Understanding Shipping Markets

PLAY THE MARKET

Market view

• Difficult to get good balance between supply and demand (time-lags in supply adjustments)

• Supply generally tends to outstrip demand: long periods of rather depressed freight markets.

• Short peaks in the freight market: demand rarely exceeds supply over a long period.

• Well-consolidated companies have the luxury of going anti-cyclical.

• Effective shipping strategy depends on anticipating the ‗turning points‘

Play the market

How to play the markets ?

Chartering:

– In/out

– Long/short

Purchase or sale of ships

Withholding capacity (lay-up)

Operations and asset play

Play the market: Chartering

Play the market: Chartering

The problem of anticipating ‘turning points‘ andintensity of cycles

Turning points

Fixture3 yr time charter rate at P1 Bad deal for S/O

P2

P1

Fixture 3 yr time charter @ rate P2

Good deal for S/O

Customers do the opposite: spot market when prices are high. Try to fix long-term contracts when market is low.

Play the market: Purchase or Ship Sale

• Newbuilding contracts are critical (timing !)

• Newbuilding prices fluctuate widely, depending on the backlog in newbuilding orders (function of shipyard capacity) and general freight rates

• Deflation in newbuilding prices: average cost of capital for the fleet will be higher (existing older vessels ‗worth‘ less)

• Shipyards aim for full order books (China, Korea, Japan)

• Second-hand market: prices lowest when market is down

• Sale of vessels: timing ! Resist selling under price distress

Play the market: Withholding Capacity

• Decision parameter to layup vessels: costs of running vessel are higher than keeping the ship idle(and to reactivate it later on)

• Reducing vessel speed (slow steaming): variation on the laying up decision

• Decision to scrap:

• Vessel age

• Maintenance cost curve in function of vessel life

• Scrapping prices are cyclical(mainly depending on price of steel at scrapping moment and vessel demand)

• Scrapping versus lay-up: worthwhile waiting for an upturn in the market?

Shipbreaking‘Beaching’ practice in countries such as Pakistan, India and Bangladesh

Scrapping operations are labour intensive and involve high risks.

Vessel owners prefer to sell out the unserviceable vessels to the countries where there is demand for scrapped steel and other items of old ships, where labour cost is relatively low and where there

Play the markets: operations and or asset play

• Flag decision has impact on costs (flags of convenience)

• Function of holding period of vessel between buy and sell/scrap

• Asset play strategy: focus on short-term charters and spot market

• Operations type strategy: longer-term charter strategies

Play the markets: asset management

Dealing with financial risks

• Currency risks: use currency term options in transactions

• Interest risks(mainly for newbuildings): interest rate swaps built into deals

• Credit risks: possibility of loss occurring due to the financial failure to meet one‘s contractual obligations:

• Higher when operations on spot market

• Hedging instruments

• Freight-volume hedging

• Bunker hedging

• Freight rate hedging through long-term and short-term charter exposures

• Credit risk hedging

Hedging

• Both tanker and dry bulk shipping markets are in transition toward becoming large financial derivatives markets

• IMAREX (launched in 2001) provides an exchange for trading and freight derivatives (market broker desk to facilitate such trades + provides trading data)

• Financial derivatives will become integrated in many of the trading and asset allocation decisions, just as in other commodity markets (oil, electricity, money markets, aluminum, etc..)

• Derivatives are becoming integrated in the commercial management of many shipping companies

Derivatives for hedging are becoming key in commodity spot markets

Derivatives for trading in basic commodities (oil, coal, grain) have spillover effects in related shipping markets

Market Sentiments

• The variable of most interest to senior decision makers is ―market sentiment‖, not a particular freight rate.

• Market sentiment can be described as the average mood of the shipping community, its degree of optimism and willingness to invest. This mood is strongly influenced by recent earnings and general expectations for the next year or so.

• Senior shipping executives are intuitively aware of the correlation of different freight rates, and are satisfied if they know when market sentiment will turn.

• This is all they need to know to help decide on purchase or sale, ordering or scrapping, operation or lay-up.

• Substitutability among market segments creates ‗one‘ market sentiment:

• If vessels are scarce in one segment, they will be scarce in others soon, since many ships can be used in different trades.

• If ship owners face lay-ups in one segment, they will soon spread their woes to other segments by trying to place their surplus vessels there.

• Authors chose a time charter (TC) freight rate as the main indicator of market sentiment.

System dynamics in tanker market

Partly based on paper: Randers J., Göluke, J., 2007, Forecasting turning points in shipping freight rates: lessons from 30 years of practical effort, System Dynamics Review, vol. 23, no. 2/3, 253-284

Shipping segments: tanker markets

• Shows cycles, not trends

• Four major sub-markets (all sowewhat correlated)

• VLCCs: > 200000 dwt

• Suezmax market: 100000 to 125000 dwt

• Aframax/Panamax market: 60000 to 80000 dwt

• Product tankers/Handy-size market: 30000 to 45000 dwt

• Tanker regulation is an important issue: e.g. phasing-out of single hull tankers

Shipping segments: tanker markets

Shipping segments: tanker markets

Shipping segments: tanker markets

Tanker market situation• 10• Prof. Dr. T. Notteboom28• Shipping segments: tanker markets• Prof. Dr. T. Notteboom• 29• Prof. Dr. T. Notteboom30Tanker market situation

• Tanker demand drivers

• Increased non-OPEC oil production

• Demand for modern ships

• Low oil stocks

• Market disruptions

• Political: Venezuela, Iraq, Nigeria, Indonesia, Russia

• Technical

• Congestion in Bosporus

• Japanese nuclear plant maintenance

• Piracy

• Random events

• Weather

Tanker market situation

• Tanker supply drivers

• Large order book

• Accelerated single-hull phase-out

• Scrapping old tonnage

• Tonnage primarily double-hull

• Drop in average age