Host Of Factors Conspire To Facilitate Bulk Market Stagnation

JL T Ihe opening months of 1998 have been traumatizing for dry bulk ship owners. Freight rates have collapsed, there has been talk of applications for lay-up berths and, to cap it all, the progressive draft limit cuts imposed by the Panama Canal authorities in the light of the El Nino phenomenon have put the Panamax sector in particular in a quandary.

Yet, six months or so previously the outlook had appeared so much rosier. In terms of cargo volumes, 1997 had been a phenomenal year.

Iron ore trade surged through the 400 million tons mark — a figure that many had regarded as an unbreachable ceiling, especially as scrapcharged mini mills rather than huge blast furnaces and integrated mills appeared to be the way forward.

A key factor was Chinese import demand, this being borne out further by the much smaller traffic improvement for coking coal, the other major steelmaking raw material. In addition, steam coal trade maintained its seemingly inexorable upward path Furthermore, on the supply side the order backlog for new ships was falling. At long last, restraint by ship owners by Mal<olm Jupe, director Drewry Shipping Consultants ltd. looked to be about to pay dividends — 1997 was going to be the start of the good times, the upcycle was here.

Then, suddenly, the bubble burst as the Asian "powerhouse economies" on which most near and medium term optimism was built, started to unravel badly. Economists began slashing growth rate expectations and the market, which is heavily influenced by sentiment, got nervous. South East Asia started the jitters but their overall trade volume is not that great. Nevertheless, they were behind a significant number of independent power projects (IPPs) - which were going to require millions of tons of coal. Some supply contracts were in place and, crucially, ships were on order. Probably, if the problems had been limited to this region, the dry bulk market could have ridden out the storm. However, the vital Japanese market — already sluggish — could not (and still does not seem able to) shake off its lethargy. Worse still, however, the crisis impacted in a major way in South Korea. When a country responsible for perhaps seven to eight percent of dry bulk demand catches a cold, everybody is likely to be sneezing.

With hindsight, as ever, some claimed to have seen the crisis coming. There were signs — extended periods before bills were paid, for example — but such market intelligence was not widely available. Most, if they are honest, will have been taken by surprise.

How serious is the calamitous market of early 1998? For charterers, rates are very low — which, naturally, suits them. This said, however, very narrow freight differentials do not necessarily enhance the competitive advantage of endusers of dry bulk commodities. Charterers also know that the advantage they hold is of little value if owners would rather lay up their ships than take loss making rates.

For owners, rates are very low — which, naturally, does not suit them. There have been claims that rates — as typified by the Baltic Freight Index (BFI) falling below the 1,000 points mark — are in reality as bad as during the disastrous market of 1986, when the catalog of dry bulk ship owners going to the wall still remains too painful for many to contemplate. If one allows for inflationary factors between 1986 and 1987, there may be some truth in this. There are, however, other points to consider.

The 1986 nadir followed a market decline that had seen rates hemorrhaging for at least five years. In 1988, troubled owners — if prudent ought to have some reserves to fall back on. With the summer months inevitably seeing a slacker market and El Nino continuing to bite, there is near term pain for dry bulk ship owners. But beyond then? The camps divide into optimists and pessimists. The former see the problems in Asia as a short term correction. Things will stabilize in, say, 12-18 months and then the growth path will resume but at a less frenetic pace. The latter fear the Asia contagion will spread and undermine other markets. A close watch on economic performance in the EU and U.S. will be crucial.

As Table 1 has indicated (see next page), with economic growth still predicted (albeit more modestly) it is still possible to envisage demand being maintained. Nearly two billion tons remains a prospect.

However, for 1998 and 1999, the orderbook averages out at over one new Handymax and Panamax bulk carrier a week. For Capesizes, the figure might be nearer to one every two weeks, and 1998 also has a notable backlog of Handysize ships scheduled for delivery. Doubtless, some will question whether some of these are firm orders or "berth space bookings," to what extent the "refund guarantee" problems facing South Korean builders will impact and whether owners will look to cancel orders and/or defer deliveries. Sentiment sees continuing inexorable fleet growth — especially given the difficulties shipbreakers appear to be having over merely staying in business — and this may well develop a negative market momentum. Could a major slowdown in further bulk carrier ordering change the picture? The answer is yes but is it achievable? Ship owners and those that finance them tend to view deals individualistically. As a result, the outcome can be — to outside observers at least — a lack of market discipline. If newbuilding prices remain low, will the "buy now while stocks last" mentality prevail? A further factor in the equation is the current stampede of ship owners to raise very large sums of money through junk bond issues. Is this going to further stoke up new ship demand? The year 1998 is set to be a memorable year for the dry bulk market, though the memories may well be unpleasant ones. It is likely to be memorable because the dry bulk sector faces a situation against which it has no real benchmark. Certainly it is used to cyclical behavior — sometimes extreme but not dislocation. Indeed, some in the industry have suggested that there has been nothing to match the discontinuity factor of the Asian collapse since the Suez crisis. Each new release of statistics on Japanese and South Korean steel production, Chinese ore imports, new ship orders, sales to breakers, etc. is likely to be scrutinized more deeply in the search for comfort.