Thursday, March 19, 2009
Thursday, 19 March 2009
For the past six years, the investment paradigm in shipping markets has been driven by the China export growth model. Both the EU and US increasingly outsourced production to the Far East. The Far East exported finished goods to Western consumer markets and imported raw materials and energy resources for production. George Economou, in a DRYS investor presentation, boasted of a commodity boom that would last 20 years and a new era for shipping markets. Orderbooks for new tonnage reached historical highs. Analysts argued that FE growth was decoupled from Western economies and would help shore up any downturn. The issue today is whether we are entering a new era of structural change and how the dynamics will affect the shipping markets.
When the financial crisis broke out last fall and shipping markets collapsed, I turned to macroeconomic analysis of the Far East for guidance. As shipping is a cyclical business, there were calls for caution long before the markets crashed. Unexpected demand, particularly from China, continued to sustain rates in both wet and dry cargo markets.
Christopher Lee, a Chinese-born and unusually astute shipping analyst, had been questioning the sustainability of the boom for some time. He underlined the risks of a real estate bubble in the rapidly developed coastal areas of China. He felt that it would be very difficult to extend the building boom into the Chinese interior and that consumption levels there would remain low. Today there is so much excess capacity in coastal areas that workers are returning to the hinterland. Lee also expressed concerns about non-performing loans in the Chinese banking system.
Michael Pettis, a well known academic who teaches in China, points out that China is very much in the position of the US at the time of the Great Depression. It has far too much productive capacity due to overinvestment. Conversely (and virtually unknown in US political circles who currently seem mezmerized by FDR) the US is now in a very different position today as a debtor nation based on consumer consumption, outsourcing of production and a very oversized financial industry. As Pettis points out, the Chinese trade surpluses are really no more than IOU's to boost exports.
The Chinese export markets have collapsed and demonstrate the need to develop internal consumption, but this will take years to accomplish. If the Chinese revalue their currency, this will cause immense economic dislocation. Yet it has been apparent for some time that China could not indefinitely be a low-cost producer of cheap goods. Already surrounding Asian economies in lower stages of development like Vietnam were gradually taking their place. Already Chinese trade surpluses are shrinking.
The new Chinese economy after the deluge is likely to be quite different from the shipping boom years. Chinese supply chain management is also likely to change with longer term contracts with end users and more shipment of raw materials under contracts of affreightment with priority to Chinese shipping companies.
Savings rates in the US are already rising after years of incredibly low levels. Politicians anguish that tax relief money is being used to pay down household debt rather than spent on consumption. They ignore basic economics. They are looking to reflate the economy with Government spending but there are finite limits on deficits and public debt levels. Already many US states and municipalities are on the verge of bankruptcy. At present it is anything but clear that US consumption levels will quickly rebound to previous levels. It is also questionable that Chinese trade surpluses can indefinitely finance US deficits. The trade surpluses themselves are drying up. There is an increasingly large competition between governments to sell sovereign debt instruments. American consumer spending habits as well as investment risk preception may change and revert to more conservative levels of previous generations.
All this is to say that things right now do not bode well for shipping. The die-hards in the container industry seem to be living on another planet. The excess capacity of container vessels is simply mind-boggling because far too much money was chasing this sector.
There has been some revival in dry cargo but this sector was traditionally very fragmented with a large number of owners competing destructively on rates and keeping them low. The smaller vessels, which are now considered the safest bet, were the least profitable. They lack the earnings volatility of the larger units in good markets but they are also prone to margins pressures due smaller carrying capacity and proportionally higher running costs. The basic investment thesis for all dry cargo vessels is unfettered economic growth in the FE. Slower future growth rates may change substantially this scenario. It may evolve to a market where only the financially strong and commercially well connected owners survive.
The tanker markets are in a somewhat better situation. Energy needs are less elastic. Lower oil prices and the difficulties in bringing in new technologies may keep this market afloat longer than expected. Also very helpful is the 'phase-out' regulation for single-hulled units and changing trade patterns. Stringent vetting standards and port state control create entry barriers. Financial responsibility laws for pollution have forced industry consolidation. There is likely to be increasing demand for clean products and chemicals with changes in trade routes from production at source in the ME and decline in refineries in developed countries. For the clean trades with cargoes in the ME, there is little incoming cargo so this voyage leg will soak up tonnage from the market and help sustain rates. LPG and naptha trade may be cannibalized for increasing chemical production in the ME. The big question remains how soon new refinery projects will be coming on line with the current economic slowdown.
Whilst we should all be optimistic for a speedy economic recovery, we should be prepared for slower growth rates than we have seen in the last years.
Source: Gerson Lehrman Group