The Race to the Bottom

The Economist reports on: Sink or swim.

LIKE unwelcome guests who will not leave, 453 container ships, 11% of global capacity, now float outside the harbours of Hong Kong, Singapore and other South-East Asian ports. They are unwanted by their hosts as well as their customers. In recent days China has quietly let it be known that it wants to rid its territorial waters of these nautical squatters.

Only five years ago huge demand from China meant that all these ships, and more, were desperately needed. This had a dramatic impact first on shipping rates, and then on supply (see chart). Between the end of 2006 and July 2008, shipyards received enough commissions to double the world’s fleet. Now these new ships—more than 9,000 vessels—are taking to the water just as demand has collapsed. The world is awash with ships.

To see how the recent boom and bust has affected value, a Hong Kong broker cites a 150-tonne “Cape class” ship that sold in 2003 for $18.5m in the used market. Critical to the price was the prevailing charter rate, then $15,000 a day. By last summer this had risen to $175,000 a day, and an identical ship sold for $85m. Rates peaked shortly thereafter at $300,000. Today rates are back where they were in 2003. Rather than try to find a buyer for another identical ship, albeit one that needed repairs, the owner dumped it for $7m to be used as scrap.

Orders for new ships have, not surprisingly, collapsed and scrutiny has shifted from what can be bought to what can be cancelled: nothing, it turns out, without great effort. South Korea’s shipyards, the global leaders, have learnt from previous busts. They typically demand 20% up front, a further 60% during construction, and the final 20% payment upon delivery. Walk away and you lose a fortune.

Somebody actually learnt from the past?!?

WOW!!! That's quite a feat. Send out the Nobel committee!

Of course, that just means that somebody's bondholders or stockholders are going to be taking that bloodbath not the shipbuilders.

But the real point is that the world is awash in an absurd amount of excess capacity. It will be more than a decade before this stuff normalizes.

And that in case you didn't notice is also extraordinarily deflationary.