Slippery Slope: Dry Bulk Shipping Contracts Begin to Default

In early December, I wrote that investors should not get too excited about existing time and charter contracts for dry bulk shipping companies:

And those contracts? Noneconomic contracts have a way of being broken. Even if the contracts are ironclad, remember that they are only as good as the solvency of the counterparty. Also, the shippers and shipping companies each have an interest in renegotiating unfavorable contracts, because neither benefits in the long term by enforcing a contract that impairs the business of the other.

It looks like that process is underway. On Tuesday, Excel Maritime (NYSE:EXM), announced that two of Excel’s charterers “unilaterally” revised the terms of the charters:

Two charterers, with long-term charters on three of the Company’s vessels, have recently unilaterally started to pay approximately 50% of the agreed charter rate to the Company. The loss of hire for Excel throughout the life of the charters, should the Company keep receiving the reduced rates, is estimated to be approximately $107 million, of which $32 million would affect 2009 cash flows and another $35 million would affect 2010 cash flows. In addition a few of the Company’s other charterers have also approached the Company attempting to renegotiate charter rates.

While the Company monitors the status of its counterparties, it cannot assure that charterers, will continue to pay hire at agreed rates, reduced rates, or at all.

Forbes cites an analyst report giving more details:

Dahlman Rose analyst Omar Nokta said in a note published on Wednesday that the three vessels were the Kirmar, Iron Miner and Sandra. The Kirmar is contracted to freight trader ETA until mid-2011 at $105,000 per day. With freight rates on Capesizes, which are the largest ships, tumbling from their summer highs to $36,815 on Wednesday, it seems reasonable that charterers who are short on cash might renege on their contracts.

But the Iron Miner and Sandra are on contract through 2012 at almost $40,000 per day–close to the current freight rate. The problem might be that those ships had been rechartered at significantly higher rates, and the ultimate end users decided they had no use for such pricey transportation.

The counterparty on the Iron Miner and Sandra is understood to be Chinese operator and owner Transfield, according to the shipping publication Lloyd’s List. Transfield then subcontracted one of the vessels to freight trader Glory Wealth for four years at $115,000 per day, said Nokta.

Because of these defaults and a general need to preserve cash, Excel said it was suspending its dividend.

Bottom line: Expect to see more of these stories in coming months. This is an industry-wide issue. What other industries could be affected by spot price moves threatening long-term contracts? Please let me know your thoughts. One area could be solar/polysilicon…

Disclosure: No position.

Comments

[coprophagous:]

With spot rates which are for a single voyage still way below operating breakeven it is not surprising that period charters for one year or more are being renegotiated by charterers. This has been the case in the dry markets but the difference this time is that owners have so overpaid for their ships and borrowed heavily to do so they now face iminent bankruptcy. Most of the defaulting charterers are intermediatries who have gambled heavily on markets continuing to rise.
The next shoe to fall will be when the major charterers also renegotiate which has already started.
Very few dry bulk companies will survive but the ships will be sold on at a deep discount which will meet the charterers lower rates.

Feb 19 11:15 PM

[bosun.j:]

And you will see $700USD a month officers and $25USD a month sailors manning those ships. Soon after you'll see those ships knocking down bridges, driving up on beaches and spilling their fuel.


On Feb 19 11:15 PM coprophagous wrote:

>
> Very few dry bulk companies will survive but the ships will be sold
> on at a deep discount which will meet the charterers lower rates.

Feb 20 01:17 AM

[Boubou:]

Down in my region plenty of sailors have been happy to work for the meals.
Now they will work for the privilege of fishing off the stern.

Feb 20 10:27 AM

[biomedlives:]

I suspect that we'll see more renegotiation of offshore drillilng contracts.

Feb 20 12:29 PM

[texalope:]

From todays' Lloyds

DRY BULK

Revival of Brazil iron ore cargoes lifts rates hopes
Michelle Wiese Bockmann - Friday 20 February 2009

EUROPEAN steel mills are booking capesize vessels to ship iron ore from Brazil for the first time since October, brokers have reported, boosting hopes of a sustained recovery in bulk carrier freight rates.

ArcelorMittal was among those mills that this week began to quietly nominate cargoes to be loaded from Brazil in March and April.

“These are the first cargoes to be transported that we have seen for some time,” said a London-based broker. “They’re trying to keep it quiet, but the principals and brokers are receiving nominations. Will it carry on? We don’t know. But for now it’s good.”

Steel mills around the world controversially defaulted on contracts of affreightment for iron ore shipments last October, when the global economic crisis saw the demand for steel collapse.

There have been no iron ore cargoes nominated from Brazil to Europe since then, several brokers familiar with the capesize market told Lloyd’s List.

The resumption of trade is viewed as one of the most positive signs for the global market for dry bulk since the five-year shipping boom ended in the final quarter of 2008. Rates to charter capesize vessels are expected to jump next week, as very few of the global fleet of capesize vessels are available for business in the Atlantic region. “I can count them on one hand,” said a broker.

Steel mills in Asia and Europe redelivered ships early and cancelled time charters or contracts of affreightments in September and October, triggering a dramatic fall in freight rates, as well as a wave of bankruptcies among vulnerable shipowners and operators.

The global steel industry provides business for roughly half the world’s fleet of bulk carrriers. Many mills are currently renegotiating long-term contracts of affreightment signed with owners to ship iron ore rates now much higher than current levels.

As a point of information the EXM contract problems are capesize vessels. Being in business and having the rights ships makes them a candidate for other business. The world has not come to an end.

Feb 20 02:33 PM

[einstein p ...:]

The renegotiation of legal contracts may also have legal ramifications if the dry bulk shippers do not rebook or rebook at lower prices and decide to litigate for their losses.

I agree that weaker companies will get acquired by stronger companies, which is one reason --- among others --- that the dividends are being cut. EXM should come out of this a much stronger company with less competition. China may also prove to be a factor and chose to buy dry bulk ships at distressed levels or acquire companies.

One thing is certain --- there only way to transport commodities by sea is in dry bulk ships. The playing field may shrink, but the business will not disappear. At 4 dollars a share, EXM is a good bet.

Feb 20 10:05 PM

[Mark Anthony:]

On Feb 19 11:15 PM coprophagous wrote:

> With spot rates which are for a single voyage still way below operating
> breakeven it is not surprising that period charters for one year
> or more are being renegotiated by charterers.

That statement is patently FALSE. As of today:
www.dryships.com/pages...

The cape size ship goes for $39401 a day. Panamax is $11504 a day and supramas is $13597 a day. The operating cost is about $6000 a day for cape size and $3000-$4000 a day for supramax. So teh daily spot rate is already way above operating cost.

To be profitable, the daily rate needs to be above the operating cost plus ship depreciation cost, which is roughly the same amount as operating cost. At current daily rate, it is ALREADY very profitable for ship owners to operate at spot market, even when you count in ship depreciation cost.

Feb 20 11:37 PM

[Mark Anthony:]

This article's concluding line is totally wrong. Rogue business partners who are unwilling to fulfill their business contract obligations, as always the case in history, are RARE EXCEPTIONS, not the norm. Such businesses lose their credibility quick and really can not survive for long. They will be unable to enter any new business agreements and no one will want to do business with them any more, because how could you sign a business contract with them if they can so easily tear up the contract terms any time it is a disadvantage to them?

Credibility is the lifeblood of any business. It's proven again and again in history. There is absolutely nothing new. Business contracts, as well as laws regulating them, have existed since ancient times. The societies have long formed ver effective mechanism to make sure everybody stick to the obligations of any business agreements they enter into.

Of course exceptional cases where parties unilaterally break away from contracts will always happen. But such cases are always the exceptions. It will NOT become an industry norm. There are legal and business consequences for breeching long term contracts unilaterally. If such contract breeching becomes the norm of the shipping industry, then chartering contracts will become something impossible to exist in the industry.

This article is totally wrong in pushing two isolated cases as a new industry wide issues of a new trend. The author made the wrong bearish call on shipping at the beginning of december, BTW.

Feb 21 11:53 AM

[PeteK:]

Just like the News people, there are some who have a mission to destroy someone or a business.
Too bad, there's no control of such bad mouths and bias.

Feb 21 01:52 PM

[Ecomike:]

It sure looks likes these bear authors have an agenda, mainly to sink stock prices for major short traders by scaring weak knee investors as options expire. Curious that this news was so timely as options expire! Not to worry, I just bought more shipping stocks as this kind of yellow journalism sinks their prices while options expire.

I expect a surprise rally next week. SURPRISE!

I am long, and trading the ups and downs on EXM, PRGN right now.

Feb 22 02:24 PM

[Ecomike:]

WOW EGLE went up 50% today, and the BDI was down on a CAPE size rate drop due to the floods in Australia's mine operations halting ore delivery to the port. Article said it might last a week before shipments to the port resume, then recover. Meantime they would need to use panamax ships to bring in ore from Brazil I think. In the mean time we had nice, did I say NICE, rally in the markets here today! Hope you weren't caught short today!

Feb 24 08:47 PM

[einstein p ...:]

Business in China, while still positive is slowing and putting millions of migrant workers out of jobs.

biz.yahoo.com/ap/09030...

The possibility of civil unrest will be countered by the government pouring billions more into infrastructure and modernizing their farm systems, employing millions of displaced workers and building a stronger China. This will require massive amounts of raw materials, equipment, seed, and fertilizer. It should also mean more business for the dry bulk shippers. Undeniably some will not make it, but the ones that survive should do well. Sad to see the dividends go, but it's the smart thing to do. My favorite picks are EXM, NMM, and PRGN.

Mar 01 12:41 PM