Concerns about economic data would suggest the sector shouldn't be prospering
Thursday 05 Sep 2019 Author: Russ Mould

There are probably many investors who, late at night, gently doze off while listening to the shipping forecasts on BBC Radio as the announcer gently runs through Viking, North Utsire, South Utsire, Forties and the 31 sea areas that define the waters around the British Isles.

But the news that the broadcast imparts is potentially life-saving and, looking at it through the narrow prism of investment and financial markets, shipping is anything but boring right now.

Given all of the concern over tariffs, trade and a global slowdown, it would be reasonable of investors to expect the shipping industry to be in turmoil.

Yet the Baltic Dry index stands at a five-year high. The benchmark measures the cost of shipping raw materials such as coal, steel, metallic ores and grains across three classes of vessel on 20 different shipping routes, which link Asia, Latin America, Africa, Australasia and Europe.

This advance is pulling shipping stocks along its wake, using the US-quoted Breakwave Dry Bulk Shipping exchange-traded fund as an industry proxy.

This has wider implications beyond shipping stocks. Given the nature of the goods involved, and the inability of financial markets and traders to influence it, the Baltic Dry index can been seen as a proxy for global economic activity.

And while the past is no guarantee for the future, the experiences of the last 25 years suggest the health of the Baltic Dry index can provide some steer on the fate of global stock markets, which are ultimately also sensitive to global economic activity.

Scrubbing up

There are three possible explanations as to why the Baltic Dry index is sailing higher when financial markets are becoming concerned about ever-more mixed economic data from the West.

The first is that the global economy could be doing better than many think. This contradicts the softness seen in many indicators, and weak trade flow data, but it must not be dismissed out of hand.

The second is that an acceleration in Brazilian iron ore exports (which were hit by a terrible accident in January at Vale’s Brucutu mine) is stoking fresh demand for dry bulk carriers. But this does not account for how rates for Very Large Crude Carriers (VLCCs) and container shipping rates look to be firming, too.

The third is that a wider shipping trend is at work and the biggest one seems to be the imposition from 1 January 2020 of tougher emission rules by the International Maritime Organisation (IMO). They state that all ships must use fuel that has less than 0.5% sulphur (rather than 3.5% now) or fit exhaust gas cleaning systems (‘scrubbers’).

Fitting scrubbers will take time and temporarily remove fleet capacity while, in the longer term, the higher-cost low-sulphur fuel could make it uneconomic to run older vessels that have not been retrofitted and persuade owners to scrap them, permanently reducing capacity – or so the theory goes.

The problem is that the scrubbers will make the ships heavier, so they consume more fuel, and they can mean that the sulphur simply ends up the sea rather than the air.

Singapore, California and Belgium are already insisting on the use of cleaner fuel rather than scrubbers and this may help to explain why the share prices of leading exhaust gas system suppliers like Finland’s Valmet and Wärtsilä are sliding and not soaring, despite the apparent retrofit bonanza that lies ahead.

Waving or drowning?

One further test is to see what the real shipping industry shrewdies are doing, namely the owners.

Intriguingly, the year began with a rash of share buybacks from US-listed firms such as Golden Ocean, Diana Shipping and Star Bulk, at a discount to net asset value, while in August US-listed shipping firm Frontline bought 10 vessels from commodities trader Trafigura for $675m.

This suggests that ship owners think their stocks are cheap and better times lie ahead. But investors might do well to keep an eye on the shipping sector, through UK-listed shipbrokers such as Clarkson (CKN) and Braemar (BMS) or US-quoted shipping ETFs such as Invesco Shipping and Breakwave Dry Bulk Shipping.

If they start sinking again, then the global economy could indeed be in trouble. But the IMO 2020 rules might just mean the owners of young, well-equipped fleets could be primed to clean up as older, dirtier vessels are put out of business, especially if the economy holds up better than expected.

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