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The legendary swordfisher Andrea Gail was not devoured by the first waves of the perfect storm. Sometime between the last communication and the tragic end, the waves grew from 30-foot monsters to heights we can scarcely imagine.
The world's entire fleet of cargo vessels has faced a huge demand disruption since the global financial crisis hit last year. Having properly described the initial 93% collapse in the Baltic Dry Index as a perfect storm, and after dubbing an early bankruptcy and nullified contracts a rogue wave, I find only one remaining metaphor to convey the enormity of the challenges ahead.
A tsunami looms ... one that will fundamentally change the face of the global shipping industry.
The quake that generates the wave
Like tectonic plates grinding against each other with seismic consequences, a monumental shift between the supply and the demand of cargo vessels has shipping operators hiding under the table.
The seeds of this crisis were sown in the very vibrancy of the boom years that preceded the fall. China's seemingly insatiable demand for raw materials like coal and iron ore stemmed from a thriving market for trade goods exported to the U.S. and Europe. From Dubai to Mumbai, emerging economies presented underserved markets that shippers raced to address. Miners like BHP Billiton (NYSE: BHP ) and Peabody Energy (NYSE: BTU ) expanded operations accordingly, and at shipyards around the world, the orders for new vessels piled in.
As a result, 146 new Capesize bulk carriers will join the fleet this year alone, representing a 28% expansion of global capacity just as world trade is expected to decline by 16%. Supply and demand are moving in fundamentally opposing directions, and new ships are set to roll down the spillways for some time. The number of Capesize vessels delivered in 2010, in fact, will outpace even 2009's record expansion.
In a recent survey, industry analysts project a 50% decline in the Capesize charter rate to about $18,000 per day before the year is through. Given this clear evidence of a massive oversupply of these bulky bulkers, I was critical of the decision by Navios Maritime (NYSE: NM ) to add four additional vessels to its pipeline.
Fools will recall that Diana Shipping (NYSE: DSX ) President Anastassis Margaronis sounded the siren back in May, warning of a "disaster for the shipping markets" unless vessel orders were scrapped. With a perspective reflected in his company's defensive posture, he added: "the challenge for most shipping companies will be to survive over the next two years or so."
China's strategic move to stockpile essential commodities -- while prices remained severely depressed by a disrupted global marketplace -- appears to be waning. China's copper imports in July were 23% lower than in June, and iron ore imports are expected to decline 16% from recent levels. I expect foreign investments like the 17% stake in Teck Resources (NYSE: TCK ) to continue, but recent import volumes were simply not sustainable at this stage.
My colleague and Editors Desk Blog contributor David Williamson brought a fascinating article to my attention through his recent post Ghosts of Christmas Future. According to the report, 12% of the world's containership fleet is sitting idle, and a massive flotilla of anchored vessels off the coast of Singapore stands as a powerful symbol of a sea change in global trade. That idled capacity is expected to reach 25% of the total sometime during the next two years.
With a global order book for 5.3 million TEUs (a TEU is the capacity of a standard intermodal container) -- or nearly half the existing worldwide container fleet -- the oversupply is very severe. German giant Hapag-Lloyd was already facing possible bankruptcy, and Maersk calls it "a crisis of historic dimensions."
Ships can sail over a tsunami in mid-ocean without knowing it, because the monster only rears its head when it approaches a coastline. The devastating impacts will be felt ashore by the shipowners, the operators, the brokers, the shipyards, and the banks that make it all possible.
At its core, the shipping tsunami is a banking crisis in disguise. Diana Shipping's Margaronis also warned of a "wave of destruction for banks to rival the subprime crisis." In this world of interconnected leverage, I believe that the tsunami will first make landfall in maritime financial centers like Hamburg, Germany, and London before flooding spreads inland through derivatives. HSH Nordbank may consider risk reserves at 1% of lending sufficient, but this Fool does not. Heavily indebted operators like DryShips (Nasdaq: DRYS ) and Excel Maritime Partners (NYSE: EXM ) may find it very difficult to service their debt as charter rates tumble, and if there is a shipping company that files for bankruptcy protection, I believe it could have a powerful domino effect.
I maintain my decidedly cautious approach toward investing in the shipping sector. With ample liquidity, low exposure to spot-market volatility, and a sober view of the challenges ahead, I continue to view Diana Shipping as the best-positioned operator to withstand the challenges.