The shipping industry is back – and it has big implications for the global economy
You may not realise it, but nearly everything from toys to power tools that you buy at Wal-Mart, Takashimaya (in Singapore), or Hudson’s Bay (in Canada) is shipped months before from ports in Shanghai and Hong Kong.
Your iPhone and MacBook were shipped by sea from factories in the southern Chinese city Guangzhou, and Taiwan.
And if you’re in China, much of the soybeans, grains and aircraft parts and components that keep the economy running were shipped from ports in the U.S. states of Louisiana or California.
In fact, about 90 percent of today’s global trade is carried by ship.
Raw materials like coal, iron ore, copper and nickel are usually produced far away from where they’re consumed. They’re shipped in massive ocean-going vessels – called dry-bulk carriers – that are the blood in the veins of the global supply chain.
Oil in ocean-going tankers accounts for about one-third of all global maritime trade.
The importance of shipping is why it’s one of the most useful indicators of the health of the global economy… And, more recently, the state of China’s economy – the largest consumer of a range of commodities, including iron ore, coal, copper, and zinc, and the largest importer of oil.
So what is shipping activity saying today about the global economy?
The big shift in shipping activity
The Baltic Dry Index (BDI) tracks the price of shipping raw materials such as metals, grains and fossil fuels by sea.
It takes into account the day-to-day changes in shipping rates for the three major carrier sizes: Capesize, Panamax and Supramax.
Shipping companies committed a classic boom/bust cycle mistake back in 2011. At the height of the commodity boom, they ordered a huge number of cargo ships.
How huge? Based on transport research firm, Crucial Perspective, the global shipping order book-to-fleet ratio stood at 36 percent by 2011.
The order book-to-fleet ratio is a key measure used by the shipping industry to determine the outlook for future supply of vessels. It’s a useful indicator of supply growth, because a proportionately high ratio will lead to a fast-growing fleet… and, if history is any guide, oversupply in the market, as these ships are delivered.
A 36 percent order book-to-fleet ratio means there were enough existing new ship orders to increase the 8,600 total cargo fleet size as of 2011 by more than 3,000 new ships over the coming years.
So even with a lot of order cancellations, an average of 400 new dry bulk cargo chips were still being delivered into the market each year – a nearly 5 percent annual increase – for the past five years.
Meanwhile, less than half of that number of old ships were being sent to the scrap heap. That means global shipping capacity continued to expand by approximately a net 2.5 percent rate each and every year.
Meanwhile, according to the World Bank, global trade of goods and services has declined by 7 percent from 2011 to 2016, as commodity prices collapsed.
So for the better part of the last five years, the global shipping industry had been plagued by overcapacity, with many shipping firms operating their ships at a loss.
The BDI has been on fire, rising 58 percent increase since April. It’s more than quadrupled from its record lows in late 2016.
That’s a pretty impressive move, and it would appear to signal that the global economy is moving ahead at a brisk pace.
China takes the lead
Back in December 2016, we wrote about how China’s economy – despite having a poorly performing stock market, an overinflated housing market and a currency that had just hit an eight-year low against the dollar – continued to grow. In particular, manufacturing industry, as reflected by the Purchasing Managers Index, stood at 51.7. (Anything above 50 indicates expansion.)
As of May 2018, the PMI was at 51.9, indicating that China’s manufacturing industry continues to expand.
This is also being reflected in industrial activity more broadly, where year-on-year growth has picked up momentum over the past 1.5 years, from 6 percent to nearly 7 percent last month.
China’s trade with the rest of the world is also booming. In May alone, Chinese exports grew 12.6 percent, while imports surged 26 percent. That’s a big leap from the flat export growth and 6.7 percent import growth in November 2016.
Imports of copper ores and concentrates, a key raw material used in electronics, wiring, tubing and motors, are up 14 percent over the first five months of the year. These imports are at their highest levels since 2000.
Chinese demand for iron ore is also keeping apace, rising 3 percent in May. And average daily crude oil imports for the month grew 5 percent year-on-year.
All this growth in economic activity and demand for commodities from China is what’s propelling the BDI higher.
Commodity prices – as measured by S&P’s GSCI Total Return Index – have risen by 30 percent in a year, and are up 52 percent since the start of 2016. And because the more valuable the cargo is, the more it costs to ship it across the world, the BDI usually rises (and falls) alongside commodity prices. This time is no different.
Why the BDI could keep rising…
Earlier, I mentioned the order book-to-fleet ratio, which keeps track of the amount of new ship orders relative to the size of the global shipping fleet. This ratio peaked at 52 percent in 2009.
That means that there were enough ships being built that year to grow the global fleet size by a whopping 52 percent – nearly 5 times higher than a decade earlier.
Although that ratio eased to 36 percent by 2011, it was still incredibly high by historical standards.
But as of this year, the ratio has fallen to about 10 percent – the lowest of the last two decades – according to Singapore-based research firm Crucial Perspective.
That means, for now, there’s likely going to be less supply of new ships entering a market that’s finally getting back to profitability.
As long as China’s manufacturing, exports, and imports continue to grow, the BDI should continue to rise.
Yet, at the same time, major shipbuilders all around the world are starting to see their order books grow once more, as better times come back to the industry. While it can take as long as three years for the biggest of these ships to be built and commissioned, too much new supply hitting the market could hurt the shipping market once again.
China’s largest shipbuilder, for instance, just signed a deal to build nine new vessels in May alone, worth nearly US$600 million. That’s twice the value of contracts it won in the first four months of the year combined.
One of South Korea’s largest shipbuilders, Daewoo Shipbuilding & Marine Engineering, secured US$4.4 billion worth of orders as of May, equivalent to 60 percent of its full-year target.
So if anything, the recovery in global shipping is already benefitting shipbuilders who have fallen out of favour in the market in recent years.
One last point. Trade wars are always bad for (you guessed it)… global trade. And the recent tit-for-tat tariffs between the US, Canada, the European Union, and China certainly risks hurting trade sentiment. That could stall the shipbuilding recovery if it results in cancellations of orders.
In short, the sector is worth keeping an eye on. And we’ll be watching to see if a sustainable, long-term recovery in the BDI – and shipbuilding stocks – is forthcoming.
Source: Stansberry Churchouse Research