Tuesday, February 24, 2009
Weak won hits newbuilding cancellation efforts
Tony Gray - Tuesday 24 February 2009
The value of the won has fallen by as much as 60% since early 2008. pic: Bloomberg
SHIPOWNERS’ efforts to secure the cancellation of billions of dollars of newbuilding contracts placed with South Korean shipbuilders are being hampered by the weakness of the won, which is threatening to result in huge currency losses for the yards.
The problem for shipbuilders arises from the forward sale of dollars expected to be received over the next two or three years from newbuilding orders - if these contracts are cancelled, shipowners will not make their payments and the yards will have to buy more expensive dollars to fulfill the foreign exchange deals.
Increased demand for dollars by the yards would also place further downward pressure on the South Korean currency, creating a downward spiral which will serve to exacerbate the country’s trading position, which is built on a strong export industry.
One shipowner said the “reality is that Korea Inc cannot afford to accept cancellations or delays as they desperately need the dollars from ship orders.”
Analysis by Daewoo Securities said the won had weakened sharply due to a number of factors, including the “potential contagion” from the economic crisis in Eastern Europe, worries over banks’ ability to repay foreign-currency denominated debt, as well as the cancellation of shipbuilding orders.
The last two factors are related as most South Korean shipyards are believed to have swapped their scheduled dollar revenues with domestic banks through forward contracts.
In turn, the banks have undertaken a similar exercise in international markets.
South Korean yards have a combined order book worth about $200bn, but the contracts most at risk of cancellation will be those placed in 2008 where construction has yet to progress significantly.
Daewoo Securities estimates that South Korean yards last year captured newbuilding orders totalling $59.5bn, of which 30% would be spent on importing raw materials and equipment.
The securities firm pointed out that the yards hedge about 90% of the remaining 70% of the order value - thus, net selling of forward dollar contracts is estimated to be about 63% of an order’s entire value.
Given the $59.5bn of contracts gained in 2008, hedging is estimated to total $37.5bn through forward foreign exchange deals.
As the value of the won has fallen by as much as 60% since early 2008 to below Won1,500 to the dollar, these forward contracts are now substantiantially ‘out of the money’ if newbuilding contracts are cancelled.
“Demand for dollars related to shipbuilding order cancellations will be determined by global financial market conditions,” Daewoo Securities said.
“The Korean [foreign exchange] market, which was thrown into crisis in the fourth quarter of 2008 due to global financial turmoil, is facing a similar predicament in February.
“Financial market anxieties are unlikely to dissipate until there is clarity over the extent of the crisis in Eastern Europe and the amount of shipbuilding order cancellations.”
Of course, many shipping companies are also under financial pressure and, with steel prices lower, may expect concessions from the yards.
“But what they don’t see is the desperate shape South Korea is in,” said the owner.
“Personally, I suspect Korean shipyards are under pressure from the Korean central bank not to negotiate or accept any cancellations and delays.”
Daewoo Securities said theSouth Korean financial authorities were expected to maintain dollar reserves by decreasing imports and borrowings, and by withdrawing overseas investment to reduce demand, “since expanding supply through exports or foreign investment has become more demanding.”
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