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How an escalating trade war could play out for ocean shipping

Containers loading in Shanghai. Photo courtesy of Shutterstock.

Now that U.S. President Donald Trump has pulled the trigger – raising tariffs on $200 billion of Chinese goods from 10 percent to 25 percent and threatening more – how will this play out for ocean shipping rates?

It depends on the ship type. Some vessel categories are much more heavily exposed to China-U.S. trade than others, and the ultimate rate consequence will be driven by the change in ton-miles (volume times distance), not tons.

Disruptions and disputes that cause the same volume of cargo to travel further to alternate destinations, which some analysts describe as ‘open chokepoints,’ are a positive for ocean rates, because more ships are needed to carry the same volume on longer voyages. Disruptions that cause a decrease in cargo volume at sea and consequently lower ton-miles, or ‘closed chokepoints,’ are negative for ocean shipping rates.

Following is a sector-by-sector overview of potential shipping fallout, a mix of open and closed chokepoints, from the escalating trade war between the U.S. and China:

Dry bulk shipping

Dry bulk shipping has already felt the pain, and it’s likely to feel more of it. U.S. soybean sales to China have been heavily curtailed since mid-2018, with America’s outbound volumes both reduced and rerouted.

According to data from the U.S. Department of Agriculture, Europe was the largest destination for U.S. soybeans between October 2018 and February 2019, with volume up 124 percent year-on-year to 5.5 million metric tons (mmt). China dropped to second place, with volumes plunging 83 percent, to 3.9 mmt.

Volume to Mexico, now in third place, was up 37 percent, to 2.2 mmt. The fourth-largest destination was Argentina, where volumes rose to 1.8 mmt from almost nothing in the same period the year before. U.S. soybean exports to all destinations fell 31 percent, to 24.2 mmt.

These statistics are particularly ominous when viewed through the prism of ton-miles, because voyages are getting much shorter. The distance from the U.S. Gulf grain terminals to Mexico is minimal; the voyage to Europe is less than half the sailing distance to China; and Argentina is just over half the distance from the U.S. Gulf as China.

The caveat is that volumes to Argentina are actually good news for bulk shipping, due to market inefficiencies. The U.S. primarily competes in the global soybean export market with Brazil and Argentina, both of which are major producers. The only reason Argentina would buy U.S. soybeans is price arbitrage – to buy America’s beans cheap and take a profit on higher exports of its own.

U.S. volumes to Argentina are positive for shipping because after those volumes are delivered, they will almost certainly lead to incremental export volumes from Argentina – whether of soybeans or soymeal – to destinations such as India and China. A cargo volume that takes an inefficient roundabout path from the U.S. to Argentina to China travels 80 percent further than a direct cargo from the U.S. Gulf to China.

Another silver lining for ocean shipping is that U.S. soybean exports to Asia are being partially replaced by Brazilian exports. The Brazil-China voyage distance via the Cape of Good Hope is around 13 percent longer than U.S. Gulf-China voyage via the Panama Canal.

On the Genco Shipping & Trading (NYSE: GNK) conference call with analysts on May 9, chief executive officer John Wobensmith explained, “U.S. soybeans are what is being impacted [by the U.S.-China trade dispute]. Last year, there were very little exports of U.S. soybeans, but Brazil took up the slack. They went from selling 65 percent of their product for exports in a typical year to almost 90 percent last year.”

Despite positives for shipping in Brazil and Argentina, the consensus view is that downside outweighs the upside, and Chinese tariffs on U.S. soybeans are a net negative for rates. U.S agricultural exports are generally carried aboard Supramaxes (45,000-59,999 deadweight tons or DWT), Ultramaxes (60,000-64,999 DWT), or Panamaxes (65,000-90,000 DWT). U.S. grain terminals are not geared to accommodate vessels larger than Panamaxes.

Eagle Bulk (NASDAQ: EGLE) specializes in Supramaxes and Ultramaxes. On the company’s conference call with analysts on May 8, chief executive officer Gary Vogel noted that the Atlantic market for Supramaxes “typically performs quite well in the first quarter, driven in part by soybean and grain exports out of the U.S.”

“But this year, very little product has been moving due to the ongoing U.S.-China trade dispute and related tariffs, and also due to the swine-flu epidemic affecting China’s pig population [soy is used as animal feed]. All of this implies that there’s less seaborne demand for soybeans, and this has a direct impact on rates. The Atlantic BSI [Baltic Supramax Index] averaged $8,034 per day during the first quarter, down 47 percent quarter-on-quarter [compared to the fourth quarter of 2018],” said Vogel.

Container shipping

Ironically, the U.S.-trade dispute has had a short-term positive effect on container volumes at sea. The initial deadline for the just-triggered tariff increase had first been set for January 1, 2019. This precipitated a rush to beat that deadline, with importers pulling Chinese cargoes forward that they would have otherwise shipped later.

Global Port Tracker, a data platform produced for the National Retail Federation (NRF) by Hackett Associates, estimated that U.S. ports handled an all-time high 21.8 million twenty-foot equivalent units (TEU) of imports in full-year 2018, up 6.2 percent over 2017.

According to Henry Byers, maritime market expert at FreightWaves, “Last September, when these tariffs were announced, it basically created another peak season for U.S. importers. These importers said, ‘To hell with the contract rates, we just need to move into the spot market and get space however we can.’

“This caused rates to spike during a time when they should have been in decline, and a buildup in inventory that has lasted for months. Many think there are still goods sitting in warehouses today that should have moved around this time this year instead.”

The delay of the tariff deadline from January led to further year-over-year increases in the first quarter of 2019. NRF vice-president for supply chain Jonathan Gold commented that retailers appeared “to be bringing merchandise into the country early in case tariffs go up.”

Trump’s decision to finally go ahead with the tariff increase on May 10 did not leave enough time for further ‘deadline beating’ maneuvers for the $200 billion in goods that were covered.

However, Trump set in motion plans to implement a tariff on all remaining Chinese imports, valued at around $300 billion. Consequently, U.S. importers are likely to seek to get as many boxes of potentially affected products onto the water as soon as possible, which could cause May volumes and freight rates to spike.

“The same thing is happening all over again and U.S. importers are trying to get their goods into the country before any additional escalation,” asserted Byers. “They have no choice because any tariffs beyond what are already announced would be critical to their bottom line.”

“I expect ocean carriers will try to capture everything they can in the spot market as rates are sure to increase and they will likely ‘blank’ a few sailings just to make sure capacity is extra tight,” Byers added.

LPG tankers

U.S. liquefied petroleum gas (LPG) export volume is primarily comprised of propane and butane; in the case of Chinese imports, it is primarily propane, about half of which goes to heating and the other half to propane dehydrogenation plants for the creation of propylene, which is used to manufacture plastics.

LPG is generally shipped to Asia from either the U.S. Gulf or the Middle East aboard very large gas carriers (VLGCs), which have capacity of around 84,000 cubic meters.

China imposed a 25 percent tariff on U.S. propane in August 2018. This has not had a negative ton-mile impact on VLGC demand because the cargoes that would have gone to China are still going to Asia – to buyers led by Japan and South Korea.

The key indicator to watch is VLGC transits through the larger ‘Neopanamax’ locks of the Panama Canal. With very few exceptions, VLGCs could not fit in the original locks. When the new locks opened in June 2016, almost all of the VLGCs carrying liquefied propane from the U.S. Gulf to Asia switched from the longer eastward route around the Cape of Good Hope to the westward Neopanamax locks route, which is about 40 percent shorter.

Data from the Panama Canal Authority (ACP) confirms that VLGC transits have not declined since the imposition of the Chinese tariff, which implies that the LPG shipping sector’s ton-mile equation has not been curbed.

José Ramón Arango, liquid bulk specialist at the ACP, told FreightWaves, “Increased LPG imports to Japan and [South] Korea offset the imports to China, and there was basically no effect in terms of [canal] traffic.”

Data from the Energy Information Administration shows that U.S. propane exports increased 6 percent on a global basis in 2018 compared to 2017, despite the Chinese tariff.

Ongoing trade tensions between China and the U.S. can be viewed as an opportunity cost for LPG shipping, more so than a downside risk. While VLGCs are finding other Asian destinations for their cargoes, resumed flows to China would increase demand and buoy rates.

LNG tankers

Given that China is the world’s largest buyer of LNG, trade tensions are widely viewed within LNG circles as a negative.

Multiple U.S. LNG liquefaction (export) projects are now under development. To reach a final investment decision (FID), many of these projects require long-term cargo purchase contracts to enable financing. China’s very limited presence in the U.S. contract market is delaying the timing of U.S. LNG export project FIDs.

The pace of these FIDs is important to shipping because an LNG liquefaction project developer reaching FID usually secures shipping capacity under multi-year employment contracts to move its cargoes. These long-term charters are often used to support funding for newbuildings. The more FIDs, the higher the capacity in the LNG shipping market.

In terms of cargo volume, direct purchasing of U.S. LNG by China has been relatively minimal to date, and U.S. export volumes have continued to surge despite trade tensions.

U.S. LNG export volumes rose 53 percent last year and are expected to rapidly increase in the coming months and years as LNG export facilities that had previously reached FID come onstream, regardless of the outcome of the trade dispute.

Oil tankers

U.S. crude oil had not been targeted with a Chinese tariff as of May 11, but trade tensions have definitely affected the tanker sector. Chinese buyers retreated from U.S. crude purchases last year, and have been almost completely absent from the market since July 2018.

Nevertheless, total U.S. crude exports have continued to hit new peaks, reaching 3 million barrels per day in February 2019, up from 2 million to 2.2 million barrels per day in May-July 2018, when China was a major buyer. Estimated seaborne U.S. crude exports (excluding exports to Canada, which are largely transported over land) have also grown substantially despite China’s withdrawal.

U.S. crude exports to Asia are carried aboard very large crude carriers (VLCCs), which have a capacity of around 300,000 DWT, whereas crude shipped to Atlantic Basin destinations including Europe are largely carried aboard smaller Aframaxes (80,000-119,999 DWT).

China’s pullback has caused the tanker mix for U.S. crude exports to change. There has been some increased buying in Asia that is replacing China-bound VLCC cargoes – to India, South Korea, Singapore and Taiwan – but overall, the destination pendulum has swung more towards Europe, meaning that Aframaxes have benefitted at the expense of VLCCs.

If the U.S. and China resolve their trade disputes and China resumes U.S. crude purchases, it would be a boon for VLCCs, and potentially negative for Aframaxes. The longer trade tensions drag on, the worse for VLCCs.

Greg Miller

Greg Miller covers maritime for FreightWaves and American Shipper. After graduating Cornell University, he fled upstate New York's harsh winters for the island of St. Thomas, where he rose to editor-in-chief of the Virgin Islands Business Journal. In the aftermath of Hurricane Marilyn, he moved to New York City, where he served as senior editor of Cruise Industry News. He then spent 15 years at the shipping magazine Fairplay in various senior roles, including managing editor. He currently resides in Manhattan with his wife and two Shih Tzus.