed but it has also faced the challenges associated with excess capacity that was commissioned during strong market conditions – the delivery period of a ship is up to three years and once orders are placed they are difficult to cancel – which has exacerbated the problems. It then takes time for the excess capacity to work its way out of the system,” explains Stephen Fewster, global head of transportation finance at ING Wholesale Banking.
“Over supply of vessels tends to be the main driver of a shipping recession as it is a very fragmented industry, with a multitude of owners and shipyards so there’s always someone willing to take an optimistic view and order new ships. Moreover, for political reasons shipyards are often kept busy even when demand should naturally subside.”
In recent years, excess capacity was also fuelled by an influx of money from private equity firms seeking yield in the low rate environment. “In the aftermath of the financial crisis, a number of banks exited the market and, with freight rates and building costs at record lows, private equity believed there was an opportunity,” notes Fewster. “With support from some of the remaining banks and various export credit agencies, they funded new capacity in the expectation of a swift recovery in shipping demand which has not yet materialised.”
The scale of the collapse in shipping demand and the high levels of surplus capacity are illustrated by the trajectory of the benchmark Baltic Dry Index, which measures freight rates on 23 key shipping routes for the most common types of dry bulk carriers carrying a range of commodities including coal, iron ore and grain. In February 2016, the index hit a record low of 290 points – down by around 98% from its record high of 11,793 points in May 2008.
Supply is gradually adjusting to demand. From next year, delivery of ships speculatively ordered during the private equity-financed boom will almost cease. Meanwhile, an increased number of ships are being sent for recycling before the end of their typical 20-25 year lifespan, as vessel earnings cannot cover their finance, maintenance, repair and crew costs (ships require a special survey every five years that can result in high repair costs, especially for ageing ships). As a result, fleet growth should slow considerably or even reverse
Nevertheless, some segments of the shipping market will continue to suffer challenges. The container ship market is likely to have excess capacity for some time given the move in recent years towards ever larger ships – recent launches carry 18,000 boxes compared to 9,000 10 years ago – in an effort to lower costs per container. However, not all shipping sectors are suffering. The tanker market is currently buoyant, with oil traders using tankers as storage facilities to take advantage of an oil price contango – where the spot price is lower than the forward price – to make a profit (and avoid having to use over-subscribed onshore storage).
In the longer term, some commentators believe that shipping will be affected by the growth in onshoring, where production capacity is brought back to developed markets to take advantage of proximity to market and low-cost automation and from changes to China’s economy that could reduce its exports. “There’s no evidence of either trend significantly affecting shipping yet, though obviously it could be concealed by the post-crisis shipping recession,” says Fewster. “Shipping is a dynamic industry and we have to be constantly aware of the changing market circumstances such as the potential for overland rail freight from China via the Silk Road route, which could be faster than sea and relatively low cost.”