Dr Adam Kent from Maritime Strategies International joins the commercial dots.
Anyone analysing secondhand vessel prices purely on the basis of earnings has probably done a lot of head scratching recently.
For example, one year TC rates for a five-year old aframax have increased pretty much month-on-month since the start of 2014. At the same time, secondhand prices have remained relatively flat, certainly over the last 12 months.
In the current tanker market, earnings should be providing much more support for second-hand asset prices, though these are much lower for containers and dry bulk. In all cases though, there is a mismatch if earnings are considered on their own.
To accurately assess prices, it is necessary to additionally understand what’s going on in both newbuilding and scrap prices.
The newbuilding price is the replacement cost, effectively an upper reference especially for modern tonnage. When an owner is looking to buy a five year-old or three year-old, the choice is whether to buy modern tonnage or order new.
At the bottom end, the scrap price is increasingly having an impact on secondhand prices for older vessels. Where secondhand prices sit between the upper and lower reference point is an artefact of the earnings environment: when earnings are strong, we would expect to see them tend towards straight-line depreciation when they are lower, the depreciation has a very pronounced sag to the curve.
MSI forecast newbuilding prices are constructed from two fundamental drivers. The first is yard forward cover, or the relationship between yard capacity and its forward order book. The second driver is how much it actually costs to construct a vessel.
A yard’s forward cover gives it the power to push for higher prices, while costs set the pricing floor. If we consider the scheduled orderbook from 2016-19 in the three major shipbuilding nations we can see that in historical terms, output in 2016 is very strong. South Korea and Japan are near maximum output and for China, if we believe the order books, we will see more ships delivered than we’ve ever seen in a single year.
However, these percentages fall quite rapidly into 2017. For Korea and Japan, 2017 shows around 70% utilisation and in 2018 both Korea and China are languishing at around 20%. Bearing in mind that yards need between two and two and a half years to start putting pricing pressure on owners and pushing up prices, then it’s clear that there will be a lot of spare capacity going forward and with that will come a softening in newbuilding prices.
At the heart of the problem is the astronomical rise in shipyard capacity between 2000 and 2011, from sub-20m CGT in 2000 to 52m CGT in 2011. When deliveries overtook ordering the market saw a huge reduction in capacity but the renewed ordering in 2013 buoyed by the eco and shale gas stories meant an increase in yard capacity into 2016. MSI believes effective yard capacity – particularly in China – will have to fall over the next two or three years to support any improvement in newbuilding prices.
On the flip side are costs. Examining the MSI weighted average index for costs across all shipyards from 2002 to 2015 shows that in 2015 shipyard costs came down due to reduction in steel plate prices. What is more interesting is the differentials between different shipbuilding nations.
Factoring in currency exchange rates, especially the Yen, it is as cheap to build ships in Japan as it has been for the last decade. This is due both to the Yen’s depreciation and the minimal wage inflation in Japan.
By converting newbuilding prices for a Panamax bulker into local currency, although overall prices in Japan have gone up between 2012 to 2015, dollar-denominated prices have gone down. Shipyard prices in Japan could therefore come down further and yards would still maintain their margins.
By 2018 a reduction in shipyard capacity coupled by an increase in contracting across a number of the main shipping sectors will start pushing up newbuilding prices.
As noted above, the floor to second-hand values is the scrap price. This is becoming more and more important and by examining fleet values compared to scrap price for 20 year-old bulkers and container ships, we can see they are only marginally above or already at scrap levels at present.
What has changed is the bifurcation in the relationship between scrap prices and scrapping volumes. Where once there was a close relationship between prices and volume, nowadays it makes no difference how many ships are scrapped to price evolution.
Ship scrap prices are these days purely a function of commodity steel prices. As an illustration, consider that imports of steel and semi-processed iron ore to the Indian subcontinent over the last two years have seen a huge increase; in net terms, the equivalent to 700 Handymax bulkers between 2013 and 2015.
So where will the markets go from here and how do supply and demand factors translate into second-hand values? One of the most interesting factors when analysing the numbers and history is that this is one of the first times that tankers and bulkers are at opposing points on the earnings cycle.
This is reflected in their depreciation curves. The MSI approach to analysing secondhand prices using net replacement value depreciation takes the price, normalises it for the newbuilding price and nets out the scrap price.
What this analysis shows for a panamax bulk carrier is that historically on an annual average basis from 1980 to 2015, the net replacement value is currently at a historical minimum. Modern tonnage in this metric has held up relatively well until now but our analysis suggests there could be further downside for modern panamax tonnage values going forward in 2016.
Looking at tankers, the story is almost the inverse. For VLCCs the net replacement value this year is at or near historical maximums. Some upside is possible on values in ‘middle-age’ as 10-year-old vessels are currently undervalued based on this depreciation method.