Global Dry Bulk Shipping Outlook – Is the current Baltic Dry Index (BDI) rally sustainable?

21st March 2017, Global - The Baltic Dry Index (BDI) has risen 25% ytd and the ytd average is 32% higher than the average levels in 2016. We explore the global dry bulk shipping sector’s key drivers to ascertain if this rally is sustainable going forward. In summary, we believe that the worst is finally over for the global dry bulk shipping sector and expect the industry’s operating outlook to improve gradually. However, we would not be too hasty to conclude that the BDI will continue its strong V-shaped rally throughout this year.

This is because we still expect the global dry bulk shipping sector capacity to grow 4.9% y/y in 2017, slightly ahead of our forecast global dry bulk shipping demand growth of 4.3% this year. This, plus the industry oversupply accumulated in the historical years, could prevent freight rates and the BDI from rising more significantly than their current levels. We believe the industry will see more significant improvements from 2018 and 2019 when the global fleet capacity growth is expected to moderate markedly to 2.1% and 0.9% respectively, unless a significant number of new vessel orders with prompt delivery dates are placed going forward. This will help drive greater upside in the dry bulk shipping rates as we expect the global dry bulk shipping demand to grow 3.5% in 2018 and 3.0% in 2019, ahead of the global dry bulk shipping capacity growth.

We are also likely to see a shorter industry recovery cycle due to the relatively lower barriers to entry and fairly short lead times between the vessel ordering date and delivery timeline at the Chinese shipyards. Supernormal freight rates and profits are likely to be short-lived as fresh capital funding new shipping capacity could potentially flood the market again within 2 years following an industry recovery.

Stock implications: The major listed Asian dry bulk shipping companies that could benefit from the longer term recovery of the dry bulk shipping sector are Nippon Yusen Kaisha (0.8x P/B), K-Line (1.1x P/B), Mitsui OSK (0.8x P/B), Pan Ocean (1.1x P/B), Pacific Basin Shipping (0.9x P/B), Wisdom Marine (0.8x P/B), U-Ming Marine (1.2x P/B), Precious Shipping (1.3x P/B) and Korea Line (1.1x P/B).

Chart: Baltic dry index (BDI) versus Global dry bulk shipping ton-mile demand and supply growth (2000 to 2019)

Baltic Dry Index Outlook 2017: Dry Bulk vs BDI

Chart: Global dry bulk shipping demand growth versus net supply growth (2000 to 2019)

Baltic Dry Index Outlook 2017: Global dry bulk shipping growth supply

KEY POSITIVE DRIVERS

+ From having the highest orderbook-to-fleet ratio (at 78%!) among the major shipping segments during the global financial crisis in 2009, the global dry bulk shipping sector now has the lowest orderbook-to-fleet ratio (at 9%) and this is its third lowest orderbook-to-fleet ratio in the last 20 years

In the last 10 years, the dry bulk shipping sector has been working through the industry’s overcapacity arising from the legacy of excessive ordering of vessels during the industry boom period when the 1-year timecharter rate for the Capesize vessel hit a record high of US$161,600/day in November 2007.

We are finally seeing the tail end of this and interestingly, the dry bulk shipping sector has the lowest orderbook-to-fleet ratio (at 9.2%) among the major shipping segments currently versus LNG carriers at 28%, containerships at 15%, LPG carriers at 15% and tankers at 12%. The world shipping sector has an orderbook-to-fleet ratio of 11% overall. The historical average orderbook-to-fleet ratio for the global dry bulk shipping sector was 27% in the past 20 years. With muted supply growth going forward, we believe that the worst is finally over for the global dry bulk shipping sector and expect the operating outlook to improve gradually.

Chart: Global bulkcarrier orderbook as % of total existing fleet (1996 to 2017)

Baltic Dry Index Outlook 2017: Global Bulkcarrier orderbook 1996 to 2017

Chart: Global dry bulk shipping trade – breakdown by commodity type

Baltic Dry Index Outlook 2017: Global dry bulk trade breakdown by commodity type

+ Strong iron ore import demand by China as steel production accelerates

China is the world’s largest importer of seaborne iron ore, driving 71% of the global seaborne iron ore imports. China’s iron ore import growth accelerated, up 13% y/y in Jan-Feb 2017 versus 7% growth in 2016. This is mainly driven by China’s increased steel production which rose 7% y/y in January 2017 versus its 2% growth in 2016.

Chart: China monthly steel output (1995 to 2017)

Baltic Dry Index Outlook 2017: China monthly steel output 1995 to 2017

+ Japan and Korea’s steel production have ticked up this year, which could lift their iron ore import demand 

Japan’s steel output rose 3% y/y in January 2017, a marked improvement from no growth in 2016. This should help lift Japan’s iron ore imports going forward. Japan’s iron ore imports were still 2% lower y/y in January 2017. Japan is the world’s second largest importer of seaborne iron ore (accounting for 9% of the global seaborne iron ore imports).

Korea’s steel production also rose 3% y/y in January 2017, after falling 2% in 2016. Korea is the world’s third largest importer of seaborne iron ore (accounting for 5% of global seaborne iron ore). Based on the preliminary data provided by Gports, Korea’s coal imports likely rose 8% y/y in January-mid March 2017.

+ The resumption of nickel and bauxite exports from Indonesia will lift the minor bulks shipping demand

Indonesia has lifted its 3-year ban on the export of nickel and bauxite. This is expected to significantly boost the minor bulk commodities’ shipping demand as bauxite and nickel drive 4% and 2% of the global minor bulks trade, benefitting the smaller dry bulk vessel segments. Minor bulks drives 38% of the global dry bulk shipping trade.

+ Stronger grain exports due to bumper harvests of major grain-exporting countries

The United States is expected to have the largest corn, rice and wheat stocks in nearly 30 years. Exporter-held wheat stocks are expected to be at the highest levels in 6 years, with United States’ wheat stocks rising 16% y/y, Australia’s rising 30% y/y and Russia nearly 100% y/y. In the coarse grains segment, Argentina and Brazil’s corn production levels are expected to reach record high while the United States’ corn ending stocks are expected to rise 35% y/y. Australia’s barley production is also expected to hit record high levels. The rise in China’s rice stocks is expected to more than offset the decline of rice stocks in the other top rice exporters, leading to the highest global rice stocks since 2001/02 (source: USDA). This should help lift grains shipping demand, which drive 10% of the global dry bulk shipping trade, this year.

+ Increased infrastructure spending

China’s Belt-and-Road strategic initiatives will help boost the shipping demand for dry bulk commodities, benefitting dry bulk shipping and port operators that have large exposure to the Asian and African markets. The Trump administration’s infrastructure projects will also boost dry bulk shipping demand to the United States.

KEY NEGATIVE DRIVERS

+ Market expectations of lower iron ore prices in the coming months could dampen iron ore shipping demand as more buyers are likely to wait and import iron ore at lower spot market prices

Iron ore shipping demand growth could moderate in the coming months if the market expects iron ore prices to fall, mainly driven by increased iron ore production in Australia (Roy Hill project) and Brazil (Vale’s S11D Serra Sul project) this year. There has historically been a significant positive correlation between the Baltic Dry Index and the iron ore price in the spot market.

Fundamentally, rising (falling) iron ore import demand tends to raise (reduce) iron ore spot prices and dry bulk shipping freight rates. In addition, market expectations of the future rise (fall) in iron ore prices also tend to drive increasing (decreasing) and sometimes speculative iron ore import volumes and consequently rising (falling) dry bulk shipping freight rates.

Chart: Baltic Dry Index (BDI) versus Iron ore spot price (US$/ton)

Baltic Dry Index Outlook 2017: BDI vs Iron Ore spot price (US$/ton)

+ China’s restocking of iron ore could slow as the iron ore inventory levels at the ports in China are already at record high levels

China’s iron ore inventory levels at the ports have reached a record high of 131 million tons as at 17th March 2017, up 37%. y/y. We see limited upside to further restocking near term, especially if buyers expect iron ore prices to fall later this year as iron ore output levels increase in Australia and Brazil.

Chart: Iron ore inventory levels at China’s ports (2012 to 2017) 

Baltic Dry Index Outlook 2017: Iron Ore inventory at China ports (2012- 2017)

+ China’s domestic iron ore output has started to rise, driven by increased domestic steel production and higher iron ore prices

China’s iron ore output rose 14% y/y in January-February 2017, turning around from its 6% decline in 2016. While we expect China to remain a major net iron ore importer, a further increase in domestic iron ore output could result in some import substitution at the margin, notwithstanding their lower quality, until iron ore prices decline again, unless China’s steel production ramps up significantly.

Chart: China monthly domestic iron ore output (2003 - 2017)

Baltic Dry Index Outlook 2017: China monthly domestic iron ore output (2003 to 2017)

+ Vessel demolition activity has slowed this year

Only 30 vessels amounting to 3 million dwt capacity have been scrapped in January-February 2017 so far. If we annualize this, the total capacity likely to be scrapped this year would amount to 18 million dwt, down 38% y/y and equivalent to only 2% of the global existing dry bulk shipping fleet capacity versus 4% last year.

Note that the average age of the dry bulk shipping segment has been falling and is only 8.7 years at present. Only 9% of the global bulkcarrier fleet is above 20 years old. The implementation of the Ballast Water Management Convention from 8 September 2017 could potentially drive some ship-owners to scrap their older vessels when weighed against the cost of complying with the new regulations.

+ Relatively low barriers to entry could attract investors to order new vessels, shortening the industry’s recovery period

Bulkcarrier orders have dried up in the sector which is positive. It also makes more economic sense to purchase a fairly new secondhand vessel in the resale market than to order a newbuild one based on the current vessel prices. However, the dry bulk shipping sector has relatively lower barriers to entry than the container shipping and tanker shipping sectors. Any sharp rise in freight rates could potentially attract fresh capital into the sector, driving a new round of vessel ordering from operators and speculative financial investors. Given the relatively short lead times between order and delivery for the standard dry bulk vessel, this could shorten the duration of the industry’s recovery and cap the extent of supernormal freight rates and profits for the sector.

+ Increasing vessels’ sailing speed would effectively release more capacity into the market

Slow-steaming has helped to absorb a substantial portion of the global dry bulk shipping capacity in recent years. If the operators decide to increase their vessels’ sailing speed given the improved freight rates, more capacity would effectively be released into the market.

+ India’s coal import demand to decline further

India, which overtook China as the world’s largest seaborne coal importer, driving 18% of global seaborne coal imports, is expected to continue to reduce its coal imports. Based on the preliminary data provided by Gports, India’s coal imports likely fell 20% y/y in January-mid March 2017.

+ Protectionism is expected to dampen some minor bulk trades

The shipping of China’s steel exports to the United States and EU will continue to be soft following these countries’ decisions to impose anti-dumping import tariffs on Chinese steel imports, hurting the back-haul minor bulks shipping trade demand. Indonesia’s import restrictions on corn is likely to continue to dampen shipping demand for the smaller dry bulk vessels in the coming years.

+ COSCO Shipping Bulk could crowd out the other smaller Capesize operators in the longer term

The world’s largest bulk shipping operator COSCO Shipping Bulk, which is state-owned, with 4% global market share has been signing more long-term cargo contracts with cargo owners and operating Valemaxes which have lower unit costs. This could eventually crowd out some of the smaller Capesize operators in the spot market in the longer term.

Note: All the P/B valuations stated above are based on current share prices and the average consensus estimates in calendar year 2017.

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