The 'Cape' Debate

The Financial Times recently had a lengthy article in their ‘analysis page’ titled the ‘Clash of the Cape Crusaders.’ People in shipping may be excused for thinking that an international, mainstream business newspaper was dedicating a whole page discussing at length the ‘Cape market.’ In the case of the FT however, ‘Cape’ referred to ‘Cyclically Adjusted Price Earnings’ ratio; according to the way PE is adjusted for cyclicality, the broader US stock market can be either undervalued or overvalued. Based on the same benchmark.

Shipping’s capesize market has been experiencing a resurrection recently that has got many industry pundits wondering whether the worst is behind us or just that the recent improvement in this market is a just another ‘false positive’ sign.  Thus, shipping’s own cape debate is whether the market is overvalued or undervalued in its own small universe. Not a small question, really.

First the good news: in the first ten days of September, average capesize rates moved from about $15,000 pd to $27,00 pd (up 80%), while the Baltic Capesize Index (BCI) climbed about 1,000 points to 3,243 (up 45%) and transport cost by 31% from West Australia to Qingdao (China) at $12.1 / ton and about 18% higher on the Tubarao (Brazil) – Qingdao (China) route to $ 23.5 / ton.   Given that this time last year capes, on average, were earning less than $5,000 pd, and that it costs about $8,500 pd in daily operating expenses to run such a vessel, the present rate of $27,000 pd is a most welcome development!  In long forgotten days, such rates may have been a cause to pop a champagne bottle.

As great the improvement in rates as it has been, we all sort of have seen this story before where rates improved seasonally / temporarily and then deflated rapidly again.  However, it seems that the increase in rates this time is driven by end demand and higher production of steel bars in China, which translates into higher demand for iron ore (while quite often in the recent past, increase in freight rates was driven by pure stock piling / replenishing inventories).  Bloomberg reported that steel reinforcement-bar futures in Shanghai have climbed to $613 per ton recently, while steel output has increased to 2.12 million tons in late August.  These all despite the fact that iron pricing is up about 25% in the last three months at $138 / ton and iron ore stockpiles stand about 22% lower than the year ago.

Thus, so far, the news is fairly encouraging, which is most welcome in a market that has been brutally battered by the storms of the weakening word trade and other market dynamic considerations.

Now, the bad news: Rio Tinto has announced an earlier than expected iron ore new capacity to 290 million tons (from 230 million tons previously) on an annual basis. This would have been ‘great‘ news, if not that most of this new production and also additional production coming to market by other miners is taking place in West Australia, which is much closer to China than new production in Brazil, which would had absorbed much more tonnage for the transport of same amount of cargo.

And more bad news: while in the last three months about six capes per month were entering the market via deliveries from shipbuilders (vs more than 15 deliveries per month in 2012), still more than twice as many capes delivered this year than got scrapped (about 70 deliveries vs 30 scrapings); year-to-date, about 130 newbuildings (plus 30 more options) were ordered.  Admittedly it’s tough sourcing rumor from fact on these ‘orders’ and still to be seen how many of these newbuilding vessels will eventually ‘hit the water’, but it’s almost incomprehensible that 10% of the world cape fleet has just been contracted anew in 2013 when on average, year-to-date, average cape freight rates ($10,500 pd) remained just above operating expense levels.  The overall cape orderbook stands at about 20% of the world cape fleet (depending on assumptions), while more than 50% of the world cape fleet is newer than five years old.

Looking at the forward curve for some guidance, while the physical freight market for capes improved and the paper market (FFAs) moved along to same levels for Q4 2013, the forward curve for the next three years stands sizably lower at about $18,500 (admittedly much higher than the level of $11,500 for CAL14 in early June but nowhere close to level covering cash expenses).

The recent developments in the cape market, as welcome and encouraging as they have been, still have not changed our bearish assessment in an earlier posting on this site. It will take more than a market rally to make us reconsider. It’s not that demand is not there…

In our opinion, the shipping ‘cape debate’ is bit clearer to award than the CAPE debate on the US stock markets, in our opinion …

© 2013 Basil M Karatzas & Karatzas Marine Advisors & Co.

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