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Dry bulk market fundamentals are still grim despite funds buying into dry bulk firms

Shipping companies and mining majors cannot really believe what they say in public – that there will be Chinese demand growth to support trimmed commodities production (albeit at lower prices than we’re used to) and occupy a vastly inflated, fuel-efficient global fleet.

They’re all trying to adapt to world in which China peak steel output is already history and commodity and freight prices seem to be moving into lower ranges which could last years by chasing economies of scale, on a huge scale, to cut their costs to the bone (miners use remote drones to cut costs).

Brazil’s Vale told the CISA conference in Qingdao, China on Wednesday that it will cut its production costs to less than $13 a tonne by 2018 – a comfy position to be in with iron ore prices forecast to remain just above $50 to 2019 and beyond.

Vale also told the Qingdao conference that it doesn’t believe China’s steel demand has peaked yet, something which is becoming a minority view.

Iron ore miners will tackle cutting production because their costs can’t fall much further and once their higher-cost competition has vanished. Although shipping firms have also cut costs hard, stopped ordering and taking delivery of so many new vessels there are simply too many ships and not enough demand.

“It seems as though the shipping industry has taken all the right precautions in order to be better placed to handle a market where slower growth levels are a new reality,” said Allied Shipbroking in a recent report.

Whatever the price of commodities such as iron ore, regardless of freight demand, shippers and miners intend to keep a tight grip on their market share and continue the price wars. Everybody plans to be the last man standing.

Which is very laudable and will likely enable the miners to continue to pay shareholders dividends but does nothing to redress the fundamental imbalances in these markets.

Here are some bald facts:

The world’s fleet of dry bulk carriers has grown 84 per cent since 2013 while bulk cargo demand has grown by only 33 per cent in the same period and is set to grow by 1-2 per cent for the next several years.
Although 10 per cent of cape size orders have been cancelled in the past year and 30 per cent postponed, 80 per cent of the fleet is younger than 10 years and made up of lower-cost, larger, fuel efficient vessels which are unlikely to be voluntarily scrapped.
This year so far 69 capes have been scrapped and 56 new capes delivered – that’s good.
This year the deadweight cape tonnage has risen despite the net fall in vessel numbers because ships are much bigger, use far less fuel and crew – that’s bad.
Vessels have increased their voyage time to reduce fuel costs further despite the low price of oil this year – that smacks of desperate.
If you look those inconvenient figures in the eye, it’s hard to muster up a positive view of the shipping industry, however deep you dig or far you reach for it. Unless you’re a ship owner, in which case belief in an eventual upturn must be a necessary article of faith to keep going.

But if the shipping bears are correct (and they convince me), the deluded will have to wait 10 years before the market rebalances.

Allied Shipbroking’s report argued that the market “might have found the ‘sweet spot’ in terms of balance between fleet and trade growth.”

Shipping sources who were asked if they agreed that a sweet spot had been found, that the market may start to turn in Q4 through into 2016 made mostly non-verbal replies expressing profound disagreement, despite a slight recovery in spot rates recently.

And activist funds including Oaktree Capital, Monarch Alternative Capital and Caspian Capital Partners are again buying into dry bulk shipping firms such as Star Bulk Carriers, DryShips, Golden Ocean Group, Navios Maritime, Scorpio Bulkers and Diana Shipping, all of which have seen share price falls this year. Star Bulk and DryShips shares fell almost 60 per cent, which would attract funds like Oaktree, which has bought heavily into bludgeoned Glencore.

Do the funds know something we don’t – is the market about to turn?

“They are deluded. They are dreaming – they’ll have to wait another 10 years,” according to one senior European shipping source who asked not to be identified.

Cape size spot freight rates have crept higher during September to around $12 a tonne for iron ore from Brazil to China, as China’s iron ore restocking continues.

Spot rates of $12 are nothing to get excited about but the germ of a hope is sprouting that a few dollars more may be in the offing next year and that some relief may emerge from an unexpected direction.

From a technical analysis perspective, there is a potential bear trap in the middle of 2016, according to Freight Investor Services’ analyst Edward Hutton (http://freightinvestorservices.com/blog/the-psychological-cycle-of-freight-setting-the-tempo-for-2016/).

If the Baltic Dry Index (BDI) sees a fifth wave of a typical cycle expire in Q4, the market is likely to correct lower in Q1 and possibly Q2, he said.

If this happens it could mean that the market price in the middle of the year would not be higher than the high achieved during the fifth wave. Spot iron ore is currently trading at around $56/T delivered into China and is widely expected to fall back to $50 soon.

Every utterance by Chinese President Xi Jinping is minutely scrutinized for clues as to how China’s government will enact deep economic reforms to increase competition, transparency and allocation of resources to revive growth sustainably.

China still has 100 million people living in poverty, having power lifted 500 million above the poverty line since 1978 through industrial growth.

As The Huffington Post reported on Wednesday “In a relatively liberal economy, capital would force such a transition [to a service-led economy] naturally… But the Chinese government’s intervention has distorted market forces to the long-term detriment of its economy.”

Since 2008 China’s central and regional authorities have splurge spent on gargantuan infrastructure projects that didn’t reflect a genuine need for them and these investments were often motivated by patronage or political considerations and this is likely to continue with any further local, smaller-scale stimulus measures, prolonging the problems, The Huffington Post said.

China’s government may be compelled to stimulate demand in coming months through public spending projects without liberalizing its economy, which would give commodity prices and freight rates a bit of a boost but risks the beginning of another bubble.
Source: Freight Investor Services