The Winds that Crested a Newbuilding Wave in the Middle of a Shipping Cycle Trough
It has been said that if you are in the shipping business, you have to be an optimist by nature. And, optimism with the boatload we have been having over the last few years despite a few bad days here and there …
In a chart in a previous posting, we noted that newbuilding orders placed so far in 2013 are already more than the orders placed in the whole calendar 2012. A proxy index for the market (BDI) in the same graph indicates that we are not faring much better in terms of freight level since last year. So, why the excitement?
The recent newbuilding wave cannot be attributed to any factor alone; however, ever since post-Lehman collapse, many factors have been simmering and eventually are finding an escape valve in the newbuilding market.
For starters, after the collapse, every shipowner and institutional investor worth their salt, they have been salivating about ‘cheap ships’, ‘distressed sales’ and the great number of vessels the bankers would be auctioning on an industrial scale. By now everyone knows that that ‘dream boat’ of business never came to port. The banks held onto the assets, and the ‘cheap ships’ that were sold were few and between, especially if one focuses on good quality, market competitive tonnage.
And, the shipbuilders, who quite a few of them were picking off the shelf designs and started experimenting on a commercial basis (aka ‘greenfield yards’) during the bubble, thought that if they were to manage to convince anyone to sign a new contract in a bad market, they better had to come up with improved designs. We heard of 30% efficiencies, etc, but once all is said and done, all else being equal, on average ‘eco designs’ are about 10% more fuel efficient than ‘average’ vessels. Still, 10% in savings in fuel for a small handysize bulker burning about twenty tons per diem, the savings are about $1,500 pd (nothing to sneeze at when freight rates are below $10,000 pd), savings that nominally add up to $14 million over the vessel’s life (nominally about 60% of a newbuilding’s price). Just imagine what that 10% in fuel savings means for a big vessel that consumers five times as much bunkers as our Lilliputian ‘handy’.
And, the shipbuilders didn’t stop at the ‘eco design’. The sweetened the terms for newbuilding contracts with back-loaded payment structures (30% on signature and 70% on delivery, instead of a more gradual and traditional ‘progress payment’ structure of 5×20% at meeting certain construction milestones.) And, why not, they even got their perspective governments to provide export credit to their qualified buyers, and, in other instances, managed to pocket a few subsidies for themselves as well. After all, they were creating jobs, and helping keep the market oversupplied with vessels (not a goal to be ignored to countries like China).
And then, there were the central bankers worldwide priming the system at levels unforeseen in history, probably for good reasons given the financial scare ensuing the Lehman collapse, keeping interest rates at very low levels; and, more importantly, promising to be doing so for the foreseeable future and ‘at any cost’, using emphatic language to ensure that all got their point crystal and clear. Low interest rates reflectively also mean that the ‘opportunity cost’ for the cash rich buyer is small enough to be ignored, which makes the prospect of a newbuilding even more enticing.
And, while in previous downcycles the market was dominated by strategic players like the shipowners, the cargo owners and the shipping banks, this time things are indeed different. Quite a few of entrants to the market, and some of these new entrants to the market are with deep pockets that could make even rich private shipowners look like paupers, are institutional investors and private equity funds that have raised or have access to multi-billion dollar pockets of money.
So, there is a market when vessels in the secondary market should be cheap but no there is no activity on grand scale, when the market index is less than 10% of its peak (see graph) implying both that sooner or later has to improve and also that till then the ‘revenue forfeited’ will be smal , when the payment structure for newbuildings is favorable and the financing cost low, when the Siren Song of the ‘eco designs’ promises that fuel efficient vessels will crowd out their older siblings even in an oversupplied market when vessels will be idling, and, finally, when in two years we will be reaching the average shipping cycle length (two years is just about the time to get a new order materialize in the form of a new vessel), one can only start appreciating the newfound excitement for newbuildings!
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