According to Diana Shipping (NYSE:DSX), the scrapping of ships from the world supply has been a major disappointment. Companies such as Navios Maritime Partners (NYSE:NMM) having been expecting much more. Could it be that over time the useful lifespan of ships is longer simply because they are better built than their predecessors? If so, any dry bulk recovery may be more muted than you think.
The reason scrapping is is important is because it affects the supply side of the equation for global market shipping rates. Less available ships help create upward pressure for shipping rates.
Navios Maritime Partners has been way off so far
George Achniotis, Executive Vice President of Navios Maritime Partners, stated in the Nov. 2 conference call, "We believe we will continue to see the scrapping of older, less efficient vessels." He was calling for scrapping to remain at record levels into 2014. He further predicted, "The current rate environment should encourage scrapping of all the vessels [which is] about 10% of the fleet [that] is over 20 years old." So far that's not happening.
Next, fast forward to Jan. 29. Again Achniotis reiterated, "The current rate environment [encourages] scrapping of older vessels [that are] over 20 years old [which is about 11% of the global supply]." He added, "The demolition prices appear to depend on overall steel prices and not on the supply of vessels. They are expected to remain high, [and we] will continue to see the scrapping of older and less efficient vessels."
Meanwhile Angeliki Frangou, CEO of Navios Maritime Partners, echoed the same sentiment in the same February call. She stated, "I think that the trend of scrapping will continue." Later in the call she added more firmly, "Definitely you will have more scrapping in 2014 [and] that will be the way forward."
Though it should be noted that Frangou believes that "higher scrap prices should encourage further scrapping" even though it hasn't been happening yet. So scrapping hasn't seemed to occurred for lack of demolition value.
Global freight rates have gone from bad to worse to levels below cost in some cases. 2014 is half over, yet scrapping has done way down, not up. What went wrong?
Diana's latest comments
During the company's May 14 conference call, Anastasios Margaronis, President of Diana Shipping, had a few comments on scrapping. He remarked that over 10% of the Panamax fleet and 7% of the Capesize fleet are over 20 years old, which is over the expected timeframe when ships have already been worn down past their point of usefulness and are expected to hit the junk yard and be sold for scrap.
One of the considerations for an owner is the higher cost to run an old inefficient ship compared to the salvage dollars. Generally low rates entice more scrapping. Yet, despite that fact, the first quarter saw a 60% drop in scrapping compared to a year ago even though rates were much lower than last year by as much as half for some size ships such as Panamax. Of course, ships can't last forever but the slow rate of scrapping lately must be making some of these guys question their original 20-years-to-scrapping thought process.
The benefit of 20-20 hindsight
Now that scrapping has failed to materialize as expected, what has gone wrong and how can we use that information going forward? Shipping expert and hedge fund manager Jay Goodgal warned late last year that he didn't think the global supply situation was going to improve as much as others thought.
Goodgal implied that sure, there is a decent percentage of aged ships out there, but the reality is that that age profile of the global fleet is still quite young. At the end of last year, Goodgal pinned 70.6% of the global fleet at nine years old or less with 54.9% at four years old or less. Worse, these more fuel efficient ships are capable of sailing faster which creates more trips per year and more global supply.
Chief shipping analyst Peter Sand of the Baltic and International Maritime Council took it a step further back in February. He went against the grain and saw lower scrapping this year while most others were forecasting higher. His logic was that the mere expectation of higher rates ahead, which everybody seems to agree are coming, will cause owners to retrofit, repair, and do whatever it takes to hold onto their ships longer than they would normally.
Sand was calling for a 33% drop in scrapping this year and so far he's on the right track. He further predicted that the higher demand for secondhand ships will mean less scrapping. Also, Sand believes executives from Navios Maritime Partners, Diana Shipping, and others have it wrong when they just talk about how old ships are. Sands stated, "Different types of ships, in size, gear, draft and operational capabilities simpl[y] cater for different demand. This is why ships are not sold for demolition due to the age criteria only." As an example, a smaller ships for shorter distances may be more easily fixed up than a larger one.
Since analysis on scrapping is apparently much more complicated than Navios Maritime Partners, Diana Shipping, and others think, or at least communicate, it's that much more difficult for us lowly investors to figure out. There are obviously far too many variables beyond simple age. My advice: applaud when you hear about large amounts of scrapping that have already occurred. But don't get your hopes up on company forecasts.
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Nickey Friedman has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.