Trimming the Fat

Malcolm Latarche
Malcolm Latarche

02 March 2017

There is almost no sector in the shipping industry that is not suffering the effects of overcapacity to some extent but despite years of warnings some investors seem oblivious to the fact while regulators appear to be making achieving a sensible balance even more difficult.

More than a decade ago at a Germanischer Lloyd press dinner in London, Dr Hans Payer, the then head of GL highlighted the threat of a growing over-capacity in the world container fleet. At the time, the delivery of Emma Maersk – then the world’s largest container ship – was imminent and the whole world was anticipating a trade boom fuelled by China that was forecast to continue for decades to come.

In the event, the boom was to turn to bust in just a few years in 2008 but bank bailouts and printing of new money on an epic scale would temporarily reverse the decline the crash caused and a new era of fleet expansion was begun. More and even bigger ships were ordered in the years from 2010 to 2012 but the spectre of falling demand defused to disappear so that 2016 was quite possibly one of the worst in living memory for shipping professionals.

Almost every market analyst’s report over the past two years has forecast an overcapacity in one section or another with the container sector being particularly singled out as being bloated. Only the cruise sector has been unaffected but then that is a rather niche area and one where very little speculative building is undertaken by the limited number of players.

Maintaining the supply and demand balance for shipping space is, on the face of it quite a simple task with new vessels only being commissioned as older tonnage is consigned to scrap. However, the reality is rather different. Very few vessels stay with their original owner throughout their life and instead are passed on through the second-hand market. The cascading continues through more changes of ownership with one ship being scrapped at the end but almost always that ship is much smaller than the new vessel at the top of the chain.

In times not so long past, overcapacity was either the result of a war, strikes or a shortage of cargoes owing to something such as a crop failure. With speculative investment in shipping almost non-existent, fleet growth was limited by the bank balances of traditional shipowners. For traditionalists, the present situation is a result of too much speculation, over-optimistic forecasts by economists (both interconnected) and an almost obsessive desire by leading owners to grow market share whatever the consequences.

With new ships flooding into the market in 2016, scrapping was never at a level to permit a balance to be achieved. Taking all cargo ship types and offshore vessels, in 2016 a grand total of 48.2mdwt was scrapped, but 118mdwt of newbuildings were delivered. In individual ship types the imbalance was even worse.

In the most affected sector, 2016 saw 218 ships with a combined capacity of 755,599teu scrapped. New deliveries in the year amounted to 303 ships totalling 2,217,749teu equating to a net growth of 85 vessels and 1,562,250teu. In February this year, container analyst Alphaliner estimated a total of 1.69 million TEUs in vessel capacity will be delivered in 2017, more than twice the amount projected to be sold for scrap. According to the report, 78% of the expected new containership capacity will be on vessels over 10,000teu

Allowing for a potential slippage of about 250,000teu as owners seek postponements or cancel options, the projected capacity addition would still reach 1.44 million TEUs, with net fleet growth after slippage and scrapping forecast to reach 3.4% this year.

The opening of the new Panama locks allowing larger vessels passage between Atlantic and Pacific has been a factor affecting the liner sector but there is no disguising the fact that it has been the advent of the new breed of mega carriers above 18,000teu that has been the cause of the most pain. As well as causing problems for the sector itself, the large ships have necessitated extra expenditure by ports and terminals with nothing to show in productivity gains or cost recovery,

There are still some that believe the current situation cannot go on forever and there are optimistic forecasts of a turnaround maybe later this year or perhaps by 2019. In the meantime finding employment for new deliveries of neo-Panamaxes when rates are only around a third of what they were when the ships were contracted is proving a headache for non-operating owners.

Another sector that has seen over-optimistic expansion in recent times is dry bulk. It is a highly competitive sector but vessels can at least shift between different trades especially in the sub-Panamax sizes. In 2016 across the bulk fleet, 435 vessels were disposed of totalling 32mdwt. In the same year 326 vessels for 34.3mdwt were delivered. A much more balanced change than in containers.

There are clear indications that some key cargoes within the bulk sector are set for reasonable growth. Coal is leading the charge and with Japan deciding in late January to commit to new coal power stations in place of more expensive LNG and poor performing renewables, the future for exports from both Australia and a resurgent US coal industry promises to underpin a bulk recovery. Financial commitment by banks and governments to the new power stations would suggest that they will be providing employment for the bulk fleet for some 30 years or more.

Shipping consultant Drewry is one of many analysts optimistic about the bulk sector. In its Dry Bulk Forecaster, published in February, Drewry said, “An impressive outlook for dry bulk demand coupled with a small orderbook of newbuilds as a percentage of the total fleet capacity will ensure a sustained recovery in the dry bulk market. Earnings in the dry bulk market are expected to improve from 2017 with a narrowing supply-demand gap. Demand is projected to grow at a healthy pace of 3% while supply is expected to grow by about 1% from 2017, making the dry bulk segment an interesting market to invest in.

The supply side is projected to grow by just 1% from 2017 because of high scrapping and a thin orderbook. Drewry also believes that the 2017 date for ballast treatment and the 2020 sulphur cap will result in older less profitable vessels being scrapped. On the other hand, a contracting orderbook and low future new orderings due to limited financing availability are keeping a check on future deliveries. At this point in time, the orderbook as a percentage of the total fleet, which is a strong indicator of future deliveries currently stands at a decade low.

The prospects for the crude tanker sector are as ever dependent on crude prices and political machinations. How long the OPEC reduction in output will last is anybody’s guess but while all producing counties would welcome a higher price there is a glut of crude which may soon increase further. The US is planning to ramp up productions and some marginal offshore fields will be in the black if current crude prices hold.

The chemical tankers market is anticipated to face a challenging couple of years ahead due to lingering oversupply made worse by many newbuilding deliveries, according to shipping analyst Drewry. Although the trade volume from the US to Europe and Northeast Asia rose in 2016, the appearance of speculative vessels brought rates down.

“We expect fleet oversupply to persist in 2017 and time charter rates for larger ships, especially MRs, to decline because of stiff competition. However, rates for vessels in the smaller categories are likely to remain stable in 2017,” said Hu Qing, lead analyst for chemical shipping at Drewry.

The chemical fleet grew by 5.2% in 2016 and is expected to expand by 3.3% to the end of 2017, which will continue squeezing rates on major routes over the next two years. New orders and deliveries are also expected to decline further because of the depressed market and financial woes of shipyards. While deliveries and ordering have reduced in 2016, there are still many ships scheduled to be delivered in the next five years because of heavy ordering during 2014 and 2015.

While maintaining a balance between newbuildings and ships sent for scrapping is in the domain of the shipowners themselves, how ships are disposed of is, for European shipowners at least, something of a political problem. It is now eight years since the IMO adopted the Hong Kong convention which would govern ship recycling globally but it is very far from meeting its coming into force criteria of 15 states covering not less than 40% of the gross tonnage of the world’s merchant shipping. There is also a rider which requires that the combined maximum annual ship recycling volume of the states during the preceding 10 years constitutes not less than 3% of the gross tonnage of the combined merchant shipping of the same states.

So far only Belgium, Congo, France, Norway and Panama have ratified and Denmark is expected to do so soon. Last year India indicated that it too as considering ratification which could come this year. The coming into force date of the convention is two years after the ratification trigger is reached so it will be some time yet before its provisions apply.

The EU, as on so many maritime regulatory matters, has demanded an earlier requirement for ships under EU member state flags. The 2013 EU Ship Recycling Regulation (EUSRR) will enter into force either six months after the date that the combined maximum annual ship recycling output of the ship recycling facilities included in the European list constitutes not less than 2.5 million light displacement tonnes (LDT), or on 31 December 2018, whichever date occurs first. Under the regulation all vessels sailing under an EU flag will be required to use an approved ship recycling facility at the end of their operating lives.

The list of approved facilities published in December include 18 facilities spread across 10 EU member states. Three each are in the UK, France and Lithuania, two each in Denmark and the Netherlands and one each in Belgium, Latvia, Spain, Poland and Portugal. Despite several yards in Alang, India having been certified by at least three classification societies (ClassNK, IRS and RINA) as meeting the requirements of both the Hong Long Convention and the EUSRR, none have yet made it to the EU list.

According to the European Community Shipowners’ Association (ECSA) the capacity of the yards on the EUSRR list is less than 30% of the EU’s own ship recycling target so the inclusion of foreign breakers is essential. Applications have been made from yards in Turkey and China as well as India and they are supposed to be considered some time this year. With the publication of the list there is now a requirement for all EU flagged ships going for dismantling to have on board an inventory of hazardous materials.

Recent incidents at breakers yards in Gadani, Pakistan involving explosions on tankers and LPG carriers that have resulted in many deaths have done little to improve the image of Asian shipbreaking. In February, the local government authorities in Gadani banned yards from breaking any more tankers until proper safety mechanisms are put in place to ensure the safety of workers at the yards. Officials also announced plans to set up a Gadani Shipbreaking Regulatory Authority to oversee regulations and carry out infrastructure projects.

Shipbreakers in Bangladesh, Asia’s second largest dismantler are considered to be perhaps the worst offenders with regard to safety and environmental stewardship and seem to be being targeted by environmental NGOs based in Europe. This, along with the problems at Gadani, may unfairly influence the chances of Indian breakers making their way on to the EU list of approved facilities but if that happens then the practice of changing flags of ships bound for scrapping will likely provide away round that for EU shipowners.