NEW YORK: 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.
• 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.
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 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.