URSABLOG: Cape Fear

It’s amazing how a re-examination of the same facts can cause you to change your mind completely. I had thought, until earlier this week in fact, that the dry bulk carrier market was looking good for at least the next year or so. I was not alone, but I was also not alone in becoming a little perplexed with the way the Baltic Dry Index (BDI) was behaving, i.e. overly susceptible to gravity.

The freight market is indeed ‘sobering’, as a major London broking house reported last week. Their take on the causes are straight from the analysts’ playbook: look for numbers to blame, and here is a parade of their usual suspects:

-         Strong dollar, and getting stronger

-         Oil prices falling and falling further

-         GDP growth slowing

-         China stable but not booming

-         Bank credit slowing

-         “Overall exports from China have held up, but are expected to fall as the trade war bites…”

-         Steel prices in China are weakening (even though production is at an all-time monthly high)

-         Iron ore prices are falling

-         Iron ore stockpiles are high

-         Iron ore import volumes are less over the last six months than they were a year earlier

-         Iron ore exports out of Port Hedland are down 12%

I could go on with this mixture of ‘may happen’ and ‘already happened’ but you will be reading more of the same from many other reports so I won’t bore you further.

Anyway, at the end of two pages of demand side woes, the ‘Big Picture’ report devoted just two lines to the supply side:

“Meanwhile supply growth remains limited, even if it steps up from 2.5% this year to above 3% next year.”

This is kind of what I thought too, and was basing my optimism on it. There was no rush of new orders to worry about. But a throw-away comment in my own blog last week started a fundamental change of mind. The line in question was:

“…it looks as though the cape market is suffering because of a switch to Brazilian iron ore using Valemaxes coming out of shipyards at a steady rate.”

I must admit now that it was an impression rather than a scientifically proven hypothesis, but it was picked up by a client of mine. He called me:

“Your blog” he said “continues to impress and depress me.”

“Why?” I said, “is it too much about Brexit?”

“No” he said, “but I want to pick your brains about iron ore.”

I explained my theory, which can be paraphrased as follows:

-         Brazil produces higher quality iron ore pellets than Australia, so is becoming increasingly attractive to the Chinese wanting to control their emissions of dirty smoke as well as upgrade their steel production

-         Valemaxes or VLOCs are being used more in the Brazil trade, displacing spot trading standard capesizes into the Pacific

-         Valemaxes in particular are being employed on long term timecharters or COAs, and don’t trade in the open freight market

-         Fresh Valemaxes and VLOCs are coming out of the shipyards in greater number (by deadweight carrying capacity) than standard capes and are almost exclusively going straight on to the Brazil-Far East Asia route

-         Each Valemax is more or less two capesizes in size alone

“So”, said my client, “It’s a supply problem then?”

“Yes,” I replied, “it appears so.”

It’s all very well talking a good game, but I had to prove this theory correct so I started my own piece of research. I looked at the numbers of ships delivered (capesizes and larger ore carriers) over the last three years and compared it with the BDI and the Baltic Capesize Index (BCI). The results were interesting:

The thin red columns are capesize deliveries, the thicker mauve ones are VLOC deliveries, both in deadweight. The BDI is the thin blue line, with the BCI the orange one. Although not a direct correlation (beware of them!) it is illustrative.

It should be no surprise for those with a memory that the huge amount of capes coming into the market in early 2016 compounded the severity of the freight market depression. What may be more surprising is the big lump of VLOCs currently delivering against the backdrop of a falling freight market.

As I suspected when I wrote last week, the volumes of higher quality iron ore coming from Brazil continue to grow. Vale’s share increased to 79% in the third quarter of 2018, up from 72% in the same period last year. Also to remind you: there are no iron and steel production cuts demanded this winter by the Chinese authorities, just emission controls.

The iron ore shipped to Asia from Brazil is not priced in the same way as Australian iron ore, nor is it as vulnerable to the vagaries of the freight market. Reported capesize fixtures are dominated by spot cargoes loaded from Australian ports. A shift of trade patterns seems to be under way.

My contention is that it is tonne-mile demand which is shaking up the dynamics of the capesize market. I did a quick ‘back-of-a-beermat’ calculation:

-         A valemax from Brazil to China represents a massive 4.5 billion tonne-mile demand

-         A capesize from Australia to China is only 635 million, and is open for employment again sooner

Every new valemax displaces at least two capes on the Brazil to China run; capes are generally trading on the shorter routes, therefore the balance of supply and demand in the spot market will increase in the charterers’ favour. Every time a VLOC is delivered, the increase in tonne-mile supply is disproportionately larger than just the size of the vessel, according to my simple calculations: the delivery of one VLOC onto a onto a long-term contract releases about 7.5 times the tonne-mile supply. Admittedly my calculations may be too simple to be taken too seriously, but they do make an important point. And remember that the capesizes released will trade in the spot market, and will have no future access to the cargoes carried by the larger ships, reducing open market tonne-mile demand further.

On top of that the increase in the supply side is not that encouraging either. Here are newbuilding deliveries from 2016 to 2022:

Ouch. 2019 in total represents a bigger lump of supply to absorb than both 2016 and 2017. 2020 is much the same.

Is there a bright spot to all of this? Well yes - I hope so at least – there is always coal. The short term does not look great however: China has decided to limit 2018 imports of coal at the same levels as 2017. This basically means that December imports will be only 40% the normal level, which is affecting the Pacific freight market detrimentally in all sizes. However, this years’ winter pollution controls in China do not involve burning less coal, just cleaner coal. This should help seaborne imports to improve, but the picture is less than clear, as usual, because we don’t know if China will enact any short-term changes like it did last winter. For all the shift to ‘cleaner’ forms of energy, coal remains a cheap and easily accessible way to generate electricity.

The Japanese are building new coal-fired power stations to offset the capacity lost from nuclear reactors after the Fukushima disaster, capacity which will not come back online anytime soon. Elsewhere in south-east Asia and India it is Japanese (and Chinese) expertise and money which is being used to build coal-fired power stations in places where little existing infrastructure exists.

But before you start breathing a sigh of relief and start ordering Newcastlemaxes (larger capes with a shallow draft), most of the coal transported to Japan from Australia will be in specially designed coal carriers to fit the ports and the trade. These have been around for a long time; some nearing the end of their contracts are now being sold on to Chinese power generators, or to Middle East aggregate traders. Either way it is very unlikely that the cargoes of coal required for power generation will be offered on the spot freight market; they will be carried by Japanese owned or operated ships under long term contracts.

So, here is my unwelcome, for owners at least, conclusion. Oversupply will continue to put pressure on the  freight market in the next year or two by directly affecting the capesize market, and by extension and sentiment the smaller sizes as well. I hope that other new facts will emerge to make me change my mind again, or the shipping gods spring another surprise on us which changes this rather depressing picture. None of us can predict the future after all, so all we can do is prepare for it in the best way we can.

Simon Ward

www.ursashipbrokers.com