Dire Straits

When steelmakers in China placed big orders for iron ore from abroad in February, global shipping companies held their collective breath. After a five-year stretch of extraordinarily strong growth, shipping firms are being pummelled by the downturn in global manufacturing that began last year. Catching many off guard, business in some markets fell by as much as 25% almost overnight, and the prices charged to customers fell even more: daily charter rates for capesize ships, the largest bulk-carrier class, tumbled to $3,000 in November from $230,000 in May. Meanwhile, the Baltic Dry Index—a key barometer of commodity shipping rates and a leading economic indicator reflecting demand for raw materials worldwide—hit its lowest point in more than 20 years, plunging to663 in December, from a record of 11,793 the previous spring. It has since recovered, but remains about 90% down from its earlier high.

Among the many reasons why the wind has been knocked out of shipping's sails is the massive slowdown in output by the manufacturing powerhouses in China. "China was not sucking as much raw material in, so the shippers shipping raw materials in, and the container companies transporting containers out, watched as their rates just died," as Clive Hinds, head of the UK shipping industry group at PricewaterhouseCoopers, notes. "No company can operate well with that sort of volatility."

And it's not just rates that have been dying. Great Ocean Container Lines in Hong Kong, South Korea's Samsung Logix, Senator Lines in Germany and Altas Shipping of Denmark are just a few of the companies that have filed for bankruptcy or gone into liquidation recently. Those still afloat have had to act swiftly to salvage their businesses, launching all manner of measures to address the drop in demand, from selling assets at fire sale prices to wriggling out of contracts with shipyards on vessels ordered months ago, even if that means forfeiting down payments and calling in lawyers.

In the end, the Chinese steelmakers' cautious February orders didn't offer much hope that global trade would be booming again anytime soon. Freight rates remain a fraction of what they were a year ago, many fleets are idle and shippers continue to live in fear of customer defaults.

Not that they haven't dealt with boom-bust cycles before. But this time is different, many say. "We've had downturns in the shipping market in the past, but there would be a downturn in one sector while another would be reasonably buoyant," says Nigel Gardiner, managing director of publishing at Drewry Shipping Consultants. "What's unusual about this one is that it's global and across all centres of shipping. Another nine months of this and you'll see more bankruptcies, more M&A, more asset disposals with companies selling off ships at deflated prices, and so on."

As shippers brace themselves for the worst-case scenario, some have already written off 2009. As Niels Stolt-Nielsen, CEO of Oslo-based chemical-tanker company Stolt-Nielsen, told analysts after announcing fourth quarter results in January, "Given the current global economic environment, we see little cause for optimism. I hope I'm wrong that 2010 is going to be a tough year."

Given the speed at which the downturn has hit their sector, shipping CFOs have little time to debate whether he is right or wrong. A hugely fragmented sector, shipping companies fall into two main groups-relatively small firms that have only recently gone public and the long-established, listed players such as Stolt-Nielsen. The CFOs of the latter have the greatest scope-at sea and on land-to influence three key factors that will see them through the downturn: financing, revenue and costs.

Shape up or ship out
At sea, CFOs' concerns aren't what they used to be. During the boom years, rapidly escalating seafarer wages vied with staggeringly high fuel prices for the top place on their list of worries. Not so long ago, for example, many CFOs required their captains to save fuel by reducing speed a few knots, or "slow-steaming" as it's known in the industry.

Hedging is another strategy that has changed dramatically since the first half of 2008, says PwC's Hinds. "What a lot of companies did was to buy more bunkers forward. At the time everyone was saying demand was going to go up, and rates were going to reach $800 or $900, so it would have seemed like a very sensible thing to do. Unfortunately a few months later the price was $250, and a lot of companies had fixed their price at $700."

How times change. Shippers now need to look for different ways both to cut costs and soak up capacity. Some are adding extra port calls, while others are taking the more drastic step of laying up ships. But all are focusing on coverage—that is, the number of days of future business that they can lock in with contractual commitments from customers.

Not everyone agrees about how much coverage is good for a company, particularly given the precarious future of many of their customers and the wild swings in shipping rates. Rather, some shipping groups argue that spot, or single-voyage, contracts can provide shippers with more flexibility, and warn that there are hazards of having too much coverage, as dry-bulk operator Atlas Shipping learned to its cost. When it filed for bankruptcy in December, it cited agreements for long-term, pre-crisis freight rates that would have led to losses of $3m a week.

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