Offshore and shipping recovery cycles…

Clarksons reported results yesterday and offered the view that that shipping cycles seem to be turning. The interesting thing is the scale of the retrenchment in the traditional shipping sector that has been required to being the market back to equilibrium (if they are right). Traditonal shipping had a boom driven mainly by Chinese raw material imports (and to a lesser extent exports which were less bulky):

Clarksea Index.png

Chinese import and export growth:

Which looks somewhat similar to the oil price and investment boom:

It is worth noting that if Clarksons are right it has taken 8 years since the slump for normality and equilibrium to start to emerge. The scale of the pullback is severe with tonnage delivered down from 2047 vessels in 2013 to 217 in 2016 (a 90% reduction) and only 266 orders for 2017. Shipyards are down from 305 to 50 (an 83% reduction). It shouldn’t be a surprise because the assets are built for a 20-25 year economic life, the offshore subsea fleet is smaller (~600 vessels), but each one had a high build cost, whereas offshore supply with its larger fleet and more commodity like structure looks set to suffer a similar pull back.

The other really interesting data point Clarksons highlight is the decreasing loan exposure banks have to the sector (which I am assuming covers offshore as well):

Global ship finance lending volumes

Source: Clarksons, 2017

Lending volumes from the top 25 banks, surely more than a representative sample and clearly the most important by size with DNB Nor having 5x greater exposure than KDB, is down 25%, over $100bn,  over a six year period. More than any other factor this is surely helping the sector rebalance but it will keep a check on asset prices for years, especially as getting a loan for a ship older than 8-10 years is nigh on impossible.

The historical reasons for the shipping boom are analogous to the oil price boom that drive offshore: As China boomed so did commodity shipping, this quote should be well understood by anyone in  offshore this quote should be well understood by anyone in  offshore:

Less than a decade ago, just before the global financial crisis, the largest of the commodities-carrying bulk ships cost some $150 million and commanded as much as $200,000 a day on charter markets. Today, a similarly modern capesize class ship is worth $30 million and a vessel owner can expect to earn just $9,000 a day in a business where the prices for iron ore, coal and other industrial goods have deteriorated.

Ships that were increasing in value (as day rates rose) were used as collateral to borrow more money from banks to buy more ships in a self referencing cycle. Which is exactly what happened in offshore, and when even the banks got nervous the high yield bond market was tapped. What could possibly go wrong?

Banks hold the key to the restoration of normality. Like normal shipping offshore will require dramatically more equity and lower leverage levels going forward. Capital will be significantly more expensive. Banks, especially those in the graph above, that continue to take large losses on their portfolios, will be very reluctant to materially increase exposure and will continue to wind the loan books down with concommitment reduction in asset prices. This will go on for years as the above graph makes clear. Yes some smaller newer banks (e.g. Merchant and Maritime) and specialist lenders will fill the void, but rationally they will charge much higher rates (as they will have a higher funding cost to reflect the risk) and will require more equity. As retained earnings are lower this will take longer to build up.

Many of the new shipping projects at the moment are 100% equity financed and until asset values stabilise even newer players are likely to avoid offshore. Slowly, over years when combined with scrapping, the offshore fleet will rebalance, but it will be a long way off. Offshore would appear to be closer to the start of its journey than the end (a point Clarkson appear to agree with in their research). Nearly all distress investors who moved in 2016 looks to have moved too early (e.g. Standard Drilling, Nor Offshore) and faces a capital loss on the positions taken as opposed to industrial companies buying one-off assets (e.g. McDermott), With high running costs and demand stagnant its hard to see 2017 being any different. 

As the author of the above quote notes:

A sizable part of the portfolio of nonperforming shipping loans cannot be expected to bring market pricing much higher than the scrap price of the ships collateralized, however. In this case, shipping banks can take a deep breath and mark them to scrap value, and then make certain those ships are dismantled and removed from the market. Under this scenario, the immediate accounting losses would be mitigated over time by a more balanced market which theoretically will push freight rates and the value of the remaining ships higher.

Whatever path they take, European banks will be shaken by the unfolding of their shipping loan portfolios. Their capital structures will be affected, and given the freight market and banking regulatory headwinds, their appetite for ship finance will be diminished. The shipping industry likely will never be the same.

The same can be said for offshore I suspect.

14 thoughts on “Offshore and shipping recovery cycles…

  1. Ciao Jeremy, very interesting. What lets you think that investors will scrap the vessels? I understand it will rebalance the market but I suppose people who can buy from bankruptcy and bring the vessel on the market without having Capex to factor in the daily rate will do so, and therefore will be more competitive than the others, creating a domino effect on people who have the higher Capex. Or I am mistaken?

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    • Spot on. If a competitor goes bust in a service industry it’s generally good news for the others – more share of the pie. In the oversupplied vessel market, a competitor going bust is bad news. It generally reflects their liquidity being exhausted as their losses mount up. The resulting fire-sale shows the new economic value of their assets based on future returns. A new buyer can trade at a competitive advantage to the established competition who have yet to accept the diminution of their own asset values. Eventually the competition will run out of cash and the cycle continues.

      Why would an owner scrap vessels to the benefit of everyone but themselves? Which investor is altruistic enough to jump out of a sinking hot air balloon in order to save the other passengers?

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      • That’s exactly what i mean Cellar, The NOR vessels are borderline because if you dont maintain the asset and you dont have proper operations in place, the cost to mobilise becomes too high and the trust of the clients is lost. So it becomes difficult to find the one who invests upfront a consistent amount of money to bring the vessel on the market in an extended period of low demand. But the Bbibby Vessels for example, once freed by the burden of their initial Capex, could be a significant pain in the neck for Subsea7 and Technip? Not event to mention UDS who has Capex and no operational readiness …

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      • Sergio the thing is with those DSVs they are not earning any return to capital at the moment. It’s OpEx only and even then the Nor boats aren’t working. On that situation even a low price is irrational. Dropping the cost of diving below OpEx still won’t materially increase demand yet you have a fixed cost of 10k a day to play the game?

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      • That’s why as you say NOR vessels and BOL vessels can have a different destiny. BOL’s are ready and can fit into a bigger scheme immediately. NOR are taking a different path which could lead to scrapping. And this could be the same with DOF assets? And UDS as well, as soon as they will be repossessed by the Chinese Shipyard? Maybe market rebalancing is not as far as we imagined, less than 5 years …
        You say bigger owners are the shipyards but the shipyards cannot operate such assets and will let them deteriorate rapidly, pushing them out of the market

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    • I agree in general. Some older tonnage will eventually be scrapped because it simply cannot support the OpEx. But as you see with rig companies and restructured US OSV companies cheaper assets drives lower day rates and it becomes a self perpetuating cycle. Kind of the reverse of the procyclicality on the way up. But cheaper prices beyond a level will not create infinite demand as they might in other industries so there is a finite number of assets needed. This is what will restore profitability.

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      • Is your therapist heading there on the Da Vinci? Perhaps you should send him to Freeport – there’s probably more call for his services there.

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  2. Sadly my therapist wasn’t able to get a job on the Davinci Cellar Shark, as you probably know the market is tough at the moment.

    Do you know any businsses with years of experience in the Marine and Subsea industries and that understand the markets and pride themselves in matching the best candidate for the position every time?

    Feel free to share the details if you do.

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