Will Dry Bulk Remain The 'Wile E. Coyote' Of Ocean Shipping?

Dry bulk has been the "Wile E. Coyote" of ocean shipping for the past decade – forever chasing after profits only to lunge at empty air and repeatedly fall straight off a cliff.

Rates for Capesizes, the workhorse bulkers with capacity of around 180,000 deadweight tons, are now enjoying their seasonal upturn, but even so, they're still below breakeven.

Will this be yet another lost year for dry bulk shipping, and for top U.S.-listed Capesize owners Star Bulk Carriers Corp. SBLK, Golden Ocean Group Limited GOGL and Genco Shipping & Trading Limited GNK? Evercore ISI analyst Jon Chappell is not optimistic on the sector's prospects. "Dry bulk challenges will just not abate," he said in a client note on Monday.

Dry bulk's lost decade

Prior to 2009, vast fortunes were made in dry bulk, the largest cargo business in the world measured by volume and the freight segment with the most active derivatives market.

According to Chappell, "Since the end of the global financial crisis, a myriad of issues … have derailed the promise of another sustainable cyclical upturn, resulting in year after year of losses and ‘cheap' stocks. Dry bulk shipping cannot seem to catch a break."

Brazilian iron-ore production estimates reduced. Photo credit: Vale

The stage was set for recovery in 2019. Then a dam in Brazil holding back iron-ore mining residue collapsed, killing over 270 people. The mine closures that followed slashed Chinese imports from Brazilian iron-ore miner Vale S.A. VALE, crippling Capesize spot rates.

The stage was then set for recovery in 2020. Vale's mines were expected to come back online and Capesize owners were predicted to profit from exhaust-gas scrubbers. The scrubbers would allow owners to keep burning cheaper high-sulfur fuel and not switch to the expensive low-sulfur fuel required by the new IMO 2020 regulations.

Then came the coronavirus. The ensuing global recession threatens steel demand, the driver of the seaborne iron-ore trade. The collapse in oil prices erased the spread between high- and low-sulfur marine fuel, destroying the value of scrubbers. Meanwhile, Vale still isn't back to full speed and the pandemic could create further delays in Brazil.

Vale production woes persist

In a production report issued after market close on Friday, which one dry bulk participant dubbed "terrible," Vale slashed its full-year iron-ore production outlook from 340 million-355 million tons to 310 million-330 million tons – a midpoint reduction of 27.5 million tons or 8%.

Vale warned that COVID-19 could have a "meaningful" impact on its mining productivity and could delay the resumption of production at mines closed by the 2019 dam accident by "delaying inspections, assessments and authorization processes."

On a positive note, Vale's first-quarter production came in at 59.6 million tons (9% below the forecast midpoint), meaning that production must accelerate to an average of 83.5 million tons per quarter if Vale is to hit the bottom end of its reduced full-year range.

"As we anticipated by looking at trade flows, Vale greatly missed its own guidance for the first quarter and naturally cut its full-year guidance," said John Kartsonas, founder of Breakwave Advisors, the creator of the Breakwave Dry Bulk Shipping ETF BDRY.

Kartsonas told FreightWaves, "The silver lining is that if [Vale] manages to sell as much as it says for the rest of the year – and that's a big if – there will be around 25 million tons of incremental iron-ore demand versus last year and the highest iron-ore trade ever out of Brazil [during] the second half of 2020. That bodes well for Capesize rates."

Rate outlook and drivers

Frode Mørkedal, managing director of research at Clarksons Platou Securities, believes a "ramp up in [iron-ore] shipments for the remainder of the year, coupled with increasing stimulus spending and seasonal improvements in activity, could support a strong freight rate recovery."

Bulkers loading Brazilian iron ore. Photo credit: Vale

Breakwave Advisors said in its latest outlook, "We anticipate a considerable ramp up in volumes [from Brazil] for the rest of the year … there is ample room to see a repeat of last year's rally when rates peaked at almost $40,000 per day in September."

U.K.-based consultancy Marine Strategies International (MSI) struck a more cautious note in its new outlook released on Monday. It estimated that average non-scrubber spot rates would rise to $12,400 per day by June and $13,100 per day by October.

According to MSI, "Indications of a bounce-back in steel demand in China – including increased sales of construction equipment, a drawdown of steel stockpiles and, surprisingly, a sharp uptick in steel imports – may provide a glimmer of hope. But the recent resurgence of COVID-19 cases, such as the outbreak in Harbin [China], underpins our more cautious expectations."

Chappell is more bearish. Last week, he cut his full-year 2020 Capesize rate forecast to just $11,000 per day, from $15,000 per day previously. He reduced his 2021 forecast to $14,500 per day, down from $19,000 per day.

Can dry bulk stocks recover?

In mid-day trading on Monday, shares of Star Bulk were down 10%, Genco 8% and Golden Ocean 4%. In each case, stocks were back to levels seen in 2016.

Chappell doesn't foresee the dry bulk companies he covers booking full-year profits until 2022 at the earliest. "Cheap doesn't always mean attractive," he said, noting that the question for investors is: "Why do I need to own these stocks?" and that his answer to investors is: "You don't."

"At a time of maximum macro uncertainty, high-beta, small-cap commodity stocks are about as far from a ‘safe haven' as there is," he added.

Deutsche Bank transportation analyst Amit Mehrotra commented in a client note last week, "There's nothing much to say here except it's bad. Clearly dry bulk stocks won't work until spot cash flows are accruing to equity holders – and we're a far way off from that happening."

Spot rates and fuel spreads

To get a closer look at what's going in with Cape rates, FreightWaves has developed a series of charts covering year-to-date Cape performance based on data from S&P Global Platts.

Last year, Platts began publishing the CapeT4 Index; it produces dual indices, one for Capesizes using exhaust-gas scrubbers burning traditional 3.5% sulfur heavy fuel oil (HFO) and one for non-scrubber Capes burning 0.5% sulfur fuel known as very low sulfur fuel oil (VLSFO).

Rates assessed on a dollars-per-day time-charter equivalent (TCE) basis are calculated net of fuel, meaning that scrubber ships burning cheaper HFO post higher TCE rates. Jefferies analyst Randy Giveans told FreightWaves that 22% of Capesizes currently on the water are equipped with scrubbers.

What's striking about the Platts index data is that scrubbers were designed to save ship owners money – and they have – but the year-to-date (YTD) rate trend for scrubber ships is down and the trend for non-scrubber ships is up.

Non-scrubber Capesize rates were assessed on Friday at $9,809 per day by the Platts T4 Index, double the rate at the beginning of the year and quadruple the YTD low set in January. In contrast, TCE rates of scrubber ships have fallen 29% YTD, to $11,680 per on Friday, because the discount of HFO to VLSFO has collapsed (and thus, the savings and TCE benefit have reduced) at a much faster pace than base freight rates have risen.

The downward rate trend for scrubber Capes has reversed in recent weeks for two reasons. First, the HFO-VLSFO spread is about as low as it can get, so there's less room for a spread decline to reduce scrubber Cape TCE rates. Second, base rates are rising off first-quarter seasonal lows, supporting both scrubber and non-scrubber Capes.

Brazil vs. Australia exports

The Platts CapeT4 is primarily driven by two roundtrip routes: Australia-China and Brazil-China.

In the Australia-China market, the scrubber advantage has almost completely vanished this month, with non-scrubber Cape rates assessed at $8,199 per day on Friday and scrubber Capes at $8,712 per day. Scrubber Cape TCE rates in this geographical segment are down 54% YTD and non-scrubber rates are up 47%.

In the Brazil-China market, rates are higher than out of Australia and while scrubber savings have slimmed, they haven't disappeared to quite the extent they have in Australia. Platts assessed non-scrubber Cape rates in this market at $11,360 per day on Friday and Cape rates at $14,493 per day. Scrubber rates in this segment are down 22% YTD and non-scrubber rates are up 141%.

Scrubber promises unfulfilled

The closing of the HFO-VLSFO spread means it will take much longer for companies that paid huge sums for fleetwide scrubber installations to recoup their capital costs, let alone earn a profit from this strategy.

Star Bulk, for example, is spending $209 million to install scrubbers on 114 ships, equating to an average of $1.8 million per scrubber. On a back-of-the-envelope basis, assuming a Capesize uses a scrubber 300 days a year, the current daily savings imply the investment won't break even for over three years.

And the actual cost is even higher still when including the opportunity cost – earnings lost during the installation process, including voyages to and from the yard.

Basil Karatzas, founder of Karatzas Marine Advisors & Co., told FreightWaves, "There is a Greek shipowner who put all five of his Capes in drydock to install scrubbers last summer. Cape rates spiked and he basically made no money on that spike because he was out of position. His ships were in the yard. He thought he was doing the right thing by installing scrubbers, but now, the spread is minimal, so not only did he miss the spike, but he isn't making any money out of the scrubbers." Click for more FreightWaves/American Shipper articles by Greg Miller

Photo credit: Vale