EastGate Report: Chinese macroeconomic trends and their impact on the dry bulk freight market

The freight market is making history galloping at decade highs, with especially the capesize segment producing some dazzling fixtures these past few weeks, while the Chinese celebrations for the National Day and the festivities for the Golden Week did not put a break on the upward momentum.

Average spot rates for capesize bulkers are approaching the hefty US$87 000/d mark, while the Baltic Capesize Index has surpassed the 10 000 points threshold, for the first time in 13 years. The Baltic Dry Index is following the same upward trajectory. This comes at a moment in time when more than 2400 bulkers (or 21% of the fleet) are caught in port congestion worldwide, pressuring the available tonnage supply and driving the freight cost to a steady increase.

Concerns on China growth

Amid a dry bulk freight euphoria, China is undergoing a power supply shock, the Evergrande crisis is looming and credit has tightened allowing for many speculations with regard to the course of the Chinese economy.

Goldman Sachs has lowered its growth forecast for the Chinese economy to 7.8% (from 8.2% previously) on the basis of significant energy shortages. Meanwhile, the official Manufacturing Purchasing Manager’s Index has registered a decline (49.6 in September compared to 50.1 in August) which illustrates a contraction in China’s manufacturing activity for the first time since the early stages of the pandemic back in February 2020.

At the same time, many bets have been placed on Beijing eventually bailing out its second largest property developer, Evergrande which is heavily indebted. The voices that warn for a possible collapse of the group, however, remain loud. The latter scenario would entail an unavoidable ripple effect in the Chinese housing sector and a slowdown in the country’s economic growth.

Whether policymakers will eventually decide in favour of bailing out Evergrande, to prevent the larger impact its fallout would have in the economy (real estate accounts for 7.3% of China’s GDP with a much larger cluster of industries directly affected by it), is yet to be determined.

In the midst of this admittedly challenging economic landscape, a claim that China’s credit growth has bottomed and it could be seen rebounding, albeit modestly, in the last quarter of the year, gains substance. Furthermore, the likelihood of more intensive issuance of governmental bonds, directly related to infrastructure projects, is high, fuelling speculations that China’s credit impulse can turn positive towards the final stretch of the year.

Iron ore bull market nearing an end?

China’s unstable property and construction landscape in tandem with the country’s consistent efforts to curb steel production, tame demand for iron ore and control its price, have made the red alloy subject to heavy volatility.

Iron ore has been trading in a tight range of US$100 – US$120/t, levels not seen since July of 2020. The spot CFR price for delivery to China soared between April 2020 and July 2021, when it neared US$230. During 3Q21, however, its price sank by 49%, the first quarterly loss since 1Q20.

There is indeed an element of a ‘demand shock’ for iron ore, which should not be overlooked; China’s decarbonisation goals, a weak property market and restrained output from local steel mills due to the ongoing electricity shortage, can have an acute impact on the commodity’s demand.

The energy-driven decline in steel output and China’s changing economy hint that the iron ore commodity market is very likely to face greater volatility going forward. Its current price point, however, still generates healthy profit margins for major miners who are upping their production, obviously incentivised to sell as much as they can.

Indeed, Chinese iron ore imports have remained elevated as supply recovers. China’s ore imports in September are estimated at 111 million t, up 14% m/m. Overall, the supply side of the alloy appears recovered compared to earlier in the year, when we saw weather disruptions in top exporter Australia and coronavirus outbreaks in number two shipper Brazil. Iron ore exports of the Brazilian giant, Vale, are accelerating pace during the last quarter of the year, expected to positively affect tonne-mile demand for the larger asset class of capesize, being the vehicles that primarily transport the commodity. Beijing’s Green push.

The Chinese authorities are intensively trying to meet their annual carbon reduction targets and are also trying to limit pollution levels ahead of the Winter Olympics which will take place in February 2022.

Further, the authorities have been pushing steel mills since early July to implement output and capacity curbs and have clearly laid out the goal: full year’s 2021 crude steel production must remain at least flat (if not sub) to last year’s record output of 1.065 billion t. In order for the target to be achieved, Chinese steel output needs to be significantly restrained compared to the production of 1H21. Already in 3Q21, China’s steel production dropped by 12% q/q and it is reasonable to expect a similar trend for 4Q21.

It is almost self-evident that the policies the Chinese authorities have rolled out to control steel output and subsequently demand for the raw steelmaking ingredient of iron ore (release of domestic reserves, waving of tax levies for scrap imports, cancelling steel export tax rebates), combined with the country’s intensive efforts for pollution reduction and a weak property market, can negatively affect (seaborne) demand for iron ore.

The power supply crisis – a bull for coal

China and India are both undergoing a severe power supply crisis with many provinces facing electricity shortages signalling augmented seaborne imports in the near-term.

This phenomenon of serious electricity shortage has been triggered by a clash between the resurgence in industrial growth and the rebound in energy demand vs tight commodity supply, rising coal and gas prices and expensive freight costs.

Chinese coal inventories currently stand at a 10-year low and state-owned miners have been instructed to produce coal at full capacity for the rest of the year and concurrently boost coal imports to secure energy supplies ‘at all costs’.

The country’s power demand has increased by almost 15% this year, but its domestic coal supply is up just 5% YTD. At the same time, China has been paying the price of its effective ban on Australian coal while supplies from Indonesia, its biggest overseas coal supplier, have been hampered by persistent rainfall and those from Russia hindered by rail and port constraints.

It is telling that in an effort to tackle the severe power shortage, recent reports have come to light indicating that China is releasing some of the Australian coal previously stranded at Chinese ports. Meanwhile, during September, a total of five vessels discharged approximately 383 000 t of Australian thermal coal in China and, in the first week of October, China imported its first coal shipment from Kazakhstan.

In parallel, Indian utilities are struggling too as inventories have hit critical lows after a surge in power demand. Over half of India's 135 coal-fired power plants have fuel stocks of less than three days and the country is now competing against buyers such as China, to ramp up imports.

What all that essentially means, is that seaborne demand from the world’s two largest coal importers, China and India, is going to become elevated, especially so during the coming winter season when heating demand is augmented, thus EastGate expects it to trigger significant tonnage demand.

Prospects

The well documented ‘frenzy’ in the dry bulk shipping sphere has admittedly created a generalised positive psychology for market participants and industry players, also reflected in the futures marks and some strong period fixtures reported across the board.

It is this time though that EastGate feels a balanced opinion, which factors in all the important metrics, can bring actual value to the industry stakeholders. Evergrande’s debt crisis may not be a Lehman moment, but it is a growing problem in China and there are equally growing concerns for the negative impact it can potentially have on steel demand.

Nevertheless, there are indeed bright signs that justify reasonable hopes for the future as more plans on Chinese infrastructure investments will benefit tonnage demand. Chinese cabinet approved in September the 2021 – 2025 plan for infrastructure investments and the spending on infrastructure could reach ¥10 trillion, or US$1.5 trillion, over the next five-year period. Furthermore, the current energy matrix brings coal demand back in vogue and is expected to support seaborne volumes.

If dry bulk shipowners remain disciplined in their newbuilding ordering (the high-earning container market with its extremely high contracting activity is not a good example), healthy profit margins can be sustained for a significant period of time. The big challenge for this China-centric industry comes from the steel production curbs and decarbonisation targets that could weigh on seaborne imports of major dry commodities and, consequently, soften the performance of the freight market.

One thing to keep in mind is that the Chinese government has proved to be incredibly powerful and has traditionally followed a pattern of injecting its economy with stimuli, with the objective to accelerate the pace of the economic growth. Despite its very real efforts to limit steel production and control iron ore demand, one has to remember that China would not want to eventually hurt its economy and lead it back to depression and new measures taken to that end will sustain moderate economic growth and underpin profitability for the dry bulk shipping sector.

Read the article online at: https://www.globalminingreview.com/special-reports/08102021/eastgate-report-chinese-macroeconomic-trends-and-their-impact-on-the-dry-bulk-freight-market/