Alternative fuels and scrubbers

The only present realistic, technically feasible alternative fuels for IMO 2030/ 2050 carbon emission targets are LNG/ LPG.  All alternative fuels have drawbacks over conventional diesel fuel in terms of energy density, storage requirements and safety.  

The most likely future scenario is dual fuel engines with capability for LNG for the next generation of ships.  All the major marine engine makers - particularly Wartsila and MAN - are ready for this.  Longer term it is likely there will be a range of fuels depending on size and trade of the vessel.  

The scrubber story has fizzled out with very small fuel spreads and drop in fuel prices.  Technically scrubbers are an absurd option:  

• You are burning dirty fuel with heavy residues over a cleaner fuel LSFO that is better for the engine with less wear and lower maintenance costs.
• You have to maintain and operate a complicated exhaust cleaning system that leads to higher carbon emissions from the main engine as well as additional maintenance costs, risks of breakdown and a burden on the crew.

The only motivation was cheaper fuel costs, which presently is nearly zero differential.  Turning off the scrubbers is a no-brainer and scrubbers are a stranded investment for the time being. Obviously, publicly listed companies like Star Bulk and Scorpio tankers, who have been selling the scrubber story to their investors argue that the fuel differentials will widen and their decisions are justified.  Time will tell.

The companies that held back on scrubbers like Euronav or installed them selectively upon charterers request and share in expenses like Safe Bulkers and Danaos have been justified and shown as more prudent management for their shareholders.

Coronavirus has changed dramatically all forecasts for shipping markets.

Covid 19 is now in a second stage, destabilizing the major consuming economics - US and EU - and unleashing a major global economic crisis of the magnitude of the 2008 meltdown.  It started in China and spread to other Asian countries in the first stage.  China, Singapore and Korea seem to have managed successfully the initial health crisis and contained the contagion, so that people have returned to work, but the problem is that export demand is now under threat due the second stage where the virus has now led to lockdowns that have incapacitated large sectors of the US and EU economies,

In the meantime, a price war has broken out between Saudia Arabia and Russian and oil prices have fallen dramatically.  These low prices threaten the US shale oil industry and many lead to more woe in the offshore sector that was showing first signs of some recovery after a prolonged slump for several years now.

We can make the following observations:

•  The best case recovery scenario is a U-shaped global recovery in the 2nd half of 2020 but lots of output destruction in the 1st half.  Hopefully better years in 2021 and 2022.
•  Scrubbers that seemed a major success story in January this year are now rendered problematic with the low oil prices and very small prevailing spread between LSFO and HSFO.
• The impact on this situation on shipping varies with the sector:

Containerships were badly affected by the factory shutdowns in China, now with the factories coming on stream they face the second wave that is reducing import demand in the US and EU.  Liner companies will face a new bout of financial stress with the weaker liner companies again in jeopard with serious cashflow problems. Likewise, third party vessel provider companies that have legacy debt problems.

Drybulk started the year with very low rates. The Capesize sector was very badly hit and still suffers.  There has been some recovery for the other sizes, but mixed.  

Tankers are experiencing a boom market with the low oil prices, but the first surge in rates has now abated, albeit rates are still very profitable levels. Both crude and products trades are currently profitable. The contango price curve favors liquid storage. With a looming recession, a lot of crude oil and oil products will go into storage.  Reduced oil demand from a prolonged economic slump would jeopardize the current profitability of the sector.   

The severity of this major global recession depends heavily on the ability of governments to contain the virus and get people back to work to restore normalcy.  The most successful cases seem to be Singapore and Korea in this regard.  Whether the US or EU can replicate this success remains to be seen.

The US government is particularly concerned about the need to restart their economy and get people back to work but they are just in initial stages in dealing with the health problems.  The EU is struggling over reflation mechanisms that are lacking in the Eurozone. The health crisis in Italy and Spain is still out of control.

Hanjin collapses into bankruptcy and receivership: Sursum Corda!

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

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

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

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

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

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

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

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

Hanjin Shipping wins Seaspan concessions: the inevitable for the vessel provider companies!

The current plight of Hanjin is representative for the Liner industry: substantial operating losses, need for recapitalization and over indebted balance sheet.  The container industry panacea of ever larger units to reduce unit costs and defend eroding earnings margins is not working out as hoped.  This has created more overcapacity with cascading.  Now there is talk of the Panamax sizes going for scrap. 

World trade growth is slowing. It is not clear that the old model of large ships for headhaul lines is going to meet the requirements of the future with trade rebalancing in China, robotics and the sharing economy of the future.

The cold truth is that there are already more liner companies than the market can support.  A large number of liner companies are making losses.  Some like NOL have been put on the block for sale and are being consolidated into other companies like CMA-CGM, others like HMM and Hanjin are staving off bankruptcy with financial restructuring.

Vessel provider companies like Seaspan and Danaos have built their fleets by every larger vessels that they let on term time charter to financially weak liner companies that want the larger units to defend themselves from the ordering and competition of the stronger liner companies but unable to carry the vessels themselves on their balance sheets.

I have repeatedly signaled out this risky business policy of the vessel provider companies on my blog.  I have stressed that it was not a sound and sustainable business strategy.  The vessel provider companies would face inevitable challenges in the future as the financial situation of the liner companies deteriorates, leading to bankruptcy and restructuring that would inevitably entail charter renegotiation.  I pointed out the heavy exposure of Danaos to HMM and Hanjin as major charterers.  I stressed the aggressiveness of Seaspan to service financially weak Asian liner companies with ever larger units.  Cosco for example recently announces losses of over US$ 1 billion in their liner business, one of their customers.

I have always felt that Gerry Wang's assertions about having a leasing company business model were overstated and disingenuous to investors.  Seaspan lets its tonnage on time charter with operating risks.  With Hanjin in financial crisis, Wang took the hard line on charter negotiations for investor ears, but Seaspan is in a weak position with its exposure in large containerships.  It cannot easily withdraw and redeploy its vessels because the market for these units is not large.  Inevitably as its liner company customers begin to face financial difficulties, Seaspan has no choice but to accept cuts in charter rates to keep them going with their creditors as long as possible. 

Since the original writing of this piece, Hanjin's restructuring negotiations have not worked out and they are going into receivership.  Seaspan is hoping for a merger between HMM and Hanjin and that perhaps with some sort of state support, they might be able to avoid cuts in charter rates.  We will see over time how Seaspans fares.  This is a test for their exposure to other weak Far East charterers and possible state intervention to keep them afloat.

I restate again these points because I have often met dead ears in NY investment banking circles, still enamored with the containership industry.  Over time, the bankers and financial industry are going to have to face the reality:

• The containership industry is just as challenged as dry cargo with overcapacity. 
• The growth days from the global megacycle and China boom are over and gone.
• Liner companies will inevitably be forced to consolidate for survival. It is not clear that very large containerships will be needed to extent anticipated.
• Vessel provider companies are going to face a long period of thin margins as their liner company employment base shrinks in the consolidation process.
• Inevitably there is renegotiation risk on their charters that they will not be able to avoid with their liner company customers. 

Danaos exposed to counterparty credit risk with large exposure to some of the financially weakest liner companies

Danaos has been a perennially weak stock since the 2008 meltdown. The company suffers from high bank leverage and a heavy capex budget. Earnings have been marginal at best. In 2010, it racked up a whopping loss of US$ 101 million. This year, Danaos negotiated an excellent restructuring agreement with its senior lenders that also covers its future capex needs. It has significant long term charter cover. Is Danaos now out of the woods?

Danaos has a fleet with an attractive age profile. It has kept pace with changing industry dynamics, with almost 50% of its fleet capacity in the 8,000+ TEU range. Its fleet’s average age is 6.27 years and it has a new building program of 13 containerships to be delivered through mid-2012.

Danaos recently carried out a massive restructuring of its debt. The company raised in excess of $1 billion through a $200 million equity issue and new debt commitments of $818 million. Further, Danaos announced formal completion of the restructuring of its new building capex finance obligations. Fortunately, Danaos is a listed company and has the size and clout to pull off this this operation, underscoring the resilience of the publicly listed shipping company business model.

The fleet is heavily contracted with average length charters between 8 to 10 years. This employment profile facilitated the loan restructuring and capex commitments. Needless to say, the loan repayment was tailored to this cash flow with no bullet payments until 2019. Interest expenses are not negligible with projections of $191/$202/$234 million in years 2011/ 2012/ 2013 respectively, which represent about 50% of anticipated EBITDA (US$ 317/ 433/ 442 million respectively).

The weakest element here would appear to be the 29% exposure to Hyundai Merchant Marine (HMM) and 28% exposure to CMA-CGM as charterers. HMM has a gearing of three times debt to equity. It announced heavy losses of $ 205.080 million for the first semester of 2011. It is a smaller liner company vulnerable to pricing pressures from larger operators like Maerk in the fight for market share.

CMA CGM was downgraded by Fitch to BBB- with negative outlook and then Fitch ceased coverage. Their first semester 2011 profits were down 72% to $237 million from 2010. CMA CGM has been selling vessels at a discount to complete the reorganizing of $7 billion-worth of debt overseen by French court authorities, part of which involved Turkey’s Yildirim Group injecting $500 million into the company in exchange for shares.

Liner companies are generally considered too big to fail (TBTF) businesses. Should a major liner company go into bankruptcy, the fall-out would be substantial given that these companies charter about half their fleet from vessel provider companies like Danaos.

Alternatively, with a deepening recessionary environment, there are prospects of charter party renegotiation as occurs normally in shipping sectors like tankers and dry cargo. Theoretically, liner companies would have substantial negotiating power given the concentration of the industry and total dependence of vessel providers on them for employment.

Gremlins returning to haunt container market

This year market a remarkable turnaround in container shipping. In 2009, major container operators took massive losses, 10% of the global tanker fleet was laid up. Projections were for two more years of losses before recovery. Ultra slow steaming soaked up surplus tonnage capacity together with robust economic recovery in Asia. Resumption of exports to EU and US head haul trades have led to a resurgence of profits. Basic over supply of tonnage remains. Head haul routes are weakening again.

Maersk is cutting its Asia-Europe capacity by 10% for the winter period in line with changing market demand. Volumes are expected to remain weak throughout the coming four months, as the seasonally weak winter period approaches.

Conversely, Singapore's NOL Group has posted net profit of US$ 282 mio for the third quarter, turning around a US $138 mio loss last year. Revenue to 30 September grew 55% to US$ 2.4 bn. Its cumulative nine-month profit is now US$ 283 mio. It lost US$ 530 mio during the same period last year. Revenue for liner shipping improved 60% to $2.2 bn in the third quarter. Containership unit APL’s core pre-tax and interest earnings were $301 mio, compared to a loss of $130 mio in 2009. Average revenue per feu was $2,799, up 21%, while volumes grew 29% to 2 mio feu.

Container port operators in mature economies face strong cost competition from emerging markets due to excess capacity and slowing growth rates as this year's sharp rebound in container shipping cools off. Port congestion was returning in the fast growing emerging markets, but sluggish growth in the mature markets meant continued excess capacity in many ports, including New York/New Jersey and Antwerp. Customers seeking the over-capacity are starting again to squeeze the liner operators and there is increasing cost competition.

This has not discouraged more asset-oriented shipping players to move into the containership sector. A number of Greek operators like Paragon and Diana have bought container vessels at current price levels and put them on charter, looking to build up a presence in the sector. More established operators like Seaspan have continued their aggressive CAPEX plans, absorbing all newbuildings due this year, putting them on charter with increasing reliance on major Chinese liner operators.

There remains a lot of optimism in financial circles that pre-2008 growth levels will return rather than a prolonged 'new normal' scenario or at least this appears to be their story to investors in these companies to back their large deals and aggressive asset expansion financied by bank debt and plans for follow-on share offerings. They argue continued robust Asian growth regardless of Western economies. Also, attractive is the long-term employment by liner companies with strong balance sheets or sovereign risk that are considered too big to fail and unlikely to renegotiate rates downwards in poor market conditions. Tanker and drybulk sectors charters are generally for shorter period of time and more prone to renegotiation.

Seaspan's share price has outperformed this year from US$ 8 levels to the present US$ 13.20 despite the weakening conditions in the underlying container freight markets. Seaspan remains highly leveraged but it has long-term employment not subject to these market fluctuations. Still its share price remains very far from the lofty US$ 30 pre-2008 levels, but this is the same pattern for nearly all shipping stocks since the meltdown.

The basic problem is that there is still a large order book overhang of tonnage and even some new ordering. The slow steaming has been masking the existing over capacity and some are even calling for these measures to become permanent. The sector would be exposed to the effects of trade rebalancing when and if this every takes place.

DAC: Perils of large order book of container vessels in a bear market

An analysis of Danaos (DAC) in the current market downturn. The challenges of rapid growth in a bear market environment. DAC is similar in fleet size and order book to Seaspan (SSW). There are a large number of competing liner shipping companies, who market their vessels to a limited number of liner operators. The key issue is whether the liner operators, under pressure from falling demand and financial losses, be able to carry the all theie present chartered units and absorb such a large orderbook.

DAC's most recent investor presentation shows a current fleet of 39 vessels with an orderbook of 31 units. Danaos projects +150% contracted fleet growth. The major issue is how will this new tonnage be employed, whether there will be order cancelations and the impact on company earnings forward. Are past record rates of investment return sustainable in this business model based on insatiable long-term charter demand from liner operators and low funding costs in this new business and financial environment?

Container markets have been weakening since the first signs of US recession in 2007. The market was sustained for a period by increased EU traffic in part due to Euro appreciation. With the financial crisis in the fall 2008, the bottom fell out of the market. Major liner operators were already struggling with high bunker prices but then demand collapsed for cargo with the hard landing in Asia economies. Liner companies started redelivering vessels on charter termination. Many liner companies are rolling up financial losses and there will be increased counter party risk ahead with the potential of defaults and charter renegotiations.

As of fall 2008, DAC has a debt equity ratio of 50% and US$ 1 billion in liquidity, putting it in a good financial position. Its commercial management is prudent. It has a good spread of charterers with well-established liner operator names. The charter renewals are staggered.

Its share issue policies have recently been a bit contradictory. Danaos announced in the fall 2008 a share repurchase program, but then in January 2009 made an SEC filing for a supplementary issue to raise an additional US$ 1 billion. The company seems to be maximizing its options. In current market conditions, there is likelihood that the funds will be raised by the ATM technique rather than sold in large blocks to investors.

Its challenges are the decline in market asset values and falling charters rates. This means that its current fleet asset value is declining and charter renewal rates will be at lower rates. The credit markets for senior debt finance are tight and finance costs are rising. This puts in question the viability of the fleet expansion program of 31 vessels in the next few years.

DAC is not alone in their expansion plans. It is about the same size as Seaspan, which has a fleet of 35 units with an orderbook of 33 units. So far SSW share value has been recovering somewhat better since December 2008 lows than DAC, which shows a weaker chart pattern. Seaspan has an employment portfolio of seven liner companies. Indeed there are 17 additional competitors with orderbooks, too. Six of them have comparable large fleet expansion plans.

Their business model as ship providers is heavily dependent on liner company charterers. Will the liner companies be able to carry DAC and its competitors in current market conditions and absorb the large orderbooks of contracted tonnage? If something gives here, DAC will suffer and it will not be alone.