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.

Scrubbers revisited.

Back in October 2018, I published on this blog a somewhat negative article on scrubbers as a means of compliance for IMO2020 regulations.  Today we are close to finishing the first month of IMO2020 in full implementation.  I think it opportune to revisit this subject in view of the experience to date with these regulations now in force.

I always saw scrubber refitting as speculative by nature depending on fuel differentials.  I never liked the concept of making a ship a factory to remove sulphur from heavy residual fuel oil.  I considered direct use of compliance low sulphur fuel oil from the refineries as a more efficient solution.  Also I believe in a level playing ground for the shipping industry and scrubbers create a tiered market for the vessel segments where they are widely used.

In fact, the initial fuel differentials have been much wider than initially forecast.  The actual fuel price spreads are well above projected levels to support the scrubber investment.  This has made the prime movers like Scorpio, Star Bulk and others the winners and substantial beneficiaries on the initial scrubber wager. Indicatively, Okeanis VLCC's are earning a staggering US$ 121 m per day as scrubber savings kick in.  The Greek shipowner says it has already made back 44% of the retrofit bill for its big tankers.

Further scrubber refitting is proving to be an excellent asset play.  Close to 20 modern or resale VLCCs are being touted for sale at high prices in a market that is offering shipowners strong returns.

Looking ahead, we do know yet whether fuel spreads may narrow.  The high differentials may be simply a product of the supply disruption in initial market conditions. Over time, the prices may normalize to lower levels.  Fuel spreads may drop significantly.

One issue to be resolved is the matter of the continued supply and availability of traditional heavy residual fuel oil.  Refineries have ramped up production of low sulphur fuel oil and are earmarking HSFO for other uses than marine fuel.  A smaller supply of HSFO and tighter availability may result in higher prices and also storage issues for the smaller quantities in the market for marine fuel.  Already it is reported that there are availability issues for supply of HSFO in the Far East and ships forced to Singapore to bunker heavy residual fuel oil.

In any case, the scrubber school is presently at the top of the shipping world as the winners in this debate. Some are thinking about monetizing their position by selling the scrubber-fitted units at a premium, but this depends on willing buyers and nobody knows how long present fuel spreads will remain of whether fuel spreads may narrow.

Furthermore, dry bulk rates are very weak and tanker rates are falling, so regardless of whether the vessels are fitted with scrubbers or not, the earnings margins are not improving.

Postscript: Fuel spreads have now collapsed with the dramatic fall in oil prices.  Plans for scrubber installations are now facing massive cancellations, particularly in the dry cargo and containership sectors. We will see in coming quarters whether the wagers made by companies like Star Bulk and Scorpio Tankers pan out in earnings results for their shareholders.

CMA-CGT merger with Ceva and its challenges

The Ceva merger is a milestone for CMA-CGT.  It represents an effort to move away from a transport provider business model to a logistics operation, in hopes of creating more value content to services sold and better earnings margins for shareholders

The liner industry has been through years of stress.  This is related to many years ofovercapacity and intense competition sending box rates to very low levels, despite China entering the WTO and a global trade boom with a massive rise in volume of container traffic on head haul routes to Europe and the US for finished goods.

The liner industry has basically exhausted any possible way of improving profit margins within its present business model as transport provider to freight forwarders.

• Initially there was an attempt to move to large tonnage to defend earnings margins by lower unit costs.  The industry moved to Panamax size to post-Panamax for the huge 10.000 teu plus vessels that are employed on head haul routes today.  Whilst this process created a cascading of the small older tonnage to other routes. Every liner company was obliged to follow suit to remain competitive in the alliance system. Financially weaker operators resorted to chartering larger units from vessel provide companies, who could carry them on their balance sheet against the period charters. None of this provided any sustained relief with improved box rates and better earnings margins.  The larger units and cascading generated more overcapacity in the process.
• The Global Financial crisis in 2008 created substantial trade disruption that put all the major liner companies in massive losses.  |Defensively the major liner companies resorted to slow steaming for lower fuel costs and soak up as much tonnage overcapacity as possible.  This mitigated the operating losses and provided some reprieve. Eventually slower speeds became a norm in the liner industry.
• It did not prove to be any game changer, however.  Eventually two major Korean lines - Hyundai and Hanjin - had serious financial problems leading to debt restructuring and the bankruptcy of Hanjin.  The Hanjin bankruptcy helped rebalance the industry. There was a revision of the alliance system to three major alliances.  For a brief period there was some improvement in box rates with this industry consolidation.
• IMO2020 and higher fuel costs is a tremendous challenge to the liner industry.  The liner industry has been the most proactive shipping segment to deal with these challenges.  All the options are painful.  Using compliant low sulphur fuel requires securing in advance necessary fuel supply to support continuation of liner service without disruption.  Fitting scrubbers on larger container vessels is an expensive CAPEX investment and means the immobilization of the significant number of vessels for refitting. Use of LNG requires new building orders for another generation of container vessels.

Last year there was a partial recovery for some of the liner companies, but others remained with operating losses.

After the 2008 GFC, CMA-GGT nearly went into bankruptcy.  They were compelled to take on a Turkish partner for fresh capital.  Only recently last year did CMA-CGT start to generate again operating profits.  This despite a merger with APL and moving operations to Singapore.;

The CEVA acquisition is an major attempt to revise their business model.  But CMA-CGT remains with a weak balance sheet and the merger execution is a major financial challenge for them.  They are looking to divest of their terminal business to raise cash to complete this merger.  CMA-CGT has also ordered a new generation of LNG powered containerships.

CMA CGM is saddled with US$ 20 bio debt and serious liquidity issues.  They must get a grip on  their debt and improve  liquidity in 2020 or CMA CTGT may have to restructure its balance sheet, 

Meanwhile the liner industry faces further challenges.  The Chinese economy is maturing and China is moving to slower GDP growth.  Trade patterns are changing.  Trade is becoming more regional.  Production is moving closer to consumption areas.

The general containership outlook remains bleak.  Box rates are likely to remain low. Older vessels may be subject to extraordinary value depreciation.  We have seen this before with container vessels even younger than 20 years going to scrap.

The only bright side is improved supply-demand balance in interregional trade and better time charter rates for old Panamax vessels and smaller containerships.

More Aegean woes

Latest from Lloyd's List:

Aegean Marine Petroleum Network has laid out its findings to date from a lengthy internal investigation by its audit committee and it does not make pretty reading for shareholders of the New York-listed company, with up to $300m of company cash and other assets now held to have been “misappropriated” through fraud. 

I met some Glencore management, who run their fuel oil business from the Chemoil merger, just last week at a conference in Athens. They alerted me to the fact that despite so many months since the Mercuria take over, the company was still a mess and there were no published accounts.

We will see whether the US authorities will intervene on the fraud charges related to the receivables. Usually this goes nowhere and the shareholders simply lose their money.

I never liked this set up from the initial IPO. This is reflected in my previous blog articles. The company was very badly run in a difficult and low margin business with a lot of debt against receivables. That was an unsustainable and high risk business Strategy.

Since the initial IPO, I have consistently advised countless institutional investors to stay away from ANW.

Mercuria have the financial and operational means to turn this around but it will need a lot of restructuring. IMO 2020 is going to be a revolution to the fuel supply industry and likely to change the credit terms with the substantial increase in fuel costs.

The scrubbers conundrum

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

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

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

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

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

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

There will be three categories of vessels: 

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

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

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

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

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

How IMTT/ MIC compares to the major international players like VOPAK and Oil Tanking.

The Macquarie Group (MIC) made a strategic decision in 2014 to acquire International Matex and enter into the liquid storage business. Liquid storage is an international business dominated by VOPAK and Oil Tanking both with a global presence of terminals in key hub locations, either direct investment or in joint ventures. Generally the share performance of MIC has disappointed compared to VOPAK. They are very different business models. 

MIC owns, operates and invests in a portfolio of infrastructure businesses in the United States.

The heart of MIC is International-Matex Tank Terminals (IMTT). IMTT has ten marine terminals located on the East, West and Gulf Coasts and the Great Lakes regions of the United States, and two partially owned terminals in the Canadian provinces of Quebec and Newfoundland.

IMTT has a dominant market position in the New York Harbor and lower Mississippi River, which are two key port areas in the United States. 

IMTT enjoys approximately a one-third market share for bulk liquid storage in the NYH (the largest terminal), and has approximately two-thirds market share on the lower Mississippi River with the St. Rose, Gretna and Avondale, Louisiana facilities. 

They compete in the liquid storage business with Royal Vopak among others. VOPAK is the world’s leading independent tank storage company. They have a 400 year history and operate a global network of terminals located at strategic locations along major trade routes. MIC management is a relative newcomer to the liquid storage business, buying an existing operator with a 70 year history.

MIC entered on the surge of the US energy renaissance with increased domestic production. They have focused on the US regionally. Whilst liquid storage is a major part of MIC, their focus is portfolio investment in infrastructure and IMTT is only one of four business segments: 

• Atlantic Aviation: a provider of fuel, terminal, aircraft hangaring and other services primarily to owners and operators of general aviation (GA) jet aircraft at 70 airports throughout the U.S.
• International-Matex Tank Terminals (IMTT): a business providing bulk liquid terminals, 
• MIC Hawaii: comprising an energy company that processes and distributes gas and provides related services (Hawaii Gas) and several smaller businesses collectively engaged in efforts to reduce the cost and improve the reliability and sustainability of energy in Hawaii;
• Cntracted Power: comprising electricity generating assets including a gas-fired facility and controlling interests in wind and solar facilities in the U.S. 

MIC had major earnings miss in February and reported that its free cash flow would likely decline by between 8 and 10 percent in 2018. It announced cutting its dividend by 28%. This resulted in a major share sell off over 40%. Since then its share value has not recovered significantly. In July, MIC entered an agreement to sell their Bayonne Energy Center for US$ 900 mio with a net proceeds of US$ 650 mio of which US$ 150 mio will be used to reduce their revolving credit facilities. MIC has a BBB- credit rating by S&P. 

MIC has had a public dispute with MOAB Capital over debt levels and executive compensation. This happens in these cases of disappointing investor results. 

VOPAK operates 66 terminals in 25 countries. It concentrates entirely on the liquid storage business. It has an AAA- credit rating by S&P and a much more consistent earnings results and dividend history than MIC. 

The liquid storage business has had its challenges the last few years. Much of this has to do with declining occupancy rates in oil storage, which a major component for both IMTT and VOPAK. Oil storage is very sensitive to price arbitrage and oil futures. In backwardization pricing environment, there is little incentive to store oil. This year the rise in oil prices has restored contango and a better environment for storage. 

Fuel oil remains an unsettled market with impending implementation of IMO 2020. The fuel importation market looks promising with structural deficits. VOPAK has invested heavily in LNG/ LPG storage in anticipation of future growth demand. IMTT has largely ignored this sector. It has a much larger exposure to refined products than VOPAK, which has a more balanced mix of products. MIC is investing in a US$ 225 mio program to repurpose and reposition IMTT, leveraging IMTT’s privileged position to respond to market changes and capitalize on growth opportunities. By comparison, VOPAK is spending end maximum EUR 750 million on sustaining and service improvement capex for the period 2017-201 as well as an additional EUR 100 million in new technology, innovation programs and replacing IT systems including terminal management software in the US with the latest in cybersecurity. 

I have always considered VOPAK a much better managed business than MIC. Of course they have different approaches and they are not entirely comparable. VOPAK is a dedicated international liquid storage provider. IMTT is a major part of MIC, it is a US liquid storage provider. MIC is invested in other infrastructure projects beyond liquid storage.

Brookfield buys into TeeKay Offshore

TeeKay Offshore Partners (TOO) has been an industry leader in the shuttle tanker and floating storage business. It most direct competitor is Knutsen Offshore, more recently listed but an established operator with Japan’s NYK as partners. Although the offshore business is under stress, shuttle tanker are on long term employment, there are entry barriers to the business and the assets are in limited supply. TOO has recently struck up a new business partnership with Brookfield Business Partners - a new dominate shareholder - that rewrites their balance sheet. This ring fences TOO liabilities for parent TeeKay Corp and makes TOO a formidable player in the marine offshore infrastructure market.

Latest 1st Quarter financial results for TOO showed profits of US$ 15 mio and distributable cash flow double that amount. Both the shuttle tankers and the FPSO floating storage business were profitable. There were no Auditors remarks. These were better result than a year ago 1st quarter 2016, when they had some small losses, most likely from asset impairment charges. Their bank leverage is on the high side (70%) but not yet to the point of breaching LTV covenants.

What destabilized TOO was the generally poor business climate and concerns about possible future difficulties. The catalyst for this was last June when their Lenders sold some US$ 75 mio of the company's secured debt in the secondary market at a discount, reportedly at levels between US$ 0.75 and 0.85 on the dollar.

This precipitated a panic in the share price and spiked over to the parent company TeeKay Corp. It was all about future issues, not  present liquidity issues that risked possible insolvency. There was the matter of future asset values for very specialized assets in a narrow resale market. Oil rig assets in recent distressed sales have lost as much as 60-70% of their value. There was the matter of future contract renewals. In fact, TOO was recently obliged to renew at reduced rate one of its FPSO contracts. Queiroz Galvao Exploracao e Producao. Finally, there was the impact on TeeKay Corp struggling itself in the currently beleaguered tanker market.

The situation was an opportunistic investment for Brookfield Business Partners with a capital injection of US$ 610 million. Brookfield is taking a 60% stake in the company. TeeKay Corp retains a 14% share in the business, injecting a smaller capital amount of US$ 30 mio. Brookfield is also taking a 49% stake in the general partner and providing them an intercompany loan of US$ 200 mio, allowing them to restructure their debt and extend maturities.

They are planning to separate the shuttle tanker business from the offshore floating storage and placing an order for four additional shuttle tankers.

Brookfield is reputedly a low risk investor, seeking 15% long term returns, which is a realistic target in the shipping industry. Given the general situation in Offshore and uncertainties with low oil prices, etc,, it may take a few years until recovery but there is a fair likelihood that the curtailment of new offshore projects the last few years will lead to shortages as older fields like the North Sea are depleted and new projects in the future.