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Oversupply to reign in on dry bulk market during 2011

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In an interview with Hellenic Shipping News Worldwide, BIMCO’s shipping analyst, Peter Sand, describes the “œhardships” expected to reign in on the dry bulk market this year, as tonnage oversupply will definitely keep rates down, especially for the larger Capesize vessels.

“The oversupply has now become too severe to counterbalance even for a strong dry bulk market that grew by 9% in 2010 and are expected to grow by 7% in 2011. The volatility in the market will come down as the upside potential will be limited. Spikes in Capesize earnings will be very rare to see during 2011 ““ if any. BIMCO forecast volatile Capesize freight rates movements going forward but at a much lower level that what have seen in recent years” Peter Sand said.

How have the recent floods in Australia been affecting the dry bulk market so far? Do you think it will take more months for cargoes supply to be restored?

The recent floods in particularly Queensland have worsened and already stressed situation in the dry bulk freight market. The seaborne freight markets for thermal coal, wheat and primarily coking coal have been badly affected as normal strong volumes did not reach the ports for shipment due to the enormous damages to the hinterland transport network. Coal exports are expected to go down by 15 million tonnes while grain quality will be downgraded and exports lower as a result of that. Mining companies and charterers called force majeure and owner and operators with ships waiting to load or on their way to the area had to seek alternative employment. This took oversupply to another high level and freight rates to another low level.
As a result of this many Panamax owners opted for a ballast trip to the Atlantic to seek employment there ““ resulting in weakening rates in US gulf. Atlantic earnings have thus gone down from USD 24,000 per day to USD 16,000 per day.
It will take months for Queensland cargoes to be back at normal level. The collateral damage from the flooding is not something that can quickly be fixed. But the situation is now slowly on the improving track, which will in turn support freight rates.

Which factors are causing this turbulence of dry bulk rates, we’ve been seeing since the start of 2009 and throughout 2010 as well?

The super-cycle in dry bulk shipping hit the wall and came to a complete stop when Lehman Bros crashed, letter of credit were impossible to get issued and demand basically evaporated from one day to the next. But the dry bulk market was rescued by giant stimuli package from all over the world, and in particular from China. The Chinese went on a buying spree on the commodity markets, taking advantage of lower prices to secure large amounts of raw materials to the benefit of dry bulk shipping. During 2010 the demand picture broadened and demand from advanced economies re-emerged to support freight rates and counterbalance the increasing flow of newbuilding coming onto the market.
The oversupply has now become too severe to counterbalance even for a strong dry bulk market that grew by 9% in 2010 and are expected to grow by 7% in 2011.
In 2009 evaporating demand caused the breakdown in freight rates ““ this is the worst thing that can happen to any market. In 2011 it is oversupply that is causing rates to come under pressure ““ this situation is expected to provide a floor under the market as demand is healthy. But it will also make the wind-fall profits due to rate spikes very unlikely to happen ““ in particular in the Capesize segment which is suffering the most.

Do you think that this volatility of the market will continue in 2011 or will things be more stable going forward?

The volatility in the market will come down as the upside potential will be limited. Spikes in Capesize earnings will be very rare to see during 2011 ““ if any. BIMCO forecast volatile Capesize freight rates movements going forward but at a much lower level that what have seen in recent years. Meanwhile, the smaller segments are predicted to continue along the recent trend as being less correlated with Capesize rates but also remain in semi-depressed condition. Freight rates across segment could very well be found in the interval of USD 10,000-16,000 per day regardless of segment on average. Influx of new tonnage into all segments is expected to limit the upside in freight rates. So in that case ““ yes I do see things becoming more stable going forward ““ but at a low that will make many owner and operators struggle.

Oversupply issues have plagued the dry bulk market since mid-2010. Are you more optimistic about 2011 or not?

I’m afraid not.Β  The dry bulk fleet grew by amazingly 16.5% equal to 76 million DWT during the last 12 months. And the same amount of capacity is due for launch in 2011. Before that it took 29 months (from August 2007 till December 2009) for the fleet to grow the same capacity.
For market participant to improve on the freight rates going forward ““ there is no real way around massive demolition and considerable lay-ups. Dry bulkers may also experiment with some slow steaming ““ but as the vessels move quite slowly already ““ the upside from applying that measure will not have the same effect to the dry bulk sector as it proved to have on the container shipping sector.

During 2010 we witnessed a strong rebound of newbuilding orders which are difficult to justify given the already huge orderbook. Are valuations really that low? What’s your opinion on the matter?

It is definitely not good news for the supply and demand balance of the industry that contracting of new vessels added to the already large orderbook to the extent that we saw in 2010. But for one the data in “the orderbook” may be overstating the real picture as information in this area of shipping is very hard to get ““ and even harder to get right. But anyway you look at it ““ the orderbook is huge ““ even if you estimate the orderbook to the 10% too high and 10% or all orders will not materialize.
Are valuations really that low? ““ I guess that answers lies in the eyes of the beholder. Looking at new contracting I would say that many will answer “yes” to that question. Newbuilding price for Panamax are back at 2004-levels ““ and up from the bottom in 2009. Newbuilding prices are kept up by increasing component costs (e.g. steel prices) but may also decline as idle newbuilding yard capacity from 2013 and onward weight in.
Should you go out and order a new Panamax vessel today and pay around USD 34.5 million -Β  you would probably need around USD 16,500 per day to breakeven on a 100% equity financed vessel making 10% in return on your investment. Should you however require a loan to finance your acquisition you could easily add another couple of thousand USD per day. Last year a Panamax made USD 20,221 per day in the spot market ““ so when you look at the market with a very long investment horizon many owners are confident that the investment will pay off in the end.

New building cancellations and scrapping of older bulkers seem to be the best chance that shipping has to improve freight rates. How is each of these solutions progressing?

As cancellation of new building orders is not that easy as some may believe it is ““ scrapping of tonnage is basically the sustainable way to move forward. But owners are of course in constant dialogue with the yard in order to postpone deliveries are or modify orders as to improve their own newbuilding and capex programme.
But for scrapping to a viable solution ““ massive amounts of old tonnage need to be scrapped. Basically to a much larger extent than the available capacity at the demolition yards may be able to handle. That makes idle of tonnage the natural third option for the market participants to make use of.

How would you characterize the current market for second hand vessels? Are asset values corresponding to current freight rates?

Sales and purchase activity is definitely high. Some owner, focussing on the asset-play, are in the market for early deliveries as they believe prices will not go lower, while other owners try to exchange 2011-deliveries for e.g. 2013 deliveries to ease some of their own short term exposure to a what seems to be a tough market. I think 2011 will be a very active year for sales and purchase activity also.
Second hand values and 1-year time charter rates tend to move in tandem. But when T/C rates weaken to the extent that we have seen lately asset prices tend to be sticky and less impacted by short term market weakness. But with the gloomy forecast for 2011 ““ asset prices are bound to come under some pressure, so asset prices dropping to the tune of 15% below current levels should not come as a surprise.

What about cargo demand in the future? Is a booming China enough on its own to sustain the global fleet growth?

To fully utilize the entire orderbook once it is delivered ““ we need more than a new China. No beating around the bush regarding that. The current orderbook still represents 52% of the active fleet even after the massive deliveries we had in 2010. But it’s not all gloom and doom in a massively oversupply environment ““ it’s merely back to basics before dry bulk shipping became “famous” with the double-super-cycles during the first decade of this century. The developing world will continue its quest for dry bulk commodities to build their societies and the world across the board will still need coal to a large extent as it is a vast source of energy.
The coming years will be full of interesting developments in the dry bulk shipping industry as we enter into a new era with focus on optimising businesses, making sure balance sheet stay healthy and industrial large customers will take much of the attention when it comes to building long-term relationships.

Nikos Roussanoglou, Hellenic Shipping News Worldwide

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