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Yard sale on the Yangtze

China’s shipbuilding skills shone through in the size of the vessels in Zheng He’s fifteenth century treasure fleets, which were four times as big as the Santa Maria, the ship that carried Christopher Columbus to the New World at a similar time.

But the Ming Dynasty emperors eroded much of China’s maritime heritage by banning seaborne trade. Ships, docks and shipyards were regularly destroyed and there were few signs of the industry reestablishing its international reputation until the 1920s, when Jiangnan Shipyard in Shanghai built a fleet of gunships for the United States Navy.

Since the 1990s the rise of the Chinese shipyards has been a lot more dramatic. Early efforts focused on boosting the number of vessels in the country’s merchant fleet. Now there are too many yards and the challenge is more about how China’s shipbuilders can sink their rivals in Japan and South Korea.

 

Filling out the fleet

In the 1980s less than a fifth of China’s merchant fleet was domestically built and the vast majority of its international trade was carried in chartered or foreign-flagged ships. China’s leaders wanted their shipbuilders to be more competitive and one of the first steps was converting the Shipbuilding Ministry into China State Shipbuilding Corporation (CSSC), which took control of the country’s yards. Its shipyards were too limited in capacity and capability to deliver many of the larger tankers and containerships needed for the national fleet, but domestic demand for small-to-mid-sized vessels provided a vital source of orders and the best of the yards started to emerge into the international market.

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In 1999 CSSC was split into two as a way of generating more competition. It kept control of the yards in the south and west, and China Shipbuilding Industry Corporation (CSIC) took control at shipbuilding operations in northern cities such as Dalian, Qingdao and Tianjin.

These state-owned champions led the efforts to boost the sector, helped by tax rebates, soft loans from the banks and cash bonuses for ships sold overseas. Today they sit atop the industry, controlling most of the leading yards, the marine component manufacturers, and the research and design institutes. In 2005 there was another round of policy sweeteners designed to position the Chinese as the top shipbuilding nation within a decade. But shipyard numbers had already started to surge in response to higher freight rates in the world market, which was fuelling billions of dollars of orders for new vessels. New entrants flooded the sector and many were privately owned. Some are sophisticated yards like Jiangsu Yangtzejiang, one of the largest shipbuilders in China. But the majority of the newcomers were speculative ‘beach yards’ chasing single contracts for newbuild. By 2010 there were said to be as many as 3,000 yards in operation and all the additional capacity was starting to churn out thousands of new vessels.

 

The order book

One outcome of all the new capacity is that the Chinese have grabbed a greater share of the world’s ship construction. Estimates of just how much depends on the definitions of output but in terms of completed tonnage, new orders received and order backlog the Chinese yards accounted for 36%, 65% and 44% of the global market last year, according to Cansi, the shipbuilding industry association.

Thomas Bracewell, director of newbuilding at Hartland Shipping Services in London, says that China’s share has grown fastest in dry bulk vessels, where its yards now control about 60% of the order book.

Their main competitor in dry bulk is Japan, where the yards build ships more efficiently and fit them out to a higher standard (the steel in the hulls is lighter so the vessels tend to be more fuel-efficient, for instance). Chinese construction is less standardised and the yards rejig the production processes to the specifications that customers want. In this regard the Chinese are more flexible, Bracewell says, even though the final vessels are typically less reliable, less efficient and therefore less liquid assets than their Japanese competition.

Ultimately the Chinese yards are competing on price, however, especially for bulk vessels, where construction is less complex. Vessels purchased from Chinese yards are about 15% cheaper than their Japanese equivalents – a new Ultramax of about 60,000 deadweight tonnes costs about $26 million from Japan but only $23 million from China, Bracewell says.

The Chinese yards haven’t won as much business for more sophisticated vessels. “They aren’t getting as many of the higher-value added contracts for vessels for the very large oil tankers and gas carriers, where the Koreans are ahead. Only a few of the Chinese yards are winning these more complex vessel contracts, such as Hudong-Zhonghua Shipyard, which has started earning a name for itself building LNG carriers,” Bracewell reports.

In the large tanker segments (VLCC, Suez, Afra & LR2) the South Korean builders hold around 50% of the order book and the Chinese 30% in tonnage terms. However Chinese market share would be much lower if one were to remove the Chinese domestic contracts. For example, in the VLCC sector, at the end of May Chinese builders had 29 vessels on order, of which 27 were for Chinese buyers and two for Japanese, at a builder which is a joint venture with Japanese firm Kawasaki.

In the international market, the South Koreans are dominant. The story is the same for the largest container ships and gas carriers, where the Korean yards’ engineering capacity keeps them several steps ahead in technology and R&D.

Another difference is that the South Koreans and Japanese are known as market leaders in marine equipment manufacturing. Chinese shipbuilders rely more on international equipment makers, importing from Europe, Japan or Korea, or producing equipment under licence from the foreign manufacturers. Bracewell says that ship owners have to accept equipment made in China if they want to build ships in China but they usually demand that major items are manufactured under licence from European and Japanese brands.

The broader point is that customers see Chinese ships as acceptable rather than outstanding in quality terms. They sell at a further discount in the second-hand market and it can be much harder to find buyers when market conditions are weak. “At the bottom of the dry bulk market last year Chinese ships were selling at huge discounts to Japanese ones – or not selling at all. But as the mood improved, the price gap started to narrow,” Bracewell says.

 

The living dead

Confronted with the challenges of reducing capacity and improving quality, the State Council changed tack five years ago and announced that it wanted fewer yards. State support would be limited to a ‘white list’ of preferred producers.

Unsurprisingly the policymakers have been backing the largest, state-owned shipbuilders. These white-listed yards are seen as safer bets by their customers but the primary advantage is that they keep their access to credit from the major banks. The private yards don’t get the same privileges and many have closed. More of the poorer performers have been culled this year as the authorities drop firms that haven’t delivered ships or taken orders over the previous 12 months.

Getting rid of the yards completely can be a challenge. Hartland Shipping estimates that there are about 700 yards registered in China, a significant drop versus the peak of the cycle. But only about 150 of them are actually building ships and less than 100 have the capability to do so for the international deepsea market, highlighting the huge number of ‘zombie’ operators still to shutdown completely, despite little prospect of securing much business.

These zombie yards have been described by an executive from one of the larger shipbuilders as the “cancer cells” of the industry. “If the market starts to recover and you have the influx of speculative yards, they will throw the supply-demand equation off balance again,” he warned.

The campaign to slim down the sector faces the same challenges as other oversupplied industries in China, such as local governments that refuse to close down local champions and banks that are reluctant to call in debts and crystallise losses on their balance sheets.

Yet there are also indications that the industry is starting to consolidate, with the top 50 yards capturing nearly all of the Chinese order book in tonnage terms. And as smaller yards close, their workforces are leaving the industry for good. “There is a lot of talk about the surplus of shipbuilding in China being massive but we need to differentiate between the infrastructural or hard capacity of the yards, and the human capital in the supply chain. And in this second area, there is a strong argument that the sector has been shrinking quite dramatically,” Bracewell suggests.

 

Beijing at the helm?

Initiatives like the white-listing of the favoured shipyards show that the government’s influence is still significant. But the state isn’t an all-powerful force. There’s a lot less sign of Beijing’s guiding hand when state-owned yards compete between themselves for business, for instance. Bracewell says he has worked on deals where two or three yards from the same ownership group are battling for the same contract.

Nor is the Chinese government unique in helping its shipbuilders out. The Japanese grant major tax advantages to ship owners that contract with local yards and the South Koreans have supported their own shipbuilders for years as well – Daewoo Shipbuilding & Marine Engineering, one of the largest yards, is effectively dependent on the Korea Development Bank, a state-owned lender.

In the United States the support has more of a legislative design: shipbuilders there are buoyed by the Jones Act, which mandates transport between American ports must be carried on American-built vessels.

Perhaps a key difference is that the Chinese are more direct about how they support their shipbuilders, with controlling shareholdings in the leading operators and unapologetic loans and subsidies for the favourites. And while the Korean and Japanese producers have a more market-driven approach, it’s clear that China’s yards are governed as much by political imperatives as profit. The most obvious of these priorities is job creation. Despite the closure of so many shipbuilders, there are still more than 300,000 workers at yards owned by the state, 100,000 in privately run facilities, and another 200,000 at companies that make marine equipment, according to Hartland Shipping’s estimates.

“Lots of these yards aren’t driven purely by profit, which is why we sometimes see prices for newbuild that seem so far below breakeven costs,” Bracewell says. “And when the order books are thin, the instinct of these yards is rarely to fire people but to slow down construction. In effect, they deal with fewer orders by becoming less productive.”

That kind of trend runs counter to efforts to improve the bottom-line in Chinese shipbuilding and it undermines some of the country’s aspirations to challenge the South Korean and the Japanese.

If all the private yards go bankrupt, the state-owned survivors may feel less pressure to reinvent their own businesses, for instance, and Bracewell thinks that a broader overhaul of the sector would see more of the state operators going to the wall, improving the prospects for the yards that remain.

“Were it not for the sanctity of public sector jobs, China might remove the excess capacity in the sector more effectively, yards could increase their spending on R&D, raise productivity and improve quality, and eventually close the price gap with Japan and Korea,” he says.


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