Maritime Market Overview

ITIC Forum, Martin Stopford, Managing Director, Clarkson Research Services Ltd -1 October 2008

1. Where is the shipping business today?

Decades can be very different in shipping. The 1980s were miserable, the 1990s were disappointing and the current decade has been astonishingly profitable. Reviewing the current freight statistics we are on the way down from a series of freight market peaks which have produced a historical high in earnings. Whether this is the end of the boom or there are other peaks ahead depends on the fundamentals - the world economy and shipbuilding, discussed below.

2. Where we are now - the world economy?

There is a long and fairly consistent relationship between cycles in the world economy and cycles in sea trade. The world economy has grown at maximum speed for last five years, the best since the 1960s. The historic series shows that growth is interrupted every seven or eight years by a major recession. There are three signals that the next one is due:

Firstly, the credit crisis has undermined the banking system in the Atlantic and seems likely to drive Europe and North America into the fairly serious recession (if they are not there already).

Secondly, the long boom has created “bubbles” in some industries, particularly real estate in most parts of the world and in supporting industries such as steel. These will present real world problems for policy makers (we also have an energy crisis), making it harder to manage the downturn. Thirdly, China, which was the engine of growth in the last five years, is looking shaky, with slowing GNP, rising costs and falling export volumes. Like the world economy, sea trade growth of around 5% pa is above trend and is likely to slow (or could even fall – it’s happened before). Really the key question is whether we are looking at a short sharp downturn of the type which occurred in 2001, or something that will last much longer than that.

3. Where are we now – shipbuilding?

Even taxi drivers know there is a shipbuilding problem, so I don’t really need to brief you. But just for the record ordering over the last three years looks uncomfortably like the big brother of the ordering spree which caused the problems in 1970s.

Newbuilding prices have doubled and this is reflected in second hand prices which have increased even more, especially for dry cargo vessels such as Capesize bulk carriers. Until recently, the sums being invested in new ships are enormous - $233 billion in 2007 and $104 billion to August 2008 - and that makes this a very challenging situation for the shipping industry. Europe still dominates investment, with Greece and Germany accounting for a quarter of investment in new ships. In effect the market has paid for the ships up front with high earnings but where that cash is today and whether it is held by the companies with shipyard orders is anyone’s guess. Finally, these orders also represent liabilities which may be difficult for some investors to meet if the difficult financial climate persists. The distinctive feature of this shipbuilding boom is that the capacity expansion was undertaken at very short notice. The shipyards only started looking at a major expansion in 2004 and the new berths only started to become available for sale in 2006. As a result, we have been through a “phoney war”. Despite all the orders, shipyard production has grown slowly at around five to seven per cent per annum in the last few years. The big surge of output comes in the next three years - I call this “stage 2” production. The big expansion is in Korea and China. Slippage has become a very big issue which I will deal with in the next section. In the 1973-7 shipyard investment bubble just about everything got built, but the financial climate was very different then.

4. Where are we – slippage?

The delivery schedule is a major issue. The problem is getting accurate information. CRSL has 600 yards on the database, but only specific reported problems at 40, but we would not expect all problems to be reported. 70% of the orderbook is established capacity and 30% in new or extended capacity. However, all shipyards are not the same. The rapid expansion raises 4 questions:

1. Technical performance of start up facilities;

2. Availability of management and skilled labour;

3. Equipment availability; steel prices etc

4. Availability of pre delivery finance.

For the start up capacity, some of which has limited financial and technical backup, these issues could prove very difficult to overcome. Looking ahead, if everything is delivered on time the fleet will grow at over 10% per annum. But if there is slippage of 15- 20% and about 5% cancellations, the growth rate of the fleet over the next three years would be 7-10 percent. But, for the reasons given above, we are just guessing how things will develop. At this time, nobody knows whether investors will want to cancel orders in large numbers and if they do, how binding the shipyard contracts will prove to be.

5. Where are we now - world fleet?

The world fleet has now passed a billion tons deadweight and its growth rate will determine how hard times will be going ahead. In the last four years the fleet has grown at around 6% per annum. That compares with trade growth of around 5% per annum. So the fleet and trade were reasonably well in balance.

Looking ahead, based on the slippage scenario we might expect the fleet to grow by 8-10% per annum over the next three years. If we could rely on the sort of accelerating growth we saw in seaborne trade over last five years that might just be manageable. In a recessionary trade scenario the graph shows how difficult things could become if the growth rate of trade slows or even declines.

Just how challenging depends on what happens on both sides of the market, supply and demand. The outlook for sea trade is very poor at the moment and the precise orderbook statistics suggest fast fleet growth – but how much is delivered and when is a matter of conjecture. Indeed these are things it is probably better not to know in advance.

6. Where we are now – conclusions?

We are near to the end of one of the best booms in shipping history. In the preceding paragraphs I lined up evidence that the industry faces a difficult period – a disturbing economic outlook; sea trade growth likely to slow; and the shipyards moving into an extreme expansion cycle which will increase the fleet by 8-10% pa. This is a bad combination for the shipping industry.

We cannot know exactly what will happen but a recession is now very likely and there are some questions we need to consider about the future of merchant shipping:

1. If there is a recession, what will the next decade look like? How deep will the recession be? Where will freight rates bottom? Will they go down to operating costs again? Could modern asset prices fall to one third of their present levels?

2. If there is a recession, how long will it be? Will it be 2 years (like 2001/2); long but not deep like the early 1990s was for tankers; or a Force 12 hurricane (like the 1980s was for just about everyone).

3. If there is a recession are the problems fundamental enough for a repeat of the sustained market disruption we saw between 1973 to 1997?

4. How will the capital markets respond to falling freight rates and asset values?

Finally, a reminder that shipping faces many other challenges – crewing, energy, regulation of quality and competition, finance and the credit crisis, shipbuilding capacity beyond the present orderbook and political stability.

This paper was produced as a basis for stimulating general interest and discussion at the ITIC Forum. For this reason its content was not subject to any audit or validation procedures and may contain errors. It should not in any circumstances be taken by participants or any other readers as a substitute for their own properly devised and executed research.