Unfortunately, the major surge in business did not materialise and the supply of ships and their capacity is totally unaligned with the level of demand. China's economy has slowed; the west is not displaying anything like a robust recovery. Such has been the saturation of consumer goods from Asia that there is little room for additional growth.
Trade growth clearly recovered after the financial crisis, however, since 2013 it has been declining. In 2015 it fell by 12.76% and in the first half of 2016 was lower by 6.12%, (first chart). If we compare global economic growth data (independent or x) from the Organisation of Economic Co-operation and Development and trade growth (dependent or y) from the World Trade Organisation one can see that for a fourth level polynomial regression the correlation or R-Squared is 0.6953. This correlation rises to 0.736 if one forces the polynomial to a fifth level., (second chart).
Source: WTO and Spotlight Ideas
Therefore, the timing of massive fleet expansion in both size and scope could not have been more poorly timed.
Storm tossed transporter or the horror of Hanjin
It would appear that the shipping industry no longer can cling to the hope that it will be possible to find the favourable current of recovery and escape the doldrums anytime soon following the bankruptcy on August 31 of South Korea’s Hanjin Shipping Co. (117930).
Hanjin was the world’s seventh-largest shipper, which had to file for bankruptcy protection in Seoul after financial support was withdrawn leaving it unable to service its $5.5 billion of debt. This action meant that Hanjin had to temporarily maroon $14bn of goods at sea given that vessels in its fleet were denied access to ports across the world.
This difficulty has seen a degree of resolution as Hanjin was allowed to unload ships at San Pedro Bay last week, after a court in New Jersey gave the company protection from US creditors and a court in its home country approved a cash release of $10 million to finance the processing of the cargo.
However, this mariner’s tale of woe is not over by any means as Hanjin and its administrators will have to find a way to manage the remaining cargoes that are still floating on the sea, sell the majority of its current fleet and offload 61 chartered ships.
Cutting costs is a priority
As is the case for many industries maritime transporters have to keep a close eye on costs. Already the industry has seen CMA CGM (France) acquire Neptune Orient Lines (Singapore) for $2.4bn.
Similarly, Hapag-Lloyd (Germany) has merged with the United Arab Shipping Company (originally established in Kuwait with its corporate headquarters now in Dubai, UAE, to form a top five global shipping operator.
These mergers are designed to reduce long-term average costs rather than being a move to explicitly gain market share. A firm’s efficiency is affected by its size and larger firms are often more efficient than smaller ones because they can gain from economies of scale. This cannot carry on for ever as firms may become too large and suffer diseconomies of scale and find, as with Hanjin that the top line cannot service the mounting operating costs of the business. Like a super-sized ship, they cannot urn and adjust course very quickly.
Too many super ships
The credit rating firm Moody’s Investors Service reported in June that the global fleet of container ships is set to grow 2% faster than the demand for their capacity this year. This mismatch is likely to remain in place at least until June 2017. Drewry Maritime Research suggest that this implies on an aggregate basis the shipping industry will lose approximately $5bn in 2016.
The problem can be seen in the fact that vessel capacity has doubled in the past five years. The new generation of vessels are as long as five city blocks or a quarter of a mile with a load capacity of over 18,000 standard sized containers. The imbalance of current total capacity over total demand is running at 20%...clearly it is unsustainable.
It is a long time until a turning of the tide
The Baltic Dry Index (BDI) Wednesday finally broke 900 for the first time since the end of October 2015, gaining 38 points to reach 903.
Source: Baltic Exchange, London
This level has been achieved four months later than was initially expected and one could argue that the sequence of declining tops since the start of 2014 is signal that all is not well in the industry.
Following the demise of Hanjin there will be price volatility. Therefore, one should not be surprised to see an element of channel overshoot before more corrective rotation in the Baltic Dry Index takes hold into the year end.
Whilst rising freight costs and a short-term tightening of supply could be to the benefit of some operators I think one has to be cautious. The capacity signals are mixed for on one hand it is pleasing to hear that new build dead weight tonnage (DWT) has fallen to almost zero, however, the pace of vessel scrapping has declined form a reported 12.9 Million DWT in Q1 2016 to 10.5 million DWT in Q2.
Too many operators are running inefficiently and ineffectively, e.g. Nippon Yusen K.K. (Japan 9101) and the Hyundai Merchant Marine Co. (South Korea 011200) are seen as vulnerable. Over the past year shares of Nippon Yusen are off 35.0% and for Hyundai Merchant Marine the decline is a disastrous 83.3%.
Shipping operators would be foolish to set too much faith into there being a meaningful recovery in rates unless there is a rapid decrease in capacity over the next two years to engineer a correction in the unbalanced nature of the industry’s fundamentals.
– Edited by Clare MacCarthy
Stephen Pope is managing partner at Spotlight Ideas