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.

Greek Shipping and EU revisited

The third Greek bailout program has now been passed by the Greek parliament and at least the basic tax increases on Greek shipping have become public.  We can now begin to take stock on the damage done to the Greek shipping community by the SYRIZA government and the EU/ Eurogroup bureaucracy.

The tax increases are hardly helpful for a business under a great deal of stress due the very poor dry cargo markets, where the majority of Greek shipping companies in Greece are concentrated.  None of this is positive for the increasing unemployment in the Greek maritime sector. There are 4% tonnage tax increases each year for the next three years.  There is also a continuation of the 'extraordinary' (now becoming permanent) levy on Greek maritime service businesses on the foreign exchange brought in to Greece for covering their office and administrative expenses.  Already tonnage taxes in Greece are much higher than other jurisdictions. 

This makes third party ship management in Greece problematic given that ship managers in major jurisdictions like Cyprus, Dubai, Singapore and Hong Kong do not have this burden.  Ironically, the EU approved the low rates in Cyprus, whilst insisting on rate hikes in Greece.  The other jurisdictions are blessedly outside the Eurozone, without fiscal problems or over indebtedness. There is little prospect of their hunting down their businesses and citizens by repressive taxation as happens in Greece and the  EU as a whole to cover their political mismanagement and losses from repeated  policy failures. 

The only positive thing to be said in terms of advantage for Greek offices is that rents and salaries in Greece are extremely low compared to rival jurisdictions.  The other places are economically healthy, Greece is in a deflationary spiral with massive unemployment and falling real estate prices.  The tax increases are offset by lower personnel and administration costs in Greece as opposed to the other rival jurisdictions.

There are, however, other negatives in Greece beyond these new EU tax measures on the Greek shipping industry.  The two most serious negative factors are the broken local banking system with capital controls and the general uncertainty of the future, including exposure to further tax hikes and erosion of offshore status of Greek shipping in Greece.  All this creates a bad business environment for an industry that is facing a lot of structural problems due changes in world trade and a particularly bad situation in the dry cargo sector, where the majority of offices in Greece are exposed.

The most unpleasant aspect is the situation with Greek banks and capital controls.  The Greek banks are now facing new stress tests and recapitalization issues.  Lending has been at a standstill for months now. The small and medium Greek shipping enterprises dependent on the local Greek banks for the financing of their fleets are suffering the consequences.  The capital controls extend to their US Dollar accounts in complete contrast to the situation prior Greek entry to the Eurozone and the drachma.  In those days, US Dollar accounts were considered freely convertible foreign exchange and there was never any issued about the solvency of the local Greek banks.  Bank finance for vessel purchase to rollover and renew their fleets is now again on hold.

Ship owners like most of the Greek bourgeoisie cling to the Eurozone.  This is becoming more and more problematic as the political and economic situation continues to deteriorate in Greece and the process of the Greece state insolvency takes its course without any debt relief in sight. 

The broader fundamentals internationally are not good.  The EU is unstable with mounting sovereign debt, very poor growth and defective, dysfunctional institutional structure.  The US is entering the last year of a two-term Presidency, where historically there have been major market meltdowns in US equities markets.  The most important of all for shipping, global trade patterns are now changing because the China story is over with falling GDP growth rates and instability in Chinese financial markets, which have caused recently  fall-on turbulence and volatility in US financial markets .  

The China situation has had already a strong effect on dry cargo markets. The tanker markets are still buoyant with the low oil prices.  With the end of the current globalization super cycle, production in the coming years may become more localized and this would have a profound impact on the shipping industry.

Greek EU Crisis and Greek Shipping Industry: Where are we headed?

The case of Greek ship owners and their embrace of the Euro is but a microcosm of Greek society and the general mindset of many in the Greek middle class. 

Last Friday before the plebiscite, I received a plea originating from Mr. Dimitris Athanasopoulos Group Managing Director of Axia Ventures Group Ltd to vote ‘yes’.   I was amazed at how so many smart, financially literate business people could be so incredibly blind to the mess in Greece and the stark reality starring at them in their faces:

• They were totally tone deaf to the prevailing public mood in Greece.  
• I was amazed that these experienced business people would side with EU Creditors and their disastrous ‘pretend and extend’ fudges that have devastated the Greek economy.
• How could they be totally oblivious to the urgent need for substantial Greek public sector debt restructuring, as now officially attested by the IMF? 
• Finally, they seemed incredibly naïve that this plebiscite would solve any problems, Greek banks could be opened in a few days and things would quickly evolve back to normality given the complexity of the present impasse and depth of the crisis.

How could they be insisting on more of the same failed remedies of the last five years that have created social and economic chaos, led to the disintegration of the Greek political system, put into economic marginalization large swathes of Greek society and left Greece more insolvent and bankrupt than ever?  It seemed to me incredibly foolish and masochistic.

For years the European Union has expressed hostility to Greek Shipping.  The European Union has consistently taken positions at IMO that were against the interests of the shipping industry in new and costly regulations that are only held at bay by opposition from the United States and Japan with the support of their Flag States.  The EU has never seen favorable the offshore status under Law 89 of Greek shipping companies. Lately, Jean Claude Juncker, the EU Commissioner has made a personal campaign to abolish Law 89 and increase taxes on Greek Shipping companies

The ship owning community attempt to deal with this EU hostility by appeasement has failed again and again.  They agreed to equalize tonnage tax to all vessels managed in Greece to the same levels as Greek flag vessels.  Shortly thereafter they barely escaped an extraordinary tax levy on foreign exchange brought into the country that their maritime service industry brethren did not escape and had to pay.  The following year, they tried again appeasement with a new ‘voluntary’ agreement for increased tonnage tax for which the Greek government reneged and passed a law that made the tax increases obligatory and even larger than initially agreed.

Was the Euro needed for the Greek Shipping industry?  Clearly no!  To the contrary, the Euro was a mismatch to the US Dollar, which is the base currency in the shipping industry.  The Euro made office expenses and Greek crewing more expensive.  The shipping industry never had any real capital control restraints with ample reserves in US dollars that allowed unlimited travel abroad.  The Euro decimated their home ship repair industry in Perama.

Did the Eurozone participation ensure political and economic stability in Greece as an intangible benefit to offset the economic costs to the shipping industry?  Clearly no!  Greece has been in turmoil for five years now whereas it had enjoyed a long run of steady growth with the Drachma.  Participation in the Eurozone dramatically reduced these growth rates, decimated local production, caused asset bubbles in real estate and household indebtedness and made the country dangerously import dependent.

Today, Greece is more insolvent than ever with an even more crushing public debt for the size of its GDP.  The country has lost 25% of its GDP in the process and now suffers nearly 30% unemployment and made its youth a lost generation with over 50% unemployment, spurring substantial emigration, especially among younger, educated Greeks.  The same applies to highly-qualified young Greeks in the shipping industry with graduate education and professional certificates in shipping qualifications like chartering, operations, finance and marine insurance.  Foreign shipping operators are flooded with CV’s from young Greeks, sitting idle and unemployed in Greece.

Ship owners talk about moving abroad should Greece revert to a national currency.  First, this seems shamefully unpatriotic and total lack of any love of country.  Second, it would mean the end of any value-added content from Greece or any vestige of competitive advantage over foreign competitors for being Greek shipping.  Greek shipping was competitive and thrived because of the Greek maritime tradition, because of the close relation between the vessel and the office with Greek seaman and finally because of favorable off-shore tax treatment under Law 89.  The Greek business model was vessel provider with a high quality of service to charters. 

This also generated a thriving Greek maritime service industry that would be put in jeopardy with the departure of Greek ship owners.  Domestic Greek banks supported particularly small, medium Greek ship owners, specializing in the financing of older, bulk commodities vessels.  These were invariably US dollar loans on the Eurodollar market.  The Eurozone crisis led to the bankruptcy of the Greek banking system and undermined this access to credit, putting smaller Greek ship owners at risk deprived of credit to roll over and renew their fleets. 

Moving abroad might work for large Greek ship owners, but it will certainly be very difficult for smaller Greek ship owners, who were very reliant on the local Greek banks and service industry for their operation.

I sincerely believe that that best deal for Greece (Greek ship owners and the Greek people) would be GREXIT with very generous public debt restructuring and transition support for balance of payments and other related issues.  Greece to be allowed to remain in EU as regular member like UK and Nordics: Sweden, Denmark or if outside the EU, be given free-trade status that would be an even better and more flexible arrangement to revive and restructure the Greek economy.

The Drachma would facilitate needed structural reforms that will take time to implement and bear results.  It would allow whatever austerity to be offset with increased exports spurred initially by the devaluation: a classic IMF work out program as succeeded in Turkey and other countries.  Sweden achieved this by devaluation without any IMF program.  Sweden as opposed to Greece demurred on Eurozone participation.

The Drachma would be good for Greek shipping.  It would take off any EU pressure to modify Law 89 and offshore status of Greek shipping companies.  It would recreate lost competitive advantage operating in Greece with savings on office and Greek crewing expenses.  It would allow renaissance of Greek ship repair industry, etc.

The Drachma would not create any personal problems for people in the Greek Shipping community.  Credit cards and travel abroad would not face any difficulties with dollar shipping income and ample foreign exchange.

Drachma would mean more employment opportunities in Greece for Greeks.  It would allow surge in investment at properly valued prices as well as prepare ground for export boom.

Hopefully the Drachma will lead to a new revitalized Greek political class that is outward looking and export oriented and rid us of the present discredited political elite that drove the country into the ground by failed EU-bootstrapping built largely on debt and transfer money that funded unproductive, parasitic domestic crony capitalism.  Hopefully, the Drachma will allow important Constitutional revisions that create genuine institutional safeguards on debt levels, public spending and political accountability to ensure the development of a sound national productive base.

Hopefully GREXIT with suitable revitalized Greek political leadership will provide the foundation for Greece to follow the example of Singapore, keep and expand its presence and role as a global maritime centre.

 

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.

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!

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.

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.