LONDON: "People are struggling to remember an era when it was this difficult. We've gone through what it was like in the 1990s, the 80s and the 70s, so expressions like 'living memory' start to apply," says Jeremy Penn, the chief executive of the Baltic Exchange in London. The exchange has set shipping rates for more than two and a half centuries but the situation its members face is grim. "Ship owners are facing the tough decision of whether to just drop anchor and hope it gets better," he says.
Fears about the global economy have seen the Baltic Dry Index fall more than 20pc this year, to its lowest level since records began in 1985. The Baltic Dry, compiled by the exchange, is an indicator of the cost of shipping dry bulk goods such as coal, iron ore and grains and finished goods such as steel. It is renowned for predicting the world's financial fortunes.
The immediate problem has been the slowing of the Chinese economy. But much of the pain is self-inflicted. Shipping has undergone massive growth, fuelled by cheap debt and steady demand.
Rapid expansion
The world fleet doubled between 2010 and 2013. At the same time, China doubled its shipyard capacity and took huge orders for new ships as it sought to control the commodities trade. "The dry cargo market was used to growth approaching 10pc for quite a few years on the trot," says James Kidwell, chief executive of London-listed broker Braemar Shipping. "All of a sudden you've hit a market that's gone flat. If you've got more ships than there are cargos, then freight rates are going to be weak - it's that simple." The impact on profits has been drastic. The average charter rate for the largest, Capesize vessels - so-called because they are too big for the Panama canal and have to round Cape Horn - has fallen to around $2,700 per day. They had traded between $15,000 and $25,000 during the past two years, and briefly touched $250,000 during the mania of 2008, according to Penn. Many trips are now loss-making as the cost of running a Capesize vessel, of up to 340m in length, can be $7,500 dollars a day.
Drowning in debt
In a normal market the rational decision would be to remove loss-making ships, but this is anything but normal. World shipping is drowning in debt. Ship owners who have financed their fleets with 60pc debt and 40pc equity have seen that equity become worthless, says Kidwell. The banks that provided the debt won't pull the plug as they would be forced to recognise the losses. They accept that they won't have debt service, and must wait and see if the owner can survive until the market recovers.
Zombie ships
"What is damaging shipping is a zombie fleet, which accepts freight at maverick prices just to keep going," says Kidwell. A zombie ship is one that can make some contribution to interest payments on its debts, but has no hope of repaying the capital. The situation might be about to get a lot worse. The calculation of loan repayments and interest depend on the expected value of a ship at the end of the loan. Kidwell says a five-year old Capesize vessel was sold for $19m in recent weeks, 40pc below the normal listing price, and less than half the $48m cost of a new ship. The collapse in prices for second-hand vessels will blow a hole in the balance sheet of any bank or individual sitting on those loans. The UK may no longer be a huge player in the ownership of fleets, but RBS is one British bank with total loan exposure of pounds 8.3bn and Lloyds bank also provides finance. London is still the centre of the world for ship broking through companies such as the FTSE 250-listed Clarkson and the smaller Braemar. It retains is position as a centre for marine insurance with Lloyd's of London writing pounds 2.1bn in gross written premiums in 2014.
Gloomy forecast
The glut of oil has led to one of the busiest tanker markets for years. But the wider outlook remains bleak for owners. At some stage they will have to take their ships out of the market. This will be a slow process, warns Penn. In the old days you could lay up ships fairly easily but with all the technology and electronics on board now it is much more difficult. "We haven't seen that cold lay-up that we have seen in past recessions," he said. "Ship owners and people who are still in the market presumably still think there is hope, and that the market turnaround will come before they are completely desperate. But there is widespread depression."