A slow boat from China

Covid-19 pandemic lockdowns created considerable disruption to global supply chains and freight costs soared. As the world has emerged from lockdown, demand has normalised and supply chains constraints have eased. Thankfully, freight costs have also fallen back significantly from their peak which has helped both company profit margins and taken some of the pressure off inflation.

However, The International Maritime Organisation (IMO) and European Union (EU) are introducing regulations aimed at restricting carbon emissions to be introduced in 2023 and 2024, to achieve a tangible reduction in maritime decarbonisation. A study in 2009, found that a single, large container ship, emitted almost the same pollution as 50 million cars.

FuelEU Maritime – a new EU regulation ensuring that the greenhouse gas intensity of fuels used by the shipping sector will gradually decrease over time. EU regulation is also expected to come into effect from the start of 2024 which may impact the cost of shipping via the compulsory purchase of carbon credits for vessels calling at ports in EU waters. The targets cover not only CO₂, but also methane and nitrous oxide emissions over the full lifecycle of the fuels.

The IMO emissions reduction plans are for two new measures – The Energy Efficiency eXisting ship Index (EEXI), a one-off certification assessing the design, construction, and technical features of the ship; and the Carbon Intensity Indicator (CII) – an ongoing measure of how environmentally friendly a ship’s operations are. Measures will likely lead to a decrease in speed of global vessels.

In combination, these may lead to a fall in productivity and a knock-on impact in freight rates, as tonnage tightens. Retrofitting of energy emergency systems will lead to increased dry dock time, further effecting tonnage availability. Meanwhile, the shipping industry could see increased acceleration of vessel redundancy arising from regulations leading to poor voyage economics and higher scrappage levels as well as greater fleet contraction. At the same time, the number of shipyards has fallen while the remaining shipbuilders have long order books seeking to address the demand for LNG carriers – a reflection of the war in Ukraine and energy crisis. There is also some uncertainty over future shipping technologies and regulation which is constraining ordering of new vessels.

Historically, a pick-up in economic activity and higher ship charter rates has quickly led to an increase in new container ship supply, which would start to be delivered within 2-3 years. However, could the new decarbonisation regulations lead to a pro-longed period of short shipping capacity and effect global freight rates?

What have we been watching?

Just as a measure of calm appeared to be returning to the US banking sector, there was another sharp sell-off in smaller regional banks, particularly Western Alliance (-38%) and PacWest (-60%). This was prompted by the news that PacWest was exploring strategic options, including a sale. This news coincided with the expected interest rate hike from the US Federal Reserve (Fed). To add to market woes, China, which is seen as the prop to global economic growth in 2023, announced disappointing manufacturing data. At least markets were able to draw a small crumb of comfort from the Fed which hinted that there might now be a pause in the cycle of US interest rate hikes. Sterling moved above $1.25 following this news. Furthermore, commodity prices, particularly oil, continued to fall which should help lower inflation.

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In the UK, data from Nationwide showed unexpected, if tentative signs of a recovery in the housing market, with prices edging up 0.5%, the first increase in eight months. The UK manufacturing PMI activity indicator confirmed the sector’s downturn has continued in the early part of the second quarter.

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The eurozone manufacturing PMI activity indicator showed conditions worsening early in the second quarter with the output index slipping back into contraction territory. In addition German factory orders fell by the most since the height of coronavirus pandemics in April 2020. The European Central Bank (ECB) raised interest rates by 0.25%, the seventh successive rise.

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In the US, the Federal Reserve delivered the expected 0.25% increase in interest rates to a target range of 5%-5.25%. After delivering the tenth successive increase in the Fed funds rate, Chair Jerome Powell did hint that a pause in that process may now be at hand. However, he also said ‘inflation is going to come down not so quickly, it will take some time and if that forecast is broadly right, it would not be appropriate to cut rates.’ US monthly jobs data was stronger than expected in April, driven by job growth in the services sector, although there were downward revisions to the March figures.

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China’s Caixin manufacturing PMI unexpectedly declined to 49.5, dropping into contraction and hitting its lowest level since January.

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Brent oil dropped to $73 on concerns about the impact on global oil demand from central bank interest rate hikes and weak Chinese manufacturing data.

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Finally, Spain recorded its hottest ever temperature for April, hitting 38.8C. Given food prices have been a significant element in ‘sticky’ inflation let us hope that climate change does not hit vegetable and salad crops too badly this year. Meanwhile, The British Poultry Council is warning the ‘sector is at breaking point’ and that unless supermarkets increase the price paid for birds that there could be a shortage of chicken. Not good news for fans of Nando’s or KFC!

 

Read Last Week’s Alpha Bites – How do you like your chips?

 

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Alpha Portfolio Management is a trading name of R C Brown Investment Management PLC which is authorised and regulated by the Financial Conduct Authority.