CHINA´S WAVE OF OVERCAPACITY / THE WALL STREET JOURNAL ( HIGHLY RECOMMENDED READING )

HEARD ON THE STREET

AUGUST 31, 2011, 12:56 P.M. ET.

China's Wave Of Overcapacity .

By TOM ORLIK


Is China's titanic economy finally running into the iceberg of overcapacity?
.
Problems at China Cosco Holdings Co. Ltd. suggest trouble ahead. Cosco, a giant state-owned shipping company, is locked into long-term contracts for chartering vessels that haul iron ore, coal and grain around the world. Many of those contracts were signed in the commodities boom, when the price for chartering a giant Capesize vessel peaked at around $200,000 a day. The price now is $10,000 a day. The consequences of that collapse are showing up in Cosco's bottom line; the firm posted a loss of $420 million in the first half of the year.


The irony is that the painful collapse in shipping rates is partly of China's own making. From 2003 to 2008, growth in China's import volumes for iron ore averaged 26% a year. Johnson Leung, an expert on shipping at Jefferies, says that a total of 550 Capesize ships, with around 50 added each year, was inadequate to cope with demand. As a result, charter rates rose sharply. The Baltic Dry Index, which tracks world-wide shipping costs, rose to a peak of 11,600 in June 2008.


Shipping companies, assuming the upward trend would remain unbroken, placed orders for new vessels or signed long-term contracts to charter ships at high prices. They were wrong. China's iron-ore import volumes actually shrank in 2010, and in 2011, growth is languishing at 8% year-to-year. The number of Capesize vessels, meanwhile, had risen to 1,150 by the end of 2010, with 200 more coming on line each year, according to Mr. Leung. A huge increase in shipping capacity and a marked slowdown in demand growth have resulted in a collapse in prices.


The Baltic Dry Index is now around 1,500. Shipping companies that assumed an unbroken upward trajectory for demand have a taste of what excess capacity looks like.


Shipping isn't the only sector that placed too aggressive bets on growth and has been caught out by overcapacity. Take aluminum. China's production capacity runs at 23 million tons a year, compared with around 16 million tons of demand. Graeme Traine, metals analyst at Macquarie, says three million to four million tons in capacity are set to come on line this year. The biggest loser is Chinalco, the state-owned giant that finds its own margins squeezed by excess supply pushing down prices.


The situation in China overall is more nuanced than some bears suggest. Overcapacity is a problem in some parts of the economy and not in others. And where there are problems, rapid growth in some cases can help solve them. Concern about excess production in the auto sector, for example, proved ill-founded as domestic demand accelerated.


But in shipping, aluminum and renewable energy, the iceberg of overcapacity is already breaching the hull. Investors should prepare to man the lifeboats.
.
Copyright 2011 Dow Jones & Company, Inc. All Rights Reserved