Talk about the future of ocean shipping and it always comes back to the cycle. When is this horrific tanker down-cycle going to end? Did investors buy the tanker stocks too early? How high can this crazy container-shipping up-cycle actually go? When will containerized cargo shippers ever get relief? Is this finally the start of the elusive dry bulk upswing?
And inevitably, the bigger question: Can shipping cycles ever be tamed or broken? Can it ever be the case of “this time it’s different?”
“Market cycles pervade the shipping industry,” wrote author Martin Stopford in “Maritime Economics,” widely considered to be the industry bible. “These shipping cycles roll out like waves hitting a beach. From a distance they look harmless, but when you are in the surf, it’s a different story.
“As far as shipowners are concerned, the cycles are like the dealer in a poker game, dangling the prospect of riches on the turn of each card,” wrote Stopford. “This keeps them struggling through the dismal recessions … and upping the stakes as the cash rolls in during the booms.”
The uncertainty of cycle timing
The shipping cycle is the pricing mechanism that adjusts vessel supply to cargo demand.
When vessel supply exceeds demand, freight rates and asset values fall, older ships are scrapped, and new ship orders decline. As the market balances, new ships are ordered (or, in the case of countercyclical orders, before the market balances). Traditionally, because it can take two years to build a ship, too many new vessels are built and by the time they’re delivered, vessel capacity exceeds demand and the cycle repeats.
A central question for shipowners, investors and cargo shippers is: Even if you know that what comes up must come down, and vice versa, what good is that if you don’t know when the cycle will turn? Being too early is the same as being wrong, particularly given opportunity costs.
In his book “Mastering the Market Cycle,” Oaktree Capital Management co-founder Howard Marks wrote, “The rational midpoint [of the cycle curve] generally exerts a kind of magnetic pull, bringing the thing that’s cycling back from an extreme in the direction of ‘normal’ [the secular trend].”
Marks believes that business cycles “aren’t as regular as the cycles of clock and calendar, but they still give rise to better and worse times for certain actions.”
Marks’ company happened to be one of the largest investors in equity and distressed debt of dry bulk and tanker shipping companies in the wake of the 2008-2009 financial crisis. Several industry sources speaking to American Shipper have opined that Oaktree came in too early.
Oaktree has spent much of the past decade waiting to monetize post-financial-crisis moves. It built up significant stakes in Eagle Bulk (NASDAQ: EGLE), Star Bulk (NYSE: SBLK) and TORM (NASDAQ: TRMD), among other shipping companies, and is finally starting to sell off more of its positions.
Oaktree has sold over $9 million in Eagle Bulk shares this year and sold $226 million of its Star Bulk stake in a block sale in May, according to Tradewinds. It has been a long wait. It invested in Eagle Bulk via distressed debt back in 2013, the same year it began building its stake in Star Bulk.
Oaktree’s early timing was the butt of a joke by Robert Bugbee, president of Scorpio Tankers (NYSE: STNG) and Eneti (NYSE: NETI), the company formerly known as Scorpio Bulkers, during a Marine Money conference in November 2013. Announcing his mock year-end awards, Bugbee said, “[The winner for] philanthropy has to go to Oaktree, again. Three-time winner.”
Ironically, Scorpio has had its own cycle timing issues. Scorpio Bulkers went public in December 2013, just a few weeks after Bugbee’s Marine Money speech, and lost money ever since. In December 2020, it announced it would sell its entire dry bulk fleet and focus on wind-farm installation ships instead, booking a $458.8 million write-down on its bulker fleet in Q4 2020.
Just a few weeks later, the dry bulk market sharply rebounded. The big winners have been the companies that bought the ships from Scorpio Bulkers, including Star Bulk and Eagle Bulk, companies backed by Oaktree.
Rough decade for cycle timers
The 2010-2020 era was a confounding stretch for shipping-cycle timers hoping to buy low and sell high.
There were some periods of profitability — tankers had a good year in 2015 and saw brief events-driven spikes in Q3 2019 and Q2 2020 — but no truly sustainable up-cycles. Countercyclical ordering by both private equity and public companies kept the supply-demand balance in favor of cargo shippers.
The cycle is less volatile in container shipping than in bulk commodity shipping because the former are liner (scheduled) operators using primarily owned and time-chartered ships whereas the latter are tramp (unscheduled) operators with a heavy focus on spot deals.
Sea-Intelligence CEO Alan Murphy told American Shipper, “Container shipping used to be cyclical prior to 2009. We had pretty high two- to three-year cycles. But since then, besides a fantastic year for liners in 2010, the market overshot because everybody ordered, which led to 10 years of oversupply [prior to the current upturn]. If you were a shipper, you could take a contract and use it as a free option, and if the market went down you could go into the spot market.”
Another way to describe the pattern would be: Container shipping is still cyclical, but it had shorter, more rhythmic cycles prior to its mass ordering of vessels in the late 2000s, leading to a decadelong down-cycle, followed by the current historically strong up-cycle driven by COVID-induced consumer spending on goods.
Is it different this time for bulk shipping?
Sustainable up-cycles in tanker and dry bulk shipping typically coincide with strong cycles in commodities, as occurred after the entry of China into the World Trade Organization in December 2001. There is now growing talk among analysts of a post-COVID commodity super-cycle, which, if true, bodes very well for dry bulk shipping and eventually tankers.
The “this time it’s different” argument for wet and dry bulk shipping cycles is that decarbonization has dramatically altered the vessel-supply equation.
According to this theory, speculative orders for tankers and bulkers are not only much lower in the current cycle due to economic uncertainty, but due to fear of future decarbonization rules on allowable newbuild propulsion systems. Ordering a ship with the wrong propulsion system would cause premature obsolescence.
Jefferies analyst Randy Giveans told American Shipper, “For dry bulk and tankers, you could certainly argue that this time it’s different. If you look at rates, you’re still not seeing a lot of orders. Clearly something is keeping orders at bay. It’s a combination of things: There’s less shipyard capacity, there are more orders for gas carriers and container ships [filling up slots], there is less access to capital from European banks, and there is real uncertainty over environmental regulation.”
Giveans doesn’t think this will break the bulk commodity shipping cycle, but he does think it will change the duration of the future up-cycle. “I think the cycle will be more pronounced and longer than it has been in the past, because we haven’t seen these [low] numbers on the vessel supply side in 20 years,” he said.
Is it different this time for container shipping?
Container shipping faces the same environmental-regulation risk as bulk commodity shipping, but this hasn’t stopped new orders.
New contracts signed in Q4 2020 and 2021 have brought the orderbook from a low of 8% of on-the-water tonnage in the second half of last year to around 18% currently. However, the orderbook remains manageable, given that a ratio of 15% is considered normal to replace aging vessels and that the ratio was as high as 60% in 2008.
The “this time it’s different” argument for container shipping is not as much about environmental regulations as it is about liner concentration.
Container liner operator operations are dramatically more consolidated than in bulk commodity shipping, with the main East-West trades now controlled by just three alliances. If there’s one thing that can tame a cycle, it’s extreme consolidation.
“The consolidation that has taken place is a game changer,” said Giveans. “Even four or five years ago, it was a much more competitive market. Now there’s really only five or six real players.”
The vast majority of container-ship orders placed in the past nine months have been signed by non-operating owners (NOOs) against long-term charter agreements or by liners themselves. In an interview with American Shipper in December, Stefan Verberckmoes, shipping analyst and Europe editor at Alphaliner, predicted, “Just as carriers have become more careful about managing capacity, they will also consider managing newbuilds as part of their plan.”
And even if there were a rise of speculative orders by NOOs, it may still not lessen liners’ market power.
The liner sector proved in Q2 2020 that when demand falls, it can manage capacity downward to support rates via the use of “blank” (canceled) sailings. If liners can continue to do so in the years ahead, it could temper the swings of the container freight rate cycle — to the benefit of liners.
On the last quarterly conference call of Maersk, CEO Soren Skou was asked about the recent wave of orders for ships that will be delivered in 2023-2024. Skou responded, “In the second quarter of last year our demand dropped 15% and we took out 20% of our capacity and kept our pricing flat. That’s the kind of operating modus we will continue in the coming years. On the question of the orderbook, what really matters to us is the capacity we deploy compared to the demand we have.
“It’s not really important how many ships exist in the world,” affirmed Skou. “It’s how many ships that are deployed that matters.”
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