The gas transportation market review, 2004

GETTING BETTER AND SET FAIR FOR 2005
Market reviews in all shipping sectors currently paint an unusually rosy picture and talk of new market paradigms abound. If some are to be believed, the bulk shipping industry is entering a new Shangri-La where eternal wealth rather than youth is on offer.

The more sober world of the semi-refrigerated gas market may not be scaling the heady heights of the dry bulk and tanker sectors, but in 2004 the doldrums of recent years have been banished. Whereas our review of 2003 described only stuttering improvement, this year no qualification is required.

The freight markets for all semi-refrigerated and ethylene segments have improved in 2004. Semi-refrigerated gas carrier freight rates have improved consistently across the board - by up to 50 per cent year-on-year in some segments.

While spot rates are by definition intermittent and erratic, a better reflection of underlying confidence is the time charter market and brokers have reported positive TC indications. For semi-refrigerated tonnage, these are up by as much as 50 per cent - approaching US$500,000 per month for an 8,000 cbm ethylene ships - and up to US$650,000 per month for 15,000 cbm semi-refrigerated ships.

INDUSTRAL RECOVERY SPURS TRADE
The improvement was not unexpected, but is not any less welcomed by shipowners for its predictability. Trade in chemical gases has increased on the back of strong demand from the industrial sector, which has sharply increased chemical consumption across the globe.

OECD economies have seen industrial production rocketing in recent months and output in Japan, Germany and the US has regained peaks last attained in the internet-fuelled boom of 2000.

While this has brought much-needed relief to these areas, it pales into insignificance compared with growth in China and the rest of emerging Asia.

Timely consumption figures for 2004 are still awaited, but a reasonable proxy is a rapid increase in chemical prices at a time when production capacity is rising and operating rates increasing. Prices for all feedstocks, chemicals and plastics have soared. To take just one example, South East Asian VCM prices exceeded US$700 per tonne late in 2004, compared with an average of less than US$500 per tonnes in 2003.

High gas prices have produced plenty of arbitrage opportunities and spurred trade for all the chemical gases. Ethylene trade has been especially strong, with Europe short all year as a series of unplanned outages reduced local supplies. Much of this has been met from the US, with support from the Middle East and, latterly, Asia.

Sporadic bursts of trade East-West, West-East and Transatlantic all added to the positive tone. As a result, the market escaped any sort of seasonal downturn in the third and fourth quarters.

Asia proved an active draw for butadiene and propylene from the Atlantic in the autumn, with both US and, to a lesser extent, European producers getting rid of surplus product to the region. VCM also provided healthy employment in August and September, with large cargo lots moving from the US to South East Asia and Australia.

Conversely, in November and December a number of ethylene cargoes provided backhaul employment out of South-East Asia to Europe due to major disruptions to ethylene distribution in Europe as a result of unplanned cracker shutdowns.

STABLE SUPPLY, PLATFORM FOR GROWTH
The stimulus given to freight rates by trade has been enhanced by an unusually favourable supply side. 2004 will see only 15,000 cbm delivered, while less than 10,000 cbm will be added next year.

Supply-side pressures will be limited over the next eighteen months due to a limited order book and limited new building capacity. The only significant new building order of 2004 emerged in December and illustrated the lack of near-term shipbuilding berths. Lauritzen Kosan ordered four 8,000 cbm ethylene ships in Korea for delivery from the end of 2006 and through 2007.

With scrapping being maintained at 40,000 cbm this year - and set to exceed deliveries next year - we expect two years of fleet contraction to provide a sturdy platform for further tightening supply:demand balances.

CHINA BOOM: SOFT VERSUS HARD LANDING
With such unprecedented stability on the supply side, the only cloud on the horizon would be a sudden derailment of the world economy – or, more specifically, a sudden derailment of the Chinese economy.

Although China does not exert a great deal of direct pressure on chemical gas market, it is a key driver of industrial production across the globe at present.

China continued to dictate the pace of the world economy during 2004, despite mounting concerns over a hard landing for the Chinese economy and the potential repercussions for shipping markets. Fears of overheating prompted the Government to introduce cooling measures, but three consecutive quarters of gently slowing growth point to a soft landing rather than a crash, with China continuing to drive the shipping market forwards over the medium term.

The first interest rate rise in nine years marks another step in the long journey towards a market-based credit system in China. But, given the parlous state of the banking sector, this transition still seems a long way off. The Government claims that 13 per cent of bank loans are bad, but observers think that ratio could be four times higher.

This means China could be exposed to a hard landing on two related fronts - an economic collapse and a banking collapse. Therefore, a controlled slowdown in China cannot be taken for granted. Our central forecast assumes Chinese GDP growth of 9.1 per cent in 2004, slowing to 7.9 per cent in 2005.

However, we have raised prospects in the years approaching the Beijing Olympics to peak at 8.4 per cent in 2008.

Another major risk to the world economy is sustained high oil prices. Economists generally use an approximation that a sustained US$10 per barrel rise in one year shaves about half a percentage point off global growth in the following year.

A rise in energy prices feeds directly into producer prices and then into consumer prices - often filtering down into ‘secondary’ knock-on effects, such as further expectations of inflation and higher wage demands. Benchmark oil futures actually rose by more than US$10 per barrel in the third quarter alone and almost US$25 since the start of 2002. This partly reflects a cyclical increase in demand for oil, particularly from booming China.

In late 2004, the price of crude oil has ranged between US$40-55 per barrel and is forecast to average US$37.6 per barrel for the year as a whole. For 2005, the oil price is expected to soften from current high levels as the year progresses in response to slowing oil demand and rising oil supplies. As a result, the oil price is forecast to average US$37.9 per barrel in 2005, falling to US$30.4 per barrel in 2006. Thus, we ascribe only low probability that sustained oil prices will destabilise the economy in 2005.

SUMMARY AND OUTLOOK: A ‘NORMAL’ BOOM
Barring major shocks to the global economy, the outlook for the small-gas-carrier market looks increasingly positive, as indicated by the recent boom in time charter rates for these ships.

For this reason, Maritime Strategies International (MSI) remains fundamentally bullish about the market in 2005. 2006 may be considered an each-way bet given the inherent uncertainty in the world economy, but in our view only the most committed gambler would risk his shirt on 2007, given the re-emergence of fleet growth and the likely onset of an economic slowdown.

Despite the ever tightening supply:demand fundamentals, the structure of the chemical industry will act to prevent a boom in LPG carrier rates of the type being experienced by the bulk shipping sectors – and for three main reasons. First, the tight interplay between basic and intermediate chemical production means most capacity for the former is not physically remote from downstream capacity, in contrast to raw materials that serve the bulk shipping sectors.

Second, investment in new, basic chemical production is constrained by high investment costs and long lead times. In contrast, additional supplies of raw materials such as iron ore can be extracted at low incremental cost.

Third, chemical industry economics often means that demand will go unsatisfied by the imbalance between feedstock costs and producer prices. This, along with the tight interplay between production and consumption of primary chemicals, precludes another key ingredient in creating super-heated shipping markets - port congestion.

NEW BUILDING PRICES REGAIN RECORD LEVELS
Phenomenal freight markets for bulk vessels and a general scarcity of new building berths have caught up with the gas carrier sector - and the recent orders by Lauritzen Kosan set a benchmark price for ethylene carriers above US$30 million. This was a substantial mark-up on the low-point of US$21 million in 2001/2 and close to the peak of US$35 million in 1990. With the pressure of these factors, we expect new building prices to remain at these levels over the next six-to-nine months. Thus, we have shifted the top of the current cycle to 2005, though we do not anticipate another price leap next year given the weaker outlook for bulk and tanker freight rates which will take pressure off at the top of the new building market.

The last time new building prices hit such a high level it was a prelude to a prolonged period of decline, due to rising shipyard capacity and falling shipyard costs.

Although much has changed since the early 1990s, there are nevertheless worrying signs for owners ordering at current levels - some of which are similar to those of the 1990s. Primarily, shipbuilding capacity remains on its upward march, with China leading the way.

Second, shipbuilding costs having rocketed upwards by at least 30-40 per cent in the last year or so, are poised to go sharply into reverse as the global economy cools and raw materials prices go into decline.

Finally, shipbuilding demand cannot continue to grow at current rates. Indeed, it is almost certain to fall over the next five or six years. By contrast, production rose to 24 million gross tonnes from 14 million gross tonnes between 1992 and 1998. Without the support of rising output, the outlook for new building prices over the next few years is weak.

After a period of retrenchment in both the shipping and shipbuilding markets, a positive aspect will return at the end of the decade, but the scale and shape of the next peak will be different. A key aspect of the current boom has been synchronised surges in contracting across almost the whole spectrum of deep-sea cargo shipping.

The next upturn is likely to be more haphazard, as different market drivers no longer generate tandem cycles. Peaks in the tanker, bulk dry cargo and container markets will become more disconnected. From this perspective, future new building price peaks are likely to be less pronounced, though more prolonged.

ASSET VALUES GET DOUBLE PUSH
The push on asset values from new building prices is being augmented by rising freight rates and market expectations.

A large number of semi-refrigerated ships changed hands in 2004. Most of the ships that changed hands last year were ‘en bloc’ sales or company acquisitions, reflecting the lack of one-off sales candidates. First, and most notably, Camillo Eitzen took control of Bergesen’s fleet of seven ethylene ships via a KS vehicle. These ships remain within the MNGC/Skandigas pool and so did not precipitate a major change in the control of the fleet.

Eitzen further enhanced its fleet by snapping up all the shares in Gibson Gas tankers, thus taking control of a further four semi-refrigerated ships.

Benchmark prices soared. Thus, the value of a three-year old, 8,000 cbm ethylene ship was put at US$29 million in December 2004, while just US$22 million a year earlier. Asset values will remain high during 2005 and into 2006.

SUMMARY
The gas carrier industry is benefiting from an unusually favourable
set of circumstances. Last year was excellent for the sector and it is set fair to be even better in 2005. Indeed this year is shaping up to be the best in a decade. However, as in any cyclical shipping market, it would be unwise to proclaim a new dawn just yet.