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Riding the bulk carrier market cycle: rebalancing after a boneshaking journey

A recurring question arises. Is a long-awaited bulk carrier freight market recovery now under way? Over most of the past decade, this sector has been weak, providing only meagre returns for shipowners. But, after a number of false dawns, improvements in freight rates during 2017 and the causes point to, possibly, a more sustainable upturn unfolding.

Market cycle history shows great variations in duration, and the current cycle in the global bulk carrier market is proving to be one of the longest. Historically also, large variations in amplitude have occurred. The current cycle’s downturn and trough has been very deep and most painful for owners, although impressions of weakness tended to be accentuated by comparison with the preceding boom’s strength and length.

An excruciating freight market trend

During the nine years elapsing since the great freight rates crash amid the global financial crisis in the second half of 2008, several nascent revivals failed to develop into an enduring recovery. Excessive growth in the world bulk carrier fleet was a persisting feature. This growth was exacerbated and prolonged by intensive bouts of new vessel ordering, when market sentiment among owners sensed better conditions approaching. An abrupt slowdown in world seaborne dry bulk trade expansion in 2015 and 2016 aggravated the demand/supply imbalance.

Baltic Exchange Dry Index (BDI), monthly averages, November 1999 to October 2017

The Baltic Exchange Dry Index (BDI) chart broadly emphasises how weak freight rates for bulk carriers have been in recent years. For the past almost seven years, from January 2011 to September 2017, the BDI monthly average only twice exceeded 2000 points (2072 in October 2011, and 2178 in December 2013). Mostly the index has been below 1500 points.

Following a spectacular downturn from a peak 10,844 points average in May 2008, to just 743 in December of the same year, amounting to a 93 percent peak-to-trough reduction in that phase, a partial rebound was seen in 2009 in the crisis period aftermath. This rebound continued into 2010, after which it subsided. Subsequently a few short-lived improvement spikes were recorded, but the general trend was very subdued, culminating in a depressed low-point of 307 in February 2016. Since then an upturn has evolved, leading to an average 1484 points in October 2017.

Revisiting the mega-boom

Although now perhaps fading into maritime history, the features of the bulk carrier freight market boom a decade ago, starting in late 2003 and extending into mid 2008 are still illuminating. This boom period provides an example, albeit an extreme one, of what can happen in the marketplace when vessel demand and supply growth trends diverge.

Looking at the main demand indicator for bulk carrier transport services, world seaborne trade in all dry bulk cargoes together increased at annual rates of 6 percent to 9 percent in the five years from 2003 to 2007. This was a remarkable period of strong advances averaging 6.9 percent annually. In volume terms annual totals grew by a cumulative 984 million tonnes, reaching 3493mt in 2007, based on Clarksons Research calculations.

Within this global growth, extra imports into China comprised a large proportion. China’s dry bulk imports rose from 217mt in 2003, to 594mt in 2007, a cumulative 377mt rise in the annual figure. Consequently, China’s imports expansion comprised 38 percent or nearly two-fifths of the entire world trade increase. Higher imports by all other countries comprised the remaining 62 percent.

Vigorous global economic growth underpinned strong production trends in industries in numerous countries requiring imported dry bulk commodities. Additional import demand for agricultural commodities also contributed. The upsurge in China, which was modernising and becoming more open to trade, was especially notable amid greater dependence on foreign sources of raw materials, fuels and agriproducts.

On the supply side of the freight market, bulk carrier capacity growth in the world fleet initially lagged because the strong trade expansion was not foreseen. In 2003, when freight rates started to surge during the final quarter, only a small 2 percent annual fleet increase occurred, resulting from preceding market weakness.

Over the next four years, higher freight rates led to higher newbuilding deliveries and lower scrapping, raising fleet growth to an average 6.9 percent annually, similar to trade growth. Bulk carrier capacity rose by 98 million deadweight tonnes over the 2003 to 2007 five years according to Clarksons Research data, reaching 393m dwt at end 2007.

These indicators of demand for, and supply of, bulk carriers during the freight market boom period are rather simplistic. Other influences, mostly harder to measure, affect the market balance. On the demand side, another key determinant is changes in the geographical pattern of trade. Longer average voyage distances raise demand by boosting ‘tonne-miles’. On the supply side fleet productivity is a crucial influence, affected by vessel speed, incidence and length of ballast voyages, port calls duration, part-cargo loading and other factors.

Despite the partial inadequacy of statistical measures available, however, it is clear that global bulk carrier demand expansion far exceeded the world bulk carrier fleet’s ability to expand transport capacity through that period. The textbook result was high, sometimes extremely high, freight rates.

The crash and its brutal aftermath

The global financial crisis which occurred during the second half of 2008, with its destructive effects on the world economy and trade, brought an abrupt end to the bulk carrier market ‘boom of two lifetimes’, sometimes characterised as a ‘super-cycle’. However, global dry bulk trade began reviving in the second quarter of 2009, followed by a sustained rebound in the following periods, aiding a partial freight market recovery. Market participants concluded that a complete disaster or catastrophe had been averted.

Swift intervention by governments was seen amid the financial markets crisis. The vast scale of problems resulted in the “biggest, broadest and fastest government response in history”, according to one commentator. Nevertheless, a severe downturn proved unavoidable, and the world economic recession which unfolded in late 2008 and first half 2009 was described by the OECD organisation as the ‘deepest and most synchronised recession in our lifetimes’.

Although there was a dramatic deterioration in economic activity and international trade towards year-end, global seaborne dry bulk trade continued growing in 2008 as a whole, at a much slower 2 percent rate. Benefits were derived from buoyant activity before the second half collapse and also China’s continued imports expansion. Meanwhile, the world fleet of bulk carriers fully maintained its previously robust expansion, increasing by almost 7 percent in that year.

Reflecting the strength and longevity of the previous freight market boom which had boosted investors’ optimism, a gigantic orderbook for new ships had accumulated at shipbuilding yards. Global orders for newbuilding bulk carriers, at end 2008, stood at 326m dwt according to Clarksons Research. This volume was equivalent to over three-quarters of the existing fleet, implying a huge new capacity surge entering the market over the following few years.

Significantly, 2009 proved to be the only year in recent maritime history when there was an actual decline in world seaborne dry bulk trade. That year’s volume was 129mt or almost 4 percent below the previous twelve months, at 3430mt. Greatly increased imports into China prevented a much larger global fall occurring. In the same year, world bulk carrier fleet expansion accelerated, with total capacity increasing by over 10 percent.

A prolonged and painful rectification

During the post-crisis years excessive fleet growth, reinforced and prolonged by more contracts for new capacity, became the typical pattern. Newbuilding deliveries reached massive quantities, especially in the 2010 to 2013 period, when a total of 345m dwt was recorded. Another significant element expanding the fleet was conversions of tankers to bulk carriers, which mostly occurred during a period starting in 2008 up to 2011, when 25m dwt was added.

In 2010 a rebound in dry bulk trade from the previous year’s extreme weakness was seen, a vigorous 12 percent increase. But the bulk carrier fleet expanded even faster, with 17 percent growth, as a result of greatly enlarged deliveries of new vessels ordered earlier through the market boom.

Over the next two years fleet expansion substantially exceeded trade advances. Although a closer growth relationship seemed to be evolving in 2013 and 2014, in the following two years, 2015 and 2016, trade again underperformed compared with the fleet’s reduced growth rate.

Comparing these trade and fleet statistics provides a rough explanation of why a full dry bulk freight market recovery proved so elusive and slow to develop. The figures are very broad indicators of the continuing market imbalance, the evolving gap between cargo movements and fleet capacity. Other influences also affected the demand for, and supply of, bulk carriers.

Within the entire period of eight years since the crisis, from 2009 to 2016, global seaborne dry bulk trade annual volumes grew by 1336mt, an overall 38 percent increase, reaching 4895mt in 2016. More than two-thirds of the expansion was comprised of additional imports into China.

Bulk carrier fleet deadweight tonnage growth was much faster at 89 percent over the entire eight years period, raising capacity by 374m dwt, to 794m dwt at the end of 2016, based on Clarksons Research figures. Enlargement was massive despite extensive orderbook slippage and postponements, reflected in many newbuildings delivered much later than originally scheduled, accompanied by order cancellations.

Why did this pattern of unbalanced trade and fleet expansion persist for so long? At various stages shipowners’ collective optimism about freight market recovery and the merits of adding new capacity proved misjudged. The enthusiastic pro-active approach towards investment in new bulk carriers was facilitated by several advantages. Profits previously accumulated, low interest rates, and attractive newbuilding prices offered by shipbuilding yards contributed and, in some cases, a counter-cyclical strategy was added justification.

The bulk carrier newbuilding orders trend since the market crash of 2008 was reinforced by two surges. The symbolic 100m dwt level was exceeded in both cases. During 2010 bulk carriers totaling 102.3m dwt were ordered. This total was equivalent to 22 percent of the existing fleet at the beginning of that year, when the global orderbook was still extremely high after the boom years. The order book before those orders were placed equated to almost two-thirds of the current fleet.

In 2013 another surge occurred when bulk carrier newbuilding orders totaled 103.3m dwt, and this pattern extended into 2014 when a further 63.8m dwt was added. Orders placed in 2013 were equivalent to 15 percent of the existing fleet at the year’s beginning, a lower annual percentage than in the preceding surge because of the strong fleet growth in the intervening years. The 167m dwt total of two years’ orders greatly boosted the overall orderbook again.

Positive freight market sentiment about an approaching recovery, stimulating investment in new vessels, was encouraged by the trade picture. After the initial sharp trade revival in 2010, consistently robust expansion was seen in the following four years, 2011 to 2014, when world seaborne dry bulk trade grew at annual 5-6 percent rates, similar to growth during the preceding boom period. In particular, China’s dry bulk imports expanded very strongly. Later, in 2015 and 2016, global trade growth became minimal and began to alter perceptions of the future pattern.

Despite support for bulk carrier demand during much of the extended post-crash period, it was clear that overcapacity in the freight market was pervasive and unlikely to be eliminated quickly. Vigorous vessel ordering activity periodically refilled the new capacity pipeline, eventually being reflected in actual newbuilding deliveries. This trend was instrumental in driving fleet growth beyond what was required for a sustainable market rebalancing.

Promising signs of recovery unfolding?

Eventually freight market cycles develop another phase, although the timing and magnitude of a new phase is often difficult to predict. Amid the prolonged trough of the current cycle, there are now signs that a strengthening phase is either already under way or approaching. How quickly or robustly this recovery period will evolve remains unclear. Uncertainties are apparent on both demand and supply sides of the bulk carrier market balance.

Early last year a critical point was reached, causing a widespread reassessment by shipping investors and others of the bulk carrier sector’s prospects. This revised view resulted in collective action over the period since then which is likely to hasten and intensify a market rebalancing.

Through 2015 there was a very subdued freight market, preceding extreme weakness at the beginning of last year. This market depression in early 2016 finally was enough to have a profound impact, and turn sentiment around. One consequence was that bulk carrier scrapping, which had already almost doubled in volume, remained high in 2016. While newbuilding deliveries continued to be relatively large, reflecting an order book that was still extensive, fleet growth last year remained restricted to an annual rate of just over 2 percent.

A modest pickup seen in the trade trend also assisted the freight market. Annual growth in world seaborne dry bulk trade resumed during 2016, albeit at a slow rate of one percent, after virtually no increase in the previous twelve months. The return to robust growth in China’s dry bulk imports last year, after a reduction in the previous period, was a sizeable contribution.

As another direct reaction by shipowners to very low freight rates, of significance for the longer term has been the retreat of ordering activity for bulk carriers. Last year the annual newbuilding contracts total fell steeply to 14m dwt, from an already low 24m dwt in the previous twelve months. There has been more activity in 2017, but it has remained tightly constrained. Resulting from limited recent and earlier ordering, the much reduced schedule for deliveries in the period ahead implies slow fleet growth next year at least, assuming that scrapping is fairly substantial.

An additional positive influence this year, aiding the move towards market rebalancing, has been a brisk gain in dry bulk trade growth momentum. The acceleration has enabled the freight market to strengthen solidly from last year’s depressed levels, even though bulk carrier fleet expansion has also picked up, mainly because of reduced scrapping volumes.

Pessimism partly confounded; doubts persist

The freight market improvement seen this year has surprised some pundits, and encouraged more optimism among owners and others. But it is still not completely clear whether, or to what extent, the stronger trend will be maintained over the next couple of years.

Contrasting views have been expressed. At the beginning of 2017 one reputable consultancy firm suggested that the dry bulk market’s higher level, achieved by the end of the previous year, was unlikely to continue for an extended period. Twelve months of depressed freight rates was predicted, based on the expectation that short term factors providing support would dissipate within a few weeks.

Not all forecasters were quite so pessimistic. Also in the early weeks of last year, another consultancy firm expected to see a recovery evolving from 2017 onwards, based on a positive outlook for bulk carrier demand and limited fleet supply growth, ensuring a sustained market recovery. That opinion has been proved broadly correct so far, although it can be argued that questions about the trend’s longevity remain valid.

Soon after this year began, international shipping association BIMCO again expressed doubts about dry bulk market recovery, describing 2016 as a “horrible year” and the “worst year on record”, despite a steadily improving freight rates trend from an all-time low point. Steps to limit fleet growth continued to be emphasised as vitally necessary for a market recovery.

Over the past couple of years BIMCO has been strongly urging shipowners to restrain fleet growth by scrapping more ships and avoiding newbuilding orders. This association’s first report under the heading of ‘road to recovery’ for the dry bulk sector, published in May 2016, proposed a “zero supply side growth” scenario. The message was reinforced by emphasising a cautious view of prospects for trade and bulk carrier demand growth, at 2 percent annually, implying limited assistance from that influence towards rebalancing the market.

BIMCO’s president stated that “the recovery of the market is wholly and exclusively in the hands of us, the shipowners. We must act together and stop the growth in the supply side. The medicine is not going to be easy to take”. Subsequent exhortations attempted to persuade shipowners to collectively restrict fleet expansion, but this campaign’s aim has not been completely fulfilled.

At recent and current bulk carrier newbuilding delivery volumes, zero fleet growth is an elusive target. In 2016 the fleet growth rate was down to just over 2 percent, similar to the previous year’s lower expansion. For 2017, reflecting freight market improvement, scrapping has been drastically cut and fleet expansion may be at least one percentage point faster, exceeding 3 percent. In 2018, however, a minimal growth rate is perhaps more likely to be attained.

Tightening international maritime regulations, which already assist in curbing fleet growth, may be more influential in the future. The new ballast water management convention, implemented this year, requires substantial spending on equipment, although application to existing vessels has been postponed for two years. Emissions controls are tightening as well. These rules could contribute to some older bulk carriers being scrapped, but the impact of environmental aspects on shipowners’ decisions about recycling is partly dependent on freight market levels.

Estimates of overcapacity in the bulk carrier market vary, but it is certainly large. Reducing it is seen as crucial for a return to sustained profitability. How and when will this result be achieved? Restricting world fleet growth to a minimum is argued as essential, although there is still a hidden surplus concealed in slow steaming and other capacity-absorbing features which could be released under some changed circumstances.

On the demand side of the freight market balance, more doubts are expressed about long-term global dry bulk trade growth prospects, with coal trade in particular facing constraints. Assuming overall trade does continue growing at reasonable rates, while fleet capacity expansion is restrained, a trend towards market rebalancing could extend what has been seen this year.

Article by Richard Scott, visiting lecturer, London universities and managing director, Bulk Shipping Analysis, arranged for Hellenic Shipping News Worldwide

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