The fundamental balance will continue to deteriorate in 2020, offering little support to operators hoping to pass on higher fuel costs, caused by the sulphur cap, to shippers.
Demand drivers and freight rates
The start of the new year has, as is often the case for dry bulk shipping, been marked by falling freight rates. The seasonal slump, typical in January after a strong Q4, has been exacerbated by the additional cost of fuel resulting from the IMO 2020 sulphur cap.
The steep drop in average Capesize earnings that began in early December continued into the new year. The Baltic Capesize Index fell into negative territory for the first time on 31 January, and average earnings stood at USD 2,660 per day on 7 February. In fact, by this date, only Supramax ships were earning above USD 5,000 a day, with average earnings for that sector standing at USD 5,400 per day. Panamax and Handysize earnings had fallen to USD 3,535 per day and USD 3,502 per day, respectively.
For the shipping industry, developments in average earnings are much more important than changes to the BCI, which is an important tool in the financial markets, but provides little information to the shipping community.
These sharp declines reflect more than just the underlying freight market dynamics. The earnings figures also take into account the cost of fuel, which has risen significantly since the implementation of the 2020 sulphur cap. The higher cost of low-sulphur fuels means earnings have taken a substantial hit. Earnings on a time-charter equivalent basis are based on a non-scrubber fitted ship. Scrubber-fitted ships’ earnings have remained higher because of the lower cost of high-sulphur fuel, rather than premiums for scrubber-fitted ships. What matters is who pays for the fuel. The steep drop in earnings illustrates that passing on the extra fuel cost has been near-impossible to implement on voyage charters.
For example, on the major Tubarao, Brazil to Qingdao, China iron ore trade, average Capesize earnings stood at USD 6,341 per day in January. This is down 71.6% from the December 2019 average and 60.8% lower than the January 2019 average. On the other hand, the dollar per tonne spot rate – the all-inclusive rate for shippers to pay – has seen much more stability but it is also abundantly clear that higher fuel costs are not, in most cases, being passed on from operators/owners to the shippers. The January 2020 average for the same Tubarao to Qingdao route has fallen just 8.3% since December 2019 and is almost 4% higher than the average in January 2019. Furthermore, a scrubber-installed Capesize ship sailing the same Brazil to China route and able to continue sailing on the cheaper high-sulphur fuel oil, averaged USD 17,541 per day in January 2020. That is USD 11,000 per day more than a non-scrubber fitted ship (Source: Clarksons).
Brazilian iron ore exports fell 10% in 2019, following huge disruption to Vale’s operations throughout the year, but in particular after the disastrous Brumadinho tailings dam collapse. Questions remain over its ability to ramp up and return to 2018 production levels. Rising production and exports from Vale – enough to require spot cargoes on top of the volumes being transported in the long-term charter market on very large ore carriers (VLOCs) and Valemaxes – would provide a much-needed boost to the shipping industry. However, the start of the new decade brought new problems for the company and other Brazilian iron ore firms when heavy rains disrupted inland transport of iron ore and damaged the mining infrastructure.
US soya bean exports in the first five months of this season, which began on 1 September 2019, are stronger than last year, up 5.5 million tonnes (+25.8%), but still 7.8 million tonnes lower than exports in the 2017/2018 season, before the trade war began.
Strong fourth-quarter US exports helped pull total Chinese imports into positive year-on-year growth, after being in negative territory for most of the year. Growth of 0.5% in 2019, however, has not been enough to make up for the losses of 2018, with Chinese demand 7.1 million tonnes lower than in 2017 – a drop of 94 Panamax loads (75,000 tonnes) – caused by the trade war and an outbreak of African swine fever that has decimated the Chinese pig herd.
Having been included in “Phase One” of the US-China agreement, US soya bean exports are expected to rise this year, although the sheer volume of commitments agreed by the Chinese casts doubt over the viability of the deal. The uncertainty that has dominated US soya bean sales to China since the start of the trade war means US farmers may be reluctant to commit to growing the much larger volumes the agreement calls for. Already in the current season, the acreage planted in the US is down 16% from the 2017/2018 season.
Furthermore, the African swine fever outbreak in China, which has led to the culling of livestock, has cut the country’s demand for soya beans, making it highly unlikely that consumption – or demand – will grow by as much as the commitments made in the deal.
After a 3.9% fleet expansion in 2019, BIMCO expects dry bulk fleet growth to slow to 3.1% in 2020. As this level of growth still exceeds demand growth, the market will also deteriorate in 2020.
Demolitions are expected to rise to 12 million deadweight tonnage (DWT) in 2020, up 4.2 million DWT from 2019. With expected deliveries of 39.3 million DWT, the dry bulk fleet is set to exceed 900 million DWT for the first time.
Demolitions this year are expected to include up to half of the VLOCs that were converted from very large crude carriers between 2007 and 2011. At the start of February, 33 of these ships were still sailing, but many of the long-term contracts on which they had been employed – transporting iron ore between Brazil and China – are now coming to an end. With the current market offering little incentive to keep ships of more than 20 years old sailing, many will be heading to the scrapyards.
Given the high volume of Valemax ships delivered in the past two years, totalling 12 million DWT, and a further three 400,000 DWT ships slated for completion this year, demolitions of older vessels will not result in a shortage of VLOCs.
China increased its imports of all its major commodities in 2019, but there is no guarantee this will continue in 2020. Chinese iron ore imports were down in the first 11 months of 2019, but record-breaking imports in December of 101.3 million tonnes, resulted in full-year growth of 0.5%. Total imports in 2019 were 6.5 million tonnes lower than the record-breaking 1,075 million tonnes in 2017.
China’s coal imports fell to 2.8 million tonnes in December, around a tenth of average monthly imports recorded during the rest of the year. The drop reduced overall year-on-year growth to 6.3%, down from 10.4% after 11 months. While the fall looks dramatic, it derives from delays in customs clearance rather than from volumes not being shipped. The coal will be cleared in the coming months. Because of the year-on-year growth, the Chinese government’s public goal not to increase coal imports in 2019 compared with 2018, has been missed. The dry bulk market continuously benefits from these steady, albeit shorthaul, imports.
Coal imports will continue to be heavily influenced by the government, but the effect of environmental policies will depend on how serious China is about implementing its commitments. The government has approved new coal power plants – in part as a form of stimulus for the slowing economy – despite its commitments under the Paris Agreement to peak greenhouse gas emissions as soon as possible.
Chinese dry bulk imports have faced severe disruptions as a result of the coronavirus outbreak. An extended holiday across the country has meant lower demand, as well as delays in ports. The ending of the Chinese Lunar New Year holiday usually sees a pick-up in demand. This year, depleted demand and low freight rates have persisted for much longer than usual.
Before the coronavirus outbreak, BIMCO estimated that demand for dry bulk shipping would grow by between 1.5% and 2.5% in 2020, compared with only 1.1% growth in 2019. The higher growth in 2020 is much needed to mitigate the increased costs associated with compliance to the 2020 sulphur cap. However, demand growth at the lower end of the range now looks more likely to be a best-case scenario following the outbreak. As fleet growth will be higher than even the best-case scenario for supply growth, the fundamental balance is expected to continue worsening in 2020.