The significance of scrapping level and shipping rates
While shipping scrappage activity does affect supply, it’s best suited to get an immediate to medium-term assessment of supply and demand dynamics (depending on how you slice and dice it). The rate at which companies scrap ships often reveals whether the dry bulk shipping industry is facing excess capacity. When excess capacity pressures the shipping industry, firms will often retire older ships to relieve pressure on shipping rates and maintenance costs.
Scrapping activity rises, but remains in downtrend
On October 18, the total number of ships retired since IHS Global Limited began collecting the data in 2005 rose 7 vessels from a week ago, reaching 2,709 vessels. On an eight-week moving average basis, used to show a clearer trend, the number of vessels scrapped rose from 7.74 to 7.75 the recent uplift that we’ve seen.
As we mentioned in previous updates, the late increase in scrappage could reflect some near-term weakness in the dry bulk sector. However, companies have been scrapping fewer and fewer vessels since June 2012, which is a medium- to long-term positive. As new ship deliveries are coming down after years of significant supply additions, there should be less of an incentive for managers to scrap vessels. We should see scrapping activity fall to levels seen during 2009 and 2010 in late 2014 or 2015.
Falling scrappage is actually positive, not negative
Companies often report the number of ships available to scrap as evidence of limited supply concerns, but the reality is that several ships do celebrate birthdays beyond 25. Managers are also unlikely to scrap ships just because they’re old and will often try to hold on to old vessels as long as they can find customers to use them.
Thus, investors should see falling scrappage as a positive sign that shipping rates are rising. Besides, when shipping rates do recover, second-hand vessels actually increase in value way more than new-build prices—another key indicator.
Why the current trend is positive for dry bulk shipping companies
As long as scrappage activity continues to fall over the medium-term trend, it’s a positive indication that fleet utilization (supply and demand dynamics) is tightening, which is positive for shipping rates and stocks like DryShips Inc. (DRYS), Diana Shipping Inc. (DSX), Safe Bulkers Inc. (SB), and Navios Maritime Holdings Inc. (NM). The Guggenheim Shipping ETF (SEA) will also benefit. In the near-term, we could see some weakness in share prices if scrapping activity continues to rise.