Capesize Joy: As Usual, It's Because of China
It has been a funny old year in the bulk carrier market. The first quarter was dismal. The Baltic Dry Index ended Q1 at around 700 points. It closed last Friday at 1,740 points. Rates gently improved in the second quarter before rocketing in this month. What might the explanation be?
Various ship broking reports point to a rise in Brazilian exports of iron ore after output slowed to inspect tailings dams at mines following the Brumadinho tragedy in January. Others report a recovery in Australian port activity following weather-related delays after Cyclone Veronica hit in March. Some point to a shortage of tonnage in one area or another following ballasting activity by ships looking for cargoes. Others report lower fleet growth in 2019 creating a better balance between supply and demand. No doubt all of these things are happening, but I wanted to think about the sudden increase of demand for Capesize spot shipments. Who is hiring these ships and why now?
The main source of demand is Chinese steel mills bringing in supplies of iron ore and coking coal. The Chinese steel industry continues to produce a bit more than half the world’s steel, at over two million tonnes per day. Most of this goes into China’s domestic construction and manufacturing sectors. The surplus is exported, usually via ports in Southern China.
In the last 12 months, central and provincial governments in China have reined in steel production as part of their efforts to improve air quality. Steel production is notorious for air pollution. Between November 2018 and March 2019, steel mills in China’s two biggest steel producing cities of Tangshan and Handan were forced to cut back production by 30%. In the April-June 2019 period, that production restriction was relaxed to 20%. The cuts were not imposed across the board, but on a mill-by-mill basis, each taking turns to cut production to meet the targets. Managers at steel mills reported that the production caps would be lifted for Q3 this year, which has of course just begun. The rise in iron ore shipping activity could well be related to the relaxation of steel production curbs in China.
In the last year, China’s domestic coke-making plants have also faced restrictions as local governments in Shanxi in particular have sought to improve air quality. In 2018, Shanxi produced around 93 million tonnes (Mn T) of coke, about a fifth of China’s total production. A team of inspectors is currently touring Shanxi’s industrial enterprises to see whether their efforts have worked and whether further cuts may have to be imposed. A survey by Mysteel suggests that production is running at about 80% capacity, so there is scope for more production cuts.
Meanwhile, the cut in domestic coke production has led to increased prices for coke in China. As the steel mills ratchet up output, imported coke may be a cheaper option than domestic coke. Indeed, the Port of Gladstone in Australia reported today that metallurgical coal shipments to China reached a five month high in June at 6.43 Mn T, up 2% year on year and 8% month on month, and the highest monthly volume since 6.45 Mn T in January.
China’s daily steel output bottomed out at 2.2 Mn T per day in January, according to Mysteel. Since then it has grown to nearly 2.6 Mn T per day. There has been a knock-on effect on exports. Finished steel exports fell 16.6% year on year to 5.743 Mn T in May, and were down 9.2% month on month, according to data from General Administration of Customs showed. The June data are due this week. They are expected to be in line with June, before a recovery in July and August, according to a June survey by S&P Global Platts. That survey ties in nicely with the expected increase in production as steel production caps are lifted.
The Take Away
I’ve spent that last quarter century being told on a regular basis that shipping is a supply-led industry. The common perception is that ship owner discipline or indiscipline can lead to booms and busts in the freight market. But the experience of the Capesize freight market in 2019 suggests that supply and demand fundamentals work differently. Let’s face it, the freight market is almost constantly oversupplied with ships. If there are 20 ships chasing one cargo, is the market so different to one with 30 ships chasing one cargo? If for some reason, such as a relaxation of political control over production in a key freight buying region like China, one cargo suddenly becomes two, then the difference between 20 and 30 ships chasing two cargoes is immense. Freight markets react accordingly. And, it turns out, short term freight market dynamics are as sensitive to policy as they are to the supply of ships.