Global Shipping Is On Course For Recovery In 2018, But All Eyes Are On Orderbooks
S&P Global Ratings believes that, in 2018, demand in the three main segments of the global shipping industry (dry bulk, tankers, and containers) will outstrip supply for the first time in several years. The lighter new vessel delivery schedule for 2018, compared with 2017, combined with our expectation of sustained imports of commodities, and longer distances travelled, point to rising charter rates across the shipping industry this year–with the exception of the container liner segment, which we forecast will see flat rates or a slight dip. What’s more, given the fundamental improvement in supply conditions, as signified by ship orderbooks being at close to all-time lows, we think recovery in shipping rates could continue beyond 2018. However, we see a risk that vessel owners, renowned in the industry for their historically poor supply discipline, could embark on an ordering spree in anticipation of better times ahead. This would disrupt the encouraging supply trend and constrain charter rates. But, assuming a typical lead-time from ship ordering to delivery of 18-24 months, we expect a slowdown in supply growth for at least the next few quarters, regardless of ordering activity.
While our base case assumes no major glitches on the demand side, underpinned by our firm 2018-2019 GDP growth forecast for all major contributors to global trade volumes, especially China, but also the eurozone and the U.S., all eyes are on the supply side and orderbooks, which will essentially shape the shipping industry beyond the likely solid 2018. If owners refrain from aggressive ordering and supply tightens further, we could see momentum in charter rates continuing into 2019. (Watch the related CMTV posted Feb. 13, 2018, titled “All Eyes On Orderbooks: Global Shipping Outlook For 2018”.)
- We expect industry conditions to strengthen in 2018 for most of the 17 shipping companies we rate globally.
- While improved supply conditions will likely prop up charter rates this year, a further recovery beyond 2018 will depend on prudent capacity management decisions by vessel owners.
- Sustained global demand for commodities is essential for further improvement of dry bulk shipping rates.
- We forecast a cyclical upturn for product tanker rates following soft rates in 2017, as the new vessel delivery schedule for this year is close to historical lows.
- Given uncertainties in container liners’ maintenance of supply discipline, we forecast flat to slightly negative growth in freight rates in 2018.
Stable Outlooks For Most Rated Issuers, Due To Resilient Charter Rates
Our 2018 industry outlook, which points to generally resilient charter rates, mirrors our stable outlooks on the majority of rated ship operators. We rate 17 shipping companies globally (see table 1), two-thirds in the single ‘B’ category, following several negative rating actions over the past few years of industry downturn and unsustainable charter rates. Ratings stabilized in 2017, with positive rating actions outnumbering negative rating actions by ten to seven (see table 2). The vast majority of the seven negative rating actions were related to company-specific issues rather than industry conditions.
We view liquefied natural gas (LNG) shipping and passenger ferries as the most attractive shipping segments, because gas tankers typically operate under very long-term take-or-pay contracts with reputable counterparties, and ferry companies tend to face more stable demand and pricing, and lower capital intensity compared with conventional shipping. Container and dry bulk shipping are the most risky segments in our view, because of typically weak credit quality of charterers, among other factors.
Despite the overall stable outlook, a few downgrades and upgrades could follow in the next 12 months, as signified by the five negative outlooks or negative CreditWatch placements and two positive outlooks. The vast majority of negative outlooks and CreditWatch placements point to downside coming from developments unrelated to charter rate prospects, such as potential covenant breaches, increased financial leverage due to an acquisition, or a likelihood of downgrade of the sovereign rating.
Financing Difficulties May Keep A Lid On Fleet Sizes
We note a few impediments to a significant pick-up in new vessel orders, such as the generally stretched financials and borrowing capacity of vessel owners after several years of the industry downturn, and low appetite from lenders for shipping loans. Most European banks, traditionally the dominant ship financiers, have significantly reduced their exposure to the shipping industry, or even exited it completely over the past few years. We attribute the shift to internal considerations such as scarcity of bank capital, stricter regulatory capital rules, an escalation in restructuring of shipping debt, and a material weakening in the quality of banks’ shipping portfolios because of low vessel values. Funding has consequently become more scarce and selective and we expect this to remain the case during 2018. Chinese and Korean banks have stepped in to partly fill the funding gap because shipbuilding is important to their economies, but these lenders alone are unlikely to reduce credit scarcity for all ship operators.
Dry Bulk Shipping Charter Rates Should Continue Recovering In 2018
Dry bulk vessels move the raw materials of global trade–commodities such as coal, iron ore, and grain. For this segment, we forecast that demand growth will exceed supply growth again this year. A combination of supporting fundamentals bodes well for the dry bulk shipping rates in 2018, most importantly:
- Rising iron ore, coal, and grain ton-mile demand. China, the world’s single-largest commodities’ importer, is bringing in additional volumes from more distant places than before, such as Brazil and North America, because of a pollution-focus-related shift to higher-grade imported commodities (most importantly iron ore and coal) and diversification of supply sources; and
- A close to all-time-low orderbook. The dry bulk vessel orderbook currently represents about 8% of the global fleet (compared with around 80% 10 years ago), and is to be delivered over the coming two to three years, according to Clarkson Research.
The sector experienced a strong rebound in charter rates last year (from rock-bottom levels) because the growth in demand for commodities exceeded fleet expansion. For example, the average time charter rate for the benchmark Capesize ship was $15,000 per day in 2017, which was double the equivalent rate in 2016, according to Clarkson Research.
We expect fleet growth will trend markedly below last year, considering the muted new vessel delivery schedule this year, including the upside coming from non-deliveries, cancellations, and delays, which we assume will be 30%-40% of scheduled deliveries (the historical five-year average rate). We therefore forecast that demand growth will outpace net fleet growth, as long as China continues its firm imports of commodities to support its economy. We forecast GDP growth for China will only marginally soften to 6.5% in 2018 and 6.3% in 2019, compared with 6.8% in 2017. This level of GDP growth, combined with Chinese regulatory pollution targets that stimulate imports of high-grade commodities, should keep the global demand growth rate in a low-to-mid single-digit range. Accordingly, we forecast that vessel utilization rates and charter rates will continue recovering this year after a rebound in 2017. Our base case in 2018 incorporates an average rate for Capesize vessels of $17,000 per day and for Panamax vessels $12,000 per day. This corresponds to the respective industry average rates seen in the fourth quarter of 2017, as reported by Clarkson Research.
But Improving Rates Are Sensitive To Global Indicators
A significant drop in global trade volumes, a key engine of shipping growth, would be damaging to the industry. We forecast solid growth in developing, mainly Asian, economies will stimulate commodities’ trade in 2018, but there are evident risks in the demand outlook. A slowdown in commodity imports and consumption by China (by far the largest iron-ore and coal importer), in particular, would harm the dry bulk shipping industry, which heavily invested in new vessels a few years back believing in China’s ability to deliver a consistently solid economic expansion. Furthermore, any changes to Chinese regulatory policies, for example, tougher restrictions on heavily-polluting industries, such as the steel sector, may be detrimental to international commodity markets. A renewed weakness in commodity prices, reversing the recovery in prices in recent quarters, could also disrupt improving trade dynamics in Canada and most Latin American economies. Furthermore, if aggressive ordering unexpectedly resumes and scrapping (which slowed over the past quarters) does not offset this, it will interrupt the process of rebalancing the industry and keep a lid on dry bulk charter rates.
The Outlook Is Better For Product Tankers, But Crude Tankers Will Still Struggle
We see a cyclical upturn for oil-product tanker rates just around the corner, as the new vessel delivery schedule for 2018 is historically low. Crude tanker rates, on the other hand, will likely remain under pressure this year because of OPEC oil production restrictions and a spike in vessel orders in 2017.
Tanker rates declined further in 2017, from the already soft rates in 2016. This was the result of the accelerated delivery of new tonnage outstripping relatively stable tanker ton-mile demand. Demand was constrained by the reduced oil production by OPEC and non-OPEC exporters and by high oil and petroleum-product inventories, which suppressed export volumes.
In 2018, we expect supply growth for product tankers to noticeably slow, in particular for medium-range tankers. At the same time, demand should be enhanced by tightening oil product inventories, leading to an uptick in charter rates. Crude tanker rates will have to wait longer for a meaningful rebound. OPEC recently extended its production restrictions until the end of 2018 (with a review in June 2018), which will hamper oil supply. In addition, there’s a firm order book for larger crude tankers after an unexpected spike in orders in 2017. These orders were driven by attractive vessel prices, but did not take into account the weak rate conditions and gloomy prospects. And they will be only to some extent counterbalanced by enlarged vessel scrapping.
The Supply/Demand Balance Is More Fragile For Container Liners
Although the overall supply and demand conditions have shifted in favor of ocean carriers, with trade volume growth likely outpacing fleet growth in 2018, we remain cautious on the freight rates’ outlook. Average freight rates on major trade lanes recovered to more sustainable levels for container liners last year, thanks to decent trade volumes, supply-side measures (such as vessel scrapping and lay-up), and streamlining of networks after yet another wave of industry consolidation. However, significant deliveries of ultra-large containerships are scheduled in 2018 and beyond. These were ordered a few years ago by ship owners looking for economies of scale to be reaped from utilizing such ships. They will pose a threat to the recent rebound in freight rates, in particular on the main Asia-Europe lane (a home for mega-containerships), despite the likely favorable supply-and-demand industry balance in general. According to Clarkson Research, the current order book for post-panamax containerships–which have a capacity of more than 15,000 twenty-foot equivalent unit–may almost double the size of the global post-panamax fleet within the next two to three years.
Bearing in mind the persistent supply burden, freight rates will ultimately depend upon how prudent the leading container liners are in their capacity management decisions. Taking into account historically poor supply discipline, we see a risk that new orders will accelerate. We are alerted to the most recent orders of 20 mega box ships by industry leaders MSC and CMA-CGM. And, given the container liners’ traditional battle for market shares, new orders from other players may follow. In addition, the demolition of older tonnage remains a critical supply-side measure to help correct excess capacity and stabilize rates at commercially viable levels. However, we are mindful that the pace of scrapping has slowed in recent quarters. Given all these uncertainties, we forecast flat to slightly negative growth in freight rates in 2018, coming from the much-improved average rates in 2017.
Consolidation Has Reshaped The Container Industry And Could Lead To More Sustained Rates
During the next 12-18 months–after the most recent acquisitions have been integrated, shipping networks and customer platforms aligned, and cost synergies realized–we expect to see whether consolidation in the container industry, with capacity management decisions now in hands of fewer players, translates into more sustained profitability. The liner industry has been through a few rounds of consolidation over the past several years, as an answer to erratic rate movements and recurring operating losses, including the most recent acquisitions of Hamburg Süd by Maersk Line, United Arab Shipping Company by Hapag-Lloyd, and Neptune Orient Lines by CMA CGM. The consolidation led to a structural change of container liners’ competitive landscape so that the share of the top five players escalated to around 65% this year from 30% around 15 years ago. About half of the top-20 players were either absorbed by mergers or defaulted (Hanjin Shipping), and the gap between the larger and smaller players, as measured by their total carrying capacity, has markedly widened. What’s more, it appears that size in this industry matters, as reflected in the above-industry average EBIT margins reported by the largest liners, such as Maersk Line and CMA CGM, over recent quarters.
A more concentrated industry is normally more rational and efficient, but a risk of destabilization remains, with a background of historically aggressive capacity management by the largest players. Our base case assumes that, notwithstanding the consolidation efforts, the container liner industry will remain volatile because of its asset-intense, operating leverage-heavy, and network-based nature. But cyclical swings could be less pronounced and of shorter duration, and mid-cycle freight rates could trend above the operating cost breakeven. We note that the drop in freight rates toward the end of 2017, as the industry hit the seasonal trough, was followed by a quick correction in rates at the beginning of 2018, which could be a sign of more reactive capacity management and which we would normally expect from a more concentrated industry.
The Improved Supply/Demand Balance May Help Spot Operators Pass On High Bunker Prices
Because bunker (ship fuel) accounts for a large share of voyage expenses that ship operators incur, a shipping company’s profitability depends greatly on its ability to pass on higher fuel prices through contracts or hedging instruments. If oil prices were to trend markedly above our current assumptions (see “S&P Global Ratings Raises 2018 Brent And WTI Oil Price Assumptions,” published Jan. 18, 2018), the resulting higher cost of bunker could hamper ship operators’ cash flows, and wipe away the upside coming from more favorable supply and demand conditions, unless the cost inflation is successfully passed through to customers.
Typically, dry bulk-, tanker-, and gas-carrier operators are protected from rising fuel prices because they operate vessels under bareboat- or time-charter contracts, whereby the charterer pays the bunker fuel bill as per a contractual agreement. However, spot operators–which enter into short-term charters, often for a single voyage at market rates–as well as container liners and ferry operators bear fuel risk. In general, they find it difficult to pass on bunker cost inflation, particularly if the industry is oversupplied. But improved supply and demand conditions and vessel utilization should play in the ship operators’ favor this time around.
High bunker prices call for our close monitoring, with a current spot price in Rotterdam at a three-year high of $370 per ton according to Clarkson Research, compared with an average of around $300 per ton in 2017 and the three-year low of $100 per ton in January 2016.
A decision by OPEC to relax its oil supply control and increase production would likely prevent oil prices from rising, or even stimulate a fall in prices, and prop up consumption and international trade, which are key demand drivers for crude oil shipping. Most importantly, a low bunker price would support shipping companies’ profits across all segments, but particularly for container liners, given their largely fixed network cost base. That said, the current OPEC-led production cuts until the end of 2018 remain the key constraint to global oil supply. If there were further unexpected cuts and a resulting surge in oil prices, this would dent demand, disrupt trade, and have an adverse knock-on effect on the crude tanker segment, in particular, which has to absorb a flood of new tonnage delivered in 2017 and some to hit the water in 2018.
Environmental Regulations Will Add Costs Over 2019-2020
International regulations to be implemented over the coming two years will increase either capital or operating expenditure for ship owners. The shipping industry will have to comply with environmental regulations, such as IMO Ballast Water Treatment System (BWTS) from 2019 and IMO 0.5% Low Sulphur Limit from 2020. Measures to comply with the regulation include, for example, installation of BWTS and scrubbers or conversion of engines to use LNG as fuel, all of which will add to capital expenditure. Operators who don’t install scrubbers would need to run their fleet on a higher-cost low-sulfur marine diesel oil to be complaint, pushing up operating expenditure.
On the positive side, we anticipate that owners of older ships might view the necessary extra investment as economically unviable and send the aging tonnage to the scrap-yard through 2020, which would help to limit net fleet growth. Dry bulk ships, tankers, and containerships that are older than 20 years are close to the end of their useful life. Ships of such age account for 5%-7% of their respective global fleets, according to Clarkson Research, and are potential candidates for demolition by 2020, in our view.
Source: S&P Global Ratings