Signs of an impending global recession are piling up. The inverted U.S. Treasury yield curve. Dangerously high debt. Industrial slowdowns. Volatile stock markets and trade wars. A world map littered with potential economic and geopolitical crises.
Ocean shipping is inordinately exposed to global recessions, given how worldwide slowdowns curb seaborne trade. The events of 2008-09 crippled ship owners and were felt for years thereafter (some would say they’re still felt today).
What if the signals turn out to be correct, not a false alarm, and another global recession ensues? How would ocean shipping be impacted this time around?
This risk was addressed in a new report by Clarksons Platou Securities, authored by shipping equity research managing director Frode Mørkedal and analysts Erik Hovi and Henriette Vevstad.
Clarksons Platou is not lowering its base-case scenario. Nonetheless, given its admission that “investors are presently unlikely to subscribe fully” to its base view, it’s estimating what it believes could happen if global GDP growth turned out to be 2% in 2020, as opposed to the current consensus forecast of 3.3%.
What’s clear from the new report, as well as from other data and information sources, is that if there were to be another global recession, consequences for ocean shipping would be different versus 2008-09 because the industry and its markets have changed.
Liner shipping has been radically transformed over the last 10 years. Liners have consolidated via ownership mergers and commercial alliances, and average vessel size has dramatically increased, with newbuildings delivered over the past decade dominated by ships with capacity for 10,000 twenty-foot-equivalent units (TEU) or more.
On a positive note, consolidation provides lower operating costs and the bulk of the orderbook has already been delivered. Container shipping’s ratio of the orderebook to on-the-water tonnage was 50% in 2008; it’s now down to just 11%.
The bad news is that all of those consolidation transactions and newbuilding orders were expensive, equating to higher debt loads.
Clarksons Platou estimates that the multiplier of container trade to global GDP growth was 1.2 in 2018. In other words, if GDP grew 1%, container trade would grow 1.2%. If there is another financial crisis, the silver lining is that container shipping is less wedded to GDP growth than it used to be. In 2005-08, the multiple was around 2; in the early 2000s, it was as high as 4.
Nevertheless, Clarksons Platou warns of a “real risk of stagnation in container trade” in a recession scenario and projects that “based on historical regression [analysis for the years] 2009-18 … if world GDP growth slows to 2%, container trade could be flat and even contract.”
The report did cite important differences with the 2008-09 crisis that could make any future recession less impactful. It noted that 2009 data was influenced by “a total freeze in letters of credit for several months” and “this is not likely to be repeated in a normal cyclical slowdown,” meaning that “the regression results could overstate the downside potential.”
Most of the U.S.-listed container shipping companies are vessel lessors, not liner companies, so a key issue will be how a recession affects charter rates.
Under its base case, Clarksons Platou predicts container ship vessel demand would increase 6.7% in 2020. Under a recession scenario, it still sees vessel demand growing, albeit by only 1%.
It believes vessel demand will be supported by slower speeds (decreasing effective vessel supply) as operators seek to conserve on fuel as a result of IMO 2020, the rule requiring all ships not equipped with exhaust-gas scrubbers to burn more expensive fuel with sulfur content of 0.5% or less.
“IMO 2020-related slow steaming is a saving grace for vessel owners and we believe the effects of this event should help avoid a collapse in earnings [in the case of a recession],” it said.
While it doesn’t predict a collapse, it does foresee a significant charter earnings reduction in a recession scenario. For 4,400-TEU ships, it currently expects rates to rise from $11,000 per day this year to $14,600 per day in 2020. In a recession case, it sees 2020 rates falling back to $8,800 per day.
For 8,250-TEU ships, its base case is for rates to rise from $25,900 per day this year to $33,900 per day in 2020; in a recession, it estimates 2020 rates would fall to $22,600 per day.
The tanker shipping landscape is also dramatically different than it was when the global financial crisis struck. Back in 2007, U.S. crude production was 5 million barrels per day (b/d). In January-May 2019, it averaged 12 million b/d. In 2007, U.S. crude exports were not allowed to any country besides Canada; in January-May 2019, exports to global destinations averaged 2.8 million b/d.
OPEC is still important to tanker markets, but with the rise of the U.S., it’s not as important as it was in 2007.
If world GDP growth were to slow to 2% in 2020, Clarksons Platou estimates that oil demand growth would decline from 1.3 million b/d to 700,000 b/d, “leading to substantial inventory build and oil prices in the $40-per-barrel range.” The investment bank believes this would spur OPEC to “cut at least 700,000 b/d to sustain oil prices at mid-$50/barrel levels.”
Once again, IMO 2020 consequences are expected to mitigate some of the hypothetical recession fallout. Theoretically (although it hasn’t happened yet), more crude should be shipped to refineries to meet demand for production of IMO-complaint fuel, and more refined products will need to be shipped around the world on product tankers to where supplies are needed at the marine fuel hubs.
Clarksons Platou’s base case is for rates of very large crude carriers (VLCCs, which carry 2 million barrels of crude oil each) to rise from $35,000 per day this year to $60,000 per day in 2020, driven in part by IMO 2020. If there’s a recession, it believes rates will still increase, but minimally, to $40,000 per day. “This would be a disappointment for most investors,” it acknowledged.
Dry bulk shipping
The dry bulk sector is finally starting to recover after a slump that has been ongoing, with a few brief exceptions, since 2008.
If there were a global recession in 2020, the big difference for dry bulk versus what happened in 2008-09 involves asset prices and charter rates.
The global financial crisis followed an unprecedented boom for dry bulk. In 2008, rates for Capesizes (bulkers with capacity of 100,000 deadweight tons, DWT, or more) hit a high of $190,000 per day, and asset values for such ships soared to $150 million. Today, Capesize rates are around $29,000 per day. A Capesize newbuild costs $51 million and a 5-year-old Cape $30 million.
In other words, should the bottom fall out yet again, there’s less room to tumble.
Clarksons Platou estimates that demand for seaborne bulker tonnage would increase by 4.3% in 2020 if there is no global recession and by only 0.9% if there is one. Barring a recession, it believes average Capesize rates would rise from $16,200 per day this year to $18,300 per day in 2020. If there is a recession next year, it estimates that Capesize rates could sink back to $12,600 per day.
Investing in shipping stocks
On a positive note, Clarksons Platou opined that “potential rates are only slightly below most owners’ cash breakeven rates and hence no major financial difficulties are expected” in the case of a global recession. It maintained that “IMO 2020 is cushioning the effects from a potential recession, thus avoiding a major financial stress.”
“That said, we have seen in prior episodes that downturns could turn out to be worse than expected,” it conceded.
In case things do turn out worse than predicted, Clarksons Platou’s advice to investors “in uncertain times” is to focus on shipping companies with “larger market caps” and “strong balance sheets.”
“Go for low LTV companies,” it advised, referring to companies with a low ratio of loan debt-to-asset values. In the tanker sector, the public companies covered by Clarksons Platou with the lowest LTVs are Euronav (NYSE: EURN), Nordic American Tankers (NYSE: NAT), Diamond S Shipping (NYSE: DSSI), DHT Holdings (NYSE: DHT) and International Seaways (NYSE: INSW). In dry bulk, those it covers with the lowest LTVs are Grindrod (NASDAQ: GRIN), Genco (NYSE: GNK), Eagle Bulk (NASDAQ: EGLE) and 2020 Bulkers (Oslo: 2020).