Full steam ahead

Cosco signs up for giant new vessels, despite the collapse in freight rates

Containers from COSCO are pictured at a port in Shanghai

Cosco: part of China’s grand strategy to dominate global shipping

When construction of the Yamato was finished in 1941, it joined the Japanese fleet as the world’s biggest battleship. The celebrations were muted. By the time of its launch, Tokyo’s naval bosses knew that the war in the Pacific was less likely to be decided by which side had the bigger battleships, and more by who had the most aircraft carriers.

In fact, the admirals kept the Yamato out of harm’s way for most of the war, before sending it on a desperate trip to defend the island of Okinawa in the final months of the conflict. It was a suicide mission – American bombers took just two hours to dispatch the 72,000 tonne battleship to the deep. (A gripping account of this one-sided engagement can be found in Russell Spurr’s book A Glorious Way to Die.)

The Yamato was an ill-conceived naval folly – perhaps one of the greatest in history – and a case of the Japanese admirals being readier to commission a ship to fight the battles of yesteryear than assess their future needs. In a similar, albeit less violent fashion, the world of commercial shipping is struggling with another act of maritime folly – this time caused by shipowners who badly misread the commodities supercycle and vastly expanded their fleets.

“It’s hard to have a positive view of this market,” says Basil Karatzas, head of the shipping consultancy and broker Karatzas Marine Advisors. “This is a crisis like no other,” he told WiC last week, pointing out that the index used to measure freight rates for commodities like iron ore – known as the Baltic Dry Index – reached its lowest point in February since its inception in 1986.

Simply put, there are too many ships at sea looking for cargoes. By the end of 2015 global capacity of dry bulk vessels (the type carrying most commodities) had reached 780 million deadweight tonnes (dwt) – an increase of 86% versus 2008. By contrast the demand for dry bulk shipping grew just 38% over the same period, resulting in a chronic surplus of freight space.

The root of the problem, says Karatzas, can be traced back to China and its demand for commodity imports. When that appetite was growing voraciously, it strained the world’s shipping fleet to its limit. At the peak of the market in 2006-2008, this led to an unusual situation: the freight rate to ship iron ore from Brazil to China was higher than the cost of the ore itself. “As a rule of thumb, the shipping cost should be below 5% of the cost of the commodity. In 2008, it was more than 100%,” notes Karatzas.

For the shipping firms this was a glorious boom, with demand for ships far exceeding the number of vessels available. In May 2008 the Baltic Dry hit a record high of 11,793. Shipowners scrambled to place orders for new, larger vessels on the assumption that China’s appetite for commodities would stay insatiable.

What happened next is reminiscent of one of those scenes when Wile E Coyote runs off a cliff. Just as these newly ordered vessels started to leave the shipyards, China’s industrial economy began to slow from its earlier frantic pace. The shipping sector has been suffering ever since – although this February was arguably the sector’s bleakest month, with the Baltic Dry hitting an all-time low of 290 – a reflection of just how far freight rates had plunged from their peak in 2008.

New York-based Karatzas says the situation has been particularly brutal for ship-owning families from Greece. Back in 2008 each supramax type vessel was making them $5 million a year; last year the same vessel lost them $1 million – and that’s just at operating level (with additional red ink from meeting the financing costs). Those same families are now reluctant to take delivery of new orders. Rather than pay up for ships destined to be lossmaking from day one, they are forfeiting their deposits to the shipyards (Chinese ones, in many cases).

Not surprisingly a shakeout is underway and Karatzas forecasts that many of the smaller Greek family businesses will exit.

Over in China, the same trend also prompted the merger of its two state-owned giants Cosco and CSCL – which created the world’s biggest dry bulk carrier last year (and fourth largest container shipper). In total Karatzas reckons the combined entity has more ships than any other at 895 (though around 80 of these aren’t ocean-going vessels).

That led 21CN Business Herald to ask in a recent article: to what extent will the Cosco-CSCL merger resolve the overcapacity problem?

Certainly the Chinese government has tried to take a more proactive approach, offering subsidies for the scrapping of older, less efficient ships. Clarksons, the shipping broker, estimates that Chinese shipping firms dismantled a record number of vessels last year: 6.7 million tonnes of capacity or 30% of scrappings worldwide. And Cosco was at the vanguard of the trend, taking advantage of Rmb1,500 per tonne of subsidy to dismantle 56 ships last year (receiving Rmb2.15 billion).

21CN reckons Cosco’s scrapping subsidy will rise to Rmb7.1 billion ($1.09 billion) by July this year.

So problem solved? Far from it. New vessels are coming into the market quicker than old ones are leaving it. Hence Clarksons estimates that the glut of vessels is only going to worsen in the near-term, warning that in the first half of this year 24.9 million dwt of capacity will be eliminated but 49.9 million dwt will be added (it also forecasts dry bulk capacity will grow 4% this year, while actual transport volumes will grow by just 0.4% – thus further pressuring freight rates).

Cosco has hardly helped the situation by ploughing its scrapping subsidies back into orders for some of the world’s most gigantic dry bulk vessels. It recently put down deposits with China State Shipbuilding Corporation for 10 vessels of 400,000 dwt each, betting that their economies of scale will help Cosco ship more efficiently iron ore from Brazil via a multi-year agreement it has signed with miner Vale.

(State-controlled China Merchants Group and ICBC Financial Leasing put down orders for 10 more ‘Valemax’ each in March too.)

Populating its fleet with bigger, more cost-effective ships could turn out to be a sensible longer-term strategy for Cosco.

But it does little to address the wider problem of too much supply today. “Analysts believe Cosco’s massive order of ships will further aggravate overcapacity,” the People’s Daily admits.

That said, the Chinese look at the current state of affairs more positively than shipowners from Greece and elsewhere, Karatzas says. After all, lower freight rates are good for a country that relies heavily on maritime transport for most of its imports and exports. China’s planners also want to take advantage of the industry’s woes to stock up on ships as others ditch theirs – thus ensuring their nation’s fleet becomes a bigger proportion of the global total.

Karatzas says that as China becomes a more dominant force in world trade, it makes strategic sense to control too the means by which these goods are moved (and drawing on historical precedent, he adds that all rising powers follow this path where shipping is concerned). As an indicator of growing Chinese prominence, he cites data showing that Hamburg port had throughput of 2.89 million TEU (twenty foot equivalent) containers in 1995 versus Shanghai’s 1.52 million TEU. Last year the German port handled 8.8 million TEU versus Shanghai’s much larger 36.5 million TEU.

As for Cosco’s vaulting ambitions, Karatzas argues that the Chinese heavyweight cannot be easily compared to international rivals such as Maersk, which are purely commercial in nature. “Is Cosco really a ‘profit centre’ or is it a ‘cost centre’ – where losses can be tolerated because of the greater good to the Chinese economy?” he ponders.

Shipping, he adds, is a strategic industry for China in which Cosco serves an additional function: helping local shipyards to win business and move up the value chain.

For example, its order of the 400,000 dwt vessels is designed to demonstrate that Chinese shipyards can build vessels to the same scale as the South Koreans and thus position them to win more orders. He argues that none of the major foreign shippers are going to buy the first super-large vessels from Chinese yards without Cosco establishing a track record that they are economical and reliable.

If Cosco’s expanionist agenda offers its rivals in the dry bulk shipping world little in the way of optimism, in container shipping Cosco is taking a slightly different tack – opting less for an approach of scrapping old vessels (and then buying bigger new ones) and more for cooperating with other players.

Late last month it became a member of a new alliance (known as the OCEAN Alliance) with France’s CMA CGM, Evergreen of Taiwan and Orient Overseas of Hong Kong. From next April the group will pool 350 container ships on 40 routes. At 3.5 million TEU the alliance is bigger than rival Maersk’s 2.1 million TEU collaboration known as 2M. On the Asia to Europe route the two alliances will each have a market share of around 34%. The hope? That they will be better positioned to establish a floor on container freight rates from 2017 onwards.

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