A Steady Hum at South Korea's Shipyards

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After almost quadrupling its net profit to $771 million in 2006, Hyundai Heavy is expected to more than double profit this year, figures brokerage Korea Investment & Securities.

That's because shipbuilding prices almost doubled from a low in mid-2002 to early 2005 and have since stayed strong. Hyundai Heavy stock has jumped some 126% so far this year, making it the best performing blue chip on the Seoul Stock Exchange.

Share gains of Samsung and Daewoo have been less impressive, although they have risen by 59% and 39%, respectively, in 2007. One reason was their greater emphasis on specialized LNG carriers, whose contract prices have climbed less dramatically than those of tankers, containers, and bulk carriers. "Although my top pick is Hyundai Heavy, all the big three will likely post double-digit profit margins by the end of next year," says Song Jae Hak, shipbuilding analyst at Woori Investment & Securities.

Industry watchers say the ongoing red-hot shipbuilding activity has been triggered by China's seemingly nonstop economic and trade growth. "The emergence of China as the factory of the world has changed the paradigm of shipping patterns, thereby fueling fresh shipbuilding needs," says Cho Yong Jun, head of research at Shin Young Securities in Seoul.

House of Cards

A big upsurge in global commerce with the mainland led to the development earlier this decade of ultra-large container ships several football fields in length. Shipping lines raced to build oversized ships, capable of stacking between 8,000 and 12,000 containers, to service ever-growing seaborne trade between Asia and the U.S. Now, many industry officials believe the race to build bigger fleets by shipping lines won't be likely to end unless China scales down its industrial ambitions (see BusinessWeek.com, 4/23/07, "Why Taming the China Dragon is Tricky").

Take the latest frenzy to build bulk carriers. China's determination to own huge steel plants for fast industrialization created a sudden upswing in coal demands to power the mills. That made China a net coal importer from an exporter in the past, forcing Japan and South Korea, which used to import coal from China for generating electricity, to switch their coal source to Australia.

The switch not only meant longer hauls, requiring a greater number of shipping days, but also congestion at Australia's coal-handling New Castle port. That holds up scores of ships waiting to be loaded, thereby contributing to the shortage of ships carrying dry bulk cargoes. To worsen the situation, the recent imposition of duty on export of iron ore from India prompted China to divert its iron ore imports from India to Brazil, again engaging more bulk carriers on longer hauls.

Rise in Freight Charges

The upshot: Ocean freight for dry bulk cargoes skyrocketed. Short-period daily hire rates for 75,000-ton-class vessels in the Pacific have hit a historic high of $46,900 per day in May, up 30% since the beginning of this year and up more than 100% from a year earlier. The Baltic Exchange Dry Index, the best indicator of bulk cargo shipping prices, has topped 6,600 in May from below 1,500 in mid-2002.

The stunning rise in freight charges is spurring bulk carrier operators to join the race to secure more vessels. Clarkson notes this pushed the price of a new, 170,000-ton-class bulk carrier to $79 million in March, up from $76.5 million in February and $71 million in January. Shipping lines are also starting to place orders for large container ships for delivery in 2010 because they are worried that docks and berths at major shipyards would be completely taken over for building bulk carriers unless they hurry.

"It looks like a case of déjà vu," says a recent Clarkson report. Last year, when there was a boom in the large tanker building market, container ship owners rushed back to shipyards to secure berths for 2009 delivery because of dangers of losing a new supply of containers for that year. "Last year the driver of the shipbuilding market was the tankers, and this year it is bulk carriers," says Cho at Shin Young.

The competition to sign shipbuilding contracts early certainly won't increase the bargaining power of shipping lines. But it is music to ears of the Korean shipyards that dominate in building mega-vessels.

Moon is BusinessWeek's Seoul bureau chief.