The iceberg is melting
4th April 2013 17:16 GMT

In shipping we always talk about vessel values, earnings and their effect on shipping bankruptcies and on a whole range of stakeholders. Looking at the maritime media, or during casual talks, shocking news of devalued vessels and bankrupt shipping companies, along with the reaction from banks and indeed bunker suppliers are now a daily part of our life.

Sensational disaster scenarios aside, at Ocean Intelligence - with the help of IT people - we put some data together to price up a very average ship. We looked at thousands of vessel values ranging from 1,000 dwt coasters to very large capesizes, VLCCs, ferries etc and came up with a average figure for this freak ship; the M/V Average. Some may go as far as claiming this is an “index” but we will just label it as an internal curiosity for now. According to our toy derived from the huge database we are sitting on: “the average ship” was worth USD 10.9 million in 2000, it climbed up to USD 14.7 million in 2003, and in 2006 the very same ship was worth USD 25.2 million before peaking at USD 37.4 million in 2008. We all know what happened after that. A head first dive, which is still ongoing, with the value of our ship now around USD 9.9 million. The though markets is chipping away from what is left to scrap price levels.

The principal problem is with expensive ships bought since 2006, when the banks were not exactly selective about who do they gave massive loans to. We know from shipowner friends that banks almost pushed them to buy ships and made really convincing arguments about why they should buy a ship, and that they were not very clever if they missed this opportunity. I presume this willingness to lend was the result of a commission-based sales culture, lack of awareness and responsibility. The very same financiers are now negotiating reorganisation under 'chapter 11' protection, or in the case of many smaller companies going straight for a shipping bankruptcy.

With ship values dropping, securities diminished and in most of the ill-timed purchases have turned into negative equity cases. Not wishing to go back to the situation of the 1980s, banks found a solution; just postpone the problem with new agreements at higher rates, payment holidays and extra collaterals. Books looked good, full of “performing and profitable” loans, but the reality was more in the region of a “junk” yard. In other words, on the back of hope for a recovery, effectively financiers employed shipowners as a ship-management companies to run the ships which they had invisible links to, but did not want to end up owning. Now, time to face up to the reality is nigh: There won't be any immediate recovery, and we are long way away from it, so these problems cannot be postponed and finding a way forward is urgent.

This situation is by no means unique to shipping. The ordinary person on the streets of America will call this a “sub-prime mortgage crisis”. Shipping has not come to the eye of this storm yet, its very own financial crisis, but it is approaching. What we had so far was the effects of the global crisis, and supply/demand imbalances, but to large extent support was there.

Lets go back to this unfortunate purchase, at 37.4 million USD in 2008, and analyse chances of survival briefly. In those days, loan to 95% of value was frequent, but let's be conservative and pay a 30% deposit, and have an extended period of 10 years for the sake of simplicity. This means paying the bank around USD 9,000 a day for the M/V Average. In a market that enables you to earn USD 30-40,000 TCE per day, thats great, but these rates are long gone, and what comes in is barely enough for the operating costs, let alone paying USD 9,000 to the bank. How can one make ends meet?

The truth is that normally ends do not meet, and hence risks to financiers are increasing constantly. In her blog titled Rewarding Risk, Unni Einemo highlighted this well, and I will borrow a sentence from it: "According to bunker players, shipowners would need to find between USD 15 billion and USD 20 billion if they were asked to pay for their fuel in cash upfront, instead of weeks later."

Managing exposures is tougher than ever, and even lawyers are not keen on arresting vessels anymore as they can quickly turn into a liability, rather than the matter of seizing an asset. What asset?

So how can ends meet? Where can savings be made? Reducing operating expenses (opex) is the first to come to mind. To us, when looking at numbers, this is just a line of expense, but with 'social glasses' on it is very different. Seafarers are suffering badly, safety is compromised which in turn endangers the environment, amongst many other things. The International Transport Workers Federation (ITF) reports a phenomenal increase in the number of cases they are dealing with: Unpaid crew, ultra sub-standard conditions of living, lack of food, fuel, fresh water, and mental problems arising from the crew who are forced to stay on board (because the shipowner does not have funds to replace him) etc etc. In some cases where the ship is in seriously negative equity and ridden with debt of all sorts, owners just “abandon” the ships at distant corners of the world.

Cutting operating expenses (opex) means developing taste for cheaper and cheaper crew. Cheaper crew most often lacks training, understanding, experience, qualifications and frequently they are working cheaper because they are vulnerable. Exploiting the desperation of seafarers may not lie in some shipowners heart, but their numbers press them to toe a line of life or death. To give an example, a small general cargo ship operating with first class crew and looking after the ship properly will have daily operating expenses (opex) of around USD 4,000. A ship with cheaper crew and cutting down on everything else can reduce this to USD 2,000. If we look at how much this ship can earn, the Istfix index tracking this market suggests around USD 2,500 per day TCE. Bigger ships show bigger differences, but across all segments fundamentals are not much different from one to the other.

Simply, the “human capital” of shipping, stock of competencies, knowledge and skills are hurt by the capital realities. Highly trained, capable, and equipped maritime graduates are increasingly “nice to have, but we can not afford them” for many ship owners. Ships that are not maintained properly are hazardous, ships that run out of fuel and drifting are like a mine – with people in it, sub-standard bunker fuels acquired from questionable sources are damaging the engines. The list goes on...

Will this situation get any better soon? I do not think so, because more ships are delivered and financially speaking shipping has not quite come to its own sub-prime mortgage crisis yet.

Some sitting in swanky London offices say “China should stop building ships!”, in theory yes but in practice why on earth China should stop? China spent decades trying to built up the infrastructure, know-how, supply chain. Shipyards in China employ over 500,000 people directly (state owned China Shipbuilding Industry Corp alone employs 300,000) and together with people in supporting industries, such as maritime equipment makers etc, this figure goes well beyond millions of people. With the families dependent on these workers, we are looking at millions of people in the most prosperous Eastern section of China. What government would want a social disruption on this scale in its most prosperous region? Surely, the social and political cost would exceed USD billions, and thus China supports Chinese entrepreneurs to build at local yards. China has an important opportunity to have better control over its logistics chain, with Chinese owned, Chinese run, Chinese built ships carrying China's future. If China stops building ships because the capitalist world would like so, social, financial and political costs to China will be very heavy and China will miss a golden opportunity to dominate the world of shipping.

Also important to note is that China is building increasingly sophisticated, better and bigger ships, an expertise the country has accumulated over the last decade. Like the Japanese in 1950s and 60s, the Chinese started off with building poor quality, and if it floated that was a success in a way. But today it has reached the capability to build cruise liners. Ironically, the new project of the Australian billionaire Clive Palmer's Titanic 2, a replica of the ill fated RMS Titanic, will be built in China.

We are on an iceberg that is melting below us. If we do nothing and pretend "recovery is coming soon and everything will be OK, this is just a blip," ice cold waters awaits us. This reminds me of the influential work of Harvard University Professor John Kotter, who wrote a fable about a penguin colony in Antarctica called "Our Iceberg Is Melting". The fable is about a group of beautiful emperor penguins living as they have for many years. Then, one curious bird called Fred discovers a potentially devastating problem threatening their home, and when he raises the issue, no one listens to him, but he is supported by Alice.

Prof. Kotter takes us through the journey of change and asks: What is your iceberg? Is it melting? Are there fissures? What fissures do you see? Are there any Freds or Alices willing to step up? Are you most concerned with success in catching fish today or planning for what may come tomorrow? Is anyone willing to swim ahead?

Are there are any Freds around?

Can Besev,
4th April 2013 17:16 GMT

Comments on this Blog
Mauro Cattana - S&P Global Platts
12th November 2013
Hello Can,
A very nice article indeed. I enjoyed the reading. Thoughtful and well balanced.
Mauro Cattana

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