Shipping may be the lifeblood of global trade but as the recent economic crisis reminded us, finance is the lifeblood of shipping. As large swathes of lenders exited the ship finance market altogether we’ve seen an influx of private equity anxious to take advantage of distressed assets in a market where the only way was up. Only it hasn’t turned out that way.
Private Equity with its love of data and wider investment interests may have been expected to be the ones who gave the industry a reality check—but not so. That’s being left to a far more niche and established player.
Danish Ship Finance focuses solely on the provision of loans for shipping companies, secured by a ship’s mortgage. Its 67 employees currently manage a portfolio of approximately DKK 44 billion, secured by mortgages on 500 vessels As its Head of Research Christopher Rex’s specialist expertise is in the shipping industry, and yet his vision is far broader.
Responsible for a must-read semi-annual Shipping Market Review, Christopher embodies the kind of cognitive diversity shipping badly needs. He and his team of economists are across not only the global trends but importantly the technology trends which are in many cases driving them. Their reports contain clear-eyed and badly needed challenges to the assumptions too many are still relying on.
Christopher and Danish Ship Finance share these reports free of charge with the industry so if you haven’t read the latest one yet, then do. And if you get the chance to hear Christopher live at an event anytime I highly recommend you do so.
I was fortunate to spend some time with Christopher in a very cold Copenhagen recently and he agreed to answer my impertinent questions. I’m delighted to have him as our first, and I’m sure you’ll agree, very worthy Futurenaut of 2016. Here’s what he told us.
Futurenautics: The WEF in Davos is currently talking about the fourth industrial revolution. What is that, and what does it mean for shipping?
Christopher Rex: It is a highly interesting but also very complex question to answer. I will do my best to introduce the basics, but I urge any interested readers to come back for more details in our next Shipping Market Review in May 2016 (to be published mid-May this year).
The fourth industrial revolution is about combining all the great technological achievements that have been occurring since the middle of the last century. It is characterized by a fusion of technologies that is blurring the lines between the physical and digital spheres.
A key trend is the development of technology-enabled platforms that combine both demand and supply to disrupt existing industry structures. Similar trends could easily find their way to the shipping industry. It could mean that entire new business models will have to be developed to serve the industry.
The fourth industrial revolution holds the potential to redefine the way we live our lives, run our businesses and understand the world. We do not yet know just how it will unfold, but one thing is clear. It develops at an exponential rather than a linear pace. In essence, it holds the potential to disrupt almost every industry in every country. The shipping industry may be in the eye of the storm.
Today, machines are profitably substituting human labour in more industries than ever before. As intelligent machines become cheaper and yet more capable, they will increasingly replace human labour. The growing capabilities of automation threaten one of the most reliable strategies that poor countries have used to attract outside investment in the past: offering low wages to compensate for low productivity and skill levels. In more and more domains, the most cost-effective source of “labour” is becoming intelligent and flexible machines as opposed to low-wage humans in other countries.
In a world where businesses stop chasing cheap labour, production will gravitate towards wherever the final market is, because that will add value by shortening delivery times, reducing inventory costs, and the like.
But the fourth industrial revolution does not stop here. The productivity of materials and resources (i.e. the circular economy) is at the heart of the fourth industrial revolution. New technologies will enable significant increases in the utilisation of materials and resources. In a circular economy, the goal for durable components, including metals and most plastics, is to reuse or upgrade them for other productive applications through as many cycles as possible.
The benefits for the environment and the global consumers seem obvious. But its potential negative impact on global trade volumes could over time be significant, not least when combined with the prospect of robotics, artificial intelligence, the Internet of Things, autonomous vehicles, additive manufacturing (i.e. 3D printers), nanotechnology, biotechnology, material science, renewable energy and energy storage (i.e. batteries).
The long-term implications for the shipping industry could fundamentally be game changing. The most obvious part of the shipping industry to be unsettled first seems to be the container industry. Not only will the extensive logistic myriad of component trades, driving the interregional trades and much of the back-haul volumes be impacted, but the very backbone of the industry, the head-haul routes, appears to be at risk if production moves closer to consumers.
And what will happen to GDP creation if the ability to create millions of jobs disappears? How will millions of people in Asia, the Middle East, Latin America and Africa be lifted out of poverty without a job? And what will happen to demand for fossil fuels in a scenario of lower growth that is increasingly building on services rather than industrial production? Industrial production tends to be shipping—and fossil fuel—intensive and often produces spill-over effects, which also promote shipping and fossil fuel demand.
Services tend to be less dependent on fossil fuels and create less spill-overs to the shipping industry. Put another way, the fourth industrial revolution is opening the gates for long-term gains in efficiency and productivity. Transportation costs will drop, logistics and global supply chains will become more effective, and the cost of trade will diminish. In essence, travel distances will shorten, trade volumes will drop and fleet efficiency could improve considerably.
This outlines the first drawings of a new architecture for the shipping industry. In other industries we are already seeing new patterns of consumer behaviour that force companies to adapt the way they design, market, and deliver products and services. A key trend is the development of technology-enabled platforms that combine both demand and supply to disrupt existing industry structures. Similar trends could easily find their way to the shipping industry. It could mean that entire new business models will have to be developed to serve the industry.
To me it seems clear that the fourth industrial revolution could be redesigning parts of the shipping industry within a decade or two, within the lifespan of vessels recently ordered.
Futurenautics: Your Shipping Market Review is an industry must-read. The most recent (November) edition was pretty hard hitting, suggesting that seaborne trade volumes could plateau or even fall. What kind of reaction have you had to it?
Many of our readers contacted us and told me that they found the ideas presented very fascinating, but unrealistic or at best relevant in the distant future. Many asked me how I can possibly argue that world trade will decline when the global population is growing.
It is true that a growing global population will require the construction of cities; more food produced and distributed, but as I have just argued above much indicates that the fourth industrial revolution is opening the gates for long-term gains in efficiency and productivity.
The current model of global growth is neither very efficient nor sustainable in terms of resource consumption, but it creates a lot of seaborne trade. We expect this to change in the years to come.
Futurenautics: Virtually every shipping industry forecast—from company growth to CO2 emissions—is based on the historical link between global GDP growth and shipping volumes. But that’s decoupling isn’t it?
Christopher Rex: Correct. The historical link between global GDP growth and seaborne trade seems to be breaking apart as the engines powering the global economy shifts from industrial production towards services.
At the moment it seems that global GDP is growing in tandem with seaborne trade. However, the fourth industrial revolution is expected to further weaken this relationship up until a point where the link between them could be decoupled.
Futurenautics: Probably one of the biggest problems the industry has is overcapacity, but in their defence, as long as ship owners can access the funds to buy ships, what’s to stop them? When asset-based lending is feeding counter-cyclical investments in tonnage rather than value creation based around customer requirements, aren’t lenders part of the problem? If so, what needs to change?
Christopher Rex: In general, I do not think it is the job of lenders to tell investors where to put their money. But from the perspective of Danish Ship Finance we have long taken the view that we prefer to support the more traditional parts of the industry. We have only had a very limited contact with new investors coming in to the market to make a short-term bet on a long-term industry.
From our perspective what needs to improve is the understanding of the mechanisms driving the industry. For more than 10 years we have provided our research free of charge to the industry hoping to contribute to the understanding of the forces at play.
Futurenautics: Danish Ship Finance is a long-established and highly respected institution—often a deadly combination in a digital world of lean start-ups. Is the new economic order you’ve identified for ship operators also encouraging new thinking internally too?
Christopher Rex: Yes indeed. Danish Ship Finance is an established niche player in the market for ship finance. We have been in the business since 1961, but we constantly strive to develop a deeper understanding of the evolution of the global economy and the shipping industry to provide a fact base that contributes to our lending strategy.
Futurenautics: I’ve heard rumours that you’ve been accepted into Singularity University – the only shipping person I’ve come across so far who has. What is it, and why are you attending?
Christopher Rex: Singularity University provides educational programs that help people understand cutting-edge technologies, and how to utilize these technologies. Their mission is to educate, inspire and empower leaders to apply exponential technologies to address humanity’s grand challenges.
In our approach to research we are always very cautious not to be constrained by our own assumptions or conventional market wisdoms. We always try to remind ourselves that the assumptions we make will echo in the answers we find. I believe that the ability to provide cutting edge market research is dependent on the ability to look at an industry from both the inside and the outside.
At Singularity University I hope to meet a cognitive diversity that will challenge and hopefully upgrade my understanding of some of the trends that are about to shape our future.
Futurenautics: Whatever shipping looks like in a decade’s time one thing seems certain—digital operations will be at its heart. How do we encourage ship operators to make digital infrastructure investments now? Will they get a hearing from lenders if they ask for funds to do so?
Christopher Rex: Today’s market is in a particular challenging stage. Many of the major segments are struggling with overcapacity, low freight rates and low asset values. Ship operators are working hard to make a profit while keeping their costs low.
Many will agree that digital investments should be part of a future strategy but the landscape of the future remains shrouded in uncertainty. Which digital investments will make a difference for the future revenue? What will the market place look like? Lenders will support the players that have a vision for the future, a clear strategy and a market position to get there.
Futurenautics: Big Data is offering the opportunity to unearth operational insights and drive evidence based decision-making. How important do you think that is for shipping? Are you involved in any projects?
Christopher Rex: I started out the interview talking about the fourth industrial revolution. To me Big Data is a vital part of this package. To know who, where, when and what is essential information for any well-functioning market place.
The success of platforms such as Uber, Airbnb and the like, all examples of third-party solutions disrupting existing industries, clearly shows that collecting data and utilising it properly may prove very valuable. The idea is not new; many companies have tried to tap into this value proposition in the shipping industry in recent years.
To our knowledge, they have so far only had limited success. But that does not prove that the value is not there. It simply shows that the right solution has not been applied. Many will oppose the idea. But to maintain the status quo hardly seems a long-term profitable business strategy if our concern about lower future seaborne demand proves accurate. The new tactics that this shift will engender have the power to eliminate the trade-off between economies of scale and profitability, and to reshape entire industries.
The opportunities and risks it presents will change over time and vary between segments. Competitive advantage will be claimed by the businesses that see and act on this shift first.
Within a few years we expect that some parts, if not all, of the shipping industry will be building upon technology-enabled trading platforms. Business models and investment strategies will be rethought to fit into a new and more efficient version of our industry. We are, however, not involved directly in any projects at this stage in time.
Futurenautics: We’re talking about SmartShips this issue. They’re the first steps on the road to autonomy, unmanned or crewless ships. Will autonomy be the most disruptive of the meta-trends for shipping?
Christopher Rex: The fourth industrial revolution offers massive changes to both supply and demand. Smart ships or unmanned ships will truly be something new, if introduced, but the genuine disruptive forces at play are those that redefine the nature of demand. Today’s shipping industry is, largely speaking, serving a global economy that is wasting massive amounts of resources.
The average material is only used once. In a future where more and more ‘items’ are being reused, recycled or remanufactured at location, the need for seaborne transportation will decline. This will impact most ship segments as both the demand for fossil fuels, petrochemicals, steel and containerized goods are expected to decline.
Combined with the expected improvements in energy efficiency and global asset allocation it seems that the shipping industry could be on the brink of a demand transformation that holds the potential to redefine the forces at play.
Futurenautics: Listening to almost every analyst on the maritime circuit, and even Maersk’s CEO at the WEF recently, everyone seems to think things are going to get better, based on the fact that they ‘have to’. Is this the shipping industry’s ‘Emperor’s new clothes’ moment? How long can it last?
Christopher Rex: The shipping industry is in the midst of a transition. As already addressed in this interview, we see that demand patterns are being redefined by various forces at play simultaneously. And supply keeps pumping into already oversupplied markets.
Several of the tanker segments currently benefit from high trading activity while underlying demand growth remains moderate. I think that many players within the shipping industry feel a bit puzzled about the future. It is like navigating with a compass rose that keeps spinning.
We have already touched upon the relationship between global GDP and seaborne trade. This relationship is about to fracture as the service sector contributes more and more to global GDP. Consumer spending is shifting from goods toward services.
It is difficult to say whether this is the early sign of the emergence of the fourth industrial revolution. I believe that the influence of the technologies driving the fourth industrial revolution will intensify in the years to come and that we may start to see declining world trade volumes in a few years, but the jury is still out.
Futurenautics: It’s been said that this year will be the ‘dry bulk bloodbath’, whilst some senior economists are recommending it’s a good time to buy ships. What’s your view?
Christopher Rex: It is definitely a difficult time for many dry bulk owners. And many new vessels are on order to be delivered within the next two to three years. The buy recommendation could rely on the belief that market fundamentals are close to the bottom. They might very well be in fact. But for secondhand prices to recover from current levels we need to have some tailwind from one of the three factors determining secondhand prices.
The three factors are: short-term earnings, long-term earnings expectations and the expected economic life of the vessel (i.e. cash-flow period). The Baltic Dry Index is low and could improve within the next years, but to add value earnings should at least cover the operating expenses.
The long-term earnings expectation is often considered linked to the newbuilding price (i.e. the replacement cost). There is little to indicate that newbuilding prices should begin to recover within the next year or so since there is too much capacity available at global shipyards.
The expected economic life of vessels is somehow anchored in the average age of vessels scrapped. In today’s dry bulk market, vessels are being scrapped prematurely and the average age continues to decline. Little indicates that the average scrapping candidate will become older before the balance between supply and demand has been re-established. But as demand seems incapable of absorbing the new vessels entering the market we see little chance that this balance will improve during the next year or two.
With all three parameters pointing towards lower future secondhand values the only mechanism available to lift prices beyond their earnings potential should be if new investors decide to bet on a market recovery. To my knowledge we currently have more sellers available than buyers, which does not exactly indicate market recovery is around the corner. But it is all about timing and now could be the time. It is for the cash-rich ship owners to decide.
Futurenautics: Which do you think are the most potentially disruptive digital businesses in maritime at the moment? What will the next major technology disruption in shipping be, and who will it most affect?
Christopher Rex: The combinatorial effects of the entire technology basket of the fourth industrial revolution seems extremely disturbing to the industry. At the moment it seems that the container business is first in line to be unsettled by some of the technologies. The energy related segments (including offshore) could as well become targets if the demand expectations behind recent orders are not being met by actual demand.
We have to remember that young fleets with few obvious scrapping candidates (e.g. crude and product tankers) are extremely exposed to freight rate declines if demand fails to absorb supply.
Futurenautics: DNV GL’s ‘The Future of Shipping’ report outlines a scenario where IMO is obsolete by mid‐century, driven by what I call the Bureaucratic Singularity – where the exponential growth of technology outpaces bureaucracy’s ability to regulate it. Can we use the same technology to develop new regulatory ecosystems with a range of stakeholders from manufacturers to customers, lenders and insurers where transparent operations demonstrate compliance in real-time, reinforcing positive behaviours and raising the costs of operation for transgressors?
Christopher Rex: During the previous Danish Maritime Forum it was widely discussed how to establish a global shipping version of the IATA (the International Air Transport Association).
But I think that you are right. If the industry becomes intercted by technology-enabled trading platforms it seems reasonable to assume that these will work as a catalyst for certain behaviours. This is in fact what needs to be done in order to re-establish and maintain an acceptable balance between supply and demand.
Futurenautics: As more of shipping’s operations become digital the connectivity and platforms we’re leveraging to drive transparency, collaborate, improve safety and create value are also creating new downside risks which have to be managed. Cyber security is essential for the maritime industry to move safely into its future, but the industry appears under-prepared. Cyber security shouldn’t be a competitive advantage, but equally, a vessel infected with malware may not qualify as seaworthy. Is that another part of the risk profile Danish Ship Finance and others like them should be evaluating?
Christopher Rex: It is indeed a topic we follow very closely and one the industry should continue to focus on.
Futurenautics: What was the last piece of technology—consumer, industrial or professional—which made you say “Wow!”?
Christopher Rex: I have become a great fan of many new technologies. But one of the latest that has caught my attention is ‘solar thermal fuel’. The solar thermal fuel polymer can harvest sunlight by day and release heat on-demand.
This is extremely interesting because it can help us address two of the most pressing challenges we face today: our expanding energy needs and how to reduce carbon emissions. Solar energy offers a promising solution to both challenges through its abundant characteristic and the lack of carbon emissions.
However, a transformation from fossil fuels to solar energy requires efficient and cost-effective processes to collect, store, and transport our most plentiful—but intermittent—source of energy.
The promising approach of solar thermal fuel is the production of synthetic fuel, which can harvest and store the sun’s energy in chemical form via rearrangement of photoactive molecules, allowing solar energy to be easily transported and stored in the form of heat on demand.
Christopher Rex is the Head of Research at Danish Ship Finance. Visit them and access their free market reports at www.shipfinance.dk
Images courtesty © Danish Ship Finance/Getty Images
This article appeared in the January 2016 issue of Futurenautics.read online and subscribe