Shipping: Sailing in troubled waters Global Economic Outlook, Q1 2017

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Since the Great Recession, the global shipping industry has been facing strong headwinds, which are not likely to go away soon, given uncertainty in trade policy and changing trade patterns among nations. Interestingly, the tanker business has been doing better than its counterparts.

Introduction

The shipping industry is no stranger to economic fluctuations, given its deep links to global demand dynamics, commodity prices, and rules of international trade. However, the current tides appear more ominous given the supposed bright future promised by strong trade and investment flows prior to the Great Recession. Since 2008–09, international trade has faced headwinds from slowing global economic growth (figure 1), especially in key markets for both finished products and commodities. According to the International Monetary Fund (IMF), global exports volumes grew at an average annual rate of just 2.9 percent in 2008–15, less than half the corresponding figure for 2001–08.1 The value of trade flows hasn’t fared any better.2

Growth in world exports has slowed since 2008 due to declining economic growth

The slowdown in both value and volume of international trade has, in turn, impacted the price paid for shipping goods across continents. In February 2016, the Baltic Exchange Dry Index—an indicator of freight rates for dry goods and commodities—fell to its lowest level ever.3 And despite a recovery in the past few months, the index is still about 90 percent below the peak of May 2008 (figure 2). Respective indices for tankers used for shipping crude oil and refined products show similar, albeit more moderate, trends.

The Baltic Exchange Dry Index is far from its peak of May 2008

The dark clouds hovering over revenues

As international trade slows and freight rates for transporting goods across the world’s seas and oceans decline, shipping revenues have been hit. Figure 3 reveals how revenues have been either stagnant or falling for key shipping companies for quite some time now. For example, AP Moller Maersk, the largest company in terms of capacity, has been witnessing weak revenue growth since 2010.4 In 2015, the company’s revenues fell by 15.3 percent to $40.3 billion, the lowest level since 2005.5 That slide continued into 2016 as well, with revenues declining 17.3 percent year over year in the first nine months of the year.6 The slowdown in revenues, coupled with elevated levels of debt for many companies, has also raised questions of sustainability for a few shipping companies.

Key shipping companies have faced stagnant or declining revenues in recent years

A good way to analyze the revenue upheaval shipping companies are facing, especially the container and bulk business that transports products and dry commodities, is to look at demand from key markets and supply from major producers. Arguably, there is no better way to do that than sift through international trade data for China—a manufacturing exports powerhouse and a big consumer of metals and minerals. A quick look at the data on China’s key trade items between 2005 and 2015 lays bare the problem of volumes and value facing container and bulk shipping. For example, the value of exports of transportation equipment as well as machinery and electrical equipment from China slowed significantly during 2010–15 compared with the previous five-year period (figure 4). This is most likely a result of slower economic growth in major markets such as Europe and the United States.

Container and bulk shipping are facing slowing trade growth in key markets such as China

The story is similar for two of China’s major imports: basic metals and mineral products (figure 4). China and other fast-growing emerging markets such as India had played a key role in the sharp surge in commodity prices prior to the Great Recession and the relatively modest recovery during 2010–11. But, with China’s growth slowing from the double-digit figures witnessed in the previous decade, global metal and mineral demand has been hit, which, in turn, has impacted prices. For example, copper, zinc, and aluminum are trading much below their respective peaks of the last decade (figure 5). Also, it is likely that shipping companies and the world’s major commodity producers may not experience the sharp price growth witnessed in the previous decade, as policymakers in China attempt to shift to a more sustainable, consumption-led growth model from an investment-driven one.

As global growth and specifically China’s growth slow, metal prices fall

Rising capacity: The micro-issue within a macro-problem

A slowdown in international trade growth couldn’t have come at a worse time—a period where capacity has been expanding faster than global demand—for the shipping industry. According to data from the United Nations Conference on Trade and Development and the IMF, growth in capacity (in dead weight tons) of the world’s merchant shipping fleet has outpaced growth in global export volumes every year since 2007, except one (figure 6).7 Figures 1, 2, and 6 also give us an insight as to why shipping companies went on a capacity expansion binge: sharp growth in international trade and a corresponding rise in freight rates.

Moreover, despite a decline in commodity prices and freight rates in recent years, capacity expansion has continued, albeit at a slower pace. This is because capacity expansion is a medium- to long-term process involving years of funding that companies often are not able to reverse (see the sidebar “Commodity and freight cycles and its impact on capital expenditure”). So even as freight rates have fallen since 2008, shipping capacity has kept growing, although the pace has slowed after 2011, when capacity increased 10.9 percent. Also, the 2010–11 recovery could have soothed nerves in the shipping business, prompting it to expect a return to a pre-2009 growth trajectory. Unfortunately, that has not happened, given the debt crisis in Europe, slowing growth in China, and moderate economic expansion in the United States.

Shipping capacity growth has outpaced global exports volumes growth for most of 2007–15

Commodity and freight cycles, and their impact on capital expenditure

The problem of surplus is not limited to the shipping industry, and it is not just because of a year or two of excess investments. The genesis of the recent surge goes back to 2003–08. Record prices in anticipation of strong demand from fast-growing Asian economies led to record capital raising and, thus, a fourfold increase in capital investments across commodities during this period (figure 7). Seeing significant capacity expansion upstream, it was natural for shippers to follow suit and invest heavily in adding capacity.

However, the 2008–09 financial crisis and a lower-than-expected recovery post the recession left the significant capacity buildup underutilized. Further, the buildup was largely of mega fields, mines, and ships, which have a longer capital gestation period and, thus, require continuous investments across the price and freight cycles. This is reflected in strong capital expenditure (capex) during 2010–13 despite moderation in prices. Although there has been a significant fall in capex and, hence, in oversupply over the past two years, a majority of commodities and the shipping industry remain in a lower-for-longer downturn and will likely witness a slow road back to recovery.

In commodities and shipping, capex spending is linked to price cycles, but with a lag

Not surprisingly, capacity expansion—a lot of which is often fueled by borrowing—has increased the debt burden for some shipping companies, especially since 2009–10.8 Given that the rise in debt has come at a time of slow revenue growth—the period after 2010—it has put further pressure on shipping companies’ balance sheets. Rising debt in recent years comes after a period of steady debt reduction by shipping companies leading up to the Great Recession; ironically, that period was also one of steady growth in freight rates and revenues.

Fortune favors the tankers

On a brighter note, the tanker business has been doing better than its container and bulk counterparts. Maersk Tankers, for example, witnessed a 22.9 percent rise in operating profit before tax in 2015 despite a sharp drop in crude prices; the average Brent price fell by half that year relative to 2014.9 In contrast, Maersk Line’s operating profit before tax—the container side of the business—fell during the above period.10 So within such a scenario of low oil prices, how did tankers fare better? There are several reasons:

  • Hydrocarbon demand from key emerging markets such as India and China has been strong, as car sales and power generation continue to expand in these economies. For example, in 2010, China replaced the United States as the world’s largest automobile market.11 Between 2010 and 2015, crude import volumes went up 40.2 percent for China and 20.3 percent for India.12 Also, countries such as China and the United States took advantage of the sharp decline in oil prices in 2015 to increase their strategic reserves.13
  • As demand from Asia rises and a glut of shale oil in the United States emerges, routes for tankers have turned longer. Crude from Latin America, for example, was earlier mostly destined for the United States.14 Not anymore: As Asian hunger for energy rises and the United States turns self-sufficient in oil, crude from Latin America and Africa is increasingly finding its way to Asia.15 Also, as the United States starts exporting oil, Asia is likely to be a key market, ensuring a long route for tankers.16
  • Finally, as oil prices started declining from mid-2014 and producers kept pumping crude, companies started following a new strategy: keeping oil in tankers offshore at sea to be sold when prices go up.17 By the end of May 2016, the International Energy Agency suggested that about 94 million barrels of crude were kept offshore.18

It is no wonder, then, that tanker demand has gone up, with companies also ramping up capacity. In the last five years, for example, oil tanker capacity has gone up 14.4 percent.19

All’s well that ends well?

As 2017 dawns, it is apparent that the shipping industry will continue to face headwinds. The global economy is in uncertain territory, with a new administration taking over in the United States, Europe still mired in weak growth, and economic activity in China not showing signs of picking up sharply. To top it all, international trade faces a rise in protectionist rhetoric, with events such as Brexit shaking the foundation of free movement of goods, services, and capital. Also, with Asian growth outpacing other regions, trade growth within Asia will rise, thereby impacting shipping distances. For example, in 2015, exports from developing countries in Asia were 18.2 percent of the region’s total exports, up from 6.6 percent in 1980, with much of the surge happening in the new millennium.20 This trend is likely to continue.

In the tanker business, companies are wary of a dent to oil demand as crude prices rise. Brent prices have more than doubled since the low of January 2016, with a proposed cut in supplies by the Organization of Petroleum Exporting Countries (OPEC) and non-OPEC countries likely to keep prices elevated in the near term. Also, as prices rise, demand for offshore tankers will decline, as will the drive to increase strategic reserves.21

Nevertheless, it would be wrong to expect only dark clouds on the horizon for the shipping industry. There appears to be a rise in tailwinds of late. Metal prices are firming up: Copper is up more than 23 percent since the end of 2015. Fiscal stimulus focusing on infrastructure and investment in China and Japan is likely to aid demand for metals.22 This augurs well for freight rates, which have also been moving up in recent months, as is evident from the Baltic indices (figure 2). Most importantly, the shipping industry can draw comfort from an expected rise in international trade growth in the near term. For example, the IMF expects growth in global exports volumes to rise to 3.5 percent in 2017 from an estimated 2.2 percent last year.23

For tankers, the advent of the United States as an energy exporter with products destined for Asia—a longer route—will aid sentiment. Also, the flow of US oil into the global market will likely keep a lid on prices, thereby ensuring a ceiling. This will ensure that demand does not falter much despite a recent rise in crude oil prices. Also, with Iran entering the fray after years of sanctions, supply is likely to increase. The country’s shipments of crude has already crossed pre-sanction highs.24 Finally, with key emerging markets and Japan searching for fuels cleaner than coal, natural gas has seen an upsurge in demand. This is likely to continue, aiding demand for liquefied natural gas tankers.