In early March, Maersk chief executive Søren Skou delivered a stinging blow to those who claim the epic decline in the Baltic Dry Index is representative not of sagging worldwide demand, but rather of severe oversupply, and is thus no longer a reliable indicator when it comes to assessing the state of the global economy. Skou told FT he sees container demand “towards the low end” of the 3-5% growth range the company forecasts for 2015. If Skou is correct, it would mark a Y/Y decline in growth for the company, which handles around 15% of all seaborne freight. Skou also flagged the generally sluggish pace of global economic growth, noting that “the economies in Europe are still very sluggish. Brazil, Russia and China: those three economies used to drive a lot of growth, and right now we are not really seeing that to the same extent. The only real bright spot is the US, and even the US is good but not great.” This led us to remark that “yes supply isn't helping, but it is the lack of global demand that is pushing equilibrium levels lower, aka global deflation.” Later in the month, we flagged further declines in shipping rates as evidence that global trade was grinding to a crawl.
Meanwhile, we’ve exhaustively documented the laundry list of signs that point to dramtically decelerating economic growth in China, including falling metals demand, collapsing rail freight volume, slumping exports, a war on pollution that may cost the country 40% in industrial production terms, and, most recently, a demographic shift that’s set to trigger a wholesale reversal of the factors which contributed to the country’s meteoric rise. All of this means that the world’s once-reliable engine of demand is set to stall in the years ahead.
Finally, we’ve been keen to note that CB policy has had the effect of allowing otherwise insolvent companies to stay solvent by tapping investors at record low borrowing costs contributing to a supply glut and, ultimately, to deflation.
Consider the above and then consider the following, from Goldman, who now predicts the intersection between soft commodity markets and the Chinese transition from investment to consumption will weigh on dry bulk trade — and by extension, on shipping rates — until at least 2020.
The transition from investment to consumption in the Chinese economy, together with a shift towards cleaner energy sources, has caused a sharp deceleration in dry bulk trade. After expanding at an average annual rate of 7% over the period 2005-14, seaborne demand in iron ore, thermal and metallurgical coal is set to increase by only 2% in 2015 to 2.5 billion tonnes as these trends persist. In the steel sector, domestic consumption growth ground to a halt in 2014 and the prospect of peak iron ore demand is nigh. In the power sector, demand for coal-fired generation is suffering from a combination of weaker economic growth, rising energy efficiency and a diversification in the fuel mix towards renewable energy, natural gas and nuclear. There are no other markets large and/or dynamic enough to offset a slowdown in China in the foreseeable future, and we forecast trade volumes to stabilize in the period to 2018.
Meanwhile, shipyards churning out large dry bulk carriers in expectation of a sustained period of strong demand for commodities now find themselves adding unwanted capacity into an oversupplied freight market. The two largest dry bulk vessel types, panamax (c.75,000 DWT2) and capesize (c.180,000 DWT), benefited the most from the bull market in iron ore and coal. The size of the fleet doubled between 2008 and 2015, and current order books will ensure that shipping capacity continues to grow until 2017, when vessel retirements will finally outweigh new deliveries.
The divergence between demand for freight and the capacity of the vessel fleet reflects the time lag between the mining and shipping sectors. In both industries, supply responds to price: rising commodity prices in a tight market leads to investment in new mining capacity in the same way that rising freight rates encourages greater activity in shipyards. On that basis, the mining sector moves first by ramping up export volumes and the shipping sector moves next, responding to rising trade volumes by investing in new vessels. Conversely, mining companies will be the first to respond in a bear market by curtailing investment, while the delayed response from ship builders will result in overinvestment and excess capacity.
The daily charter rate for a capesize vessel has declined from a peak in excess of US$100,000 in 2008 down to its current level below US$10,000. Faced with the risk of leaving vessels idle over long periods, we believe that ship owners will charge charter rates that are range bound between the cash cost of operating the vessel and the accounting break-even rate. This compounds the impact of lower fuel prices, resulting in a period of cheap freight that should last until older vessels have been scrapped in sufficient numbers to balance the market, most likely beyond 2020.
In other words: not bullish for global trade/demand. So as we anxiously wait to hear from those who claim it's all about oversupply and nothing to do with the fact that between a decelerating China and the utter failure of central bank policies to stimulate demand to soak up a global supply glut which QE has to a large extent facilitated, we'll leave you with a fresh look at the Baltic Dry Index which, all things equal, signifies a global depression of epic proportions.