Normally, in my articles, I try to use reliable and varied sources to establish trends in shipping that are beginning, underway, or ending. I try and stay as factual and objective as possible. It's not too often that I step out of that zone, but for this article, I have done just that. I am doing this because many readers have contacted me lately, asking for my thoughts about the overall economic environment and how it pertains to shipping. Be warned, this will involve Keynesian economic theory and some degrees of forecasting - something economists routinely demonstrate is not an exact science. So get ready as we stare into the Magic 8 Ball together.
Maritime trade demand can be thought of as a reliable indicator of global economic health. In short, that's because a vast majority of goods and raw materials are transported via water. Typical voyages can take anywhere from 30-90 days, and therefore, what is loaded up one day will find an end-user one to three months later.
The end destination is often where the final purchase is made in the case of finished goods, or a value-adding process begins in the case of commodities and/or energy. Therefore, a trend of softening charter rates brought about by weakening demand can indicate a slowdown in related sectors, and vice-versa.
Maritime trade can basically be broken down into three main segments. They are commodity transport, containerized transport, and energy transport.
Commodity transport occurs through dry bulk vessels that move iron ore, coal, grains, etc. through the waterways. Drybulk companies include, but are not limited to, DryShips (NASDAQ:DRYS), Diana Shipping, Inc. (NYSE:DSX), Golden Ocean Group Ltd. (NASDAQ:GOGL), Navios Maritime Holdings, Inc. (NYSE:NM), Navios Maritime Partners L.P. (NYSE:NMM), Scorpio Bulkers (NYSE:SALT), Safe Bulkers, Inc. (NYSE:SB), Star Bulk Carriers Corp. (NASDAQ:SBLK) and Ship Finance International Limited (NYSE:SFL). However, some edible oils and such are transported via product tankers, but that point is inconsequential for this analysis. Dry bulk demand can be an important indicator of projected demand for infrastructure builds, materials consumption, real estate construction, coal-based energy consumption, and related consumer patterns.
Containerized transport typically moves finished products to end-consumers. It is perhaps the most important indicator of global economic health, as the vast majority of global economic activity is based on this consumption. Some of the containership companies traded in the U.S. market include Seaspan Corporation (NYSE:SSW), Costamare, Inc. (NYSE:CMRE), Diana Containerships, Inc. (NASDAQ:DCIX), Global Ship Lease, Inc. (NYSE:GSL), Danaos Corporation (NYSE:DAC), Box Ships, Inc. (NYSE:TEU), Ship Finance International Limited, and Navios Maritime Partners L.P.
Finally, energy transport has three distinct segments: crude oil transport, product transport, and natural gas transport. Typically, crude oil and energy demand have had a direct correlation with growth.
Companies engaged in the ownership of crude tankers include DHT Holdings (NYSE:DHT), Nordic American Tankers (NYSE:NAT), Euronav (NYSE:EURN), Frontline (NYSE:FRO), Gener8 Maritime Inc. (NYSE:GNRT), Navios Maritime Midstream Partners L.P. (NYSE:NAP), Ship Finance International Limited , Teekay Tankers Ltd. (NYSE:TNK), Tsakos Energy Navigation Ltd. (NYSE:TNP), and Navios Maritime Acquisition Corporation (NYSE:NNA).
Companies engaged in the product tanker sector include, but are not limited to, Scorpio Tankers (NYSE:STNG), Teekay Tankers , Tsakos Energy Navigation , Ardmore Shipping (NYSE:ASC), Navios Maritime Acquisition, and Capital Products Partners (NASDAQ:CPLP).
You might notice there is some overlap, as not all companies engage exclusively in one type or another.
Looking at a survey of economic indicators that companies follow, it's easy to see how maritime trade is associated either directly or indirectly with a number of these indicators.
Let's be positive and provide a bullish example here: a massive expansion that begins, at say, the construction, infrastructure, and/or real estate level (the root of this specific expansion is unimportant for this example, but could include increased targeted government spending or an interest rate drop). This infrastructure expansion initially requires the importation of commodities, raw and finished, to begin the project; dry bulk demand increases as a result. As people are hired to begin the value-adding process, whatever it may be, from smelting to finished assembly of skyscrapers, unemployment dips. As unemployment decreases (and if the unemployment rate is low enough, this could produce wage competition or cost-push inflation, impacting inflation expectations - a whole other chapter) the population has more purchasing power. Consumption increases (producing demand-pull inflation, which is a whole other chapter as well), thus requiring more container ships to fulfill the demand for imported goods. So, in this example, we can see how inflation expectations, unemployment, GDP expectations, new construction, industrial production and utilization, etc. are all impacted. We also see how dry bulk and container ships would be among the first to feel the collective increases in demand. Now look back at the chart of what companies follow, and I think you get the idea of why shipping can be an important indirect economic indicator.
To be exact, the FRBSF notes that "demand-pull inflation occurs when aggregate demand for goods and services in an economy rises more rapidly than an economy's productive capacity." This often leads to greater imports.
Cost-push inflation, on the other hand, "occurs when prices of production process inputs increase. Rapid wage increases or rising raw material prices are common causes of this type of inflation." As noted earlier, if unemployment is already low, firms compete for workers with higher wages.
(I bring these definitions to the reader because this will be brought up later on in the article.)
We could go on, but I think you get the idea. So hopefully, this helps to illustrate the web and interconnectedness of maritime trade with the big picture, and this is just the tip of the iceberg.
Recently, I have completed a round of macro economic updates for all sectors, and this article is designed to piece together an overview of the global economy at large using this segment-specific macro data.
The reason for this is simple. No single company can escape the macro outlook for this highly competitive and global marketplace that dominates maritime trade, and similarly, no sector can escape the global economy at large - meaning each segment's macro outlook will be impacted by significant contractions and expansions in the global economy at large.
So, let's get right to the point: After completing my latest container shipping macro update, I feel that the potential exists for a global contraction in 2016. If large enough, it would exacerbate the already bad situation in dry bulk, contribute to further deterioration in the containerized segment, and could even threaten to derail the bull rallies in both the crude shipping and product shipping segments.
I will be referring back to my previous reports several times, so before we go any further, here are the reports for you to review after this article, or perhaps before you go any further:
- Container Macro Outlook 2016
- Dry Bulk Macro Outlook- November - December
- Crude Tanker Macro Outlook Part 1 - Part 2
- Product Tanker Macro Outlook
For me personally, the two most important segments regarding economic forecasting are dry bulk and containerized shipping. Both are experiencing headwinds right now, and an increasing amount of trouble can be traced to the demand side.
The trouble in dry bulk demand can be traced first and foremost to China, which saw imports of copper drop 0.3%, coal imports fall 30%, and iron ore imports rise just 2.2% in 2015. That 2.2% was greatly helped by a massive iron ore stockpiling effort that began mid-year.
Container shipping, as noted in my latest macro outlook, saw just 2.5% growth in 2015 - the lowest in about two decades, taking the outlier of 2009 off the table. Keep in mind that 1996-2007 saw an average of 9.6% per annum growth.
So, what does this mean?
Well, here comes a lot of economic speak, so brace yourself.
The lack of commodity import growth from China amid the lowest prices seen in years, even decades at this point for some commodities, is worrisome, since the relationship of low prices equating to higher demand is breaking down.
A supply glut continues to emerge, and stockpiling can only offer a temporary solution for so long before supply-side concessions must be made.
Actually, many of those concessions are already being made in the form of job cuts, curbing CAPEX, cost reductions, etc. But sadly, this may be just the beginning of what is needed to return to a state of equilibrium.
This means high-paying jobs relating from everything to the actual extraction of commodities (oil, gas, copper, iron ore, etc.), as well as supporting (complimentary) industries could be in jeopardy. Those jobs are not easily recovered, and pay substitutes are hard to come by, as those in the coal industry have found out over the past few years.
The "spillover" could be drastic. Let's take an example, using the coal sector. Prices drop as coal demand weakens, production and jobs are cut. Those initial workers are hurt, but so are those supplying and working on the machines used to extract coal, the railroads and dry bulk shippers transporting it, the business that once found a customer base through now laid off workers, etc. But most importantly, this shows up in the form of reduced consumption by those hurt. Remember that consumption is a key economic input to GDP.
Most remember from Econ 101 that GDP=Y=C+I+G+NX. Y represents output, C is consumption, I is Investment, G is Government spending, and NX represents net exports. Recall that consumption makes up about 70% of total output (yes, of course, that measures only the final value, but let's not get into that debate here).
Now, let's take this scenario to other commodity sectors seeing record low prices amid supply gluts and introduce short-/long-run outlooks.
So, in the short run, these price drops provided some relief to consumers and inflationary pressures. Companies could withstand lower prices for a while before beginning to adjust long-term outlooks. So, people had yet to be laid off, CAPEX was still on the table, etc., and the consumer was benefiting through lower prices. With inflationary expectations under control, it also allowed the Fed to keep the ZIRP intact for a bit longer.
But the long run is shaping up to tell a different story. This commodity collapse has all the makings of a long-term trend. If that is the case, and demand remains sluggish with prices depressed, we could see the aforementioned negative effects and "spillover" pressures begin to compound.
Therefore, the long run looks more like job losses, consumption decreases, and mounting deflationary pressure. I am expecting this hard commodity collapse to negatively impact dependent economies such as Brazil, Russia, South Africa, Indonesia, and even Australia, New Zealand, Mexico, and Canada.
The collapse in oil will impact even more economies, as illustrated below.
Numerous countries derive well over 20% of their GDP from oil revenue. The collapse in prices will not just impact the workers and companies, but also the governments who will be seeing less taxable revenue. Of course, revenue shortfalls impact each country differently, but can be devastating to governments facing already difficult times and political unrest, and we find several names on this list.
This alone could paint a grim picture for some nations. First, note that in the equation presented above for GDP, government spending is a key component; therefore, any decrease in government spending would negatively impact GDP for these nations. Let's speculate, shall we, about one potential scenario? Troubled countries could face increasing unemployment and a slowing business sector. This results in decreasing taxable revenue. If government spending remains constant, a troubled nation would see deficits rise. Speculation surfaces about the ability of this commodity-based government to service the mounting debt, and borrowing rates adjust accordingly, currency troubles begin, the government is forced to cut spending, and GDP is further impacted negatively.
Additionally, since we are back to talking about components of GDP, let's not forget the reduced CAPEX on the part of these companies, which falls under investment, and the decreasing amount of commodities exported, which negatively impacts NX. Remember, Net Exports is simply Exports-Imports.
So, we covered the theory behind job losses, waning investment, decreased government spending, and decreases in consumption. But many might be wondering where the deflationary aspect comes into play. Commodities are key inputs/feedstock into finished products. When prices of inputs decrease significantly, theoretically, competitive pressures will eventually cause producers to lower prices. Adding to the mounting deflationary pressure would be the exact opposite of the demand-pull and cost-push scenarios presented earlier brought about through increasing unemployment and waning, or even negative, consumption growth. You guessed it, both resulting in deflation.
The following is taken from Economics Online and explains the theory of deflation as it relates to the current situation:
"Deflation tends to occur when the economy's capacity, as indicated by the position of the AS curve, grows at a faster rate than AD. Firms have to cut prices in order to stimulate sales and get rid of stocks."
Source: Economics Online
Furthermore, "deflation can be triggered by an increase in supply. As business and consumer confidence in the economy declines, AD falls, resulting in recession."
Does any of that sound familiar? Cutting prices to stimulate sales... increasing supply? Yep, it's the commodity sector as of late. Let's not forget to highlight the fact that these same commodities are key inputs in numerous products across all aspects of the economy all over the world.
But what about the crude tanker rally?
Many might think that lower crude prices may insulate the crude tanker and product tanker sectors from any sort of a contraction, but let's examine that. The theory goes that lower crude prices inspire more demand, and therefore, more activity in crude tanker, and consequently, product tanker vessels. In the short run, and provided the economic backdrop is sound, that does indeed work out to be the case. The short-run theory has held, and rates have responded accordingly. So, isn't that segment safe? Unfortunately, the spillover effects could create some headwinds.
Here is a scenario that I see as a legitimate possibility to illustrate the spillover impact.
There has been a great amount of tonnage absorbed over the past years through increasing ton miles traveled. This is a fancy way of saying that a ship is traveling further to deliver the same amount of cargo. This impacts the supply of vessels available and results in higher rates.
Source: Ardmore Shipping 20-F 2014
The illustration above by Ardmore serves to highlight this trend for the product tanker trade, and the crude tanker segment is experiencing a similar trend.
As noted in my product tanker macro outlook, one of the prime reasons for the increase in ton miles traveled can be traced to emerging economies requiring greater crude imports (feedstock and refined products) as they develop. Much of this development can be traced to the exploitation of their commodity base. Long story short, if these economies begin to show weakness or even contract due to the commodity collapse, the demand for crude tankers will be impacted. Furthermore, as destinations with high ton miles associated with them require less crude, the available supply of vessels increases, resulting in lower rates, compounding these headwinds.
China and tankers
In the past, I have stated more than once that the crude tanker rally should stay intact, provided we "avoid any sort of China inspired global meltdown." Here's a few reasons why that is the case: Yes, energy demand is relatively inelastic, but also associated with growth. China's oil consumption growth accounted for about 43% of the world's oil consumption growth in 2014, according to the EIA. It was also the top oil importer for 2014, coming in at 6.1M bbl/d.
The EIA noted that:
"China's demand growth for oil products has decelerated following a growth spike in 2010. Diesel (gasoil) is a key driver of China's oil products demand and accounted for an estimated 34% of total oil products demand in 2014. Diesel demand declined on an absolute level in 2014 for the first time in two decades, as a result of several factors-slower economic growth, decreased production from the coal and mining sectors that transport products via rail and trucks, greater efficiency in heavy-duty vehicles, and increased use of natural gas-fired vehicles in recent years."
I haven't seen this discussed much, but China's 12th-Five Year Plan actually targets oil imports reaching no more than 61% of its demand by the end of 2015. This could mean a major effort by China to begin exploiting its own reserves and abundance of tight oil and gas; however, these global prices also make continuing to import highly attractive. It should be interesting to see the moves Chinese officials make in 2016 regarding this five-year plan.
Moving on, roughly 20% of China's primary energy consumption comes from oil. The industrial sector currently accounts for almost three-quarters of China's electricity consumption. In my latest container shipping report, I noted the slowdown in manufacturing for the 10th straight month. The conclusion here is obvious. Slowing or declining manufacturing will hurt energy demand, of which 20% is supplied by oil.
Finally, some keen readers might remember this chart that I often used to illustrate China's role in maritime demand increases from 2002-2014.
As noted above, China's economic growth has also helped to fuel crude oil imports (equivalent to 95% of world growth). As Clarksons states in the same article, "Of course, anything which harms the Chinese economy will generally be bad news."
Lately, many smart people, such as Larry Fink, have come forward to reaffirm that lower oil prices are good for the world, and this recent price decline is entirely supply-driven. As stated above, I believe this is the case in the short run, so I would agree with him. But I see the potential for the long-run scenario as being entirely different. Moving back to the components of GDP as stated earlier, I see the potential for commodity-based economies and businesses to curb CAPEX impacting investment. We could see increasing unemployment, which would decrease consumption, as well as less taxable revenue, which could force some economies to curb government spending. Finally, there could be reduced exports, which would impact overall net exports. All impact the GDP in a negative way.
The spillover effects could be drastic, and as noted above, it's not just the workers who will be impacted. Numerous aspects of the economy are involved in the commodity sector, from machinery to bankers who finance the projects. It is also noteworthy that this potential collapse won't be confined to just one nation. The list of countries presented in my latest container shipping macro outlook should bring to light the developing and even developed countries that are heavily reliant on commodity revenue and exports. Think back to the 2008 collapse that began with real estate and eventually reached almost every aspect of the economy. Now consider that this price collapse is more severe, in percentage terms for a given product, and impacts numerous nations.
So, I am officially done gazing into the Magic 8 Ball. Once again, these are just some random thoughts from an economist on the potential for how the long run could play out. So please take that all into context.
I welcome all questions/comments and invite you to follow me on Seeking Alpha as I continue to cover all aspects of maritime trade. Thank you for reading.
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