Associated Press (Bernat Armangue)
“We are pleased to put 2016 behind us”—this recent quote from a prominent shipowner may well be the industry understatement of the year.1 It was by no means a year that began on a high note:
• The industry reached the nadir of (Moore Stephens’) Shipping Confidence Index in late 2015 and an all-time low on the Baltic Dry Index on 10 February 2016.
• A survey by the law firm Norton Rose Fulbright found shipping to be the most despondent of all transport providers.2
• The ClarkSea Index estimated the first six months in 2016 to be the worst half-year since the 2008 crash.
• An August 2016 VesselValue.com analysis found that one in every six ships was worth only its scrap value.
It was a rough start for an industry that has been attempting to swim upstream for eight years against surplus capacity and anemic trade growth. As predicted, even the tanker market, which remained remarkably resilient in 2015, felt the pain in 2016.
However, shipowners who weathered the prolonged down cycle should be ecstatic about how the year ended. Fleet expansion slowed drastically in 2016. Even the Shipping Confidence Index registered steady upticks as 2017 began, albeit there was nowhere to go but up. Overall, despite some spectacular bankruptcies, market exits, and mergers and acquisitions, a guarded optimism is slowly emerging in the broader shipping markets.
The International Monetary Fund estimated global GDP growth at 3.1 percent in 2016 versus 3.2 percent in 2015, with a 0.8 percent drop in goods and services trade. The 2016 UNCTAD Report on Maritime Transport attributed the dip in world trade to lower commodity prices, the appreciating U.S. dollar, a shortening of the global value chains, and changes in manufacturing strategy. Advanced economies as well as emerging markets and developing economies are expected to pick up pace in 2017, with projected GDP growth rates of 3.4 percent and 3.6 percent, respectively. This and the long overdue signs of market discipline being exercised by shipowners and investors are reasons for the silver linings sighted in late 2016.
Dry Bulk: It was another bad year in terms of financial results. In fact, the head of Pacific Basin, one of world’s biggest dry bulk operators, referred to it as “the worst in 45 years.”
Given this market’s relatively low barriers to entry, it is highly susceptible to poor decisions by speculative market players. The prolonged down cycle has dampened this behavior, however, and a rare commitment to market discipline is clearly visible. Per Clarksons’ statistics, the new tonnage ordered in 2016 was only about half of that in 2015. Similarly, shipowners held back or delayed new ships entering the market and recycled their older ships at an unprecedented level. Collectively, this tended to offset marginal changes in market supply and demand, and although not universal, optimism is slowly on the ascent.
Strategic moves by strong incumbents are indicators of the new optimism. Swiss Capital Alternative (SCA) Investments reportedly is partnering with the Tsakos Group, a big Greek shipowner, to invest $500 million in relatively new, good-quality ships.3 SCA, now owned by a New York-based investment company, is projected to make 6-8 percent yield on its investment in the short run and significant capital gains later. Other similar ventures are being planned by Hunter Maritime Acquisition and Seaborne Capital Advisors. Established incumbents such as Dryships, Golden Ocean, and Chartworld have strengthened their balance sheets and are now well primed for new investment. Atlas Maritime, a company that exited the market ten years ago, has announced plans to return. Eagle Bulk, the New York-based operator that was in serious financial difficulty in 2015, announced plans in February 2017 to buy ships and expand its fleet.
There are two key drivers behind these plans—(1) the historically low cost of acquiring good-quality used ships, and (2) signs of increasing trade growth.4 The projected 3.8 percent growth in trade in 2017 is to come from China’s increased demand for coal and iron ore and its planned infrastructure spending, as well as a $726 billion domestic stimulus package. Other factors include increased Brazilian and Australian iron ore exports to China, Indonesia’s resumption of nickel ore and bauxite exports, China’s suspension of coal imports from North Korea, and the higher steel production needs of India and Japan.
However, not all stakeholders believe the worst is over. Consulting group Maritime Strategies International cautions about uncertainties in Chinese and Indian trade policies.5 Courage Marine recently sold off all its ships after three years of losses and made a complete exit. Giuseppe Bottiglieri Shipping, an established Italian dry bulk company, filed for bankruptcy protection in early 2017.6 Clarksons warns that 30 million deadweight tonnage (dwt) of older ships must be recycled annually in future years to benefit from any likely growth in dry bulk trades this year. This is a tall order in an improving market, which is why the Baltic and International Maritime Council (BIMCO), the largest association of shipowners, is repeatedly warning its members to exercise caution.
Tanker Market: The 2016 tanker market turned out to be an excellent case study in microeconomics. The spot market rate for very large crude carriers (VLCCs)—which peaked at $170,000 per day in 2008 prior to the crash and reached $100,000 per day in July 2015—is in a firm down cycle, with the VLCCs earning $27,400 per day in late February 2017. Market forces played their traditional role in initiating the slide; other drivers then took over and seem to be more in control now. For example, although the International Energy Agency estimated an increase in global oil demand of 1.4 million barrels per day in 2016, a large number of new ships were delivered during the year, which along with the reentry of previously banned Iranian tankers increased the total tonnage supply at a faster rate than demand growth. Nevertheless, the tanker sector turned out to be the best performing major shipping market in 2016. Regretfully, this also nipped the incentive to recycle older ships, limiting it to a minuscule 0.6 percent of the current fleet.
The decision by OPEC and 11 non-OPEC producers to cut back production by 1.8 million barrels per day during the first six months in 2017 has worsened market conditions.7 Absent cheating by cartel members, the cutback is equivalent to eliminating cargo for 32 average VLCCs of 280,000 dwt. In addition, as planned by OPEC, the primary oil market fundamentals have shifted, and the incentive for storing oil temporarily on board tankers has vanished. As a result, the ships that served as storage tankers are reentering the market and competing for employment. These developments have worsened the woes of tanker owners, but there is at least one minor offsetting improvement—the increase in U.S. and Nigerian crude oil exports.
Overall, the market currently is witnessing a 35–40 percent reduction in freight rates; asset values of new, good-quality secondhand ships have declined; and new construction orders have shrunk 83 percent from 2015. On a positive note, the forthcoming worldwide implementation of the new Ballast Water Management Convention is likely to incentivize the recycling of older ships. Maritime economists are postulating a compression of tanker market cycles from about seven years to four, which would imply 2019 being the next boom year.
Liner Market: Liner shipping experts may chronicle 2016 as the year during which the operators came of age at last. Whether it was late maturing at age 60 or the Damoclean sword that fell on the seventh largest container operator in the world, rational behavior appears to be permeating the sector. The early summer shock of the near collapse of Hyundai Merchant Marine, saved just in time by a South Korean government bailout, was immediately followed by the even more shocking collapse of the much larger Hanjin Shipping, stranding its 83 ships and $14 billion in cargo in various parts of the world. There was further market concentration, with Maersk Lines acquiring Hamburg-Sud, Hapag-Lloyd taking over United Arab Shipping Company, and the three Japanese operators reaching a consensus on rationalizing their liner services and saving more than $1 billion in operating costs.8
Although benefits of the market consolidation and the exit of Hanjin Shipping will not be realized until later, the year ended on an optimistic note. Container trade worldwide grew 1.3 percent per Drewry statistics, slightly surpassing the estimated 1.1 percent fleet growth, a novelty in recent history.9 A record 660,000 TEUs (20-foot equivalent unit) in shipping capacity was recycled during the year, and, per Clarksons, new construction orders in 2016 were less than a tenth of the TEUs ordered in 2015. There was, however, 7 percent idle capacity in the market in 2016. In addition, 1.7 million TEU in new capacity is to be delivered in 2017, 78 percent being ships capable of carrying more than 10,000 TEUs.10
So, despite the projected recycling of 750,000 TEUs and the estimated 2.1 percent growth in container trade in 2017, there will be no quick transition to boom times. Regardless, there is a good foundation for better years ahead.
As a result of increased market concentration, the top ten carriers will control 80 percent of global capacity by 2017. The top operators also are realigning themselves in three vessel-sharing clusters—2M, Ocean Alliance, and The Alliance—to better facilitate discussions on operational issues.11 These structural changes and the alliances’ reported attempt to jointly procure third-party services in U.S. ports seem to have triggered the Justice Department’s recent subpoenas to the industry titans to testify in its antitrust investigation.12
Shipbuilding Market: Shipowners’ attempts to exercise self-discipline in ordering new tonnage and getting out of their economic morass have had an opposite effect on shipbuilders and led to their worst year in more than two decades. Had it not been for the increase in new orders for cruise vessels and ferries, the situation could have been far worse. Based on Clarksons’ annual statistics, contracting for cargo ships and offshore crafts declined 71 percent in number—from 1,665 in 2015 to 480 in 2016—and 63 percent in value—from $90 billion in 2015 to $33.5 billion in 2016. The number of yards that received an order for a ship of 1,000 gross tonnage or more went down by more than 100 in 2016. This has elevated the level of state involvement and also consolidation efforts among shipyards.
All three leading nations in commercial shipbuilding have been affected by the market collapse and are now engaged in greater price competition.13 An October 2016 study from McKinsey & Co. concluded that Daewoo Shipbuilding and Marine Engineering Co., one of the top three Korean builders, may not last until 2020 because of negative operating margin and high liquidity shortfall. The South Korean government plans to stimulate the sector by building 250 new ships by 2020 at a cost of $9.59 billion.14 In return, the yards are to restructure their operations and boost their competitiveness. They are to focus on high-value ships, such as large container ships, liquefied natural gas (LNG) ships, and oil tankers, and reduce their workforce. In addition, the government will set up a $5.6 billion ship finance program through Korea Shipping Company, a new entity that will assist the shipowners. Korea Development Bank will finance 80 percent of the new company’s total assets.
These massive South Korean government initiatives still are falling short in resuscitating Daewoo. The yard secured only 13.4 percent of the $11.5 billion in new building orders anticipated in 2016. Although it has a current backlog of 114 ships valued at $34 billion, its debt-to-equity ratio exceeds 2,700 percent. The likely outcomes from a potential collapse include major national economic disruption and estimated 50,000 job losses.15 Fearing this, the government announced another $6 billion bailout plan that comprises debt restructuring and stakeholder sacrifices, failing which Korea Development Bank and Korean Exim Bank will choreograph a plan to rehabilitate prior to undergoing court receivership.
U.S. Merchant Marine
For most trading nations, commercial ships flying their national flags are a source of pride and prestige and, more important, an instrument of their trade policy, with typical goals being revenue generation, job creation, societal welfare, and a source of foreign exchange for balance of payment purposes. A secondary mission, in many cases, is rendering assistance to the flag-state and its citizens at times of need. In addition, there are ideological and political reasons for which some nations promote their commercial ships, understanding that maritime power can act as an extension of national influence.
The role of the U.S. merchant marine is historically different from the typical potpourri of national merchant marine expectations. In particular, the contributions of Alfred Thayer Mahan and other key military strategists have directly or indirectly influenced the raison d’être of U.S. commercial shipping, convincingly intertwining its role during times of war and peace. In particular, since World War II, the United States has viewed its merchant marine as a means of power projection and sustainment during overseas operations and, to a limited extent, as an instrument of trade. Although the dual missions and expectations have been executed with remarkable proficiency, the domestic fleet seems to have reached a tipping point.
Currently, the privately owned U.S.-flag commercial fleet is ranked 39th worldwide based on number of ships and 27th based on deadweight tonnage.16 The internationally trading fleet has depleted at an alarming rate in recent years, and the cargo carried by foreign-flag ships in U.S. oceanborne international commerce is at a staggering 99 percent. The privately owned U.S.-flag fleet is so low in numbers today that there is genuine concern over having sufficient qualified mariners to crew the Ready Reserve Force (RRF) surge sealift fleet in a major contingency exceeding four to six months, i.e., beyond their initial activation.17 As the numbers of ships drop and the mariner jobs vanish, so do the mariners, who exit the field to pursue other careers.
Complicating this further, many of the RRF ships are steam propelled, demanding a technical expertise that is rapidly disappearing from the commercial sector.18 So there is limited opportunity for entry-level marine engineers to gain proficiency in steam propulsion and earn upper level certification.
It seems ironic that a mariner shortage is being experienced when all the nation’s maritime academies are reporting record enrollment. The simple explanation is a shortage of ships to employ the mariners.
Congress recognized the widespread concern about the availability of mariners and charged the Maritime Administration (through section 3517 of the fiscal year 2017 National Defense Authorization Act) to conduct a comprehensive study in consultation with key stakeholders and report back. This is an opportune time for new policymakers to leave their legacy, as President Franklin Roosevelt’s team did by enacting the original Merchant Marine Act in 1936.
The nation’s sudden emergence as an important supplier in the global energy market poses several interesting possibilities. U.S. crude is becoming more attractive to foreign buyers because of its lower price, and exports have risen to about 1.2 million barrels per day.19 The United States also is currently the world’s largest exporter of petroleum products, including liquefied petroleum gas (LPG) and ethane. The Energy Information Administration forecasts the nation becoming a net exporter of natural gas by 2018 and energy by 2026.20
Regretfully, the U.S. merchant marine has not benefited from any of these developments or projections. On the contrary, the current oil glut and the drop in price have led to a cutback in domestic shale oil production. The Jones Act tankers that earned about $120,000 per day in 2014 are now making a quarter of that, less than half of the $65,000 per day required to break even.21 The fast-growing LNG and LPG exports have been of no help either as there are no U.S.-flag LNG or LPG ships trading today.
LNG exports from Sabine Pass in Louisiana now reach Europe, as an alternative to Russian supplies, and Japan, which is the world’s largest LNG importer. NYK, the Japanese shipping conglomerate, has begun building an LNG ship solely to carry U.S. exports.22 The Energy Information Administration estimates shale gas production will reach 90 billion cubic feet per day by 2040 and LNG exports will rise to 12 billion cubic feet per day.23 LNG exports, 170 billion cubic feet in 2016, are estimated to reach 530 billion cubic feet in 2017 and 1 trillion cubic feet in 2018 before stabilizing. This is a stunning 600 percent increase in two years. The increasing U.S. exports are partly responsible for LNG carriers’ current two-year high in spot market earnings.24 The widened Panama Canal also has played a role.25
There is widespread stakeholder support for H.R. 1240, the “Energizing American Maritime Act,” introduced on 28 February 2017. It requires 30 percent of all domestic LNG and crude oil exports to be transported on U.S.-flag vessels. A 2015 Government Accountability Office report found that completion of all the planned LNG export projects would result in employment for 100 or more specialized ships and 4,000–5,200 mariner jobs, which would be a major boost for the industry.26 Reserving 30 percent would result in 30 U.S.-flag LNG ships and 1,200–1,560 mariner jobs by 2025. A recent report from Fearnleys LNG projects a much higher level of U.S. exports, which at 30 percent share would add 57–75 ships and 2,280–3,900 mariner jobs.27 The reality, however, is there are no U.S.-flag LNG ships today, and none have been built in the United States since 1980.
The demand for LNG is rising rapidly, especially in China and India. Six new countries—Colombia, Egypt, Jamaica, Jordan, Pakistan, and Poland—started buying it in 2016, raising the number of importing nations to 35. Worldwide, LNG supply is expected to increase 47 percent within the next four years to meet the rising demand.28 The market itself is changing from a preponderance of long-term contracts and fixed routes to a more competitive and transparent one, with a third or more of the cargo being sold on flexible, short-term volume contracts.29 The U.S. LNG exports are expected to have an impact in the global market by 2018 and raise charter hires in general.30
There was an abortive attempt by the Gas Authority of India to transport its LNG imports on domestic ships when it signed a 20-year purchase agreement for U.S. LNG from the Sabine Pass facility and the yet-to-be-operational Dominion Energy Cove Point plant in Maryland. The plan to contract 11 new vessels for the 5.8 million tons per year of U.S. exports failed because of the requirement to build a third of the ships in India.31
The market for LNG ships is less transparent than the traditional tanker market and the ships themselves are more than twice as expensive to build. Other policy issues to consider include any likely impact on the price competitiveness of U.S. LNG and its commercial flexibility.
On 20 June 2016, the U.S. Coast Guard issued a final rule on compliance that applies to all U.S.-flag towing vessels. They may choose either the Towing Safety Management System or the traditional Coast Guard safety inspection process. Overall, a drastic change in safety culture is anticipated.
The Polar Code, which applies to all ships operating in Arctic and Antarctic waters, entered into force on 1 January 2017. Its objective is to enhance safety in shipping operations in polar waters and protect the pristine environment. Notably, a recent modeling study on ice coverage by the Russian Academy of Sciences and the Kiel University in Germany found that by the year 2100, the Northern Sea Route across Arctic waters would remain open for ship operations for more than six months a year.
Other major regulations enacted in 2017 include the comprehensive 2010 (Manila) Amendments to the Standardization of Training, Certification, and Watchkeeping Convention that affects every mariner credential and the International Code of Safety for Ships using Gases or other Low-flashpoint Fuels (IGF Code), which enhances safety for gas-fueled ships.
The Ballast Water Management Convention will become effective on 8 September 2017, by which time every ship trading internationally must have a treatment system that meets the worldwide International Maritime Organization standard. DNV GL, a classification society, estimated a cost of $1.5 million per ship for installation and $43.5 billion industry-wide.32 The United States opted to establish a more stringent domestic standard and did not approve a suitable system until December 2016, which understandably affected shipowners’ plans to comply. Three ballast water management systems have now received the U.S. Coast Guard’s type approval and satisfy the requirements, but there is widespread concern about delays in installing those systems.
Overall, the industry appears poised for a year of guarded optimism.
1. “Dryships Narrows Losses Despite Lower Revenue,” Lloyd’s List, 8 February 2016.
2. “Despondency Over Shipping’s Future Hits the 85% Mark,” Lloyd’s List, 6 July 2016.
3. “Tsakos Teams Up with Fund for Huge Dry Bulk Flash,” Lloyd’s List, 8 February 2017.
4. “Clarksons Forecasts 3.8% Growth in Dry Bulk Trade This Year,” Lloyd’s List, 8 February 2017.
5. “Dry Bulk Market Buffeted by Mixed Trade Prospects,” Lloyd’s List, 16 February 2017.
6. “Giuseppe Bottiglieri Shipping Files for Bankruptcy Protection,” Lloyd’s List, 20 January 2017.
7. “VLCCs Slump to Five Month Low,” Lloyd’s List, 28 February 2017.
8. “Better Late than Never as Japanese Box Lines Unveil Merger Plans,” Lloyd’s List, 31 October 2016.
9. “Contract Freight Rates to Surge in 2017, Says Drewry,” Lloyd’s List, 25 January 2017.
10. “Boxship Deliveries to Outpace Scrapping in 2017,” Lloyd’s List, 25 January 2017.
11. The 2M Alliance consists of the Maersk Group, Mediterranean Shipping Company, and Hyundai Merchant Marine. Ocean Alliance members are CMA CGM/APL, China Cosco Shipping Corp., Evergreen Marine Corp & OOCL. The Alliance members include Hapag-Lloyd, K Line, MOL, NYK, and Yang Ming.
12. “U.S. Justice Department Subpoenas Box Club Members,” Lloyd’s List, 21 March 2017.
13. “Korea Beat China in Tanker Orders on Competitive Newbuild Deals,” Lloyd’s List, 6 March 2017.
14. “South Korea Throws Its Shipbuilders a $9.6 Billion Lifeline,” Wall Street Journal, 1 November 2016.
15. “State-backed Creditors Unveil $6 Billion Rescue Plan for DSME,” Lloyd’s List, 23 March 2017.
16. Based on Merchant Fleets of the World Statistics as of 1 January 2016. If the entire U.S.-flag fleet, including Great Lakes fleet, passenger/ferry vessels, and RRF ships, is included, the rankings would be 23 based on DWT and 27 based on number of ships.
17. See Opening Remarks by Ranking Member Courtney on Seapower and Projection Forces Subcommittee Hearing on Logistics and Sealift Force Requirements and Force Structure Assessment, 22 March 2016.
18. The commercial sector is rapidly shifting away from steam propulsion to diesel.
19. “U.S. Oil Exports Hit Record Levels,” Maritime Executive Newsletter, 24 February 2017.
20. U.S. Energy Information Administration, “Annual Energy Outlook 2017,” www.eia.gov/outlooks/aeo/.
21. Comments by Paul L. Magnussen, CEO, American Shipping Company at the TradeWinds Shipowners Forum USA, 21 September 2016.
22. “NYK Targets American LNG,” Lloyd’s List, 14 December 2016.
23. See note 19.
24. “LNG Tankers’ Spot Rates Near Two-Year High,” Lloyd’s List, 9 January 2017.
25. “Panama Canal is Redefining LNG Shipping,” Lloyd’s List, 18 January 2017.
26. “Implications of Using U.S. LNG Carriers for Exports” (GAO-16-104), Government Accountability Office, 3 December 2015.
27. “Shipping Divided Over U.S. Moves to Control Its Energy Exports Supply,” Lloyd’s List, 10 March 2017.
28. “Golar LNG looks Beyond $209m Loss,” Lloyd’s List, 28 February 2017.
29. “LNG: Supply and Demand Aligned,” Maritime Executive Newsletter, 20 February 2017.
30. “U.S. Will be Net Exporter of Energy in 2020s,” Lloyd’s List, 22 February 2017.
31. “GAIL Trades Cheniere LNG Cargoes with Gunvor,” Maritime Executive Newsletter, 3 March 2017.
32. “Do Not Rush to Install Ballast Water Treatment Systems, Warn Experts,” Lloyd’s List, 8 March 2017.