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.

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