China-Russia vs. US-EU: How global shipping is slowly splitting in two
Another meeting between a House speaker and Taiwan’s president, another spike in tensions in the Taiwan Strait.
Last summer’s meeting between Taiwan President Tsai Ing-wen and Nancy Pelosi prompted Chinese live-fire exercises. Wednesday’s meeting with Speaker Kevin McCarthy prompted another large-scale Chinese military exercise in the Taiwan Strait, with the situation becoming increasingly tense by Sunday.
Ever-worsening relations between China and the U.S. — which took yet another big step down after February’s spy balloon incident — are part of an evolving story for international trade. Shipping fleets and cargo flows are becoming increasingly bifurcated.
In 2022, the Word Trade Organization (WTO) warned about a worst-case scenario it called “long-run decoupling” that involved the “disintegration of the global economy into two separate blocs,” highlighting research by Carlos Goes and Eddy Bekkers.
A WTO working paper published this January analyzed an outcome called “geopolitical rivalry,” featuring a “bipolar trade war” with severe consequences for future GDP and trade volumes.
The authors (Jeanne Metivier, Marc Bacchetta, et. al.) looked at two sub-scenarios: “full rivalry,” in which all countries join either the Western or Eastern trade bloc, and “partial rivalry,” in which some countries remain neutral and trade with both.
The “partial rivalry” scenario should sound very familiar to those following current developments in ocean shipping, most visibly in tanker shipping, but also in container and dry bulk shipping.
Geopolitics is cleaving global shipping systems into two, with the U.S. and EU leading one side and China and Russia leading the other, and some countries trying to stay in the middle, play both sides and keep their options open.
Tankers: Near-term positive
The geopolitical schism is initially positive for tanker shipping rates but has the potential to turn negative in the future.
The Russia-Ukraine war rerouted Russian crude from the short-haul EU trade to long-haul runs to China and India, and Russian diesel from the EU to replacement buyers in North Africa, Asia and South America. The EU replaced lost Russian barrels with more-distant supplies from the U.S., the Middle East and Asia.
Shipping demand is measured in ton-miles: volume multiplied by distance. The post-invasion trading pattern is far less efficient than the pre-war pattern, significantly boosting tanker ton-miles, a plus for freight rates.
The same distance effect was seen previously after sanctions against Iran, which shifted Iranian crude exports that previously went to the EU and India onto longer routes to China; and with sanctions against Venezuela, which shifted that country’s crude exports from the U.S. to China.
Geopolitics has also caused a bifurcation in the tanker fleet, a physical manifestation of the decoupling scenario laid out by the WTO.
On one side are tankers transacting in U.S. dollars and using Western insurance and finance providers. On the other, now representing 10% or more of global tanker tonnage, is the so-called “shadow fleet,” vessels with opaque ownership that do not transact in dollars and do not use Western services.
The shadow fleet first emerged after sanctions against Iran, grew after sanctions targeted Venezuela, and ballooned after Russia invaded Ukraine. Older crude and product tankers continue to be purchased by buyers in the Middle East, China and India for use in the growing shadow fleet.
Longer-term risks to tanker demand
Geopolitical unrest poses downside risks to tankers, as well.
The higher the global GDP growth, the better for oil demand over the long term. The January WTO working paper by Metivier and Bacchetta estimates that a shift to geopolitical rivalry as opposed to multilateral cooperation would translate into a 6.4% GDP hit for developed countries through 2050, a 10.2% GDP loss for developing countries, and a 11.3% GDP blow to the least developed countries.
Moreover, an escalation of the Ukraine-Russia war or a military conflict involving the U.S. and China over Taiwan is predicted to have a highly negative effect on the global economy, tanker demand and tanker stocks.
Robert Bugbee, president of Scorpio Tankers (NYSE: STNG), said during a luncheon presentation in January, “It’s a given to me that the Chinese won’t forget about Taiwan. It’s a given to me that the Chinese will go for it in the future. But it’s such an enormous thing, should it happen, that you can’t think about it on an everyday basis. You just put it in the back of your mind and get on with it, as an operator.”
Oystein Kalleklev, CEO of Flex LNG (NYSE: FLNG), said at a Marine Money conference in November that a future U.S.-China war is “almost not even worth worrying about because the consequences are so big. If that happens, we’re all screwed. Russia and Ukraine would look like a small bump in the road. You would have an energy shock like you’d never seen before. The whole world economy would stop.”
Container shipping: The ‘friend-shoring’ effect
U.K.-based consultancy Drewry highlighted the effects of geopolitical unrest on container shipping in a report released on Tuesday.
According to Drewry, the “superpower grudge match” between the U.S. and China “has been brought to a boiling point by Russia’s invasion of Ukraine,” with Russian President Vladimir Putin “a useful puppet to China” who “can help widen the geopolitical schism and bring more countries over to [China’s] side.”
Geopolitics is heightening the focus on “friend-shoring” — container trade between trusted countries that share common values. “If friend-shoring becomes the standard trading model, ocean carriers will need to start thinking creatively about how they can continue to serve both sides of the divide,” said Drewry.
“It will also put countries such as Vietnam and India in a very awkward predicament. They are understandably trying to play both sides at the moment. But there will come a time when China or the U.S. will decide for themselves if they are one of theirs or not.”
To put it in the terms of Metivier and Bacchetta, the “partial rivalry” pattern seen in shipping markets today could evolve into a “full rivalry,” with no one able to play the middle anymore.
Container ships dedicated to Russian trade
The splitting of the fleet seen in tanker shipping is also apparent, albeit to a much lesser degree, in container shipping.
Almost all container shipping lines, with the notable exception of MSC, ceased serving Russian ports shortly after the invasion of Ukraine. Other ship operators are now filling in the gaps left by the departed ocean carriers.
“MSC keeps on continuing to trade with Russia — and with New York. It’s interesting how it can do that,” said Clemens Toepfer, managing director of ship brokerage Toepfer Transport, during the 17th Annual Capital Link International Shipping Forum, held recently in New York.
The departure of other ocean carriers has spurred higher activity in the secondhand container-ship market, akin to the purchase of older tankers for transfer to the shadow fleet.
“There is buying interest to replace the ships withdrawn from the market,” said Toepfer, who reported that “about half of the purchasing interest for container ships is backed by trade into Russia — buyers from Turkey, Dubai and China who are actively looking into that area.”
Geopolitical downsides for container shipping
Geopolitical unrest poses high risk to future container shipping demand. Reshoring of manufacturing to the U.S. and nearshoring to Mexico would reduce trans-Pacific volumes.
Furthermore, container shipping is more exposed than tanker shipping to global GDP, which economists argue will be negatively affected by geopolitical rivalry versus multilateral cooperation.
George Youroukos, chairman of Global Ship Lease (NYSE: GSL), said at the Capital Link forum, “To predict [the future] of container shipping you see what the supply of ships is and you look at the world economy. We know the orderbook. The unknown is the world economy.”
And the fallout from a war involving China would be as extreme or more extreme for container shipping than for tanker shipping.
“How do you take the proportion of global trade that moves through the South China Sea today and say, ‘OK, we’re just going to stop that because there’s a live war going on?’” said Paul Bingham, director of transportation consulting at S&P Global, in an interview with FreightWaves last year.
America remains extremely dependent on containerized imports from China. U.S. Customs data shows that imports from China represented 30% of total U.S. imports in 2022.
Dry bulk fleet splitting as well
Dry bulk is the largest ocean freight market in the world, measured in terms of cargo volume. It too is bifurcating.
The near-term effect on dry bulk is similar to tanker shipping. Trade has become less efficient. Bulkers with Russian cargoes are sailing longer distances and are not loading non-Russian cargoes on backhaul legs, leading to less triangulation, higher ballast time and lower utilization.
This is positive in the near term for rates. However, in the longer term, dry bulk demand is heavily driven by global GDP and the Chinese economy in particular, both of which would theoretically suffer under a “geopolitical rivalry” trade scenario.
The EU banned imports of Russian coal after Russia invaded Ukraine. It’s now buying coal from sources farther afield (Colombia, South Africa, U.S., Australia). Russian coal exports have shifted to longer-haul voyages to India and China.
Brokerage BRS reported Thursday on how much farther bulkers loaded with Russian coal are having to travel.
“Since the war, as trade flows realigned, the average laden sea duration has worsened from 19.07 days to 34.82 days — up 82.6% year on year — a stark reminder of how geopolitics and sanctions have the unintended effect of introducing supply chain efficiencies,” said BRS.
Mark Nugent, senior analyst at ship brokerage Braemar, wrote in a research report that China’s imports of Russian dry bulk cargoes rose 25% in the year since the war, with Indian imports of Russian dry bulk up almost three-fold.
Nugent also pointed to a growing number of bulkers that are “almost exclusively dedicated to performing Russian trades.” He added, “We have seen this fleet grow as some owners look to bolster their fleets with older tonnage to take advantage of the freight premiums when calling in Russia.
“While not necessarily a ‘shadow fleet’ as in the tanker market, it has developed into somewhat of a two-tiered market, as these vessels have rarely deviated to perform other trades.” The number of bulkers that are going directly back to Russia after discharging Russian dry bulk exports has increased by around two-thirds since the war began.
More dry bulk players choosing sides
Other examples of “choosing sides” are piling up.
On Monday, trading giant Louis Dreyfus announced it would cease handling Russian grain exports as of July 1. That move followed announcements the week before by trading houses Cargill and Viterra that they would cease handling Russian grain exports.
Elsewhere in global grain trades, Nugent wrote that “Brazil and China have been working to improve trade relations in recent months, most recently agreeing to trade in their own currency and bypass the U.S. dollar as an intermediary.”
Add it all up and it looks like cargo flows and shipping fleets are on a path toward fragmentation. As the WTO warned in its new world trade outlook, released Wednesday, “Fragmentation … remains a significant threat, which could hinder economic growth and reduce living standards over the long term.”
Source: Freight Waves by Greg Miller, https://www.freightwaves.com/news/china-russia-vs-us-eu-how-global-shipping-is-splitting-in-two