The Maritime Industry Hopes for Silver Lining as Talks of Tariffs Escalate

Talk of possible trade wars has kept executives in a wide range of industries at the edge of their seats; this is even more true for people in the maritime industry, which  afterall is the hauling provider on a global scale. Trade wars imply lower trade volumes, which would be a monumental concern to the shipping industry.

The New York Stock Exchange. Image credit: Karatzas Images

Intuitively, trade wars are bad for the shipping industry; tariffs and higher barriers to trade result in lower trading volumes that lead to lower demand for ships, and that, in turn, results in lower freight rates. However, nothing is as simple anymore in today’s world: higher tariffs can also lead to disruption of established supply chains, which, in the short term at least, can mean longer and less efficient paths between manufacturers and buyers, which could mean a lengthier than normal supply chain.  Talks of dismantling NAFTA, for instance, has led Mexican importers of grains to substitute imports from the U.S. with imports from other countries, primarily from countries in South America. U.S. grains to Mexico are mostly shipped from the ports of Texas and Louisiana to Veracruz in Mexico in a week’s long sailing voyage; however, Mexican imports from South America take twice as long to transport, and, all being equal, this shipping trade has been beneficial for the (international) shipowners.

Trying to assess the impact of possible trade wars on the maritime industry and try to plot an optimal strategy are in the minds of small and large shipowners alike worldwide. If a shipping company, for instance, was planning for an expensive fleet renewal, the potential of trade wars likely to be a cause to chart a new course of action. Who wants to be investing in expensive new ships when the prospects are less than rosy?

There are many permutations of possible scenarios of international trade wars as there are many variables; mostly, however, there are many theories and lines of thinking, as well as egos involved, and also grave political implications to consider, or ignore that could affect potential outcomes. On one extreme, there is the scenario for maximum tariffs on an international scale that could lead to a complete collapse of trade; at least for now, the probability for such a catastrophic scenario seems slim, thankfully. Focusing on the more likely scenario of small to moderate tariffs but where logic and economic sense would still drive decisions for the most part, it seems to be a more probable scenario.

A consideration to ponder is that the U.S. strategy so far seems targeted on imposing tariffs mostly on finished-products imported to the country, and such tariffs seem to be encompassing many industries and also being most disruptive to the supply chains; for example imports from China often have been sub-assembled in other countries and the supply chain in these countries is impacted too. China, Canada and Mexico so far seem to apply a more surgical approach by placing tariffs on mostly raw materials and commodities that concentrated political impact and relatively small collateral damage to the supply chain.

International trade bridging the seas… Image credit: Karatzas Images

Under a probable scenario of moderate tariffs and under the current modus operandi, different segments of the shipping industry will experience a varying degree of disruption.  The containership industry likely to experience a direct negative impact as import containers are mostly filled with consumer and other end products. Head-haul trade routes from China, whether to the West Coast or via the Panama Canal to the East Coast of the U.S. seem to stand at bull’s eye, but the impact  will percolate to other trade to Europe and other smaller traders localized trades. Earlier in the summer, there has been a noticeable increase of input volumes in U.S. ports and strong export data have been reported out of China; this positive impact has mostly been attributed to seasonality, as some of the peak season volumes were moved forward to dodge the first round of tariffs imposed in early July. The heightened trade due to timing considerations is expected to taper off and eventually volumes to tick downwards. Liner containership companies with their modern, huge boxships, especially those with focus on the China to North America trade, stand to be impacted most.  Localized containership markets that feed on the main trading routes had been the bright spot of the long-challenged containership market in the last couple of years, but now there are signs that smaller feeder containerships are getting off-hire at an alarmingly high rate.  It seems that pro-actively charterers opt to stop renewing charters in anticipation of reduced need for trade.

One of the great surprises in the energy world in the last decade has been the success of the shale oil production in the U.S. that potentially can make the country a net exporter for oil. Energy seemed to be getting a free pass from tariffs, but with escalating threats, now it seems to be fair game as well.  China and Far East are the biggest consumers of oil these days, and slowly the success of the shale oil in the U.S. was forming into a new trade of exporting crude oil from Corpus Christi in Texas to China via supertankers (VLCCs); this potentially could had been a game-changer trade for the crude oil tanker market given the large ton-mile numbers involved and also given the overall disruption in the trading patterns for VLCCs. This trade now seems in jeopardy, although just earlier in the week it was announced that Trafigura was still considering building a deep sea oil export terminal in Texas; but again, just this week, Chinese stated-controlled Unipec was suspending oil imports from the U.S., rattling the crude tanker market. To the extent that long term contracts will be honored or competitive pricing for U.S. shale oil can be obtained, there is a scenario of petroleum product tankers benefiting from the trade as well, whereby refineries will be focusing more on export trades. The U.S. natural gas LNG trade could also be adversely impacted by tariffs, and this is most unfortunate as the LNG tanker market desperate needs some hope in chronically oversupplied market; in addition, U.S. LNG export infrastructure is still being built up, and talks of tariffs possibly will stall some of these much-hoped-for projects.

The dry bulk market seems to be least impacted from talks of tariffs as the trade concerns mostly commodities and raw material used in the first steps of industrial production. For now, these trades seem safe, and, in the case of the grain trade to Mexico mentioned earlier, and grain trade worldwide, this would be a downright positive development for the shipping industry. Tariffs on Chinese steel will eventually catch up with China’s imports of coal and ores from Australia and Brazil and could negatively affect big-sized dry bulk vessels (capesize and Newcastlemax vessels).

The shipping industry is impacted by a wide range of factors, and the impact of tariffs is not isolated or easily quantifiable, and definitely at this stage, still much is unknown on how tariffs will be applied in terms of products, levels, reciprocity or exemptions, etc; on the other hand, no doubt some shipowners will find talk of trade wars a convenient excuse to blame for the industry’s and even their own companies’ structural problems.

Shipowners internationally have maintained a sanguine approach to talks of tariffs and trade wars. To a certain extent, this is understandable as the shipping industry has proven to do better at times of conflict, high uncertainty and interrupted trading patterns. On the other hand, continuous talk of trade wars can sap investment and trade sentiment, and trading volumes, that cannot be good for shipping. Or, anyone else.

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

IMPORTANT DISCLAIMER:  Access to this blog signifies the reader’s irrevocable acceptance of this disclaimer. No part of this blog can be reproduced by any means and under any circumstances, whatsoever, in whole or in part, without proper attribution or the consent of the copyright and trademark holders of this website. Whilst every effort has been made to ensure that information here within has been received from sources believed to be reliable and such information is believed to be accurate at the time of publishing, no warranties or assurances whatsoever are made in reference to accuracy or completeness of said information, and no liability whatsoever will be accepted for taking or failing to take any action upon any information contained in any part of this website.  Thank you for the consideration.


Moral Hazard and Hanjin Shipping

Not a week has passed since we posted an article on the Maritime Executive’s website about moral hazard in shipping, and the shipping world got a big-proportions, real-life case study of the risks in the industry. We argued that when shipowners are over their heads in debt and with little promise of ever recovering any equity, there is precious little they care about financing, operations, trade, safety and even the environment.

Hanjin Shipping, based in South Korea and world’s seventh biggest containership company, filed for protection in S. Korean courts in late August, and subsequently started filing for protection in several jurisdictions worldwide, including in the United States federal bankruptcy court (filing for Chapter 15 restructuring in Newark, NJ). As of the end of second quarter this year in June, the company had outstanding obligations close to US$ 5.5 billion, approximately US$ 900 million of which due by the end of 2017. There were approximately US$ 700 million in equity on the balance sheet. Hanjin stands as the manager of appr. 142 vessels, 98 of which are containerships and 44 are tankers and bulkers. Only one-fourth of Hanjin’s fleet is self-owned, 38 of them owned and the rest chartered in from leasing companies and other financially-minded shipowners. The ownership mix of the tonnage indicates more of a light-asset, trading company rather an asset-heavy, ship-owning balance sheet. The current value of the owned fleet stands at appr. US$ 1.7 billion.


Shipping crossing a bridge… Image Credit: Karatzas Images

Many details are still too opaque and covered by bilateral non-disclosure agreements, but where several of the counterparties have been publicly listed companies, one can draw certain conclusions: Hanjin had chartered in two 2010-built capsize vessels from publicly listed Navios Maritime Partners (ticker: NNA) MV ‘Navios Luz’ and MV ‘Navios Buena Ventura’ at a daily rate of US$ 29,356 pd each; the average spot capesize market was barely $6,000 pd during the last year, and presuming that Hanjin was trading the vessels on the spot market, they were losing $23,000 every single day for the last year ; of each of the two vessels. That is $16 mil down the drain for the two vessels in just the last year alone; each of the vessels had more than four years of employment remaining with the shipowner, and presuming that the spot capesize market would remain at present levels, Hanjin would had to suffer another $90 mil in losses for just these two vessels. Eight containerships chartered in from Danaos (ticker: DAC) had charter payment obligations of appr. $565 million. Similarly, three neo-panamax containerships from Seaspan (ticker: SSW) had outstanding charter obligations of close to US$ 370 million. These charter obligations add up to close to US$ 900 million, and under present market conditions, reasonable estimates would be for losses of more than US$ 500 million. And these are the calculations based on publicly available information for only thirteen of the 100+ vessels chartered-in, with only three counterparties. There are un-accounted obligations for more than eighty vessels that have been chartered in from other owners.

$23,000 losses every single day in the last year for each of the two capes chartered from Navios. Talk about destruction of value!

What options such a ‘shipowner’ like Hanjin (effectively a structured house of cards) does have under the circumstances? As one would suspect, very few. There is little in matter of equity, there is little in matter of collateral, there is lots of debt, and mostly, most of the debt is in relatively unsecured position since it’s in the form of charter obligations for the vessels that have been contracted on charter arrangements.

Playing the devil’ advocate and ask surreal but economically oriented questions: How much vested interest the shipowner has in the assets and the business? Precious little, at this stage. What are the odds that they will recover any equity? Probably better than hitting the jackpot in a national lottery, which we all know is not a fair proposition. What would any rational economic being would do? Briefly, either ask for the mercy of their creditors, or, having little to lose, just stop paying the creditors and pass the buck to the other side. What we called moral hazard in the previous posting.

Hanjin had been rumored (along with their co-patriot Hyundai Merchant Marine (HMM)) to be facing financial problems and was an accident waiting to happen. HMM, being slicker, and faster, and part of a big chaebol (traditional corporate conglomerate structure in S. Korea, strongly affiliated with family management style and running businesses deemed strategically important to the State, in exchange of the State’s preferential treatment), managed in August to find their way out of their financial ‘pickle’. When Hanjin tried to secure the consent and more financing from their lenders (mostly Korean banks and the state-owned Korean Development Bank), there was little empathy. This would make perfect sense, as their lenders were in relatively preferred senior position, and any new financing would be considered either ‘throwing good money after bad money’ or diluting their position and getting lower on the seniority scale of claimants. It would make economic sense to refuse any new financing and let the un-secured creditors (that is the shipowners of the hundred vessels on charter to Hanjin, like Navios, Diana, Seaspan) accept a less demanding solution. Again, Hanjin and their prime financiers decided to drop the moral hazard bomb to the parties with a lower legal claim, the shipowners of the vessels.


The good times left behind… Image Credit: Karatzas Images

Hanjin Shipping is the seventh containership company in the world but with only appr. 3% market, thus, belonging in the lower tier of containership companies as compared to behemoths like Moeller Maersk, Cosco, MSC and CMA CGM. A default by Hanjin cannot be expected to have a major domino effect on the overall shipping or containership world markets. The majority of Hanjin’s lenders were Korean banks, including the Korean Development Bank (KDB), and the Korean banking system (and the Korean taxpayer, if so required) can absorb the losses without posing a systemic risk to the Korean economy, at least at this stage. Hanjin had been a major carrier for LG electronics, but again, even Hanjin’s demise could not be detrimental to LG and the Korean electronics and manufacturing industries; not to mention, since HMM’s successful restructuring in the summer, now there has been an alternative, an alternative based in Korea itself (subsequent reports state the LG has already been shifting their shipment contracts to HMM). Thus, once the situation was ‘ring fenced’ and a fall-out was determined to be contained, Hanjin and its main creditors stopped paying to the lower standing creditors (other shipowners with charter-in tonnage). An example of moral hazard in all its glory.

Hanjin has filed for restructuring (and not for liquidation) expecting to find a way to save the company as a going concern over the long term. However, owners of vessels on charter to Hanjin, companies like Danaos, Seaspan, Navios and many other smaller, private owners, stand to lose the most. In an oversupplied market of low freight rates, it will be difficult to withdraw their vessels from Hanjin and seek equally profitable charter rates elsewhere in the present market; likely, they will have to accept lower and extended rates that Hanjin will offer them, and possibly some equity upside if and when the company recovers. Otherwise, the shipowners will have to seek legal remedies which are costly and time consuming, and always risky on whether there will be a chance to ever collect. After all, the events of last week have shown that Hanjin is not a systemically important company to the Korean economy, there is little the Korean constituents that can lose, there is little left for Hanjin’s management and shareholders to lose. Heads I win, tail you lose.

A case of moral hazard of the highest caliber.

A better edited version of this article was originally published on The Maritime Executive website on September 6th, 2016 under the title ‘Moral Hazard Case Study: Hanjin Shipping’.  This article builds on our essay on the dangers of the moral hazard in a weak freight market posted in early September in this post, when market participants were left with few options and little to lose, so much so that they care little for the outcome or the interests other constituents of the shipping industry.

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

IMPORTANT DISCLAIMER:  Access to this blog signifies the reader’s irrevocable acceptance of this disclaimer. No part of this blog can be reproduced by any means and under any circumstances, whatsoever, in whole or in part, without proper attribution or the consent of the copyright and trademark holders of this website. Whilst every effort has been made to ensure that information here within has been received from sources believed to be reliable and such information is believed to be accurate at the time of publishing, no warranties or assurances whatsoever are made in reference to accuracy or completeness of said information, and no liability whatsoever will be accepted for taking or failing to take any action upon any information contained in any part of this website.  Thank you for the consideration.