Anxiety about fleet expansion is a recurring feature of world shipping markets. Within the global maritime community, worries about the vast amount of money being committed to investment in new ships intensified last year and have persisted into 2015.

During the five years since the market crash of 2008-09, well over $500 billion has been invested in newbuildings, according to some estimates. A strong desire to participate in future world seaborne trade growth and potentially profitable market activity resulted in additional tonnage being ordered, despite continuing over-capacity depressing freight rates in many market sectors. These trends and their rationale are examined in this article, which also looks at aspects of the shipping finance scene.

Money invested: an impressive revival
After the shipping market boom ended in 2008, investors’ appetite for new vessels plummeted. At its peak worldwide investment in newbuildings, the contract value of orders placed for new ships, reached a staggering $266 billion in 2007, and was still very high at $178bn in the following year when the market crash occurred in the second-half. The next year, 2009, saw a drastic downturn to only a fraction of that total, $44bn. But, based on figures compiled by Clarkson Research, since then totals have been far larger, within a range of $91bn to $131bn annually.

The first astonishing pick up happened during 2010, when players in some sectors began sensing a move towards better-balanced market conditions. Taking advantage of the much lower prices quoted by shipyards, newbuilding orders surged, especially for bulk carriers. In that year the value of contracts placed reached $112bn. Market conditions over the next two years amid a large world shipyard orderbook then prompted second thoughts about prospects. A decline in ordering ensued, to $91bn in 2012. This downturn was enough to sharply reduce the world shipbuilding orderbook to a more manageable level equivalent to 17 percent of the existing (greatly expanded) world fleet, at the end of that year, almost half the percentage seen two years earlier.

Renewed optimism about market recovery emerged in 2013, particularly in the bulk carrier sector again, towards year-end. Together with increasing focus on fuel economy amid sustained high bunker fuel prices (resulting in attractive eco-design vessels being offered by shipyards) this prompted another resurgence in newbuilding orders which jumped to $131bn. While some of that upturn can be attributed to shipbuilders’ success in raising their prices, the volume of orders was also sharply greater. The provisional total for last year, 2014, confirms anecdotal evidence that such a relatively high level was not maintained, but it remained solid at an estimated $101bn. One result of the further ordering spree is a world shipyard orderbook which has edged upwards as a proportion of the existing world fleet, to 18 percent at the end of 2014.

Who has been arranging these heavy investments? Figures derived from an analysis also compiled by Clarkson Research, based on owner country (location of contracting owner), reveals that over the period of five years from 2010 to 2014 investors in the United States achieved the largest total, amounting to $61.6bn. This amount was closely followed by owners in Greece, investing $60.4bn, with China $57.7bn and Norway $53.3bn in third and fourth places. Japan attained a large $37.7bn, and Singapore $28.3bn. The overall global total contract value of newbuilding vessel orders placed during the five years is estimated at an impressive $541bn.

A breakdown by vessel type is revealing as well, indicating where owners collectively envisaged profitable trading opportunities arising eventually. As shown in the chart, bulk carriers were a popular choice, attracting investment of $132bn during the 2010 to 2014 period. This total was far higher than seen in the other two mainstream sectors, tankers ($65bn) and container ships ($58bn). But the offshore vessel sector saw the largest total, reaching $167bn over the five years, while gas carriers (LNG and LPG) also saw a very big $59bn invested.

What are the current ‘hot’ categories? In 2014 newbuilding orders for five specific types and sizes of vessel were most prominent: (1) LNG carriers of 140,000 cubic metres or larger; (2) capesize bulk carriers; (3) handymax bulk carriers, including the supramax and ultramax sub-groups; (4) handysize tankers; and (5) LPG carriers of 60,000 cbm or larger. These priorities for investors were identified in a recent Lloyd’s List article based on Clarkson Research statistical data. However, only gas carriers were ordered during last year in larger numbers than seen in the previous twelve months. The other three hot vessel types, two sizes of bulk carrier and smaller-size tankers, saw greatly reduced orders while remaining popular choices for additional investment.

Another way of observing investment patterns over a longer period is to look at the global shipyard orderbook trend in vessel tonnage terms. At its peak at the end of 2008, the world orderbook for new ships of all types totalled 393 million gross tons, according to Clarksons, equivalent to almost one half of the existing world fleet trading at that time. Gross tons is a useful measurement, because the widely-used deadweight tonnage is not normally applicable to some specialised vessel types. Over subsequent years, as deliveries outpaced new orders, the total orderbook shrank to 184m GT at end-2012. But over the following two years, deliveries were more than offset by new orders, causing the orderbook total to rise to 214m GT at the end of 2014.

Vigorously pursuing profits
As is well known investment, from a business viewpoint, usually can only be justified if expected profits are good enough. Returns depend on finance and operating costs, and on income reflecting rates for charter hire, or alternative employment revenue such as, in the case of container service operators, box rates. These income streams, in turn, reflect the interaction of demand and supply trends. Trade volumes and distances on the demand side, and fleet evolution and productivity on the supply side, are the prominent drivers affecting market rates and prices, which are watched closely.

In recent years, as a broad generalisation, shipowners’ expectations in a number of sectors ran ahead of market realities. It can be argued that too much investment has been made in new ships, causing successive delays in the move towards improved market conditions and better profits. Periods of greater optimism, encouraging intensified newbuilding ordering, have resulted in excessive additional capacity being delivered. Fleet expansion has proceeded more rapidly than employment opportunities have expanded. This feature has not affected all sectors to the same extent, or throughout the entire period, but it explains much of the subdued market conditions which have been experienced over the past few years.

A number of news articles (mostly in the non-specialised media) have suggested that lack of global trade growth is the main explanation for subdued or depressed shipping markets. This contention is misleading. The overall trend actually has been evolving robustly. Global seaborne trade in all cargoes apparently grew at an average annual rate of 4 percent in the past four years, from 2011 to 2014. This achievement followed a much higher rate in 2010, but that was a bounce-back from the previous year’s unusual reduction in trade volume resulting from the world economy’s Great Recession. An annual 4 percent growth rate is well in line with historical performance. Moreover tonne-mile growth (a better indicator of ship employment, measuring voyage distances as well as cargo volumes), appears to have grown slightly faster, at 4.5 percent annually in the past few years.

Nevertheless, some parts of the trade picture have been weak for long periods or for a limited duration. Seaborne crude oil movements, for instance, a very prominent part, remained broadly flat during the past ten years. Liquefied natural gas (LNG) trade was also flat over several years.

On the whole, shipowners optimism about global trade expansion has proved well-founded up to now. Unfortunately, for owners, these expectations led to collective over-optimism about how much transport capacity would be required in the years following the points at which newbuilding investments were arranged. In some cases investment views evidently were affected by historically low newbuilding prices offered by shipyards, coupled with favourable financing terms. Also, during the recent period exceptionally low interest rates were an added attraction when financing could be secured.

New investors climb aboard
Another factor has allegedly distorted the supply side of the shipping markets by accelerating fleet expansion beyond its more natural growth rate. The involvement in the recent era of industry ‘outsiders’, more specifically non-traditional owners like private equity investors and hedge funds, certainly has added impetus to capacity enlargement. These types of investment funds, participating over the past decade, had not previously shown much interest in shipping. A counter-argument is that banks, the main traditional source of external finance for ship investments, have been pulling back to reduce their exposure to the shipping industry, and therefore new major sources of funding were urgently needed.

Estimating the extent of private equity, hedge fund and other alternative investors’ penetration of the shipping industry is not easy; many deals remain private and are not fully reported. Some investors have purchased vessels directly as well as through joint ventures with shipping specialists. One source suggests that, at the beginning of 2014, private equity financed a substantial part, 22 percent, of the global vessel orderbook. Private equity investors also have been very active in buying shipping loan books (portfolios of loans on individual ships) from banks, with a total value during 2013 estimated at $5 billion.

Private equity can be defined as investment from private sources, often a private equity firm in partnership with institutional investors such as pension funds and insurance companies. Typically, money is invested in equity shares of unlisted (not publicly traded on a stock exchange) companies. Providing finance for management buy-outs and refinancings is another aspect, also known as venture capital. Private equity investors often make an active contribution to the target company’s management, seeking to boost efficiency and performance, as well as supplying capital. The usual strategy is to enhance value and resell as quickly as possible at a large profit, sometimes by floating the company on the stock market. Hedge funds are another category also emerging as shipping investors: these are more speculative, trading heavily in asset-price and other market fluctuations.

An essentially short-term focus is a feature of such players (although usually, in the case of private equity in particular, a period of a few years rather than just months), potentially causing ‘disruptive’ activity in markets. As a group, private equity investors are often characterised as temporary participants, although some aim for longer-term returns. Moreover, they are sometimes regarded as having no firm commitment to the industry, with only an intention of obtaining ‘quick profits’ over the shortest possible period, buying at low or distressed prices and selling at the highest price possible. Consequently they are often viewed as somewhat predatory. While welcomed by many, others view their involvement as suspect and potentially unfavourable, leading to controversy.

Investment strategies vary, a three to five year timeframe tending to be the norm, with the aim of achieving a total 15-20 percent return on invested funds. But returns of that size have often proved elusive, amid what is regarded (by traditional shipping industry players) as the inability of many private equity and hedge funds to fully understand the nature of global shipping markets and the challenges these pose for investors. In many cases these funds’ attempts to exit their investments through asset sales (at a large profit) or IPOs (initial public offerings – floating the company on the stock market) have been problematical.

Tight credit markets globally clearly has been a key factor instrumental in enlarging opportunities for shipping finance supplied by ‘outsiders’ in recent years. Traditional bank financing for shipping investments continued to be very limited and available for only a restricted number of solid transactions. Relatively low vessel values added a compelling incentive attracting new investors. Many opportunities for participation in both shipping companies and individual ships were created.

Future surfing
Over the next couple of years at least, the world fleet of ships in many sectors is set to continue expanding, at varying growth rates, often quite robustly. The current orderbook almost certainly will ensure this outcome, as most ships currently on order will be delivered eventually. Delivery schedules are likely to alter, and some orders may be converted to other ship types or sizes, but these changes will merely modify the pace at which new capacity is added. Scrapping of old or uneconomical tonnage is likely to only partly offset newbuildings entering the market. For some time ahead, consequently, market players’ worries about fleet expansion probably will be an enduring feature.
Source: Article By Richard Scott, Visiting Lecturer, University of Greenwich & MD, Bulk Shipping Analysis | Hellenic Shipping News