“Be careful what you wish for”… Such an expression describes particularly well the humility that one has to possess when making forecasts for the shipping markets. Supply and demand projections and the resulting balance are the easiest way for analysts to promote their own narrative in a convincing way but the hard truth is that shipping is much more complicated and virtually impossible to model using such simplistic econometric equations. In an ever-changing geopolitical map, shipping plays the role of connecting economies through mutual trade, and thus remains highly sensitive to global events that affect and transform such economic relationships, in the process throwing out of balance any analyst’s supply and demand forecast.
Case in point the last few years. A global pandemic unlike anything the modern world has ever seen, has so far led to some unprecedented conditions across the global economy, let alone the shipping sector. In tankers, the initial collapse in oil demand drove oil prices into a steep contango, significantly increasing storage costs and pushing tanker rates to historical highs, a process that reversed sharply and consequently led to a collapse and a prolonged bear market that is still hurting owners’ profits to this day. In containers, the concurrent reopening of the western economies combined with significant pent up demand for physical goods rather than services, combined with a $20+ trillion global stimulus and a synchronous inventory rebuilding, continue to push container freight rates to new all-time highs day after day with no end in sight. In dry bulk, demand for raw materials and bulk commodities ex-China and the delays and congestion that the global shipping sector is facing as a whole, has propelled rates for smaller bulkers to unimaginable for the sectors highs while (most) commodities still remain in short supply and thus demand for bulk commodity transportation is booming.
Take any analyst forecast (including ours) from a few years back and any estimate generated at the time is miles away from what the reality ended up being. Obviously, such “black swan” events are impossible to predict, but even once the events started to unfold, very few market observers were able to recognize the change before it was too late and accurately predict the path of shipping rates in each of the respective shipping segments.
The dry bulk market has so far experienced its own rollercoaster. Interestingly, Capesizes have been the rather quiet observers this time around, casually following the smaller size segments as they reach new highs, given that the balance of the market remains much tighter the smaller the vessel gets.
Although achieving spot rates of $50,000 per day should not be dismissed, the Capesize market is faced with specific obstacles that do not exist in other sub-segments of dry bulk, at least to the same degree. The reliance on Chinese-consumed iron ore is the most important one, which combined with a handful of countries and regions where Capesizes operate, makes it particularly vulnerable to geopolitical changes and risk concentration.
Capesize Spot Index, 2017-Today
In the midst of all the above, additional unforeseen events add to the uncertainty. Without trying to become experts in West African politics (for us as for most, Guinea was a quiet country with lots of bauxite just a few days back) the recent coup in Guinea brought to the table another risk for future Capesize demand from a region that a few years back was irrelevant to shipping but that currently accounts for almost 5% of Capesize loadings. It would be foolish to disregard the situation and pretend the future will look like the past. And yet, given our ignorance, we can not make any intelligent analysis on the political stability for that part of the world without sounding like “cocktail hour experts”. Ulf Bergman from Ocean Analytics has an excellent piece here on the issue and the fine relationships associated with the events.
Brazil is also another area where recent developments are becoming more concerning: Political stability is important when half of Capesize demand originates from that country. The news flow has been concerning and once again political predictions are a fool’s game, especially when it comes to Latin America politics (we still remember the early 2000s forecasts of Venezuela surpassing Saudi Arabia in oil production; today, Venezuela’s oil industry is decimated and oil output from the country represents a rounding error in the global oil markets).
Last but not least, China has recently been pushing aggressively its own steel industry in a direction that can conservatively described as unfriendly to global trade. Under the umbrella of a cleaner environmental policy, steel mills are forced to curtail production and reduce exports, hurting iron ore demand (iron ore prices haven been halved in the last few months) and potentially impacting iron ore imports.
On the opposite spectrum, coal trade remains a shinning area, ironically reflecting strong competition from energy-thirsty countries ex-China that have for years dismissed the “dirty” fuel only to recently see energy costs skyrocketing. Combine the above with the increasing inefficiencies in trading as it relates to China’s own trade dispute with Australia, and coal trading is back with a vengeance although by no means this should be considered a trend.
China Steel Production YoY Growth, 2015-Current
All of the above are red flags when it comes to Capesize demand. Such an environment, especially as it relates to China, sounds at best challenging. And yet, here we are with the spot index at ~$40,000 (though on the way down) after reaching decade highs a few weeks back, and with most market participants optimistic enough to be bidding physical ships to multi-year highs.
The good news is that the freight market is demand driven but supply enabled. And vessel supply growth is low, multi-decade low. As long as demand growth remains positive, the future balance continues to point to strong rates.
As once again we look at what we previously described as relatively inaccurate calculations (i.e. supply and demand figures) in order to predict the future state of the dry bulk shipping market, we remain very conscious of the limitations that such an approach has. However, undoubtedly shipping operates more profitably in a “tight” environment and that’s what such predictions are useful for. Timing on the other hand, takes a life of its own in the volatile and complicated world we live in.
Regarding the short term, we remain concerned that this correction has yet to run its course. On the other hand, we continue to believe that the fourth quarter will end up being better than what the market has priced in, primarily reflecting the ongoing congestion issues that have the potential to become even worse as the winter approaches (let alone any increase in the virus impact on port operations).
Of course, the above prediction assumes that the issues described above (Brazil, China and Guinea) do not deteriorate further to any meaningful extend. Especially as it relates to China, additional curbs in steel production have the potential of having a meaningful negative impact on iron ore trading activity and thus freight rates. Patience is a virtue, and although the futures market is already at a sharp discount to spot, Capesize rates have proven over time their ability to move further than what market participants had imagined. We all operate in real time and thus information should be evaluated as it comes.
Finally, once again, the attractiveness of shipping is the volatility it brings to the table. For those that understand that such volatility is the reason why shipping-related investment returns can be significant and have the patience and courage to position accordingly, outsized profits will follow. We are entering a historically strong seasonal period for dry bulk shipping (those who are old enough remember how the fourth quarter was always THE quarter), and the odds are once again stacked in favor of a brief correction that will be followed by another meaningful multi-month upturn in freight rates leading us towards the end of a spectacular year for global shipping.