Professor H.E.

Haralambides Erasmus University Rotterdam

Terminal Operations Conference, TOC Europe 17-19 June 2008 Rai, Amsterdam, The Netherlands

Current Developments in the US Economy

Together with defense industries, the real estate market has traditionally been the locomotive of the US Economy. Over the past 20 years, the US Economy has demonstrated a more robust growth, compared to other industrialized economies. This was fueled by buoyant consumption, encouraged by rising real estate values. This wealth effect however, in its turn, caused excessive imports, large current account deficits (7% of GDP; Figure 2) and a low dollar that, since 2001, has depreciated more than 60% against the Euro (Figure 1) The subprime crisis and its globally cascading effects started when real estate values began to decline.

Figure 1. Source IMF

Figure 2. Source: IMF

The Capital Account in the US Balance of Payments

Historically, US Current Account deficits have been financed by autonomous capital inflows. Due to a low dollar, however, capital is fleeing US stock exchanges in search of better investment opportunities in other regions (Asia; Europe; Middle East; L. America; Figure 3). In addition, having learnt their 1970s lessons, oil producing countries are investing their surpluses not in financial l Paper or currencies, but in sustainable infrastructure.

Figure 3. A low dollar: Capital is fleeing US stock markets to Asia; Europe; Mddle East; Latin America

Source: IMF

The China Syndrome: A new Imperium is being born

The export-led growth and development of China is a cause for concern. China builds up tremendous foreign exchange reserves used to buy oil and commodities. This pushes prices up (food prices too), crowding out other countries, causing inflation and recession to the rest of the world, but helping Chinas own economy. I firmly believe that western economies will not import from China as much as they did in the past. Changing views in Europe on cheap manufactures consumerism; rising concerns on standards; and environmental degradation will all contribute to this, and these concerns have already started changing consumer behavior in Europe.

How likely is, therefore, such a scenario? In my view, highly unlikely

Total throughput 2007 407 million tons 2030 800 million tons Container throughput 2007 11 million TEU 21 million TEU 2015 2020 27 million TEU
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Sub-prime Mortgages Crisis

The crisis began when US mortgage companies made hundreds of billions of dollars of unsecured loans to individuals with poor credit records. These debts were then packaged (securitized) and sold to financial institutions around the world who in their turn sold them to pension- and hedge funds. Total losses, conservatively estimated, in the region of one trillion dollars (Figure 4). Total home foreclosures: 4.5 million houses. Central banks have intervened to ease liquidity. The Bush and Brown Administrations have handed out almost 1/3 of the above amount, from their fiscal balance sheets (tax rebates, bonds, etc.). At the time of writing, consumer confidence has been the lowest in 30 years.

Figure 4. Growth of Sub-prime Lending

Source: Center for Responsible Lending; Inside Mortgage Finance

Prospects of Bulk Shipping

The Baltic Dry Index (BDI) has risen from an already high 8000 points (April 08) to 12000 index points (May 08); i.e. 50% increase (Figures 5 and 6). Capers command spot earnings of 300K/day (iron ore Brazil-China). Chinese iron ore stockpiling rate : 16% p.a. (MEL forecast). Asian coal imports (Korea; India): buoyant demand. As a result, at the time of writing, the bulk carrier orderbook represents 55% of the world dry bulk fleet. Gross capital formation (orderbook) of this magnitude is unsustainable and unexplainable by any economic fundaments, particularly in the face of a looming economic downturn. Shipowner investments are, I believe, rather ill-advised and I expect the market to collapse as of next year.

NB: similar developments in the tanker markets (not discussed here).

Figure 5. The Baltic Dry Index (BDI): June 2008

Source: Baltic Exchange

[20 (red) and 200 (green) day exponential average]

Unprecedented in the history of shipping!

Jan 2005

Jan 2002 Jan 2006

Source: InvestmentTools.com

Prospects of Container Shipping

Despite sluggish demand, excessive orderbook, and high fuel prices, rates have declined only moderately and 2008-Q1 earnings are acceptable and, in any case, 15% higher than corresponding earnings of 2007. This result was achieved through: Enhanced profitability of Europe-Asia trades. Better alliances coordination and Vessel Sharing Agreements (Maersk/MSC/CMA-CGM). Slow-steaming (Asia-Europe). (Adding one vessel to weekly rotations reduces supply by 12%, thus maintaining rates). Successful fuel surcharges in Asia-Europe trades (15%). MEL forecast: Notwithstanding the above, there is presently a 40% gross capital formation (orderbook) and this market situation will not last beyond 2008 (Figures 7 and 8).

Figure 7. Top 30 Carriers

(roughly half of the fleet is chartered)

Source: MDS Transmodal

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Figure 8. Top 10 Container Operators and their Fleet Composition (x1000 TEU)

Roughly half of operated tonnage is chartered. Average orderbook as % of operated tonnage: 40%

Source: BRS-Alphaliner

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Conclusions MEL Forecasts

We are at the doorstep of the onslaught of a severe economic downturn, caused by the collapse of the US real estate market. The 5-year period of economic prosperity (2003-2005) has come to an end. As a result, I expect an overall slowdown of western Economies imports from China. A declining trade demand is coupled with substantial excess capacity in shipping. The result of this can only be depressed freight rates, and a rather long period until shipping markets return to long-term equilibrium.-