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Boom to bust, and back again?

China’s economy has grown at such a bewildering pace in the last 20 years that some of its more recent records haven’t raised much reaction, however staggering the statistics might be.

So it was easy to miss another mind-blowing milestone when the Chinese topped a billion tonnes of imports of iron ore last year, accounting for more than two-thirds of seaborne trade in the commodity. A delivery rate of 32 tonnes a second is barely believable in logistical terms and it would have been impossible to imagine in 1961 when China’s government acquired the first ship for the newly created China Ocean Shipping Corporation (or Cosco as it came to be known).

A second-hand passenger steamer was purchased from a Greek merchant and it sailed to Jakarta on its maiden voyage, ferrying back to China some of the Chinese-Indonesian migrants unnerved by local unrest in the Southeast Asian country.

The longer-term goal was to carry a greater share of China’s trade on ships of its own, however, and Cosco responded by building up its fleet, largely through purchases of vessels from overseas.

290 points

The lowest ever level in the Baltic Dry Index, recorded in February 2016

All the same, the merchant fleet wasn’t much larger than a few hundred vessels at the beginning of the 1980s, when Japanese lines were carrying the large majority of Chinese exports and foreign brokers were arranging most of the ships that were importing commodities for its industrial base.­

Previous contact with the shipping world had been limited to joint ventures with communist partners in countries such as Albania, Poland and Czechoslovakia. But by the time that Tim Huxley – now the chairman of Mandarin Shipping, an owner and operator of feeder container ships – started his career in ship broking in the 1980s more of the business was shifting to Hong Kong.

Contact with key customers across the border was heavily restricted, however. Sinochart, a government agency, had sole responsibility for chartering and its relationships with the shipbrokers were limited. “We never met any of them in person and they were identified only by number so we didn’t even know their names,” Huxley recalls. “We would send them the lists of ships that were available and then negotiate the rates entirely over the telex machine. It was all centrally controlled, so effectively we were haggling with the Chinese government.”

Hong Kong’s shipbrokers had little experience of Chinese vessels, most of which were operating in China’s coastal waters, and contact with the country’s shipbuilders was also minimal, because the shipyards didn’t have an international outlook.

“That was apparent in things as basic as the design of the railings in the engine rooms, which were too small for Westerners to get their hands around without chafing their knuckles,” Huxley remembers.

 

Trade starts to take off

As China’s economy began to open to the wider world, contact with the world’s merchant fleet started to broaden as well. “Sinochart’s stranglehold on bulk chartering didn’t last for long,” Huxley says. “Ocean Tramping and Yick Fung – two state-backed firms that worked primarily with Chinese customers – began to contract for more vessels, and they were joined by industrial giants like Baosteel and Sinochem, who even purchased some of their own ships.”

Something similar was happening in the container trades, where Richard Hext was working for the shipping division of John Swire and Sons.

When Hext first arrived to work as a “ship jumper” in Hong Kong in 1978 China’s manufacturing miracle was only just beginning and the majority of exports were coming direct from the British colony, which was still a manufacturing hub in its own right.

“All the container boxes at the port were either identified as Hong Kong ‘local’ cargo or Hong Kong-China transshipments, and for the early years of my career the ‘local’ category was the bigger business,” he says.

High Demand w

The growth of export processing zones in the Pearl River Delta and around Shanghai soon meant that more of the trade flows were starting to originate across the border in China. For a while Hong Kong kept a firm grip on the international container trade, because the ports in China were so inefficient. Heavy congestion was keeping vessels waiting at anchor for days. In the early 1990s investment in modern terminals and deepwater berths was reducing the delays. By then Hext was running P&O Swire Container’s trade between Australasia and Asia (now a part of Maersk) and his business was one of the pioneers in making direct calls at China’s export hubs. “Shanghai was first for the Australian trade but there were more direct services to other points as trade flows grew, including the new terminals in Guangdong province, which were undercutting Hong Kong on price,” he recalls.

Inbound flows of commodities like coal, iron ore and oil were growing rapidly as well, fuelled by urbanisation and industrialisation in the Chinese economy, and the consequences for the shipping industry were profound.

Construction of larger cities with bigger populations – as well as the infrastructure that connects them – generates greater demand for steel. Steelmakers need raw materials, especially iron ore, which thus is imported in ever-growing quantities by the bulk shipping lines. Increases in industrial activity pushes up demand for electricity, requiring more shipments of fossil fuels such as coal or oil. And as China’s provincial economies modernise their exports increase, stimulating demand for containerships to carry the finished goods.

China’s GDP was expanding at a pace and scale unprecedented in history. Total imports surged from 200 million tonnes in 1998 to a billion tonnes in 2008, accounting for 60% of the growth in seaborne trade. Exports trebled from 150 million tonnes to 400 million tonnes, and containerised exports grew even faster, increasing at 25% a year on the key US and Europe routes.

“These trade flows are what changed the world of shipping. Demand for raw materials saw China’s industrial economy come to life, boosting the bulk trade, and then exports took off, triggering the surge in the container business,” Huxley says.

 

The boom in dry bulk

The clearest evidence of how China was transforming the shipping world came in the five years after 2003, which was a golden period for the dry bulk carriers.

For much of this time Hext was in charge of Pacific Basin Shipping, one of the leading fleets of mid-sized dry bulk vessels. Demand from China for commodities like coal and ore was already buoying prices, he says, but a key factor in the subsequent surge in charter rates was a shortage of ships. Shipbuilders had suffered from years of low profits before the boom, so shipyard numbers had dwindled. When China’s appetite for iron ore suddenly started growing at 15% a year, there wasn’t the seaborne capacity to carry it.

“We got to a point where there simply weren’t enough ships to meet demand and by 2007 the freight rates were going through the roof,” Hext confirms.

As the super cycle accelerated, charter rates for Capesize vessels – the largest in the dry bulk fleet, and the biggest carriers of iron ore – climbed the highest, surpassing $150,000 a day at their peak. The supercharged returns also drove up asset prices, with the price of a modern Capesize rising from $24 million to as much as $165 million five years later. Hext says that many of Pacific Basin’s fleet quintupled in value between 2004 and 2008, while the company’s share price rose more than sevenfold in what was one of the most profitable periods in the industry’s history.

Flow Iron Ore w

magnifying glass

But the super cycle was sowing the seeds of its own destruction as the lure of quick profits saw investors pour unprecedented capital into shipbuilding.

A conversion programme of oil tankers into ore carriers brought more vessels into service in some of the most overheated parts of the market but capacity really surged as a result of hundreds of new shipyards in China, which were churning out new vessels in record numbers. The result: an order book that soon ballooned to more than 75% of the existing fleet.

All of this was happening as the impact of the credit crunch began to ripple through global finance. Slowdowns in the wider economy were starting to take hold in the US and Europe, and the mood darkened in China too, where steel production crashed and economic growth fell to its lowest level since 2001.

Lehman Brothers collapsed in the autumn of 2008 and trade finance dried up completely, just as many of the new ships were setting sail for the first time. Freight rates dropped viciously and the market in dry bulk charters capitulated in a matter of months. Average daily rates for Capesize charters had been $175,000 in the second quarter but they had disintegrated to not much more than $2,300 in the first week of December. The super cycle had come to a shuddering halt.

 

China as the market maker

The shipping world has spent most of the last nine years trying to survive the effects of the market collapse, particularly in absorbing the oversupply of new vessels.

The adjustment has been more painful in a time when the world economy has been slowing. Average growth in global export volumes was 2.9% between 2008 and 2015, according to IMF data, or less than half the corresponding figure for the previous seven years.

Bigger picture, the landscape has been changing from a period in which China’s impact was felt most as a customer – and as the key contributor to the fabulous profits that were made at the peak of the market.

Over the last decade the Chinese have been emerging as competitors for the international shipping lines, and companies like Cosco and China Shipping have built up their own franchises in the bulk and container trades (see section 4).

Equally significantly, the Chinese yards have been key players in the newbuilding spree that has laid the industry so low, contributing a major share of the surplus ships (see section 5).

Analysts now seem cautiously optimistic that the shipping sector could be set for a more sustainable recovery. Perhaps the worst is behind the container shippers, for instance, as demand has shown signs of improving, while new orders have been reduced by years of poor performance.

Container trade grew at about 5% year-on-year in the first quarter of this year and throughput at China’s top eight ports increased by 7% in the first five months.

The bulk shipping market has also suffered horribly since the collapse in freight and charter rates in 2008. After averaging about 1,300 points in the 18 years before the super cycle, the Baltic Dry Index shot up almost ten times during the boom, reflecting the surge in Chinese commodity demand. Apart from brief rallies in 2009 and 2010, the index has been trading at deeply depressed levels since the boom turned to bust, and it fell to its lowest ever point in February last year.

In the second half of the year the index recovered some ground and it has been trading higher again in 2017. China’s thirst for commodities was once more a key factor after steelmaking picked up, fuelled by spending on domestic infrastructure and real estate construction. Higher demand for electricity has lifted imports of coal at a time when local miners have been prevented from operating at full capacity, while lower oil prices have encouraged stockpiling of crude and more ordering from China’s smaller ‘teapot’ refiners.

What’s clear is that shipping executives will be watching China closely for evidence that more optimism is warranted.

Among the bearish signals this month were reports that iron ore inventories have reached record highs at Chinese ports, raising fears that orders of future shipments of the commodity might start to weaken. Output at Chinese iron ore producers will also be scrutinised for signs that the pick-up in prices is encouraging domestic firms to restart their operations.

In a similar way, the shipping community will be monitoring Chinese coal production, hoping that a fuller implementation of government restrictions on the most inefficient and high-polluting producers will prompt further spikes in imports from overseas.

On the supply side, any evidence that the authorities are paying out more in scrapping subsidies will be welcome, as well as news that more of China’s shipyards are being denied credit by the local banks. Both trends would help in shrinking capacity across the world’s fleets, a key factor as far as the two maritime veterans from Hong Kong are concerned.

Indeed, both men highlight how what happens in China is fundamental to the fortunes of their industry.

“You have to hope that demand for the raw materials that China needs to underpin its continued industrialisation and urbanisation will hold up, whilst its yards will not (again) turn out too many ships,” says Hext.

Huxley agrees: “This prolonged downturn has very much been driven by oversupply of ships, so keeping an eye on Chinese shipbuilding capacity is key. But China is also going to remain the driver of the bulk trades, so cargo volumes – and where they are sourced from – are key indicators of shipping’s future health”.


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