DRY BULKMARKET OUTLOOKShipping Industry Intelligence

2014Q2

newportshipping.com

SECOND QUARTER

Forecasting TurningPoints in Shipping Markets

Handy Size Edition

Harald LoneChairman

Newport Shipping Group

harald.lone@newportshipping.com

Mr. Shipping Market - forecasting turning points in shipping marketsIt is amazing what a few months can do to change leading and knowledgeable shipping figures’ market outlook. In February, bulk owners were optimistic that freight rates had bottomed out and that the market would start a strong recovery in Q2 2014.

A unison panel of shipowners and shipping analysts at the recent Marine Money conference in New York were all “disappointed” that the recovery had not taken place, and the prevailing market outlook was for a soft recovery in Q4 2014. What makes market sentiment change this quickly?

Jørgen Randers and Ulrich Göluke argued in their empirical study “Forecasting turning points in shipping freight rates” that the world shipping markets since 1950 interact in two “balancing feedback loops; a capacity adjustment loop which creates a roughly 20 year wave, and a capacity adjustment loop which generates a roughly 4-year cycle.” Are we at a 4 years cycle turning point? Most of the recent dry bulk boom markets were due to a strong world economy leading to robust demand for shipping dry bulk commodities, and limited tonnage supply. As I wrote in the Q1 report, world economy is undoubtedly the most important and dominant factor regarding the demand for dry bulk shipping. Leading indicators include a multitude of factors such as commodity prices, interest rates, exchange rates, industrial stockpiles and orders, unemployment rates, global geopolitical unrest, and psychology. Every dry bulk trough since the 1950s has been caused by oversupply amplified by a geopolitical or financial event. The shipping boom in 2003 consequently brought massive new building orders and deliveries, which magnified the already weak market following the 2008 financial crisis. Can a prolonged bearish market psychologically hold the market to abnormally low freight rates? During a finance class at Stanford Graduate Business School, I was introduced to the term “Mr. Market” by Nobel Laureate professor Bill Sharpe. “Mr. Market is never wrong” he explained. To think otherwise is a grossly arrogant statement, because Mr. Shipping Market consists of all the brokers, shipping analysts, ship-owners, FFA traders, ship operators, cargo owners, freight traders who make up the market and daily fix ships and cargoes setting the market. They set the market based on supply and demand. But is it a perfect market place? Mr. Shipping Market has endured a 4-year bearish sentiment. Although as Bill Sharpe proclaimed that Mr. Market is never wrong, we are all influenced by the shipping market’s sentiment, and Mr. Market’s struggle between fear and greed. Mr. Shipping Market’s sentiment or tone at the moment seems to be one of cautious optimism, perhaps influenced by Randers capacity adjustment of approx. 4 years cycles. Crowd psychology can be a factor influencing freight rates and fluctuations. Some have tried to quantify how much Mr. Shipping Market is influenced by market psychology, with estimates that this makes up as much as 20-25% of freight rate fluctuations and can trigger large volatility. Important turning points in the shipping market are associated by psychological extremes. Let’s not get paralyzed by bearish psychological sentiment extremes, and instead prepare for this shipping cycle’s turning point.

London, 18th July 2014

Herald LoneChairmanNewport Shipping Group

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Dry Bulk Market Outlook2014 2nd QuarterThe dry bulk markets, especially panamax, supramax and handy size, have not been at the current low levels since the financial crisis in early 2009.

Strong supply growth (10.5% up y-o-y for Panamax) combined with a decline in most of the major coal trades (typical panamax markets) have

pushed spot earnings for panamax to just above $3,000 per day, well below operating cost. Due to correlation and the substitution e�ect, falling

spot rates for panamax and declining soybean, cement, nickel ore and bauxite trades have put pressure on and driven down spot earrings for both

supramax and handy size vessels.

There has been a significant shift in the pace of fleet expansion as scrapping has eaten into slowing deliveries the last few years. Total dry bulk

supply growth has declined dramatically since the peak during 2011 and 2012. Synchronized world economic growth, especially high growth in

China, however, with lower steel intensity, is going to initiate higher import demand to China, especially of iron ore and coal. Despite a slow start of

the year, total dry bulk demand should rise faster in 2014 than in the past two years. However, from 2015 seaborne trade growth will slow due to

reduced construction activity in China and hence, slower iron ore import demand. Relatively strong demand growth and moderate supply growth

should ensure improved tonnage balance during the next couple of years. Consequently, dry bulk freight rates and ship values are likely to

continue to rise, however slowly in 2014/2015 and peak during 2016/2017.

Due to less ordering and more scrapping, the supply growth in the small handy segments up to 30,000 dwt will hardly increase at all over

2014-2016 compared to 30% increase for the total dry bulk fleet. However, due to the ordering in 2013/14, the fleet in the handy segment

30-40,000 dwt will increase by more than 30%. Supported by synchronized world economic growth seaborne trade of handy size commodities

should rise by an average annual growth rate of more than 5%. Supported by improved tonnage balance in both the total dry bulk market and in

the handy segments, freight rates for all handy size segments is likely to rise during the next couple of years.

1. EXECUTIVE SUMMARY

There is a very high degree of correlation and hence, substitution between size classes in the dry bulk market. The smaller segments, handy and

supramax will therefore be strongly influenced by supply and demand developments in the cape size segment, and hence, one cannot analyze the

handy segments without looking at the total dry bulk market (ref. graph below). I.e., seaborne trade of iron ore, a typical cape size market, has a

major impact on the handy segments. In fact, the iron ore and coal trades are more important to handy size freight rates than the minor bulk trades.

However, the minor commodities are important to ensure low downtime and short and optimal ballast legs and hence, ensure strong earnings

development. There is less volatility in the minor bulk trades and consequently less fluctuation in freight rates, especially compared to the cape

size markets. In this report, we will therefore analyze the impact of the total dry bulk market balance on handy size freight rates, the supply

developments in the handy size segments (10-19,999 dwt, 20-29,999 dwt and 30-39,999 dwt) and seaborne trade of minor bulk commodities.

2. HANDY AND DRY BULK MARKET STRUCTURE

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In our analysis we start with the macroeconomic developments, as they determine demand for the dry bulk commodities, and has historically been

one of, if not, the most important factor for the development of the dry bulk markets. Global economic growth is expected to continue to gain

momentum this year and through 2016, however, potentially slow in 2017.

GDP Growth in key economies

3. KEY MACRO-ECONOMIC ASSUMPTIONS

Economic growth in the US is driven by private consumption (70% of US GDP growth) and fading fiscal policy tightening, and is likely to evolve into

a self-sustained expansion the next couple of years. Despite the decline in GDP growth during the first quarter of 2.6%, which was almost entirely

due to an extremely cold winter, the consumer and business confidence are rising and confirming a positive outlook for the US economy.

US: Strong fundamentals driving a self-sustained expansion

The recovery should gain momentum in 2014, but is vulnerable to external shocks and need monetary support. Consumer confidence in a strong

rebound indicates further improvement in consumer spending and economic growth that will also be supported by less restrictive fiscal policy,

declining unemployment, low interest rate and easing credit conditions.

EU: Gradual recovery with main drivers beeing consumption and investment

Rebalancing of China’s economy to a more domestic demand driven economy

should soften but ensure sustainable long term growth. This has materialized

lately with lower growth in investment and industrial production while consumer

spending and exports are expected to increase. Convincing income growth (28%

in Q1 2014), robust labor markets, improved health care system and not at least

supporting measures by the government should ensure private consumption

growth. The economy should also benefit from exports to the improving

economies of the US and Europe.

Synchronized World economic growth is expected to support stronger growth in

seaborne trade of dry bulk commodities and hence, solid demand for dry bulk

carriers.

China: External recovery but softer housing

P3

“Solid demand for dry bulk carriers projected.”

GLOBALGDPGROWTHOUTLOOK

New OrdersNew orders for dry bulk vessels are correlated with spot earnings. The increase in freight rates in the second half of 2013 initiated an ordering

boom with a breathtaking 35.5 Mdwt and 31.0 Mdwt ordered respectively in Q4 of 2013 and in Q1 this year. The current strong drop in freight rates

have initiated a relative significant reduction in ordering activity as preliminary data show new orders in Q2 of 14 Mdwt. The ordering is likely to

slow, but as freight rates are expected increase the next couple of years it is likely that ordering will pick up momentum again in the second half of

2015.

Ordering of the handy vessels more than doubled in 2013 to 7.8 Mdwt, however, this is a much more moderate ordering activity compared to the

other dry bulk segments that quadrupled. During the last two quarters, ordering of handy size vessels was respectively 2.4 Mdwt and 0.7 Mdwt –

only 4-5% of total dry bulk ordering activity. During these two quarters most of the ordering in the handy segment was vessels in the range

30-40.000 dwt.

4. MODERATE SUPPLY GROWTH WILL SUPPORT A CONTINUED DRY BULK MARKET REBOUND

The dramatic decline of deliveries is now behind us. Deliveries of bulk carriers declined from almost 32 Mdwt per quarter in the first half 2012 to

currently just above 10 Mdwt per quarter. Deliveries will remain at this level throughout the year. Due to the ordering boom in 2013/2014, deliveries

in 2015 and 2016 will increase to about 15 Mdwt per quarter, i.e., 60 Mdwt per year. Future deliveries of handy size vessel will remain around 1.5

Mdwt per quarter of, which more than 90% will be in the segment 30-40.000 dwt.

Deliveries

Like with new orders, scrapping activity is also correlated with earnings. Low earnings and low expected earnings lead to increased scrapping.

There are many candidates for demolition. About 126 Mdwt, or 15% of the fleet, is and will become 20 years or older by the end of 2017. In the

handy segment more than 25% of the fleet is and will become older than 20 years.

The dramatic decline in freight rates during the first half of 2014 have initiated more scrapping. In the second quarter scrapping was 4.5 Mdwt, up

1.0 Mdwt from the final quarter last year. However, as the dry bulk market is expected to rebound and continue to rise, scrapping will fall and remain

low throughout the next three years. 20% of dry bulk scrapping is likely to be in the handy segments.

Scrapping

Consequently, Newport expects a significant shift in the pace of fleet expansion as scrapping eats into deliveries. Percentage wise, dry bulk supply

expansion goes from 15% in 2011 and 14% in 2012 to 7.4% in 2013 and a mere average of 5.3% in 2014 and 2015, setting the stage for a dry bulk

market rebound. Handy supply growth during 2014-2017 will be 20%, less than the total dry bulk fleet growth of close to 30%.

P4

Key dry bulk demand drivers are the steel industry and Chinese imports, especially iron ore and steam coal. The steel industry, through generating iron

ore, met coal and steel product trade, is responsible for almost 50% of incremental demand growth. Of the expected increase in total seaborne trade

of iron ore and steam coal, imports to China are responsible for more than 91% and almost 78% respectively.

In 2013, 780 out of the 1580 mill tons (50%) of crude steel produced globally, was produced in China. Roughly 3/4 of the increase in global crude steel

output during 2011-2013 can be attributed to increased output in China. In other words, despite its size relative to total production, volatility in China

has had an even larger impact on the global steel markets. Highlighting yet again that the answer to if we may expect a continued recovery in dry

bulk and handy earnings, still hinges on the assumption on Chinas steel industry. Therefore we will focus on the steel industry in China.

5. THE STEEL INDUSTRY AND CHINESE IMPORTS ARE KEY DRIVERS FOR DRY BULK DEMAND

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Steel production in China started 2014 on a soft note. However, preliminary data for production in June indicate a record level of 880mt, up 13%

y-o-y. This brings the first half up 4.3% on last year. Chinese policies have already been announced that support a continued expansion of the

economy in general, and of the steel sector specifically. Of course, given that construction is roughly half of domestic steel demand, developments

in construction will have to support demand in order for crude steel output to grow. In 2014 and 2015, continued economic growth, infrastructure

investments construction, supported by urbanization of 25 million people annually, will drive steel production by respectively 5.3% and 6.0%, which

is well below the growth of 9.3% in 2013. However, in 2016 and onwards, expected measures to cool o� the real estate market will eliminate

growth in construction. Hence, Chinese steel production could fall to only 4.0-4.5% annual growth.

Chinese crude steel output forecast

Chinese iron ore imports in Q1 2014 were up 15% y-o-y to 906mt annual rate, well above our forecast of 835mt. This was due to stock building in

the first quarter rather than a normal seasonal stock draw seen the last 4-5 years.

There is a strong technical relationship between steel production and input of iron ore. Hence, steel output defines the need for iron ore, which

can be produced domestically or imported. Due to falling Fe (iron content in the iron ore) since the end of 2006 almost all of the increased iron ore

needed in steel production has come from overseas iron ore. Domestic iron ore production is expensive. Low and declining international iron ore

prices will likely lead to falling domestic iron ore production. Consequently, imports will have to both meet increasing demand and replace falling

domestic production of iron ore. Chinese imports of iron ore is expected to increase from 824mt in 2013 to 1150mt in 2016, which is about 100mt

each year, or 13% annual growth.

Iron ore imports to China

With a large increase in iron ore imports to China, supported by increases in iron ore to the EU, Japan and Other Asia as well, seaborne trade of

iron ore is expected to increase by 9% on average during 2013-2016, of which 92% will be imports to China. Most of the increased trade will come

from Australia and Brazil.

Iron ore, total seaborne trade

Besides iron ore to China, steam coal to China is the second most important trade driving dry bulk demand. Coal is the source of almost 70% of

Chinas energy consumption, and will continue to be the major source of energy in our forecast horizon. During the first quarter this year, however,

coal imports to China were down 3mt compared to expectations of a strong increase during the first half of 2014. Total seaborne trade of coal was

down by almost 45mt during the first quarter, most likely due to falling coal prices. The decline in coal trades is one of the main reasons for the first

half weakness of the panamax, supramax and the handy size segments.

Half the coal consumed in China was used in thermal electric power generation. The continued focus on curbing energy consumption in the 12th

Five-Year-Plan contributes to our assumption of a lower rate of growth in our forecast period. Coal consumption is expected to increase by about

210 million tons each year on average during 2014-16. According to announcements from the NDRC, coal output growth is to be reduced

dramatically. In light of these announcements and despite the slow start of 2014, the more than 50mt per year increase of coal imported to China

from end 2013 to end 2016 may be moderate.

China coal imports

P6

Indonesia imposed a ban on Bauxite, nickel ore and some concentrates which came into e�ect in January 2014. Nickel ore, concentrates and

bauxite were a fair component of the Southeast Asian handy and supramax markets and hence, the ban had a negative impact on these markets.

Approximately 60 MT of Nickel ore and Bauxite exports could have been a�ected by the ban. Despite an increase in grain and steel product

trades, typical handy size trades were down about 60 Mt.

Handy size demand, which is seaborne trade of minor bulks, grain, steel products and cement, are also dependent on world economic growth.

The financial crises lead to a decline of 6% in 2009 of these handy related commodities. The strong economic recovery 2010 generated a

substantial rebound in seaborne trade of minor bulks and other handy size commodities of 13%. With synchronized world economic growth going

forward, seaborne trade of handy commodities is expected to rebound to 9% in 2014, and then continue at a healthy average annual growth of

almost 6% during 2015-16.

Handy size demand – Minor dry bulk commodities

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TOTAL DRY BULK DEMAND

Summarizing total seaborne trade measured in million tons,

including other dry bulk commodities such as Met Coal, Grains,

Soybeans, Steel Products, Cement and other minor bulks, we

expect demand to pick up after two moderate, on slow world

economic growth, years 2012 and 2013 of respectively 6.3 and

6.1% growth. World economic recovery will drive up seaborne

trade to almost 9% in 2014 and then continue at around 7%

annual growth.

The slowing long term growth is mainly due to 2014 being a recovery year and

reduced construction activity in China and hence, slower iron ore import

demand. Due to longer average haul for dry bulk commodities, total demand

for dry bulk carriers (measured in dwt) will rise by about 1-2%-point faster than

seaborne trade.

“Seaborne trade up almost 9% in 2014.”

P8

As earnings in the dry bulk segments are highly correlated, we need to analyze both the total market balance and the specific segment balance in

order to forecast future freight rates (ref. graph in chapter 2). After a substantial decline in the total utilization during 2010 through 2012, the dry

bulk markets rebounded in the second half 2013. The dramatic decline in supply growth and the anticipated growth in Chinas imports of iron ore

and steam coal drove up the market balance from 77% in the first half 2013 to almost 83% by the end of 2013. During the first quarter this year, the

dry bulk market balance dropped to 80% as demand declined and supply increase. Freight rates for all dry bulk vessel decline from relatively

strong levels during the final months of 2013. This was an expected development, but that the softness continued into and throughout the second

quarter came as a surprise.

After a soft start of the year, the dry bulk market balance is expected to rebound in the second half of 2014 and continue to rise through 2016, when

the total dry bulk market balance could peak at 90%, with peaks during the fourth quarter of close to 94%. This will drive up freight rates for all dry

bulk segments. The balance for vessels below 100 000 dwt (the handy, supra and panamax segment) are expected to rebounding from the

current low levels, and will reach 88% in 2016 with fourth quarter peak of 91.5%. This will support a rise in freight rates for handy size vessels.

6. DRY BULK MARKET BALANCE AND FREIGHT RATES

7. FUTURE FREIGHT RATES Handy size spot earnings is expected to recover and rise from the current relatively low levels during the second half of 2014 and peak in 2016 as

dry bulk demand will outpace supply growth during the next couple of years. A turning point could materialize in 2017/2018.

8. NEWBUILDING AND SECONDHAND PRICE FORECASTThe utilization of ship building capacity during 2013, combined with a dramatic increase in ordering activity and improved freight rates have

supported a strong rise in newbuilding and secondhand prices during especially the second half of 2013 and the beginning of 2014. Values could

come down during the second half of 2014. The ordering activity has fallen in response to the market softness and the breather in ordering could

last thorough the first half of 2015.

The expected rise in freight rates in the dry bulk and other shipping markets will lead to a further rise of newbuilding price in 2015 and 2016.

Consequently, newbuilding and secondhand (10 year old vessel) prices for handy size bulk carriers will rise and peak during 2016/2017 close to

respectively USD 26-27 million and USD 19 million.

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"Newport Dry-Bulk Market Outlook" is published quarterly by Newport Shipping UK LLP. This report reviews dry-bulk supply&demand with a special focus on the handysize vessels, commodity news and important developments in the markets and provides insight to Newport's outlook as to the future of the vessel prices and freight rates

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EDITORIAL BOARDHarald Lone, Cpt. Aykut Yilmaz, Cpt. Aylin Coskun

We would like to take this opportunity to thank Robert E. Stenvik and the Viamar team for their invaluable support and professional guidance every time we are in need of assistance with hard-to-access data and outlook of the shipping industry. We truly appreciate all your help.

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