Shipping Market Comment Q1 2020
World Economy: Outlook for 2020 – ... entering the late-cycle
(Dr. Thomas Hartwig) Macro-economic conditions look fairly steady as 2020 gets underway. We should probably not expect a stellar performance, but we shouldn’t play up the risk of a recession either. In the western world a combination of monetary policy and fiscal stimulus will drive the economy for another year. It would be wise, though, to guard against an extended credit cycle with mounting risks due to relatively low interest rates across major economies across the globe, although a crash is probably not on the cards, yet.
During the new decade we are faced with two new problems: First of all, how to measure digital growth? For an economist, the last 0.25 % economic growth are relevant, but the IT side of things and in particular digital innovation is extremely difficult to measure. Secondly, automated trading in investment banking! In many commodity markets close to 80 % of all trading is originated by computers, bringing with it the risk of “flash crashs” where price declines are rapidly amplified. These two factors will make it a lot more difficult to assess the real strength of any real economy. With this macro disclaimer upfront and for lack a further bad news, it seems the overall outlook is getting better. World GDP growth is forecast at 3.4 % this year, up from 3.0 % in 2019.
Let us look at the major economic blocks in more detail:
- China is the growth engine of the world and for shipping. During the last decade, government debt increased to 55 % of GDP. This is moderate and not worrying at all. Sure enough, China is not the problem child of the world. Especially if you consider the $ 3 trill. of foreign exchange reserves that the Chinese hold up their sleeves. By contrast, corporate debt in China is more of an issue as default rates are higher than normal. However, this is in line with the government’s strategy to diversify the economy away from big private and state run companies towards the smaller private sector.
- In the year ahead, China will provide enough stimulus to keep its own economy buoyant and to provide support for the rest of the emerging markets. Although absolute economic growth in China decreased last year, it is still one of the highest in the world.Perhaps real growth is lower than official numbers suggest, but such concerns may also be politically motivated seeing that it was the US Brookings Institution, which raised the issue for the first time. Bear in mind that China produced more cement in the last 3 years than America in one century. The GDP growth forecast for 2020 is down by 0.2 points to 5.8 %.
- Sino-American Trade conflict: Trumps needs a deal that he can sell as a success, but the root issue of the trade conflict has still not been addressed: the protection of intellectual property. Developments on the trade front, especially the Sino-American trade conflict, need to be monitored closely because they are a key driver of investor and economic confidence. The biggest risk this year is another escalation of the trade conflict – whether Donald would rather prefer a deal or not.
- 2019 saw the Fed cutting interest rates three times when everyone was expecting no change or even an increase. The Fed justified its moves with the need to bolster the economy in the face of a global slowdown. So far so good. For 2020 expectations are the same, i.e. interest rates remain unchanged in the 1.5 %-1.75 % range until November. With the lowest unemployment rate since 1969, what else is necessary to change the Fed’s mind?
- The key question: Will the strength of the dollar be over soon? According to many investment banks, the answer is yes! Many see the dollar heading for a modest fall and the euro appreciating against it – from 1.11 today towards 1.16 by the end of 2020. But what are such forecasts worth considering the lousy track record of investment banker polls in former years? From my point of view, the current strength of the dollar strength is based on the interest rate differential and the perception of US money markets as an investment class in their own right. Although three cuts to interest rates reduced the spread towards Euro interest rates, it seems 1.75 % interest is still too compelling for investors when other major economies are stuck with negative rates. It is too good to be true: an investment that offers positive returns.
- This year is election year in the US and usually the economy performs quite well in any election year which is more reason to go into the dollar. As of today it is expected that the US economy will grow by 2.1 % this year.
- Europe is the current hotspot of financial dislocation: Since 2016 we have a world of negative bund rates. It is a glaring example of how central banks’ stimulus has completely overturned traditional assumptions about bond markets. 2019 saw some extremely embarrassing financial dislocation: the 100-year Austrian bonds with a coupon of 2.1 % gave investors in 2019 a return of 87 % as the debt was trading 210 cents the Euro. Furthermore Greece was for the 1st time in a position to issue short term debt at negative interest rates! The Greek 10 year debt was trading below 1.2 %, unthinkable 5 years ago and yields slipped below those of Italy!!! These two examples are just the peak of the iceberg and an indication how hungry investors are for yield. At the moment negative debt is on the way back (12tn vs. 18tn at peak times), which is very positive.
- As a side note: the overall price swings on longer matured debt were looking negligible most of the time, but this is mainly due to the fact that they were quoted as annual percentage points. So they were given some verbal smoothing. The price range was from +0.25 % down to -0.75 % on the 10 year bunds.
- Following the changeover at the ECB helm, Mrs. Lagarde put current policy under review since the inflation target was heavily missed. Lagarde said she is not there for a quick turnaround and she will take her time during the course of year. Therefore it seems monetary policy will remain expansive until the end of this year.
- She is believed to have made it her mission to persuade policy leaders of greater fiscal spending in order to boost economic activity. Sentiment among researchers now leans towards more state spending (as the last resort) – hardly surprising in view of recession fears, positive budgets and negative debt. It is hoped this could lift GDP growth in Europe above the 1.4 % mark.
Globale Asset Allocation
- What’s the right portfolio make-up then? It is certainly worth to rethink certain positions. For instance: What are new positions on bonds worth, when all they offer is a guaranteed loss over time.
- Institutional money has a clear preference for corporate debt, rather than low-yielding public debt.
- We understand that a lot of institutional investors have an appetite for emerging market risk and a clear preference for cyclical investments. Even though shipping is absolutely out of fashion with institutional investors – the investment characteristics are a perfect match, since we have the most cyclical industry in the world.
- Fundamentals are supportive in bulk and in container shipping. Due to IMO 2020 provisions, bunkers are extremely expensive compared to a year ago. Logically, operators will adopt slow steaming to maximise their profits which again offers strong tailwinds for an increase in time charter rates.
- The biggest external threat to shipping are headwinds from wrong climate policy based on wishful thinking and not taking into account commercial facts. Sure, shipping will become greener. But today people simply indulge in industry blaming, rejecting current practice without naming the better alternative... This is the challenge for the decade to come!
Despite very modest growth in the container trades, 2019 was a year of partial recovery in the container ship charter market – but with massive variation across the different fleet segments. Classic post-panamax tonnage chalked up the most spectacular gains, with spot charter rates increasing by 100 % or more since the start of the year to high $ 20,000’s for 8,500 TEU and mid $ 20,000’s for 6,500 TEU ships. Charterers were faced with a worsening shortage of large vessels as more and more ships were taken out of service for scrubber retrofits in the shipyards. The situation was compounded by growing time overruns and waiting times in repair yards, driving the idle container ship fleet to around 1.4 mill. TEU or 6.0 % of the world fleet in December. Scrubber installations accounted for more than 1.0 mill. TEU or 77 % of all inactive capacity and the story is far from over. Time out-of-service due to retrofits will continue to be a drain on fleet capacity, as the massive price spread between high-sulphur and very low-sulphur fuel oil (over $ 300 pmt) continues to spur investments in scrubbers. Apart from short-term idling, the largest vessel classes are believed to benefit from a broad increase in demand as operators look to consolidate more cargo on big ships to raise the economies of scale. The cost hikes for compliance with IMO2020 provide a major incentive in that respect.
Going down the size spectrum, the impact of scrubber retrofit activity begins to wane. Panamax vessels still benefit from the scarcity in supply of bigger ships, filling in for post-panamax positions on period or extra loader deployments. Flexible as they are, they are a good substitute for the interim. Hence rates for 4,250 TEU ships closed the year with gains of more than 36 % on levels concluded just a year ago. Below 4,000 TEU, the performance has been more muted, with period assessments for 2,500-3,500 TEU tonnage only up between +0.6 % and +11.9 % year-on-year, according to the New ConTex. 12-month periods for the geared 1,700 TEU type were assessed 10.5 % higher than one year ago, whereas the geared 1,100 TEU class even suffered a year-on-year deterioration (-3.5 %). There has been a shift in tonnage deployment in the Asian feeder trades with operators upgrading from small to midsize vessels. This would have lent support to the 1,700 TEU segment, but at the expense of the 1,100 TEU class. Contrary to previous years, the charter market managed to hold on its gains up until the end of the year. The “correction” during the fourth quarter was as small as 3 % when comparing the October 2019 and January 2020 readings of the New ConTex. With tonnage supply in the charter market still very low by historical standards, the expectations are that rates will resume their firmer trend very soon.
Activity during the final month of 2019 continued in a similar vein as in October and November. The number of fixtures was again low when compared to earlier years: only around 150, against 237 in December 2018 and 219 in December 2017. The reserve by charterers may in part be explained by uncertainty over the new IMO fuel regulations and their impact on vessel operations. Still, the fact is that tonnage supply and demand remained fairly balanced, resulting more or less in a sideways trend in charter rates. The key developments throughout December from our point of view were higher last-minute demand for panamax vessels and an increase in scrubber-related long-term charters. Charterers tried to play it very carefully at first. However, as the trickle of offhand enquiry increased, it became clear to owners that there is some serious collective demand for panamax tonnage delivering in January. Consequently, rates picked up again, with one baby panamax reportedly achieving $ 14,750 for six months. Scrubber-related fixtures at premium rates came to the fore in all segments above 3,000 TEU. 4 of the 13 charter transactions in the 3,000-3,900 TEU segment that we counted were related to scrubber installations. In the panamax segment, it was three of 19 fixtures, and in the post-panamax and neo-panamax sector 3 out of 6. Highlights included the fixture of scrubber-fitted maxi-panamaxes for 24-month periods at rates that are 30 % higher than those for standard vessels. Looking ahead, the supply of post-panamax units in the charter market should remain very limited, resulting in very firm demand even for the older, less efficient designs in this segment. We notice again and again that many post-panamaxes, which are still believed to come open this year, have already agreed charter extensions or new long-term charters as precondition for financing following a vessel sale.
For the dry cargo market, the year 2019 was a tale of two cities. The first half was largely doom and gloom due to the collapse of iron ore loadings ex. Brazil following the dam burst at Vale’s Brucutu mine. The sudden shortfall of cargo pulled the rug out from under capesize owners’ feet, sending time charter rates tumbling way below opex levels. It was not the only backlash for bulk shipping demand. Other issues weighing down on cargo flows included hurricane damages and logistical problems in Australian ports early in the year and - later in the year – outages in bauxite loading in West Africa, the ban on nickel ore exports in Indonesia, restrictions on coal imports in China and South Korea and a general weakening in the steel products trades. The latter was bad especially for the smaller geared vessels. On a positive note, combined imports of iron ore, coal and soya beans into China surged to a quarterly record in Q3, pushing freight and charter rates to annual highs in August and early September. However, by and large demand growth throughout the year was very poor, with overall dry cargo shipping volumes estimated to have expanded by no more than 1.0 %. The saving grace for dry bulk shipping came from the supply side as effective fleet capacity was limited by the temporary withdrawal of more and more ships for scrubber retrofits. Especially, the downtimes on a significant chunk of the Valemax fleet – coinciding with some recovery in Brazilian iron ore volumes – served to tighten capacity and push rates back up.
Comparing spot earnings in 2019 with those of 2018, only the capesize segment enjoyed a better year, with average time charter earnings of $ 18,025 versus $ 16,529. In a longer perspective, compared with the 10-year average of $ 15,031, 2019 was ok. It makes the forward curve for the years 2021-24 at just $ 12,000-13,000 look like a bargain. Panamax bulkers showed a similar performance as in 2018, logging average spot earnings of $ 12,499 in 2019, down around $ 500. Like capes, they also beat their 10-year average of$ 11,031, while the forward curve looks extremely cheap with calendar years 2021-24 trading at round $ 10,500. Looking only at the freight market during December, things slowed down dramatically as from the middle of the month when most remaining cargoes had been covered and traders had little left in their books. Rates for capes have been in free fall, dipping to opex once more, with transpacific rounds slashed to $ 7,000’s and China/Brazil round trips into the $ 8,000’s. Panamax rates have also been battered, with North Pacific rounds down to around $ 5,000.
The smaller geared sectors had a more disappointing time as average earnings dipped not just below 2018 but also below the 10-year averages. Supramaxes achieved only $ 9,948 on average throughout 2019, against $ 11,487 in 2018 and $ 11,037 over the past ten years. Of note, the spread versus panamax earnings increased sharply to $ 2,500 last year whereas in a 10-year-perspective earnings had been on a par. The segment is suffering heavily under the lack of coal business in the Pacific, with North Pacific trips into China offering only $ 3,000. Discounts for older Chinese tonnage are practically not applicable with the market in such dire straits. Most business shows no more than $ 3,000 – even a premium Singapore position was fixed away for a short trip to China at just $ 4,500. Activity is not expected to pick up until after Chinese New Year. Fronthauls from the Atlantic are still paying relatively well, but those who can should give the Pacific a wide berth. On the period side, 4-6 month business in the East is rated at $ 5,000-6,000 for the first 30 days and $ 9,000 thereafter – so overall just $ 7,000-8,000. Very good ultramaxes were able to obtain $ 9,000. By contrast, in the Atlantic smaller 52,000 dwt supramaxes can fetch $ 11,500-12,500 for two or three laden legs basis APS delivery on the East Coast of South America. It is a similar story for handysizes which saw average earnings for 38,000 dwt units dwindle by almost 20 % to $ 8,258 (down from $ 10,472 in 2018). This was also below the 10-year average of $ 8,747. At the turn of the year, momentum was slow across the board, with the indices even looking overvalued by around 10-25 % versus actual fixing levels (e.g. HS1: $ 8,400 versus only $ 6,000-7,000). Besides, the rise in bunker costs associated with the transition to IMO2020 since December saw many handies trapped in bad markets as repositioning trips became more expensive and painful. It makes it tougher for the market to balance itself.
One of the main reasons for the collapsing freight markets from mid December onwards was the fact, that most commodity traders in Middle East and in China made their pricing against high sulphur bunker prices. However ship owners insisted to have the fuel change towards much more expensive low sulphur fuel. As a consequence voyage freight rates increases easily by 30-40 % and evaporated the commodity trading margins, which means the whole business had less margin than the increases in freight rates. As a consequence the whole trading business wasn’t done and shipping volumes collapsed further than in former years. Looking forward it will take some further weeks till the commodity prices spreads between CIF and FOB will adopt towards the new shipping underlying.
Dr. Thomas Hartwig
Extract - originally published in “The Maritime Overview” Issue 01/2020