Asset Risk Assessment, Analysis and Forecasting in Asset Backed Finance
2.2 Global Demand and China: Cyclicality, Super Cycles, Sector Cycles and Counter-Cyclicality
2.2.2 Cyclicality and Variables Affecting Cyclicality
A Political Variable in a Commercial Industry
In cyclical markets, such as the shipping and off shore industries, understand- ing the overall cyclicality, the respective sector and subsector cyclicality, and
0 20 40 60 80 100 120 140 160
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2002
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No. of Yards Start Up in Each Year
Government’s policies play an important role in the development of Chinese shipbuilding industry since the government regards shipbuilding industry to be critical to national security.
The National Medium-and Long-Term Plan of the Ship building Industry (2006-2015)
• By 2010, output to reach 17mdwt and capacity will reach 23mdwt
• By 2015, output will reach 22mdwt and capacity will reach 28mdwt
Stimulus and Adjustment Plan for Shipbuilding Industry
• Annual shipbuilding output to reaches 50m dwt in 2011 and global market share to increase to 35%
• Optimize product mix of Chinese yards
• Control new shipbuilding capacity
Implementation Scheme for Accelerating and Structural Adjustment and Promoting the Transformation and Upgrading of the Shipbuilding Industry (2013-2015)
• Extends the support for scrapping old tonnage to the end of 2015
• Urges credit support for shipbuilders, studies the potential of securitization of shipbuilders’ loans
• No authorization from local governments to approve any new capacity. Close down unauthorized projects.
Fig. 2.1 Timeline of shipbuilding related policy in China ( Source : DVB Shipping Research, Clarksons)
the associated risks and implementation of these in forecasting scenarios is critical. Understanding the history and identifying changes and shocks (expected and non-expected, on a scenario basis) in the industry, as well as in the respective sectors and subsectors, is what enables a good analyst to prepare reliable forecasts for both earnings and asset values, as well as to identify risks in the respective sectors and subsectors.
As can be seen in Fig. 2.2 , a “normal” shipping cycle is characterized by developments across the cycle, starting from a low level of newbuild- ing prices causing massive ordering of new tonnage which eventually, upon delivery, results in excess vessel capacity. With a demand–supply imbalance, with supply growing faster than demand, this leads to a downward pressure on freight rates, which again results in a slowdown in newbuilding orders and an increase in scrapping of old tonnage. Th is, in turn, brings about an improved demand–supply balance, driven by a slowdown in supply growth.
As a consequence, a recovery in freight rates occurs, which again induces increases in demand for newbuildings, subsequently increasing investment in shipyard capacity, thus putting downward pressure on newbuilding prices.
When orders resume, an upward pressure on newbuilding prices follows. In this way, the cyclicality is commercially held in check. However, due to the fact that shipyard capacity has always been a politically dominated variable in the equation, which has been true for all major shipbuilding countries including Japan, Korea and China, this has led to a market that has not stabilized newbuilding prices according to a commercial demand–supply balance.
So why, for commercial shipyards, has a capacity-demand equilibrium not materialized over time? Why are we further from an equilibrium than ever before, and what are the consequences? During the last decade, global shipbuilding output has experienced a super cycle with total output increas-
Ship prices drop
cycle
Excess of shipbuilding capacity
Yards reopened or new yards created
Demand for newbuildings increases
Demand for newbuildings drops Freight rates recover
Freight rates drop Over tonnaging Over ordering by specu- lators / bargain hunters
Fleets shrink Demolion
increases
Fig. 2.2 Shipping market cycle ( Source : DVB Shipping and Offshore Research)
ing from only 18.3 million compensated gross tonnage (CGT) in 2001 to the historical peak of 52.6 million CGT in 2010, representing a compound annual growth rate (CAGR) of 12.5% over this period. 1 When going back even further in the history of global shipbuilding capacity, a signifi cant build-up of shipyard capacity is evident, which has been driven by the development of three major shipbuilding countries from the 1970s until today, following the
“fl ying geese paradigm” that was part of the economic development of East Asian countries, as described by Kaname Akamatsu. 2
With the surge of the Japanese economy in the 1970s, the center of the global shipbuilding industry started to move east to Japan, where in 1975 it accounted for 52% of total global shipbuilding production (Fig. 2.3 ). As one of the “Four Asian Tigers”, South Korea started to emerge as a fast growing economy in the 1980s and, following the path of the Japanese shipbuilding industry, South Korean yards continued increasing their market share which accounted for almost 30% of the global shipbuilding output by the beginning of 2000. Since then, the center of the global shipbuilding industry shifted again and continued to move westbound to China, which followed up the growth model of the East Asian economies, with its market share of the global shipbuilding industry increasing from only 7% in 2000 to approximately 38% in 2013, thereby reaching its political ambition as per its then fi ve-year plan of becoming the world’s largest shipbuilding nation.
South Korea 2%
Korea(LHS) China(RHS) Japan (RHS) China
1%
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0 0
10 20 30 40 50 60 2013
2000 1975
Second Wave
Third Wave
South Korea 36%
South Korea 41%
Japan 20%
Japan 43%
Japan 52%
Others 45%
Others 6%
Others 7%
China 38%
China 9%
First Wave
No. of Shipyards Strang to Delivery First Ship Market Share of Major Shipbuilding Countries
1950 1952 1954 1956 1958 1960 1962 1964 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012
Fig. 2.3 Shipbuilding countries market share and shipyard start-ups by major shipbuilding country ( Source : DVB Shipping and Offshore Research)
As can be seen in Fig. 2.4 , Chinese shipbuilding capacity has experienced the strongest growth over the last decade—during the peak in 2008, more than 50 Chinese yards started to deliver their fi rst vessel. Th e trend after 2008 has been a decline in the opening of new shipyards and, in 2013, less than 20 delivered their fi rst vessel.
However, market conditions in 2015 put signifi cant and increasing pressure on Chinese yards, especially small, privately owned ones. Th e initiated decrease in Chinese shipbuilding capacity is expected to continue, although at a mod- est pace and not suffi ciently to lead to a commercially viable supply–demand balance in global shipbuilding capacity. Th is is due to the government’s poli- cies playing an important role in the development of its shipbuilding indus- try, since the government considers the industry to be critical to national security. First of all, the booming shipping market before 2008 was the main driver for the industry. Policies from the central government also boosted the surge. In the meantime, local governments were motivated to encourage new shipbuilding capacity (some even contrary to guidance from the central government) in order to take advantage of the tax-sharing system. Besides overcapacity concerns, and as a result of overcapacity and, consequently, the lack of a suffi cient order book coverage, the industry is experiencing serious liquidity constraints. Th is is due to the lack of down payments for new orders placed and a lack of shipyard utilization, amongst other things. In order to protect its strong ambition to maintain and protect China’s long-term market share within the global shipbuilding and off shore industry, the government is channeling new orders toward its state owned shipyards and encouraging consolidation. In the meantime, CEXIM (Chinese Export Import Bank) also supports orders at domestic shipyards by providing loans to foreign owners.
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Mn CGT
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Nominal Capacity - China Nominal Capacity - South Korea Nominal Capacity - Japan Delivery
1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 (f) 2016 (f) 2018 (f)
Fig. 2.4 Shipbuilding capacity ( Source : DVB Shipping and Offshore Research)
Policy Bank Supports Shipowners Ordering in State Owned Shipyards
Date
USD (millions)
Shipyard/
group Comments
May 2013 146 CSSC CEXIM provides Angelicoussis Group with secured loan facility for three VLCCs May 2013 30 CSSC CEXIM provides Diana Shipping with loan
for two bulkers
May 2013 CEXIM signed strategic cooperation with Dynagas to build LNG carriers in China Aug 2013 312 Shanghai
Waigaoqiao/
CSSC
CEXIM supports CSSC to move into VLCS market by providing fi nance to three 16,000 TEU containers, to be chartered out to CMA CGM
Note : CSSC China State Shipbuilding Corporation, CMA CGM Compagnie Maritime d’Affrètement Compagnie Générale Maritime
Th e government has published a “white list” of 51 shipyards which “qual- ify” for further policy support, such as export tax rebates and bank credit. 3 Th e shipyards benefi ting the most from the government’s visible supportive hand are the state owned ones; this is to fulfi ll the government’s ambition to secure their survival and to support consolidation in the industry. It is also important to note that these 51 yards account for the majority of the Chinese shipbuilding capacity, which is expected to continue as it is.
Korea’s “Big Th ree” (i.e. Hyundai Heavy Industries, Samsung Heavy Industries and Daewoo) historically have grown to today’s leading positions with strong support from the Korean government, and are now considered guarded from closure in the short to medium term. Th is is because their respective order books are dominated by high value off shore units, container- ships and gas carriers. However, other medium-sized Korean yards also face deleveraging pressure, mainly due to their order book focus on conventional merchant ships, such as bulkers and tankers.
Japan’s shipbuilding capacity is not expected to see signifi cant reduction due to its relatively good capacity management. Japanese yards are also benefi ting from “Abenomics” 4 (i.e. the yen’s depreciation and a wave of new orders from non-domestic owners). 5 Except for bulk carriers, which are mainly from domes- tic orders, the product mix of Japanese yards focuses on LNG carriers, chemical tankers and LPG carriers, which require technical “know-how” to build.
All in all, this big, global, idle, “hidden” shipyard capacity is not expected to disappear completely, will continuously put pressure on newbuilding prices and may have a “fl ooding” risk to the shipping markets (i.e. it is important to consider the substitution risk amongst shipping and off shore sectors).
Th is fl ooding eff ect is not expected to have the same impact on all ship- ping sectors. In Fig. 2.5 , the historical variation in lead time by ship types
is illustrated. Th e fi gure shows the diff erence in lead time from year to year, with “lead time” defi ned as the time between the contracting date and the delivery date (i.e. the order book period coverage). With small annual changes in lead time, the shipbuilding market is supply driven (i.e. there is plenty of shipbuilding capacity to satisfy the demand when it picks up).
With big changes in lead time, shipbuilding capacity for a specifi c segment is scarcer. Bulk carriers, containerships and crude oil tankers are vulnerable to this fl ooding eff ect, as Fig. 2.5 shows, as lead time responds less to con- tracting. Th is is due to the supply of these slots, which is overwhelmingly larger than demand. Chemical tankers and LPG carriers remain relatively immune to the limited number of slots available; as the graph shows, lead time responds more to contracting activities, because building these types of vessels requires specifi c experience, which is only available to certain ship- yards. Hence, the supply is a constraint. Th e building capacity of LNG car- riers is ample (dominant by Korean yards), which means that the supply side can easily be adjusted according to demand. However, we still expect a cap in available LNG carrier slots as yards will need to balance between other high value added ship types. Th is means that chemical tankers and LPG car- riers are relatively better protected by excess yard capacity. However, under the current situation with excess liquidity and excess shipyard capacity, no sector is safe forever. Once a certain sector becomes a “buzzword” for the market, it is inevitable that an over-ordering in this sector will be seen—as shipyards move up the value chain, the fl ooding eff ect will make a stronger impact, including on the more lucrative segments.
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Bulk Carrier Containership Crude Oil Tanker Chemical Tanker LPG Carrier LNG Carrier
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2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
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2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Fig. 2.5 Flooding effect across segments ( Source : DVB Bank Shipping and Offshore Research)
So, what about off shore? Has off shore been relatively safe from this fl ood- ing eff ect? Th e answer here does not seem to be very optimistic either. China has been moving up the value chain by securing an increasing market share of the more lucrative orders in the off shore industry during high markets, up to the second half of 2014, thereby allowing some relief of the pressure to secure orders in shipping sectors. As can be seen in Fig. 2.6 , China has already started to enter the off shore shipbuilding market, initially from the lower end of the value chain (i.e. anchor handling tug supply vessels (AHTs) and platform supply vessels (PSVs)). With yards speeding up their learning curves, Chinese yards have also started to take market shares in building jack- ups and semi-subs from Singaporean and Korean yards—they have moved up the value chain. Also, part of their current fi ve-year plan includes shipbuilding as one of nine core industries, which now targets quality, as discussed above.
Th e drillship market is still dominated by the Korean yards, though Chinese yards have also started entering the construction market, as shown in Fig. 2.6 .
As can be seen in Fig. 2.7 , global excess shipyard capacity is putting signifi - cant pressure on lead time. Th e average time to delivery at the time when the order was contracted has decreased across segments from the good times up to 2008, when shipowners had to wait up to 50 months to get their vessels delivered. Today, delivery in most segments can take place within 24 months.
During the boom period (2004–08), the utilization rate of Chinese ship- yards had increased from about 75% in 2004 to 85% in 2010 with the stron- gest growth in the period 2004–2008, as illustrated in Fig. 2.8 . Th is shows that Chinese shipyards were trying their best to deliver the ship as soon as possible and, due to the tight production arrangements, lead time inevitably increased. However, the utilization rate has signifi cantly reduced: to 75% in 2013. Th is shows that yards have (intentionally or unintentionally, which usually comes from the request of shipowners to postpone delivery) slowed down their production processes. On one hand, it is good for shipyards to keep their production line running, since, once it stops, it is very diffi cult
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Fig. 2.6 China gaining market share with more lucrative orders ( Source : DVB Bank Shipping and Offshore Research)
to restart. On the other hand, this causes a vicious cycle of overcapacity and further dampens the yards’ cash fl ow.
During this process, small privately owned Chinese shipyards are expected to suff er the most, with almost 75% of their capacity likely to disappear.
Together with other types of Chinese yards, it can be argued that approxi- mately 25% of the total nominal Chinese shipbuilding capacity is expected to disappear from 2014 to 2016. Another 10% of total nominal capacity is expected to face tremendous pressure, and its survival will depend on market conditions and the government’s policies. As a result, total nominal Chinese shipbuilding capacity is expected to reduce to close to the level seen in 2010
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50 50 Containership Contracng Ave. Months to Delivery
Ave. Months to Delivery Crude Tanker
Products Tanker Bulk Carrier Contracng
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Ave. Months to Delivery
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Fig. 2.7 Average time to delivery at contracting time ( Source : DVB Bank Shipping and Offshore Research)
100% Historical Nominal Capacity Actual Delivery Ulisaon Rate (LHS) Esmated Nominal Capacity Esmated Actual Capacity 90%
80%
70%
60%
50% 0
5 10 15 20 mn CGT30
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2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 (f) 2014 (f) 2015 (f) 2016 (f) 2017 (f) 2018 (f)
Fig. 2.8 Chinese shipyard capacity utilization rate and estimated capacity ( Source : DVB Bank Shipping and Offshore Research)
(in terms of CGT). Another important factor is the utilization rate of ship- yard capacity, which, if it is factored in and remains at its current level (75%), actual Chinese shipyard capacity might reduce to almost half of its peak by 2018 (see Fig. 2.8 ).
Together with the “deleveraging” process, the market structure of the Chinese shipbuilding industry is also expected to change with the rise of state owned shipyards—it is expected that this capacity share will increase from 40% in 2013 to 50% in 2018 (see Fig. 2.9 ). During the same period, it is expected that for small privately owned shipyards the capacity share will decrease from 20% in 2013 to 10% in 2018. Th is is in line with the govern- ment’s intention to consolidate the industry.
Newbuilding prices for major ship types are expected to remain subdued for some years more, due to excess shipyard capacity. Th e “hidden” shipbuild- ing capacity may fl ood the market when newbuilding prices start to face an upward pressure, thereby keeping prices in check. Not until the shipyard dele- veraging process reaches its end, can a sustainable recovery of newbuilding prices be expected. In the meantime, this inelasticity of supply in certain sec- tors might provide a suffi cient condition for seeing some sustainable recovery in them. With the demand side of these sectors eventually showing positive developments, asset values, including newbuilding prices and secondhand prices, are slowly bottoming out, which could potentially lead to the start of a new cycle.
Under the current situation with excess liquidity and excess yard capacity, the supply side can easily be changed and may work against any potential recovery. Th us, owners tend to choose good shipyards, which can deliver good quality assets, so as to compete with the threat of increasing ordering activity.
Large Privately
Owned Yards 34%, 17 Yards Large
Privately Owned
Yards 32%, 20 Yards
2013 2018
State Owned
Yards 52%, 30
Yards State
Owned Yards
39%
30 Yards Small
Privately Owned
Yards 8%, 19
Yards Small
Privately Owned
Yards 22%, 150 Yards
Joint Venture
Yards 6%, 10 Yards Joint
Venture Yards
7%, 10 Yards
Fig. 2.9 Forecasted structure of the Chinese shipbuilding industry ( Source : DVB Bank Shipping and Offshore Research)
As a result, a two-tier market in the shipbuilding industry is expected to con- tinue, where owners prefer top tier yards, and second tier yards off er lower prices to attract new business.