Shipping industry not buoyed by low fuel costs

A Sinotrans Shipping Ltd. container ship sits moored next to gantry cranes at the Port of Manila in the Philippines in November. Sinotrans & CSC Holdings will become a wholly owned subsidiary of China Merchants Group as the government steps up efforts to shrink industries plagued by overcapacity and create globally competitive businesses. Must credit: Bloomberg photo by SeongJoon Cho.

In February, the Baltic Dry Index, which assesses the prices of moving major raw materials by sea, dropped to an all-time low of 290 points. While such low freight rates may be good news for the global trade market and consumers overall, it is not good for the shipping industry, which has been facing numerous challenges in recent years.

Basil Karatzas, founder and CEO of Karatzas Marine Advisors & Co., an international maritime consulting and shipping finance advisory firm based in New York City, outlined the challenges facing the shipping industry during the Mare Forum at the Cayman Islands Shipping Summit last month.

“Expectations are getting lower by the day for shipping,” Karatzas said during his presentation, “Still Looking for Smart Investments in Shipping.”

As shipping finance becomes costlier and concerns rise about the industry’s regulatory regime and the obsolescence of current technologies in shipping, “bottom line, shipping is an out-of-favor industry from every point of view,” Karatzas said.

Ironically, a major challenge facing the industry is the low cost of fuel.

“Typically the cost of fuel is the higher cost that the ship has to pay; typically it is much more expensive to pay for the fuel of the vessel than for the vessel itself,” Karatzas said.

The faster a ship goes, the more fuel it consumes, but as fuel prices have dropped, ships have been speeding up, burning tons more fuel on average than even a year ago.

“They don’t have to be very economical at what speed they go because the cost is so low,” Karatzas said. “Let’s say from West Africa to the U.S. it would take 10 days at 11 knots. Now it takes only seven days [at 14 knots], so now the ship arrives there sooner, is discharged sooner, and is available to look for new cargo.”

With ships running at maximum speeds and arriving at their destinations earlier than what used to be standard, the problem of low demand for freight ships and too much supply of available ships is exacerbated.

“If the price of oil goes back up, on average, it would be a good thing for shipping,” Karatzas said.

The weak market for shipping is also affecting the longevity of vessels.

Typically, vessels are designed to run for 25 years, but these days they are being scrapped earlier.

“If the freight market is very strong, as it was in 2008, the maintenance goes up, but it makes sense to spend more money for maintenance and to keep a vessel for a long time,” Karatzas said. “But if the market is very weak, obviously you do not want to be spending money to maintain an old vessel.”

Now that the freight market is “very weak,” Karatzas said, vessels are being sold sooner for scrap.

“It doesn’t make any sense any more to spend money maintaining the vessels since you are not making enough money,” he said.

Also, when the market was strong in 2008, shipowners were asking shipyards to build vessels as fast as possible.

“They were compromising on craftsmanship, workmanship and the quality of the ships,” Karatzas said. “Shipowners didn’t really mind low quality because they were making a lot of money on the trade market. But now, 10 years later, you see that these vessels show their age and they age much faster than what you would expect from an average vessel over time.” Those who want to buy new ships now may have a tough time doing so unless they are large corporations. As traditional shipping banks are closing, those that are still financing ship owners are under pressure by the banking regulatory environment and low interest rates to lend to well-established corporate shipowners, ignoring the rest of the market, Karatzas said.

Institutional investors are steering away from lending to ship owners, leaving smaller, family-owned shipping companies in the lurch, creating a tremendous funding gap in shipping financing, Karatzas said – but one which smart investors can exploit.

“If you have money to finance or finance somebody to buy ships, basically you can ask for very onerous terms and most likely they are going to be accepted because there is not much alternative, and the shipowners do not have that many options,” Karatzas said.

Niche markets, he said, are where the current opportunities are in shipping investments.

His advice to investors includes focusing on good quality vessels and staying away from markets where competition is very tough, for example, large vessels whose routes are between Brazil and China.

“If the market does not recover any time soon, you know quick investments are not going to do very well in the short term. On the other hand, if people are desperate to borrow money to buy a ship and you can lend money at 8 percent to 10 percent interest, I think that’s a much more conservative investment and the risk to reward is much more favorable,” Karatzas said.

“There are always packets of opportunity to be found,” he said.