Stopford - Covid and Climate Change: Two big challenges to the Shipping Industry

Yesterday listening to Martin Stopford's interesting presentation in a Capital Link event and lengthy Q&A session, it seemed to me that the two major drivers of events shaping the shipping industry today are Covid and Climate change.  They have a number of similarities. They have far ranging effects on world trade and ship technology that will affect the future.

Covid crisis and climate change start with natural phenomena that have morphed into highly contentious political issues due human response to them and the ensuing politics involved, particularly in the EU and US. 

Viruses and microorganisms are as old as life on the planet.  New viruses appear all the time.  Coronaviruses are well known and this is a new strain of this existing family.  We have had virus outbreaks from China repeatedly in the past years like SARS and H7N9.  Nobody panicked  and eventually these new strains took their course through natural means with human immunity and some efforts for vaccine,  Vaccines are simply an artificial means reinforcement of human immunity systems that would otherwise develop antibodies in reaction to exposure to the virus.  Ultimately there is no other way to deal with viruses.  The human race would have long ago become extinct from viruses if there were not biological immunity systems.

What is startling in the case of Covid is the political response to it that was first initiated in China by mass lockdowns/ social distancing of the healthy population and economic shutdown of production. Historically quarantines in reaction to infectious diseases were done by isolating sick people from the general population and holding travelers from infected areas for a certain period before entry into national territory.  

The Chinese government shutdown had an immediate effort on the shipping industry with a reduction of port cargo movement of 20% on the average, affecting the container industry negatively, forced to blank sailings and facing box build ups in Europe from the imbalances produced by the factory shutdowns in China.

Then there was an even more damaging and recessionary impact on the shipping industry with Western Governments collectively adopting the Chinese lockdowns and imposing them on their populations, quarantining large segments of their healthy population in fear of exposure to the virus, something never done before in human history.  

This has caused a great deal of instability for global shipping. There are projections of significant reduction in world trade this year,  Ship operations have become challenged due difficulties to carry out surveys and repairs. Normal crew changes have become a major problem to carry out .  Economic impact varies by sector.  

• Container shipping was looking to recover with Chinese reopening of factories and increase in port cargo volumes in March, when it got slammed by the recessionary impact of the lockdowns in Western economies that created even deeper losses of revenues and blank sailing. Major container lines have been plagued by poor earnings margins for years.  Some were just beginning to turn profits in 2019.  Now all these major liner companies are likely this year to go back into operating losses.  Stopford feels they will eventually muddle through this, depending on the speed that Western government reopen after lockdown and the severity of the global recession.  Stopford feels that large containerships were always a problematical response to the structural problems of the industry.  Globalization is over after Covid and trade is likely to evolve more regionally.  The use of these units will be restricted and the transport needs will be more for regional distribution.

•  Conversely the tanker sector has been enjoying a bull market with record rates.  This in related to failure of OPEC to extend production cuts and a new price war, when at the same time Western mass lockdowns have provoked a significant drop in oil demand.  The system is flush with oil from overproduction.  This has resulted in a surge of demand for tankers both for transport and storage, even backing into product carriers from refinery overproduction.  Ironically this situation will eventually result in obligatory and severe cuts in oil production and a dead tanker market with fewer hydrocarbon cargoes ahead.  Stopford pointed to the inherent weakness of the tanker sector in his presentation.  For now the tanker companies are the darlings of investors and flush with cash and profits.

•  Dry bulk is more mixed and nuanced here.  This sector has not been very profitable for at least 10 years, except for short rate spurts in certain segments.  The large bulk carriers depends on the steel industry,  coal and iron ore cargoes.  This segment had an awful first quarter with BDI indexes going into negative territory. Stopford does not see a very bright future here for these units with a maturing Chinese economy and the likelihood of stimulus spending to be more focused on technology rather than further infrastructure projects.  The smaller units will fare somewhat better. Panamax units carry more diverse cargoes like grain that are driven by other factors than the steel industry. The smaller sizes carry a much wider range of cargoes, including minor bulk trades.  More of this is related to foodstuff and general population needs. These segments will muddle through the crisis but present rates are low.

Stopford sees a secular trend towards regional trading zones with production closer to consuming areas.  He outlined three recovery scenarios.  All this is related to Western governments and how they manage the reopening of their economies.

This is entirely a political issue and it will have big effects on the depth of any recession. The drop in world trade will be milder than drop in GPD, but the effect on the shipping industry will be far reaching.

I see this as complicated political issue, not directly related to the virus. Western governments have taken unprecedented actions imposing drastic restrictions on their populations and curtailing basic civil liberties like freedom of assembly and religious worship.  All this together with significant social and economic cost on their populations that has led to the specter of global recession.

Scientific studies are beginning to indicate that there is nothing novel about this virus.  Infection rates on general population are much higher than originally anticipated despite the lockdown measures.  Death rates are much lower than wildly inaccurate early studies from places like Imperial College.  There is no easy way for the political class to reopen quickly.  They are fearful of the future political cost of their actions.  How this unfolds in the US and EU depends on the boldness of the political leadership and their effectiveness to return to normalcy and limit damages by getting their populations back to work and reflating their economies with the stimulus programs.

Despite the three scenarios, Stopford closed with a hopeful note that by fall, most of this Covid crisis will be over.  We shall see!

Climate change and environment regulation has taken the back seat due Covid crisis but this is a similar case of politics overwhelming natural phenomena and creating considerable challenges.  The earth has underdone significant changes in climate for millions of years. Anthropogenic causes by burning hydrocarbon fuels are a very recent phenomenon.  Carbon is essential for life on the planet.  There is a natural recycling of carbon from plant life back to oxygen.  Science is even more divided over these matters than Covid and human immunity systems.  The climate depends on so many other unquantifiable factors such as solar radiation and tilt of the earth.

But the present political consensus like the massive Covid lockdowns is that carbon is bad and greenhouse gasses GHG must be reduced and eliminated.  IMO has adopted GHG targets for 2030/ 2050 for which there is presently no technological means to comply.  The EU dominated by Northern European Green parties wants even more drastic measure such as a carbon tax trading scheme imposed on the shipping industry.  Like the Covid lockdowns, these measures will have negative economic impact on their populations, particularly the poorer classes.  There have been mass protests like the Gillets Jaunes in France in reaction to government taxes on fuel, just as in the US there are increasing protests against the government lockdowns. But generally the political class stands firm on these matters and it is not easy for them to back down in terms of their positions for the political cost.

For the shipping industry, Stopford points out that diesel and fossil fuels are far more efficient technologically than alternative fuels.  There is much higher energy content in the fuel.  It can easily and safely be stored on vessels and it does not take much space.  For these reasons, Stopford feels that diesel propulsion is the only alternative for the next generation of ships with a lifespan of another 20 years. 

The innovations in shipping for less fuel consumption and GHG levels will come from 'smart' ships with messages via CPU modules replacing wires, as Stopford puts it.  I would add this would also dictate more use of digitalization and software maximization programs in the offices linked to the vessels that they manage.  Metis - a Greek software system -based on the internet of things is a good example and a number of leading Greek Shipping companies have adopted it.

Stopford then outlines a growing use of LNG and dual fuel vessels. New technologies like this are more easily implemented in short sea shipping in early stages. Already this is the case for use of LNG in the cruise industry and tanker feeder vessels in Europe, for example.  This will lead to a new generation of vessels that will start to replace the  'smart' diesel/ fuel oil vessels. 

Then rather far out, Stopford sees electric vessels with fuel cells powered by hydrogen, etc. None of this is close to reality today.  The fuel cells cannot produce sufficient power and the new fuels presently can  only be produced from processed that create GHG that must be sequestrated.  Many of alternative fuels are noxious and difficult to store on vessels.

It is very intriguing to note that the same political class that supports decarbonization and vigorous climate change regulation also support with passion the mass lockdowns in reaction to the Covid virus  Many are extolling the positive results from the mass lockdowns on the environment with the drop in air and land transportation and falling demand for hydrocarbon fuel. They are the ones most critical to attempts to reopen economies and get people back to work. They are advocating universal income guarantees and green new deals for stimulus as long term solutions. 

They are not keen to return to the status quo.  They are not particularly troubled by adoption of  restrictions of movement and civil liberties on the general population. They tend to be indifferent to empirical scientific method and how it may evolve over the particular ideology that they promote to support their policies and actions.  They are not especially concerned about the social cost and economic hardship on the general population from their decisions. They place more important on their longer term ideological political goals that they feel are good for society and their political careers.

We will see in the next few months how this political debate evolves and how soon we reopen. The political climate is looking toxic and divisive. Inevitably we are entering a new post globalization era for the shipping industry with far reaching consequences.  Stopford parallels the challenges as analogous to the transition from sail to steam in the 19th and early 20th century.  The political and economical ramifications are huge.

How long will this bull tanker market last?

Despite looming global recession, the tanker sector has been enjoying a rate boom from the oil price war and failure of OPAC+ to agree on rate cuts.  This market boom comes at a time of falling oil demand. The tanker market is being driven by ramped up production. The present large contango in pricing favor physical oil storage, further reducing tanker supply and keeping tanker charter rates very firm.

Many of the major listed tanker companies feel that the tanker industry has entered a new era and will finally be enjoying several years of good earnings.  Frontline's MacLeod characteristically sees floating storage as a 'generational' opportunity.  What is the incentive for build up oil inventories even with wide contango when oil demand is falling in a looming global recession? Is this bull run sustainable and what are the risks for tanker share investors?

There are substantial risks that this could be another false start for the tanker industry, sooner than later.  Even if there are no agreed on cuts in the near future, present production seems so out of proportion to falling oil demand that available storage space is filling up rapidly.  There is the risk that at some point, the storage space will be so tight and expensive that production will have to be physically reduced.  At that point, the tanker market could become frozen for a period with very little demand for oil transport and refineries drawing off oil stocks.

More likely agreed production cuts will come sooner than later and contango spreads will narrow. Negotiations failed this week 15 because Russia and Saudi Arabia are insisting that non OPEC producers like the US and Brazil join in the production cuts. In the US environment, voluntary production cuts are almost impossible legally.  Sooner or later, production cuts seem inevitable.  Physical oil storage has never been sustainable over the long run.  

Maritime consultancy Marsoft predicted in a recent webinar that a significant oil supply cut of Opec, Russia and nine other producers – also known as the Opec+ group – will end the bull runs in tanker markets from July onwards.  Marsoft partner Kavin Hazel estimates that a reduction between 5m barrels per day (bpd) and 10m bpd would pressure tanker rates later this year.  This would lead to a much smaller stock buildup and less floating storage. A rise in oil price from production cuts would narrow the contango spreads. Tanker rates would fall back more significantly in the second half of the year with less oil put into the market.

This view was recently seconded by Cleaves Securities,  who turned bearish and are projecting that Oil Tanker spot rates plummet in concert with asset and share prices. Their tentative VLCC spot rate forecast for 2H20E is now only US $ 15k/d, which is extremely low given 4Q represents high-season, in a tanker note yesterday.

The clean sector also faces challenges with dropping oil demand in  recessionary environment. The jet fuel market, for example, has collapsed with the fall in air travel.  Refineries are trying to change their product output mix to compensate for the collapsing margin spreads in these products. Excess jet fuel can be stored, but unlike crude oil, there is a limited shelf life and the product become off specification and can no longer be used as intended.

At least the tanker markets profitable and building up cash.  Other shipping sectors are not so fortunate with container lines and cruise business burning cash and struggling right now. Dry bulk is showing some improvement but just above water at present.

These are complex matters, but the most worrisome presently is falling global oil demand and depth of the coming recession. The timing and shape of a coming global recovery is critical here. It all depends when the quarantines are lifted and how soon we return to normalcy.

The scrubbers conundrum

IMO 2020 is a daunting challenge for the shipping industry. After initially a long period of ‘wait and see’ with considerable verbal resistance to retrofitting their ships with scrubbers, there is a sudden rush since June this year of companies jumping on the bandwagon to retrofit their fleet with scrubbers. Whether over time this proves an effective means to meet the environmental challenges ahead for the industry remains to be seen. It is likewise questionable in terms of the interests of the shipping industry as a whole. 

The IMO 2020 regulation places an impossible burden on the shipping industry. Normally environmental regulations on matters like exhaust emissions start with the engine makers and refining industry, not with the end users of the equipment. 

Here the shipping industry will be monitored and fined for exhaust emissions from not using compliant low sulfur fuel oil (LSFO). The existing fleet is equipped with engines designed to burn heavy sulfur fuel oil (HSFO). It not clear that the refining industry will be able to supply sufficient LSFO. The refinery industry is not mandated to do this under IMO 2020. They do not know themselves how much HSFO will continue to be used and how much LSFO will be needed. Changing the refinery cycle to produce LSFO requires investment. Also possibly this will necessitate change of supply chain for crude oil in favor of lighter crude grades more amenable for production of LSFO.

None of the means of compliance for ship owners is guaranteed to be without risks, expenses and issues. 

• Scrubbers are an exception in the IMO 2020 legislation that allow ship owners to continue to burn HSFO in their engines. No one knows for how long the regulatory authorities will continue to permit this exception. The technology is based on land applications in heavy industries like power plants. Scrubbers are heavy and expensive equipment. The residues from the process have a disposal issue. The process requires additional energy and has maintenance costs. Fitting scrubbers is a costly capital investment in the millions of dollars per vessel as well as requiring off-hire and expenses for installation. The CAPEX may be recovered in the operation of the vessel with cheaper HSFO but no one yet knows how much the price differentials will be between HSFO and LSFO and how long or soon will be the payback. The growing sentiment for scrubbers at least for larger tonnage comes from fear of being left out with charterers, who will give preference to vessels that can burn the cheaper HSFO. Some major oil company charterers are offering period charters at substantial premium to current T/C rates for vessels fitted with scrubbers. 
• Burning compliant LSFO will have considerably higher costs than previously with the HSFO. Nobody knows whether there will be sufficient supply. Ships could be forced to wait for supply and be immobilized. There are no clear fuel standards. There are technical and safety issues in burning LSFO in conventional engines built to run on HSFO. 
• LNG is prima-facie an elegant alternative but this practically can only apply to new buildings since the costs of refitting existing vessels with new main engines is simply not practical nor feasible. The major oil companies are preparing to supply LNG for fuel but so far availability is only at a few major ports and use of LNG as fuel is only feasible regionally in ECA areas like the Caribbean, Northwest Europe and the Baltic Sea. With LNG, there is another potential environmental issue with methane slip, where there might be future regulation. 

Lately in the Trump administration in the US, there is growing concern about the impact of higher transportation costs to consumers from IMO 2020 and talk about finding some means for delay in implementation of IMO 2020. Since these regulations have been ratified many years ago, the general feeling is that delay in implementation is not too likely. Simply, 2020 will be a tumultuous year in the fuel business and there will be considerable lenience until supply issues are settled. 

There will be three categories of vessels: 

• Those fitted with scrubbers, mainly larger vessels with higher fuel consumption that perform long haul voyages. 
• The modern ECO vessels without scrubbers with low fuel consumption. • All the other vessels available. •
• Smaller vessels will be the least affected. Many of them are burning mainly gasoil distillates, trading in ECA’s. They are too small physically to fit scrubbers.

A key issue for the shipping industry is the incidence of the higher fuel costs – on the ship owners or on the charterers? The shipping industry is a very low margin business with some sectors like tankers making operating losses. Already fuel costs are mounting this year with the rise in oil prices internationally. The liner companies are posting fuel surcharges. Already some are starting surcharges for IMO 2020. The shippers are protesting but given that this sector also is low margin and low making, there is not much to protest or otherwise more liner company bankruptcies. 

My view is that the shipping industry would be best served to boycott scrubbers and force the higher fuel costs on the charterers, letting the politicians face the regulators over the higher costs to consumers for use of more expensive fuel. Also slow steaming is a constructive measure that reduces emissions as well as oversupply of vessels for better utilization of the existing fleet. 

The shipping industry, however, is highly fragmented. Shipping companies have no market pricing power. They are price takers. Essentially it is a highly competitive, low margin business with low returns on assets and investment, except for market swings and asset arbitraging. 

2020 will be an interesting year. There may be a silver lining in term of more cargo volume, especially in the product tanker sector to supply LSFO and generally lower supply of vessels with increased scrapping pressure on older, less fuel efficient tonnage and vessels taken out of the market for scrubber refitting.

Hanjin collapses into bankruptcy and receivership: Sursum Corda!

I have been predicting this sort  of high profile bankruptcy of a major liner company as inevitable for years now.  There are just too many loss making liner companies and sooner or later state support would reach its limits.  The whole matter of counterparty risk for the vessel provider companies has been misconstrued for years now on the false assumption that the liner companies were just too big to fail. 

Seaspan's Gerry Wang calls the Hanjin bankruptcy a nuclear bomb and mixing his metaphors a 'Lehman moment', but did not Wang see this coming?  For years, he was ordering aggressively and chartering out to loss makers like Hanjin.  His policies contributed to this!

This industry suffers from chronic overcapacity and low margins.  Further their business model based on China and head haul routes is in risk of becoming outdated with the slowing of Chinese growth and trade rebalancing as well as technologically obsolescent with the robotics, 3-D printing, etc.  I have always been in agreement with my friend Christopher Rex of Danish Ship Fund on this industry and its prospects. 

I have argued this time and again with my Wall Street investment bank friends. Hopefully, with this Hanjin case, they will start to wake up and understand better the container industry dynamics.  See some of my  blog articles on this subject over the years.  For example, I was very early to point out the large exposure of Danaos (NYSE: DAC) to financially weak liner companies. 

Danaos was somewhat fortunate with the HMM charters receiving shares in restructured HMM in return for reduced charter rates.  In the case of Hanjin, DAC has estimated exposure of US$ 560 million on Hanjin.  First estimates are creditor returns of 35% for secured claims. But only 5% for unsecured claims and zero on liquidation.  That is quite a mark down!

Over the years, Wall Street has made some bad shipping calls like the earlier reckless, irresponsible dry bulk speculative asset plays.  Investors in shipping stocks have frequently lost their shirts. 

Of course, the great thing about shipping markets as opposed to politics in the US and EU - where the usual reaction is to double up on failed policies, buy time and hide the truth from the public - is that you cannot hide financial losses, financial resources are limited and there are natural market corrections, asset write downs and consolidation.  Raw Schumpeter capitalism always prevails keeping the industry lean and mean over the long run, but not without significant volatility and market swings. 

It is not a good idea to get lost in the noise and ignore supply chain logistics that generates the underlying cargo demand for marine transport.

Greek Maritime Cluster: Role of the small family shipping business – challenges and opportunities.

What will be the future landscape of the Greek maritime cluster in the coming years ahead?  The Greek maritime cluster has been facing a period of rising unemployment and shrinkage in the small medium sector,  It has been hit by the bankruptcy of the local banking system, tight money, rising taxation on ships and most significantly the very poor dry cargo markets the last few years, where there is a very heavy exposure.  Generally these smaller private companies have a lot of bias against their larger listed company compatriots and their use of capital markets and private equity money, which they see as an unsustainable passing fad and a primary reason for the over investment in shipping assets and poor markets.  These companies generally have older and smaller vessels, primarily handy size bulk carriers, with the larger better capitalized companies operating also Supramax and Panamax bulk carriers. This sector has been the incubator of the maritime cluster, allowing newcomers to enter.  Given the larger number of this type of company, it is a key market for the local Greek service companies such as chartering and ship brokerage firms, crewing, insurance and suppliers.   As George Economou astutely observed during Posidonia this year, Greeks have been predominate in shipping because they were willing to accept the lower long term returns on shipping assets that others found unattractive. There are a variety of historical reasons for this:   Greece is a small, relatively resource poor country. This drove many Greeks to the sea and created a maritime tradition.  Greece was prior entry to the Eurozone, a soft currency country with constant moderate inflation, where investment in assets was a hedge to currency depreciation and an opportunity for capital gains. Because of the abundance of local seafarers and the family nature of the business, the Greek ship was cheaper and more efficient than most competitors on operating expenses, but this advantage started to erode and has largely been eliminated with the Greek entry into the Eurozone, where Greece lost many other local industries such as ship repairs, textiles, etc. Still today despite the hikes in ship taxation and EU pressure to eliminate Law 89 offshore law, the cost of maintaining a shipping office in Greece is relatively low compared to lower tax jurisdictions in the Far East like Singapore and Hong Kong. There is an abundant supply of personnel with the increasing unemployment in the sector. The Greek business model is owner operator. It is based on owning shipping assets and chartering them out for hire with the crew. About 70% of the Greek maritime cluster is invested in dry cargo vessels because of the lower capital requirements and the ease of entering the sector, which is highly fragmented. The period of growth and success of Greek shipping from the early 1970’s was due to several key factors:     The ability of Greeks to acquire older vessels and keep them running for longer than expected trading life.   The inflation of shipping asset and scrap values along with market fluctuations created significant capital gain opportunities that allowed the company to borrow against higher values to expand and renew their fleets and reduced the nominal value of the bank debt. Abundant bank debt to finance ship acquisitions and roll over the fleet at low cost. Greek shipping was initially fueled by petrodollars and merchant banks, then the German landesbanks and the expansion of the local Greek banks until the 2008 financial crisis and the Greek national bankruptcy within the Eurozone.

The past few years, the climate has changed for Greek shipping. Money has become tight and more expensive, ship values and scrap prices have declined. Earning margins have tightened. The dry cargo chartering market has become more age conscious with a tiered market structure similar to the tanker sector. Ships over 15 years have become less preferred with lower rates with the overabundance of newer tonnage in the market for hire.

Investments in older tonnage at close to scrap levels are no longer a guarantee of safe returns. The earnings margins are very poor, sometimes negative. Often over time, the vessel values erode such that it is not possible over the limited remaining trading life of the vessel to recuperate the asset impairment loss.

This is a highly emotional and very controversial subject in Greek shipping circles. Most of the local Greek shipping industry would vehemently contest this view, but I can safely say that I have seen frequently this phenomenon reflected in balance sheets for older vessels over the last few years.

The present hope today is for a surge in investment in dry cargo shipping assets, even with negative carrying costs as a means of substantial future profits to reflate the sector. This is very understandable with the current depleted balance sheets of the industry and the suffering service industries, particularly the local chartering and sale and purchase firms. A lot of private Greek money has been invested this year in dry bulk shipping assets. More units keep employment for the shipping offices, and create needed income for the local Greek brokerage firms.

For a family business, the top priority is to reinvest in the future of the business that is their prime source of livelihood. Under these conditions, it is quite a different investment decision than an institutional investor or shipping industry outsider. The key differentiating factor is the returns criteria. An outsider is looking for the best possible return for his risk profile in a variety of alternatives. A family business dependent on the shipping industry is willing to live with much lower returns and higher risks initially, even to the point of no returns or negative carry for the prospects of future capital gains. The reason for this is obvious: The critical factor is the future of the family business. A family shipping business without outside investors does not really need profits, investing their own money in their business as long as it stays solvent and supports a good life style.

Another important point to be considered is that the local Greek banks have a lot of older, unattractive dry bulk assets on their books and they will make every effort to keep these assets operating with local family companies rather than scrapping them and taking losses now on weak balance sheets. They will also be willing on a limited basis to finance older vessels for local companies that have the necessary liquidity to carry them.

So there will always be a place in the market, particularly for older bulk carrier operators. More than likely than not, there will be less scrapping and more efforts to prolong trading life than the larger players invested in new tonnage would like to see. The fragmented nature of the bulk carrier industry will allow space for this, even with the lower operating costs and fuel consumption of the newer vessels because the family operator will accept lower margin business and remain viable.

Unless present economic conditions change, however, I do think that there will be inevitable further consolidation in the Greek shipping SME’s as well as the larger operators and less space for new comers in the industry. The profits on capital gains will be subdued and below expectations for some time to come because ship replacement value will remain low and there will not be sufficient banking liquidity to support the sale and purchase turn overs to generate a significant rise in asset prices. The older tonnage will eventually be scrapped at low prices.

Those companies with resources to invest in younger vessels, build up larger fleets and develop good trading platforms will be the best positioned for the future.

Is the Greek dry cargo business model now obsolete?

Of the 700 odd Greek shipping companies listed in Greece, the majority are in the dry cargo sector with small fleets of three to ten units, mainly smaller and older vessels.  Apart from the ubiquitous handy size bulk carriers, Greek shipping is also heavily invested in Panamax bulk carriers. Will these companies survive this current freight market crisis?  Will the crisis result in consolidation?  Is the business model sustainable or will it have to change for the times?

Many of the publically listed dry bulk companies ranging from the smaller ones like Free Seas, Hellenic Carriers and Globus to the larger ones like DryShips and Paragon are suffering from legacy debt problems and weak earnings.  The smaller private companies are at the mercy of the local Greek banking system with its insolvency and capital control issues.  The best off are the cash rich, mature private Greek owners like Eastern Mediterranean or the Angelicoussis Group.

The predominate business model in Greece is vessel provider.  The Greek shipping companies are long in shipping assets, but generally weak in commercial platforms.  The majority of the companies are small and lack scale efficiencies.  This is particularly true for the smaller listed companies with fleets too small to support the high administrative expenses for the public listing. 

This business  model is entirely to be expected for historical and structural reasons.  Greece is a major maritime nation. Greek seamen were the backbone of this system.  The biggest strength and competitive advantage of Greek owners was the link between their offices manned by former mariners and chief engineers and their vessels.  They offered low cost, high quality shipping services to charterers and end users.  Greeks unlike their Scandinavian rivals were never big in cargo operations or freight trading, a particular strength of the Danish shipping industry historically.

The nature of the Greek shipping  business model leads to asset arbitraging as a major means of enhanced earnings.  Freight markets in bulk commodities shipping is highly commoditized with low earnings margins from vessel operations.  This waxes and wanes with the shipping cycles, but historical mean averages have been low.

The dry cargo markets in particular are very fragmented with low entry  barriers.  Shipping companies have no market pricing power.    Vessel values rise exponentially on future earnings expectations in good markets, making vessels sales a highly lucrative business over vessel operations.  It was Greek historical acumen in these skills of sale and purchase profits that has made Greek shipping so enticing to US Capital markets over the last ten or fifteen years. 

Major US institutional groups like Oaktree saw the same US real estate paradigm in the shipping markets.  They were attracted to Greek shipping for a similar sort of play. This led to investor partnerships pioneered by Peter Georgiopoulos and more recently by Petros Pappas both very close to Oaktree Capital.  This also extends to non-Greek groups like Scorpio Bulk, a highly speculative dry cargo asset venture on new building contracts, close to a futures market play.

This sort of play to be effective depends on the right kind of financial and freight market conditions. These conditions were at their prime thirty years ago in the heady days of petrodollars, high inflation and eager banks with abundant credit facilities for shipping companies.  Since the 2008 Global Financial Crisis, with ZIRP (zero interest), QU (quantitative easing) and the end of a globalization super cycle, the environment for asset arbitrating on cyclical freight markets is becoming more and more problematical.

There is a glut of overcapacity globally and a dearth of demand.  Banks has weak balance sheets and limited credit availability.  There is enormous shipyard overcapacity.  The Chinese infrastructure boom is over.  Speculative investment money in shipping has more than often been a godsend to cargo interests, providing ample ship supply to service their transport needs, but it has not been kind lately to investors in the underlying shipping assets. 

With the credit crunch is a limited number of buyers for shipping assets compared to prior years, limiting the potential for mark up in prices.  With the general weakness in commodities prices and ship yard over capacity, shipping assets are exposed to deflationary effects and fall in value over time with lower replacement cost.  Falling scrap prices means lower residual values.

The most successful and resilient business models are the cargo operators of which the Navig8 Group has been an industry leader.  They serve end users customers with chartered vessels.  They are popular with ship owners, hungry for employment in weak markets.  Their business has small margins and depends on  high volume for profits. It is an asset light trading model.

These businesses can go both long and short in shipping assets.  They do not carry long term exposure in shipping assets or bank leverage.  For larger vessels on standardized voyages, they can hedge their positions with freight futures desks.  They can adapt quickly to sudden market changes, adjusting their cargo books and positions in vessels.  These are the flourishing businesses of the times as opposed to the suffering Greek vessel providers.

Institutional investors have been lately turning to partnerships with cargo operators like Navig8 to adopt to the times.  Oaktree and Peter Georgiopoulos incorporated this model in the restructured Genmar from the ashes from Chapter 11 reorganization proceedings, by merging with the Navig8 VLCC venture and renamed their company Gener8.  This ties vessel owning long in assets with a lighter more agile trading model including chartering in vessels.

The question for the Greek dry cargo owners is whether their business model is obsolete and they will have to consider moving into cargo operator business models on a hybrid basis like a Norden or a Pacific Basin with mixed fleets or owned and chartered vessels..  Companies heavy in shipping assets but weak commercially lack economies of scale in the market and are weaker in understanding the freight market risks.  They are overly oriented to asset arbitraging, which in present market and financial conditions is a backwards-oriented business strategy of yesterday, not effective in the present environment.  Chartered vessels would create needed fleet scale for companies with smaller fleets

These Greek companies are facing survival risk and becoming dinosaurs.  They face a double whammy of violent changes both domestically in Greece with the failure of the Greek state as well as external forces in the aftermath of the globalization super cycle of the past century.

Is asset arbitraging a valid investment theory for the shipping space in today’s economic environment?

Asset arbitraging accounts for at least 90% of all investment in the shipping industry. It is particularly predominant with institutional and private equity investors. Major groups like Oaktree, Apollo and Bayside have taken large positions in various classes of shipping assets. The rationale is cyclical market recovery. This been the bread and butter of many ship owners in the past, but can this work in the current environment of immense shipyard overcapacity, weak global demand and soft commodities prices?

I have never been a warm fan of asset arbitraging as a strategy to build value in the shipping industry. It is another version of the old stock market trading theory of buying low and selling high. The concept is that prevailing shipping assets are somehow mispriced too low. Eventually markets will pick up and the true higher prices will be revealed, when the shipping assets can be resold with a markup.

This viewpoint distorts the nature of the shipping industry, which is a service business to transport cargo. The fundamental driver in this space is cargo volume. The more cargo volume to be transported for the existing fleet available, the better the freight rates. Higher freight rate expectations result in higher vessel valuations in terms of future earning capacity. If you take away the noise from the volatility of the freight markets, long terms returns on shipping assets tend to be moderate and earnings margins restricted.

Costs in shipping are highly dependent on capital and labor. Ships are very capital intensive. They are wasting assets that require considerable maintenance. They have a limited trading life until they are recycled and sold for scrap. Getting in and out of shipping assets depends on class of ship and the liquidity of the resale markets.

I use the term ‘asset arbitraging’ for these shipping asset plays because it reminds us of what this process is and where it leads. Arbitraging eventually evens out market fluctuations. If enough investors see that a class of shipping asset is underpriced and then take speculative positions, then this supplies the market with ample tonnage that provides the end users more than ample vessels for their cargo transport needs and keeps a lid on freight rates. The whole effort is a wash out with no profits.

The dry cargo space illustrates this situation. Several years ago there was an orgy of private and institutional money in dry bulk shipping assets. The purest version of this was Scorpio Bulk (SALT), where they made a massive play in new building orders without even having an existing operating company in dry bulk shipping. All this was predicated on the new building deliveries coming at the time of a market upturn in rates that would lead to significant appreciation in vessel values. Now Scorpio Bulk is trying to lighten up and reduce their position by resales of some of their new building contracts, even possibly some conversions of the orders to tankers.

Unfortunately, the current economic environment does is not supportive of these asset plays:

• There remains significant shipyard overcapacity.
• China and emerging markets, which are the main source of cargo volume growth, are slowing down.
• Advanced economies are still in sluggish recovery and substantial debt overhang.
• Vessel working life is growing shorter, with both dry cargo and tankers facing age restrictions and trading limitations after reaching 15 years (3rd Special Survey).

Added to these factors is the industry consolidation that is reducing the universe of buyers in the resale markets and the limited credit from the banks available to finance these sales.

So I was not surprised by the recent Tradewinds article on Apollo Global Management putting the 12 Suezmaxes of Principal Maritime onto the market, where some finance sources expressing reservations that it will be easy to find a buyer for an all-cash deal. Also I would not expect the mark up in price to be as much as Apollo was hoping, depending on how much hard cash they can get as opposed to payment in shares from a publicly listed entity.

The other factor is vessel replacement cost. I am not optimistic here. There is an overcapacity of shipyards. Order books are thinning. Steel and scrap prices have been falling. New building prices are more likely to fall in the near future than harden.

Consequently, the best positioned people in these market conditions are freight traders who are asset light business models rather than those heavy in shipping assets. The institutional money in the shipping space has done wonders for end users in providing them more than ample tonnage for their needs to transport cargo, keeping freight rates very low.

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.

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.

Peter Georgiopoulos tries to regain his lost credibility with a US$ 23 million follow-on offering to expand Baltic Trading

Investors seem to have given a warm welcome to Peter Georgiopoulos’s (Peter G) latest gambit, raising US$ 23 million to scale up in the dry cargo market, looking towards a cyclical recovery.  Representative of this sentiment was Doug Mavrinac of Jefferies, who thought that this was “well-timed play” for Baltic to “realize its potential for shareholders as a consolidator in the dry bulk shipping sector” Does this argument make any sense for a company of nine vessels that has never turned a profit and is managed by another Peter G company - Genco  at high transaction costs that has 50% chances of bankruptcy, running out of liquidity later this year - if the dry bulk markets do not turn up? 

Peter Georgiopoulos reminds us of Nassim Taleb’s anti-hero John – a high yield trader – who was perceived as a financial genius and made a vast fortune - until he blew up as market conditions turned against him. Are we fooled by randomness? Is Peter G a skilled investor and ship owner/ manager in the shipping space or was he simply (to paraphrase Taleb) a lucky fool  successful in the pre-2008 shipping boom, now trying to repeat the same formulas again with investors riding his coat tails?

To be honest, what is any different in the approach of the Oaktree venture with Petros Pappas from the premises of the Baltic gambit, except for scale, money and wider shopping list of the Pappas venture? Both cases are asset plays based on arbitrage, rather than any effort towards a serious business plan to build a credible shipping business with competitive market position, servicing end user customers. Both Peter G and Petros Pappas tend to view shipping as trading in floating assets. In turn, their financial backers like Oaktree view them as high yield traders, who share in the risks by putting some personal skin in the game.

The investment thesis is a hefty return on asset appreciation, having bought in at low prices with the object to sell out as the market rises. The eventual sale could be in terms of shares as NAV rises or vessels in the fleet or an eventual merger with another shipping company. Transaction costs are relatively high in terms of management fees and hefty executive compensation. It is a vessel provider business model. Employment is largely by time charter to cargo operators, often at indexed rates. The enterprise really does not have much intrinsic value beyond the physical assets and the gut instincts of its management in timing decisions.

With a US$ 23 million war chest even with bank leverage, Baltic will likely never be much of an industry consolidator or a shipping enterprise of scale. At best, Baltic might expand by two or three units. Already speculative money pouring into shipping assets in pursuit of yield in a ZIRP world have pushed up dry bulk prices by 10%, without any appreciable increase in demand for these vessels. Further, as RS Platou Markets pointed out: “shares printed at below net asset value,” are “expensive growth”, albeit “historically low asset values mitigate a large portion of the dilution in a mid-cycle perspective”. In short, the acquisition prices will be at a premium with expensive funding and vessel operating expenses will have to cover high transaction costs – requiring a hefty future market upturn to make a profit. I wonder whether Doug Mavrinac pointed any of this out in his above-quoted analysis to would-be investors.

Nassim Taleb points out some of the negative traits of traders:

• Overestimation of the accuracy of their beliefs. This was what led Peter G to disaster in the 2010 Metrostar block tanker deal for Genmar. It was a carbon copy repeat of previous deals that went well. Investors bought the story and suffered major losses.

• Tendency to get married to positions. Peter G has always stuck to commodity shipping, ignoring other growth areas like LNG or offshore. The tanker deal was a repeat of two previous deals. This dry bulk deal is a repeat of his first attempts with Baltic that did not meet expected results.

• No precise idea what to do in case of losses. In fairness, Peter G handled the General Maritime debacle quite well putting Oaktree into the business at an early stage and then pre-packing the Chapter 11 reorganization with support of his senior creditors. The issue with Baltic and Genco is whether or not Peter G is running out of resources to afford another losing position. After all, Peter G is no John Fredriksen in terms of personal wealth or scope of shipping empire to back stop his losses.

• Absence of critical thinking expressed in their stance with “stop losses”. Peter G has never been involved in any pro-active business restructuring to consolidate; sell assets and redeploy capital more productively like a Fredriksen, Maersk or TeeKay Shipping. In the case of Baltic Trading – like the Genmar misstep – he is looking to double up his position for a cyclical market recovery, even to point of share dilution by raising expensive capital with Baltic shares trading below NAV to grow himself out of his present woes.

Peter G’s management of Aegean Petroleum Network demonstrates some of these same tendencies. For example, the marine bunkering has some of the poorest margins and lowest returns in the fuel business. Peer companies like Chemoil - backed by giant Gencore - want to expand in more profitable sectors like aviation fuel and reallocate assets by selling off storage facilities. By contrast, Aegean Petroleum insists on expanding in the bunker fuel sector and craves for investment in low yielding related physical assets like bunker vessels. Further Aegean Petroleum has no problem borrowing money with a new massive US$ 800 million loan (despite  debt covenant problems not long ago) to boost low margin incremental bunker business.  By contrast, better capitalized competitors like World Fuels are virtually debt free and heavily diversified in more profitable aviation fuel and land fuel business with a mean and lean balance sheet. The results are that Aegean’s share price consistently trails its peer competitors.

Like a trader and many peer Greek market vessel providers, Peter G really does not care about his operating margins or returns on asset because he expects to make up for this by taking a long position and make a killing in cyclical market upturn. The facts are that Baltic has been consistently making losses. Just compare Genco and Baltic stock performance since the 2008 meltdown with Pacific Basin, an integrated and well managed dry cargo company operating from Hong Kong that considers its business transport.

 

This does not present a flattering picture for Peter G management for the pockets of its shareholders. Likewise, Aegean Petroleum under Peter G management exhibits same poor share performance with peer competitors. 

None of the above is meant to condemn this strategy. If there is a recovery in the dry bulk markets, buying into Baltic Trading stock could prove to be an extremely profitable play. Peter G will certainly regain his aura of a shipping tycoon. That would be nice for everyone.

What concerns me personally is that current mass of speculative capital pouring into the shipping space - particularly Greek companies - chasing the same cyclical asset plays and even pushing up asset prices in current dismal market conditions. It would be a terrible mess if markets ultimately disappoint. This could lead to a substantial shake up in the Greek maritime industry, especially with major dry bulk players like Eagle Maritime and Excel Maritime Carriers on the verge of bankruptcy along with Genco, which is interconnected with Baltic Trading.

Greeks face loss of competitiveness with Asian Peers

Keynote Speaker at Hong Kong Shipping Forum on Business Models and Strategy in the Shipping Industry

Structural changes in the crude oil tanker sector: failure of companies to adapt may prove fatal!

The crude oil tanker sector faces the double whammy of excess capacity from overinvestment as well as structural changes in trade flows.  It is not a growth industry.  Developed economies have proved successful in rolling back consumption and diversifying in alternative fuel sources.  Marginal demand growth to fill the slack depends on emerging market economies.  The degree of hard landing in China and future level of growth rates in emerging market economies thereafter is very critical in the short and medium term.   Those tanker companies heavily dependent on traditional crude oil transport – VLCC’s, Suezmax and Aframax – without other revenue sources are severely exposed.  Those with high bank leverage are in severe distress.

Spot market tanker rates can be very volatile. These vessels are dependent on one cargo only: crude oil. Demand is driven by inventory levels; futures pricing, oil production levels and underlying oil import needs. Oil production is in part manipulated by the oil producer cartel OPEC and particularly Saudi Arabia as a swing producer, so productions levels play a key role in available cargo volume for transport. Politics plays a big role with the Iran oil sanctions. Speculation plays a role depending on the future pricing curve whenever it is favorable to buy and store the physical commodity in chartered tonnage for sale at a later date, taking this out of the transport market, leaving less tonnage available for lifting cargos to destination.

As the US has been the greatest consumer of crude oil in cargo volume, the VLCC trades were developed as the most economical means per unit cost to transport crude oil to the Houston area for refining from the Middle East. With the China and emerging market boom of the last decade, there was a deluge of new refinery projects in the Middle East, China and India.

Middle East producers wanted to develop a more value-added economy, investing their profits from oil sales into refineries to produce products at source for export. This led to great optimism in the product and chemical tanker sector that jumped the gun in over investment in these sectors. Since the 2008 global financial crisis, some of these projects have been cancelled, some delayed and some progressed and are on stream. Demand was less than expected for the ship owners.

One of the most novel projects from the Middle East was the Motiva refinery. This is a 50-50 Shell and Aramco joint investment of three new refineries in the US Gulf region. It is the reverse concept of the Middle East refinery projects. They transport crude to the US and refine there. This has been a boon to the product tankers trades in US Jones Act cabotage trade; albeit due project delays and a refinery closure due an accident, it has been slow to come on stream.

Conversely, there have been some overwhelmingly negative structural changes that threaten crude oil trade to the US, namely:

• Technological evolution in the production of tight oil and shale gass, allowing more US domestic energy production, together with the Keystone pipeline project facilitating Canadian oil imports. Whilst this is another potential boost to US Jones Act shipping for distribution of products, it is one of the main contributing factors this year to a dreadful international tanker market.

• Expected increased domestic use of energy resources in the Arabian Gulf, making less crude oil available for export. This is developing on several fronts. First, there is the political front with the Iran oil embargo. Second, there was a drastic reduction of Saudi oil exports during the summer where the oil was diverted to domestic use for electricity production. Finally, the above-mentioned refinery project now coming on stream to produce clean products and chemicals for export. After the GFC, about a third of the projects were cancelled and another third in delay, but the last third is now coming on stream and exporting. This means production at source and less crude oil for export.

The rise of gas shipping as a new growth area is also impacting negatively on crude oil transport. The LNG market is dominated by cargo operators and normally done on long period contracts. Historically, returns have been less than desired and tonnage ordering has overshot the market, but the Japanese tsunami provided the catalyst to rekindle this market to profitable rates with attractive returns to investors. The vessels are much more complex to build than crude oil tankers and capital costs are significantly higher, providing serious entry barriers. The limited number of yards that can turn out such specialized vessels has created a two-year window of opportunity for nice run on rates with existing tonnage in relatively short supply.

Increased LNG production as a long-term secular trend means also downstream enhanced prospects for LPG shipping. Together with the offshore sector, these are presently the major growth sectors in the tanker markets.

Conversely, the crude oil tanker market – except for sudden brief demand spikes in refinery restocking – does not seem to offer good long term growth prospects in the face of these secular trends. A number of established tanker operators like BW Shipping have been shedding VLCC tonnage.  BW like Teekay Shipping and major private owners like Angelicoussis in Greece, foreseeing these secular treds  have diversified themselves in timely fashion into other more attractive areas like LNG shipping and offshore, positioning their businesses with profits from these new growth areas that shelter them from the current losses on their tanker tonnage.

Some like TeeKay Shipping have sought to develop a franchise in tanker trades demanding special expertise, namely shuttle tankers offloading directly from oil rigs. These vessels have special mooring fixtures and are equipped with dynamic positioning technology. They require specially trained crews. An extension of this offshore business is the FSO and FPSO business with floating oil storage and production facilities, another current growth area in shipping.

Companies who have been slow to adapt to these developments are generally in deep trouble. General Maritime (GMR), for example, just recently got out of Chapter 11. Peter Georgiopoulos appears to have ignored totally all of these developments. His company was probably the weakest of the large listed tanker operators in terms sound commercial management. Perhaps he was distracted by his ventures into dry cargo. Now he has lost control of his tanker business and is fighting to save Genco and Baltic in the current severe bulk carrier markets correction. What Oaktree gained in taking over General Maritime remains to be seen. Presumably they were attracted by a cyclical asset play because the enterprise value of their acquisition is quite low compared to peer tanker operators.  Oaktree now seems to be ready to do a startup asset play in dry cargo with Petros Pappas of Oceanbulk.  At least this venture promises to have a lower entry and transactions costs than Genmar....

Overseas Shipping Group (OSG) was too little and too late in these structural market developments and left with heavy crude oil spot exposure. It appears to be heading to Chapter 11. Whereas their peer colleague Peter Georgiopoulos by contract proved timely and diligent bringing in Oaktree to support his company, OSG management also appears to be failing with senior lenders in prompt action in debt restructuring. Hopefully, OSG management ultimately will prove adequate to the circumstances.  I have always felt that their age and career path has made it very difficult for them to adapt to crisis management. The OSG Board made a good decision to appoint outside advisers.

In these cases, it is not only the over indebtedness of the companies, but also the failure of the business model that put these shipping groups in their present predicament. Conversely, the successful operators like TeeKay Shipping have outperformed peer tanker operators because they adapted in timely fashion their business model to anticipate structural market changes and have much better business models.