Barrier to expansion
Analyst: Containership fleet unlikely to expand greatly due to lack of financing for small lines, non-operating owners.
By Eric Johnson
It may not be a newfound discipline within the liner carrier community that keeps the industry from ordering too much capacity in the coming months.
More likely is that new orders will be difficult to make due to barriers in the securing of financing, especially for non-operating owners, according to Thomas Kim, executive director of Asia investment research for Goldman Sachs.
'Our view is that we won't see orders in the next two years,' Kim said in October at the Journal of Commerce-organized TPM Asia conference in Shenzhen. 'It's not because carriers will be more disciplined. It's because there's no money, honey.'
He said non-operating owners will have less access to financing, as will operators with tenuous balance sheets. He said if the London Interbank Offered Rate (LIBOR) wasn't so low, a number of charterers and small carriers would have gone under by now.
'Some operators will have access to capital, but the vast majority will not,' Kim said.
He added the German KG houses that traditionally financed roughly one-third of the global containership fleet are likely to go away soon, scalded badly by the downturn in 2008 and 2009.
'Commercial banks can't sell their risk on the syndicate market and investors in KG houses were burned,' he said.
Only two major carriers, APL and Evergreen, have placed orders for vessels so far this year after none were placed in 2009.
'Most ship financing is allocated to existing orders, but I don't know that for sure because it happens behind closed doors,' he said. 'But ship orders are not growing.'
Yet Kim is bullish that the recovery of container lines' profitability this year is sustainable.
'The order book today is 28 percent of the current fleet, down from 60 percent in 2005,' Kim said. 'I'm optimistic the industry will improve its discipline. I think we'll see incrementally better discipline by carriers.'
He said it would take about 30 months for projected supply growth to be soaked up, based on a simple formula: with an order book of 25 percent (28 percent new orders minus 3 percent of the existing fleet being scrapped) and two-year forecast demand growth of 10.2 percent, that 25 percent of new capacity will be swallowed up in two-and-a-half years.
And he said the situation could be tilted even more in favor of carriers than that formula suggests.
'Supply growth might only go up by 6 percent compared to 10 percent demand growth,' he said. 'That means (ocean freight) rates are going up, and going up by a lot. The industry has something working in its favor, because supply growth is going to be constrained' by financing.
Kim also downplayed the role that new, already ordered capacity will have on the market.
'Carriers have had five years to think about how they'll deploy their capacity,' he said. 'For shippers to think 'all this capacity is coming online, so rates will come down,' it's probably premature. I'm giving the benefit of the doubt to carriers, but if carriers price themselves too low, shame on them.'
At the conference, Kim was asked whether Chinese banks could step into the breach and provide the ship financing that European banks are increasingly wary of providing.
'Today, two-thirds of ship financing demand is from Europe, but Chinese banks are stepping up to help out,' he said. 'But they are only providing a fraction of the global shipping finance that's required.'
APL President Eng Aik Meng added that 'Chinese financing comes with strings tied. Financing is tied to ships being built in Chinese shipyards. Also, if (China's currency, the RMB) appreciates, the cost of that financing is much higher over a 25-year period.'
Eng agreed with Kim that financing barriers will limit the expansion of the global container fleet.
'The cost to build vessels for one loop to Europe is $1 billion (10 vessels at a roughly $100 million each), and that's not even counting the costs of terminal investment,' Eng said. 'This industry doesn't really allow a return on investment for its shareholders that is at least commensurate with risk. There's a huge amount of cash flow required. In the KG system, you had some ships being built with no equity. Now that that is gone, the ego of ship owners will be kept in check, and that puts a restriction on how much capacity can grow.'
Kim said that as ship financing moves from Europe to Asia, 'the consolidation of Asia as the true center of shipping will be complete.' He also pointed out how emerging regions of the world ' namely Latin America, Africa and the Middle East ' are growing in importance to shipping lines.
'Latin America and Africa, taken together, are more important than North America,' he said. 'Truly global lines know this is where growth really lies. The largest ports won't just be in Asia, but also near resource-rich markets. The challenge is serving these lanes profitably. There would already be more development in Africa if not for the geopolitical risk.'
Finally, Kim said the carrier industry can't ignore the impact of voyage lengths on its business.
'Lengthening trips are reducing the number of turns,' he said, adding that the fewer times a carrier can turn a vessel, the fewer times it can charge shippers for its services. 'Carriers must price properly. If there are less turns and each turn is not priced properly, they could lose huge amounts.'