Shipping – a real world asset class, but complex!

Yesterday’s ongoing pain in crashing financial asset markets demonstrates the need to diversify portfolios and decorrelated returns. Shipping is one such asset; returns have been boosted by scarcity as a result of the pandemic – the question is: can these returns be maintained?

Blain’s Morning Porridge, 10th May 2022: Shipping – a real world asset class, but complex!

“I am leaving the sea. I shall walk inland with an oar on my shoulder. When someone asks what it is – there I shall bide.”

This Morning – Yesterday’s ongoing pain in crashing financial asset markets demonstrates the need to diversify portfolios and decorrelated returns. Shipping is one such asset; returns have been boosted by scarcity as a result of the pandemic – the question is: can these returns be maintained?

Yesterday I promised I would look more closely at diversified non-financial assets. This morning I’ve going to start with Shipping… but let me caveat it’s a complex and expert-led market. While Shipping has massive investment potential – recent results from shipping funds have been stellar – I am not a shipping expert. Talk to shipping professionals before you risk anything in the sector.

Writing about subjects I don’t fully comprehend raises a credibility risk – but it’s worth highlighting Shipping and some other areas for the opportunities they present in terms of uncorrelated returns. One way to skip the looming crisis in financial assets will be to differentiate portfolios away from listed stocks and shares – and look to buy the real world; what we call alternative assets.

And, after yesterday’s miserable day in markets, these uncertain times means it’s absolutely necessary for investors to look outside their conventional comfort zones to generate returns. Wearing my day-job hat, I am Head of Alternative Assets at Shard Capital, so feel free to contact me on email (bill.blain@shardcapital.com) to ask questions – and who knows, I may have just the deal for you! (Sorry – qualified professional investors only!)

I remain convinced global stocks and shares are massively overpriced relative to the prospects for the global economy. That’s not just because of the deepening new Covid lockdown crisis in China (which threatens a catastrophic repeat of 2020-21 supply chain breakdowns), energy & food inflation, the Ukraine war, but also unravelling the consequences of 12 years of Monetary experimentation and cheap liquidity distorting markets.

Judging from the talk of capitulation trades I’m hearing, or more miserable tech results to come (Pelaton tonight), I’m not the only person thinking the crash, bang, wallop “moment” approaches.

For instance, there was a fantastic quote in Grants Interest Rate Observer last night about how DoorDash posted a 35% jump in revenues to $1.46 bln, but still didn’t make a profit – it now carries a $1.7 bln cumulative net loss. Grants’ quoted the former head of Dominos pizza: “In 60 years, we’ve never made a dollar delivering a pizza. We make money on the product, but we don’t make any money on the delivery. So, we’re just not sure how others do it.”

Which is why you should stay away from modern companies who don’t understand why successful companies never did it that way… DoorDash, and many others, will be remembered for inventing the Square Wheel…

Back to Shipping…

Shipping is an enormously complex sector. You need to understand what all the different classes of boats do, how their demand patterns work, to understand how the supply of new and old ships will affect prices, while overlaying everything with an understanding of global trade to work out likely returns. And even then, you will be swimming in an investment pool of players who will know far more than you…

Yet, the numbers are enticing. The returns from owning ships have gone skywards – charter rates have risen dramatically, ship values have trebled in some cases, and even the older ships are commanding high resale values. Funds set up to manage vessels have done exceptionally well.

Be warned: shipping can get very messy. In the past it’s been an easy way to lose money quickly – and always there will be some very clever Greeks just waiting to scoop up the bargains. Typically, it’s a boom/bust industry – every time the global economy booms there is a shipping shortage, new vessels are ordered leading a glut of capacity just as the next downturn starts.

But, shipping is absolutely critical to making the global economy function. Take a look at the crisis in supply chains…

Two of most interesting leading indicators of how the global economy is really performing are the Shanghai Export Container Freight Index and the Baltic Dry Index. The first measures the all-important freight rate and volume of Containers being sent from China around the globe, while the Baltic Dry measures the flow and price of transporting raw materials. I’ve been watching the Baltic since I was a tiny wee banker back in the 1980s.

Since May 2000 – when global trade began to anticipate Covid recovery – the Shanghai leapt from a low of 836 to peak in January this year at 5094. Now the container index has fallen to 4163 – suggesting, perhaps, that global container costs are beginning to moderate. The Baltic Dry spiked from a May 2020 Covid low of 350 to over 5500 in Oct 2021 as the global economy re-opened – it fell below 1500 earlier this year but has recovered to 2831 reflecting slowdown in China.

Both indexes correlate to inflation – which is hardly surprising as they are leading indicators of global trade. The fact both are weaker than their peaks might suggest moderating inflation and increasing recessionary conditions. Both are probably better indications of the real economy than stocks. I find it fascinating how the Baltic Dry basically flatlined through the last decade of excessively low interest rates and a raging bull equity market, reflecting the utter detachment of the financial asset universe from the reality of a very slow stuttering real economy.

When I try to understand why shipping values have risen so much since 2020… it’s complex. It’s all been about blockages as the economy reopened. The price of shipping basically depends on the availability of ships. I am told the global fleet of handy-size freighters is over 5000 vessels, but there only 5-6 actually available for charter at present!

I came across an interesting example of cost “friction” while looking at shipping. When freight costs are so high, it infers demand must be high, therefore it’s an inflationary signal – people willing to pay more to get goods.

However, the current energy/oil shock means the price of bunker fuel is pretty much at an all time high. As a result, ships are slowing down. Slow steaming requires considerably less fuel – it’s called the “cube-rule”: slow a boat by half, and it will use 1/8th the fuel it would at full speed.  In the past there has been a pretty close correlation between the speed of boats and the cost of freight. When its high, ships slow.

But… things are never that simple. Slowing a boat down means it takes longer to sail from A-B. That means it costs more to hire a ship as the rental is a daily charge – and charter rates have risen between 20-35%. This is where friction comes in; shipping costs have become a compromise between rising demand, the higher cost of fuel and crew, plus the rising costs of hiring ships.

That is great news for ship owners. First it means they get paid more because their boats earn a higher rental on longer voyages. Second, its reckoned for every 1 knot (a knot is the speed of boats, its not quite the same as miles per hour) global shipping slows, about 6% of the global fleet is taken out as not available – meaning slower ships mean fewer ships for hire, further pushing up charter rates. Shipping earns more, but goods reach markets slower, thus generating inflation!

The next problem is global ports. From Shanghai, Long Beach and Harwich global ports were swamped by the post-Covid reopening. This was exacerbated by shortage of lorry drivers, stevedores, and now renewed lockdowns in China. While Western Ports are full of empty containers, there are practically no empty TEUs (Twenty Foot Equivalent Units) anywhere in Asia. The result is massive delays unloading vessels. About 20% of the Global Shipping container fleet is currently queued waiting for entry to the big ports – again creating scarcity and pushing up charter prices.

All of which is great news for the owners of smaller Handysize vessels – we’re even seeing smaller bulk carriers carrying containers to smaller ports (many have their own cranes on board). It’s not particularly efficient, but it solves the immediate transport crisis.

There are other problems – about 3% of the global merchant marine is Russian flagged, but Russian sailors make up 10% of the 2 million odd global merchant sailors. Following the pandemic its clear many sailors have retired or have given up – many were effectively trapped on board for the duration of the crisis. There is a massive shortage of crew and officers building – by 2025 we could be short over 90,000 officers, particularly in engineering – a long term problem for the whole global economy.

The question for investors is this: will the current global supply chain problems which have driven up shipping prices ease, and mean prices, and therefore returns, continue to drive results? Perhaps, but the problems will be solved in the medium term. Its not necessarily bad for shipping – in many shipping classes the ships are getting older and less efficient, and new fuel and environmental regulations mean they need replaced.

The numbers are all out there.. but this is where you need the expert advice on which shipping types are likely to prove most valuable. I’ll be very happy to assist. For instance, I am reliably informed not to buy container ships, but handysize bulkers… and maybe some tankers…

Five Things To Read This Morning

FT – Emerging Markets hit by “Toxic” mix of rising rates and slower growth

FT – What is a Softish Landing, and El Salvador’s bitcoin debacle

BBerg – Global Banks Flee the Monster SPAC Market They Helped Create

BBerg – EU Weights Joint Debt to Fund Ukraine’s Long-Term Reconstruction

WSJ – Uber Plans to Cut Costs as Investors Tech Optimism Recedes

Out of time, and back to the day job..

Bill Blain

Strategist and Head of Alternatives, Shard Capital

5 Comments

  1. Surely, there is one trend just being established that is not driven by the economic cycle, but by the inevitable long term change in Energy Security instigated by Putin and the longer term climate requirements that must dictate more not less Natural Gas. LNG. I wouldn’t mind a few of those tankers please!

    • Aye… LNG tankers to bring gas from Qatar and US to Yoorp, and then to bring Ammonia from the Solar Power fields of OZ to power a hydrogen economy.
      Its a fascinating market!

  2. For the last year I’ve invested in shipping stocks and done well (dry bulkers, container shippers and tankers). I’ve learned its an incredibly complicated industry (as you recognize in your post) and that there are some very sharp people running the best shipping companies. I’ve been very impressed by a smattering of Greek, Israeli, French and Brit shipping executives. I’d put some of them up against the best managers in any industry. I wouldn’t dream of competing with these people in any aspect of their industry. I’d rather just buy their stocks and collect the divvies (some of them fat) they are yielding at present. That may be lazy and may have some tail risk I have to manage given stock valuations, but I know I would not do well trying to outsmart them at their game. Just sayin.

  3. there are some interesting monopoly related posts about shipping (of containers):

    a light note from a trucker
    https://medium.com/@ryan79z28/im-a-twenty-year-truck-driver-i-will-tell-you-why-america-s-shipping-crisis-will-not-end-bbe0ebac6a91
    >Nobody is compelling the transportation industries to make the needed changes to their infrastructure. There are no laws compelling them to hire the needed workers, or pay them a living wage, or improve working conditions. And nobody is compelling them to buy more container chassis units, more cranes, or more storage space. This is for an industry that literally every business in the world is reliant on in some way or another.
    >nothing is going to change and the shipping crisis is only going to get worse. Nobody in the supply chain wants to pay to solve the problem. They literally just won’t pay to solve the problem. At the point we are at now, things are so backed up that the backups THEMSELVES are causing container companies, ports, warehouses, and trucking companies to charge massive rate increases for doing literally NOTHING. Container companies have already decreased the maximum allowable times before containers have to be back to the port, and if the congestion is so bad that you can’t get the container back into the port when it is due, the container company can charge massive late fees. The ports themselves will start charging massive storage fees for not getting containers out on time — storage charges alone can run into thousands of dollars a day. Warehouses can charge massive premiums for their services, and so can trucking companies. Chronic understaffing has led to this problem, but it is allowing these same companies >to charge ten times more for regular services. Since they’re not paying the workers any more than they did last year or five years ago, the whole industry sits back and cashes in on the mess it created. In fact, the more things are backed up, the more every point of the supply chain cashes in. There is literally NO incentive to change, even if it means consumers have to do holiday shopping in July and pay triple for shipping.
    >This is the new normal. All brought to you by the ‘experts’ running our supply chains.

    or a deeper analysis:
    https://mattstoller.substack.com/p/too-big-to-sail-how-a-legal-revolution
    >carriers are exempt from certain parts of antitrust law, and can cooperate with loads and scheduling in what are known as alliances, with three alliances controlling over 80% of the global shipping market
    >And it is the consolidation that led to the mega-ships – the biggest ships are four times the size of what they were 25 years ago. The reason is simple, and it’s not efficiency. Individual shipping lines simply don’t have enough cargo to load a mega-ship reliably, it’s only by being very large and cooperating with each other, as well as forcing ports to build the infrastructure to accommodate them, that they can do so. And then with their bargaining leverage, they can force other players, from ports to truckers to terminals, to build the infrastructure to deal with the costs of the ultra-large ships. Then, once the transportation system runs on such ships, the ships themselves, with their high financing costs, become a barrier to entry. A new ocean carrier could break into a business with medium sized boats, but who can afford to run and lease something so massive? Moreover, the ocean carriers now have buying power over the whole supply chain. Which terminal or port would dare anger massive customers to accept business from a competitor?
    >In other words, mega-ships like the Ever Given are a new phenomenon that are tied not to economic logic but to the consolidation of ocean carrier lines and their ability to offload risk onto counter parties. As Jensen observed, without the consolidation, “ships would likely not have grown above 12,000-14,000 TEUs [twenty-foot equivalent units].” So we’ve moved from a grid with lots of different size ships owned by different lines that could dock in lots of ports, to one dominated by hundreds of mega-ships that can only go to certain ports, all controlled by a de facto small cartel. The game in the business is to acquire market power and then use mega-ships to offload costs onto others and block new entrants.
    ‘destructive competition’
    >Think of a transportation system like buying a car to run an unregulated taxi service. Once a driver has a car payment every month, it doesn’t matter if he or she picks up an extra customer or not, that car payment is due. So every additional dollar from a customer is useful, since the car payment has to be paid no matter and selling an additional ride doesn’t cost the driver very much. If there’s competition with a bunch of people who all owe car payments, then every cab driver is willing to undercut everyone else even if they can’t make enough to pay the car payment, since it’s better to get some revenue than none at all. Ultimately, all but a few will miss their car payments, and leave the industry.
    >With destructive competition, entire high fixed cost industries first over-invest in capacity. Then firms become unprofitable as they undercut one another, undermining safety standards, system reliability, and worker pay. Eventually there are mass bankruptcies of weaker firms, and consolidation as the strong buy the weak and establish pricing power
    >The way to stop destructive competition is to allow some form of public price-setting, so that firms in such industries have enough to cover their fixed costs, make some profit to induce investment, and pay their workers and suppliers. Transparency in pricing helps everyone identify problems immediately. That’s what the Shipping Act did for ocean carriers. It stabilized the industry.
    >in the 1970s, policymakers turned away from the basic public utility model in multiple industries, including trucking, rail, telecommunications, finance, and airlines
    >Prices indeed went down at first, seeming to prove the efficiency experts correct. But long-term, the change led to destructive competition in these sectors. Airlines, for instance, expanded rapidly and then went bankrupt, in turn cutting labor costs, ending air service to smaller and medium sized cities, and then consolidated into an oligopoly with pricing power.
    >There were similar changes in the rail and trucking sectors.
    >The Ocean Shipping Reform Act of 1998 undid the Shipping Act, bringing deregulation in force to shipping. The goal was to induce the same “efficiency” gains to shipping, that policymakers imagined they saw in trucking, rail and airlines.
    small shippers were apoplectic
    >the bill would allow “large carriers and huge multi-national shippers easily and purposefully agree to bypass entire port communities in an attempt to monopolize the market and inflate profits.” There were warnings that the American fleet would disappear, that a boom and bust cycle would return, that dominant carriers would emerge, that the transportation grid would be stressed, and that the small would become prey for the big.
    >“This legislation, I would suggest, was conceived in darkness, it was written in the back rooms, it is a bill that addresses special interests, not the public interest,” said Louisiana Senator John Breaux at a hearing for the bill. “It was designed to help a narrow group of interests in the shipping business, it is supported not by logic, but mostly by threats.”
    >When those in power are doing well, and they can hide their dealings behind secret contracts, they don’t have responsibility for problems like too many empty containers crowding the yard, a lack of chassis, poor management of trucking appointments, problems for towage or barge operators, or anything else. They just raise fees and collect monopoly profits.
    >Congress should get involved, and investigate the shipping industry the way it did big tech a few years ago.
    >Of course, we can’t undo 20 years of ultra-large container ship construction, but we can end incentives for building more of them by charging harbor maintenance fees based on ship size, or otherwise forcing carriers to internalize the full cost of big ships. This will have to be on a national scale, with the threat of antitrust, so carriers can’t play U.S. ports off one another.
    >it’s time to start to talk about re-regulating the sector with transparent pricing to facilitate new entrants and end price discrimination. That way, we will stop the wild swings and monopolization in the industry

  4. As a US Merchant Mariner (Engineer), I have to say that you nailed it.
    Anyone older and with the means to retire, already has or is seriously considering it. Others have turned away due to the vaccine requirements.
    The ships are getting older and the regulations and never-ending inspections we have to deal with are getting stricter. The training and other requirements just to keep your Mariner documents valid each year are getting tougher. I am currently onboard a ship, sailing short various positions… as are many of our sister ships… with no sign of getting better any time soon.

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