Ship construction activity for bulk ships is an important indicator for future supply. In a supply driven market, high construction activity is negative because the shipping industry will experience large amounts of new deliveries in the near term. This will result in lower revenues and earnings as incumbent firms drive down shipping rates and utilization of ships, hurting earnings and share prices.
Construction level for bulk shipping still elevated
On February 22nd of 2013, the number of ships under construction stood at 425 according to a report from IHS Global Limited. Historically, levels of construction stood below 300 when the industry was operating under much favorable conditions with returns on equity of above 10%. However, managers’ overly optimistic view of future trade growth from 2005/6 to 2008 led to excess order placements causing the industry to face oversupply thereafter.
Construction level may hit decade low by the end of this year, capping shipping rates
Current construction activity points to a near term risk for the bulk shipping industry as more ships are delivered.1 Last year, the number of ships under construction fell ~250 ships from near 700. If the pace continues, construction levels may fall below 200 by the end of the year, putting construction activity below levels prior to 2009.
Because of new deliveries this year, shipping rates for bulk materials such as iron ore, coal and grain will likely be capped. Companies may have to rely on aggressive scrapping to lower supply growth and support shipping rates as well as ship utilization in the mean time (see “Dry bulk orders still at elevated levels, negative for shipping” and “Aggressive bulk scrapping reducing capacity growth, value ahead“).
Strong turnaround unlikely this year
Until both construction and order levels hit record lows and stabilize, dry bulk shipping will unlikely see a strong turnaround. This applies to Eagle Bulk Shipping Inc. (EGLE), DryShips Inc. (DRYS), Diana Shipping Inc. (DSX) and Paragon Shipping Inc. (PRGN). Whilst the Guggenheim Shipping ETF (SEA) will also be affected, the downside risk is lower as the SEA ETF also invests in tanker companies that are showing signs of stabilization2.
- More ships mean less utilization of ships and lower prices. ↩
- See ”Tanker order may be bottoming, opportunities ahead.” ↩