Shipping beyond the cycle: why an earnings upturn does not equal business as usual

Shipping beyond the cycle: why an earnings upturn does not equal business as usual

A trio of factors is upsetting the status quo but could shipping’s greatest challenge also turn out to be its best opportunity, asks James Frew from Maritime Strategies International.

The shipping markets have struggled through 10 years of depression, with an overhang of both vessels and shipbuilding capacity from the previous boom of 2003-8 supressing earnings. However, in 2019 we believe that the vast majority of shipping and offshore sectors are now on the upcycle, whilst shipbuilding capacity has now been consolidated sufficiently to also permit the newbuilding market to make some positive progress.

The beginning of the market upswing seems to support the argument that shipping markets are after all, cyclical and that this is just another cycle. This generalisation ignores three key sources of disruption that will increasingly shape the shipping industry over the coming decade. These are the evolution of the Chinese economy, technological advances in oil and gas production and – the slowest moving but ultimately most important – the need for shipping to respond to the low carbon transition.

The evolution of the demand side is reflected in all of the main sectors. The oil tanker and gas carrier markets are being shaped by the resurgence of oil production in the Atlantic basin, as ultra-deepwater oil production in Latin America ramps up and the tight oil/shale gas revolution in the US continues to disrupt the industry.

This increase in Atlantic oil production is driving tanker demand ahead of underlying crude trade, which we believe will benefit the tanker markets as the heavy delivery schedule begins to be absorbed by the fleet.

Furthermore, we believe short-term disruption stemming from IMO 2020 will have a positive impact on the tanker markets, not only from the well-publicised increase in middle distillate cargoes to ensure fuel availability, but also the need to distribute residual fuel oil from Europe – where it cannot be processed and has historically been marketed as ship fuel – to Asia where Chinese and SE Asian refineries have the capacity to further refine HFO.

Unaffected by IMO 2020 but still shaped by increasing US production is the LNG market, which has seen stupendous growth led by increasing Chinese demand for LNG, displacing coal largely on environmental grounds. Whilst this effectively guarantees rapid trade growth for the next two years, fleet growth is projected to respond to meet the improved earnings environment.

This is ominous as increases in liquefaction capacity will have something of a hiatus in 2022-4 as a result of the lack of investment in 2016/17. In other words, whilst we have relatively few qualms about underlying demand for LNG in the longer term, we believe that a shortage of LNG cargo supply could lead to some downwards pressure on the LNG carrier market in the early/mid-2020s.

However, the evolution of the Chinese economy is less promising for dry bulk. Chinese coal imports have already peaked, whilst we believe peak Chinese iron ore imports will be upon us within two years. Whilst growth in grains and minor bulks will support the smaller segments of the bulker fleet, we believe that larger bulkers face significant challenges.

The evolution of the Chinese economy has also reshaped container trade. As manufacturing was unbundled, distributed across multiple locations and outsourced from North America and Europe to Asia, it drove massive growth in container trade, with growth on the major Asia-Europe and Transpacific trades far outstripping trades such as the Transatlantic which were unaffected by these trends.

However, even the scale of either the shale revolution or China’s industrialisation shrinks relative to the challenge posed by the low carbon transition, and shipping will have to play its part.

According to MSI’s forecasts, shipping’s carbon emissions will rise from 800 million tonnes in 2018 to 1100million tonnes in 2030 unless action is taken. We do believe that a reduction in speed, particularly for older ships, may well be implemented, which will help both support vessel earnings and lead to a greater demand for new vessels.

In turn, this will support shipbuilding demand, with a potential increase in the orderbook of 30m CGT if the fleet were to slow by one knot and 50m CGT if the fleet were to slow by two knots.

In this respect, the reluctance of shipping to proactively address the low carbon transition is approaches the ironic. A well-devised and implemented shipping speed limit could rejuvenate the fleet, support shipbuilding and deliver shipping’s social responsibility to limit its carbon emissions, all at the same time.

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