Current economic risks and their likely impact on shipping
It has been a long while since global economic developments were the common denominator explaining the rise and fall of all major shipping sectors. Idiosyncratic developments within each shipping market drive shipowners’ fortunes, at least in the short term. One needs to look no further than surging tanker rates and booming LNG carrier rates today and compare those to the freefall seen at the same time in liner freight rates (from the astronomical highs containership markets had climbed to at start of 2022) to ascertain the validity of this statement.
Concerns of a worsening energy crisis in Europe and in Asia Pacific as the winter approaches have rendered tankers capable of carrying (or storing at sea) crude, oil products and, especially, LNG hot commodities. Similarly, bulkers benefit from a resurgence in demand for coal, as natural gas supplies dwindle.
At the other end of the spectrum, containership owners may feel as if someone is pulling the carpet from under their feet. Supply chain disruptions and associated extraordinary port congestion single-handedly boosted containership rates to undreamed of levels in 2021H2 and in early 2022, during a period of lackluster containerized trade growth (at least outside the US). Congestion at terminals resulted in slowsteaming and in locking a substantial portion of the fleet at major gateways for extended periods of time, thus drastically reducing available fleet capacity.
But the reverse is now true. Dissipating supply chain disruptions and easing congestion has unlocked this capacity to return to the markets (by improving fleet productivity). This fact alone should effectively bring more tonnage back in the containership market by the end of 2023, than the total boxship newbuilding capacity scheduled to be delivered from late 2023 through 2025 (also a disconcerting figure due to the ballooning containership orderbook).
Despite such idiosyncrasies and exogenous events (war in Ukraine, geopolitics, tariffs, Covid, etc.), it is still the global economy which binds everything together.
Today, inflationary pressures (which are near 40-year highs at major western economies) present the largest threat for the world markets. Many global central banks have chosen to raise interest rates to combat the threat of long-lasting inflationary pressures. While this is an appropriate action, it also increases the risks of recession, especially for emerging economies which are not commodity exporters. Europe, battling an energy crisis which may soon escalate if it suffers a harsh winter, also is liable to succumb in a recession.
The recently published OECD outlook sets global GDP growth at a mere +2.2% in 2023. To set this figure into perspective, when excluding negative growth of (-) 0.1% during the global financial crisis in 2009 and (-) 3.1% during the pandemic in 2020, one has to go back to 1993 to find a year with slower global economic growth (+2.1% in 1993).
But there is a silver lining. While the increase in interest rates spells short-term pain across many countries and the world economy, a successful slicing of inflationary pressures should translate to a faster economic rebound, perhaps starting as early as late-2023. By that time, we also expect that Europe would have turned the page on the worst of the energy crisis. With Europe steadily improving its independence from Russian oil and gas supplies after 23Q1, we expect energy prices to moderate (absent a substantial escalation of wartime activities).
The two charts at the end of this note may help explain our somewhat optimistic view on inflation. The first chart showcases inflation figures in representative regions around the world before the Russian invasion of Ukraine (February 2022) and the most recently reported figures (August 2022). One may easily see the impact of fast rising energy and food prices in the aftermath of the war, especially on emerging economies with heavy dependency on oil and grain imports (like Egypt). Europe’s dependency on Russian gas supplies has also led to a surge of inflation in the Euro-area, from 5.9% to 9.1% (February to August 2022). On the other hand, commodity exporters like Brazil have benefited from elevated commodity prices and by a strong USD (a result of rising US interest rates).
However, this chart also shows that the world’s leading consumer markets, the US and Europe, faced heightened inflationary pressures prior to the start of the war. As the US Fed pointed out, these pressures were attributed to the aforementioned supply chain disruptions. Accordingly, the rise in interest rates aims at slowing demand growth (primarily a red-hot US consumer demand) and easing supply disruptions. Easing dwell time of container boxes at US port terminals is an early sign that this policy is working, as US retailers cut back on import orders from overseas in anticipation of slowing consumer demand. In turn, falling supply chain disruptions should lead to lower inflation and allow the Fed to freeze monetary tightening and halt the interest rate increase.
The second encouraging sign relates to developments in commodity prices. The CRB index, which summarizes developments in global commodity prices, peaked in early-June 2022 60% higher than its 2021 year-long average, but by late September it had relinquished nearly 20% of its June peak. A slowdown in global demand has also led to lower commodity prices, thus easing the burden on inflation.
Of course, there remains today considerable uncertainty regarding the short-term path of commodity prices, particularly for energy prices. But as we can see in Figure 2 below, by late September, most prices for energy products (other than coal), metals, agricultural and industrial products had eased significantly from the peaks they reached earlier in 2022. Steel prices have even fallen below their 2021 averages, while coal prices remain at very elevated levels.
All in all, while economic prospects for 2023 have dimmed significantly, we believe that the economic slowdown should not be long lasting, as we expect inflationary pressures to subside substantially over the course of 2023 (absent a significant escalation in geopolitical tensions and conflict). Even so, shipping-market specific idiosyncrasies should continue to pave the way forward. Tankers and LNG carriers should continue to enjoy strong markets in the near term thanks to dislocation of trade patterns and low fleet expansion, but rates should adjust somewhat lower than recent highs after the start of 2023. Market sentiment has soured in the dry bulk sector, despite expectations that a revamp of the Chinese economy in 2023 (after the extended lockdowns in 2022) should help bulker demand next year. Developments in the Chinese real-estate industry should remain pivotal for dry bulk rate developments and a falling Chinese Yuan (at 14-year lows today) could compromise Chinese commodity imports in the short term.
Meanwhile, the easing of supply chain disruptions and lower port congestion should lead to a correction in containership markets. But unlike previous market cycles, liner companies and, especially, boxship tramp owners are better prepared to face a downturn in rates. This is attributed to the windfalls of cash accumulated in recent months and also to long-term contracts already secured for the year(s) ahead. The latter should translate to healthy revenues in coming months and year(s), despite rising counterparty risk. Furthermore, the down cycle presents investment opportunities at the market trough, opportunities which are rendered more appealing due to cash availability and increased emphasis on new environmental technologies.
Figure 1. Key inflationary developments, before and after the Russian invasion of Ukraine
Figure 2. Characteristic price developments by commodity, late-September versus peak-2022 levels (2021 average prices = 100)