Must-know: Weekly dry bulk shipping industry fundamentals update (Part 4)

Continued from Part 3

Ship retirement can indicate excess capacity

For a more near-term assessment of capacity growth, investors can look towards ship scrappage (retirement) activity. The rate at which companies scrap ships often reveals whether the dry bulk shipping industry is facing excess capacity or not. When excess capacity pressures the shipping industry, firms will often retire older ships to relieve pressure on shipping rates and maintenance costs. However, high levels of retirement reflect continued stress within the industry more than the potential effect in reducing pricing competition. So ship retirement reflects negative fundamentals in the short term for shipping companies.

Legal ApologiesEnlarge Graph

Scrappage reduced capacity by 263 ships, more expected

For the week ending July 19, the total number of ships retired since IHS Global Limited began collecting the data in 2005 rose to 2,115 ships—an increase of eight ships from the prior week’s 2,107. So far, shipping companies have broken up 271 ships since the beginning of this year, which represents 3.22% of the 8,428 existing ships reported at the beginning of the year. This scrappage has helped keep supply increase lower, which is showing some improvements lately (more on this in Part 5) and will support fleet utilization.

Dry Bulk Age Profile 2013-07-14Enlarge Graph

Scrappage expectation

Scrappage will likely continue towards the end of the year because shipping rates are at a record low. Additionally, an approximate 6% of existing vessels were older than 25 years old at the beginning of the year. Since the life of a vessel is approximately 25 years, according to annual reports provided by shipping companies, the industry could scrap another ~250 ships by the end of the year to support industry fleet utilization.

Hypothetical Shifts to Industry Supply Curve (Ship Exits and Entrances) 2013-07-09Enlarge Graph

Does scrappage actually increase shipping rates?

Although basic economics point out that lower supply raises shipping rates by shifting the supply curve, whether it actually does is questionable because firms tend to scrap older vessels that are less fuel-efficient and costlier to maintain. As these ships are more expensive, they’ll sit on the top right end of the industry supply curve. So, if the industry does retire some ships, the result can be either an A supply curve (in which shipping rates don’t change) or a B supply curve (in which shipping rates rise). Given that the utilization rate sits at 83%—which is fairly low in the shipping industry—and several new ships have flooded the industry in the past, an increase in shipping rates due to scrappage is unlikely.

As long as companies continue to scrap ships, this trend is a negative indication that there’s excess supply or unprofitable ships in the market due to current or expected low shipping rates. This is negative for DryShips Inc. (DRYS), Diana Shipping Inc. (DSX), Eagle Bulk Shipping Inc. (EGLE), Safe Bulkers. Inc. (SB), Navios Maritime Partners LP (NMM), and Knightsbridge Tankers Ltd. (VLCCF) in the near term. However, like construction activity (see Part 3), this negative may be outweighed by positive developments in other indicators. Since the market is forward-looking, smart money could have begun to rotate into companies that are best positioned to take advantage of this recovery.

Learn more about the key performance indicators of the dry bulk shipping industry

Continue to Part 5: Capacity growth, or go back to Part 1 to see the list of key shipping indicators.