Shipping’s Structural Challenges

Article originally appeared on Splash 24/7 under the title ‘Canaries in a Coalmine’ on July 5th, 2016.

With the dry bulk freight market so low for so long, half of world’s dry bulk shipowners are trying to raise money in order to survive and the other half are trying to raise money in order to buy cheap ships. Both kinds of endeavors are commendable and that’s exactly the activity this market one would had expected to stimulate at this stage: a historically depressed and unexpectedly prolonged low market is about to wash out part of the ship ownership population while the better (and maybe luckier) part is using this market to grow and increase market share.

Historically, great fortunes were made for a propitious entry to the market and astute timing in this volatile industry. As some trading minds love to say, one makes their money when they buy: a hopelessly low price gives enough room for error for any miscalculations and takes much of the market uncertainty out of the investment.   To a certain extent, aspiring buyers at presently distressed prices are trying to do what always has been done in such circumstances, buy low and wait to sell high. So far, so good – as no one lost money with this investment strategy.

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An industry in a storm. Image credit: Karatzas Images.

However, buying low and selling high presupposes a normal business cycle, sort of a wheel of a bicycle rotating while the bicycle speeds on an even surface; just imagine, if you will, a leaf picked by the wheel from the road surface, span a bit, and let go when the wheel has turned half circle; the leaf is now at middle air, diametrically higher than the surface, thus with more energy (read value), as we would had said in elementary physics class. Actually, at any point higher than the surface, the leaf would have more energy (value), and that’s what many asset players have been trying to do over time. Visualize the bicycle wheel as a business cycle and substitute the road surface with the horizon over the oceans: the value of the ships varies relative to the position of the wheel over time.

A buy-low-sell-high investment argument presupposes of a normal, repeatable business cycle, immune to any exogenous shocks. Same wheel, more or less, over cycles, same level surface more or less, same enthusiasm and strength to pedal the wheel, more or less…

When today one makes the argument for buying cheap ships, as commendable and self-evident as such argument may be, one has to wonder whether everything else has remained the same… whether the surface is still even…

Protectionism and Isolationism

A thriving shipping industry depends on thriving trade, and one has to observe that at present there is a wave of protectionism and isolationism circling the globe. From the outcome of Brexit to supposedly building huge walls in North America to the polarization of the electorates in many countries, one has to wonder whether there is a tailwind or a headwind for shipping. Probably our lives and the world are too integrated at this stage and populist politicians may not get their chance to implement their simplistic and populist view of the world, but again, a big push for the shipping industry should not be expected in the immediate future.

Structural Changes and Disruption Risk

There have been interesting news recently as officials at the Port of Oakland in California are trying to do away with a ban to ship coal (mostly from Utah) to Asia (China), a proposal based on environmental concerns. This is about banning shipping for a commodity by a third party who effectively is not a party to a contract (between buyer and seller or even shipper of coal) on reasons of environmental pollution that will take place thousand miles away (in China, as Oakland is only transshipment center). We do not pass judgment here, and we are always for clean business practices, but see this event as a canary in the coal mine, literally, drawing attention to shifting tides in the shipping industry. Certain cargoes, coal in this case, are becoming obsolete as the world moves towards renewables and clean energy. Shipping volumes are affected and certain asset classes get to be at a greater disadvantage. And, the energy industry and energy storage are at the crosshair of many technology companies as the energy industry is deemed a mature target for disruption. The mighty Apple depends 93% for its energy needs on renewables, and has spent for R&D on renewables more money that they have spent on the iPhone, iPad and iWatch combined. Coal and oil and gas are prime cargoes for the shipping industry.

Mind the Money

In June alone, more than $1 trillion of sovereign and corporate debt has been added to bonds yielding negative rate, for a total of $11.7 trillion. There are 355 corporate bonds that have negative yields, meaning that the bondholders actually pay money for the privilege to lend to these companies. In macro-economics, sovereign interest rates at close to zero are defined as Zero Lower Bound (ZLB), and it’s often a sign of central banks running out of options. We are living in a world of increased risk with few fiscal options (and / or political will) where cash holders and savers are getting penalized for being frugal, whereas some borrowers are getting paid to borrow lots of money. But, given heightened regulatory environment in the banking industry, a great deal of borrowers is not the kind of clients the banks wish to finance. In short, in a world flooded with free money, most businesses cannot access it. We would think that this is a structural shift in the market, when our proverbial bicycle has stopped moving on an even surface and has moved to off-road terrain.

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Looking for a Captain. Image credit: Karatzas Images.

Many hopeful buyers are pounding the table that shipping asset prices are cheap and this is one-in-lifetime opportunity. And over time, cheaply acquired assets appreciate and generate huge profits; just a uni-directional bet and a view that history repeats itself, actually. But, this has been the logic that got us into trouble in the first place: ships were priced at once-in-a-lifetime levels in 2012-2013 when primarily asset players and opportunistic investors were ordering newbuildings by the dozen. Why the same logic would get us out of trouble, especially when canaries in the coal mine seem to be dropping dead in related industries?

Probably a higher level of logic may be required to make profits and save the industry from another shock, than just the buy-low-now mentality.

© 2013 – present Basil M Karatzas & Karatzas Marine Advisors & Co.  All Rights Reserved.

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