16 August 2015

Is The Recent Surge In Drybulk Demolition Over?


The record setting surge in drybulk scrapping has been a contributing factor to the 100% increase in the BDI following lows set back in February.

But a few factors might be turning against the continuation of this trend.

So could a main catalyst in the drybulk rate recovery be removed from the equation?

Over the past year, drybulk companies such as DryShips (NASDAQ:DRYS), Diana Shipping Inc. (NYSE:DSX), Golden Ocean Group Ltd. (NASDAQ:GOGL), Navios Maritime Holdings Inc. (NYSE:NM), Navios Maritime Partners L.P. (NYSE:NMM), Scorpio Bulkers (NYSE:SALT), Safe Bulkers Inc. (NYSE:SB), Star Bulk Carriers Corp. (NASDAQ:SBLK) and Ship Finance International Limited (NYSE:SFL) have experienced a historic downturn. But an unexpected rate rise has given some hope to the beleaguered sector. Here I would like to take a minute to discuss a main factor contributing to this recent recovery and if it is a viable long-term trend.

It has been well established that the recent collapse in the drybulk space is due to disequilibrium, with too many ships for the prevailing demand. However, recent record rates of scrapping have restored some market balance and were a main contributor to the recent rise in rates.

Notice that if the first half figures for drybulk demolition were to keep pace, we would be seeing a new high for the amount of DWT scrapped in a single year. But a few factors might be working against that trend.

First, the age of Capesize vessels being scrapped has become progressively younger, now down to approximately 21 years on average, which is the youngest average age for scrapping in over 20 years.

This trend was brought about by charter rates which fell far below the operating costs of vessels. Prevailing thought over the first half of 2015 had any prospect of a recovery still far off into 2016 and even 2017. It was therefore simple math for many owners who considered the ongoing losses for ships in the 20 year age range too great to justify keeping them with a recovery far off and an unsure rate environment beyond that.

Second, rates have increased. After setting a historic low of 509 on February 18th, the BDI has moved up over 100% in the past five months to over 1,100, reflecting a rate recovery across all classes.

The beaten down Capesize sector has seen an increase of approximately 300% in spot rates since hitting lows on March 13, while the Panamax sector has recovered by around 150% after reaching its low on February 6th.

This means that for the first time since November of 2014, Capesize rates are poised to cover running costs for the vessels, though they are still lower than most owners need to break even after finance charges, according to Bloomberg.

When vessels were losing money on a daily basis due to low rates, it was an easy decision to get rid of some older tonnage. But it becomes harder to justify scrapping a vessel that still has the potential for a profitable service life when rates are turning favorable. Notice from the chart above, when rates were good back in 2007 you can see owners extending a ships service life well beyond the 30-year mark, while demolitions rapidly decreased.

Finally, due to a massive oversupply in the iron ore and steel sector, prices paid for tonnage destined for the scrap yard have fallen.

Intermodal stated in their week 29 report that "after all these months of intense scrapping, the reasoning to get rid of older tonnage is now less supported than before, as neither offered (scrap) prices, nor (strong) dry bulk rates make such decision inevitable any longer."


Together, these three factors could mean that the recent spike in demolitions may wane going forward. As I said earlier, this recent surge in scrapping was a catalyst for the recovery, and if removed from the equation, could stymie future progress.

But while scrapping has made for some solid short-term progress, it isn't going to be the factor behind the long-term health of the supply side. That comes from the orderbook which appears to be coming under control. In a recent report from Platts, 159 new dry bulk vessels were ordered in January-June 2015, down 69% from the same period of 2014. Platts quotes an anonymous shipbroker who states that "at the end of the day, what's going to have more of an impact than scrapping is fewer new ships being ordered," said the broker. "We're already seeing this and, although it'll take longer for it to help demand meet supply, it'll get us there."

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.

Source: seekingalpha. 31 July 2015

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