Greek Competitiveness II: the tax man cometh. End of the era of Law 89 offshore shipping?

Greek shipping is not only facing difficult freight markets and lagging in investor returns in the face of competitors; but now due the Greek debt crisis, the Greek government is beginning to abrogate its offshore status by imposing a new onslaught of taxes as well as threatening to regulate office practices like domestic industry.

Already, the Euro has been hardening this year against US Dollar, the shipping industry base currency, making office costs and salaries more expensive.  Now the Greek shipping industry will have to pay Greek flag tonnage tax level on all foreign flag vessels managed in Greece.  The shipping services offices in brokerage and crewing were slapped with a ‘temporary’ retrogressive special tax of 10% on all foreign exchange that they bring to Greece starting last year for the next four years.  The golden years of Law 89 offshore shipping seem to be coming to an end.

Being locked into a heavy (quasi-Deutschmark) currency zone never seemed a sustainable policy for an industry based on the US Dollar and emerging market cargo demand such as Greek shipping. Eurozone entry has destroyed already a number of traditional Greek industries such as ship repairs and textiles. Will ship management be added to the list of bygone traditional Greek business, no longer competitive and be forced to move abroad?

As opposed to cautious distance from the Eurozone by the UK financial industry in the London City , Greek ship owners warmly embraced Greece in the Eurozone. They never considered the long term implications of this on their industry in Greece with the higher costs from unfavorable currency parities, the risks of encroaching EU regulations and the potential tax liabilities that would eventually render Greece an unattractive jurisdiction for shipping offices. Greek owners and managers are losing their structural competitive advantages, without even thinking about it.

Already Greek crews are largely a thing of the past with most of the sea academies closed and Filipino seamen manning a large portion of the Greek-controlled fleet. The middle management of port captains and engineers that run the ships and serve as the link between the office and the vessel remain predominately Greek. Many are retired seamen. Now their jobs are at risk because of new, heavy-handed government policy that would restrict them from working as a second career in offices.

The new tonnage tax agreement was negotiated by the large Greek ship owners, where there is the biggest concentration of Greek flag vessels. The smaller Greek shipping companies simply cannot afford to operate under Greek flag with its higher costs. This agreement permanently extends the same Greek flag tonnage tax rates to all foreign flag vessels. It makes the operation of foreign flag vessels more expensive in Greece as opposed to other jurisdictions. The rate increase more than doubles the tonnage taxes for medium size tonnage. The money involved is not large prima-facie amounting to approximately US$ 5.000- 7.000 per vessel per annum, but it can be even more onerous for companies managing very large vessels like VL’s or large numbers of vessels.

It is a direct threat to third party management in Greece because foreign principals will be loath to accept the extra cost for management with venue in Greece and may likely prefer to change management venue to more competitive jurisdictions like Dubai, Monte Carlo and Singapore, without these charges. These alternative jurisdictions are not heavily burdened with high public debt, keep taxes low and are generally business friendly without the Greek uncertainty.    

Already foreign ship management firms are seriously considering curtailing their activities in Greece or moving out. One major foreign management firm with over fifty employees in their Greek office called on the Greek government in protest. The Greek official in charge reportedly told them that he could care less if the people were laid off and the closed office was closed. It was also reported that the Greek tax authorities invaded the offices of a major Greek ship owner and manager. The owner was compelled to fire a large part of his staff of port captains and engineers. Greek politicians have always been indifferent to Greek jobs in the private sector.  

Shortly after the Greek ship owners thought that they had resolved their problems with the tonnage tax agreement, they were suddenly confronted with a new special ‘temporary’ tax that amounts to 10% on the foreign exchange brought into Greece starting retroactively in 2012 for the next four years. The owners reportedly sent a high profile law firm to the Greek government, protesting and threating litigation if the law were passed. At the last minute, just prior the vote of new draconian tax laws in January, the ship owners escaped these special taxes through amendment, but the law still stands for all the Greek shipping services offices under Law 89 such as brokerage firms and crewing offices. Ironically, these are smaller firms, who have also been suffering in difficult market conditions. They are less able to cover the taxes than their ship owner/ ship management brethren, but generally seen with complete contempt by the Greek political class.

Just as there is no guarantee that the tonnage taxes may be increased in future years, neither is there any guarantee that this ‘temporary’ tax may become permanent.  These new tax laws are going to put a lot of pressure on the smaller service firms, forcing them to close or curtail their activities. The larger firms are already considering changing venue and reducing their staff in Greece. Foreign firms may prefer to move out of Greece and service Greece via more business friendly jurisdictions.

There is no doubt that the current climate of taxes and government heavy handedness means that unemployment will rise in the Greek shipping industry. Greek shipping jobs are among the best paid in Greece. These people will be joining other social groups in unemployment in the general mounting social misery that prevails in Greece.

Added to these issues is the reorganization of the domestic Greek banking system and question marks on availability of credit for Greek shipping companies. Eurobank, for example, is going to be merged into the National Bank of Greece. Commercial Bank of Greece is being absorbed by Alpha Bank. We still do not know how the new Basel regulations as well as the EU overseers of the Greek banks will view shipping credit, moving forward.

All indications are that Greece is not going to be a place for small companies, entrepreneurial startups and innovation in the shipping space. Industry consolidation seems far more likely with fewer and larger shipping firms across the board. Larger firms may prefer to move out and downgrade their Greek presence to representative or technical offices It remains to be seen how this traditional Greek franchise will evolve; but the creative, expansionary phase of offshore Greek shipping under Law 89 seems over.

Greece like most of the EU has become a high tax, big government, heavily regulated jurisdiction that simply cannot compete with the Far East or the US, either on innovation, costs or low energy prices. The EU has lagged for many years on growth rates compared to other parts of the world. The EU is probably unique in terms of favoring very high unemployment and severe recessions as affirmative public policy choices to make its member states more ‘competitive’. It seems likely that these policies will continue to kill more jobs than they create.  This is the dismal track record of European policy makers for many years now.

Greek listed shipping companies have a competitiveness problem with their peers in terms of investment returns

One of the biggest problems in Greek-listed companies is that many have been trailing on profitability. This was recently brought home in excerpts from Fearnley report tracing these companies from 2000 onwards that was recently published in the Tradewinds.

Vancouver-based TeeKay LNG (TGP) delivered a 10% return for its investors but Livanos-controlled GasLog (GLOG) late in the game is presently at -3% returns. Tsakos (TEN) with scant returns of 5% against TeeKay (TK) overall at 14%. Peter Georgiopoulos (GMR) went into Chapter 11 largely wiping out common shareholders.

The same goes for dry bulk company listings. Palios-controlled Diana Shipping (DSX) with negative returns as opposed to Danish-based Norden (DNORD) with 38% returns. Fredriksen’s Golden Ocean (GOGL) secured a 19% return for its shareholders, whereas Panayotides’s Excel (EXM) and Zoullas’s Eagle Bulk (EGLE) have lost money for their shareholders with negative returns. Both companies have had serious financial problems.

Why have so many of these Greek-controlled listed companies delivered such poor results for their shareholders?

Admittedly, the shipping industry as a whole has been under a lot of pressure lately with difficult market conditions. This has placed management under stress with extraordinary challenges. Greek shipowners are relative new-comers to capital markets. Traditionally, Greek companies have been closed private family businesses. Most privately-held Greek shipping businesses have been performing well in current difficult market conditions.

The Greek listed companies were mainly start-ups. The only case of a mature company was the Angeliki Frangou’s acquisition of Navios as a platform and she has since managed the business well, outperforming her compatriots. The start-up companies were all on the vessel provider business model, providing ships and crew for charter employment. They had no cargo books. Conceptually, they were cyclical asset plays with high dividend payouts to entice investors. This situation was fueled by the remarkable rise of China with its double-digit growth rates, insatiable appetite for raw material imports and its burgeoning export market to the EU and US in finished goods.

The challenge for these newly-listed companies was that shipping is an old-fashioned labor and capital intensive industry with relatively low returns on assets. The traditional benchmark for a good ship acquisition deal is 15% return on asset on the basis of 60% leverage with cheap bank finance. This is not a big margin to cover the unforeseen if results do not work out as well as planned nor would this satisfy normal institutional investor return requirements of 30% returns for start-ups and 20% returns on existing businesses. Covering the risk profile with longer term employment from charterers entails a discount on the charter rate for the counter party risk transfer. This sort of arrangement creates additional challenges, capping further market upside in a rising market where there is premium on vessel values and lowering financial returns.

Capitalizing on magic of the China growth story for cargo, these companies could only entice investors on rising earnings multiples from fleet expansion. The concept was double the fleet with large block vessel acquisition deals. Presto: double the profits! Most of these companies expanded their fleet by buying fleets from existing private shipping companies. Peter Georgiopoulos was a forerunner with his tanker deal with privately held Metrostar in the early part of the Millennium. Indeed for some private Greek shipping companies like Metrostar, it became a lucrative business to sell their tonnage to listed shipping companies at premium prices. Eagle Bulk, for example, expanded in the same fashion in the dry cargo Supramax sector, doing a large block deal from another Greek private company rather than building the business themselves.

Ironically, this concept with investors came to a halt two years ago with a repeat deal that Peter Georgiopoulos did with Metrostar to expand and renew his Genmar tanker fleet. Investors loved the deal and gobbled up the supplementary share offering at par with no discount for the risks involved. Unfortunately, the tanker markets came under pressure shortly thereafter. General Maritime strained to secure bank finance to complete the deal. Ultimately, GMR went into Chapter 11 and investors literally lost their shirt. This debacle was a cold shower for institutional investors in shipping deals. Criteria for new money became more demanding. Institutional investors started to press for deep discount entry prices. The best placement source shifted to day-trader retail investors who, could care less whether their stock picks were solvent or their business strategies made any sense. 

All these deals were cyclical asset plays. No one cared about earnings margins or value creation from competitive advantage other than a large fleet. Profits were generated from rising freight market expectations. If you were lucky, you would sell the assets down the line to another shipping company in a game of musical chairs. Excel Maritime (EXE), for example, bought out Quintana in a merger shortly before the 2008 financial meltdown. Excel was obliged to raise a great deal of bank finance to complete the deal. Stuck in the chair when the music suddenly stopped after 2008, Excel has been reeling with liquidity problems and bank covenant violations ever since. The main shareholder was obliged put in additional cash from his personal money for recapitalization to keep his lenders happy and at bay. It is no surprise that Excel Maritime has been for its shareholders neither a profitable Norden nor Golden Ocean, but rather a source of painful disappointment.

An unfortunate derivative of these asset plays is that they distracted Greek managers from moving into other more profitable growth areas like gas shipping and offshore. Peter Georgiopoulos (and his investors) missed out entirely entirely these opportunities.  Instead Georgiopoulos moved into similar dry bulk asset plays in Genco and Baltic with poor investment returns. This ultimately ruined his tanker business where other competitors like TeeKay Shipping comfortably trumped him in the tanker markets with their franchise in shuttle tankers and nice play in LNG shipping, rewarding their investors handsomely.  His management team involvement in Aegean Marine Petroleum (ANW) (albeit his personal role here may be more of a figure-head position) does not appear to be getting any better results in the fuel supply business where competitors like World Fuel or Glencore-controlled Chemoil have much better share performance for their investors.  (See the below article with comparative stock charts and discussion of business strategy)

The future of Greek shipping lies in regaining competitive advantage and better earnings margins. Greece entering the Eurozone was a big structural setback for its shipping industry. It put its management and ship repair companies in a high cost, slow growth currency zone with a 30% premium over the US dollar. Shipping industry revenues and customer base are mainly with emerging market countries with exactly the opposite strategy of cheap currencies following the US dollar to foster their export markets in goods and services.

Greece is tied to the mill stone of a low-growth economic zone that is getting progressively poorer as time goes by.  It is also facing significant fiscal drag from massive barrage of taxes due to an unsustainable debt overhang held by EU government creditors in debt peonage.  The PSI+ debt restructuring bankrupted local Greek banks, severely limiting bank credit for small-medium Greek shipping companies.  The aggressive high tax environment may even ultimately eliminate the tax-free offshore status of Greek shipping companies. A Eurozone venue means continued higher administrative and crewing costs for Greek seamen than Far East competitors. Greek companies will struggle to compete with peer vessel management companies in business friendly places like Singapore free from these issues.

Given erosion of their cost structure, Greek shipping companies may have to focus more and more on niche markets and new growth areas to make up for their higher operational cost structure and sharp competition from foreign competitors with more disciplined growth strategies with emphasis on earnings margins, investment returns and risk profile on the business that they develop.

It is fair to say that this cyclical downturn in shipping markets will also open new opportunities in asset play strategies for those who have the wallet, financial backing  and patience. In these cases, the first-ins and early-outs are generally the most fortunate. The last-ins get caught when the music stops. Too many Greek listings proved to be in this category.

Aegean Marine Petroleum Network: lagging competitors with low return on investment and mounting financial expense eroding earnings margins

Aegean Petroleum (ANW) has an unusual business model compared to its bunker supplier competitors.  Its sole focus is the low margin marine fuel business.  It prefers expansion in physical assets and shuns derivatives to hedge fuel purchases. This asset heavy business model means that expanding bunker sakes put pressure on its receivables financing, resulting in breached loan covenants. Mounting financial expense is eroding profit margins. Sales volume has lately been flat.  Aegean has been consistently behind its competitors in share price and financial performance.

Many investors confuse Aegean for a shipping company. In effect it is a commercial trading company focusing solely on the marine fuel market. This is highly competitive market place with margin pressures. Marine fuel market is less profitable business than aviation or land fuel markets. The shipping industry as a whole suffers from over indebtedness and over investment. Aegean rather than diversifying into more profitable fuel markets is investing heavily in new marine fuel supply points, mainly on the basis of local start-ups as well as building storage facilities for a bigger share in the marine fuel market despite eroding margins, poor shipping industry fundamentals and larger competitors, who are stronger financially and diversified in other more profitable fuel markets.

It is hard to see any coherent strategy for competitive advantage. The original concept of gaining market share from a fleet of double hull bunker tankers scarcely made any sense for a company, whose main activity was buying fuel from major oil companies and selling this to shipping companies at a mark-up for the service. The delivery service with the bunker tankers is included in fuel price and is a cost, not a source of revenue. Fuel oil supply is a highly competitive business, where price and bunker quality are the main customer concerns. Whether the fuel is delivered by a fancy new bunker tanker is not a major factor in choice of supplier.

Aegean, moreover, contracted its bunker fleet prior 2008 at top of the market yard prices. This strategy may actually in retrospect be putting Aegean at disadvantage with competitors, who chartered in tonnage avoiding long term involvement in costly physical assets as well as those who waited and are now covering their needs with tonnage at present lower yard prices. In fact, Aegean has been lately selling off older tonnage to rationalize its fleet at tell-tale vessel disposal losses.

The latest strategy for competitive advantage seems to be investment in storage facilities. This does not seem in concept very different from the old strategy of the bunker vessel fleet. The new storage facilities are not primarily to be rented out to 3rd parties for a new source of revenue, but rather to be used to accumulate fuel for flexibility in customer sales. Note that Aegean’s larger, more sophisticated competitors make use of derivatives desk in managing their customer commitments at lower cost and more efficiently. Some like Chemoil are even divesting of their storage facilities for better asset allocation.

Expanding fuel sales puts pressure on working capital because suppliers must pay in advance for the fuel that they supply to their customers, who then pay later for the purchases. For this reason, bunker suppliers often factor their receivables for cash. Aegean lacks free cash flow to facilitate larger receivables because so much of their free cash flow goes to investment in physical assets and debt service. Their bunker fleet is mortgaged, which entails debt service and interest costs to their bankers. Their quarterly earnings reports demonstrates higher interest expense than competitors like Chemoil, even though Aegean is a smaller company with lower sales turn-over. Larger competitors like World Fuel are much stronger financially with very little debt and their receivables factoring is on much better terms. They have better earnings margin from their fuel sales and more free cash flow available with very little encumbrance for debt service.

Aegean was obliged to state in their 2011 financial report that they had covenant violations with their lenders from their receivables financing. This year a major loan facility is up for renegotiation with lenders. It is hard to see how Aegean will manage lower finance costs than their competitors. This puts Aegean at disadvantage with them, so it is hard to see why Aegean is so interested in expanding when the additional market share is at diminishing financial returns.

Unlike competitors, Aegean also has an unusual management structure. Their management team is from Peter Georgiopoulos, who sits as Chairman. No one in the Georgiopoulos management team has a history in oil trading or bunker supplier business and the Chairman role appears to be largely a figure head position. The major shareholder in ANW owns Aegean Oil, a Greek-based domestic oil retail business, which is their sole physical supplier in Greek ports and has acquired land for envisaged ANW storage facilities in Dubai. Perhaps the shipping background biases this management team toward physical asset plays, albeit the main shareholder has a history of developing a successful retail fuel business in Greece.

The management depth of competitor bunker suppliers is formidable. Chemoil after the founder’s tragic deal was acquired by Glencore a major commodities trading house with enormous financial strength. Its present CEO, Tom Reilly was the former head of OceanConnect Holdings, Inc - an innovative company combining state of the art on-line technology as well as 24/7 traditional expertise to provide global energy and risk management products and services. He also held a major management position in a Texaco Chevron joint venture in bunkering and fuel trading. Michael J. Kasbar, President and CEO of World Fuels has worked in the fuel business all his career and was the driving force in World Fuel’s proven strategic acquisition record in diversified fuel markets.

Aegean stock performance in comparison with World Fuel speaks for itself in terms of the results of its strategy in a striking way as seen in the adjacent stock charts.

Whilst Aegean has fallen significantly since its initial IPO and stagnated with low volume, World Fuel has significantly outperformed and rewarded its investors.

Even Chemoil stock despite the succession turmoil has also outperformed Aegean and it has been improving lately after being acquired by Glencore with revamped management.

Given such dismal share performance with peer companies, what does Aegean management have in their heads using surplus company funds to repurchase shares?  Would not the interests of Aegean shareholders be better served by merging Aegean with a bigger, financially stronger and better managed fuel company like World Fuels in return for INT stock?  Indeed such has been the fate of many a marine fuel supplier company in this highly competitive sector! 

Greece’s national fate in view of the mounting Italian challenge to present Eurozone system

I have long maintained that Greece is so chronically dependent on the EU that its fate in the Eurozone will be determined by events in the larger periphery Eurozone members, particularly Italy and Spain.  Italian elections in two months’ time may prove a significant catalyst.  The Italian PDL under Silvio Berlusconi appears to have thrown the gauntlet to the Eurozone establishment, withdrawing their support from the Monti government and provoking the resignation of Mario Monti with early elections.

Berlusconi is openly attacking German mercantilism and threatening to leave the Eurozone.  Monti is forming an alliance with the centrist parties with tacit support from the Italian socialists favoring continuity of austerity. The outcome of these elections will be crucial.

Franklin Allen of the Wharton school at Penn has long maintained that leaving the Eurozone albeit temporarily with a national currency and devaluation is a faster road back to economic growth that the present hair-shirt forced deflation programs of the European Union. He foresees the risk of a populist politician in Europe, who effectively pulls the plug on Eurozone and leaves the system.

This situation seems to be brewing presently in Italy not only with Silvio Berlusconi but also two other major Eurosceptic political groups: the 5-star movement of Beppe Grillo and the Legha Nord. Historically, Italy was instrumental in the break-up of the 19th century Latin Union.

Unlike the smaller Eurozone members under TROIKA programs like Greece, Spain and Italy as larger countries with more leverage have resisted this type of work out program as degrading to their national sovereignty. They also have considerably more debtor leverage with the core EZ countries.  An Italian Eurozone exit and debt repudiation would leave the EZ core countries in serious financial problems.  The French have already suffered a minor downgrade.  Germany - a country with two major debt defaults over the last 100 years - is not necessary invulnerable.

Spain is presently in limbo for months now, trying to resist entering the Draghi-proposed OMT funding trying to survive with ad hoc austerity measures in mounting social and regional turmoil. The Brussels elite effectively created a putsch in Italy installing Mario Monti to lead a technocrat government. This was at the same time that they deposed the Papandreou government in Greece leading to present coalition government under Antonis Samaras, totally submissive to austerity policies and forced integration.

Monti was not unaware of the risks of austerity by the Greek example. He was instrumental with his compatriot Draghi in the creation of the ECB OMT program that has stabilized financial markets for the time being, despite many question marks concerning viability and never actually tested in practice. The Monti program entailed massive tax increases and Italy has fallen into a deflationary tailspin that is causing havoc and mass discontent.

Italy unlike Greece is an industrial country with a productive goods and service economy. There are significant economic interests open to challenge German mercantilism in the Eurozone system and its persistent policies to promote trade surpluses at the same time punishing the deficit countries with hair-shirt austerity programs. There is a rising Italian anti-European Union sentiment in reaction to the hardship from the imposed austerity conditions and movement to exit the Eurozone system. The Greeks by contrast are terrified of losing the EU transfer money and bailout loans, so they are willing to suffer like former Soviet satellite states to remain in the Eurozone.

Silvio Berlusconi, a self-made business man, is the antithesis of a European politician. The European (and Greek) political class is largely an idle rich, who have made politics their sole career or former labor union leaders. Antonis Samaras, the present Greek PM, like most key European politicians never held a normal job in his life. Indeed, he married into a wealthy family to subsidize his political career just as his socialist coalition cohort, Vangelis Venizelos.

In Europe there is a firewall that keeps people from the working world outside of key political positions. Democratic representation of the productive classes is scant, indeed virtually non-existent in Greece for example. It is rather disconcerting that European politicians – bereft of any practical work experience - engage in top-down economic central planning programs without any real skin in the game in terms of their own economic livelihood related to the success or failure of their policies, affecting millions of their hapless citizens.  For all the moral hazard issues in business transactions, the European Union with its enormous and non-transparent lobbies is one of the most dangerous examples of excess and lack of restraint from concentration of power.

Clearly, the European political elite seem to be betting the house for economic recovery in 2013 with every Eurozone politician from the all-powerful Wolfgang Schäuble down to humble and subservient Antonis Samaras, seeing the crisis over by the second semester and the Eurozone back to economic growth.

What is difficult to reconcile is how this is going to happen with the doubling up of heavy taxation that will inevitably increase fiscal drag. The debt overhang is not being serviced because of increased tax revenue from new economic activity, but rather governments are closing their primary deficits by taking a larger chunk out the GDP in increased taxes. Will this concept of hopefully borrowing ‘cheaper’ in spite of massive debt overhang In Eurozone periphery countries address the issue of deep recessions and shrinking GDP at alarming rates?

The issue of debt restructuring down to credible levels (below 90% GDP) in the Eurozone periphery countries or the matter of the trade balance surpluses in the core countries is still very much politically taboo in Europe, making this a mounting challenge from Italy a very interesting political development. Certainly if Italy gets into an open dispute with the European Union on German trade balance abuses and the merits of aggressive deflationary front-loaded austerity measures on deficit members leading to ultimate withdrawal from the Eurozone, Greece is ill-prepared to face the consequences.

On the positive side, the Italians may force the Germans into a corner where they are constrained to give up their export privileges and forced to close their trade balances, creating a more equitable system. This would benefit smaller Eurozone periphery countries like Greece if they all remain in a new reformed system with Germans at bay. As noted above, there are many issues that would have to be addressed for this to be workable. Generally, European experience has shown that regions like the Italian mezzogiorno living on transfer money from richer areas are not happy places and tend to remain laggards, which is not at all encouraging for Greece even under this favorable scenario.

More likely in my view is that the Eurozone becomes smaller and more coherent in terms of Mundell optimum conditions. How Greece would fare locked into the Eurozone system in a perennial hair shirt with major countries like Italy leaving and devaluing their currency is a big question mark. Historical practice has been that those countries first out and in devaluation are the ones who gain the most economic benefit.

My view is that Greece really needs an entirely new developmental model that follows the pattern of Far East emerging market countries or even better, neighboring Israel. Israel and Greece have parallels in terms of a large diaspora and the concept of the national homeland. Israel has been extremely successful in harnessing the energy of its diaspora and its people for viable economic growth. Greece has been a disaster in this regard. To the contrary, the country has become a Mecca for unskilled immigrant non-Greeks. Presently there is over 50% Greek youth employment. 61% of Greek youth are looking to emigrate according to latest polls. Greek economist Yanis Varoufakis warns that Greece could evolve into another Kosovo.

Israel, only two thirds the size of Greece, exports twice as much goods and services with much higher added value. It is also successfully engaged in energy development with its off-shore gas fields in operation. Greece is mired in dysfunctional European Union infrastructure projects that have created a bloated construction industry. The lion share of private investment has been rent-seeking real estate projects. The Eurozone entry has removed any concern to earn foreign exchange by gaining new markets abroad to export goods and services.

Greece needs its own currency that follows the US Dollar (which was the Greek policy of the 1960’s and early 1970’s) and a viable developmental model to promote its shipping franchise, regional exports and encourage invisible inflows from its large Greek diaspora. This would not be possible without further deep haircuts, reducing its public debt to 90% GDP or below and with IMF credits to finance the transition and advise structural reforms on a bilateral basis. 

Above all Greece must guard its national shipping franchise and promote ancillary industries as well as off-shore energy and tighter political integration with Cyprus as a regional economic hub. It could remain in the European Union (albeit an external free trade agreement following the example of Switzerland might be preferable) to benefit from the customs union.

Unfortunately, present Eurozone and Greek policy seems to be moving in the opposite direction with mounting pressure to abolish the free off-shore status of Greek shipping and impose taxation, further eroding any competitive advantages.  Greece gambled its entire future on EU integration, having no coherent national development policy. Further, most of its public debt is currently in the hands of the EU with Germany the largest creditor so that any negotiation is a highly political subject where the EU and particularly Germany currently have total hegemony over Greece.   

How Greece in this position is to avoid becoming another Kosovo -an impoverished and ethnically divided protectorate - is a big question.  Greece is far from the enviable position of other European countries like the UK or Norway, who can debate the merits of joining or leaving the EU.   A financially and politically weakened EU and downgraded Germany from an Italian EZ exit might well prove a salvation in the long run for Greece.

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.

The Leucadia buyout of Jefferies and departure of Hamish Norton to a job in the Greek shipping industry marks a tsunami of change in the investment banking industry for shipping

There have been profound changes in capital markets for shipping since the Global Financial Crisis of 2008. The market for shipping IPO’s has been severely limited.  Follow-up share issues from solid shipping names can only be placed with discounts to entice investors to enter into the business at levels that they feel comfortable.  A much larger portion of shipping issues now goes to retail investor, giving the large bulge-bracket investment banks with substantial retail capacity considerable competitive edge in placements.  As a result, boutique shipping investment banks like Jefferies and Dahlman Rose have become marginalized in the new market conditions, leading to dramatic changes in both organizations.

After the GFC shock, the shipping industry waxed and waned but never fully recovered from the drop in cargo volume and lower freight rate levels. Initially in 2009 there was a sort of Zarnowitz-style bounce in freight rates that provided a good feeling. Over time, conditions in the bulk shipping markets deteriorated. Cargo demand could no longer keep up with the order book overhang of new tonnage. More recently incremental demand in emerging markets has begun to dry up, leading to significantly bleaker conditions this year for both dry bulk and tankers as well as a new dip in the containership market. Only gas shipping and offshore sectors have healthy demand.

Companies suddenly faced a dramatically different banking climate. The shipping industry, being labor and capital intensive, has relatively low investment returns over time except for cyclical booms. It is has always been dependent on low cost shipping finance to provide necessary leverage for expansion and adequate investment returns. Bank spreads rose to unprecedented levels only sustainable due the very low LIBOR cost of funding.  Even that depended what cost the particular bank could raise its funding. No longer were there banks looking for new customers. Companies become restricted to their existing banks. Credit conditions hardened with far more restrictive loan conditions. Credit generally was hard to find.

Investors lost a great deal of money holding shipping stocks. Many of the new issues in the boom times prior 2008 were startups with little intrinsic enterprise value. They were asset plays on a shipping provider business model. They tried to generate high investor returns with large block vessel acquisition deals that were leveraged with bank finance. As asset values began to shrink and cash flow tightened in weaker freight market conditions, many listed shipping companies began to face covenant violations and required additional capital.

Among the exposed companies was DryShips, who very early in the game recapitalized successfully with repeated ‘at the market’ share offerings to retail investors, which resulted in severe share dilution. This marked a shift from the initial placements with hedge funds and institutional investors taking large blocks of shares. Only a large investment bank of the bulge-bracket nature with a large retail operation could do this kind of placement, raising large amounts of money from feeding day traders and others in small amounts over time.

The IPO window closed with the GFC was briefly opened when General Maritime (GMR) jumped in to raise capital for its Metrostar block tanker acquisition deal. Genmar was not in the greatest health at the time, having bruised itself with a bond issue at higher pricing than anticipated when the bond investors discovered covenant issues with senior secured bank lenders. At the time of the IPO despite a minority of the wary, institutional investors bought the deal and Genmar received a rapid placement without suffering any share discount. Unfortunately, the deal proved poison for investors, who suffered severe losses with the subsequent financial difficulties of the company. Chapter 11 wiped out the unsecured Genmar bond holders in a sizeable cram down.

I believe that the Genmar debacle marked a major change in market perception of the risks in investing in shipping shares. The bond of trust between investors and Peter Georgiopoulos could never be the quite the same again.  This appears to have changed dramatically risk perception. The IPO window closed again. Follow-on issues and rare IPO's were only possible for a select number of shipping companies. For new money - even top shipping names - investors were now demanding substantial discounts for entry prices. Despite very soft rates in the US corporate bond markets, shipping bond issues continue to carry substantial premium.

This new climate proved lethal for Dahlman Rose, leading to major shareholder changes and senior executive departures like David Frischkorn to Global Hunter. Hamish Norton was initially successful in holding on at Jefferies longer than his Dahlman peeor.  Hamish had come to Jefferies prior the GFC from a very timely and prescient move from Bear Stearns shortly before the meltdown there. His assistant Nicky Stillman left Jefferies for Clarksons last year. Market conditions, however, severely restricted potential to build a book of business in the shipping space. Jefferies tried to get restructuring business, but the Omega (ONAV) account was small and precarious with limited options.

Jefferies is now selling itself to Leucadia. Perhaps this influenced Hamish’s decision to leave the firm. Jefferies actually outperformed its larger investment bank peers since the GFC, but wanted bigger capitalization under the umbrella of a larger financial group. Leukadia is their biggest shareholder and its unused tax benefits will shelter Jefferies profits.

Hamish is one of the most capable and conscientious investment bankers in the shipping space with solid rainmaker reputation.  When he leaves banking to go to a private shipping industry position with Petros Pappas in a dry cargo joint venture start up with Oaktree, this is a statement in itself of the dire situation in the investment banking industry regarding shipping issues. Of course, who could ever imagine likewise an established blue chip tanker operator like OSG teetering on Chapter 11 proceedings with shell-shocked CEO and former banker Morten Arntzen at the helm!  Times are difficult indeed in the shipping sector.
   

Shipping is a cyclical industry so there is always hope for a recovery and reversion to boom psychology, but after several years of repeatedly pushing forward market recovery dates because improvement never came, people are less sure of recovery time than before.  No one knows what 2013 will bring.

My personal concern is the increasingly fragile situation in China and emerging market economies, which are the sole source of global incremental demand.  The European Union has been the worst performer with its macabre fascination with debt deflation.  The IMF has signalled repeated EU policy failurs especially in the EU Periphery as high risk to the global economy.  China has a very large and risky speculative position in commodities, having assumed unsustainable double digit forward growth rates that have slowed considerably with negative impact on shipping markets. 

Should commodities prices fall further, this could trigger another leg down in the shipping markets.  Softer iron ore, steel and scrap prices would lead to even lower vessel values.  With dwindling resources have such prolonged weak market conditions, many companies are ill-prepared for a further market leg downwards.  Bankers holding many of these lame duck companies alive fear sizeable losses on their loans.  Understandably, many are hoping for a floor in place from further decline in freight rates and ship values. 

There is the old saying that once you lose virginity, it is impossible to get it back again; but fortunately when good times appear investors tend to have short memories.

Greece as Iphigenia: the consequences of poor judgment in public policy decision-making in both Greece and the EU

After months of negotiation for the next bailout loan tranche, the plot thickens for Greece in downwards debt deflation and deep recession.  The much touted spring PSI+ loan restructuring now appears too little and too late with the IMF now arguing for OSI (official sector) participation, opening political drama in EU donor countries.  How to explain to their taxpayer- voters these losses from very unpopular bailout loans to Greece? The IMF is expressing deep concerns about deteriorating economic fundamentals in the EU as a major threat to the global economy.  The Greek economy continues with GDP sliding at 7% per annum and 25% unemployment with total GDP shrinkage from the outset of these EU bailout programs surpassing Great Depression levels.  The utopia of the single currency zone has become a nightmare for the Greek people as well as most the Eurozone Periphery.  

Greece is a European periphery country and traditionally a sea power with a larger merchant fleet. Shipping is a major offshore industry, which is as an important national franchise as the City financial services are to the UK. The Greek Diaspora lives in large numbers outside the European Union. The clientele of Greek merchant fleet is mainly emerging markets, all in the US Dollar zone. Neighboring countries like Turkey and Israel as well as the Arab world are outside of the EU. Fundamentally, Greece never met the Mundell criteria for optimal currency zone membership in the Eurozone.

For these reasons, it is very hard to understand why Greece chose to enter the Eurozone and did not take a more prudent stand following the Scandinavians like Norway, Sweden and Denmark, not to mention its traditional ally, the UK. Conversely neighboring Turkey, who at present is only part of the EU trade union without full EU membership and outside the Eurozone, achieved far superior GDP growth rates with a new class of entrepreneurs and burgeoning exports. The Greek economy was not able to keep up. Now Turkish GDP overshadows Greece in totally different league of successful emerging market countries, whereas Greece is locked in an economic zone of losers.

Why did not the business savvy Greek shipping community follow the example of their financial brethren in London City and see the dangers and risks of Eurozone membership, lobby against it to protect their economic interests and thus spare millions of Greek compatriots from the current pain and misery of rapidly declining living standards, business failures and massive unemployment?

Austerity fatigue is rampant in Greece with the third bout of austerity measures passing by a slim parliamentary majority of 153 votes and the New Democracy party dependent on the PASOK Socialists, who have less than 8% of the vote by latest polls.

The pattern over the last few years is Greece falling consistently behind targets with an ever deeper recession and then required to make additional austerity measures for the next tranche of EU bailout money to stay in the Eurozone. The tax code changes every few months as the government runs out of money. No one in Greece except its political class expects that they will ever see the end of new and harsher measure down the line. Accordingly, the Greek political elite has largely lost any credibility with the Greek electorate.

It was amusing in the parliamentary debate to see Alexis Tsipras of the leftist SYRIZA party citing IMF reports about Greek debt unsustainability and need for further public debt restructuring (OSI) - in front of Harvard Business School educated PM Antonis Samaras, stone-faced clinging to the confidence fairy of debt deflation, as the only remedy – something that American economists like NYU’s Nouriel Roubini, Princeton’s Paul Krugman or Wharton’s Franklin Allen sharply dispute. What an incredible role reversal!!!

Economics minister Ioannis Stournaras made straight face budget projections of GDP shrinkage of 4.5% in 2013 at the same time, talking about additional austerity measures for billions of Euro that he was unable to extract this year due falling tax revenues from a moribund Greek economy. Opposition leader Alexis Tsipras was probably more realistic in his projections of 7-8% GDP shrinking in 2013. Stournaras has been systematically wrong in his projections since 2010. He was part of the team who fudged Greece’s ill-fated entry into the Eurozone with EU collusion, yet Samaras rewarded him the Economics ministry portfolio, not a sign of great leadership or critical thinking!

Whilst the Greeks are in an increasingly difficult position to comply with EU demands with the severe carnage that the EU internal devaluation dogma has on their domestic economy, Northern European taxpayers are increasingly outraged by the Greek bailout and concerned about throwing good money after bad.

This was evidenced in the slow pace of negotiations between Greece and the European Union since the June 2012 elections and increasingly tough conditions set for Greek compliance to release the bailout money tranche. The IMF suggestion of an OSI restructuring poses a substantial political dilemma for northern European politicians. Understandably the Germans are avoiding the subject with upcoming parliamentary elections next year.

Clearly, there is increasing pressure to limit losses and cut Greece loose from the Eurozone, but the Greek political elite seem ill-prepared for such an eventuality. Ironically the only politician, who has dared to publically to raise the subject of a Plan B for Greece going back to a national currency as suggested by eminent people like Nouriel Roubini and Franklin Allen cited earlier, is Alekos Alavanos, former leader of SYRIZA.

Added to this is high drama of the Lagarde list. In 2010 Christine Lagarde, then financial minister of France, sent a list of 1991 names of Greek customers with bank accounts at HSBC's Geneva branch to the Greek government. This list traces offshore companies to their principals and word has it that it contains significant representation from the Greek shipping community – not only high profile Greek ship owners, but also middle level Greek management.

Shipping is an offshore industry and under law 89, shipping companies have no tax liability. Bonuses and salaries are commonly paid in US dollars. It is no secret that some circles German creditors have been pressing for abolition of the Greek shipping free zone. Greek politicians have done their best to avoid the subject but as economic and social conditions deteriorate in Greece and the EU increases its demands for more bailout money, anything could happen.

The Greek shipping community not only risks the Greek government confiscating a significant portion of private savings money in foreign currency accounts abroad for the ultimate benefit of foreign Greek creditors for debts and mismanagement that they played no part in creating; but even more sinister, the eventual abolition of their off-shore business zone status as part of the price extracted for Greece to remain in the Eurozone in these interminable and indeterminate bailout negotiations.

How many in Greece are now seriously considering that the price of remaining in the Eurozone is becoming intolerably high simply to perpetuate the whims of the Greek political elite, who have so mismanaged the country and have no alternative games plan?

Jettisoning the current failed and discredited Greek political leadership may well prove a more prudent sacrifice…. Returning to the Drachma may well prove a salvation from the current economic and social hell in the Eurozone.

Greece should denounce the Troika for wrecking its economy with five years of debt deflation that has created suffering and poverty for large parts of the population and bankrupted over 20% of the private sector, press hard for OSI debt restructuring as per IMF recommendations and ask to leave the Eurozone consensually with a bridge package for the transition instead of any more Ponzi bailout loans.

PS I am appending the impressions of Nouriel Roubini from his spring trip to Greece. I find very true what he says about the present psychology and unsustainability of the present course:

I attended a public debate on whether Greece should exit the EZ; three-quarters of those who attended were against that option. One caveat is that most of the attendees were middle class folks who work in the private sector, speak English, are europhiles and blame the government and public sector for all of Greece’s problems. Lower-income individuals, employees of the large public sector and left-of-center voters have different views.

In my conversations with a large sample of private-sector businessmen — shipping magnates, other manufacturers, representatives of the financial sector — and members of the government, a similar view emerged: No one wants to even consider an exit from the EZ. Many forcefully argued — without any evidence — that Greece doesn’t have a competitiveness problem — despite data suggesting that unit labor costs rose by over 40% in the decade before the crisis — and blamed all of the problems of the private sector on the inefficiencies and tax burden of the public sector. Again, this sample of prominent Greeks is obviously as europhile as one could get, so can be regarded as somewhat biased.

… it was quite dissonant if not outright disturbing to hear 5 billionaire shipping owners claim that they care about Greece, but forcefully argue that they should not pay a single penny of tax because: Their shipping businesses are highly competitive globally; they cannot afford to pay tax; and, if the authorities try to tax them, they would move somewhere else. With its own business elite being so willing to contribute to Greece’s fiscal problems, one may rightfully despair that the country can ever successfully tackle its tax evasion problems.

Like what I saw in Argentina in 2000-01, when most Argentines wanted to stick with the currency board and fixed peg to the U.S. dollar, most Greeks have an irrational faith that, by some miracle, economic growth and competitiveness will be restored without an EZ exit. Frankly, most discussions with Greeks become emotional rather than rational assessments of whether an exit from the EZ — with all the collateral damage that it would imply — would be preferable to 5 more years of depression after 5 years of a deepening recession.