; Its impact on shipping in the last decade and the next China Marintec, Shanghai 7 th December 25 Professor Dr Martin Stopford, Managing Director, Clarkson Research Services Limited
China in Transition; Its impact on shipping in this decade and the next Marintec Shanghai 7 th December 25 Dr Martin Stopford The sudden expansion of Chinese seaborne trade, which started exactly ten years ago in 1995, triggered the fourth wave of regional development which the shipping industry has had to deal with over the last fifty years. So this development cycle has been enormously profitable for shipowners and expensive for cargo shippers, but a careful analysis of previous development cycles shows how vulnerable the shipping business is to the mismanagement of resources which extreme market growth can trigger. This paper draws the parallel between the latest development cycle and the Europe-Japan cycles of the 196s and highlights the lessons to be learnt. 1. Introduction The world is constantly changing and somehow the shipping industry has to produce the right amount and mix of ships to carry that trade efficiently. That sounds simple enough, but past errors have had a devastating effect on the companies in the business. Change comes in many forms. New commodities and new technologies are important, but over the last 5 years perhaps the biggest single source of change has been regional. China is just the latest in a succession of regions to join the global economy over the last fifty years, and this has created all sorts of challenges for the shipping industry. My aim in this paper is to put the recent growth of the Chinese trade into the context of earlier regional development cycles and to assess its impact on shipping in the last decade and the effect it may have in the next. 2. Building the global economy In the last fifty years the world economy has been transformed from a collection of closed economic zones dominated by the European and Sino-Soviet empires, to a system of free Figure 1: Regional import cycles Bn tons trade between more than 1 independent 195-25 imports countries. This evolution introduced a 2.5 Europe period of almost continuous change as the Japan European empires were dismantled in the 2 S.E..Asia 195s, the soviet empire in the late 198s China and as China joined the world market in the 1.5 199s. The impact on shipping was profound, triggering four consecutive waves of seaborne trade growth, spread at ten to fifteen year intervals between 1955 and 25 (Figure 1). The first came in the 195s as Europe dismantled its colonial system and rebuilt its economy after the war around 1.5 195 1955 196 1 2 3 4 1965 197 1975 198 1985 199 1995 2 12/12/25 2 Martin Stopford, Clarksons
the principles of free trade established at the Bretton Woods conference in 1944. A decade later in the early 196s the Japanese economic miracle produced a decade of growth during which Japanese imports reached 6 million tons Both regions used a business model based on carefully planned development of domestic industry and infrastructure, using bulk shipping to import high quality raw materials, especially for the steel and energy industries. Each wave generated rapid trade growth as the economy became established and much lower growth as it matured - this change of pace is very clear in Figure 1. As the growth of Europe and Japan halted in the early 197s, a similar pattern of development was started by South Korea and the Asian Tigers (see Figure 1) and their imports grew rapidly from 3 million tons in 1975 over 1.2 billion tons in 1995 when China started along the same path, with imports reaching 5 million tons in 25. 3. The shape of trade development cycles The last three waves of seaborne trade had a distinctive pattern, illustrated in Figure 2, and studying their causes provides a useful starting point for reviewing China s trade today. These waves are sometimes referred Trade Development Cycles (TDCs) and they are driven by the different stages developing economies go through as they grow. At the development stage the focus is on the rapid growth of resource intensive activities such as steel, and construction, then as stocks are built up demand moves on to more service orientated activities and bulk trade volumes stabilize. The process as follows: economy undeveloped Stage 1 Pre Industrial China? Resource intensive growth Stage 2 Transitional Stage 3 Mature As the economy develops through stages 2 and 3 the demand for raw materials such as oil, iron ore, coal, nonferrous metal ores and forest products increases as the industrial infrastructure is built up. If raw materials are not available locally they must be imported, as must the more sophisticated machinery, and paid for by exports of manufactures and any primary exports which are available. The reconciliation of domestic and foreign markets thus forms a basic requirement of growth at this stage. Assembly industries, shipbuilding and automobiles are frequently developed as lead export earners; a pattern set by Japan in the 195s and subsequently followed by South Korea and several other countries. 1 Although the pattern is clear enough, in practice is that it is very difficult to predict the turning points. This is precisely the problem we have today with China, a massive economic force which is somewhere on the steep slope of its development cycle. 1 Value added growth 2 For the shipping industry the key issue is the timing of the two turning points Source: Maritime Economics martin Stopford (1997) Development cycle turning point Figure 2: The trade development cycle 1 Stopford, Martin (1997) Maritime Economics Routledge, London 12/12/25 3 Martin Stopford, Clarksons
4. The management of transport capacity 195-25 Previous TDCs confronted the shipping industry with a complex supply management task which, with the benefit of hindsight, it did not handle particularly Phase 1 195s & 6s well. For example the rapid trade growth 9 Growth coordinated by caused by the European and Japanese 8 shippers TDCs in the 195s and 196s ended with 7 an investment bubble in the early 197s 6 that left the industry under a cloud for twenty years. As we move through the 5 Chinese TDC, shipping investors would be 4 well advised to consider how these past 3 mistakes can be avoided in future. 2 1 The problems caused by the previous TDCs are illustrated in Figure 3 which compares the growth of ship demand (the blue line on the right axis) and the growth of the world merchant fleet (the bars on the left axis). Figure 3: Supply/demand 1963-25 M. Dwt Fleet Bill. Tons Cargo Phase 2 2 Year Shipping depression 1963 1966 1969 1972 1975 1978 1981 1984 1987 199 1993 1996 1999 22 Tankers Combos Bulk carriers Other Demand There were three different phases. During Phase 1, which lasted until the late 196s, the growth of trade and the fleet were closely coordinated, but in Phase 2 which started in the mid 197s trade and the fleet diverged and did not converge again until 1997. In other words there was a 2 year period of overcapacity in the shipping industry. Finally in Phase 3 trade seems to be pulling ahead of the fleet, creating one of the best booms in the shipping industry s history. The protracted imbalance did not happen by chance. It was the result of changes in the factors driving shipping supply and demand. During the 195s and 196s the European and Japanese steel mills and oil companies regarded shipping as a core business activity to be carefully planned. They invested heavily in their own fleets or, to save costs, subcontracted transport to shipowners such as YK Figure 4: Cargo owners managed supply Pao (see Figure 4 right) through long-term time charters. The result was a planned flow of ever larger ships to carry the rapidly growing sea trade, and the co-ordination of supply and demand was excellent (Figure 3). The logistics system developed in the 196s, especially in the oil business, has never been matched since for sheer efficiency in the use of ships.. Phase 5 2-5 Boom 7 6 5 4 3 2 1 By the end of the 196s this period of coordinated system of shipping investment started to show signs of strain. The careful planning relied on the ability of the steel and Hong Kong owner Y K Pao signing his first newbuilding against a Japanese timecharter 12/12/25 4 Martin Stopford, Clarksons
oil companies to predict demand, which worked fine during the Stage 2 phase when growth was regular but broke down when they came to the turning point in the TDC. Most forecasts wrongly assumed growth would continue indefinitely. For example in its December 197 forecast the OECD commented We possess the experience of a quarter century of uninterrupted growth. This record points to the existence of strong forces built into modern economies favoring growth 2. For the shipping industry this optimistic economic outlook was reinforced by a series of three freight market spikes (see Figure 5) which made shipowners trading on the spot market enormous sums of money. These spikes allowed owners to accumulate equity and bank credit was easily available as the Eurodollar market grew and banks were keen to lend to good customers. The plentiful supply of good quality time charters during the 195s and 196s had established shipping as a strong business segment and the concept of name lending had evolved. With such a positive economic outlook, independent shipowners decided to "to go-italone" on the spot market. Shipping banks were prepared to back them and lend against the unsecured asset value, so the availability of timecharters was no longer a constraint on investment. These circumstances triggered an investment bubble and Figure 5 shows that during the third and biggest spike in 1973 shipowners ordered an additional 12 m dwt of Million Dwt 8 7 6 5 4 3 2 1 1963 1966 Investment bubble Figure 6: The shipbuilding & scrapping cycles 1963-25 Deliveries 61 m dwt in 1976 1969 1972 1975 1978 1981 1984 Deliveries Scrapping 2 OECD (197) The Growth of Output 196-8, Paris page 8 27 Year Cycle Distress scrapping Orders 12 Figure 5: Tanker Orders & Rates 1963-75 1987 199 1993 1996 1999 Another investment bubble? Last phase of 197s scrapping! Deliveries 7 m dwt in 25 22 25 12/12/25 5 Martin Stopford, Clarksons 1 8 6 4 2 Orders Tanker rates Suez closure 1967 1973 Boom Oil crisis Oct 1973 1963 1965 1967 1969 1971 1973 1975 1977 W/S 45 4 35 3 25 2 15 1
tankers in a single year (for perspective, at the start of 1973 the tanker fleet was 193 m dwt). By 1976 world shipbuilding deliveries had increased to 61 million dwt, a level not reached again until 24 (see Figure 6) and by 1978 the world merchant fleet had shot up to 6 million deadweight tonnes (Figure 3). Unfortunately just at this point demand stopped growing. World seaborne trade had peaked at 3.2 billion tons in 1974 and was still 3.2 billion tons in 1984 (Figure 3). A decade later Peter Beck, Shell UK s Planning Director commented in a retrospective study When looking at the forecasts made in the late 196s and early 197s, one can find many failures, but few successes. Indeed one may be shocked at the extent to which the most important forecasts and their surrounding assumptions turned out to be wrong 3. There were two reasons why the forecasts were so wrong. One was that they did not anticipate the turning point of the European and Japanese Trade development cycles which were reached in the early 197s. The second was that the rapid expansion of the European and Japanese economies had put pressure on the world s primary resources, leading to pricing problems which accelerated the change. OPEC, the oil producer cartel founded in 196, became increasingly active and the oil embargo introduced in October 1973 triggered an oil price increase to $1/bbl, followed in 1979 by the Iran revolution which pushed prices up to $38/bbl. These price shocks triggered two major recessions in the world economy and a collapse of the oil trade which fell by 2% in the early 198s. The result was disastrous for shipping and inefficient for the world economy. Many of the ships built during the 197s shipbuilding bubble spent their early years in lay-up, and some were scrapped when there were only two or three years old. Bankers wrote off billions of dollars of loans and many shipping companies were reduced to near destitution. The conclusion is that the rapid growth generated by trade development cycles, when combined with liquid investors, easy credit, and demand instability can have disastrous effects for the shipping industry. We need to be careful. Today the industry is at last back in balance, with approximately the right volume ships for the cargo to be transported, and China, is moving through its development cycle. So far the effect has been entirely beneficial for shipowners, but there are some disturbing parallels with the 197s. The three market peaks of the last seven years bear an uncomfortable resemblance to the three peaks of the 197s and we have seen the same sort of extreme ordering activity (Figure 7); the shipyard capacity is well past the 1976 peak, with more on the way (Figure 6); and shipping investors are very liquid. So should 3 Peter W Beck (1981) Corporate Planning for an uncertain Future page 3 14 12 1 8 6 4 2 Fig 7:Orders & Rates 1995-25 Orders M dwt Earning shown by Clarksea index Orders Tanker rates Peak 1 Peak 2 Earnings $/day Peak 3 1995 1996 1997 1998 1999 2 21 22 23 24 25 35 3 25 2 15 1 5 12/12/25 6 Martin Stopford, Clarksons
Fig 8:China's Trade Development Cycle Mt 4. Investment 65 Sea Exports overheating? 6 55 Sea Imports 5 3. Asia 45 Crisis 4 2. Trade setback 35 takes off 3 in 1994 25 2 1. Internal 15 reforms 1 5 198 1982 1984 1986 1988 199 1992 1994 1996 1998 2 22 24 Billion Tons trade Figure 9: China s share of sea trade World less China China Imports 8 7 Chinese 6 imports 5 4 3 2 1 195 1954 1958 1962 1966 197 1974 1978 1982 1986 199 1994 1998 22 2% 18% 16% 14% 12% 1% 8% 6% 4% 2% % China's share of sea imports % we be worried? To answer this question we need to look at China s growth both internally and in a world context. Then we must match it with the investment trends. 5. China in Transition It is exactly 1 years since Chinese trade "took off" - the trends are shown in Figure 8. By the early 199s China s import trade had edged up to 1 million tonnes, but was still globally insignificant, accounting for only 2% of seaborne imports (Figure 9). However the internal reforms of the early 199s, comprising the liberalization of the financial system; the decision to open the country to foreign investment; and ambitious plans for a nationwide infrastructure programme produced a trade boom on a scale which I suspect even the Chinese government had not anticipated. By 2 Chinese imports had reached 3 mt, and in 25 they will increase to about 78 mt. In tonnage terms exports have grown more slowly, reaching if approximately 4 ma in 25, but of course the export cargoes include many manufactures which have a high-volume for their weight. For example containerized cargo is estimated to have reached 128 million tonnes. In 24 China accounted for about 1% of world imports, but its real contribution has Figures 1a and b China s share of world trade growth 1995-23 W. Europe 194 FSU -8 S.America 87 North America 266 Africa 3.7 Japan S & E Asia 96 China 434 M. East Oceania W. Europe FSU S.America North America Africa Japan S & E Asia China M. East Oceania 7.3 3.1 South Africa South Africa 49 166 112 152 158 192 192 177 5 1 15 2 25 3 35 4 45 5 2 4 6 8 1 12 14 16 18 2 M. tons import growth 1995-23 M. tons export growth 1995-23 12/12/25 7 Martin Stopford, Clarksons
been to growth, accounting for 4 to 6 per cent of the increase in seaborne trade volumes over the last five years. The histograms in Figure 1 put this into perspective. On average China accounted for 32% of import growth during this period (Figure 9a), far more than any other region and 15 per cent of export growth (Figure 9b). However these statistics are heavily weighted towards primary commodity producers, whereas China's principal role was as an exporter of manufactured goods, particularly using the liner services. 7. Future development of China s trade China s growth cycle today shows many of the characteristics of the classic Trade Development Cycle. Normally steel and energy dominate the process, and that is precisely what has happened in the case of China. During the last three years 7% of the growth of Chinese import cargoes has come from iron ore and oil. Figure 11 shows that the growth of imports 22-5 was dominated by iron-ore (33%) and oil (23%). When the other steel related trades such as steel products are added, energy and steel manufacturing generated about two thirds of the country s import growth. This is precisely what happened in Europe and Japan during the previous TDCs and without these rapidly growing commodities we would hardly have noticed China's appearance in the market. On point to note is this sort of growth is strongly influenced by the trade off between domestic reserves of these commodities and available overseas supplies. In 25 the high cost of overseas iron ore stimulated the growth of domestic production Figure 11 China s import growth Iron Ore Steel Products Oil Containerisable Soybeans Coal Forest Prods Scrap Org Chemicals Other and reducing imports. Looking ahead these is major potential for coal imports if the domestic mines are unable to sustain their recent output growth. So far the development of China has been even more profitable for shipowners and expensive for shippers than even the growth of Europe and Japan in the 196s. But is there a risk that this period of exuberance could lead to the same sort of structural imbalances which produced the long recessions of the 197s and 198s? And if there is, what can be done about it? Past cycles are not much help in judging timing. For example the European TDC lasted 23 years from 195 to 1973, whilst in the case of Japan it was little more than a decade. In terms of population China is the biggest development region yet, though the geographical area is comparable to the USA. 8. Where next for the Chinese trade development cycle? As we noted at the outset Chinese seaborne trade seems to be progressing very much as Europe and Japan did many years ago. Industry has grown at 13.9 per cent per annum since 199 and the construction, motor vehicles, shipbuilding and consumer durable industries are all prominent. As in the case of Japan and Europe, the key sectors to watch 6% 4% 11% 23% 33% -2% 8% 18% 28% 38% 48% % growth 22-5 12/12/25 8 Martin Stopford, Clarksons
Figure 12a Monthly steel production Fig 12b: China's iron ore production 35 3 Japan EC-12 S.Korea China 4 Million tons per month 25 2 15 1 32 million tons a month in October Million tons iron ore 3 2 1 5 Jan '92 Jan '93 Jan '94 Jan '95 Jan '96 Jan '97 Jan '98 Jan '99 Jan- Jan-1 Jan-2 Jan-3 Jan-4 Jan'5 1992 1993 1994 1995 1996 1997 1998 1999 2 21 22 23 24 25 26 Fig 9c: China's steel trade Fig 12d: China's steel prices Mt/Month 5 4 Steel Import Steel Export 6 3 2 1 RMB per tonne 5 4 3 HRC 2.75mm HRS 1mm Plate 6mm Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan- Jan-1 Jan-2 Jan-3 Jan-4 Jan-5 Nov-3 Feb-4 May-4 Aug-4 Nov-4 Feb-5 May-5 Aug-5 carefully for signs of transitional change are energy and steel and this is where we should start. Today, after five years of unprecedented growth when it has added more capacity than Europe and South Korea combined, China s steel industry seems is moving into a period of change, at least compared with the recent trend. There are five signals:- o Firstly: the monthly production of steel in September was 32 million tonnes, an annualized rate of 384 million tonnes. This is almost sufficient to produce the 4 million tons of output predicted by many analysts for calendar 26. So growth of raw materials demand may not increase much over the present level in 26 (Figure 12a). o Secondly; the production of domestic iron-ore has increased by 3 per cent over the last 12 months, with predictions of a further 15 per cent next year. This is the first time iron-ore production has grown significantly in a decade, and is undermining imports (Figure 12b). 12/12/25 9 Martin Stopford, Clarksons
o Thirdly; in 24 the surge of imports of steel products which had developed during the previous two years changed direction and China started exporting steel. This is a sure sign of capacity moving ahead of demand (Figure 12c). o Fourthly; steel prices which rose sharply in 24 have fallen equally sharply this year. The price of 6 millimeter plate Forecast is now 4 per cent lower than it was in May (Figure 12d). 12 Other o Fifthly; steel consumption levels in the coastal regions are now up to 1 Oil Japanese levels and we may Steel reasonably expect inland provinces 8 Ore to develop much more slowly than the coast. 6 For all of the above reasons we should expect the imports of raw materials for the steel industry to stabilize over the next year or two, even if the general level of economic growth in China continues to grow. Bearing in mind that steel related products accounted for 45 per cent of the growth of Chinese imports over the last three years, this is a significant trend. Source: China Trade Report C Fig 13 Trade forecast for China imports Turning to oil, so far this has accounted for less than a third of the growth of imports, so we have still not yet seen the full impact, at least on this scale experienced for Europe, Japan and South East Asia. But China s energy balance particularly difficult to appraise. China appears unwilling to become too dependent on imported energy and the massive coal reserves, plus nuclear, hydro and coal/oil conversion are all contributing to this objective. Oil imports are around 3 m bpd, and growth in 25 is just 3% on an annualized basis. Next year the forecast is for a 7% increase, all of which is quite modest, especially when compared with 24 when problems in coal logistics resulted in imports increasing by.8 million bpd. In the energy area coal is the most promising prospect for volume growth. Chinese resources are under pressure and imports have increased by 2 million tons in 25, though exports declined by 12 mt. Million Tons importsd 4 2 1995 1997 Base Case 1999 21 23 25 27 29 Table 1: Development of world fleet to 27 M dwt Forecast November 25 21 22 23 24 25 26 27 Orders 45.4 52.8 117.2 13.9 Deliveries 45.6 49.5 55 61.4 7.5 71.8 71.3 Scrapping 28.3 28.7 27.1 1.6 8.5 13.1 13 World Fleet yr end 755.3 773.3 797.1 843.9 96 966 1,24 Increase (m dwt) 13 18 24 46 62 6 58 12/12/25 1 Martin Stopford, Clarksons
There are many difficulties in seeing what lies ahead. For such a large region imports of 2 billion tons would not be impossible. For shipping much will depend upon the development of the Chinese coal industry, but also the alternative energy sources open to China which do not require sea transport. Oil and gas pipelines from Russia and Kazakhstan there are obvious examples, as is the development of coal to oil technology and nuclear power. The trade forecast shown in Figure 13 suggests that imports will reach 1 billion tons in 21, but for the reasons discussed in the previous sections, the outcome could be much higher or much lower. One of the aims of the paper is to put China s contribution to trade into a global shipping context and we can now do this. If import volumes grow to 1 billion tons in 21 that would create about 8 million dwt demand for new ships each year. This is a lot of growth (and it does not include export demand which is not really considered in this paper). However the fleet growth likely to arise from the orderbook is much higher. Table 1 shows that fleet growth increased from 13 m dwt in 21 to 46 m dwt in 24. On the basis of the November 25 orderbook and modest scrapping assumptions we face three years of 6 m dwt per annum growth. That is a challenging target, and the China import forecast in Figure 13 would soak up only about 13% of it. 9. Conclusion In conclusion, China has made for an enormous contribution to the growth of the shipping business over the last decade and no doubt will continue to do so in the future. However the shipping industry is responsible for managing change, and cargo owners and shipowners need to be mindful of the complexity of managing sea transport from economy moving through this transitional phase. In this paper I have argued that even if we cannot know the future, we can at least learn from the past. Aspects of the shipping market today are reminiscent of earlier development cycles. To take two specific examples, high oil prices are a reminder that trade does not necessarily grow every year and record shipyard capacity is a reminder that oversupply can be very painful. Today, as in the early 197s, we have heavy investment and the prospect of rapid fleet growth to 1 billion dwt by the end of 27. Business must go on, and cargo carried, but it would be real progress if we could learn to manage change as well as we manage ships. One twenty year recession is enough. That ladies and gentleman, is the challenge. Martin Stopford Clarkson Research December 6, 25 12/12/25 11 Martin Stopford, Clarksons