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What drives the shipping industry?

Dec 14, 2000

The shipping sector is back in the limelight. After the slump triggered by the South East Asian crisis, prospects are seemingly looking better. Worldwide, shipping stocks have appreciated sharply over the past six months. To understand what is driving this euphoria, we make an attempt to highlight the key factors that influence the shipping industry.Freight rates are a function of demand/supply…
As in any other industry, the key factors that determine prospects of shipping industry are demand and supply. By demand, we mean, demand for tonnage to transport goods like iron ore, coking coal and crude oil. Supply refers to the aggregate tonnage available for shipment of these commodities.

The level of industrial activity drives the shipping sector, as industrial raw materials account for a large part of the total tonnage. While capesize (780,000 dead weight tonnage (dwt)) vessels are used to transport iron ore and coal, panamax (50,000-80,000 dwt) vessels are used in transportation of coal and grains. So, if demand for these commodities moves up, the demand for tonnage to transport these commodities also rises. This benefits shipping companies in terms of higher freight rates. If demand for tonnage is more and there is short supply of tonnage, as there is now, freight rates tend to move up sharply.

Now, let us consider the supply side. When markets are on the uptrend, shipping companies tend to order more tonnage to capitalise on buoyant freight rates. If there are indications of an excessive order backlog, freight rates come under pressure. However in the current year, stiffening environmental norms by European Union have resulted in large scale scrapping of old tonnage. This has also contributed to higher freight rates.

World output growth influences demand…
International Monetary Fund (IMF) expects the world economy to grow by 3.9% in FY01. Besides, world trade growth is also expected to grow 4% during the same period (2.5% in FY00). So, how does this relate to prospects of shipping industry? The key economies that influence world trade and in turn freight rates are USA, Japan and Germany. Higher growth in gross domestic product would require incremental resources like crude, iron ore and coal. This would lead to higher world trade growth. However, developing economies like South East Asian countries and South Asian economies cannot be ruled out, as these regions collectively account for more than 50% of world sea-borne trade.

For instance, in FY98, slow recovery in manufacturing sector (especially in South East Asian countries) resulted in subdued world demand for most of commodities like iron ore, and coal. Hard hit by the currency crisis, production slumped in this part of the world. The sharp slowdown in GDP growth resulted in contraction in trade volumes. This led to lower goods movement, which in turn led to a sharp drop in freight rates. The average time charter rates for capesize came down from US$ 11,000 to US$ 6,500. As a result, BFI also touched its decade low level of 800 points in mid FY99.

Crude–the top of the lot…
Historically, crude transportation as a percentage of cumulative sea-borne trade has been hovering around 30% with product transportation (petrol, diesel and naphtha) accounting for 9%. Any fluctuation in transportation of these commodities would have a direct impact on the shipping sector. This is because crude and related products are the basic raw materials for key sectors like automobile and power.

Another key factor that influences tanker rates is the increase in crude output by the OPEC (Organisation of Petroleum Exporting Countries). When the OPEC increases crude output, tanker markets gains momentum. In the current year, higher crude output by the OPEC coupled with low reserves in US have resulted in higher freight rates. Besides, tanker rates have a direct co-relation with crude prices, as they tend to move up when crude prices are high and vice versa. In FY99, when crude prices touched US$ 10 per barrel, tanker rates also dropped significantly.

Outlook is positive…
As per the World Bank’s estimate, world trade is expected to grow strongly in FY01 and FY02. If industrial activity were to rise worldwide, demand for crude and crude related products could go up in the future. This holds true especially for Asian economies like India, Malaysia and Thailand that are highly import dependent for crude. Since these countries are among the fastest growing economies, per capita consumption of crude and related products is more likely to increase along with recovering industrial activities. Besides, this would also mean higher demand for goods like iron ore and coal.

Since sea borne trade is on the uptrend, rates are likely to hold steady. This is based on the fact that World Bank expects sea-borne trade to double within next 15 years. Though there are apprehensions about high oil costs, International Monetary Fund does not expect this to have a major impact on world trade. Nevertheless, with a world order book in excess of 15% of existing fleet, there is fear of excessive supply. Therefore, freight rates are expected to come under pressure in the later half of FY01.

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