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CHAPTER 2

THE SHIPPING MARKET CYCLE

2.1. Shipping cycle and shipping risk

The market cycle pervades the shipping industry. Just as the weather dominates the lives

of seafarers, the waves of the shipping cycle ripple through the financial lives of shipowners

as well as businesses with cargo to transport when the cost of transporting, price of buying,

selling or chartering ships are so volatile by time.

Shipping cycleis related to volatilities in shipping markets and this term is there for a

purpose of managing the risk of shipping investment in a business where there is great

uncertainty about the future.

Shipping risk is consequence of the imbalance between ship supply and cargo transport

demand that shippers and ship-owners facing to in the shipping markets.

There are 2 shipping risk cases:

- Case 1: ships are not built but trade grows (P.38).

Reasons:

Shippers are confident about how much cargo they will need do transport in future.

Or if shippers feel that transport is of too great strategic importance to be left to

chance.

And to make sure that ships are always available to transport.

Decision

Shippers decide to take the shipping risk themselves by carrying out shipping

operationswith their owned fleets or by pre-construction time charters with

independent ship owners, if this is found to be a more cost-effective solution.

Results

The shipping risk is taken by the cargo owners:

Business will grind to a halt.

Oil company could not ship their oil.

Steel mills run out of ore and manufacture exports would pile up in the factories

and ports.

Cargo owners have to auction their commodities to the highest bidder to make

their fortune.

This leads to an “industrial shipping” business in which the ship owners are

subcontractors and cost minimizers:

Shipowners become risk subcontractors because: although the is freed from

market risk, that does not remove all risk. Charterers strike a hard bargain and the

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owner is subject to inflation, exchange rates, the mechanical performance of the

ship and the ability of the shipper to pay his hire.

Shipowners are cost minimizers because: with the assurance of cargo, the owner

purchase ships and try to make a living by keeping costs below the contract

margins.

- Case 2: ships are built but trade does not grow (P.39).

Reason

For some kinds of industries, such as agricultural cargoes, shippers never know how

much cargo they will need to transport in future.

Decision

Shippers decide to go to the freight market and hire transport when they need instead

of concluding pre-construction time charter parties with independent shipowners like

other industries.

Result

The risk is taken by shipowners trading on spot market and the business becomes

highly speculative.

Because, to make their living they have to invest ships in advance for meetingthe

future cargo transport demand of shippers. That means they have to take a shipping

risk.Iftheir ships are hired, they will get profit and vice versa. Shipswill sit idle and

the unfortunate investors have to watch their investment rust away.

2.2. Characteristics of shipping market cycles

2.2.1. Short shipping cycles (p.40-44)

- Kirkaldy (1913)1, saw the cycle as a consequence of the market mechanism. The peaks

and troughs in the cycle are signs that the market is adjusting supply to demand by

regulating the cashflow.

Shipping market (increasingly normal)

Trade (progressively regular)

more tonnage than

cargo ready for shipment

the cutting of rates

At times, shipping had to be run at a loss

Shipping market cycles create the environment in which weak shipping companies are

forced out, leaving the strong to survive and prosper,fortering a lean and efficient shipping

business.

- E.E Fayle (1993)2 suggested that the build-up of a cycle is triggered by the world cycle or

random events, such as wars which create a shortage of ship.

The resulting

High rates

- attract new investors

- encourage a flood of speculative

Expanding

shipping capacity

Short boom in trade, usually

followed by a prolonged slumps.

1Kirkaldy (1913) p. 174 and 208h2E.E Fayle (1993), p 276

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investment

- Forty years later, Cufley (1972) also drew attention about to the consequence of 3 key

events common to shipping cycles. First, a shortage of ships develops, second, high

freight rates stimulate over-ordering of the ships in short supply which finally leads to

market collapse and recession.

An elegant definition of the cycle as the process by which the market co-ordinates supply

with changes in demand by means of the familiar cycle of boom and slumps. But Cufley

is convinced that the cycle is too irregular to predict.

- Hampton (1991), long and short shipping cycle emphasis the important part played by

people and the way they respond to price signals received from the market.

And, market sentiment plays an important part in determining the structure of cycles and

this can help to explain why the market repeatedly seems to over-react to the price signals.

- All these descriptions of the shipping cycle have a common theme.

Shipping cycle is a mechanism devoted to removing imbalances in the supply and

demand for ships. If there is ships are little supply, the market rewards investors with

high freight rates until more ships are ordered. When there are too many ships it

squeezes the cashflow until owners give up the struggle and ships are scrapped.

The length of the cycles is incidental and they last as long as is necessary to do the

job.it is possible to classify them by length, but it is not very helpful as a forecasting

aid.

Stages in the shipping market cycle: (1) trough (2) Recovery (3)Peak/flateau (4)

Collapse (see more Figure 2.1, p.43).

The cycles are too irregular to predict the shape of the next cycle. Because,shipowners

are constantly trying to second guess the cycle, crowd psychology gives each cycle a

distinctive character. To be morspecific, Recoveries can stall half-way and slump back

into recession. Market collapses may be reversed before they reach the trough.trough

may last 6 months of 6 years. Peaks may last 1 month or a year. Sometime, they stuck

in the middles ground between trough and decession.

2.2.2. Long shipping cycles and the technological trend

The long cycle theory of the world economy (1790-1916) was developed by a Russian

economist - Nikolai Kondratieff. According to his study3:

- Over the period of 150 year of studying, it was possible to distinguish 3 periods of slow

expansion and contraction of economic activity in which a long cycle lasts about fifty

years, with the peak –to – tough length was 20-30 years.

- The explanation of long-wave cycles in the economy at large could be found in technical

3Kondratieff (1935)

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innovation.

- The upturns of the first Kondratieff cycle (1970-1813), the second (1844-1874) and the

third (1895-1914) were largely due to the dissemination of steam power, the railway boom

and the joint effects of the motor and electricity respectively.

- The post-war upswing may be attributed to a combination of major innovations in the

chemical industries, aircraft and the electrical/electronic industries.

- The technological trend which has done so much to shape the shipping industry over the

last century. For much of the last century changing technology has set the stage for

shipping cycles:

In 50 years to 1914, as downward spiral in freight rates was drivenby the increasing

efficiency of merchant ships and the phasing out of sail.

50 years form 1945-1995 was dominated by the mechanization of the bulk and liner

shipping businesses through bigger ship and mor efficient cargo handling technology.

2.3. The frequency of shipping cycles (P. 45-48)

2.3.1. The vital statistics of shippingcycles

The statistics was considered in a period of 116 years between 1869 (the beginning of modern

shipping) and 1994, excluding periods of 2 world wars. There were 12 dry cargo freight

cycles (figure 2.2).

2.3.2. The length of shipping cycles

The seven years is a handy guide for predicting the length of shipping cycles.

2.3.3. Volatility of shipping cycles1914

The freight rates volatile from year to year. The ones next year will increase by 100 percent,

fall by 50 percent, or anything in between.

2.4. Freight market cycles, 1869-1914 (figure 2.3, p.49)

This is the forty-year period before the First WorldWar with 4 freight market cycles about

7years each.

2.4.1. The technological trend

The technical changes in this period facilitated the steady reduction of shipping costs.And

The appearance of bigger vessels built by shipyards and the efficiency of steam engines

helped save voyage time, motive power and number of labor.

2.4.2. Cycle 1 (1873-1881)(P.50)

- There freight market was weak, but not a particular severe recession. The rates were

seasonal and words “dull”, ‘Lifeless’ and ‘stagnant’ were repeatedly used in contemporary

reports to describe business.

- Steamers dominates over sailing ships.

2.4.3. Cycle 2 (1881-1889)(P.51)

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- From 1879 to 1883, when rates showed considerable firmness, this was a real

shipbuilding boom with the significant increase of ships’ gross tonnage.

- After a slow start in 1883 the shipbuilding recession gathered force in 1884. The rate at

which steamers have been chartered are lower than have ever before been accepted.This

state of things was:

brought about by the large over-production of tonnage during the previous three years,

fostered by the reckless credit given by banks and builders,

and over-speculation by irresponsible and inexperienced owners.

The universal contraction of trade also aggravated the effect of the above causes4.

-The 1880s ended with a real freight boom, described as ‘remarkable in the history of

shipping’ and the continuous growth of shipbuilding output. In fact, the freight index had

fallen to 59 in 1886, but then peaked at 76, 29% increase 2 years later.

2.4.4. Cycle 3 (1889-1900)(P.52)

- If freights in 1889 remained at the same level like the year 1888, in 1890 the market

moved sharply into recession. By the end of the cycle, there was a sudden relapse of all

freights and all values of steam property from high points reached in 1889 to about the

lowest figures touched during the long recession from 1883 to 1887.

- The recession which followed lasted most of the decade, There was a modest recovery in

1895 and the market progressively improved during the next 3 years.

2.4.5. Cycle 4 (1900-1912)

- There was a three freight market booms and 3 shipbuilding booms.

The year 1899 proved less profitable than expected, but far from unsatisfactory. The

freight reached the first peak in 1900.

In 1901 shipbuilding launches close to 300.000 gt before dramatically hit the troughof

about 50.000 gt in 1903.

By 1901 the freight market was back into recession when by the autumn of rates were

50% below the peak levels in 1900. The market remained more or less in depression

until 1909 although a small recovery in freight could be seen in 1907.

Despite the recession, by 1906 shipbuilding market experienced a suddenlyprosperous

progress.

Finally in 1910 the industry moved into a period of better trading conditions during

which most owners made modest profit. In 1911 freight were higher than in any year

sine 1900. 1912 witnessed a boom in freight which enables ship-owners to make real

profit. The freight market collapse started again in 1913 but was interrupted by the

war.

4 Gould, Angier & Co. (1920)

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Shipbuilding market followed the same pattern of freight rates.

2.5. Freight market cycles, 1919-1938(Figure 2.5, P.55)

- The period between the First and Second World Wars had a very different character.

- It was not a particularly prosperous period for shipowners. In fact, the period falls into 2

separate decades:

The first (1922-1926) was poor when it was volatile and shipping was modestly

profitable from time to time.

The second (1927-1938) was disastrouswhen it was dominated by the great shipping

depression of the 1930s.

2.5.1. Cycle 5: 1921-1926 (p.54)

- The cycle was volatile:

The 1920s start with as boom and the freight rate at 1921 reached 200.

After this spectacular start to the decade, the market was never really strong. The

freight index had fallen to 110 in 1922. From then onwards freights fluctuated with a

brief recession in 1924-1925 followed by a brief boom when the freight touched 170

in 1926.

- There were 3 developments which gave this period character:

The rapid trade growth motivated the volume of seaborne trade

More than adequate shipbuilding capacity available to meet this shipping demand.

This time was a period of technical change and several changes going on

simultaneously like: internal combustion engines were replacing steam engines, oil

was replacing coal…

2.5.2. Cycle 6: 1927-1937 (the great depression)(p.56)

- This cycle included a great shipping depression of the 1930s, lasted 11 years.

- The recession was considered as a consequence of the Wall Street Crash of October 1929

and the subsequent recession in world trade.

- The freight index decreased constantly to 80 points and stayed there during the

periodexceptfor a not very last long boom that could be seen from 1936-1938

2.6. Freight market cycles, 1945-1995 (figure 2.7, p. 58+59)

This is the fifty-year period following the Second World War with 5 freight market cycles

about 7.4 years each.

- Tanker and dry freight rates are shown separated. The dry cargo cycles are more clearly

defined and the peaks are longer, while the tanker cycles are more spiky.

2.6.1. The technological trend 1945-1995

- The first 25 years after the Second World War was dominated by an extraordinary growth

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in sea trade.

Once this was a period of great technical change in shipping industry though the

emphasis was on organization as much as hardware.

The developing integrated transport operation was designed to reduce transport costs.

The trend towards specialization that allowed the size of ship to increase was

continuous and pervasive.

The market was disrupted by a series of political development.

- From the mid-1970 to 1995, the shipping environment changed:

In the tanker market: the sprint of size lost momentum and the fleet, which had

previously been young and dynamic, grew old and sluggish.

In bulk market: ships’ size continued to increase with volume cargoes like iron ore and

coal moving up. A fleet of car carriers was built. Container ships increased from

2000TEU (1970s) to 6500TEU (1990).

Ship technology improved with: the unmanned engine room, satellite navigation, mor

efficient diesel engines, vastly improved hatch covers …

2.6.2. Cycle 7: 1945-1951

- The post-war market got off to a good start in 1945. –

- As a result of scarcity of tonnage and the tremendous need of transportation, the freight

was at a sky high level and seemed fantastic compared with pre-war rates (1945-1946)5.

- 1947 started to see a downward trend in rates which reached a trough in 1949.

2.6.3. Cycle 8: 1951-1957

- From 1951 – 1952: anxieties raised by Korean War sparkled off a wave of panic stock

building. The result was seaborne trade’s increase. The freight index significantly

fluctuated between a peak of 85 and a low of 30.

- From 1953-1957:The freight market went from bad (1953) to worse (in the first half of

1954) and then to a considerableimprovement in the last half of 1954.The improving trend

continued through 1956.

2.6.4. Cycle 9:1957-1966

The decade following the 1956 Suez boom was less prosperous for the shipping industry.

- Sizeable losses were made by owners trading on the spot market during the first half

because of many reasons like:

Out stock-building,

Overbuilding

More efficient ships,

5Platou 1970, p.158

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Volatilities of the world economy

- And, although in the second half the market improved, demand never got sufficiently far

ahead of supply to push rats to acceptably profitable levels.

2.6.5. Cycle 10:1966-1975

- The Six Day War between Israel and Egypt in 1967 and the subsequent closure of the

Suez Canal marked the start of 7 prosperous years (1967-1973) for ship-owners in the

charter market.

There were 3 freight market booms and many owners were able to fix time charters at

highly profitable rates.

Because oil was the largest cargo moving through the Suez Canal at this time, the

main impact of its closure was felt in the tanker market.

The dry cargo market benefited indirectly from improved rates for ore carriers owing

to combining carriers switching into oil trading, but, in general, the increase in rates

was less noticeable than in the tanker market.

Reason for the buoyant market was an unprecedented growth of trade, a phase of

stock building in the world economy.

- From 1973-1975:

The tanker market collapsed following the Yom Kippur War in 1973

The bulk cargo market held up through 1974 and for small bulk carriers into 1975.

2.6.6. Cycle 11(Tankers):1975-1980

- In the tanker market, the October 1973 Yom Kippur War ushered in a structural depression

which lasted until 1988, relieved by only a brief market improvement in 1979.

- Three problems contributed to the depth of this recession:

The oversupply of tankers resulting from the speculative investment in the early

1970s.

The world shipbuilding industry was able to build 60m.dwt of merchant ships each

year which was far more than the shipbuilding demand.

Oil price rose in 1973 and 1979 dramatically reduced the demand for oil imports.

- The result was a severe depression as the market squeezed cash flow until sufficient

tankers had been scrapped to restore market balance. There was little sale and purchase

activity, but by year end prices had already fallen by more than 50%.

2.6.7. Cycle 11 (Dry bulk carriers): 1975-1980

- The spot market moved into recession in 1975 and the 3 year from 1975 to 1978 were

very depressed for all sizes of vessels.

- On average freight rates were not sufficient to cover running costs, although there were

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showing some seasonal fluctuation.

- In the autumn of 1978, the recovery started, leading to a very firm market in 1979-1980.

2.6.8. Cycle 12 (Bulk carriers): 1980

- The cycle started with a freight boom lasting until March 1981 before a sharp fall set in.

- Falling oil prices, stagnant coal trade and elimination of congestion pushed rates down to

levels that by 1983-1984 some brokers were describing as the worst ever experienced.

- In 1982, the rates halved together with a great number of time charters negotiated in the

previous year had to be renegotiated.

- 1983 was a bleak year. The freight rates improved slightly in the spring, but fell to the

bottom level in the summer and stayed there.

- Despite of the freight depression, in 1983-1984 large numbers of orders were placed for

bulk carriers. Because:

Ships at that time were cheap,

Owners ordering in 1983 expected that after the cycle 12 lasting six years they would

take delivery in the next cycle upswing which was due in 1985.

- From that time on to 1989, the freight market varied drammatically and ended the period

with an upward trend.

2.6.9. Cycle 13 (1989 onwards)

- After the market bottomed out for tankers in 1985 and bulk carriers in 1986, rates rose

steadily to a new market peak in 1989, coinciding with a peak in the world business cycle.

- During the next five years the tanker and bulk carrier markets developed very differently,

due mainly of the different attitudes of investors in the two market.

In the tanker market: The freight peak was accompanied by three years on heavy

ordering 1988 to 1991, during which 55 million dwt of new tankers were ordered.

Dry bulk market: conditions in the dry bulk market took the opposite path. The world

economy’s effect on bulk market is less than on tankers. Anh demand for the new

formers was not as high as the latters.

2.7. The return on investment in shipping

2.7.1. Definition of return on capital (ROI) in shipping

- ROI is the remuneration the investor receives in return for committing his funds to the

enterprise.

- In fact, Shipowner earn profits by buying and selling (or just owning) ships as well as by

trading cargo, so from the economic view point the return on investment for a shipping

company can be defined in the following way:

ROI = ¿¿

10

Where:

R: Trading cash receipts during the investment period.

DP: Depreciation of vessel.

MV: The market value of the fleet of ships.

Using this definition we can subdivide the return on investment into 3 component parts:

Trading profit (Return from tading the ships): is the revenue by trading the ship on the

spot or time charter markets (R), less the depreciation of the ship during the year (DP).

Asset play profit (return from asset appreciation): The second item is the change in the

market value of the ship (MV1-MV0) during the accounting period.

Asset employed (How much capital it has tied up in the fleet): the value of assets, i.e

the value of the fleets.

Total profit must be divided by the value of assets, i.e the value of the fleets, to give thr

retuen on investment over the period.

2.7.2. Comparision of shipping ROI and other investmen

- Considering an example in table 2.5, it shows the return available from the stock market

and the dry cargo shipping market during the same period. There is not much doubt that

shipping is a low-return business.

2.7.3. Measure shipping risk

- Risk premium: reffered to the higher return required by investors to put their money in

risky investment. Or in another word, high risk investment requires a higher level of

return

2.8. The prediction of shipping cycle (p.72+73)

- It is possible to predict when the market will move upwards (or fall). Because economic

conditions, the business cycle, trade growth and the ordering and scrapping of ships are

the fundamental variables which can be analysed, modelled and extrapolated.

- However in fact, many of the variables and relationships in the model are highly

unpredictable, so the prediction process should be seen as reducing risk rather than

creating certainty.

2.8.1. The importance of market intelligent

- Most of bad decision often flowed from inadequate consideration of the facts or that

certain important pieces of available information had been ignored, discounted or given

insufficient attention.

- So, the process of gathering and organising information for decision making needed

improvement.

2.8.2. The challenge of successful risk management

- Making shipping sound like a glambing game. When shippers turn into the shipping

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market because they dont know how much shipping capacity they will need in the future.

And the job of the shipowner is to make the best estimate he can and take a gamble. If he

is wrong he loses.

- In shipping cycles, as in a poker game:

Every winner there must be a loser in risk management

Shipping cycles are not random.

Each player must assess his opponent, take a view on how thay will play the game, an

work out who will be the loser this time.

No loser means no winner.

2.9. Summary

In this chapter we discussed the economic environment in which the shipping industry

operates:

- Shipping risk:

This is the risk that the investment in the hull of a marchant ship, including a return on

the capital employed, is not recovered during a period of ownership.

Shipping risk can be taken by a shipper (industrial shipping) or the shipowner

(shipping market risk).

The market cycle dominates shipping risk.

- Shipping cycle:

4 stages in a cycle: a trough, a recovery, a peak and a collapse.

There are no firm rules about the length or time of these stage. Each stage continues

until its work is completed.

2 types of shipping cycle: short and long term cycle:

Short cycle: When ships are in short supply freight rates shoot up and stimulate

ordering. When ther is a surplus, rats fall and ramain low until enough ships have

been scrapped to bring the market into balance.

Long cycle: is driven by technology development such as: the triple expansion

engine, containerization stimulate investment in new ships, steam power replaced

sail...

- Analysis of short cycle over the period 1972-1989 with 13 cycles, averaging 7,2 year

each. Each business cycle developed within a framwork of supply and demand. The big

freight booms or freight recession are often result of unexpected events relating to

economics and political condition of the world.

- Return on investment (ROI) in shipping is lower than in other industry, averaging less

10% per annum.

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- Predicting cycles is difficult, but not impossible for a skilled played.

- Making shipping sound like a glambing game.