6/12-too much of a good thing

Interesting x 2

Looks like we are going to end the week with Real signed Ronaldo, Nikkei back in the 10k level, and Penguins win Stanley cup. Hm….speaking of sports, last year this time around shepherd left a message on my previous blog saying

“ Great win for Wang (5-0) today against the reigning cy young award winner. Turbo sinker has a new sibling: the nasty slider that breaks 10 inches. “

Ever since that sibling comes along, I haven’t heard much good things about wang. Not that I know anything about baseball, but if I would to run real madrid, I would keep either Kaka or Ronaldo but not both. We just cant have too much of a good thing.

Thursday was a real treat from my brokers. I went to Jim O’neil luncheon, GS served very impressive lunch catering. That shrimp fried rice is so authentic I miss home. At night, I went to CLSA sponsored film festival. Usually not a big fan for short amateur movies, but my CLSA sales cutie is too cute to say no to. So, thursday treat was worth a note.

Last week ML hosted a BDIY conference. These geniuses set the conference call at 6pm, Friday night. Normally I would just come in on the following Mondays and delete all the records/voice mails so i dont hear singlish accent first thing in a gloomy monday morning. now that since Chris is here, so this is saved for chris. Q&As looks interesting, check them out!

great weekend.

Merrill Lynch Conglomerate Team Global Conference Call
Friday 5th June 2009; 6PM (HK & SG /11AM (UK)
Speaker: Michael Saverys, FFA Trader
Hosted by Christie Ju (Head of Conglomerate Research)

Michael Saverys is the Director and Founder of Mineral Securities, the exclusive FFA trading desk of Bocimar International which is one of the largest European dry bulk ship owners running a Capesize fleet of 25 vessels. Michael used to be the dry bulk freight trader of Merrill lynch Commodities Prop desk in London. Before that, he was a soft commodity trader at Noble in Singapore.

Opening Statement by Michael Saverys
Good afternoon. Over the past 2-3 months, we have seen unbelievable rise in the Baltic Dry Index (BDI). I will start by given a brief overview.

BDI is a composition of 4 main dry bulk sizes: Capesize (170K DWT), Panamax (75-80K DWT), Supermax (55-60K DWT), Handysize (25-35K DWT). . Currently, every year about 3bn tons commodities are transported by these 4 sizes of vessels. Their current weights in the index are: Capesize (65%), Panamax (25%), Supermax (14%), and Handysize (6%).

The main focus is on the biggest sizes, they are the ones striking our attention and having the most volatility. They are driven by the one commodity everyone talks about: iron ore. The big movement we have seen over the couple of months is 100% driven by iron ore imports by China this year.

Last year, China imported ~460mn tons of iron ore. From Jan-Apr 2009, total imports by China was 189mn tons. It took everyone off guard. Basically China is importing 20mn tons extra every single month this year. The main reason is the substitution of local domestic ore by international imports. China’s iron ore prices collapsed last year. It was trading at around US$60/ton. Prices must be US$85/ton to make mining interesting in China. Below this price, it doesn’t make sense for Chinese domestic mines to produce. So there is a shift into the international market. Of course the Australians and Brazilian are very keen into selling iron ore to the Chinese market.

Since January 20mn ton of extra iron ore has been dropped into the market every month. Fleet utilization in Dec 2008 was about 60%. As soon as this import trend started, the utilization went through the roof. Basically all the legal and financial problems we have seen in the last 6 months have been forgotten, and everyone has put their vessels back on the market because rates were rising.

In all honesty, I think the current situation will continue. The current iron ore prices are still around US$70-75/ton. So it still doesn’t make sense for the Chinese mines to produce. We are going to see for the rest of the year the substitution of domestic iron ore by international imports. We are expecting ~600mn tons of iron ore imports by China this year, up 150mn tons y/y.

Everyone was expecting the dry bulk market to collapse, because there is a tsunami of Capesize and Panamax vessels coming at us. Because of last year’s dry bulk boom, ship owners ordered an unbelievable amount of vessels. According to Charkson and SSY research department, in 2010 there will be 325 Capesize vessels coming onto the market; 2011 will have around 200.

This year is a big questions mark: there was supposed to be 160 Capesize vessels come onto the market, but so far this year we have only seen 21. So we have seen a massive 75% slippage on order book delivery. This is on top of the China iron ore switch from domestic market to international market. The big boom in rates so far this year is because there hasn’t been enough delivery to coup with China’s iron ore imports demand.

The numbers for the rest of year are staggering. We still needs to see 136 Capesize delivered onto the market, which means there needs to be one delivered every 2nd day for the rest of the year. As I have discussed with Christie, we definitely don’t believe this is going to happen. The reasons are a lot of banks today have taken control of the shipping assets from some of the bankrupt ship owners. Basically they’d rather sell the vessels at a fire sale than operating the vessels on the market.

To operate vessel, you need to put a crew on board, as well as a department handling all the hassles of operating a ship. So I still think for the rest of the year we going to see a massive slippage in delivery.

As we all know, the world economic picture is looking a little better now. We are expecting that very quickly are going to find a solution to those vessels, and gradually they will be put on the market.

I will now give a quick overview about the FFA market.

BDI is an index following the prices of the four different sizes of vessels. As FFA traders, we speculate on the price movement of the hires in dollars a day. If you want to hire a vessel today, you pay a certain amount. For a Capesize, it is US$85K/day, a Panamax is US$27/day. We speculate on how those rates are going to move in the next month, quarter, half year, or year.

In the past 3 days, we have seen a 50% correction in the FFA prices. You saw the first drop in BDI yesterday, meanwhile our index has dropped 50% since Monday. We are expecting the BDI to correct in the coming days. A lot of operators/ship owners have hired a lot of vessels to cover their cargos. The only way to hedge those cargos is through the FFA market.

Since last year we have seen a big problem in our market: liquidity. A lot of Asian players have left our market because of the losses last year. So our market is hit by illiquidity. Over the last couple weeks, liquidity was fine, market was rising, and we see the massive % rises in BDI. But suddenly those operators were forced by their credit departments or financial controllers to control risk, so the only way to hedge your requirement today is by using the FFA market.

The credit crunch as put enormous pressure on the OTC market and the creditability between different shipping counterparties. So people would rather fix with BHP, Rio Tinto and CVRD on the spot market, and hedge their requirements on the FFA market. So what happened in the last few days was a lot operators came into the market and sold down very aggressively to hedge their requirements. No illiquidity. We saw on the Capesize market, Q309 future market was about US$60K, and spot market was 85K, so there is already a discount included.

The big correction we have seen is not because of the fundamental of the past couple of weeks, but of the illiquidity we have seen in the markets. Also more and more people still think the big order book that is coming at us at some point. So people sold it very heavily in the past few days,

For the next couple of months, I still think there will be a massive slippage in delivery. I think China is going to continue to import a lot of iron ore to substitute domestic iron ore. So I think we will see a rebound from now on to the end of June. For the next 3-6 month, I will see continued problems on the delivery schedule.

For anything beyond 2010, I must admit that there are so many vessels coming onto this market; we will have to see a very big correction during 2010. The current strength is because of the artificial demand from China and the artificial congestion at ports and high utilization of the fleet.

For the moment the fundamentals are still very strong, and I am a believer of a rebound in the future market prices. What you will see in the coming days is correction in the BDI since it always lags behind the future market.

1. Question from Christie: BDI rebounded to above 4000. Do you think the industry already passed their breakeven level for the Capesize? We saw a lot of ships laid up in 1Q. Would you say they all have come back to the market?

Yes. We have seen at least 99% of utilization for the fleet because the rates have started to make sense again. Even for companies in big legal issues (there were a lot of counterparty default last year on time-charters), they started to put vessels back onto the market.

The other 1% is basically vessels taken by the banks. Some banks don’t have operating departments to operate a physical vessel, for them it is very difficult to put the vessel back onto the market. I believe for the next 4-6month the utilization ratio will be at least in this range.

2. Questions from Christie: Iron ore demand from China is very strong. A few dozen of Capesize vessels are waiting outside of ports across China. Some of the vessels owners are related to mining companies, and they may not want to get those vessels unloaded. How much of the supply/demand shortage is driven by the iron ore negotiation/steel prices and how much is due to port congestion?

In the past of couple weeks we have seen CVRD completely disappearing from markets. Based on Monday’s rate, ship one ton of iron ore on a Capesize from Brazil to China would cost you US$45. So for CVRD it doesn’t make sense to ship the iron ore since the prices in China is only US$70/ton.

The Australians have taken the geographically advantage. They have pushed the rates so high that CVRD has been taken out of the market. Definitely BHP, Rio and FMG have played a very big role in the surge in the past of couple weeks. They have played the iron ore negotiation game. To me they are looking at China as a client, not as an adversary. But they are looking at CVRD as an adversary.

As everyone read in the newspaper this morning, BHP and Rio are joint-venturing together. I think this reinforces my statement that although they are unable to take the Brazilians out of the iron ore market, they will definitely play games with them.

3. Questions from Christie: year to date, we have just over 20 Capesize deliveries with 136 to come. Do you think these vessels are coming at us, or some of the banks already stopped financing them?

Without criticizing the broker research department, it’s been one of the very big disappointments of the industry that no one was able to capture.

The number of vessels in our industry is very easy to count: each vessel coming onto the market was given an international maritime organization number. The broker research department has completely underestimated the bank’s ability to seize the vessels and not doing anything with it. No one realized that if the bank seized the vessels, they won’t be put back onto the market since the banks don’t have the resources to operate them.

In the coming weeks, we will still see problems. But I think they will find a solution if rates stay above BDI 2000 points. Of course the timing will be an issue. I think 3Q and 4Q will still be strong as there won’t be so many vessels delivered. But from 2010 and onwards, those vessels will be built. The main thing to water is the speed of the fleet delivery, Capesize in particular.

I don’t think the 136 vessels will be delivered from now to the end of the year, maybe another 25-30 vessels. It won’t be able to offset the massive demand by China.

4. Questions from Christie: We touched on the strong surge in BDI and now we are due for a significant correction. How much of that is driven by real demand vs. speculation?

I think the collapse we have seen is purely sentimental driven correction. The fundamental is still entirely intact. There is no less demand from China. It is just that we have been so hard and so fast on the way up. I think this is a reasonable correction. On the short term, we will see a rebound in end of June/beginning of July.

5. Questions from client: how much of the dry bulk fleet in the hands of banks?

I asked that question a couple of weeks ago to one of the leading shipping managers. My answer is I don’t know. A lot of the banks, especially the German banks, have been very secretive to their exposure to the dry bulk market. There isn’t any transparency.

The shipping manager I asked told me that he thinks currently around 20-25 vessels, mainly Capesize, of the current 2009 order book is in hands of the banks. But it was only an estimate.

Of the 20-25, they are mainly Capesize. The panamax is a much more fragmented market, which has been much less hard hit by the crisis because the speculation on those vessels was much less.

6. Questions from client: it never occurred to me that this would have been much of a factor because there haven’t that much bankruptcy in amongst dry bulk companies.

A lot of the order book ship owners today are struggling to finance their requirements. All these financing trouble hasn’t hit our market yet. We have seen a credit crunch but haven’t seen a shipping crisis. We have seen a couple of bankruptcies, mainly operators. But big ship owner are not divulging whatsoever their exposure.

The industry needs US$55bn in the next 2 year to finance vessels. Currently the banks can only provide 15-20% maximum. At some points, the banks will have to seize those assets. Otherwise why would those vessels not come onto the market? This is the only reason we can think of that the banks are seizing assets. Because we know the Japanese and Korean shipyards can deliver those vessels. But we don’t see those vessels, although they are ready in the yards. The only explanation is that those vessels are seized by banks, and the owners are renegotiation the financing of their fleet.

7. Questions from client: do you think financing is a problem for the fleet on the water at the moment?

Not for the on-the-water fleet. Otherwise they wouldn’t be on the water. The only issue is that there are a couple of Capesize vessels anchored at Singapore because there are massive legal claims basically. Because the claims are so big, the counterparties don’t want to put the vessels into water.

8. Questions from client: do you have any anecdotal evidence from Bocimar’s negotiations with shipyards?

Unfortunately I am an agent to Bocimar. I could organize a conference call with their financial department but I can’t comment on that. The only thing I can say is that Bocimar has always been a very prudent toward their financing. We haven’t had any problems with banks because our prudent approach. A lot of analysts were criticizing the company last year because it wasn’t benefiting from the surge in spot rate. But this year it has been fantastic for the company as their prudent approach allow it to outperform many of their peers.

9. Questions from client: what do you think will happen if by next year most of the ships are delivered and China starting to use domestic iron ore? How would the supply/demand picture look like? Would there be a serious oversupply of dry bulk capacity?

If China doesn’t import as much iron as they do today and switch back to domestic supply, port congestion will decrease. As Christie said, there are about 90 vessels waiting outside China, around 10% of global capacity.

If China moves to domestic iron ore, the iron ore majors will not export as much as they do today. If the fleet current on schedule comes onto market, it is very simple that we will go back to BDI levels in January/February. The market can’t cope with a reduction of iron ore seaborne trade and an increase of 200 vessels between now and 2010. If those happen, we will see massive reduction in rates in all sizes.

I want to emphasize that the fleet is very inefficiently used, and you would see demand spikes. Suppose BDI goes to 1000, and suddenly China were going to import 40mn extra tons of iron ore a month, the rates would surge in a short period. There is another market has those characteristics, the VLCC market. There isn’t a lot of demand for the product today. When we see the Saudis dumping a lot of oil, we see big surges in rates, but it only lasts 2-3 weeks.

I think in 2010, we will see very volatile trade. The bottom line will be very negative, if we do see this shift of demand in China iron ore and this fleet comes onto market.

I am trying not to make any predictions about 2010. It only depends on the speed of the delivery of the fleet, especially Capesize. The speed of delivery will be the key factor of if and when the rates start to fall. If for some reason 2010 deliveries were to be postponed to 2011/12, we would see very decent rates in 1H2010.

10. Questions from client: a question on substitutability. What prevents from other Capesize to Panamax? And what is the delivery for Panamax for next year?

The substitution is basically there in the past. But due to congestion, a lot of Brazilian exporters and Australian iron ore miners do not want to split capsize cargo anymore, because it will create additional congestions at their ports. If the rates of Capesize and Panamax differ too much, there will always be substitution at some point. But a lot of iron ore majors do not want to split their capesize terms because they are so afraid of congestion.

For the moment, the Brazilians and Australians have been able to manage the congestion very well. Obviously they do not want to add additional vessels because it takes the same time to load one Capesize cargo or two Panamax.

The Capesize order book is around 90% of current fleet; Panamax is around 70%. Delivery schedule of Panamx is a lot more regular this year; this market has a lot of deliveries. A lot less slippage than we have seen with the Capesize.

11. Questions from client: Can you give us a sense of the demand outside of Asia?

What happened in the last few weeks was we have seen Acerlo, EDS, etc suddenly started to exercise their denomination on their cargo for tin ore and iron ore. It means the future price in US and Europe are going up and spot price is going up as well. Because those guys are coming into the market, it has added pressure to this already very tight Atlantic market.

Basically, the bulk of the fleet is on the pacific, I am talking about the Capesize vessels now. But the problem is that 1/3 of the iron ore is exporting out of the Brazil. It is very inefficient to send a Capesize from the pacific to Brazil and then back to the Pacific. It increases the ton-mileage enormously. There was in the past a backward route, which send the cargo from the Pacific to the Atlantic. The backward has completely died. This is because the South Africa’s tin ore trade to Europe has almost completely died. A lot of Africa’s tin ore is now going to Asia.

So there will be no re-positioning of vessels from the Pacific to the Atlantic. A lot of the vessels in Atlantic are just staying in Atlantic, because there will be at some point these vessels will be needed by Acelo, EDS, etc. The Atlantic market will stay firm and the pacific market has to use their fleet inefficiently. The situation is still very explosive on the spot market currently; we could see rates going up again for the short term.

12. Questions from client: You mentioned before that the iron ore price difference is $65 vs 85 domestic. How is the sensitivity to the freight rate? Will the increase in BDI make the import uneconomical?

To make Chinese domestic iron ore viable, we need spot prices above $85. Today this price is about $70. Obviously the surging freight rate has been a very big problem for the Brazil iron ore miners because they have to pay $45 today to export their iron ore. That means their margins have been completely abolished. In the beginning of the year, CVRD said that they are looking for the long term freight price of about $15; obviously, they have been a bit wrong.

Because BHP and Rio have geographic advantage, they have pushed the freight rate in the pacific market very very high, because for them to pay $20 or $25 does not really matter as long as they can make sure CVRD can not export iron ore into China.

If we see iron ore price is going up above $85, we will have a situation where CVRD, BHP and Rio will try to sell as much iron ore as they can. But there will also be a substitution into domestic iron ore. So the impact to the freight rate will be quite negative because of the substitution.

13. Questions from client: Regarding the seasonality, in past years, we see weakness in summer, but you just said the BDI will surge higher in the next few months, so you do not expect any seasonality?

You may see today the BDI to have one of its biggest percentage claps. The Capesize will probably be down 15-20%. I am speculating BDI to drop very sharply this week and next week. But from next week’s level, I expect the index to come back up, because of the tightness we have seen.

In terms of the seasonality, we do see rates coming off in second part of Jun and beginning of July, but as the world economy is coming out of the worst time, we will see rates to rise again since July. It is not only the Chinese iron ore demand we are talking about, we will see the tin ore demand coming back, and we will see Japanese, South Korean, and Taiwanese iron ore demand coming back.

14. Iron stocks are pretty high at the ports, but we do not get much data on the mainland. How about the consumer level in the mainland China, are they normal, above normal or below normal?

From what I read and hear, we have seen in the last few weeks the stocks are staying at more or less the same level, about 75mn tons for the moment. Since the iron ore import are rising, that means Chinese are consuming their iron ore a lot rapidly than we expected.

Christie Ju: Great question, sorry I don’t have the answer. We have a conference call scheduled with a Top 3 Chinese iron ore importer next Wednesday Jun 10 at 430pm HK/930am UK time. Please join us to find out the answer.

15. Questions from client: Whose problem is it? Is it the shipyard’s problem? The shipping company’s problem? Or the bank’s? Because it is ultimately the banks who seize the assets and the resale value will be significantly lower than what they have paid. We heard the write down could be as high as 500bn. Who ultimately hold the problems here?

I think it is the banks’. I just give an example in the container market. The container market, as everyone knows, does not move at all. We have $3000 for every single size, whether it is 1000 TEU or 14000 TEU vessel, just because consumer demand is still not there and there is massive excess capacity. I think the banks are not realizing or they are just not broadcasting how big a problem they have. Be aware, if a ship company can’t finance it, they just go bust. I mean this market is fragmented. They will start over again next year under different names. Unfortunately, the triple A names are not what I am talking about now. They are very few. In this market, only when the market is on your side or does not go significantly against you, you will honor your contracts.

To come back to your question, I just think banks have such a big problem and we will see more bankruptcies in the coming months. They will seize the assets and try to find crew where they could operate these vessels. They have to do something. Imagine you are sitting on a $100mn Capesize today which basically means you pay $50,000 breakeven, financing included, and you see the spot rate goes to $85,000, but you feel so frustrated because you don’t have crew and operating department and can’t do anything. I speculate the banks will act very quickly to put the capacity onto the market. I don’t know whether I answered your question.

16. Questions from client: I saw Yang Ming Marine in Singapore a month ago. They think the write down rates on some vessels could be as high as 50%. They are looking for buying these assets when they are written down, is this another kind of sub prime for the banks?

Yes, we are talking about Deutsche Bank, Nordic banks and S&H in Germany, they have not written off any of their assets yet. They are renegotiating with the old ship-owners and trying to get out more equity from ship owners. Only those have cash today and were prudent last year can pay up. There are only a handful of them.

Everyone has forgotten in the last couple of weeks that there is a financing problem. I mean today the Capesize is $85000/day, but the financing is not there. People are living in a dream world day because rates have been rising so much on dry bulk. But in container market they are struggling enormously to try to finance their books. The bulk ship owners/operators are not worried today, because the rates are high. It is a problem for tomorrow. But I can tell you the dry bulk market has not seen its crisis yet. It will come at some point. It all depends on the speed of the delivery.

The banks may form pool of operation. Goldman and Barclay already have operations under their arm. I am seeing joint ventures between banks to put the capacity onto the market and get some cash out of them, because if you have to do fire sale, you will basically lose 50% on that.

17. Questions from client: How easy is it to trade the BDI? Is it a specialist market or is there any other way to speculate on the BDI?

As an ex-ML employee, I will recommend the fantastic ML FFA desk. BDI index is not liquid at all; its volume is negligible compared with the billions of dollar traded on FFA market. In FFA market, you are trading on a particular size.

The correlation of the BDI and future market is very very high, but obviously, there is a lagging effect. We have a very sharp correction in FFA in the past 3 days, the BDI will have its correction in the next few days. This is my expectation.