The shipping industry often acknowledged as the ‘lifeblood of the global economy’ and a proxy for global economic growth, plays an important role in international trade. The industry has an important role in the exchange of capital, goods, and services across international borders or territories.
Unless there are 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. Amid the added pressure laid by the introduction of IMO 2020 – an environmental-related regulation enacted to reduce emissions, and the prominent US-China trade war which had severely impacted trade – the industry had to face additional pressures from the unprecedented outbreak of COVID-19.
Despite the environmental benefit, the IMO 2020 regulation led to a substantial increase in bunker costs, leaving shipping corporations no option but to partially shift the added operational cost and/or one-off capital expenditure onto the consumer through surcharges, pushing freight rates: typically positively correlated to demand, higher.
The move to safeguard profitability margins proved effective and perhaps sufficient to mitigate both the impact posed by the enacted regulation and also the drop in demand for raw materials and goods, triggered by lockdowns imposed by governments to try mitigate the spread of the deadly respiratory virus which also pointed towards a supply-demand imbalance. Mitigating the impact on profitability margins was the unexpected breaking up of the OPEC+ agreement, which sent global oil prices into a tailspin.
Furthermore Low sulphur fuel, which initially leads to a substantial increase in bunker costs, significantly dropped.
In a bid to further reduce the supply-demand imbalance and to further sustain profitability margins, shipping corporations announced blank sailings. To clarify thoughts, a blank sailing is a shipment that has been cancelled by the carrier. Cancellations typically involve a vessel skipping one port or the entire string.
By reducing supply through blank sailings, shipping corporations managed to compensate for the drop in demand for shipments, this preventing the freight rate from dropping further amid this turbulent period. Despite reaching their scheduled peak in the month of April, the current schedule of blank sailings has created some optimism.
In attempt not to trigger a supply-demand imbalance, and thus negatively impact the freight rate, carriers announced a decline in blank sailings for the coming weeks – a likely indication that carriers are seeing an increased number of bookings due to either lockdown measures being lifted or a sufficient backlog. Should shipping corporations manage to undertake this task successfully, freight rates should remain trading within an adequate range.
Moreover, assuming that bunker costs; a predominant operational expenditure sustain current levels, shipping corporations may indeed survive this challenging period. Surely, the main players within the industry where also agile in reducing other operational costs, where permissible, in the wake of COVID-19. This will perhaps sustain margins further. In such an environment, we are of the view that if blank sailings maintain this downward trend, this is a clear signal that COVID-19 brought about a deferral of consumption which now seems to be picking up.
This ray of hope is starting to be reflected in bonds issued by major shipping players. That said, we continue to hold a prudent approach in the current unprecedented scenario.
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.