At the Boao Forum last month the chairman of Chinese shipping giant Cosco raised eyebrows with some of his remarks. When asked about Cosco’s chances of being delisted after making losses of Rmb10.5 billion ($1.7 billion) in 2011 and Rmb9.6 billion in 2012, Wei Jiafu lashed out at stock exchange rules which had designated his firm as a ‘special treatment’ share (meaning it’s liable for delisting if it makes losses three years running).
Having produced the most red ink in the A-share market for two years running, Wei could be forgiven for trying to shift attention away from Cosco’s performance. But even so, his line of defence was a curious one. Wei said Cosco’s mission wasn’t just about money. “Cosco’s social responsibility is about making a contribution to humankind,” he insisted loftily.
Then again, Wei’s tactics underline a troubled financial situation not only for Cosco, but for the shipping world in general. Are things getting any better? We spoke to Basil Karatzas, the founder of New York-based Karatzas Marine Advisors, a specialist ship-broker, advisory and services firm. And he told WiC the worst may not be over for the world’s shippers…
Is Cosco symbolic of the plight of the global shipping industry?
Not necessarily. The global shipping market faces an even worse plight than Cosco. At least Cosco has the benefit of its relationships in China, which give it access to cargoes. The rest of the industry has idle vessels, but Cosco’s ships aren’t idle, they’re just under-utilised. And Cosco has the implicit guarantee of the Chinese government that it won’t go bankrupt. For most shipping companies in the West there is no such guarantee. The Chinese government has virtually unlimited resources with which to support Cosco.
More broadly speaking, is the Chinese economy still the great hope for the shipping industry?
Very much so. A couple of weeks ago you saw the equity markets sell off when China came out with slower growth. That’s indicative of how reliant we are on China. And I am not sure that growth in the West will be sustainable enough to absorb the growing supply of tonnage in the shipping industry. The only place with enough growth to do so is China, which makes it the greatest hope for shipping in this major crisis.
Is this cycle different to others, in terms of its severity?
It is a little bit different – and I don’t think we have seen the worst of it yet. Usually you have the notorious ‘blood in the streets’ where some players think enough is enough and are just happy to walk away. This time there are still people who remain optimistic. That means that every time the market dips you see more vessels ordered – such as the so-called eco-design models which are 10% more fuel efficient. So I think it is going to take some time for all the excess tonnage to be absorbed and for the market to turnaround.
In previous market downturns, the participants in the cycle were very delineated. You had the shipowners, the charterers and the bankers. Now one of the big players is the institutional investors – the hedge funds and private equity funds. They have an enormous amount of money. It’s not like a Greek shipping family. Yes, those families are very wealthy too but at the end of the day their pockets stop at a couple of hundred million dollars. Here you can have a private equity fund drop a billion dollars on a transaction, no problem. They can do it every day including Sundays. So every time the market shows evidence of bottoming, a lot more money floods in, which only pushes the recovery further away thanks to all the new ships they order.
The other great unknown is China. Cosco’s boss talked about his “social responsibility” and what that means is that economics don’t matter. If Cosco thinks it’s on a social mission, there is nothing you can do about it. It can order more vessels and charter more ships.
Of course, all of this is also related to how much support the Chinese government wants to give to its shipping industry. Back in 2008 a lot of ship owners made a fortune because the freight costs were more expensive than the commodity being shipped. That cost China a lot of money, and I don’t think the Chinese ever want to go through a situation like it again. So they prefer to subsidise the industry, build new vessels, and control the ownership of ships more strategically. You cannot project accurately how this will all play out. The Chinese have the money, and the government also wants to support its shipbuilders because of employment.
Whenever anyone tries to corner the shipping market, you see that China reacts strongly too. When Vale built its enormous Valemaxes to transport iron ore, the Chinese said they weren’t safe and refused them entry to Chinese ports (see box). That was to protect their interests. And guess what? There is nothing you can do about it. Vale will have to scrap the vessels or sell them. And who is going to buy them? There’s only one buyer: China. A proxy for the Chinese government will buy those vessels for cents in the dollar. As soon as that happens, those vessels will be back in the market, adding to the huge oversupply issues.
It sounds like you are saying there is a Chinese masterplan to control a bigger portion of the world’s fleets and muscle out traditional players like the Greek families. Is that correct?
I think so. The Chinese have their five-year plans. Not many countries have these. It means they look forward at the next decade, not the next election or quarter. It’s not only in shipping we see this. There’s a similar strategy in Beijing’s approach to accessing commodities and raw materials in places like Africa.
Shipping is a part of the overall masterplan, whereby China wants to secure access to the commodities it needs and then to transport them cheaply on its own vessels.
Do the Chinese look at the shipping industry as a national security issue, at least in economic terms?
Yes. The Chinese are huge importers of raw materials and exporters of finished goods. So shipping is an integral part of the economy. You can appreciate why there is a desire for fuller control of the sector. That’s a big contrast with the United States where you never had meaningful vessel ownership or the same goal. In terms of worldwide significance, American ship ownership is a rounding error. The Americans are not a significant force in shipping.
A major reason is cost. To give you an example: a 50,000 deadweight tonne tanker built in China or South Korea would cost around $35 million if purchased brand new. To order the same vessel in the US would cost around $120 million. It would also cost about $7,000 a day to operate that ship in international waters but a similar vessel flying an American flag usually costs around $25,000 a day to operate. That’s the result of it being a protected market. Due to the Jones Act only an American flagged ship is allowed to move cargo between US ports. That leads to freight rates that are about six to seven times higher than international ones. What does that mean? US ships are simply not competitive in international markets.
How many years do you estimate it will take to work off the oversupply in the global shipping fleet?
This is the $64 million question. It depends who you ask. Publicly-traded shipping companies tend to say that 2014 will be a year of recovery. But they have to be optimistic because they have to raise capital. I am not sure how long it will take, but I don’t agree with the 2014 forecast. It’s more likely recovery in freight rates won’t occur till 2015 or possibly 2016. The primary concern is that vessels are still being delivered from orders when times were good and daily rates were high. There is little you can do to stop this. The payment is already in place and the yards are building them.
The only way to remove vessels is by selling the older ones for scrap. But that’s not something done lightly. If you are a shipowner with a 20 year-old vessel, which has a 25 year design-life you have to think carefully about scrapping. Yes, the market is lousy but there’s always hope that tomorrow will be better. Unless the vessel starts breaking down, you’ll try to buy more time and avoid scrapping it. Once you sell it for scrap, it’s gone. You can’t get that ship back.
The numbers suggest that more scrapping is required. Economic growth worldwide is 1-2% but tonnage supply in certain market segments is growing between 5-10%. So there’s a mismatch. Plus there’s all that institutional investor money on the sidelines that I mentioned. Any time there’s vaguely optimistic news, more vessels will be ordered. That’s why I am not bullish that the market will turnaround soon.
And a lot of the yards that have been shuttered in China could easily come back to the market as soon as the data looks more positive too. That will only worsen the supply issue and further delay the turnaround. It takes about nine months to build a vessel, so when that happens we could see a lot of dormant yards pumping out still more vessels and very quickly.
Is there a silver lining: there will be more scrapping of older, less environmentally-friendly ships?
This is a very good argument and to a certain extent the answer is yes. Obviously, an older and less fuel-efficient ships is more likely to be under-utilised. But if you have a chronically oversupplied market like we have now, you find both the new, fuel-efficient vessels and the older ones are both likely be idle, because there simply aren’t enough cargoes.
It’s also true that a driver of all the new build is fuel efficiency. However, it’s also because a lot of private equity funds have not been able to buy second-hand ships from banks. So instead they order new vessels, which happen to be eco-friendly and more fuel-efficient.
But, yes, all the new-built vessels can only accelerate the scrapping process for older ships. That’s because the differential in fuel efficiency has become more exaggerated. That’s not to say that all the older ships are fuel-inefficient. I have been looking at a nine year-old tanker built in Japan. Its efficiency is as good as a lot of the new builds. If you scrap vessels like these, there isn’t much of a net gain for the environment.
How about the impact on the shipyards, particularly Chinese ones? Are they making losses on each new order?
They claim they have been at break-even or losing money for at least the last 18 months. They complain the price of new ships is so low they can’t make profit. But you cannot put all the shipyards in one category. You have different types. For example, the Japanese yards have been uncompetitive due to the formerly strong yen. And within China you have state-owned and private yards. A lot of the newer private yards cannot compete but the state ones have more pricing power, because they have preferential status with shipowners and the backing of the government.
Definitely it is not a good time to be a shipbuilder. It is another one of the industries that gets the cycle wrong. At times like these the yards face slim margins and are begging for orders. Meanwhile there’s inflation and rising commodity prices.
What’s the impact of these trends on your own firm?
The turmoil has been rather good for us, to be honest. I have been dealing with banks in Europe that financed vessels at the top of the market. Back then banks were giving 100% financing on new ships and now they are worth only half their value. The freight rates are too low even to pay operating expenses. So you can imagine how big a problem this is for the banks and the shipowners. There’s a lot of friction. Our business is ship-broking, advisory and services, and it’s at times like this that more deals are generated.
There’s much more need for advice and solutions which is a positive for me, especially compared to pre-2008 when shipping was booming. But if I were a shipowner or a banker right now, I’d be crying. At least I don’t have a balance sheet or ownership of vessels to worry about. For me it’s about trading and advisory.
You mentioned that the banks were lending 100% against new ships back in 2008. What percentage would they lend today?
Most European banks are closed for new business. If you can find a bank willing to lend, they won’t offer more than 50% financing. So versus the top of the market, banks are only lending a quarter of the absolute amount they were loaning in 2008.
To illustrate this: I am working with a Greek shipowner who has been in the business for 30 years and had always worked with a single bank. Right now, it has five vessels, with mortgages performing on all of them, and $50 million of cash. But the bank says that the most it will lend against a new ship is $5 million.
What were the banks’ risk managers thinking back in 2008? In retrospect, 100% financing sounds insane.
Yes, and it was particularly bad in Germany. Historically banks would lend 60% of vessel value but in 2008 they lent 90% and also offered 10% bridge financing. So even if a ship owner couldn’t make a downpayment to the shipyard, the bank would say no problem and lend the entire amount. The banks would also provide working capital financing. That could leave some of them with 120% exposure to vessels at the top of the market. It’s mindboggling.
To be fair, if you talk to some of the people in the banks’ credit departments, they will tell you that they had no choice. They claim they tried to say in their reports that they shouldn’t make loans on those terms, but that management said to do the deal. It was no different to the craziness of the US subprime market where you had people working at McDonald’s buying $1 million houses. Some German banks were making vessel loans every bit as crazy. But you look back now and say, wow that was stupid!
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