Tuesday, November 18, 2014

Changes in perception of Shipping Risk

We are now well into the fall season. The expected rebound in rates has been tepid. There is growing concern that the slowdown in global growth is structural and not temporal. Integration of economic activity across borders beginning to plateau. The vast pool of low-cost workers in China is no longer available and the credit-driven expansion cycle based on large state-sponsored infrastructure projects has reached its limits. In time, the impact on seaborne demand volumes and travel distances is likely to be profound. There may be a rise of regional production centers that shortens seaborne distances. Commodities prices are softening. Freight rates and secondhand prices may stay low for some years. Risk perception towards the shipping industry is changing, making it harder to raise money in capital markets. Investors playing a short-term asset game may find it difficult to exit with the expected profits. 

 My concern since the 2008 financial crisis is that the central bank policies of low interest rates, quantitative easing and flattening of yield curves is compressing risk premium and distorting asset pricing, which has been spilling over into the shipping industry. Weak commercial bank balance sheets have led to a zombification of the shipping industry, keeping lame-duck companies alive and second-hand prices artificially high.

Current shipping industry environment characterized by:
  • Deflation and weak demand, low profitability, frequent credit defaults and limited bank finance availability.
  • An inflow of speculative money into shipping assets, searching for yield from resale at marked-up prices with a cyclical shipping recovery. · 
  • Preference for new ordering rather than industry consolidation of existing tonnage since asset prices are not marked down and remain stubbornly high in relation to present earning capacity.
To sum this up, zero interest rates together with chronic shipyard overcapacity has caused an inflow of investment money into new building shipping assets exacerbating over supply of tonnage. Weak economic recovery and slowing growth in emerging markets does not generate sufficient increased cargo volume to absorb the tonnage overhang. This puts the shipping industry into a vicious cycle of prolonged secular stagnation. 

The world shipping fleet age profile in bulk commodities dry bulk and tanker tonnage is composed of modern vessels and a dwindling number of scrapping candidates. Useful life of shipping assets is shrinking and ships are now going to the breakers at earlier ages. This has led to increasing asset impairment charges on older second hand tonnage that are highly unlikely to be recouped in current marginal freight markets. Buying older bulk carrier shipping assets is no longer a risk free investment secured by scrap value. 

On the other hand, speculative orders of new tonnage in projects like Scorpio Bulk carries more risk than normally perceived because new building prices may begin to soften again in the next few years. The price of steel has been steadily weakening, making potential replacement cost lower. In the meantime, Scorpio Bulk efforts to develop a chartered fleet for an operating company prior the new deliveries has resulted in operating losses due adverse arbitrage and compressed earnings margins. New deliveries in a period of slack demand and softer replacement cost would create a perfect storm that no one in this venture was originally prepared.

Industry consolidation in mergers like the Oaktree-generated merger of Excel Maritime into Star Bulk is no industry panacea. This is a drop in the bucket in terms of the overall fragmentation in the dry bulk sector and does little to consolidate pricing power.   The speculative new ordering at Star Bulk in open employment positions offsets pricing power.

This is an operation - like Scorpio Bulk - with a highly concentrated position in dry bulk shipping assets. Present returns on shipping assets are low. Profit margins frequently cannot cover depreciation expense. The whole investment exercise depends on the degree and timing of a cyclical market recovery and sufficient financial liquidity to turn over the assets at marked up prices to lock in the capital gains profits on assets.  No shipping investgment can make acceptible returns without asset gain on market uplift in future years.

Case in point is Scorpio Tankers - heavily exposed to the MR product tanker sector and underperforming with the eco-ship argument - where the only appreciable profits have been capital gains from VLCC's sales and potential sale of the Dorian shares from the LPG sector, which has performed well this year.

There are pockets of better quality shipping business in the tanker sector and specialty trades like gas shipping. But there always hangs the Damocles sword of shipyard over capacity where earning margins can be put under jeopardy with new ordering that quickly leads to softening of freight rates. We have seen this in the LNG sector very recently.  Rates are beginning to soften in the LPG sector after a very good run this year.

Sentiment on shipping risk is changing.  Capital market deal volume for shipping transactions is down from last year’s levels. Investment groups have moved on to other sectors. There is increasing discussion about how institutional investors are going to divest of their present shipping holdings in the current climate and how the expected mark up in asset prices for a cyclical shipping recovery may disappoint. 

I have long been skeptical of how this would ever work on any scale to repeat the boom years, not only because of the changed macro-economic conditions with slower Chinese growth rates and chronic ship yard overcapacity, but also because of the finance gap in the banking market needed to facilitate sales at higher prices. What is required is greater demand and exit of the present deflationary environment.  

This is still a work in progress for policy makers and central bankers struggling with an increasingly restless public!

Thursday, August 21, 2014

Reversal in Tanker Markets with Crude trades more robust than Clean

Although tanker rates are hardly booming after being the wall flower last year in the shipping markets, this sector has been consistently outperforming the dry bulk sector this year. This contrast is more due to weakness in dry bulk rates and somewhat better tanker rates than last year. The crude sector is showing signs of strength over the popular clean sector. At the heart of these developments are changes in energy sources and trade flows. 

Not surprisingly, the clean tanker sector has an order book that is nearly twice as big on a relative basis. Asset values were broadly higher in the tanker markets in the first half of 2014, but current values do not support the expected earnings environment The vast majority of tanker demand originates from the movement of crude and residual fuels.

Crude oil marine transportation demand for tankers arises from matching refinery raw materials needs with crude oil production. Petroleum product marine transportation demand arises from matching consumption with refined product production in refining regions. More than 50% of projected growth in demand is forecast from China and India. Energy use in the US and EU has been fairly stagnant for many years. Oil market fundamentals suggest a moderation of crude price increases in the near future in the absence of geopolitical influences. Natural gas is the fastest growing fossil fuel, supported by increasing supplies of shale gas, particularly in the US. 

US domestic oil production forecasted in 2015 to rise to the highest level since 1972. Most of this domestic production is light sweet crudes. A steadily increasing proportion of heavy crudes are being imported to the US driven by growing abundance of domestic light sweet grades. The US is likely to restart export of crude oil, but not for several years ahead. This will be light sweet crude. It will be highly dependent on the prevailing level of oil prices and US domestic politics. Meanwhile, the US Gulf has become a major clean product export hub providing robust volumes of gas oil and gasoline to Atlantic Basin. 

Tanker ton-mile demand is likely be modest over the next few years. Ton-mile demand has been falling in the MR sector. Currently LR freight rates are higher for trading dirty cargoes than clean. Further the MR sector is being cannibalized on longer haul routes by larger LR units. The clean sectors are burdened by heavy supply outlook against only moderate demand growth. The MR’s are under the most pressure with the poorest fundamentals. 

The dirty sector tonnage supply is moderate and demand positive. The VLCC sector faces a large number of deliveries in 2015 and 2016, which creates a neutral freight outlook until the 2018 when some increase is anticipated, assuming new contracting is controlled. Suezmax demand growth is somewhat more positive but dependent on continuing demand for this size in longer haul trades. The Aframax sector has been subject lately to high geopolitical volatility especially with the chaos in Libya but order book situation is more favorable. than the larger sizes, opening more opportunity for rate increases. 

Critical to any meaningful improvement in the tanker markets is a global economy gaining traction to approximately 4% growth needed to underpin the necessary expansion in oil demand and trade. This year, growth projections have been reduced due the poor performance of the European Union with its deflationary policies and China rebalancing with a slowing in infrastructure projects and sorting out losses in the domestic banking system. 

This remains a prerequisite for the freight market to make a return to a moderate level of profitability. Given the number of high profile publicly listed tanker company bankruptcies, the fate of the reorganized companies like Genmar and OSG will turn on when and how soon there will be recovery in the tanker freight markets. 

Earnings margins are likely to remain tight. Trading life of tanker fleets is likely to become shorter. Competitive advantage will come from modern fuel efficient tonnage, good commercial management, and moderate financial expense.

Monday, August 18, 2014

Suspense in the OSG Chapter 11 resolved with remarkable recoveries for both debt and equity holders.

OSG has scrapped the original reorganization plan with its lenders for an enhanced plan from its equity holders that involves a larger rights offering, increased from US$ 430 million to an incredible US$ 1,5 billion for institutional investors and a much larger refinancing of US$ 1,35 billion by a record breaking deal from Jefferies in the ‘term loan b’ market as opposed to the US$ 935 million financing from Goldman Sachs. This increased minimum recovery for equity holders from US$ 2 per share to US$ 3 per share whilst repaying debt holders at par. The outcome sets a very high industry bar in Chapter 11 reorganization. 

Both OSG debt and equity holders are large institutional investors and hedge funds. 

Leading the equity group is the Boston-based Brown Rudnick. Among others signing on behalf of the group: Alden Global Capital, BHR Capital, Blue Mountain Capital, Brownstone Investment Group, Caxton International Ltd, Cerberus Capital Management, Cyrus Capital Partners, Luxor Capital Group, Paulson & Co and Silver Point Capital. 

The rights offering is divided into Class A and Class B stock. Any holder than is deemed an accredited investor or qualified institutional buyer is eligible to purchase 11.5 Class A shares or warrants for $3 per security. Each holder that does not fall into one of those categories or choose not to support the plan is to receive one Class B share or warrant per existing share held. 

Jefferies underwrote the ‘term loan b’ facility in four separate facilities and syndicated it to more than 100 institutional investors. Terms on amortization and covenants are said to be liberal, but finance costs are considerably higher than bank finance with spreads of 425 and 475 basis points respectively for its domestic and international fleet. Minimum LIBOR is 1% per annum. Some recent conventional loans have been in the order of 250 basis points over Libor, but these are not companies coming out of Chapter 11 reorganization. Helping to drive the ‘B’ market is a revival of collateralized debt and loan obligations (CDO’s and CLO’s) popular before the 2008 global financial crisis. 

Demand is so strong currently in this market that OceanRig originally planning a ‘term B’ worth US$ 800 million plus a bond issue of US$ 500 million to meet liquidity needs, simply upsized the ‘term B’ facility to US 1,3 billion and scrapped the bond issue. 

Consequently Jefferies may be setting a new trend for shipping companies looking for secured debt that replaces traditional bank finance. 

Where OSG goes after coming out of Chapter 11 is still an intriguing issue. Whilst its US flag fleet is profitable, the international tanker fleet is still losing money. Indeed, OSG recorded a hefty loss of US$ 204.11 for the first three months to the end of June up from a loss of US$ 24,15 million in 2013. Total losses in bankruptcy have been US$ 959 million. The lengthy Chapter 11 proceedings have been very costly. 

Erik Nikolai Stavseth of Arctic Securities seems to share my original views that there remains the likelihood of a separation of OSG’s domestic and international assets at a later stage. Stavseth feels that a pure Jones Act focused company should attract significant investor interest and also put AMSC in play should OSG wish to acquire the 10 MRs in order to obtain control over the vessels. 

It is also possible that the international assets (47 vessels ranging from VLCC to Handysize) will also evolve as a candidate for either splitting up through sales or creating a separate listed entity offering cross-class exposure to both crude and products. These are decisions for the present investors and new management team ahead.

Tuesday, July 29, 2014

End run for Berlian Laju Tankers bankruptcy and reorganization and challenges ahead

With KKR and York Capital now owners of 65-70% of the bank debt in Berlian Laju Tankers (BLT), they are likely to come out with a sizeable equity stake in the company.  This would appear to resolve what was a very messy bankuptcy without any clear source of recapitalization or clear outcome when first declared.  Unlikely that the private equity firms would be prepared to accept further involvement of the Surya family in the business.  Obvious direction would be to rebuild the company with Jack Noonan as CEO, which was already built into the restructuring plans. 

Private equity is said to hold presently US$ 500 million of BLT senior debt, which is secured by first preferred mortgages on the vessels in the fleet. 

Only a few months before declaring bankruptcy protection, BLT had completed a massive US$ 685 million restructuring led by banks like Nordea and BNP Paribas.  New banks like Standard and Chartered participated in a large refinancing.  These bankers did not appear to do proper credit analysis of the risks, even willing to extend new money to BLT as part of the restructuring package or Standard and Chartered to refinance problem credits of other banks.  Their claims were that the Surya family was extremely wealthy and would stand by the company with their resources if needed.

The swift fall into bankruptcy thereafter opened controversy about where fresh funds were deployed. Delos, one of the creditors has alleged US$ 135 million diversion of funds.  In any case, the Surya family did not show interest in supporting BLT financially in difficulties.  There were calls at the time about the necessity of keeping them in the management, but this never made any sense to me.

In the end, the private equity firms are said to have bought out the bank debt at discounts between 70 to 80 cents on the US dollar.  BLT has been a zombie company since the declaration of bankruptcy in early 2012.  Since then, there has been a surge of newcomers and new investment in the chemical tanker industry.  Players like Celsius, Navig-8 with an Oaktree partnership and even Peter Georgopoulos have started a new order binge mainly in Chinese yards for stainless Dwt 20-25.000 tonnage, which was the mainstay of the Chembulk operation that BLT acquired from AMA with considerable mark up that eventually brought them down.  

Delos had invested in two BLT stainless units on a lease back deal prior the bankruptcy for which they have since repossessed but kept with the Noonan operation (former Chembulk) on employment.

KKR has been backing Borealis, who specializes in smaller chemical tanker tonnage trading regionally in north west Europe under North Sea Tankers commercial management.  Borealis has recently acquired the Crystal Pool as well as bought two small ethylene carriers at auction.  The BLT operation is not obviously compatible with Borealis.   

The challenge for KKR and York will be rebuilding and rebranding BLT under the former Chembulk operation in Connecticut.  They will have to contend not only with the slew of above-named new comers with more modern, fuel efficient tonnage, but also the chemical tanker majors like Stolt, Odfjell, and Jo Tankers allied with Tokyo Marine in Milestone Chemical Tankers in Singapore.  These are older, operators that have moved into a more diversified logistics provider business model and have built up over the years large contracted customer base with their brand image.  These groups have punted in defense of their earnings margins and need for competitiveness by ordering larger stainless tonnage Dwt 30-38.000 for the long haul routes that risk putting pressure on the freight rates of the smaller Dwt 20.000 units, even those of the newcomers.  

Stolt and Ofjell also have the back stop of a profitable chemical storage and terminals business sheltering them from the vagaries of the transport side.  All the mature groups have looked to diversify into other shipping sectors, particularly the LPG sector in the case of Stolt and Odfjell.

Private equity has poured a lot of money in the chemical tanker sector the last few years.  Triton bought up Nordic Tankers and some other smaller European operators like Herning.  Apollo Global Management has created a new offshoot Princimar Chemical Carriers managed from Connecticut.

It will be interesting to see how these investments perform and how these firms will ultimately divest of their holdings.

Tuesday, July 8, 2014

Waiting for September and the fall rebound in freight markets

We are now only a few months away from the fall period and all eyes are on a confirmation of a widely anticipated rate upturn in freight markets from September onwards.  This will be a key litmus test driving market sentiment.  This has been fundamentally bullish since last year, where there was surge of investment in shipping assets on expectations of a cyclical upturn.

Expectations continue to be bullish for next few years, when investors will be looking to liquidate their positions in shipping assets with profit and move on.  Likewise there are a number of high profile deals based on new orders in bulk commodity vessel tonnage that will be coming into the water from 2015 onwards. The case of Scorpio Bulk - a dry bulk play from Scorpio Tankers based on a very aggressive booking of dry cargo vessel orders without any owned drybulk tonnage in the water - is a prime example.

In an unanticipated repeat of last year, freight markets opened this year with a whimper instead of the much hoped for bang.  There was a premium in period fixture rates, but a downwards correction in spot dry bulk and tanker bulk commodity shipping markets, creating an inverted earnings curve between these two markets.  It was during these inopportune market conditions that Scorpio Bulk entered the market to charter tonnage to build up an operating company in the dry bulk sector until their massive new building orders are delivered.

There are two basic issues that may challenge conventional wisdom in recent shipping placements:

  • Chinese rebalancing.  China is presently the single largest contributor to global consumption growth.  This has been a boon to both the tanker and dry bulk markets.  Chinese rebalancing to more of a service economy may be less positive for the growth potential of Chinese seaborne import volumes.  With a leveling of infrastructure projects, Chinese dry bulk import volumes could reach their short-term maximum potential within the next few years.  This year, dry bulk markets have been badly affected by the ban on mineral exports from Indonesia and high Chinese iron ore inventory levels.  
  • US and EU central bank policies of very low interest rates.  Again there are signs of excess asset inflation without support of underlying demand growth.  Shipping markets this year are a prime example where current freight levels do not support the current surge in asset prices.  As long as there is substantial excess ship building capacity and sluggish demand growth at best on par with GDP growth as opposed to being a multiple in the not so distant past, there is likely to be a continued supply glut of vessels, leading to shorter trading life and depressing resale values. Christopher Rex of Danish Ship Fund predicts possible softening of new building prices as early as next year.
Meanwhile sentiment in shipping markets is evolving.  The latest monthly update from RS Platou takes a more cautious near term demand growth in the dry bulk markets.  Conversely, Plato is more optimistic on crude tanker demand with growing potential of US crude oil exports, short term VLCC demand from potential supply disruptions with the growing turmoil in Iraq and improved Suezmax demand as European refiners return from maintenance.

Soon the fall will be here and then the new year 2015.  With the heavy concentration of long shipping asset positions and new buildings orders coming on stream,  it will be very interesting to see actual investor returns and prevailing asset prices ahead.

Personally I am skeptical of a repeat boom of the last decade.  Demand growth in emerging markets seems to be leveling off and there are not the same liquid credit markets anymore that fuelled asset prices and facilitated sales transactions. There is still a lot of shipyard capacity to turn out more vessels at marginal prices.  Apart from cyclical volatility and the noise that it creates, earnings margins in shipping companies continue to be under pressure.  I am concerned that the upturn may be short and poor quality weaked by too much asset arbitraging and current fundamentals.

The old Wall Street adage “Sell In May And Go Away” may possibly take on a new meaning, but then again perhaps asset prices will continue to firm as per expectations.

Saturday, April 5, 2014

A challenging marriage: Private Equity and Shipping

Last December, former banker and well regarded dean of Greek shipping finance, Ted Petropoulos, railed against private equity shipping partnerships, arguing they were entirely incompatible. Yet 2013 proved an incredibly fertile year, where the capital markets window again opened for the shipping sector and private equity partnerships in the shipping space flourished. The predominate investor premise was cyclical asset arbitraging, where investors were convinced to place millions of dollars into shipping assets that they feel are under-priced and certain to rise substantially in value in a few years for hefty and quick profits. Will these ventures justify investor expectations or will many of them end in bad marriages, vindicating the views of Ted Petropoulos? 

Working with NY investment banking firms, the dichotomy between their due diligence vetting and actual placement of funds is striking. Due diligence procedure vets the management team and their past performance as an operating company. It centers on balance sheet analysis and particularly profit and loss performance. 

Yet when these organizations move to the actual placements, the whole emphasis is in asset speculation, with little or no interest in operational profitability. Often institutional money is happy to fund start-ups, where the management team sometimes even puts up relatively little or no money and often does not have much past operating record in the assets purchased. Big ticket name deals abound, centering on well-known shipping personalities - even sometimes with histories of hefty losses in previous ventures that led to bankruptcy and restructuring. The predominate business model is bond trader portfolio, where in this case it is shipping assets. To some degree, it is a country club approach with house entry barriers and old-boy favoritism. 

If the main thrust of the venture is asset speculation rather than building enterprise value, then – of course - past ventures do not really matter so much. In bond trading, a common way to deal with losses is simply to double up and/or close out the past losing positions and move to new asset positions. Enterprise building is not of any importance. 

What drives the investment banking industry is fees, so that the larger the deal, the more money and it is easier to place a large deal with a well-known name in NY circles. 

The whole emphasis is in quick turn over where shares rise on expectations and are sold ultimately to retail investors, The loss risk is on those who hold the shares on a long term basis. Indeed if we look at shipping shares from the last bull period up until the 2008 meltdown, many of these companies ultimately became penny stocks, but a significant number of institutional investors sold their shares and took their profits, rather than holding the shares. 

The irony, however, is that whilst maximization of profit in asset speculation depends on high market volatility, arbitraging reduces the very volatility on which the profits are generated. So theoretically, the more asset arbitraging positions in shipping assets, the less volatility in market pricing for shipping assets and lower profits as the arbitraging process levels out market pricing. 

There are other deeper looming problems, however, that may prove analogous to the iceberg that sunk the Titanic. This is related to the credit crunch and damaged banking system that has created a shortage of money to finance vessel purchases. Right now is very much a 'have and have-not' market for shipping companies that is reducing the universe of potential buyers. We have already seen a few block purchase deals fail for inability to raise funds. This might create a drag on any repeat of the musical chairs block shipping asset deals of the previous decade that made major shipping fortunes until the 2008 meltdown. 

Major investors like Wilbur Ross ardently sponsor industry consolidation. The theory is that few players would also better pricing power. In fact, this has been a predominate trend in the ship supplier space for many years. Telecommunications was extremely competitive with a large number of entrants and now there has been price consolidation with the stronger players, buying out the weaker smaller players, etc. Marine engine makers are now reduced to two major groups: Wartsila and MAN. This again, however, means a smaller universe of players to purchase shipping assets. 

Particularly detrimental to the resale market - especially for older units - would be the demise of the small and medium shipping companies, who are currently starved of bank credit.  This is inhibiting them from properly rolling over and renewing their fleets by selling off the older units often for scrap and buying somewhat younger second-hand units.  There have been an increasingly larger number of cash deals, but deal volume is down.  Many companies will be forced to trade out their older assets and leave the shipping space.  This means potentially a smaller market for older tonnage and lower values.

In a slack demand environment where we are possibly at the end of a globalization cycle and particularly in the case of lower than anticipated Chinese and emerging market growth rates that seems to be the case this year, this surge of investment in new buildings may be very good for the environment with a more modern fleet of new energy efficient vessels. Institutional investment in shipping assets also may be very beneficial to shippers, ensuring a more an adequate supply of vessels for future transport demand at low, competitive freight rates.

In the end, however, the investors in this floating real estate may be disappointed with many of these shipping ventures, following the pattern Diamond S with a much longer time than anticipated for any quick profitability and divestiture. The ultimate in this respect would be an international shipping space that begins to resembles the domestic US Jones Act environment (prior the shale oil renaissance) where there was essentially an oligarchic structure of a very limited number of players – half of them constantly in and out of Chapter 11 bankruptcy reorganization - and very marginal profitability at best. 

Realistically, there will probably always be a certain amount of fragmentation in the shipping industry. If there are not expected results, the institutional money may begin to follow the course of the major oil companies, who divested of their shipping assets some years ago because the shipping investments were a drag on their balance sheets and it was a better use of capital to charter in the vessels from independent operators rather than to get into the transport business themselves.

Tuesday, April 1, 2014

Is Peter G’s sudden foray into chemical tankers a clear signal to short the sector?

 Peter Georgiopoulos in his effort to make a comeback in the shipping space has decided to enter the chemical tanker sector with a speculative order for five firm 25,000-dwt vessels, plus five options at the state-owned Avic Dingheng yard. Well-placed sources say the ships are costing more than US$ 40 million each, with Avic slated to deliver the firm units in 2016 and 2017. Rumor is that Georgiopoulos had teamed up with unidentified private-equity investors to enter the chemical tanker segment. Given the recent history of his tanker company General Maritime in and out of Chapter 11, with massive losses to share and bond holders and his dry bulk company Genco teetering on the edge of Chapter 11 reorganization for some time now, should investors jump in to support this sort of asset play, especially in an entirely new sector where he has no prior operating or commercial experience? 

This latest movement of Peter G could well serve to vindicate the viewpoint of Niels Stolt Nielsen that “the amount of [private equity and institutional] money now entering into shipping is extremely worrisome……”  The Stolt CEO goes on to say: “The orders for new ships are being driven not by increased demand for logistical services, but by the overflow of capital available in the market.”   Finally, he expresses his concern about the acceptance of fee structures where the managers of these new “shipping companies” get fees up front when ordering ships, or for managing the ships they order, without having any equity stake in what is being ordered. 

Peter G’s new venture opens all Stolt Nielson’s concerns. If we take as a benchmark the Georgiopoulos dry cargo venture; Baltic Trading has had fairly steady losses from inception until very recently, but provides valuable source of collateral revenue, shoring up his main dry cargo operation Genco, with a hefty management fee structure to husband Baltic. It is speculative, asset arbitrage driven venture. Not surprisingly, Baltic stock trades very much like a freight market derivative instrument.

The challenge for any investment in the chemical tanker sector is that historical returns on asset have been exceptionally low (less than 10%). The number of players is limited, making for an illiquid sale and purchase market. In the case of the Eitzen Chemical distressed debt, senior lenders preferred to become shareholders and even waive loan spread, staving off any distressed asset sales under these limitations. Finally, this is has been a high cost, low margin business based on contracts of affreightment for base cargoes and the spot market to fill up the remaining empty space. The cargo contract commitments on the vessels further limit flexibility for asset plays in this sector because they create restrictions on timing for sales.. 

The mature groups in the chemical tanker sector have all transformed their business models from vessel  to logistics services provider and diversified into parallel sectors like chemical storage and gas shipping to improve their financial returns and risk profile. They have also kept their finance costs as low as possible and maintain strong balance sheets. None of the major players like Stolt see a quick market turnaround. They are companies with long term commitments to their customer base. 

None of this fits with Peter Georgiopoulos and his business approach. Peter G is above all an asset player. He keeps to the traditional Greek business model of vessel provider. His focus is mainly on acquiring shipping assets in large block deals. Further it is unlikely that he is putting a large amount of his own increasingly limited capital into this new venture and more likely that he is acting as an asset manager in this venture.  Here, however, in contrast to Baltic Trading, he does not have an operating company like Genco to back this new venture, which is fundamentally a start-up play. 

Another interesting twist is that the Avic Dingheng yard is also a newcomer to chemical tanker construction. The large, established players like Stolt and Jo Tankers have contracted larger size units (Dwt 38.000 and 30.000) at Hudong and Minde respectively. They appear to be aiming for lower unit costs, using larger deadweight units for emerging US chemical exports over the smaller competitor vessels. Both these yards have a proven track record in building chemical vessels. 

The Navig8 venture with Oaktree Capital has placed their orders (Dwt 25.000) at Kitanihon Shipbuilding and Fukuoka Shipbuilding, which are well established, first class Japanese yards with a long history of building stainless chemical tankers. By contrast, Avic has only built small coastal chemical tankers.

It will be very interesting to see how this new venture fares, but it likely be challenging for the investors unless there evolved an exceedingly bullish market given the stronger position of competitor peer companies.

Tuesday, January 21, 2014

New direction in the OSG Chapter 11 reorganization

Collapse of blue chip OSG was one of the biggest stories last year in the shipping space. OSG management got itself in such a corner, overwhelmed by evolving events, that they were forced into Chapter 11 reorganization proceedings without any clear exit plan. 

Now their options for potential exit are becoming clearer. Unsecured bondholders are likely to be a driving force, making an equity investment through back-stopped rights offering estimated at US$ 430 million. This will be used to refinance OSG lenders under the original revolving credit facility, pay off the IRS claim and give OSG some operating cash to emerge back into business

One of the biggest catalysts of the fall of OSG was their unexpected problems with the US Internal revenue on tax liabilities, but this appears to be heading for a happy end with an agreed settlement for US$ 267 million from the original IRS claim of US$ 463 million even below OSG provisions for US$ 308 million. This is very significant because it resolves one of the biggest sources of uncertainty around OSG and allows them to confront the remaining issues in an orderly fashion. 

Another positive development albeit indirect is the Kinder Morgan acquisition of the American Petroleum Tanker fleet as it sets a market benchmark for the value of their US flag tanker fleet, which is presently their most valuable asset. 

From press reports, the major thrust in the OSG reorganization plan will be a debt for equity exchange with the unsecured bond holders. This will result in massive dilution for existing OSG shareholders, who will be luck to retain about 10% of the company. This appears to be the major source of needed recapitalization. 

The bond and notes holders of distressed OSG debt are likely to have recoveries of 115% and 128-171% respectively, putting the noteholders in an especially profitable position. Conversely, the OSG senior debt holders, who are now mainly hedge funds with lenders having disposed of their debt holding, are likely to be repaid in cash as opposed to receiving any equity. This would certainly be a disappointment for the hedge funds, who bought into OSG debt, depending on their discount entry price.

All this presupposes that negotiated agreements that get OSG out of Chapter 11 are finalized by June this year.

Changing economic paradigms: Governments and financial industry crowding out capital and labor

The great divide of 19th and 20th century capitalism was the antithesis between capital and labor. Our perceptions today are molded in this framework, but this is slowly being displaced in the 21st century by a new divide line between governments, big bureaucracies like the European Union with their banking industry partners declaring war on capital and labor mutually, putting them both under severe pressure by massive socialization of losses created by their policy decisions at the expense of general society.

Essentially this new state corporatism is a modern form of rent extraction fuelled by ‘pretend and extend’ policies on unsustainable public debt levels. This is crowding out productive investment, creating negative returns on capital and reducing wages in a downward spiral of debt deflation and at best sub-par recovery with high levels of unemployment. 

The old Marxist theory was that capitalism was unstable because the capitalists were using their power to suppress wages and this was leading to ever deeper economic cycles of boom and bust. Gradually with mass production, entrepreneurs like Henry Ford realized the importance of a mass consumer markets to sell these products even to their own workforce. Later in the Great Depression era, this evolved to the Keynesian view that governments can soften the impact of economic downturns by increasing their spending for economic stimulus to reflate. 

In the last 30 years, we are experiencing very high debt levels in excess of those that preceded the Great Depression and overly saturated consumer markets primed by bank credit. Today we have an evolving system of state corporatism. 

There is nowhere where this is more heavily concentrated than the Eurozone in the European Union. The common currency system has made governments reliant on commercial banking system to finance their deficits. The trade deficits are locked in because there is no natural adjustment mechanism by currency devaluation. The only way for member states to adjust the imbalances is either to borrow or to reduce consumption by aggressive use of deflation. Use of deflation results in bankrupting the domestic banking and pension systems as well as massive unemployment. 

This process has created mountains of unsustainable government debt, it has infected the entire EU banking system and it is currently being shored up by ECB programs like LITRO and OMT. The hard monetary policy of the ECB militates against monetization and the Eurozone policy has been to increase tax levels and declare war on capital with increasing use of the banking system as means of tax collection. The high levels of taxation are pro-cyclical and deepen the recessions. Greece is a textbook case.

Despite years of austerity with GDP output decline to Great Depression levels and massive PSI+ haircuts, Greek public debt levels remain as high as ever and unsustainable. The ultimate in this policy thinking was the Cyprus bail-in where depositors become shareholders and were taxed directly to absorb the banking losses, generated from default and haircuts on government debt instruments. Decisions are arbitrarily made by EU policy makers and their governments without direct representation of the people affected in the member states. The old rules of no taxation without representation have been broken. 

With the massive economic scandals in Greece with the TT and arms procurement, the Greek political elite are increasingly looking like a class of robber barons. This same class of people has been aggressively increasing levels of taxation on businesses and private individuals with new draconian and repressive tax laws with powers of garnishment and expropriation of bank accounts and income streams for collection. Backlash and resentment is rising to the boiling point in Greece. 

In the shipping community, we have an interesting phenomenon of ship owners, office staff and Piraeus port dock workers all adversely affected by these policies. The Greek shipping SME’s (small medium businesses) cannot get sufficient bank credit from the Greek banking system to roll over and renew their fleets, the management companies are forced to pay double Greek flag tonnage tax on their vessels, the service offices have been arbitrarily taxed (even retroactively) on their imported foreign exchange to pay general office expenses, the office staff is being taxed right and left reducing their disposable income and the dock workers face low wages, unemployment and competition from foreign immigrants for labor needs. 

Admittedly, these groups do not perceive necessarily that they are all in the same basket with common adversaries, but in fact a new dividing line is becoming increasingly clear. The zero sum game is between EU policy makers, the political elite with their banking system partners diverting resources from the general population and the business class. The resources are going to sustain the Eurocurrency system and the political elite at the expense of both capital and labour, putting them mutually under increasing pressure, resulting in increasing business closures and high unemployment.  

Added to this, the political dynamics of the Eurozone are changing with the recent turn of the French government (presently at record lows in public opinion polls} in complete capitulation to the Germans by embracing of Say’s Law (supply creates its own demand). The old French-German partnership that drove the European Union is being superseded by an all-powerful Germany, who drives major policy decisions as it sees fit. This is more than just a calamity of economic policy but an event of major political consequences. 

  • It fuels domestically in France the Eurosceptic movement of Marine LePen leading in the polls for the forthcoming Euro parliament elections. 
  • It reinforces the German supply-side consensus and establishes the principle that the only way to co-exist in a monetary union with Germany and the other Nordics is to become like them. 
  • This makes Eurozone membership virtually compulsory to stay in the EU, which will ultimately lead to the exit of the United Kingdom. 
  •  It also makes adjustment in EU periphery countries like Greece likewise virtually impossible to remain in the Eurozone and EU. 
In the forthcoming Euro-elections there is a deepening divide between the Federalists, who want more EU centralization and integration and those, who want to break up the Eurozone, want to reaffirm the sovereignty of the nation-state with a smaller, weaker EU that functions as a trade zone.

For these reasons, the party system in Greece is fragmenting and the two main political parties are in disrepute. There is likely going to be increasing instability in Greece and the European Union in the coming months. The Europarliamentary elections are likely to be a catalyst for major policy changes, should the prevailing 'status quo' be altered by the results.