Demand: Chinese Rebalancing Threat To Dry Bulk Shipping

BMI View: China's slowdown in growth is set to affect the dry bulk shipping sector, reliant as it has become upon Chinese demand. Although Capesize vessels are at present benefitting from a tick up in demand, with rates heading upwards, we believe that a fall in demand growth for iron ore in China will impact upon the sector in the coming years. Coal will offer some cushion, however, and China come to increase its imports of coal from southern Africa and the US, then the resultant tonne-miles could boost the dry bulk shipping rates.

China, riding on the back of a decade-long golden age in investment-driven growth, now accounts for some 40% of dry bulk imports globally. The massive development of the country's infrastructure in recent years, not to mention huge growth in autos production and consumer demand, has driven imports of iron ore, coal (both coking and thermal), copper, zinc and other metals, and grains, ever upwards. The growth in Chinese demand has been a boon for dry bulk shipping companies as the country has been one sure source of volume growth, a source even more important to the industry in the post-global crisis world. However, the reliance of the global dry bulk shipping sector on the Chinese market leaves it wide open to the impact of any slowdown in Chinese economic expansion or restructuring of its economy.

BMI holds a broadly bearish view on the China macro story; following impressive average real GDP growth rate of 10.3% per annum over the past decade, we forecast China's real GDP growth to decelerate and average 6.1% between 2013 and 2023. The metal-intensive manufacturing and construction sectors will be especially hit as the economy undergoes a painful restructuring from its current investment-driven model to one led by domestic consumption, and this will impact upon the country's commodities imports growth rate. This, in turn, will hit dry bulk tanker and port operators counting on the China growth story to continue at a stronger rate then we at BMI envisage happening.

The Slowdown
China's Real GDP Growth, % Change, & Averages, 1993-2002, 2003-2012 & 2013-2022

Demand: Chinese Rebalancing Threat To Dry Bulk Shipping

BMI View: China's slowdown in growth is set to affect the dry bulk shipping sector, reliant as it has become upon Chinese demand. Although Capesize vessels are at present benefitting from a tick up in demand, with rates heading upwards, we believe that a fall in demand growth for iron ore in China will impact upon the sector in the coming years. Coal will offer some cushion, however, and China come to increase its imports of coal from southern Africa and the US, then the resultant tonne-miles could boost the dry bulk shipping rates.

China, riding on the back of a decade-long golden age in investment-driven growth, now accounts for some 40% of dry bulk imports globally. The massive development of the country's infrastructure in recent years, not to mention huge growth in autos production and consumer demand, has driven imports of iron ore, coal (both coking and thermal), copper, zinc and other metals, and grains, ever upwards. The growth in Chinese demand has been a boon for dry bulk shipping companies as the country has been one sure source of volume growth, a source even more important to the industry in the post-global crisis world. However, the reliance of the global dry bulk shipping sector on the Chinese market leaves it wide open to the impact of any slowdown in Chinese economic expansion or restructuring of its economy.

BMI holds a broadly bearish view on the China macro story; following impressive average real GDP growth rate of 10.3% per annum over the past decade, we forecast China's real GDP growth to decelerate and average 6.1% between 2013 and 2023. The metal-intensive manufacturing and construction sectors will be especially hit as the economy undergoes a painful restructuring from its current investment-driven model to one led by domestic consumption, and this will impact upon the country's commodities imports growth rate. This, in turn, will hit dry bulk tanker and port operators counting on the China growth story to continue at a stronger rate then we at BMI envisage happening.

The Slowdown
China's Real GDP Growth, % Change, & Averages, 1993-2002, 2003-2012 & 2013-2022

The impact of the China slowdown will not be immediate, nor will it affect all commodities to the same degree, and this has attendant implications for dry bulk tanker operators, both in terms of the volumes carried and their tonne-miles, or the distance those volumes are carried. Nevertheless, it is clear that the China growth story, the crutch of the dry bulk shipping sector for years, cannot be relied upon to fuel growth in shipping in quite the same degree in the coming years as it has been since 2008.

Iron Ore: Number One Dry Bulk Commodity

Iron ore is the most-shipped commodity in the world after crude oil, and as such is hugely important to the global dry bulk shipping sector. Not only are the volumes the greatest, but the key trades - namely from Brazil and Australia to China - provide significant tonne-miles given the great distances involved. The routes to China are by far the most important to the industry, with the country accounting for some 60% of global imports of the steel-making ingredient.

As mentioned, Brazil and Australia are the key sources of Chinese imports of iron ore, accounting for roughly 20% (Brazilian iron ore accounted for 18.0% of Chinese imports in July 2013, or 13.1mn tonnes) and 50% (in the same month Chinese imports of Australian iron ore was 37.7mn tonnes, or 51.6% of the total) respectively.

Given the distances involved, the vessel class most associated with the seaborne iron ore trade is the Capesize, with around three quarters of all of these vessels employed carrying the steel-making ingredient. These ships are among the largest dry bulk carriers afloat, and as such offer significant economies of scale, essential to shipping companies if they are to make a profit when sailing commodities half way around the globe. These same economies of scale drove mining company Vale to produce the Valemaxes - very large ore carriers (VLOCs) with a deadweight tonnage of 400,000, in an effort to generate such economies of scale that the disadvantage the company faced in shipping to China from Brazil rather than Australia - the Brazilian port of Itajaí is some 14,000km further from Chinese iron ore import facility Tianjin than Port Hedland - was cancelled out.

The outlook for Capesize ships has been fairly sanguine in 2013, though this is a relative statement, with the ships' primary index, the Baltic Capesize Index, which is generated from an amalgamation of different routes and services around the globe for the vessel class, having fallen a long way from its pre-crisis highs of over 12,000 (on August 15 2008 the index stood at 12,581). The ships, like all dry bulk shipping, have suffered from an acute over supply of tonnage since the global economic crisis of 2008/2009 stalled the growth of demand for seaborne commodities, especially in the West.

Stronger Than Last Year, But Far From Former Glories
Baltic Capesize Index, 2012-2013 (LHC) & 2008-2013 (RHC)

Nevertheless, the Baltic Capesize Index has been stronger to date in 2013 than it was in 2012. To September 2 the index has averaged 1,559, 8.8% stronger than the 1,433 it averaged over the same period in 2012. The average for 2013 so far has been dragged up in recent months; between June 3 and September 2 (last close at time of writing) the index has climbed 69.8%, from 1,333 to 2,263.

The index was boosted by strong demand from China in recent months, as anticipation of a coming economic stimulus package has strengthened demand for industrial metals, including iron ore. Buoyed by improving sentiment towards China's growth prospects, China's iron ore imports surged 26.4% y-o-y in July. The rise in Chinese demand for the steel ingredient can is demonstrated further in the export figures for the Australian iron ore exporting facility, Port Hedland.

China Crucial To Australian Exports
Port Hedland Iron Ore Exports By Destination, July 2013 (LHC), And Port Hedland Monthly Iron Ore Exports To China, 2011-2012 (Tonnes)

The port is the largest iron ore exporting facility in Australia, and volumes bound for China make up the majority - over 75%. Exports to China have been up year-on-year for every month so far in 2013, with the gain increasing over the past few months - in July 2013 the port exported 20.42mn tonnes of iron ore to China, 36.5% greater than the 19.95mn tonnes shipped in the same month last year.

However, we do not believe that the strong growth in Chinese iron ore imports will last into 2014. Although there is significant new production capacity set to come online in Australia over the next year, we believe that growth in Chinese demand will falter in the coming quarters and years. While the recent announcement of a 'mini-stimulus' may encourage more Chinese steel mills to step up production, demand from the bloated steel sector is set to disappoint over H213, and longer term we expect iron ore imports to disappoint over the coming years. Our core view has been that significant overcapacity in China's steel sector will have to be addressed in the face of mounting debt levels for steelmakers and local governments (the primary purchasers of domestic steel). Moreover, demand for steel products will further weaken with the slowing of the Chinese economy and our view that real estate investment in China has peaked, thereby pushing more steel mills into the red.

China's Rebalancing Drag On Miners
China - Select Indicators (% Change), 2008-2017

A slowing or stalling in demand growth for iron ore in China will have the effect of pushing down rates for Capesizes employed to transport iron ore once more, as the growth of the fleet will outpace that of demand. The effect will not only be to drop the growth in volumes, but also tonne-miles given the large distances of the two primary iron ore suppliers - Australia and Brazil - are from China. This will be a blow for dry bulk shipping companies counting on the current surge to last and support their future operations. Diana Shipping, which made a net loss of US$8.4mn in H112, has said that it expects iron ore trade from Australia to rise by 10% in 2013; forward freight agreements (FFAs) for Capesize vessels are also looking strong for Q4, with Capesizes around US$22,000. However, with economic clouds gathering over China we are not convinced that demand will be sufficient to support Capesize rates at their current levels into next year. Equally we expect to see a marked slowdown in throughput growth at Australian facilities such as Port Hedland.

Coal: A Brighter Outlook

Although Chinese demand growth for iron ore is set to slow, we believe that the Asian country's need for coal should support the dry bulk shipping sector, to a certain extent, as imports will continue to grow. This is not only in terms of thermal coal, but also coking coal; while steel production will decline in the coming quarters, China is reliant on seaborne imports of coking coal due to a domestic shortage of reserves. However, the rebalancing of trade routes will lead to both gains and losses in the tonne-mile generated by China's imports in the coming years.

As noted above, the slowing in demand growth for iron ore we envisage will take place in China will impact upon Capesize vessels operating out of Australia. Capesize vessels are also used to transport coal when travelling these distances (Panamaxes are also often used) and the continued growth in China's coal imports will soften the impact of the iron ore slowdown to a degree. However, there are risks to this as the competitiveness of the coal industry is being reshuffled with the growing prominence of secondary suppliers. We believe Australia will lose its pre-eminence in the seaborne market, tipping the scale in favour of other countries including Mongolia and Canada ( see 'China Coking Coal: Shifting Import Dynamics', June 19).

While any gain in Mongolia's exports to China over others further afield would be a clear blow to dry bulk shipping companies, a rise in Canadian exports of coking coal to China - 15.3% of the total in July 2013 - would necessitate transpacific sailings, generating strong tonne-miles for the industry. We note that the Americas are the source of other potential tonne-mile dividends for the beleaguered dry bulk shipping sector, this time in the form of thermal coal.

Coal Reigns
China - Total Electricity Generation, By Type, (TWh)

Thermal coal is essential to China's power generation, and accounts for over 75% of its total electricity production. The country is looking to diversify its power mix, and we expect electricity generated from thermal coal to fall as a proportion of the total over our long-term forecast period to 2022. Nevertheless, we believe that thermal coal will account for over 70% of electricity generation still at the end of our forecast period. Further, although the proportion will have declined slightly, the gross amount of kilowattage will have grown, meaning that increased volumes of thermal coal will need to be imported.

This continued growth in Chinese thermal coal imports will support export facilities in its traditional sources, Vietnam and Indonesia. While the relatively short distances involved in these trades will not generate significant tonne-mileage for the dry bulk industry, the growth in volumes will support rates for Panamax and Handysize vessels in particular.

However, it is from the Americas that there is potential not only for volume growth, but also considerable tonne-mileage, though these are wildcard possibilities at present. Colombia currently accounts for less than 1.0% of all China's coal imports, though if this were to grow it would generate considerable mileage over the transpacific trade route. Looking further ahead, once the Panama Canal's locks are widened in 2015, there is a possibility that the economies of scale generated by the fact that larger ships will be able to traverse it could lead to US exports of thermal coal to China. Another potential growth source is southern Africa; although volumes from this region are traditionally shipped to India, we see scope for growth in trade with China.

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