“He who lives by the crystal ball soon learns to eat ground glass” is a proverb of American economist Edgar R. Fielder and a personal favourite of Bridgewater Associates founder Ray Dalio.
Hedge-fund giant Bridgewater has amassed enormous returns, not by betting on predictions, but by understanding the consequences of what actually happens and making the right decisions in response, using computer algorithms to position its investments both rapidly and profitably. As Dalio once put it, “Rather than forecasting changes and shifting positions in anticipation of them, we pick up these changes as they’re occurring and move our money around to keep in those markets that perform best.”
This is how the shipping industry’s stakeholders – the executives, owners, operators, investors, builders, bankers, suppliers, and cargo customers – should be managing their resources for the future. No one can know what the freight rates and asset values will be in 2018 and beyond, or how the pattern of global trade will play out. The variables are simply too complex, myriad, and interrelated.
Shipping’s traditional approach is to attempt to predict the unpredictable. As one industry executive recently put it, “Our crystal ball is no better than anyone else’s, but we take a view, because that’s our job.” This sounds perfectly reasonable, but over the years, ‘taking a view’ in shipping has very often translated into placing enormous bets based on market predictions – and doing so using ‘other people’s money’, either borrowed from lenders or taken from investors.
Instead of putting so much emphasis on what is ultimately unknowable, wouldn’t it make more sense to place more focus on understanding what the decision-making ‘puzzle pieces’ could be in the year ahead? What the discernible trends, issues, changes in fundamentals, and ‘wildcard’ events are that could move the needle? How they are interrelated – how one piece fits into another? What to do in response if one or more of these triggers transpires?
The word ‘algorithm’ is generally associated with computers, but by definition, an algorithm is simply a process of rules and calculations used to solve a problem. Shipping must endeavour not only to understand the puzzle pieces of its perennially volatile marketplace, but to develop the decision-making algorithms for how to react to them, in the same way a hedge-fund manager like Dalio’s Bridgewater pre-programmes its digital trading systems to pounce on opportunities and retreat from threats.
That is what this special ‘Outlook 2018’ edition of IHS Markit is all about: not freight rate or asset-value predictions, but an examination of the issues related to each shipping sector and the potential consequences for the bottom line. Our goal is to provide shipping stakeholders with a guide to decision-making in 2018 – not spot-rate forecasts.
As you will read in the pages ahead, each shipping sector has its own unique headwinds and tailwinds. Sector fundamentals vary wildly, as do the potential wildcards that may come into play.
At the top of the sentiment ranks are the product-tanker and dry-bulk sectors. A long period of vessel overcapacity seems to be coming to an end at a time when cargo demand appears to be healthy. The caveat is that market cheerleaders have been this exuberant before, only to be proven wrong.
Among the key dry-bulk indicators to watch this year: the orderbook – which was ominously creeping up again at the end of 2017 – and the related spread between the price of second-hand tonnage and newbuildings (the tighter that spread, the more orders are likely); the effect of this year’s Valemax newbuilding deliveries on Capesize rates as incoming 400,000-tonners push 180,000-tonners from the Brazil–China iron-ore run into other trades; and the extent that China sources its coal and iron ore domestically as opposed to via imports, a particularly important and opaque indicator on the coal side.
The sector-specific issues dictating product tankers’ fate include the timetable of new refinery capacity additions and where those facilities are located (in relation to end consumers of products, and thus, the need for tanker transport); global levels of product inventories, which affect the scope of arbitrage-driven voyages; and the destinations and volume trends of outbound flows from the United States, the single largest source of export cargoes.
The view on crude tankers is as dismal as the view on dry bulk and product carriers is buoyant. There are simply too many ships, but as the newbuildings keep coming, could crude tankers surprise the market?
Among the 2018 puzzle pieces to track in the crude-tanker space: whether OPEC keeps production cuts in place through year-end as initially scheduled or reopens the taps mid-year; the extent to which Nigeria co-operates with cuts and reduces its long-haul tanker shipments to India; how US crude exports can fill the gap created by OPEC for Asian buyers (and how the WTI-Brent spread plays out – the larger and more sustained the WTI discount to Brent, the higher the US export number should climb); and how quickly the US Gulf Coast can develop terminals capable of handling direct calls by very large crude carriers – in particular, when the Louisiana Offshore Oil Port will make its predicted switch and reverse its flow from imports to exports.
In the gas sector, there is somewhat improved sentiment toward 2018 fundamentals for both liquefied natural gas (LNG) and liquefied petroleum gas (LPG) carriers, although the mood is not as bullish as for bulkers and product tankers, and it is generally more positive on LNG than LPG.
LNG shipping faces some pivotal questions. When will liquefaction projects that have long-term, chartered-in tonnage go on-stream, and will those newbuildings hit the water before the liquefaction starts, temporarily inflating available spot tonnage? Will Pacific Basin LNG pricing possess enough of a premium over Atlantic Basin pricing to offset transport costs and induce cross-basin arbitrage trading? Or will the global market increasingly settle into a shorter-haul intra-basin pattern that offers a lower transport cost to shippers and equates to lower demand for vessels?
The questions ahead for LPG shipping: how much will US propane inventories be drawn down during the colder, winter months? If they fall too precipitously, how high will global prices rise in response? If LPG pricing goes too high, will Chinese propane dehydrogenation plants cancel cargoes, increasing available spot tonnage at US Gulf Coast terminals and weighing freight rates?
In terms of routing, will LPG shippers keep their US Gulf–Asia cargoes almost entirely on the shorter westward route via the expanded Panama Canal – a more effective use of fleet capacity and thus a negative for rates – or will they revert to the much longer eastward voyage via the Cape of Good Hope?
As for container shipping, many of the issues that lie ahead are entirely different than those facing bulk shipping of liquids, dry cargo, and gas. One reason is that container carriers boast a level of concentrated ownership and co-operation among competing owners that is not found anywhere else in shipping.
The focus is on which company will be taken over next; how the new vessel-sharing alliances fare and what complications they face; whether liner ownership becomes so consolidated that carriers can exert significant pricing power over beneficial cargo owners, and if so, whether regulators finally step in; and whether newbuilding orders of ultra-large container ships resume after the spate of contracts booked by MSC and CMA CGM in the second half of 2017.
Regardless of the shipping segment, vessel interests must prepare themselves for the eventualities ahead. Decision-makers cannot know what will come next, but as Bridgewater’s Dalio advised, they can pre-emptively focus on what could happen and how they should react based on what transpires.
It won’t be easy. Complicating the equation even further is the fact that bellwethers are not just sector-specific. There are several broader issues that affect decisions in virtually all shipping segments, albeit not evenly.
Consider technology. The rhetoric implies technological advances will precipitate sweeping change across the shipping landscape – and soon. The reality is that at least some of this is hype from those hoping to sell that technology, and the actual implementation timetable will be lengthier, with acceptance driven by the cost-benefit analyses of both shipowners and cargo shippers.
Third-party technology that does not necessitate newbuilding platforms and offers immediate cost savings to owners and operators by cutting out middlemen fees and paperwork costs will be embraced as soon as possible.
In contrast, the large-scale evolution toward so-called ‘Smart Shipping’ – whereby a purpose-built fleet of satellite-connected vessels functions as a co-ordinated ‘transport factory at sea’ – will require an enormous investment of time and money by shipowners. As a result, first movers will likely have very long-term, industrial-style relationships with cargo interests (for example, companies with LNG carriers on decade-plus charters to energy majors for dedicated projects) or with very large, mature liner-service operators such as Maersk Line.
In the dry bulk and oil tanker sectors, the majority of vessels are employed in the spot market; vessel supply is cheap and abundant and will almost certainly remain so; and shippers often view tonnage as commoditised ‘dump trucks at sea’. Wet and dry bulk cargo shippers would have little incentive to commit to the long-term contracts necessary to underpin a technological step-change if they can get what they want – flexible vessel supply and low rates – by sticking to the spot model.
Regulations represent another front that has implications across virtually all shipping sectors. Over the years ahead, shipping will be forced to bankroll significant equipment upgrades to meet new environmental regulations, such as those on ballast water treatment systems and emissions.
Still unknown is whether owners will pre-emptively make equipment investments now or take a ‘wait-and-see’ approach. The answer, which will differ by shipping segment, will have huge implications for the competitive landscape of the future.
Finance is yet another broad-based issue for shipping, fueling overcapacity in some segments and upside opportunities in others. Funding patterns – whether from founders using retained earnings, outside public or private equity, banks, leasing companies, or providers of shipyard finance – render the shipping puzzle even more complex, transforming a game of chess into one of three-dimensional chess.
Money distorts shipping markets. Private equity (PE) newbuilding investments surged in 2012–14 partly because PE had too much money, funds were nearing maturity dates, and managers had to either use their cash or lose it. Another example: tanker rates rose in 2016 but asset values did not, partly because so many tanker owners also owned bulker and offshore assets, and their losses in those sectors prevented them from spending more retained earnings on tankers. Yet another example: government-backed finance in Asia has been and continues to be provided to support shipyard employment, not necessarily because the resultant newbuildings will be profitable.
Finally, there is geopolitics, which has had an enormous effect on shipping returns across all segments for decades. Conflicts and crises dislocate normal trading patterns. They can push freight rates to stratospheric heights or destroy cargo demand and cause rates to crash.
As 2017 came to a close, there was no shortage of potential game changers. Could there be a war on the Korean Peninsula, where a significant portion of global shipbuilding capacity (particularly for tankers) is located? Would a war in the Middle East affect crude, tanker, LNG, and LPG flows? A default by the Venezuelan government and national oil company PDVSA? The popping of a debt bubble in China? The crash of the US stock market? A trade war between China and the United States? A ‘hard’ Brexit? A new military conflict involving Russia? A ‘black swan’ event that is totally unforeseen?
Of all the wildcards in shipping, geopolitics is the biggest in the deck, capable of making and destroying fortunes virtually overnight. It is one of the main reasons why shipping markets will always be unpredictable and why so many of those who have made big bets based on rate and asset-value forecasts have found themselves – as Fiedler so viscerally put it – eating glass.