Is the recent recovery in Cape Rates here to stay?

Marsoft eBriefs - July 2020

Marsoft’s July eBrief market reports are now available.  These summaries for the dry bulk and tanker markets have got everything you need to know this month, with current market developments and implications for forecasts of rates, newbuild and secondhand prices, and more.

 

In our Dry Bulk market eBrief, we are talking about Cape spot rates, which have staged an impressive rally over the past two weeks. As we head into early July, they have topped $30,000 per day, approaching the peak level seen just about a year ago. The jump in rates is even more impressive given the current macro climate, with a deadly pandemic crushing demand for steel in much of the world.

 

But a big question is whether the recent recovery in Cape rates is likely to have any staying power. In this eBrief we talk about why we think the answer to that is ‘No.’ See why we forecast Cape rates will fall by some 30-40% in the second half of this year and again in 2021.

 

Cape spot rates have staged an impressive rally over the past two weeks. As we go to press in early July, they have topped $30,000 per day, approaching the peak level seen just about a year ago. The jump in rates is even more impressive given the current macro climate, with a deadly pandemic crushing demand for steel in much of the world. But a big question is whether the recent recovery in Cape rates is likely to have any staying power.

As a quick read of our Market Outlook makes clear, we think the answer is no, as we forecast Cape rates to average only $17,500 per day in 20H2 and just shy of $11,000 per day for 2021 as a whole. Of course, we acknowledge that rates could hold up much better than we expect. Given that Cape rates have seen a much more spectacular rise than rates in the other dry bulk sectors, we believe Cape-specific factors, rather than a broad-based improvement in dry bulk fundamentals, are behind the most recent jump. In particular, it is likely that Chinese iron ore purchases picked up dramatically in June, after the country’s stockpiles fell to a 4-year low at the end of May. And to add fuel to the fire, the recent China-Australia political dispute is probably pushing China to look for alternatives to Australian supplies wherever possible, across a number of dry bulk commodities, most likely boosting tonne-mile demand (although China’s ability to shift away from Australian iron ore supplies is extremely limited, given Australia’s dominant share of the market).

One possibility for Cape rates to stay relatively high over the next six months would be for a “perfect storm” of Cape-friendly developments to persist over this period. Such a scenario could entail such developments as: 1) Higher Chinese steel production, due to a rapidly-enacted stimulus program. 2) A significant shift, to the extent possible, in China sourcing its raw materials away from Australia and towards longer-haul sources. This would apply to iron ore, met coal, grain, and bauxite. 3) A recovery in Brazilian iron ore supplies up to the high end of Vale’s recent sales guidance, implying a sharp rise in Brazilian exports in 20H2. 4) Continued high port congestion, remaining near the peak level seen in 20Q2, as opposed to the decline in congestion that is anticipated in our Base Case scenario.

If all these developments were to come to pass, we would expect a much stronger Cape market as compared to our Base Case. But Cape earnings would still be likely to decline relative to their recent peak level, and they would be projected to average less than $25,000 per day in 20H2 even given these developments. And while assigning a probability to such a scenario is highly subjective, we would put the probability at no more than 20%. But it’s worth noting that we saw a somewhat similar confluence of events a year ago, as strong Chinese steel production, a rapid recovery in Brazilian iron ore supplies (following the Brumadinho dam disaster), and increasing offhire days for scrubber installation led to Cape

rates averaging $25,000 per day in the second half of 2019. So, perhaps lightning can strike twice!

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