April 19, 2012

Giant ships- Too big to sail?

The biggest producer of iron ore in the world- that controls a quarter of the seaborne trade in iron ore all on  its own- can afford to ride through economic and operational problems in connection with its massive Valemax (Chinamax, when other owners buy) ships and survive. However, my guess is that the giant's difficulties will have a downstream effect that will kill off quite a few pygmies and bring some other carriers to the verge of bankruptcy.

Last week, Bloomberg reported that Vale has idled two of its 400,000-ton vessels- Vale China and Vale Brazil- at Subic Bay in the Philippines after they completed discharging ore. Vale declined to comment, but it is no secret that the carrier is suffering from the combined effect of the economic downturn, a drop in Chinese demand, structural issues with one of its ships (Vale Beijing's ballast tanks cracked while loading its first cargo) and developments in China that have ended in a ban on the entry of Chinamax vessels into that country, and Vale having to now tranship ore in the Philippines. This compulsion has undoubtedly hit the company's transportation costs, which were slated to drop by twenty-five percent or so post Valemax entry.  

After its original business model took a hit thanks to the ban, Vale modified its strategy somewhat. Committed to spending $8 billion on 35 of these vessels- eight of which have been delivered so far- to push economies of scale on ore carriage between Brazil and China, Vale ran into a brick wall after the Chinese development. Although environmental concerns were cited as the reason for the ban, it is an open secret that a fear that Vale would control the ore freight market prompted the move. A little less than half of Vale's ore business is with China; consequently, Brazil’s first-quarter ore exports have plunged 27 percent after the ban was enforced. 

Rumours say that Vale wants to sell or lease its Valemaxes to Chinese shipping companies long-term to circumvent the ban. Meanwhile and unsurprisingly, it is now reported that Vale is delaying the delivery of two Valemaxes that are being built at China's Rongsheng yard. Even so, Chinamaxes will clean up- as a sponge- long haul routes if all new build orders finally fructify. Giant ships have giant issues when their business models run into trouble. With daily operating costs for Chinamaxes running between 35 and 40 thousand dollars- fuel and loan repayments included- shipowners who have these ships on order must be getting the jitters today.

Vale's stated objective is to hammer down transportation costs; unstated is the desire to have a near monopoly on the iron ore trade, from production to the supply chain running all the way to Asia, allowing it to compete robustly with Australia that has the advantage of being geographically closer to China. Vale has made a statement that it sees a hundred Valemaxes out at sea in future; whether this is bravado or a case of a conglomerate ready to sink billions to control freight rates and kill the competition is anybody's guess.

In addition to Vale's own order book, Chinese and South Korean yards are believed to have contracts for building approximately twenty more Chinamaxes for other shipowners. These are to be chartered to Vale long term. Unless things are slowed down, almost three dozen Valemaxes/Chinamaxes will be out there by the end of next year. What cargo will they carry? Will the demand projections of approximately 100 million metric tons a year of new iron ore hold? Will there be too many Chinamaxes on offer in a market that may shrink? 

Even before the Chinese port ban, Vale's decision to build or promote so many of these giant bulk carriers was received with dismay by many. Some of the fears have come true already; although it is difficult to gauge by how much, the Valemax entry has certainly driven down freight rates (that are down 80% since 2008). Gloomier long-term predictions say rates will eventually be hammered down to 1977 levels once the full Chinamax order book is delivered. BIMCO's CEO reportedly went on record to say that the Valemax ships could 'displace' up to 168 Capesize bulk carriers- around 15 % of the fleet- from long haul voyages. Vale is not a traditional ship operator, but it can kill off many who are. There is never free or fair competition when a giant is involved; there is only dominance and the big squeeze.

The same fate that has befallen, even if temporarily, Chinamaxes may befall other trades where giant ships are being built. This is because the philosophy that drives economies of scale also exposes shipowners to greater risks during a downturn- when cargo volumes shrink and draft and other operational restrictions mean that alternative options are limited. The giant containerships on order by Maersk and other biggies, for example, may well suffer similar- almost ignominious-fortunes in future. In any case, the entry of giant vessels of any kind, usually owned by monopolistic companies in sometimes-cartelised industry segments, will tend to drive many traditional shipowners out of business; they simply cannot compete if they cannot match Vale's deep pockets.

 That, coupled with the rising trend of bankers calling the shots in the maritime industry, means that we may be looking at a future where massive ships are being run by accountants or commodity companies who have little idea about what ship owning and ship operations actually involves. 

Synchronised with falling officer standards, the poor calibre of fresh blood in the industry, often chronically fatigued crews and a poorly regulated industry will mean that navigational, operational and environmental safety will become a much bigger interrogation point than it is today.  I foresee that more and more nations will start questioning officer quality after each (almost inevitable) environmental incident. More regulation will be rolled out, putting greater financial burden on shipowners. The costs for cheap, substandard and short manned crews- and giant ships chasing the economies of scale dream- will be paid by the shipowner- albeit under a different accounting head.

If all this happens in bad economic times like those seen today- amidst falling rates, tonnage overcapacity and a global meltdown that has a way to go before it expels its last sigh- the industry may well find that the idea of giants ships is just a little bit too risky. Some shipowners may well reach the conclusion that some of these ships are actually too big to sail profitably, and that the gamble is not worth the reward. 

Postscript, April 22: Three days after publication of this piece, agency reports say, " Vale has refused to take delivery on three completed very large ore carriers (VLOCs) it ordered from China Rongsheng Heavy Industrial Group Holdings Ltd, the country's second largest shipbuilder.

Vale has refused to take over the carriers partly because it wants to prompt the Chinese government to allow the vessels to dock at Chinese ports. Also, the move will delay payment and put pressure on Chinese shipbuilders to reduce their prices, according to marine industry experts".

All kinds of stuff comes out of the woodwork when one isn't making money- or as much of it as forecast.



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