Global overcapacity, plunging demand, and a price war

In the first quarter, South Korean shipbuilders saw their orders collapse by 94.1% to 170,000 compensated gross tons (CGT), compared to the prior year. In terms of dollars, orders collapsed 94% from $6.5 billion in Q1 2015 to just $390 million.

Global orders for new vessels in Q1 have collapsed too, but slightly less, according to the Export-Import Bank of Korea, cited by IHS Fairplay: down 71% year-over-year to 2.32 CGT.

“Their business slump may continue throughout this year, and demand for oil tankers may improve slightly during the second half of the year,” Korea Eximbank said in the report. Current order backlog will provide work for about two years. For all of 2016, orders are expected to plunge by 85%, from $23.7 billion in 2015 to just $3.5 billion.

Chinese shipyards are in even deeper trouble.

In May so far, three shipyards went bankrupt and began liquidation: Zhong Chuan Heavy Industry, Zhong Chuan Heavy Industry Equipment, and Zhoushan Xuhua Metal Material.

In April, Zhenjiang Shipbuilding, a subsidiary of Sinopacific Shipbuilding Group, commenced reorganization under bankruptcy proceedings. Another subsidiary of Sinopacific, Yangzhou Dayang Shipbuilding, is currently restructuring and plans to lay off 38% of its workforce.

Two days ago, Shanghai Clearing House announced that Sinopacific’s parent company, Evergreen Holding Group, has defaulted on 400 million yuan ($61 million) of one-year bonds it had issued just last year — part of the wave of corporate defaults building up in China

In February, state-owned Sainty Marine went bankrupt, the second state-owned shipyard to do so, after Wuzhou Shipyard, which had gone bankrupt in December 2015. Privately owned shipbuilder Mingde Heavy Industries had gone bankrupt earlier in 2015.

New orders for ships received in Q1 by shipyards in the Jiangsu province – where about 40% of Chinese shipbuilding and 16% of global shipbuilding take place – collapsed by 96% from a year ago. And some of the orders received earlier are getting cancelled.

Total order backlog at the end of the quarter at shipyards in the province had plunged 21% to 836 ships, totaling 50.9 million deadweight tonnage (dwt). For all of China’s shipbuilders, the order backlog is down 17% from a year ago to 120 million dwt.

According to local authorities cited by IHS Fairplay, of the 600-plus shipyards in the Jiangsu province, only 157 have started construction of new ships in the first quarter. The rest have nothing to build.

“Taking orders at current low prices is like a ‘slow suicide’ for shipbuilders,” an insider told IHS Fairplay. “However, without new orders, shipyards are waiting for death.”

China has long subsidized the entire shipping industry, including shipbuilders and shippers. But rampant overcapacity in the industry has destroyed the pricing environment and is now leading to capital destruction.

Many Chinese shipping companies received far more in subsidies than they generated in profits, according to IHS Fairplay including COSCO with 4.25 billion yuan in subsidies in 2015, China Merchant Energy Shipping with 2.08 billion yuan in subsidies, and CSCL with 250 million yuan in subsidies.

The government has been trying to cut back on subsidizing overcapacity. Alas… a local shipping expert told IHS Fairplay that without these subsidies, and this kind of collapse in orders, about half of the Chinese shipyards will go bankrupt.

This is the environment in which South Korean shipbuilders and other sectors in heavy industry are trying to stay alive. But according to the report by Korea Eximbank, they’re losing market share. The orders they received in Q1 accounted for a share of only 7.4% of global orders, down from a share of 30% a year earlier!

Korea’s shipbuilding industry faces tens of thousands of layoffs in a rigid labor market where lifetime employment is the rule, where laid-off workers rarely can find full-time jobs at other companies, and where the unemployment safety net is limited, pushing many of these folks into poverty.

According to Bloomberg:

About 205,000 workers were employed in Korea’s shipbuilding industry as of the end of 2014, according to the Korea Offshore & Shipbuilding Association. Hana Financial Investment Co. analyst Lee Mi Seon wrote in a report this month that 10% to 15% of workers in the industry are estimated to lose their jobs. With average monthly income in the shipbuilding industry at about 4.5 million won ($3,800) last year — relatively higher than other industries — the layoffs could lead to a downturn in consumption and weigh on the regional economy, Lee wrote.

Unemployment claims in Korea rose 1.3% in Q1 year-over-year. But for example in the industrial city of Ulsan on Korea’s southeast coast, unemployment benefit claims jumped 18%. Bloomberg:

Many of the layoffs will be in industrial hubs along the southeast coastline, where shipyards and ports dominate the landscape. These heavy industries, which helped propel South Korea’s growth in previous decades, have seen losses amid a slowdown in global growth, overcapacity, and rising competition from China. As a condition of financial support, creditor banks and the government are pushing companies to cut back on staff and sell unprofitable assets. Korean exports have fallen for more than a year and mounting levels of corporate debt are weighing down companies that need to find new growth engines.

The government is now trying to support the restructuring of these industries and help laid-off workers find a place somehow in some other function. It won’t be easy. Other countries too, including the US, have gone through deindustrialization and the brutal shifts it entails. But rarely has this happened as fast and furious as in Korea and China, where entire industries are on the verge of falling off the cliffs of overcapacity.

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