Dry bulk freight market conditions improved significantly in 2017 from a historically low base in 2016 which, combined with our high laden utilisation and competitive cost structure, enabled us to record a much improved and positive net result.
Freight market indices in 2017 followed a similar seasonal pattern as in 2016, although at a significantly higher level. The market improvement was largely demand driven with stronger seaborne trade growth apparent across most dry bulk cargo categories.
Stronger Chinese industrial activity drove robust growth in coal and iron ore imports and, more importantly for us, in the trade in minor bulks. Global grain trade expanded more than expected primarily due to record South American grain export volumes. Longer trade distances also supported stronger global dry bulk seaborne tonne-mile demand which Clarksons Research estimate to have grown 5.1% in 2017.
The improved earnings environment resulted in much reduced scrapping which, combined with new ship deliveries, led to total dry bulk fleet net growth of 3.0% and 3.6% in the global Handysize and Supramax fleets.
Despite the gradual improvement, the market remained challenging during most of 2017 with average annual freight rates at historically weak levels.
Our TCE premium and operating margins are driven by our ability to draw on our experienced teams, global office network, strong cargo support and large fleet of high-quality interchangeable ships in a way that optimises ship and cargo combinations for maximum utilisation.
In the first half of the year, we completed our owned vessel newbuilding programme with the delivery of seven newbuildings of modern, efficient designs which we committed to build in 2013. We used the still historically low asset values to purchase two high quality secondhand Handysize vessels. We also purchased a secondhand Supramax and sold an older, smaller Supramax, thereby trading up to a vessel of better design and longer life at an attractive price.
In August, we committed to acquire five modern, efficient dry bulk vessels funded by a combination of (a) new Pacific Basin shares issued to the sellers, (b) cash raised through a share placement, and (c) cash from our existing cash resources. This innovative transaction enabled immediate equity financing and enhances our operating cash flow, EBITDA and balance sheet. Four of the five vessels delivered into our fleet by year end, and the fifth joined in January 2018.
These latest acquisitions have increased our owned fleet to 106 ships on the water, grown the proportion of our owned versus chartered ships (especially in Supramax), and reduced our owned vessel daily break-even levels.
We have grown our owned fleet more than threefold since 2012 as part of our refocus on dry bulk and our divestment of non-core businesses. Including chartered vessels, we operated an average of 241 ships overall in 2017 and currently operate about 220 ships.
We completed the sale of our final tug during the third quarter of 2017, thereby concluding our exit from our non-core towage activity.
Our new commercial office in Rio de Janeiro has contributed valuable new business since it was established early in 2017 to help grow our cargo volumes and support our many customers on the east coast of South America while enabling us to cover more fully all regions in the Atlantic.
In May, we relocated our headquarters to Wong Chuk Hang, about 15 minutes from Hong Kong’s Central business district. We now benefit from a better, more energised, collaborative and productive office with a markedly lower rent. We continue to invest in state of the art systems with our most notable project being the on-going implementation of our new integrated ship management software.
In August, Pacific Basin became an eligible stock for southbound trading under the Shenzhen-Hong Kong Stock Connect programme effective from September, which helps to enhance our profile in the mainland Chinese capital markets. We hope that this will contribute to more interest in and trading liquidity of our stock in the long term.
In September, Pacific Basin won the Company of the Year award at the Lloyd’s List Global Awards. To be named the best shipping company in the world is a great honour and welcomed recognition of both our seagoing and shore staff’s combined contributions that drive us towards our vision of being the first choice partner for customers and other stakeholders.
As at 31 December 2017, we had cash and deposits of US$245 million with our final newbuildings all paid for and delivered, except for one resale that joined our fleet in January 2018. We drew down our remaining long tenor Japanese export credit and other committed facilities following the delivery of our newbuildings resulting in net borrowings of US$636 million, which is 35% of the net book value of our owned vessels at the year end. After paying for the vessel that delivered in January, we have 10 unmortgaged ships.
Our solid balance sheet and strong corporate profile combine with our robust business model and track record to set us apart as a preferred, strong, reliable and safe partner for customers, finance providers and other stakeholders.
The general market improvement since early 2016 is encouraging and, with supply and demand fundamentals now more positive, we are cautiously optimistic for a continued market recovery albeit with some volatility along the way.
The outlook for favourable global GDP growth bodes well for dry bulk demand, and supply is expected to be kept in check by the continued gap between newbuilding and secondhand prices and the uncertain impact of new regulations on ship designs, both of which cause many shipowners in our segments to refrain from ordering new ships.
Tonne-mile demand growth of 5.1% in 2017 was higher than expected, but even if growth slows in 2018, we expect it will still exceed supply thus supporting further improvement in the demand-supply balance.
Potential negative factors include a possible reduction in China’s difficult-topredict coal imports and, on the supply side, the risk of excessive new ordering and increased ship operating speeds. Continued commodity demand growth, scrapping of older and poorly designed ships, and limited ordering are required for a further improved market balance.
We continue to achieve cost savings without impacting maintenance or safety. Primarily through scale benefits and other efficiencies, we have gradually reduced our daily vessel operating expenses by 12% since 2014 to US$3,840 in 2017, and we have reduced our total G&A overheads by 28% to US$54 million over the same period despite operating a larger fleet.
This has helped us reduce the current breakeven level on our owned Handysize and Supramax ships to about US$8,300 and US$9,100 per day respectively after G&A overheads.
We are well positioned for a recovering market and, based on our current fleet and commitments, a change of US$1,000 per day in annual average TCE market rates would be expected to change our net results by about US$35-40 million per year.
Our healthy cash and net gearing positions enhance our ability to take advantage of opportunities to grow our business and attract cargo as a strong partner. We will continue to look at good quality secondhand ship acquisition opportunities as prices are still historically low, resulting in reasonable break-even levels and shorter payback times.
We do not intend to order newbuildings in the medium term, and will watch technological and regulatory developments closely. There remains extra capacity in the existing global fleet through potentially higher operating speed, and the market does not need more newbuildings. What we shipowners need is a more reasonable level of profitability. Moreover, today’s newbuildings offer only limited efficiency benefits over good quality Japanese-built secondhand ships and, in our view, the risk and payback time for newbuildings is currently excessive due to several uncertainties in our market, including:
These uncertainties, the attraction of low secondhand prices and new accounting rules requiring time charters to be capitalised from 2019 are discouraging new ship ordering in our segment.
We welcome stricter environmental regulation, but we do not think sulphur scrubbers are an effective solution technically or environmentally, and we much prefer a mandate for everyone to burn cleaner fuel and the level playing field this would create. A further consequence of a global adoption of low sulphur fuel is that its higher cost will prevent ship operating speeds from increasing, contributing to lower emissions and a better supply-demand balance.
The extra capex investment for ballast water treatment systems (and potentially for scrubbers) and the higher cost of low sulphur fuel will penalise the oldest and worst performing ships, potentially driving such ships to demolition.
Overall, we believe these new regulations will be positive for the supply-demand balance and benefit larger, stronger companies with high quality fleets that are better positioned to adapt and to cope practically and financially with compliance.
We will continue to focus on our worldleading Handysize and Supramax dry bulk business where our strategy is to be the best operator maximising our fleet’s utilisation and TCE earnings by leveraging all the key attributes of our business model. Minor bulk shipping demand is characterised by diversified geographical, cargo and customer profiles. This, combined with our large fleet of interchangeable ships and worldwide office network, allows for the combination of cargoes to achieve higher laden utilisation, which is exactly our strategy and how we can deliver value over market earnings.
We have a robust business model, experienced staff, a quality fleet and strong balance sheet that position us well to navigate and benefit from a recovering market.
We thank all our stakeholders for your continued support.
Chief Executive Officer
Hong Kong, 28 February 2018