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Dry bulk chartering strategy: Who fared better?

Following a year of ups and downs in 2019, dry bulk operators were fully geared to meet the challenges of IMO 2020 fuel regulation, a global anti-pollution initiative that would greatly lower sulfur emissions from high-sulfur fuel. Operators chose one of two options – either burn low-sulphur fuel, which would lead to high operating costs, or install scrubbers for the high-sulfur fuel, which had significant upfront costs. Some operators, including Star Bulk, chose to install scrubbers on most vessels in their fleet to gain a competitive advantage over peers and thus brace for a good 2020.

But the hope that it would be a great year for dry bulk soon fizzled out when the COVID-19 pandemic hit commodities demand in early 2020. The virus outbreak coupled with global lockdowns lowered the consumption and cost of fuel while simultaneously decreasing the demand for bulk goods and rendering the scrubber investments worthless, albeit, until the demand increases. The operators that were trying to pass on their capex (incurred on scrubber installations) and/or operational (related to low-sulphur fuel) costs to charterers now had to wait.

The spot charter market, represented by the various Baltic indices, also registered multi-year lows with the Capesize index BCI diving into negative territory for the first time ever in January this year. Following the OPEC+ tussle and contrary to consensus estimates, the spread between low sulphur fuel oil (LSFO) and high sulphur fuel oil (HSFO) narrowed to a mere USD ~50 (estimated cost of desulphurisation) by 2H20, a level that would have been reached in two years under normal circumstances.

Be that as it may, at present, a balanced approach of putting vessels on long-term fixtures coupled with some exposure to the spot market seems to be an appropriate strategy as we expect markets to experience heightened volatility, notably around the US election. Although a recovery remains on track in China, US politics and the increase in COVID-19 cases in Europe have reduced the visibility around the economic and asset market outlook.

In this piece, we look at three dry bulk operators: the very aggressive Star Bulk Carriers Corp, the diversified Golden Ocean Group and the conservative Diana Shipping. All three operators have a similar fleet composition as can be seen below, but differ starkly in terms of chartering strategy and fleet deployment. Star Bulk is a pure-play spot market operator, while Golden Ocean group deploys a mixed chartering strategy and Diana shipping leans completely towards long-term fixed charters.

While Newcastlemaxes/Capesizes account for at least 50% of the fleet by capacity for the three operators, with the Panamaxes/ Kamsarmaxes taking the second biggest share of at least 30% of the fleet by capacity, the three operators employ contrasting chartering strategies.

In 3Q19, Star Bulk decided to retrofit all its vessels with scrubbers in order to comply with the IMO 2020 sulphur cap regulation; the installations are now complete. The company’s management as well as investors hoped that with some older ships of competitors being uneconomical due to IMO 2020, freight rates would rise leading to higher earnings and dividends. However, primarily due to the pandemic, 2020 has so far been the most volatile year on record for freight rates. The Capesizes in particular have seen huge swings in rates, with the market trading at opex levels for several months, followed by two USD 35,000pd spikes.

To manage this volatility, a balanced chartering approach was needed — long-term coverage where possible during weak freight periods while trading some vessels in the spot market to maintain exposure to the upswings.

In this regard, while Star Bulk had hedged majority of its exposure to fuel prices through swap contracts, the strategy was not as successful as the diversification strategy deployed by the Golden Ocean group. The latter was able to take advantage of improvements in dry bulk shipping in 2Q20 by securing additional charter coverage during the period when day rates spiked. Golden Ocean now has 38% of the remaining days for its Capesize vessels and 56% of the remaining days for its Panamax vessels this year secured by charters. The average time charter equivalent (TCE) rate of these chartered days is substantially above that of Golden Ocean in 1Q20 or 2Q20. Of the 46 Capes under operation, 25 are in the spot market and 21 in the charter market. Some of Golden Ocean’s vessels on fixed rate include KSL Sydney, a 2014-built Capesize fixed at USD 23,905pd (until February 2021), and some vessels on pegged rates include KSL Sydney’s sister ship, KSL Singapore, another 2014-built Capesize, pegged at a premium to the Baltic Capesize index.

Golden Ocean also completed the planned installation of eight exhaust gas scrubbers across its fleet during 2Q20 to comply with the IMO 2020 mandate. As a result, the company has been able to retain a greater proportion of its operating cash flows which can be used to pare down debt or reinstate the dividend policy.

Diana Shipping on the other hand enters solely into long-term fixed charters, with many current fixtures extending beyond 2Q21.

The company generated better average returns in 1H20 compared with overall returns for each vessel class mainly because most of these charters were fixed before the outbreak of the virus. Nine (of 14 Panamaxes), four (of five Kamsarmaxes), four (of five Post-Panamaxes), 10 (of 13 Capesizes) and all four Newcastlemaxes were chartered out before the outbreak of the virus and had contracts extending beyond 2Q20, as of 21 February 2020.

However, in 2Q20, Diana suffered a 26% decline in revenue year on year, in part due to a trimmed fleet which the company has pursued rather aggressively, selling older vessels in an attempt to improve fleet quality. Star Bulk and Golden Ocean on the other hand have sold no vessel so far in 2020.

For Golden Ocean, the impact of COVID-19 lockdowns is clearly visible on the financial results. Unlike the US, China was primarily shut down in the first quarter and not the second. As we can see, the average charter day rates for all categories of dry bulk ships were much higher than in 1Q20 for the group, although they are still much lower than a year ago.

On the other hand, Star Bulk had spot fixtures and swap contracts (hedging contracts) for majority of 1Q20, which allowed it to secure strong rates for its larger vessels. However, after a weak 1Q20, Star Bulk suffered in 2Q20 with rates falling significantly below the average rates both in 1Q20 and in 2Q19. It is noteworthy that during 2Q19 large vessel average rates took a major blow as many vessels were out of charter for scrubber installations.

Star Bulk’s strategy relied heavily on acquisition of vessels and fitment of scrubbers in all of them to gain competitive advantage over peers when IMO 2020 regulation would have kicked in. Golden ocean, on the other hand, maintained its diversification strategy on scrubbers as well, with 15 of its vessels retrofitted with scrubbers, and the remainder running on IMO-compliant fuel. Diana, meanwhile, has kept up its defensive approach in terms of management, utilizing the vessel sale proceeds to clear debt and buying back shares, instead of acquiring vessels.

Conclusion
During the current volatility when concerns around a second wave of COVID-19 pandemic loom amid US elections, dry bulk operators would like to play safe in our view. In light of this, a balanced chartering approach, similar to that of Golden Ocean Group, is necessary to navigate the swings, taking long-term coverage where possible during weak periods, while keeping a portion of the fleet trading in the spot market to maintain exposure to the upswings. Separately, should the dry bulk market face a bull run, Star bulk becomes the obvious choice. Conversely, if the spot market is muted for long periods, Diana becomes the go-to-stock.
Source: Drewry

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