We have recently finished our quarterly round of forecasts, in which we model how we expect demand, supply, fleet utilisation and rates to shape up over the next five years. Below are some of the key points underpinning our view.
By Nick Ristic
The view from up here
As we summarised in our review of 1H 2021 a couple of weeks ago, the dry market has been on a roll for the last six months, with rates hitting their highest levels in over a decade. While our outlook remains positive for the remainder of the year, and we are constructive on the longer-term fundamentals for the dry market, there are several COVID-related factors that we see currently keeping rates high. The unwinding of these effects presents a risk to freight. These can be split into fleet inefficiencies directly caused by the pandemic, such as lengthy quarantine requirements and diversions for crew changes, and trades which have indirectly received a boost from the disruption caused by the virus. An example of the latter is steel trade, a key driver of the Supramax market, which has benefitted from regional imbalances in production and consumption.
Many of these market distortions are temporary, in our view, though the pace at which they ease is largely down to how the pandemic continues to unfold. As we have seen over the last 18 months, nobody has been able to predict this element correctly, but with this in mind, the below is a summary of how we see the underlying fundamentals of the market developing.
Steel and iron ore
On the demand side, the elephant in the room is still China’s steel sector. This is likely the most important call we have to make in our forecasts, given it is the single largest driver of bulker employment. Chinese steel output over the first half of the year grew by 11.5% YoY to a record 560.2m tonnes. This was despite continued rhetoric from central planners on limiting production due to concerns over emissions, which, if anything, had the opposite effect as steel prices soared and mills were incentivised to crank up output.
There are however signs that these measures will be felt in the second half of the year, with June marking the lowest YoY growth rate since May 2020 and the third consecutive month of slowing growth.
On top of weakening producer margins (partly driven by extremely high input costs), authorities have made moves to throttle steel exports by removing tax rebates, and we believe that external demand will likely ease as production in other countries climbs back to prepandemic levels.
As such, we expect output growth over July-December to slow to 8.7% YoY, with output for 2021 as a whole reaching record 1.16bn tonnes, up by 10% YoY. In 2022, we expect these pressures and a cooling economy to weigh on growth further, with output rising by 3.0%, and then easing by 1.5% in 2023 as the economy’s steel intensity also starts to decline. As the government steps up efforts to boost recycling’s share of output, in line with targets set out in the most recent five -year plan, we forecast blast furnace production steel production in 2022 to be virtually flat on this year’s levels.
Outside of China, where production grew by 16.8% YoY over the first half, representing an extremely low base in 1H 2020, we expect the recovery to continue over the next six months as strong steel prices coax more product out of mills, with output growing by 7.2% YoY. This brings total output from these countries in 2021 to 855.9m tonnes, an 11.8% YoY improvement, which we believe will be followed by a 0.8% pullback in 2022.
The payoff for iron ore demand is that we expect total trade to grow by 3.7% YoY over the second half of the year to 881.5m tonnes, which also represents a 7.9% improvement on volumes over the first half. This is partly driven by continued strength in global steelmaking activity, but also a boost in exports from Brazil, which we expect to recover in the second half and address the current deficit in the iron ore market. These volumes translate to a 5.0% YoY increase in shipments for 2021 as whole.
Coal
Coal trade has surprised us so far this year, bouncing back far quicker than we had initially expected. After a 10% YoY slump in shipments last year (excluding cabotage trade), volumes over 1H 2021 grew by 3.6% YoY to 673.2m tonnes, and with this momentum continuing into the second half, we expect coal trade over July-December to grow by 10.0% YoY, lifting trade over 2021 as a whole by 6.7% YoY.
Part of this is a natural recovery in demand as economies reopen and require more power, but a recent global surge in energy prices is also giving coal a lift. In China, shortages of hydro power and a boost in air conditioning demand have left stockpiles extremely low. But elsewhere soaring natural gas prices are also raising coal burn rates. In Europe for example, even after accounting for the pollution costs under the emissions trading scheme, spot and forward prices justify switching to coal for power generation. On top of this, as we have covered recently, the shake-up in trade flows due to frosty Australia-China trade relations has also had a positive effect on demand for some vessel types, by increasing average voyage lengths.
We expect these factors to provide support to bulk carrier demand from coal trade over the next few months, but longer-term, the outlook is still relatively weak. Although we have revised up our forecasts for coal trade over the 2020s, we still expect total trade to decline by 1.9% in 2022, and then to continue at a compound annual growth rate (CAGR) of -0.6% through to 2025. Within this however, the outlook varies by vessel size, with some classes more exposed to certain regions than others.
The grains
Agribulk commodities have been the star performers of 2021, as unrelenting Chinese demand has hoovered up supplies from the major producers. After an 8.6% YoY jump in imports over the first half of this year, we expect volumes over the second half to grow by 11.5% (this partly reflects a large volume of arrivals of shipments exported in the first half), as the US soy crop is harvested and the Black Sea season ramps up. This brings total grain shipments for 2021 to 611.5m tonnes, up by 10.1% YoY.
While we remain very positive on the growth prospects for grain, this year does represent an anomaly, driven by depleted stockpiles in China and a thawing in trade relations with the US. With the US’ export inventories being drawn down, it is unlikely that a surge in exports on the same scale as this year’s will be repeated in 2022. Based on the USDA’s analysis of the various producers’ export potential over the next marketing year, we forecast trade growth over 2022 to fall to 2.7%, picking up to a CAGR of 3.2% out to 2025.
Minor bulks
Across the 27 other bulk commodities that we forecast, 2021 has also seen a swift recovery in trade. After falling by 3.1% in 2020, minor bulk trade surged by 11.5% over the last six months. We believe that this pace will be sustained, with volumes rising 10% YoY over the second half of 2021, helping to keep rates for the geared ships at strong levels. This brings full-year growth to 11.0%, but from next year, we expect this pace to slow, in line with global economic activity. 2021’s growth figure also includes the aforementioned jump in steel trade, which we expect to ease next year as global steel production recovers to 2019 levels.
Supply
With the demand picture mixed across the different commodities, a common theme for all the sectors is limited supply growth for the next few years. Yards reportedly have very limited scope to increase capacity in the near-tern, and potential bulker newbuildings are being crowded out by containership orders. Meanwhile, investors are also being held back by growing uncertainty over compliance with emissions regulations. There appears to be limited confidence that the technology currently offered by yards will meet the tightening standards coming into place over the next decade.
Given the current orderbook, age profile of the fleet and expectations for future orders, the total fleet is on track to grow by about 2.8% this year, to just shy of 900m dwt. This is down from a rate of 4.0% in 2020. We had previously expected a lower growth rate in 2021 but scrapping numbers have been curtailed by the strong returns in today’s spot market. We see this dynamic continuing in 2022, with the fleet growing by 2.7%, and by 2023, an extremely limited orderbook brings growth down to 1.4%.
What to watch
The above assumptions come together to form our base scenario for utilisation and freight rates for the different sectors, but we think that there are a few swing-stories that could have a significant impact on the supply and demand balance. Aside from these, the path of the pandemic will of course be a key determinant of global economic activity. On the upside, some of these are:
• Less aggressive steel targets in China - If, by next year, Beijing decides that the economic sacrifice of curbing steel output to meet emissions targets is too great (or it is unable to reign in individual producers), iron ore demand will remain firmer or longer, lifting Cape utilisation. The scrap steel supply chain may also not develop fast enough to allow for meaningful increases in steel recycling.
• Prolonged global energy shortages - Persistently high prices for oil and gas might make consuming more coal unavoidable for some countries. Despite commitments to reduce emissions, surging consumer prices in some countries may be politically too hard to swallow when coal can be found at a discount.
• Persistently low ordering - We have built in a pickup in deliveries from future orders in 2024, but if question marks over regulatory compliance persist into the next couple of years, we could see even fewer deliveries materialise in 2024-25, lifting the utilisation curve over these periods.
And on the downside:
• Tougher emissions stance in China - Alternatively, we may see authorities in China take a tougher stance on steel and other polluting industries that are key to dry bulk demand, with obvious implications for the market. This becomes a possibility if steel prices start to make meaningful declines from current levels.
• Slowdown in Chinese grain demand - Record Chinese grain imports have made headlines this year, but with prices and crush margins coming under pressure, it is unclear how much of this volume has been driven by underlying demand versus strategic restocking. If we see Chinese buyers pull back from the market next year, there could be severe implications for the Panamax market.
• Slowing growth in bauxite trade - For the Capes, the rapid rise in bauxite shipments from Guinea has played a major role in supporting the market. But growth appears to have slowed over the last few months as a sluggish bauxite price, combined with high freight costs, have eroded shippers’ margins. Though we are still confident that the rate of shipments will improve, if this situation continues, some demand growth may be sapped from the bigger ships.