introduction to shipping - hellenic management centre · pdf filesome of these ships covered...

Economics of Sea Transport & International Trade Ch. # 5 Competitive Shipping Markets - Bulk Dry Cargo

Supply

Demand

C.ORPHANOS

Some history

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FIRE 1-1.5 MILLION YEARS AGOMODERN MAN 200-250,000 years agoBOAT TRANSPORTATION 40,000 SAME PERIOD THAT DIFFERENT RACES BEGAN TO BE MORE PRONOUNCEDROPE ABOUT 30-40,000 YEARSPHOENICIA/ GREECE /ROMEENGLAND / SPAIN / PORTUGAL / VENICE / FRANCECHINESE EMPIRES IN THE 1700 AS WELL

MODERN PERIOD: SPANISH –BRITISH EMPIRE/GERMANS/AMERICANS/JAPANESE/ NORWEGIANS/GREEKS NOW CHINESE

GENERAL CARGO

TEND TO BE MANUFACTURED GOODSSELDOM ENTIRE SHIP USED SO THERE IS A GENERAL MIXTUREBREAK BULK OR CONVENTIONAL CARGO WHERE PROPERLY PACKEDSTEVEDORES (SHORE BASED PEOPLE THAT DO THE LOADING)CONTAINERIZATION EX. ON COFFEE BEANS AND BAGS

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MAIN PARTS OF A SHIP

HULLDECKHATCHESHOLDSTANK TOP

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MAIN PARTS continued…TWEEN DECKSSTERN (REAR)AMIDSHIPS (CENTER OF SHIP- WHERE MACHINERY IS PLACEDDIESEL ENGINESGENERATORSSUPERSTRUCTURE BRIDGE

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Basic layout

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General Purpose layout

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Standard Danish Motor Tramp around 1930

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Some sizes in DWT

• Capesize and Newcastle Capes 120-210k dwt Brazilianmax/Chinamax400k+

• Panamax (Post Panamax/Ultramax/Kamsarmax60-82k dwt

• Handymax 40-60k dwtSupramax 52-60k dwt

• Handysize from 1k-40k

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DRY BULK CARRIERS

• Market research and route planning pretty basic for the owners of large bulk carriers such as coal and iron ore and dictated by the price of raw materials and manufacturing demands

• There is a thriving voyage charter market based on charterers cargo based on supply and demand

• Many ships built to the specification of charterers

Examples in the U.S. and Ukraine Most notable entrepreneurs are the Greeks with presence in London, New York and Greece London Greeks before the war Mass produced 10000 tonner Liberty Ships Grain charterers are the big players in the dry bulk markets since depend more on single voyage or short-term

charter…merchants seek lowest grain prices affecting loading area

Liberty ships were cargo ships built in the United States during World War II. They were cheap and quick to build, and came to symbolize U.S. wartime industrial output. Based on vessels ordered by Britain to replace ships torpedoed by German U-boats, they were purchased for the U.S. fleet and for lend-lease deliveries of war material to Britain and to the Soviet Union via deliveries through Iran. Eighteen American shipyards built 2,710 Liberty’s between 1941 and 1945, easily the largest number of ships produced to a single design.

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DRY BULK CARRIERS CONTINUED……

Liberty ships toward the end of the war were being produced at a rate of 3 a day in the U.S. to supply the war effort and replace loses from the U-Boats.

Liberty’s become available at very low prices after the war with chartering rates soaring to supply grain and coal to war torn Europe. Some of these ships covered their purchase cost after one voyage under their private owners and far outlasted their anticipated lifespan.

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Bulk Carrier layout

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Bulk Carriers

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Tweendecker Cargo Ships• Tweendeckers are general cargo ships with two or

sometimes three decks.

• The upper deck is called the main deck or weather deck, and the lower deck is the tweendeck. Cargo such as bales, bags, or drums can be stacked in the tweendeck space, atop the tweendeck.

• Beneath the tweendeck is the hold space, used for general cargo. Cargo ships that have fittings to carry standard shipping containers and retractable tweendecks (that can be moved out of the way) so that the ship can carry bulk cargo are known as multipurpose vessels.

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Tweendecker layout

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GENERAL CARGO SHIPS

Some features may include one or more of the following:

Holds divided by one or more tween decks

Cargo carried on deck or hatch covers

Facilities for specific type of cargo (e.g. heavy lift derrick/crane, container securing arrangements, hoistablevehicle decks

Strengthening for the carriage of heavy cargo

Some cargo space for carriage of perishable cargo

The carriage of liquid cargo, usually vegetable oil in special tanksloading cargo by way of side doors/side loader

The simultaneous or alternative carriage of bulk cargo and other forms of cargo

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Economics & Sea Transport Ch. 5 18

Introduction..

The Dry Bulk Trade has changed drastically in the past 25 years…

…. with the average size vessel doubling in size

Dry bulk trades have evolved in the Tramp market – the Spot Market whereOwners and Charterers seek their business through Shipbrokers….

……. yet, as vessels have grown so did the volume of

COA’s & Consecutives and Projects

… Shipping is becoming more integral in the supply chain…

In this study of Dry Bulk Trades focuses on a simple Tramp / Spot-Voy Model


5.1 Definition of the Dry Cargo Sector

In order to further study the “Dry Cargo sector” we need to include and comprehend:

The Tramp Ship itself:o The Basic Unit (Vessel) that provides the serviceo Ability to navigate safely the deep seas

Various modeling attempts have been made, i.e. the 1960’s by Prof. Metaxas assumed:- Deadweight / Size of > 4.000 dwt - Greater Distances

Yet in real Market Conditions the following have also to be taken into account:- Cargo Size & Volume increase- Ships size growth & Capital required- Employment

• Voyage & COA’s & Consecs• Time Charter

- Fixtures in the Open Market • Prompt Loading• Short (voyage) - medium term (TC) employment

- Quick & easy Information dissemination


5.2 Market Characteristics

The economic characteristics of the dry cargo bulk trade are close to :

“Perfectly competitive model used by economists”

Containing certain assumptions:

1. Every participant seeks to maximize his profit2. Numerous (infinite) Buyers & Sellers3. Service provided by one owner can also be offered by others4. Easy Exit & Entry in the market5. Full information & disclosure

no participant can influence the market (rates)

Elasticity of demand is the degree to which consumption of a given product will vary in response to changes in price.

There are some things which we just have to have, and which therefore have a relatively inelastic demand.

Other things we might enjoy having but we can do without them if necessary, hence, the demand is more elastic.

If you have, for example, a medical condition which requires you to take a certain kind of drug, without which you will get very sick or die - for example, a diabetic who needs insulin - you will pay whatever that drug costs; you would never decide to do without it because it is too expensive, short of actual bankruptcy, and even then you would try to find a way of getting it, by means of some kind of assistance.

But you don't have to drink champagne. You may like champagne, but if the price gets to be too high, you will stop buying it. You can always drink something else. And if prices go up excessively for all wines, you can drink soda, and if the soda gets too expensive, you can still drink water. But demand for water is relatively inelastic.

Meaning of Elasticity and Inelastic


Case Study ? : Elasticity of Derived Demand

The elasticity of derived demand is the measure that expresses the strength of thechange in a derived demand when there is a variation in prices.

To continue the example of the car industry, it is known that shipping is rather priceinelastic as the price of transport, for most goods, is a very small part of the total cost.

Let us assume that the derived demand elasticity is -0.15.

From the example of demand elasticity we know that at a price of $10,000, thedemand for cars is 100,000. lf we assume that 8,000 cars are transported in one Carcarrier, a minimum of 13 carriers are needed.

Now as the price increased to $11,000 the demand fell to 88,000 cars. A simplecalculation would reveal that only 11 ships would be needed. However, following thederived demand elasticity calculation, the demand for shipping would only dropby 1.5% (-0.15*10) meaning that still 13 ships would be needed, but that overall theywillcarry less cargo……….

In microeconomics, economies of scale are the cost advantages that enterprises obtain due to size, with cost per unit of output generally decreasing with increasing

scale as fixed costs are spread out over more units of output.

The simple meaning of economies of scale is doing things more efficiently with increasing size or speed of operation.

Economies of scale often originate with fixed capital, which is lowered per unit of production as design capacity increases. In wholesale and retail distribution, increasing the speed of operations, such as order fulfillment, lowers the

cost of both fixed and working capital. Other common sources of economies of scale are purchasing (bulk buying of materials through long-term contracts), managerial (increasing the specialization of managers), financial (obtaining lower-interest charges when borrowing from banks and having access to a greater range of financial instruments),

marketing (spreading the cost of advertising over a greater range of output in media markets), and technological (taking advantage of returns to scale in the production function). Each of these factors reduces the long run average costs (LRAC)

of production by shifting the short-run average total cost (SRATC) curve down and to the right.

Economies of scale are also derived partially from learning by doing.

As quantity of production increases from Q to Q2, the average cost of each unit decreases from C to C1.

The Bulk Dry Trade in the past 20+ years has evolved dramatically, observing:

1. Demand growth has been rather uneven on a year to year basis2. Growth rates do not follow a steady pattern


5.3 Dry Bulk Market Demand Structure and Trends over the past 25 Years

Part of Table 5.1 - Dry Cargo – Seaborne Trade, Fleet and % Surplus 1985 – 2005


5.4 An Analysis of the Cost Structure of Tramp Ship Operators

In Ch. # 4 the basic concepts of cost analysis were presented, in regard the Short Run:

… understanding these and their effect, helps in making operational/business decisions, such as :

“Lay – up” or “Trade”

Fixed Costs > independent of cargo size > Unavoidable

Variable Costs > cargo size sensitive > Avoidable


5.4.1 The Lay-Up Decision

The dilemma faced by a vessel operator of whether to Lay-up or Continue Trading can be analyzed as follows, under the following conditions:

• Lay- up has costs, albeit reduced• Certain costs are incurred whether trading or not (i.e. loan pmts..)

Trading(42 days) Layup

Daily Op. Costs $10.000 $4.000 Capital Costs -$3.000 -$3.000 Relevant Costs $7.000 $1.000 Cargo size 50.000 tons -/-

Freight $14/ton (market @ $16/ton) $700.000 $0 Relevant Cost 42 x $7.000 -$294.000 -$42.000 Voyage Related Costs -$380.000 $0

Net Result (before Capex) $26.000 -$42.000

Adding back the Capital Cost -$126.000 -$126.000Net Result (after Capex) -$100.000 -$168.000

Table not in textbook

break

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5.5 The Use Of Break-even Analysis In Determining Minimum Freight Rates

Finding the Break Even Rate at Full Cargo / Quantity

In estimating the Break-Even Freight Rate, i.e. the (minimum) freight rate atfull cargo load to generate sufficient revenue to cover (zero) costs.

The analysis requires the following assumptions:

1. The Vessel is the basic unit of analysis2. Variable Costs and Revenues are Linear3. There are many Sellers (Shipowners) and Buyers (Charterers)4. Freight Rates are fixed (i.o.w. no price alterations)


Break Even #1 Quantity & Rate with Part Cargo - OE Price Level Break Even #2 Quantity & Rate with Full Cargo -OX Price Level

Total Fixed Cost ------

Cargo Quantity

Tota

l Cos

ts T

otal

Rev

enue

s

Profit

VariableCost

Fixed cost

Figure 5.1 Break Even Model

F

T

V

X

E

P

0 Q2 Q3

B/E #1

B/E #2

5.5 The Use Of Break-even Analysis In Determining Minimum Freight Rates (cont’d)Finding the Break Even Rate at Full Cargo / Quantity


5.5.1 Finding the Break-Even Rate

At TR2, we have the Break-Even Freight Rate (subject to full cargo – OQ3)

Cargo Quantity

Total Costs/Total Revenues

Figure 5.2 The Break Even Freight Rate Model

F

T

VE

P

0 Q2 Q3

TR1

TR2

TR3

B/E

Total Fixed Cost ------


5.6 Modeling the Dry Cargo Market

In analyzing the bulk dry trade (in Tramp Shipping) we make the following assumptions:

1. Each Shipowner seeks to maximize their profit, or minimize their loss.

2. Each Charterer seeks the cheapest rate, consistent with acceptable quality.

3. There are a large number of fixtures, their details widely known to all participants.

4. The model of perfect competition is assumed to be an appropriate framework.


Frei

ght R

ate

$/To

n

Figure 5.3 Inelastic Freight Demand Schedules

0 Cargo Quantity/ton miles per yearD1 D2 D3

5.6.1 Modeling Demand

Reminder: The higher the Rate the smaller the Demand for cargoes and vice versa.

What would be the derived demand elasticity to freight rate changes ? Price elasticity conditions for Derived Demand:

1. The value of the own price elasticity of demand for the final good.2. The existence of close substitutes3. The proportion of the total final price which transport constitutes.

(Shipping has few if any substitutes – very inelastic)

D1, D2, D3 illustrate different demand curves, of respective volumes of demand generated by different levels of economic activity, industrial production, world trade volume, etc.


Case Study ?? : Derived Demand for Shipping

The demand for shipping is a derived demand as the product being consumed is notthe transport itself (except in passenger transport), but the goods that are beingtransported.

The shipping demand of the car industry is a very good example. Cars are producedall over the world in a wide variety of makes and models. Not every country produceseach make or model and so cars need to be transported to satisfy customer demands.

Therefore, when demand for cars increases, demand for transport increases. Forexample if more American families decide to order cars produced in Japan, Japanesecars will need to be transported from Japan to the United States. To transport thesecars more ships will have to be chartered. Therefore, the transport by ship is a deriveddemand from the purchase of the car……


5.6.2 Supply

Differing Vessels have differing Average Variable Costs… - Vessels with lower AVC are employed first - Vessels with higher AVC are employed later as cargo volumes/prices increase.

Keep in mind:- Speed alters output and costs- Older vessels are less efficient with higher variable costs.

As we reach full capacity utilization the supply curve becomes steeper, illustrating the additional or marginal costs of extra output required. – i.o.w. A very competitive market.

Maximum Output/Full Capacity

Freight Rate $/Ton Mile

Figure 5.4 Short Run Shipping Supply Curve

0 Ton Miles / Year

2,0

1.5

1,0


Maximum Output

Freight Rate $/Ton Mile

Figure 5.5 Short Run Market Interaction

0 Q1 Q2 Q3 Ton Miles / Year

F4

F3

F2

F1

D1

D2

D3

D4

5.7 Determining the Equilibrium Freight Rate

Different short term market demand equilibria exist at different market conditions:

Shifts from D1 to D2 = Big Demand - small freight increase – large ton mile increase

Shifts from D3 to D4 = Large freight increases - Supply becomes very inelastic

Shifts from D3 to D4 = Max output - Strong earnings - new vessel orders (or the reverse)


5.7 Determining the Equilibrium Freight Rate (cont’d) Extending the model

While an rise/fall in demand generates a respective rise/fall in rates, there is more incentive to increase/decrease ton-miles, through the following mechanisms:

a) Higher(lower) rates encourage a higher(slower) speed, (when possible)b) Higher(lower) rates, encourage owners with high variable costs to employ them or

lay-up vessels.

Extra Table not in Textbook

Freight Rates

Supply Curve

Lower Higher

Speed

Lay Up - Trade

Scrapping - Lay-up - N/B Orders

Low

High


5.8 Confronting the Model with the Evidence

The previous analysis concludes/implies that:

1. Freight rates should be sensitive enough to short run market conditions, to reflect the current and future market state.

2. Demand growth and new orders have a strong positive correlation between them (subject to strong utilization ratios).

3. Freight rates and new orders have also a strong positive correlation (sustained levels of orders versus low scrapping & lay ups).

4. Exceptional events generate significant increases in rates, specially when the fleet is rather fully employed. (Consider political or wars, i.e. closure of Suez)

Figure 5.6 .

The cyclicality of the Shipping markets is easily observed in a myriad of graphs and tables, such as these:


5.8.1 Historical Developments


i.e. During 2003 to 2007 the excess demand led to

o Extreme Profitso Nil scrapingso Second Hand vessel prices reaching N/B prices

Whereas this growth was a result of : (to name a few factors) ….

1) The rapid growth in world trade , stimulating demand and thus manufacturing which … requires raw materials.

2) The “China effect”, with China becoming a major player in international trade with an annual trade growth rate of +10% (note the steel production and demand).

3) Steel production required iron ore and coal, noting also increases coming from China.

4) Other economies have grown also, like India, another major steel producer needing iron ore and coal.

5) Shortage of suitable ships, to the point of splitting cargoes to smaller lots and to a certain point causing transport costs to rise.

Yet we should not forget that what goes up must-usually comes down….

5.8.1 Historical Developments (cont’d)


5.9 Dynamic Considerations

• The model and examples insofar have concentrated primarily on current demand and supply conditions.

• Looking forward or attempting a forecast, even the very Short Term, it is necessary to comprehend the past and hopefully learn something of it. Yet the evolution of all variables (of supply-demand) make it very difficult to see further beyond, into the Long Term.

• The fact is, that shipping (not just the dry cargo) markets, just like any other economic activity, move through cycles of boom, recession, slump, recovery and back again. Shipping IS CYCLICAL

• While it is generally accepted that overall economic cycles are of about a 7 year duration, in shipping these same cycles have yet to be attested, some claim shipping cycles are on the average 7, or 13 years, while others claim even 50 years..!!!

• If you add to the overall economic demand – supply conditions, the peculiarities of shipping, i.e. haul distance, ship’s size, scrapping, one may end-up clueless.. adding to all this, the Owner’s psychology – thus expectations…

Figure 5.9 Sheds some more light (or confusion) in the attempt to link Freight Rates – Demand - Supply


5.10 Conclusion

This Chapter has examined the Dry Cargo Market for Tramp Shipping in some detail.

Having examined the definitions of a Tramp. and the changing nature of the market,various aspects of the costs of operating as a tramp were explored, in the highly competitive shipping market, of which Bulk Dry is integral in.

A model of the market was developed based on few assumptions, with demand always being price inelastic, and yet this dependent on the fact that supply elasticity depended on present-existing fleet utilization.

The behavior of market rates was examined, and relevant historical data was examined, while also considering the dynamism of the industry.

introduction to shipping - hellenic management centre · pdf filesome of these ships covered...

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