Cleartrade Exchange Pte : Freight Commentary

12 January 2017
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Supply Outpaced Demand for Dry Bulk Shipping in 2016

2016 started in the worst possible fashion with rates falling sharply, pushing the Baltic Dry Index (BDI) to an all-time record low of 290 points on February 10. The BDI trended mostly upwards since then, but from such a low base that 2016 will remain a year that dry bulk shippers will want to forget. Capesize timecharter earnings averaged $6,374 per day in 2016, 9 percent lower than in 2015 and well below operating costs of around $8,000 per day.

Sentiment at the beginning of 2017 is a lot better than a year ago, but do fundamentals support this?

Better-than-expected demand growth

Demand growth in 2016 was higher-than-expected but still way below levels from previous years, when double-digit growth was not uncommon. Dry bulk shipping demand (as measured by the total volume of iron ore and coal shipped by sea) increased by 2.5 percent year-on-year in 2016. However, since not all routes are equal, it is more accurate to measure dry bulk shipping demand in tonnemiles. When doing so, dry bulk shipping demand grew by 3.4 percent year-on-year in 2016. This higher value suggests that trade on longer distance routes grew at a faster rate than on shorter distance routes in 2016. Most of the growth came from the iron ore market, where tonnemile demand grew by 4.6 percent. With expectations at the beginning of 2016 suggesting that global coal trade would decline, the 1.4 percent increase in tonnemile demand was a surprise.

China was the driving force behind the better-than-expected demand growth in 2016. According to Thomson Reuters trade flows data, Chinese iron ore imports increased by 7.6 percent compared to 2015, while Chinese coal imports were up 16 percent. Chinese iron ore imports from Brazil increased by 16 percent in 2016 to over 200 million tonnes. The distance between Brazil and China is approximately three times the distance between Australia and China (where imports increased by 7 percent year-on-year to nearly 658 million tonnes). As such, if Brazil continues to win market share from other exporters it will increase demand even if Chinese imports are to remain flat.

The main reason why demand growth was better-than-expected last year is because domestic Chinese iron ore, steel and coal production cuts helped to create more demand for imports. Continuing the trend, there will be further capacity cuts in China this year. The Chinese province of Hebei, which forms roughly a quarter of Chinese steel production, announced on Sunday that it plans to cut 15.62 million tonnes of steel and 16.24 million tonnes of iron ore capacity in 2017. It had previously announced that it will cut 7.42 million tonnes of coal capacity in 2017. Further planned cuts in the country's steel and coal industries are likely to be announced in due course as the Chinese government increases its efforts to tackle pollution.

In addition to falling domestic production, the outlook for the Chinese economy strengthened throughout 2016. A much more positive outlook for the Chinese economy as compared to this time last year bodes well for the dry bulk shipping market.

Supply growth likely to fall further

According to data from Lloyd's List, the dry bulk shipping fleet grew by 3.6 percent in 2016. This is down on previous years, but still higher than demand growth. The slowdown in demolition activity in the second half of the year was a major supply-side disappointment. Scrapping volumes increased by 16 percent year-on-year in 2016, according to data from Athenian Shipbrokers. However, when rates were at all-time lows in the first quarter, many market participants were hoping that 2016 would be a record year for scrapping. Unfortunately, annual scrapping volumes ended the year 19 percent below the previous record set in 2012.

The most positive indicator for the future prospects of dry bulk shipping is the shrinking orderbook. The total amount of dry bulk shipping capacity on order has fallen to around 10 percent of the live fleet. This is the lowest the ratio has been in over 14 years. The shrinking orderbook will make the oversupply problem easier to manage in the coming years. Almost two thirds of the capacity in the orderbook is due to be delivered during 2017. As such, as long as demolition activity in 2017 can come close to the levels seen in 2016, supply growth will be below 3 percent in 2017 (even before accounting for slippages).

Current market conditions suggest that the orderbook will continue to shrink further. The spread between newbuilding and prompt delivery secondhand prices supports buyers buying in the secondhand market rather than ordering new ships. If ship owners continue to stay out of the newbuildings market, fleet growth in 2018 and 2019 could quite possibly drop to close to zero percent. This will mean that demand will slowly start to absorb the supply glut.

The brighter outlook for dry bulk shipping in the coming years as a result of the market developments that unfolded in 2016 is why sentiment is better than it was a year ago. The supply glut has not been reduced but there are clear signs that it will be and this gives market participants hope for the future.

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