The Recovery Continues: A Fearless Forecast
The headline in the Financial Times is enough to raise the hair on the back of our necks: “Growing Global Confidence Helps Risk Appetite.”
I hope that this headline, if you saw it, scared you as much as it did me. Although I have some confidence about the future of shipping, or I wouldn’t be here, my topic today is about forecasting. Forecasting, to the ancient Greeks and Romans, had a lot to do with omens. The ancient Greeks sought their guidance from the stars, which they believed help them predict the course of future events.
The Romans, on the other hand, sought to predict the future in the flight of birds, the cackling of geese, and most famously in the examining of entrails of poultry and domestic animals.
The experts who did this kind of thing were called augurs.
Today, we rely on Alan Greenspan and Ben Bernanke. History, however, is on the side of the ancients. Their track record, after all, was reasonably good, and over a longer period of time than we have put in.
When you consider that the past decade was famously that of Mr. Greenspan’s efficient markets hypothesis (EMH), the entrails of goats and chickens begin to look fairly reliable.
There is an old joke about an economist and his friend walking down the street. The friend points to a $100 bill lying on the pavement. The economist says: “It isn’t really there, because if it was, someone would have already picked it up.”
Economists, in other words, are good at telling about statistical probability. They are also good at telling investors how to focus on the short term, where the opportunities supposedly lie, rather than on the long term, where the true informational advantage is likely to be.
The real world is something quite different, and drawing upon my experience of about 40 years in this business, I would like to regale you with a few observations.
I of course cannot forecast the future with any degree of accuracy. What I, and you, can do is to make a number of hopefully astute predictions. We all, here today, can make some observations about what is happening at present. First of all, there are time-tested market indicators that have proven to be reasonably reliable in the past. They are likely to be just as reliable in the future.
The following indicators are instructive:
• China’s demand for base metals;
• China’s demand for other commodities;
• The availability of credit in China and elsewhere;
• The Baltic Dry Index;
• The price of coking coal, particularly in China;
• The value of ships, in various categories;
• Global seaborne trade;
• The size of the world fleet today;
• The projected size of the world fleet in coming years.
There is no question that we are in the presence of a massive contraction in trade. This comes after a significant expansion of the world fleet during the last decade. Over the last 5 years, this has averaged 7% per year, by capacity, of new ships ordered. During January of 2010, the global fleet expanded further, totalling 80,770 ships of a total of 890.2 million gross tons at the beginning of February.
Most of the new ships entering the market have been under construction in China and Korea. This brings me to my first prediction, which is that notwithstanding all the talk of cancellations, most of the ships under construction will be completed and will enter the maritime supply chain over the next few years. These include tankers, dry bulkers, and containerships.
And so we are told that up to January 1 of this year, 107 orders for ships totalling 4.6 million dwt, at those famous Chinese shipyards, have been cancelled.
Statistics from the China Association of the National Shipbuilding Industry tell us that 65% of China’s shipyards did not obtain a single order during 2009.
The picture is more complex, however. Over the past year, leading shipbuilders in China did receive considerable financial support from local banks.
Believe me: most of the ships on order in China will in fact be built; when you hear the word “cancellation”, please remember the advice of former President Bill Clinton, “That depends on how you define the word sex”. The word “cancellation” has a similar elasticity. A great many of these ships will be built, and delivered to owners in the Far East, or elsewhere, even if they were ordered by companies in other parts of the world.
When it comes to predictions, the old adage “you pays yer money, and you takes yer choice” still applies. But some predictions seem to me to be very wise. One prediction is very interesting. This is put forward by researchers at DnB NOR Bank, to the effect that Chinese annual iron ore imports will continue to increase, and could peak as high as 1.3 billion tons a year before 2020.
This would be double last year’s level, and would create a demand for a further 584 capesize bulkers by then.
I agree that industrialization and urbanization will continue in China over the next 10 years, notwithstanding all of the talk of this bubble, that bubble and the other bubble.
This is reflected in the little-noticed agreement earlier this month, for a 55% increase in coking coal prices, a critical element in the manufacture of steel. We saw an agreement take place between BHP Billiton, the world’s largest miner, and JFE Steel of Japan, and which will run only for the quarter between April and June of this year, marking a break with decades of annual contracts.
The sharp increase in coking coal and iron ore costs is likely to boost the price of steel, possibly by about 30% over the next 3 years. Quarterly contracts will track the spot price of iron ore, and reflect a drop in the production of China’s domestic production of coking coal. Last year, China imported about 30 million tons of coking coal, an increase from 1 ton in 2008!
This is a very basic indicator of the shape of things to come, and certainly - - to me at least - - means that not only China, but Europe and North America, as well as India and Brazil, will be emerging from the current recession a lot more quickly than many augurs and omens seem to indicate.
When China, a year ago, announced a stimulus package to assist its shipbuilding industry, it also showed China’s policy “hand”.
While we understand that smaller Chinese yards are suffering, and may be shut down, leading shipbuilders such as Jiangsu Rongsheng Heavy Industries and New Times Shipbuilding have received significant financial support from the government.
Domestic Chinese banks have considerably increased their advances to the shipbuilding sector.
China’s largest ship finance service provider, Exim Bank of China, has used its export credits to extend the amount available to local shipyards and their customers.
Exim Bank has supported foreign shipowners such as Overseas Shipholding Group in support of its newbuilding programme at Chinese yards.
So there is ambiguous news in this message of continued growth: What are we going to do with the ships that will be built? And are we making a mistake by using China as an example, when conditions are often very different in other parts of the world?
I believe that overcapacity will continue to afflict the global shipping market, as deliveries of new tonnage are pushed back by most shipowners from the years 2009 and 2010 to 2012. This means that the total supply in the global market will increase by 56% in 2012 - - by which I mean the newbuildings - - by about 56%, by 2012, to 103 million dwt.
I also fearlessly forecast that the considerable fall in vessel values and prices is going to greatly reduce the profitability of ship yards in China, Korea, and elsewhere. We saw that during 2008 and 2009, the average price of all of the major ship types fell by 30% to 40%.
It appears that the session this month of China’s National People’s Congress, the highest legislature of China has approved the strategic industrial sectors of that nation, including shipbuilding and shipping. It appears that China hopes to provide a significant domestic demand for shipping, as a result of the development of its growing consumer economy.
But while Chinese growth remains strong, and the United State’s economy is starting to recover, the weakness of the recovery in Europe is a cause for concern.
I have dwelt on the completion of newbuilding orders, and I have predicted that most of them, at least in China, will be completed, although they will be delivered to “players to be named later.”
I am optimistic because I see significant economic recovery this year - - 2010 - - and I think that the omens are better than many of us realize for a resumption into the growth of seaborne trade. We should not remain in the grip of inert academic theories. Shipping is not an industry that lends itself to the projections and prognoses of quants, techies and academics. It is cyclical, and also cynical.
We must turn away from bad theory and incorrect information. We must also recognize that while prosperity may be just around the corner, traditional forms of credit have suffered a severe blow. Financing remains a major problem as we recover from the current recession. One of the biggest problems in securing finance is the collapse in vessel asset values. As Hamish Norton of Jefferies and Co. recently said: “You can’t finance something that costs more than it’s worth.” Where debt appears to be higher than the value of the asset, banks and other lenders will be reluctant to lend. While it is a hopeful sign of Spring that IPOs seem to be making a modest comeback, some of the real losses, and possible bankruptcies in the shipping industry quite possibly lie ahead.
And so we bid farewell not only to hard times - - or so we hope - - but also to faulty risk management, option pricing theory, the belief that markets know best, and its faith in the efficient markets hypothesis.
We look ahead, or at least I do, optimistically. In doing so, I hope we remember the past, particularly the recent past. As the late professor J.K. Galbraith said, financial markets - - and shipping is no exception - - are characterized by “extreme brevity of financial memory; there can be few fields of human endeavor in which history counts for so little as in the world of finance.”
The lessons of the past, our “financial and commercial memory” remind us of what may happen in the future: China’s approximately 90 ship yards accounted for about 38% of global newbuildings in 2009. As Svein Steimler, executive vice president of NYK Group Europe recently said, “Western owners may boast about cancelling ships to be built in Chinese yards, but those ships will continue being built, and many will become Chinese-owned and financed at a lower price”.
• This overhang of newbuildings raises some unappealing prospects:
• Speculative purchases by speculative purchasers;
• Inexperienced operators and managers of highly leveraged ships;
• A decline in the quality of maintenance, and of crews;
• A lack of transparency of ownership and management;
• Growing protectionism.
While China may view shipping as a “champion” industry, essential to China’s economic future, and the transportation of raw materials to feed its growth, there is a danger that unrestrained growth in this particular sector could lead to a succession of bust as well as boom. China presently follows a strategy of supporting its shipping industry by owning its ships. As capital is drawn down, it may however see the wisdom of acquiring overseas partners, integrating into world markets rather than dominating them.
Right now, China’s obvious aim is to maintain control of the raw materials that it needs, and its own supply chain. If we look at the past, other industrialized countries have eventually done the same thing. As its shipping sector matures, China is likely to find that, as costs increase, financial subsidies to the industry, including builders, carriers and banks become less attractive. To sustain its shipping industry against competition - - which will come - - China will have to focus on a strategy of independent ownership and management, just as Japan did 20 years ago.
About the Author
Clay Maitland is a Managing Partner of International Registers, Inc (), the administrators of the Marshall Islands Registry. He is a maritime lawyer with some 40 years experience in the shipping industry. Email: [email protected]
