Thursday, March 3, 2011

Domino effect in Dry Cargo Market?

The dry cargo sector started the year badly in 2011 with the KLC bankruptcy and reorganization. The US bankruptcy fillings in NY Federal court name three major previous shipping failures: Britannia Bulk, Armada and Transfield as counterparties, all of which went bust in the wake of the financial crisis. Its collapse created shockwaves in the dry-cargo market with Eagle Bulk, Golden Ocean, Paragon and Goldenport Holdings among those with vessels on hire to the cash-strapped company.

KLC is a major Korean shipping company controlling a large fleet of both tankers and dry cargo vessels. Its dry cargo operation is divided into five groups: Cape team, Panamax team and three tramper teams. They are major charterers for numerous listed dry cargo companies like Eagle, for example, who depended on them for the employment of many of their vessels.

KLC’s needed US $186.94 mio in February to repay debts and meet operating expenses. At the same time its liquid assets totalled only US$ 60.66 mio. Operating income was insufficient to cover these amounts. Its red figure for the whole of 2010 was KRW 328.6 bn (US $291.55 mio), which added to a loss of KRW 584.1 bn in the previous 12 months.

They had tried unofficially to renegotiate some of their charters. KLC earlier sent out 60 to 70 letters to shipowners seeking to revise charter contracts in a bid to stay afloat, but of course, owners resisted. Hard pressed companies like Eagle had little room to give. KLC is already facing six separate legal battles in the US and others are expected to make similar claims. It also has 47 ongoing arbitration disputes. KLC began receivership proceedings in Seoul in mid February a couple of weeks after filing for court protection.

Erik Nikolai Stavseth, an analyst at Arctic Securities, said in his morning note: "In light of the weak market fundamentals and cautious outlook on the dry bulk sector, we maintain our view that more situations like Korea Line are likely to emerge." Platou Markets forecasts utilization and earnings in the dry cargo sector to decline. They estimate a 10-20% decline in asset values depending on vessel type, but note that dry bulk stocks reflect a softer market ahead to a greater extent than tanker stocks. On the other hand, dry cargo owners like Michael Bodouroglou of Paragon maintain up upbeat view that the market will strengthen in the 2nd half of the year and pressure on vessel values will be minimal.

Prevailing forecasts for the world economy in 2011 suggest somewhat lower growth than in 2010. It is therefore likely that seaborne dry bulk trade will also increase more moderately than in 2010. Last year China’s imports grew less than expected, while imports to the rest of the world were significantly stronger. World market prices for iron ore will be of vital importance for how much China will source from the international market. Sailing distances for iron ore, soybeans and forestry products are also expected to increase somewhat due to higher South American exports to Asia. The imbalance in trade between the Atlantic and Pacific Basins will continue to widen. It is also possible to expect slower speed due to high fuel prices and excess ship capacity. All this provides a scenario of stronger growth in tonnage demand compared with cargo volumes in 2011.

What continues to plague the dry cargo market is the huge orderbook overhang and flood of new deliveries into the market, creating a chronic oversupply that depresses freight rates. In 2010, about 77 mio dwt of new ships were delivered from yards and 4 mill dwt of converted tankers entered dry bulk operation. Only 6 mio dwt were scrapped. On a yearly average basis, the active dry bulk fleet grew 12.5% from 2009 to 2010. By segment, the fleet above 100,000 dwt expanded by 23%, while vessels ranging from 60,000 dwt to 99,999 dwt grew by 9%. The 40,000 dwt to 59,999 dwt segment rose by 13%, while the fleet below 40,000 dwt increased by only 4%.

Around 140 mio dwt of new ships are scheduled for delivery in 2011. From previous years, we can assume a 60% slippage, some 85 mio to 90 mio dwt of new ships will start operation. Scrapping is a function of the ships’ earnings, but assuming 15 mio to 20 mill dwt will be sent to breaking, a fleet growth rate in the region of 14-15 percent seems plausible. This far outpaces demand projections of seaborne dry bulk trade increasing by 6% to 7% from 2010 to 2011.

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