What goes up must come down. Certainly this was the case for the credit markets and the global economy for the last two years. Stock markets around the world have surged in anticipation of a global economic recovery, with stocks like PotashCorp (NYSE: POT ) and Caterpillar (NYSE: CAT ) rocketing. And it finally looks like that recovery may have come. With developed countries like the U.S. and the Eurozone growing again, and emerging-market countries like China posting 10%-plus growth, the global economy appears to be on the mend.
The dry bulk shipping sector can be seen as a proxy for the health of the global economy. I spoke with Pankaj Khanna, chief operating officer of dry bulk shipping company DryShips (Nasdaq: DRYS ) , to gain some insight on the status of the global recovery and the dry bulk shipping sector.
In Khanna's opinion, the global economic recovery is fully under way. He believes that 2009 was the bottom for vessel oversupply, and expects a more normalized situation by the end of this year or early 2011. He is bullish on shipping rates this year, but says that liquidity and credit remain a challenge for the industry.
What follows is an edited transcript of our conversation:
Jennifer Schonberger: What's your sense of the global recovery that is taking hold now?
Pankaj Khanna: 2009 was a story of China. The rest of the world virtually didn't exist, and most of the growth came from China. From the start of the fourth quarter last year and into this year, we're seeing the rest of the world starting to import as well. The inventories of iron ore and coal have gone down quite a bit, and so they are starting to import again. Steel prices have recovered in Europe and the U.S. as well. So we are seeing what seems to be not just the green shoots of a recovery, but a more full recovery from the rest of the world.
Schonberger: In terms of China, we recently learned that it's instituting restrictions on its lending, which some say could curb economic expansion and in turn dampen appetite for commodities. What's your take on that, and what will China's actions mean for your business?
Khanna: China is the key for the dry bulk markets; however, the news you are referring to is a very short-term view of things. Last year, China put together a stimulus plan of about $600 billion, of which only half has been spent on projects this year. So there's still the remainder to be spent, and most of that has gone to infrastructure projects. So we expect continued growth in Chinese iron-ore imports and coking coal imports. Then we also see a jump in their thermal coal imports, which is for their power plants.
So with the Chinese economy growing at the rate of 10.7% in the fourth quarter, and forecasts for average GDP growth of about 10% in 2010, I think they needed the cooling-off pressure -- otherwise they'd be growing at 13% to 15%, which wasn't too good for them in the long term.
Schonberger: Then you don't anticipate China's latest actions to adversely impact your business or the industry?
Khanna: No. I think in terms of demand, we anticipate dry bulk demand will be very strong.
Schonberger: Shipping rates plunged in 2008 by over 90% from peak to trough. The Baltic Dry Index shows rates have recovered from lows, but still remain far below peak levels. What is your sense of where shipping rates are going for 2010?
Khanna: For this year, I'm fairly bullish on the market.
If you look at the supply demand equation on an organic level, which means looking at purely how much demand is going to grow and how much the net fleet supply is going to be, they don't factor in things like port congestion, weather delays, or slow steaming due to bunkers being so expensive. So, on a purely organic basis, I think demand in 2010 will grow by 8% on average. When you look at the supply side of the equation, the forecast from industry analysts suggests somewhere in the range of about 10% to 12%. So if the fleet increases 10%-12% and demand growth is about 8%, it suggests that there is an imbalance, and on average rates ought to ease up. But that's purely on an organic supply demand basis.
If you take into account port congestion, weather delays, and slow steaming due to bunkers being so expensive, I think you'll find that the gap between supply and demand is not quite what is implied. This was reflected last year, [when] most analysts predicted doom and gloom for the dry bulk market when rates fell 94% or so in the first quarter. But if you look at the last three quarters of last year, we had Cape [capesize vessels] rates back up at $100,000 for a while. They were back at $80,000 again back in the fourth quarter.
Schonberger: The recession saw many shipping companies hit with credit problems because the credit markets shut down -- namely problems with letters of credit. Also, Diana Shipping (NYSE: DSX ) warned of the risk of a massive maritime credit crisis for the industry that could rival the subprime crisis, given the amount of shipping industry debt and the oversupply of vessels. What is your sense of credit availability now and the probability of a debt crisis for the industry?
Khanna: I think we've been facing that for a while ... Credit has loosened up a tiny bit since Lehman's bankruptcy, but it's so tiny that you don't really feel it across the industry. Large, well-capitalized companies like DryShips have access to finance, but the small mom-and-pop companies that used to finance just don't have it anymore.
...The amount of money banks used to loan to the investee is not as large as it used to be ... liquidity has definitely dropped dramatically. I would say today it's probably 20% of what it used to be, and that's a fact going forward.
But I think the lack of financing is actually a positive for the industry, because otherwise, all of the new buildings that have been ordered in the last three years would actually deliver. Because of this lack of credit, a lot of new buildings that were ordered have been canceled, or have been delayed quite a bit. Also, shipyards that had planned expansions have had to cancel or delay those expansions because of the lack of financing.
... As for the probability of a debt crisis, I would say we've gone through a debt crisis over the last year and we've passed the worst of it.
Schonberger: What is your sense of the vessel oversupply right now for the industry?
Khanna: I don't think that we're seeing anything as acute as was forecasted by analysts. For example, for 2009, the forecast for deliveries for dry bulk ships was 71 million tons at the start of the year, but the actual total deliveries were just over 40 million tons. So approximately 30 million tons got canceled or delayed. I don't think you would be seeing Capes at $40,000 per day consistently for the last few months had there been a huge oversupply situation. In the fourth quarter, we had Cape rates at $80,000 per day. We wouldn't have seen that if there were a huge oversupply situation.
Schonberger: When do you see the sector bottoming out and a new growth phase reemerging?
Khanna: I would say probably 2009 was the bottom. Maybe 2009 and 2010 are the bottom, and from this point on we see growth. When you look at the forecasts from China and the rest of the world in terms of consumption, the growth is still intact. You can go on BHP Billiton's (NYSE: BHP ) website or Rio Tinto's (NYSE: RTP ) , and you will see, in terms of the projects that they have ongoing to expand iron ore production -- it's massive. So I think the demand side of the story is still strong. On the supply side, I think we will come to a more normal kind of situation by the end of 2010, or in 2011.