The shipping industry, often acknowledged as the life blood of the global economy and a proxy for global economic growth, plays an important role in international trade. Being a function of cyclical supply-and-demand, international trade is the exchange of capital, goods, and services across international borders or territories.
Unless in extraordinary circumstances, the demand for sea transport, mainly comprised of; imports and exports of raw materials for the manufacturing industry, and manufactured goods, is driven by global economic growth.
It is worth highlighting that, without the shipping industry – said to be responsible for approximately 80 per cent of world trade, International trade would simply not be possible.
In the face of a slowdown in global economic growth, partially weighed down by the prominent US-China trade war, and the pressure laid by the introduction of IMO 2020 (an environmentally related regulation) looming large, the global shipping industry is undoubtedly facing increased uncertainty.
In a bid to mitigate the environmental impact posed by emissions released from vessels, burning fuel containing a high level of sulphur content, the International Maritime Organisation (IMO) introduced a regulation (IMO 2020), set to come into force as from January 1, next year.
Despite the environmental benefit the regulation brings along, IMO 2020 leads to a substantial increase in bunker costs for international shipping companies. In a bid to comply with the imposed regulation, vessels have to be either retrofitted with scrubbers, or start burning fuel containing a significantly lower sulphur content; capped at 0.5 per cent. To clear thoughts, scrubbers are installed in order to remove particulate matter, and gases produced by a ship’s engine, posing a one-off capital expenditure.
Notwithstanding the significant increase in operational costs, the uncertainty posed by the regulation set in stone, is another reason why the order book has been more benign in recent years.
Given the significant increase in operational costs, and/or the enforced one-off capital expenditure, the regulation has left international shipping companies no option, but to partially shift the incremental bunker costs onto the consumer, this resulting in an increase in freight rates, partially compensating for the lower margins.
As previously conferred, the demand for sea transport is often considered as a good proxy for global economic growth, with considerable demand for shipments, signalling a positive economic performance. Ultimately this being reflected in the freight rate – the price at which cargo is shipped from one point to another, varying according to the distance to delivery destination, and mainly measured in TEUs (20-foot Equivalent Units).
Albeit 2019 looking certain to post the worst global economic performance for a decade — reflecting rising US-China trade tensions and their dampening impact on exports and industrial production, financial markets, which pride themselves on being forward-looking, are pointing towards a broad recovery. This being reflective in the recent market sentiment, with yields experiencing a slight increase.
While monetary practices have buoyed financial markets, they have not yet found their way into economic forecasts.
The outlook for 2020 vis-à-vis economic growth has stopped getting worse, but upticks in forecasts remain tiny. Forecasts which will undoubtedly weigh on the demand for shipments of durable and non-durable goods.
One may argue that given the rally seen in equity markets to-date, the probability of a “phase one” deal between US-China may indeed be priced-in. Meanwhile, should the latter fail, the negative news may have a bigger magnitude to the downside.
In such environment, one should be prudent, namely to highly correlated sectors, such as the shipping industry. Thus, in our view, a neutral stance is warranted at this point.
This article was issued by Christopher Cutajar, credit analyst at Calamatta Cuschieri. For more information visit https://cc.com.mt/. The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.