Standard Life Investments

Through the Lens

Global Shipping – smoother waters ahead

  • A boom in shipbuilding during the first decade of this century led to a glut
  • Shrinking capacity, industry consolidation and improving global trade point to a better future for the shipping industry
  • With the global fleet still 50% larger than pre-crisis, shipping remains a risky industry

The Hammonia Grenada holds an unfortunate record for a container ship. In 2010, it was delivered from a Chinese shipyard to its German owners at a cost of about US$60 million. Seven years later, the ship became the youngest ever sold for scrap, for about US$5.5 million. The value of the Panamax‐class vessel fell over 60% in value in 2016 alone following the widening of the Panama Canal.

A boom in ship building during the first decade of this century, on the back of optimism towards the Chinese economy, led to a glut. This helped send the Shanghai Shipping Exchange Containerized Freight Index down by over 70% between 2012 and 2016 (see chart). Global trade has weakened since the financial crisis and container shipping is the life blood of trade. Slower global growth, a stall in globalisation and a collapse in commodity prices have combined to take a heavy toll on the industry.

Shanghai Shipping Exchange - Containerized Freight Index

Better times ahead?

A silver lining is emerging. We see a number of changes taking place that point to a better future.

First, capacity is shrinking. Last year, there were record numbers of ships sold for scrap. The typical useful life of a container ship can be 25‐30 years. But many younger ships were scrapped last year.

Second, shipping lines have become more disciplined on their pricing and freight rates have been rising. This looks set to continue.

Third, the widening of the Panama Canal means that Panamax ships – the largest that could squeeze through the old locks – have become uncompetitive and more are likely to be scrapped.

Fourth, tougher environmental regulations are coming into force. Investing in new technology to cope no longer makes economic sense for the owners of older ships. These too will have to be decommissioned.

Fifth, the industry is consolidating. Denmark’s Maersk Line is in the process of buying Germany’s Hamburg Sud, joining a number of its competitors involved in mergers and takeovers.

Sixth, the industry is also forming new alliances that will control an increasing share of the global container trade, and potentially make competition more disciplined and rational.

Seventh, the fall in shipping rates has led to financial distress among highly‐indebted owners, sending some out of business. Shipping lines such as Maersk Line and Orient Overseas Container Line own and operate their own fleet. In contrast, financial owners of ships, often groups of highly‐leveraged private investors, rely on shipping lines to charter their vessels. South Korea’s Hanjin Shipping went into receivership in August last year, and this resulted in cargoes being stranded en route to their destination. In response, shipping line clients are becoming more selective, which should contribute to improving pricing power for the industry.

Eighth, cyclical help is on its way. Our economic outlook is for an acceleration in global growth. The management of Maersk Line, an industry leader, suggests container shipping volumes will grow 2%‐4% this year.

Risky business in an information age

Freight rates have doubled from their record lows in 2016. The positive structural changes could see freight rates trending higher. Still, we do not expect trade growth to return to its pre‐crisis levels. We live in an information age where value is increasingly measured in knowledge and know-how, not the number of boxes shipped. Shipping will remain a risky, volatile and cyclical industry. The global fleet of all types of commercial shipping remains 50% larger than before the financial crisis, despite the rise in scrapping. But we believe the industry has turned the corner and this creates opportunities for investors.

We own AP Moller‐Maersk, the Danish‐listed owner of Maersk Line, in our European and global equity portfolios; and Hong Kong‐listed Orient Overseas (International) Limited in our Asia and global emerging markets portfolios.