Ocean shipping begins the year with unusually high optimism in the crude-tanker sector and very strong sentiment in the product-tanker and liquefied petroleum gas (LPG) segments.
But fundamentals in markets outside of petroleum transport are not nearly as firm, and in general, ocean shipping boasts a long history of surprises to the downside.
As Robert Bugbee, president of Scorpio Tankers(NYSE: STNG) and Scorpio Bulkers (NYSE: SALT), once said in an interview: "There have always been events in shipping you can't foresee ... wonderful and terrifying things. World events smash us to the floor and inflict amazing pain, then we have great things happen and we're back to making money again."
In a high-stakes business that's this unpredictable, it's vital to keep a sharp watch on the top variables and wild cards you can foresee, and mentally prepare yourself to be surprised by those you can't.
Following are some of the most important "devil's advocate" questions for ocean shipping to consider in 2020:
What Will Happen With Demand?
Shipping has an unusually visible supply side because it takes 18-24 months from the signing of a newbuilding contract to the vessel hitting the water. This leads many market watchers to focus more on the measurable supply side than on the unpredictable demand side — despite the fact that big rate moves often derive from unexpected demand changes.
Consider dry bulk shipping. At this time last year, dry bulk was widely expected to do very well in 2019. It didn't because vessel demand collapsed.
A catastrophic mining accident choked off Brazilian iron-ore exports to China; weather battered the U.S. corn harvest; the African swine flu wiped out millions of pigs in China, and with them, a good chunk of the country's soybean demand; both the swine flu and the trade war slashed U.S. soybean exports; and liquefied natural gas (LNG) prices plunged, accelerating coal-to-gas switching in Europe and curbing U.S. coal exports. No one could have predicted such a confluence of negative demand drivers when writing a dry bulk outlook in early January 2019.
The top vessel-demand-related questions for 2020:
Will there be a global recession and/or a sharp downturn in China? Every passing year without a financial crisis makes it easier to forget, but shipping rates and equities are particularly vulnerable to this risk.
Why is it "different this time" for product tankers?A demand rebound has been predicted virtually every year of the past decade but has failed to materialize. After a spike in October-November, rates remain strong but are now back below year-ago levels.
How much downside demand risk does the crude-tanker sector face? The Middle East-to-China trade has been a major driver of recent demand strength, but China's economy is slowing and January-November 2019 Chinese automobile sales were down 10% year-on-year.
Will Gopolitics Be A Positive Or Negative?
Ocean shipping rates are acutely affected by geopolitical events. The crude-tanker sector was the poster child of geopolitical upside in 2019.
Crude tankers were sabotaged in the Gulf of Oman; Iran arrested a British-flagged tanker; an airstrike heavily damaged Saudi oil facilities; the U.S. sanctioned China's COSCO, a key owner in the crude-tanker sector; and an Iranian tanker was attacked in the Red Sea. No one writing a tanker outlook a year ago today could have predicted this confluence of events, which propelled crude-tanker spot rates to 0,000 per day in early October.
And of course, geopolitical issues are not always good for rates — trade wars are a case in point.
The most pressing geopolitical questions for 2020:
Will America's killing of a top Iranian general precipitate a military conflict between Iran and the U.S.? Despite near-term upside for tanker rates, could the worst-case scenario emerge, in which a large volume of crude, products, LNG and LPG is blocked from transiting the Strait of Hormuz?
Is the phase-one trade agreement between the U.S. and China for real, and even if it is, is it a game-changer? If not, container markets in particular could suffer more demand destruction, and the chances of a global economic slowdown could increase.
Will IMO 2020 Play Out As Predicted?
The IMO 2020 rule, which is now in effect, requires all ships without exhaust-gas scrubbers to burn fuel with low sulfur content, either new fuels with 0.5% sulfur known as very low sulfur fuel oil (VLSFO) or 0.1% sulfur marine gas oil (MGO). The questions raised:
Will the new VLSFO blends actually work? Reports are already surfacing of excessive sediment in new VLSFOs. On one hand, VLSFO-related breakdowns remove vessel supply to the benefit of rates. On the other hand, the owners of the ships suffering VLSFO-related snafus would be negatively affected.
Will shipowners really be able to pass along the cost of VLSFO/MGO to cargo shippers? In markets where the supply/demand balance favors cargo shippers, this may not necessarily be possible. Thanks to IMO 2020, the cost of marine fuel has now doubled year-on-year, based on bunker prices in Singapore. On Jan. 3, 2019, the price of 3.5% heavy fuel oil (HFO) was $363 per ton; the price of VLSFO on Jan. 3, 2020 was $724 per ton.
Will scrubber upside take longer to play out than expected? Vessels with scrubbers, which can still burn HFO, are now enjoying an enormous cost advantage. As of Jan. 3, Clarksons Platou Securities estimated that VLCCs (very large crude carriers; tankers that can carry 2 million barrels of crude oil) with scrubbers could save $24,300 per day in fuel costs and Capesizes (bulkers with capacity of around 180,000 deadweight tons) could save $10,000 per day.
But scrubbers are being installed on less than a fifth of the global fleet, and there have been extensive installation delays at the shipyards, pushing completion timelines well into 2020.
Vessels tied up in the shipyards for installations are not earning revenue. To the extent installations are completed, true profit upside won't come for at least a year, as installation cost must be recouped. Furthermore, scrubber ships are not yet showing year-on-year fuel cost savings. The price of HFO in Singapore on Jan. 3, 2020 was $367 per ton — virtually unchanged from one year prior.
Will Newbuilding Orders Remain Muted?
Much of today's bullishness toward shipping stems from the slow pace of new vessel ordering. Executives including Bugbee and Lois Zabrocky, CEO of International Seaways (NYSE: INSW), believe concerns over premature obsolescence are constraining orders.
The International Maritime Organization (IMO) plans to implement new rules to meet greenhouse-gas (GHG) emission-reduction targets for the year 2050. The concern is that a new ship ordered today would be rendered obsolete by IMO 2050 rules before the end of the vessel's 25-year lifespan.
The questions to consider:
Will orders ensue anyway? As panelists noted at the recent Marine Money forum in New York, some owners will order newbuildings despite the obsolescence risk, on the premise that they will earn enough before the ship becomes noncompliant. Other owners will order because they don't believe the IMO 2050 GHG rules will be implemented.
Will new orders for transitional designs spur future overcapacity? Whatever the IMO 2050 rule turns out to be, it's widely accepted that LNG and LPG will be allowed as transitional fuels. If LNG- and LPG-fueled newbuild designs become more economical, will orders featuring these transitional designs create overcapacity (similar to how orders for fuel-efficient "eco" ships did earlier in the past decade)?
Will shipbuilding nations support their yards? The vast majority of commercial ships are built in China, South Korea and Japan. If the forward orderbook sinks too low, shipbuilding nations can support their yards through contracts by state-linked shipowners using state-backed financing. Such orders offer another strategic advantage to these nations, as well: Flooding the market with new capacity lowers a country's cost to transport commodities and containerized goods.
These newbuilding-related questions won't affect capacity in 2020, but the answers should become clearer this year — and that clarity should either positively or negatively affect sentiment and equity prices in the near term.
More FreightWaves/American Shipper articles by Greg Miller
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