URSABLOG: What to expect in 2018

 

What will the New Year bring? Let me say straight away I am optimistic, for the dry bulk market at least. Without drowning you in statistics, my thesis is very simply this:

 

-          Demand: all three major economies (US, China and Europe) continue to surprise on the upside. With all these motors running, prospects for demand growth are good. Japan is looking more positive than usual too.

 

-          Supply: there are not that many newbuildings to deliver this year, and whilst scrapping is low, as BWTS issues come to the fore there will be a steady trickle of ships continuing to go up the beach.

 

I think it will be the unintended consequences of geopolitical activity that will affect shipping in the coming year rather than anything that the “numbers” show at present. These effects can be divided roughly into two categories: internal and external policy. 

 

By internal, I mean China of course. There are two contradictory influences at present which are both affecting the dry bulk market: the need for growth, and the need for clean air. 

 

On the economic side, things look good. China’s manufacturing sector continues to see improved sales and stronger demand, both internally and for exports. But that is not to say that the state wants economic growth at any cost. There are signs that growth will be sacrificed for better air quality, but at present how much and when remains in doubt. 

 

As we enter the winter this paradox has shown up in a refreshingly new way. Burning coal in winter is bad news for the air, but it turns out that freezing to death is worse. By switching to gas, local authorities have been able to meet cleaner air standards, but because of this shift, demand – and therefore the price - of LNG has increased, and shortages have been keenly felt. The authorities have therefore had to relax environmental controls in order to keep their people warm. It’s all about priorities. 

 

This is good news for shipping of course. Short term LNG shortages cannot be satisfied immediately by domestic supplies, or via Russian pipelines from Siberia. LNG carriers will fill the gaps, finally there is a healthy spot market where volatile tonne-mile demand dictates freight rates, rather than long term COAs or timecharters. Additionally, as China continues to close down coal mines and reduce domestic capacity, the shortfall will have to come from sea-borne supply. Although the Chinese are confident that there is sufficient thermal coal supply available as “domestic advanced production capacity will be unleashed further” – at least according to Sarah Liu, vice president of Fenwei Energy Information Services – this cannot be relied on to fill all the sudden gaps in demand. The first quarter slow-down in the freight market may not be as marked as expected. 

 

So with China’s manufacturing growth still proving strong, and energy demand (and supply) still erratic and volatile, tonne-mile demand for bulk carriers will probably surprise on the upside in the short term. This is a direct result of divergent and contradictory demands from the government. 

 

On a macroeconomic scale, the problems ahead could also prove beneficial for shipping. A reversal of the prevailing trade regulatory environment as the USA and other economies rewrite the rules will reduce the efficiency of how things are moved around. The more barriers are put up, the less the simple factors of supply and demand for commodities will matter, and the more comparative advantage of producers deemed previously uncompetitive will. This will disrupt the markets, and in my view probably increase overall tonne-mile demand. It doesn’t take the closure of the Suez Canal to improve freight rates; sometimes invisible barriers work too. 

 

The one real area of concern I do see, apart from war in the Far East, or a real political crisis in the western world, both sadly possible as long as President Trump stays in the White House, are the signs of a bubble developing in the major economies, in particular in the USA. 

 

I remind you of Howard Marks “seeds of a boom” in a recent paper for Oaktree investors:

 

-          A benign environment 

-          A grain of truth 

-          Early success

-          More money than ideas

-          Willing suspension of disbelief

-          Rejection of valuation norms

-          The pursuit of the new

-          The virtuous cycle 

-          Fear of missing out

 

At least as far as the equity markets are concerned, all of the above conditions apply at present. With interest rates still at historic lows, and shares at record highs, we should be hearing more warning bells ringing than we are at the present. If interest rates do rise more quickly than expected (and not only is this possible, it is probable) then things will start to get out of control. 

 

Why would interest rates start rising quicker than expected? Surely the central bankers have it all under control? Well they may end up being surprised. Again. The threat of massive global debt remains. Global economic growth is so dependent on cheap debt that no big economy can cope easily with rapid tightening of monetary conditions. 

 

Inflation has been all but missing from any economic discussions except frustration with an inability to create any despite the loose monetary policy since the 2008 financial crisis. There are signs that China may begin to export inflation, and if it does, the overall impact of China export price inflation on global inflation will be around 13%. A large and unlucky number.

 

The effects of this are unknown, obviously, but one of the happy effects of the major and painful restructuring of ship finance by the banks recently will mean that although owners will pay more for their debt, they will not be as over exposed as they were ten, or even five years ago. That said it should make many owners question their future capex assumptions. If this means that less newbuildings will be ordered this will be a good thing too. 

 

Ship prices are still at the low end of the scale, historically speaking at least. There are alarming gaps between the prices of newbuilding resales and older ships, particularly in the smaller sizes. There are pockets of value, at least until the value gradient straightens out. Owners may also be tempted to cash in and sell tonnage that they bought since the beginning of 2016, but funnily enough I think 2018 will be a good year to be a shipowner, so it is probably better to keep them for a while. 

 

So, whilst I expect the market to be good in 2018 for those who already have ships in hand, the ability to invest wisely will become more difficult as time moves on.  This does not mean people should not buy ships of course; as a ship sale and purchase broker I can hardly advocate this course of action. But what I do think is that unless there is a sudden spurt in demand for long term period charters, sadly missing at present, buying ships will depend much more on identifying the best deals available than just betting on the hope of a golden future. 

 

Simon Ward