The new sulphur regulations: A credit manager’s perspective

From a bunker trader’s perspective, there is little doubt that margins will increase and the capital cost of trading more expensive fuels may push some of the smaller traders out of the market. With this is mind, many traders have been dancing round the fire hailing the coming of the 'apocalypse', comments Christopher Morgan, lead – bunker credit management, GP Global

Christopher Morgan, lead – bunker credit management, GP Global.
Christopher Morgan, lead – bunker credit management, GP Global.

I watched a programme recently about a giant asteroid that hit Earth and supposedly killed off the dinosaurs. It mentioned how some bacteria, plants and animals did manage to survive the cataclysm but that the dinosaurs had no chance.

Obviously, my mind moved to 2020. The new sulphur regulations mean (if we assume the rules will be applied rigorously and fines will be an actual deterrent) that most people buying bunkers will likely see their fuel bills go up by 30-40%. This of course comes from the cost of adding scrubbers, buying gasoil, or low sulphur fuel oil, or switching to liquid gas.

From a (cynical) credit manager’s perspective, the whole thing leaves me shivering in fear in my cave. We have a good, conservative handle on our customers and we feel confident about their ability to absorb this increase in their fuel bills. Even so, we can never be 100% sure. Simplistically, if a company has been struggling over the last 10, or 11 years around the break-even point for freight vs. opex costs, then 2020 is seriously bad news.

People seem to think there will be some magical increase in tonne/mile demand in the freight markets to soak up this movement of the opex line in the sand. I am not convinced. The Chinese and Koreans (and others) are continuing to use state funding to prop up and stimulate their vast shipbuilding industries and we still have overcapacity (that is to say, more ships that we have cargo demand for) in the box, bulk, tanker and offshore sectors. Record levels of scrapping have helped stop things get completely out of control (and will increase again in 2020) but the yards are still churning out as many cheap subsidised ships as possible. Ominously, the Chinese banks have been looking at a series of initiatives to make ship financing easier and cheaper for Chinese businesses. Where will the increase in freight rates come from if the tonnage oversupply imbalance is not going to change?

Then the full horror of the scenario becomes clear, like the faint outline of the asteroid appearing in the blue skies above the serene planet Earth.

Imagine then, that the redeeming increase in freight rates does not happen. The biggest single opex cost goes up for everyone by 30-40%. Any prospect of breaking even for major strata of the charter/operator market disappears. COA’s default and take-up of future contracts dry up. Charterers slip out of the market. Most go quietly, a notable few go the hard way, and leave defaults, misery and losses.

With fewer charterers out there, the ship owners see further contraction of tonne/mile demand as the tidal wave of cheap Chinese and Korean tonnage continues unabated.

Bunker players see terms and delays lengthen as charterers try desperately to stay afloat. The banks (wisely) refuse to help, and bunker players become an even more important source of financing than they are now. Bunker companies lend fuel credit worth several times what their charterer customer’s actual equity figure is. The less-savvy bunker players think they see salvation in focusing on ship owners for new business, as they think they retain the lien and that their customers possess more asset strength. The problem is that the asset strength underpinning some ship owners is a bulk carrier, or tanker (in an oversupplied market) with an actual market value far lower than its nominal book value. She simply is not worth what the ship owner is paying for her, and write-downs on this value make things very difficult.

On and on, the tide of cheap Chinese and Korean tonnage sweeps, carrying nine-year-old box ships and bulkers to their doom on the sand in Gadani, or Alang. Defaults grow. And grow. And grow. Even the solid household name player strata start to see their herds thinned in the catastrophe.

Credit insurers look at the value proposition of covering bunker credit and driven by a distinct icy cooling in appetite from the Re market, start to unwind their bunker and shipping books and cover levels drop as premiums rise and rise like floodwater. Bunker companies that have outside financing (most of them) have to have credit insurance to secure the financing but face paying radically more for radically less cover. It is hard now, but post-2020, it becomes basically impossible to secure additional cover without seeing latest financials from the insurance majors. That leaves China, Vietnam, Indonesia, Turkey, Greece, most of South America, the Middle East and of course the US to become credit black spots.

Then, for bunker traders, it all boils down to one simple equation: Will the expected increase in unit margins post-2020 be enough to offset the increase in cost of credit financing, much greater cash flow burden, higher default/bad debt losses and associated much-greater credit insurance cost? For 2020, probably. But 2021? 2022?

Are we then forced to hope that the disaster drowns enough of the competition so that the margin gains will be greater than expected so we at least can survive?

The key to surviving this event will be determined by rock solid partnerships with the best credit insurers who really know what they are underwriting. We have that. Also, ever more important will be knowing your customers and staying disciplined in terms of not chasing silly margins on high risk, zero disclosure customers that could bite you (hard!), post-2020. We have that too. Lastly, it will require management with the farsightedness to be able to see 2020 for what it is (and is not) and stock up on capital and resources to survive what will surely be a very difficult time. We have that as well, fortunately. Do you?

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