Blain’s Morning Porridge, March 15^th 2024: Trade Finance – Shipping, Inflation, Trade, Growth and Headwinds.

“International trade is a key component of economic strength; hindering trade is a recipe for disaster.”

 There has been much noise about the potential impact on global supply chains due to the shipping attacks in the Red Sea. There are imposing significant costs and delays – but are not as critical as many fear. Financing global trade is one of the oldest businesses in markets – and produces dull, boring predictable returns. What’s not to like…

Housekeeping Note:

A number of readers have been asking if I am still part of Shard Capital. Yes, I am. I am strategist to the Group, available to advise and help the group and its’ clients. I’ve simply moved my pre-existing capital markets and alternatives work out of Shard and into my new independent business, Wind Shift Capital. The upside for me is I can pick and choose deals, and how much time I devote to the Morning Porridge – which gives me enormous pleasure writing…. Even if it is “ill-informed propaganda” as an American threw back at me after I was critical of Trump.

Podcast:

As Shard’s strategist I also remain in involved in Shard’s weekly Finance Lite-bite Podcast. This week I chatted with Chris Ash who sits within Shard Credit (Shard’s direct lending business), where he runs Trade Finance. The Podcast is up and listenable to here.

Global Trade, the Inflation Threat and Trade Finance

This morning I read about how up to 190 Russian Dark Fleet tankers are sailing through the English Channel every month loaded with discounted oil for China and India in contravention of economic sanctions. These elderly, (mostly over 15 years old), poorly maintained vessels are effectively uninsured; the Russian Ingosstrakh insurance agency includes a “sanctions exclusion clause” in all its contracts, meaning Russian ships have notional insurance documents, but will never be able to claim it if there was something like a Exxon Valdez disaster in Europe’s busiest shipping lanes: “Russian “dark fleet” lacks oil spill insurance, leaks suggest”.

You can imagine the reaction if there is an accident…. The fact some ship owners have responded to the current oversupply in the notoriously cyclical shipping industry by offloading aging surplus capacity to the Russians demonstrates just how capitalism really works. Shipping, costs and prices are all factors in global trade.

Back in the world of markets and the game of guessing when and if central banks are going to ease interest rates – there are many who fear there remains a significant inflation threat from global trade frictions.

Inflation may not be dead, but it is dead simple. If too much money is chasing too few goods, then prices will rise to a new equilibrium. If global trades grounds to a halt, or even slows just a little, inevitably goods become scarce. Broken supply chains during the pandemic were as much a driver of inflation as the Ukraine energy shock. To get a handle of the availability and supply of goods, it’s important to understand how trade is working as much as to understand what central banks are thinking about rates.

If global trade is going to experience increasing “frictions” – from supply chain blockages, trade wars, outright conflict (like the Houthis in the Bab-al-Mandeb straight at the mouth of The Red Sea), or the imposition of tariffs that diminish the supply of goods (or push up the price directly), then inflation is likely to rise as demand pushed up costs. However, if money is too plentiful because money is too cheap (as happens with zero-interest-rates) then  cash is redirected into other goods – during the QE era, this was stocks and shares where we had classic inflation: too much easy money pushing up the price of all financial asset through the yield tourism process (whereby if bond yields are too low, you hunt for more yield by taking greater risks, buying stocks instead.)

Trade and trade friction ranks alongside wage demands, corporate greed, behavioural science and central bank watching when it comes to predicting inflation, and thus rates. When I started in financial markets one of the key numbers we were taught to follow in order to get a sense of international trade flows was the quaintly named Baltic Dry Index.

It would be sweet to write how the Baltic Dry originally measured the costs of doing business around the old Hanseatic league and the North Sea costs, indexing the costs of transporting timber, ships masts, jute, tallow and tar from Scandinavia and what we then called Muscovy. (Hint: you don’t hear Putin’s Russian history lessons talking about how Moscow was once nothing more than a minor statelet the Tartar Hordes permitted – Kyiv was the real centre of Rus power.)

The Baltic was key strategic geography for the UK’s power projection during the centuries when Britannia ruled the waves – all these materials were critical to maintaining the superiority and fighting condition of the Royal Navy’s fleet. During the last unpleasantness with France in the 1800s we fought the Danes, and even the Swedes at one point, to ensure timber was available for ships masts. (We also declared war on Finland in 1941, not long after offering to support them against Russia – but that’s another matter entirely, you should probably ask the Germans about that one…)

Sadly, the Baltic Dry Index is named after the coffee shop, The Virginia and Baltick (reflecting two of the UK’s major trade interests, other important ones being sugar from the Caribbean and goods from India), where shipping interests started meeting in the 1740s. Today the index measures the costs of shipping charters – Capesize, Panamax and Supramax ships since you ask.

Perhaps even more important for global trade are the Shanghai Container Indices which give a sense of the cost of exporting a container of goods from China to Europe and China to the US. In recent years containers have proved volatile – reflecting the grounding of the Ever Given, the container ship that blocked the Suez Canal in 2021, and problems with port access during the pandemic.

The current attacks by Houthis on Red Sea shipping and the fact so much global trade has now been redirected away from the Suez Canal (over 40% of Europe’s Asia trade flows through the Suez, 50 ships carrying $3-9bln in cargoes), has created fears of another crisis in supply chains impacting the global economy, triggering another inflation outbreak. Last month, Tesla was forced to suspend production in its Berlin plant because re-routing deliveries around South Africa led to an acute shortage of components for its cars.. (Well, that was story – maybe no one wanted to buy them?)

I asked my trade finance expert, Chris Ash to explain the effects. Sure enough there was a bounce in container rates, but it’s been somewhat mitigated by Ramadan and The Chinese New Year. Although it takes some 4 weeks longer for large vessels to transit round the Cape of Good Hope in South Africa, by slowing down (to use less fuel) the actual cost difference between the additional fuel cost and paying the significant transit costs through Suez isn’t that much – say $1.3mm in fuel and delay costs vs a $900k canal fee for a large 20k container ship.

There are issues – just-in-time producers will be impacted as deliveries slow down – like Tesla – and there are potential consequences in terms of complex supply chains. The additional cost of a 4-week longer trip won’t much impact the marginal cost of goods in a container stuffed with high value goods, but if we’re talking low value bulk goods like packaging or basic materials, then the returns on a $50k container cargo are seriously impacted by a couple of thousand extra on shipping costs. The consequences can be felt down the line, when suddenly there are shortages of such simple but critical key products, for instance packaging materials to allow re-export of time sensitve products. It’s the old “for want of a nail, the shoe was lost” scenario…

Perversely, one of the drivers of vol in shipping prices is the containers themselves. During the pandemic empty containers piled up on the US Pacific Coast empty, while none were available in China. That caused a dramatic spike in container prices. It may happen again as containers at sea for 4 weeks longer causes knock on availability issues down the line.  (The fact shipping containers are now desirable building materials for pop-up markets and luxury housing isn’t yet a factor – a house recently sold in the US constructed out of containers for $5mm!)

And, if ships are spending 4 weeks longer at sea, that means a potential shortage of shipping to replace those that miss their anticipated dock times. However, shipping supply is notoriously cyclical with a massive potential over-capacity issue as ships ordered during the last period of scarcity come on to market – that cycle peaks in 2025 as new ship launches will exceed ship’s scrapped in 2023 by some 27%, according to ING!

Although the amount of trade friction from the Red Sea is significant, it’s not yet critical. It’s not going to significantly impact global trade in the way a wider conflict might. In terms of trade finance Chris is confident in the returns his group is generating – trades that were impacted by Red Sea events were quickly sorted with extended tenors. All cargoes are insured so losses to investors are fully mitigated across his diversified portfolio of financed trades.

I asked Chris to sum up: ‘Trade always finds a way despite headwinds, and following the pandemic, is more robust than ever before. The short-term nature of trade finance makes the asset class extremely responsive to world events, and offers a very secure investment opportunity when compared to other forms of finance.”

If trade finance, and the double-digit, decorrelated returns it generates, sounds like an asset you need to know more about, send me an email and we’ll arrange a chat.

Out of time, off to do the day job, and have a great weekend…

Bill Blain

Strategist, Author of the Morning Porridge

Wind Shift Capital