Dry Bulk Shipping - Setting Course for China

Extreamly volatile is how one can describe the dry bulk market of the present and the past few years. It started with a record year in 2004 when new building prices, sale and purchase prices, charter rates hit all time highs. After moderating a bit in 2005 they again rose strongly in 2006 and 2007. The most important driver behind this phenomenal rise has been the staggering import demand for commodities from China. Chinese dry bulk import volume nearly doubled from 2001 to 2004 accounting for roughly 94% growth in demand for dry bulk trade [Stopford, Martin, Dec. 7, 2005: “China in Transition: Its impact on shipping in the last decade and the next.” Clarkson Research Services Ltd.].

This demand was further supported by the lack of Chinese logistical infrastructure which lead to port congestion and long delays at Chinese ports, putting upward pressure on charter rates. The rates rose from $7/ton in the 1990's to $30/ton in 2004 and by mid 2007 Brazil/China route vessels were reported fixed for $60/ton [http://www.fearnleys.com].

The average earnings of a Handymax vessel in 2007 were over usd 48000/day while the historical earnings have been at around usd 15000/day over the last decade [http://www.worldmaritimeconsultants.com]. The Panamaxes in 2007 averaged around usd 55,000/day, while the Capesize's hit the bullseye commanding an average of over usd 1,00,000/day with a lot of vessel fixed over usd 150,000/day for a 1 yr T/C.

The year 2008, started with the scare of US recession and that has put a damper for the moment on the prospects of the future Chinese commodity demand and this fear has been reflected in the charter rates which have fallen by almost 20% across the board. The market is stabilizing a bit, however it can't seem to decide whether this is temporary or based on physical support. The market hasn't really absorbed the effects of the actions of the Fed, the impact of the global financial crunch and how the long term iron-ore contracts will turn up?

The dry bulk market has become more balanced in the last year owing to the new buildings being delivered that were ordered in 2004/05 and minimal scrapping. The existing order book now stands at almost 64 mn dwt, about 18% of the existing fleet [end 2006]. The balance is expected to weaken in the near term, although strong demand growth is expected to continue for 2008.

In the medium term fleet growth will be limited owing to more scrapping of the older vessels in 2008/09. The dark clouds of a US recession might scare away any future investment by the ship owners both for new buildings and conversions. Therefore, I feel in the medium term as demand continues to grow albeit at a slower pace, the balance will become tighter helped by constrained supply.

The New Sultan of the Sea: VLOC's

The absolutely sizzling dry bulk market and IMO 13 G regs have made the conversion of older single hull VLCC's into VLOC's a commonplace. Nearly 30 vessels are up for conversion as per the latest reports from the industry. China's growth and in turn it's appetite for commodoties has led to this fire in the dry bulk market, especially the iron ore demand. This has further led the big producers from Brazil [CVRD] and Australia [Rio, BHP] to concentrate on larger vessels to maximize economies of scale and decrease delivery cost of bulk product sold on CIF basis to China.

Shipyards in China are turning single hull VLCC's into VLOC's instead of refurbishing them as double-hull vessels. COSCO alone is looking at converting 10 vessels in the next 2 years [Li Jian Xiong, Cosco]. Mitsui OSK Lines is also considering converting some of their older single hull VLCC's. Shipyard capacity seems to be the deciding factor as to how many will eventually see new life a VLOC's in the coming years [http://www.worldmaritmeconsultants.com]

The economics of converting a VLCC into a VLOC's seems to make perfect sense at the present moment based on the following calculation [McQuilling Services];

Conversion Cost = 25 million USD

TCT Tubarao/Beliun = 60,700 USD/day [Average 2006 earnings based on 165k mt on this route]

Share of project Financed = 65% @ 8% per annum

The conversion cost based on the above assumptions would be paid of in 17 months [8 round trips] or at minimum monthly payments after 5 years of trading with a net cash flow after financing and operating costs of USD 40,700/day [http://www.mcqservices.com/]

These converted vessels are expected to trade for roughly 10 years after conversion, enough to more than recoup their cost of conversion and provide a lucrative alternative for dry bulk owners to sending their older VLCC's for scrap.

$100 Oil : A Reality!!

January 2nd 2008 12:09 p.m EST Nymex recorded the historic $100-a-barrel price [WSJ]. It was the price of a single floor trade of the benchmark February crude oil futures contract. The dizzy heights that the crude oil has climbed to from $10.72 a decade ago caught mostly everyone in the oil and financial industry off-guard. A number of factors came together in the last decade or so to catapult crude oil to its present levels and it seems as if they are here to stay and perhaps would push the oil prices even higher in the near future.

The most dominant of the factors seems to be the unsatiable demand from the emerging economies of asia and the middle east, mainly China and India. China especially since 2004 has been growing very fast and its oil demand is set to reach approx 9 mil bbls/day by 2011, growing at the rate of roughly 500 kbd/yr. The middle east economies awash with oil cash will see their demand rise to roughly 8.5 mbd in 2011 from 6.4 mbd at the end of 2006 [IEA]. The higher oil price might moderate the demand growth, however, the rapid economic growth in these regions will mitigate the effect of the higher price.

The other significant factor is the lack of new easily recoverable oil around the globe to keep up with this surge in oil demand. Most of the easily recoverable oil has now been tapped or is control of national oil companies that are slow to react to changes in demand. The western oil majors are now forced to go further off-shore into the deeper water or hard to reach areas to keep up with the oil demand. These projects take years to complete and are nowadays even slower owing to shortage of cranes, drilling equipment and trained labor.

The coming together of the OPEC players in the last decade as a more cohesive and disclipned group, has also helped to shore up the crude oil price. Cutting production and staying within their quotas kept a lid on excess supply and higher pressure on prices.
In the coming years, the noticeable slow down in the US and European economies might moderate oil demand to some extent, but the dramatic growth in asia and the middle east will keep upward pressure on oil prices. A weaker US economy will also put downward pressure on the dollar and therefore will have a net upward price effect on oil denominated in USD.

In the near term, with main crude oil benchmark trading round the clock on NYMEX and other new financial instruments being developed to make energy trading easier and more robust, the financial institutions will become the major players effecting the price of a barrel of oil. A flood of new money, especially from the hedge funds seeking to profit from the volatility, pension funds trying to diversify and other wall street commodity desks trading more frequently will have a significant effect on the price of oil. Already the number of oil futures bets outstanding on the NYMEX has quintupled since 2001 [http://www.wsj.com].

The surging economies of asia and the middle east creating significant oil demand growth, geopolitical tensions and the flow of money from the financial institutions chasing a slowly growing number of barrels will result in keeping upward pressure on oil as has been evident in the past few years.