The freight market is one of the markets Jevons must have had in mind when he wrote the definition cited in the previous section. The original freight market, the Baltic Shipping Exchange, was opened in London in 1883, though its functions had long been performed, in a less organized way, by the Baltic Coffee House. The Baltic operates in exactly the way Jevons described. At this institution merchants looking for transport met ships’ Captains looking for cargo. The freight market today remains a market place in which sea transport is bought and sold, though the business is mainly transacted by telephone and telex rather than on the floor of the Baltic. Nowadays there is a single international freight market but, just as there are separate sections for cows and pigs in the country market, there are separate markets for different ships in the freight market. In the short term the freight rates for tankers, bulk carriers, container ships behave quite differently, but because it is the same group of traders, what happens in one sector eventually ripples through into the others. Also, because it takes time for ships to move around the world, there are separate regional markets which are only accessible to ships ready to load cargo in that area. This becomes important when we discuss the theory of short term and long-term freight rate determination.
The freight market has two different types of transaction, the freight contract in which the shipper buys transport from the shipowner at a fixed price per ton of cargo and the time charter under which the ship is hired by the day. The freight contract suits shippers who prefer to pay an agreed sum and leave the management of the transport to the shipowner, while the time charter is for experienced ship operators who prefer to manage the transport themselves.
Fixing a ship
When a ship is chartered or a freight rate is agreed, the ship is said to be ‘fixed’.Fixtures are arranged in much the same way as any major international hiring or subcontracting operation. Shipowners have vessels for hire, charterers have cargo to transport, and brokers puts the deal together. Let us briefly consider the part played by each of these:The shipowner comes to the market with a ship available, free of cargo. The ship has a particular speed, cargo capacity, dimensions and cargo handling gear.Existing contractual commitments will determine the date and location at which it will become available. For example, it may be a Panamax bulk carrier currently on a voyage from the US Gulf to deliver grain to Japan, so it will be ‘open’ (available for hire) in Japan from the anticipated date at which the coal has been discharged, say 12 May. Depending upon his ‘chartering strategy’, the shipowner may be looking for a short charter for the vessel or a long charter.The shipper or charterer may be someone with a volume of cargo to transport from one location to another or a company that needs an extra ship for a period of time. The quantity, timing and physical characteristics of the cargo will determine the type of shipping contract required. For example, the shipper may have a cargo of 50,000 tons of coal to ship from Newcastle, New South Wales, to Rotterdam.Such a cargo might be very attractive to a bulk carrier operator discharging coal in Japan and looking for a cargo to reposition into the North Atlantic, because he has only a short ballast leg from Japan to Australia and then a full cargo back to Europe.The question is, how does the shipper contact the shipowner?Often the principal (i.e. the owner or charterer) will appoint a shipbroker to act for him. The broker’s task is to discover what cargoes or ships are available; what the owners/ charterers want to be paid; and what is reasonable given the state of the market. With this information they negotiate the deal for their client, often intense competition with other brokers. Brokers provide other services including post fixture processing, dealing with disputes, and providing accounting services in respect of freight, demurrage, etc. Some owners or shippers carry out these tasks themselves. However, this requires a staff and management structure which only very large companies can justify. For this reason most owners and charterers use one or more brokers. Since broking is all about information, brokers tend togather in shipping centres. London remains the biggest, with other major centres in New York, Tokyo, Hong Kong, Singapore, Piraeus, Oslo, Hamburg, etc.
Four types of contractual arrangement are commonly used. Under a voyage charter, the shipowner contracts to carry a specific cargo in a specific ship for a negotiated price per ton. A variant on the same theme is the contract of affreightment, in which the shipowner contracts to carry regular tonnages of cargo for an agreed price per ton. The time charter is an agreement between owner and charterer to hire the ship, complete with crew, for a fee per day, month or year. Finally the bareboat charter hires out the ship without crew or any operational responsibilities.
Glossary
Shipper => Individual or company with cargo to transport.
Charterer => Individual or company who hires a ship.
Charter-party => Contract setting out the terms on which the shipper contracts for the transportation of his cargo or the charterer contracts for the hire of a ship.
Voyage charter => Ship earns freight per ton of cargo transported on terms set out in the charter-party which specifies the precise nature and volume of cargo, the port(s) of loading and discharge and the laytime and demurrage. All costs paid by the shipowner.
Consecutive voyage charter => Vessel hired to perform a series of consecutive voyages between A and B.
Contract of Affreightment (COA) => Shipowner undertakes to carry quantities of a specific cargo on a particular route or routes over a given period of time using ships of his choice within specified restrictions.
Period charter => The vessels is hired for a specified period of time for payment of a daily, monthly or annual fee. There are three types, time charter, trip charter and consecutive voyage charter.
Time charter => Ship earns hire, monthly or semi-monthly. The shipowner retains possession and mans and operates ship under instructions from charterer who pays voyage costs
Trip charter => Fixed on a time charter basis for the period of a specific voyage and for the carriage of a specific cargo. Shipowner earns 'hire’ per day for the period determined by the voyage.
Bare boat charter =>The owner of the ship contracts (for a fee, usually long-term) to another party for its operation. The ship is then operated by the second party as if he owned it.
Laytime =>The period of time agreed between the party to a voyage charter during which the owner will make ship available for loading/discharging of cargo.
Demurrage =>The money payable to the shipowner for delay for which he is not responsible in loading and/or discharging beyond the laytime.
Despatch => Means the money which the owner agreed to repay if the ship is loaded or discharged in less than the laytime allowed in the charter-party (customarilydemurrage).
Common abbreviations
c.i.f. => The purchase price of the goods (by importer) include payment of insurance and freight which is arranged by the exporter.
f.o.b. => Goods are purchased at cost and the importer makes his own arrangement for insurance and freight.
The Voyage Charter
A voyage charter provides transport for a specific cargo from port A to port B for a fixed price per ton. For example, a grain trader may have 25,000 tons of grain to transport from Port Cartier in Canada to Tilbury in the UK. So what does he do?He calls his broker and tells him that he needs transport for the cargo. The broker will ‘fix’ (i.e. charter) a ship for the voyage at a negotiated freight rate per ton of cargo, e.g. $5.20. The terms will be set out in a charter-party and, if all goes well,the ship arrives on the due date, loads the cargo, transports it to Tilbury, discharges and the transaction is complete.If the voyage is not completed within the terms of charter-party then there will be a claim. For example, if laytime (i.e. port time) at Tilbury is specified at seven days and the time counted in port is ten days, the owner submits a claim for three days demurrage to the charterer. Conversely, if the ship spends only five days inport, the charterer will submit a claim for two days despatch to the owner.
The rates for demurrage and despatch are stated in dollars per day in the charter-party.The calculation of demurrage and despatch does not normally present problems,but cases do arise where the charterer disputes the owner’s right to demurrage.Demurrage becomes particularly important when there is port congestion. During the 1970s there were delays of up to six months in discharging cargo in the Middle East and Lagos, while during the coal boom of 1979–80 bulk carriers had to wait several months to load coal at Baltimore and Hampton Roads. In cases where the demurrage cannot be accurately predicted it is important to the charterer that he receives a demurrage payment equivalent to his daily hire charge.
The Contract of Affreightment
The Contract of Affreightment (COA) is a little more complicated. The ship owner agrees to carry a series of cargo parcels for a fixed price per ton. For example, the shipper may have a contract to supply ten consignments of 50,000 tons of coalfrom Colombia to Rotterdam at two-monthly intervals. He would like to arrange for the shipment in a single contract at an agreed price per ton and leave the details of each voyage to the shipowner. This allows the shipowner to plan the use of his ships in the most efficient manner. He can switch cargo between vessels to give the best possible operating pattern and consequently a lower charter rate. He may also be able to arrange backhaul cargoes which improve the utilization of the ship.Companies who specialize in COAs sometimes describe their business as ‘industrial shipping’ because their aim is to provide a service. Since a long-term contract is involved, COAs involve a greater commitment to marketing the service to the shipper and providing an efficient service.Most COA business is in the major dry bulk cargoes of iron ore and coal and the major customers are the steel mills of Europe and the Far East. The problem in negotiating COAs is that the precise volume and timing of cargo shipments is not generally known in advance. Cargo volume may be specified as a range (e.g.‘minimum x and maximum y tons’) while timing may rely on generalizations such as ‘The shipments under the contract shall be evenly spread over the contract period.’
The Time Charter
A time charter gives the charterer operational control of the ships carrying his cargo, while leaving ownership and management of the vessel in the hands of the ship owner. The length of the charter may be the time taken to complete a single voyage (trip charter) or a period of months or years (period charter). When on charter, the shipowner continues to pay the operating costs of the vessel (i.e. the crew, maintenance and repair), but the charterer directs the commercial operations of the vessel and pays all voyage expenses (i.e. bunkers, port charges and canal dues) and cargo handling costs. With a time charter, the shipowner has a clear basis for preparing the ship budget, since he knows the shipoperating costs from experience and is in receipt of a fixed daily or monthly charter rate (e.g. $5,000 per day). Often the shipowner will use a long time charter from a major corporation such as a steel mill or an oil company, as security for a loan to purchase the ship needed for the trade.Although simple in principle, in practice time charters are complex and involve risks for both parties. Details of the contractual agreement are set out in the ‘charter-party’. The shipowner must state the vessel’s speed, fuel consumption and cargo capacity. The terms of hire will be adjusted if the ship does not perform to these standards. The charter-party will also set out the conditions under which the vessel is regarded as ‘off hire’, for example during emergency repairs, when the charterer does not pay the charter hire. Long time charters also deal with such matters as the adjustment to the hire charge in the event of the vessel being laid up, and will set out certain conditions under which the charterer is entitled to terminate the arrangement, for example if the owner fails to run the ship efficiently.There are three reasons why subcontracting may be attractive. First, the shipper may not wish to become a shipowner, but his business requires the use of a ship under his control. Second, the time charter may work out cheaper than buying,especially if the owner has lower costs, due to lower overheads and larger fleet.This seems to have been one of the reasons that oil companies subcontracted so much of their transport in the 1960s. Third, the charterer may be a speculator taking a position in anticipation of a change in the market.Time chartering to industrial clients is a prime source of revenue for the shipowner.The availability of time charters varies from cargo to cargo and with business circumstances. In the early 1970s about 80 per cent of oil tankers owned by independent shipowners were on time charter to oil companies. Twenty years later the position had reversed and only about 20 per cent were on time charter. In short there had been a major change of policy by the oil companies, in response to changing circumstances in the tanker market and the oil industry. About 30 per cent of iron ore is carried on the spot market but a larger proportion of grain.
The Bare Boat Charter
Finally, if a company wishes to have full operational control of the ship, but does not wish to own it, a bare boat charter is arranged. Under this arrangement the investor, not necessarily a professional shipowner, purchases the vessel and hand sit over to the charterer for a specified period, usually ten to twenty years. The charterer manages the vessel and pays all operating and voyage costs. The owner,who is often a financial institution such as a life insurance company, is not active in the operation of a vessel and does not require any specific maritime skills. It is just an investment. The advantages are that the shipping company does not tie up its capital and the nominal owner of the ship may obtain a tax benefit. This arrangement is often used in the leasing deals.
The Charter-Party
Once a deal has been ‘fixed’, a charter-party is prepared setting out the terms on which the business is to be done. Hiring a ship or contracting for the carriage of cargo is complicated and the charter-party must anticipate the problems that are likely to arise. Even on a single voyage with grain from the US Gulf to Rotterdam any number of mishaps may occur. The ship may not arrive to load at the time indicated, there may be a port strike or the ship may break down in mid-Atlantic. A good charter-party will provide clear guidance on precisely who is legally responsible for the costs in each of these events, whereas a poor charter-party may force either the shipowner, the charterer or the shipper to spend large sums on lawyers to argue a case for compensation.For the above reasons the charter-party or cargo contract is an important document in the shipping industry and must be expertly drawn up in a way that protects the position of the contracting parties. It would be too time consuming to develop a new charter-party for every contract, particularly voyage charters, and the shipping industry uses standard charter-parties that apply to the main trades,routes and types of chartering arrangement. By using one of these standard contracts,proven in practice, both shipper and shipowner know that the contractual terms will cover most of the eventualities that are likely to arise in that particular trade.
An example of a basic general charter-party is the BIMCO ‘Gencon’. This consists of two parts, a schedule (Part 1) setting out details of the charter, setting out the standard terms. It is usual to specify the standard charter-party to be used at the time when the order is quoted—this avoids subsequent disputes over contractual terms,a very important point in a market where freight rates can change substantially over a short period and one of the contracting parties may look for a legitimate loophole. Because there are so many variants there is no definitive list of charter-party clauses.
Taking the ‘Gencon’ charter-party as an example, the principal sections in the charter-party can be subdivided into six major components:
1. Details of the ship and the contracting parties.
The charter-party specifies:
•The name of the shipowner/charterer and broker;
•Details of the ship—including its name, size and cargo capacity;
•The ship’s position;
•The brokerage fee, stating who is to pay.
2. A description of cargo to be carried, drawing attention to any special features.The name and address of the shipper is also given, so that the shipowner knows whom to contact when he arrives at the port to load cargo.
3. The terms on which the cargo is to be carried. This important part of the voyage charter-party defines the commitments of the shipper and ship owner under the contract.
This covers:
•The dates on which the vessel will be available for loading;
•The loading port or area (for example, US Gulf);
•The discharging port including details of multi port discharge where appropriate;
•Laytime, i.e. time allowed for loading and discharge of cargo;
•Demurrage rate per day in US dollars;
•Payment of loading and discharge expenses. If loading or discharge is not completed within the time specified the shipowner will be entitled to the payment of liquidated damages (demurrage) and the amount per day is specified in the charter-party (e.g. $5,000/day).
4. The terms of payment. This is important because very large sums of money are involved. The charter-party will specify:
•The freight to be paid;
•The terms on which payment is to be made;There is no set rule about this—payment may be made in advance, on discharge of cargo or as instalments during the tenure of the contract. Currency and payment details are also specified.
5. Penalties for non-performance—the notes in Part 11 contain clauses setting out the terms on which penalties will be payable, in the event of either party failing to discharge its responsibilities.
6. Administrative clauses, covering matters that may give rise to difficulties if not clarified in advance. These include the appointment of agents and stevedores, bills of lading, provisions for dealing with strikes, wars, ice, etc.Time charter-parties follow the same general principles, but include boxes to specify the ship’s performance (i.e. fuel consumption, speed, quantity and prices of bunkers on delivery and redelivery) and equipment, and may exclude the items dealing with the cargo. Efficient business depends upon shippers and shipowners concluding the business quickly and fairly without resorting to legal disputes. In view of the very large sums of money involved in shipping cargo, this goal can be achieved only by detailed charter-parties that provide clear guidance on the allocation of liability inthe event of many thousands of possible mishaps occurring during the transport of cargo across the world.
Freight market reporting
The rates at which charters are fixed depend on market conditions and the free flow of information reporting latest developments plays a vital part in the market.Since the starting point for the charter negotiations is ‘last done’, shipowners and charterers take an active interest in reports of recent transactions. We shall review the way in which charter rates are reported. As an example we will take the daily freight market report published in Lloyd’s List.
Dry cargo market report
The report consists of a commentary on market conditions followed by a list of reported charters under the headings: grain, coal and time charters. Not all charters will be reported. On this particular day the report comments: ‘Panamax freight rates continued to edge lower, while capesize levels moved higher due to the volume of forward coal cargoes.’ In the fixture report, the details of the charter are generally summarized in a specific order. For voyage charters we can illustrate this point by referring to the first example of a grain charter as follows:US Gulf to Japan—Tai Zhou Hai, 52,000–54,000 t heavy grains, $24.25 fio, basis no combination, 11 days, Mid-Mar, (Korea Line)The vessel Tai Zhou Hai has been chartered to load cargo in the US Gulf andtransport it to Japan. The cargo consists of 52–54,000 tons of heavy grains, at a freight rate of $24.25 per ton. According to the Clarkson Bulk Carrier Register the Tai Zhou Hai is 64,170 dwt, so this is a part cargo, loading the ship to the maximum draft for Panama Canal transit. ‘No combination’ means it will be a single port discharge (many cargoes have two or three port discharge). Eleven days are allowed for loading and discharge. The vessel must present itself ready to load in mid-March, though the charter-party will certainly be more specific, naming the precise dates. The charterers are Korea Line.The layout for time charters is slightly different, as we can see taking the first example: Cape Jupiter (170,000 dwt, built 1997) delivery Japan, end March, Pacific round voyage, $ 18,000 per day. (K Line)The ship details are given in brackets after its name, and in this case the vessel is abrand new 170,000 dwt bulk carrier delivered 1997, so it is almost certainly on itsmaiden voyage. Sometimes the speed and fuel consumption are quoted, since theseare significant in determining the charter rate. The vessel is to be delivered tocharterers in Japan at the end of March, to undertake a Pacific round voyage at acharter rate of $18,000 per day and is chartered by K Line. Often the location of redelivery is specified. For example, the next time charter for the Hell as specifies‘redelivery China’. Note that the daily charter rate for the
Hellas, a 139,000 dwt vessel built 1982, is $13,300 per day, about 26 per cent below the charter rate for the
Cape Jupiter. All of the time charters are for a single round voyage or a six-month period, emphasizing the fact that the time charter is not exclusively a means of fixing vessels for long periods.
Tanker market report
The tanker charter report follows a similar pattern to the dry cargo market, though the main division in the reported charter is between ‘clean’ and ‘dirty’. The clean charters refer to products tankers carrying clean oil products, while the dirty charters refer to crude oil and black products. Tanker fixtures are generally in World scale, an index based on the cost of operating astandard tanker on the route. The first item reported in the commentary is the firming of rates for tankers of 50–70,000 dwt in the Caribbean from W115 toW125. Also the report notes that rates for ULCCs like the Jabre Viking, the world’s biggest tanker of 564,763 dwt, were quite steady at about W42.5 (the vessel had been fixed to Exxon two days earlier). The details reported for each charter follow a similar pattern to dry cargo. For example:Aden to Persian Gulf and Japan—Sponsalis, 55,000 t, Worldscale 205, Mar2.(SSS). This means that the motorship Sponsalis has been fixed for a voyage charter from Aden to Japan via the Persian Gulf. The cargo is 55,000 tons, which is a part cargo—checking in the Clarkson Tanker Register, we see that Sponsalis is a 1986-built epoxy coated products tanker of 87,000 dwt. The charter rate is Worldscale 205 and commences on 2 March. The charterer is SSS, which is the designation of Showa Shell. Note that the charter rate for the 87,000 dwt products tanker is almost four times higher than for the 564,763 dwt ULCC, reflecting the smaller cargo size and in direct voyage under taken on the products fixture.
Liner and specialist ship chartering
The biggest international charter market is in tanker and dry bulk tonnage. There is also a significant market for liner and specialist vessels. Liner companies from time to time need to charter in additional ships to meet the requirements of an up swing in trade or to service the trade while their own vessels are under going major repairs. For this reason there is an active charter market in ‘tween deckers, roll on, roll off vessels (ro-ros) and container ships.
Freight rate statistics
Shipowners, shippers and charterers take great interest in statistics showing trends in freight rates and charter rates. Three different units of measurement are commonly used.
1) Voyage rate statistics
for dry cargo commodities are generally reported in $/ton for a standard voyage. By convention this is a negotiated rate covering the total transport costs. This measurement is commonly used in the dry cargo trades where,for example, brokers such as Clarksons report average rates on 26 routes each week. For example, $12 per tonne for grain from the US Gulf to Rotterdam or $5.50 per tonne for coal to Queensland to Japan.
2) Time charter rate
In contrast time charter rates are generally measured in $000s per day. Time charterer rates are commonly reported for ‘trip’ (i.e. round voyage), 6 months, 12 months and 3 years.
3) Worldscale
The tanker industry uses this freight rates index as a more convenient way of negotiating the freight rate per barrel of oil on many different routes. The concept was developed during the Second World War when the British Government introduced a schedule of official freight rates as a basis for paying the owners of requisitioned tankers. The schedule showed the cost of transporting a cargo of oil on each of the main routes using a standard 12,000 dwt tanker. Owners were paid the rate shown in the schedule or some fraction of it. The system was adopted by the tanker industry after the war and has been progressively revised over the years, the last amendment being in January1989 when ‘New Worldscale’ was introduced.The Worldscale index is published in a book which is used as the basis for calculating tanker spot rates. The book shows, for each tanker route,the cost of transporting a metric tonne of cargo using the standard vessel on around voyage. This cost is known as ‘Worldscale 100’. Each year the Worldscale Panel meet in London and updates the book. The standard vessel has, from time to time, been updated.
The Worldscalesystem makes it easier for shipowners and charterers to compare the earnings of their vessels on different routes. Suppose a tanker is available spot in The Gulf and the owner agrees a rate of Worldscale 50 for a voyage from Jubail to Rotterdam.To calculate how much money he will earn he first looks up the rate per metric tonne for Worldscale 100 from Rotterdam to Jubail. Consulting the appropriateentry he finds that it is $17.30 per metric tonne. Since he has settled at Worldscale 50 he will receive half of this amount, i.e. $8.65 per metric tonne. If his ship carries 250,000 metric tonnes, the revenue from the voyage will be $2,162,500. It is an equally simple matter to make the same calculation for a voyage to Japan.
The Baltic Freight Index (BFI)
The volatility of the charter market creates uncertainty over future freight charges that may be unwelcome to many businessmen. Consider the case of a European grain merchant who in February purchases 55,000 tons of maize to be shipped from the US Gulf to Rotterdam in July. Since he is obliged to wait until July before chartering a vessel, there is a risk that the freight rate will increase, wiping out his profit on the deal.
The Baltic International Freight Futures Exchange (BIFFEX) was opened in January 1985 to enable shippers, owners and charterers to hedge against sudden changes in the freight rate. The freight future market is based on the Baltic Freight Index (BFI), a statistical index covering freight rates on eleven different trade routes (grain (four routes), coal (three routes), iron ore, and trip charter (three routes)). The index is calculated each day as the weighted average of actual rates on the thirteen routes. If there are no charters, a panel of brokers independently submit their estimates of what the charter rate would have been and these are averaged. In addition to providing a settlement index for hodging, the Baltic Freight Index (BFI) is the most widely used market indicator in dry bulk shipping.
Over the decade 1987 to 1997 there were thirteen occasions on which the index moved several hundred points up or down in a period of a few months.This is the volatility which hedging markets are designed to deal with.The hedging operation is achieved by trading units on the freight futures exchange. Like any futures market, the price at which individuals are prepared to buy and sell forward depends upon their expectations of the future—if in January it is expected that freight rates will have risen by April, then the price of contract units for settlement at end April will be higher than the current BIFFEX Index and vice versa. Contract units can be bought and sold at a rate of $10 per BIFFEX index point, with units traded ahead for settlement at three-monthly intervals.
The sale and purchase market
We now come to the sale and purchase market. About 1,000 deep sea merchant ships are sold each year, representing an investment of $9.6 billion. The remarkable feature of this market is that ships worth tens of millions of dollars are traded like sacks of potatoes at a country market. There are many bigger commodity markets,but few share the pure drama of ship sale and purchase.The participants in the sale and purchase market are the same mix of shippers,shipping companies and speculators who trade in the freight market.
The shipowner comes to the market with a ship for sale. Typically the ship will be sold with prompt delivery, for cash, free of any charters, mortgages or maritime liens. Occasionally it may be sold with the benefit (or liability) of an ongoing time charter. The ship owner’s reasons for selling may vary. He may have a policy of replacing vessels at a certain age, which this ship may have reached; the ship may no longer suit his trade; or he may think prices are about to fall. Finally there is the ‘distress sale’ in which the owner sells the ship to raise cash to meet his day-to-day commitments.
The purchaser may have equally diverse objectives. He may need a ship of a specific type and capacity to meet some business commitment, for example a contract to carry coal from Australia to Japan. Or he may be an investor who feels that it is the right time to acquire a ship of a particular type. In the latter case his requirements may be more flexible, in the sense that he is more interested in the investment potential than the ship itself.Most sale and purchase transactions are carried out through shipbrokers.
The shipowner instructs his broker to find a buyer for the vessel. Sometimes the ship will be given exclusively to a single broker, but it is common to offer the vessel through several broking companies. On receipt of the instruction the broker will telephone or fax any client he knows who is looking for a vessel of this type. If the instruction is exclusive, he will call up other brokers in order to market the ship through their client list. Full details of the ship are drawn up, including the specification of the hull, machinery, equipment, class, survey status and general equipment. Simultaneously the broking house will be receiving enquiries from potential purchasers. For example an owner may be seeking a ‘modern’ 65,000 dwt bulk carrier. The broker may have suitable vessels for sale on his own list, and would not pursue enquiries through other brokers. If no suitable candidates can be found, he may look for suitable candidates and approach their owners to see if there is any interest in selling.
The sales procedure
Broadly speaking the procedure for buying/selling a ship can be sub-divided intothe following five stages:
1)Putting the ship on the market.
The first step is for the buyer or seller to appoint a broker—or he may decide to handle the transaction himself. Particulars of the ship for sale are circulated to interested parties in the market.
2)Negotiation of price and conditions.
Once a prospective buyer has been found the negotiation begins. There are no hard and fast rules. In a buoyant market the buyer may have to make a quick decision on very limited information.Alternatively during a weak market, he can take his time, inspecting large numbers of ships and seeking detailed information from the owners. When agreement has been reached in principle, the brokers may draw up a ‘recap telex’ summarizing the key details about the ship and the transaction, before proceeding to the formal stage of preparing a sale contract.
3) Memorandum of Agreement.
Once an offer has been accepted a Memorandum of Agreement is drawn up setting out the terms on which the sale will take place. A commonly used pro forma for the Memorandum of Agreement is the Norwegian Sales Form (1987).
The memorandum sets out the administrativedetails for the sale (i.e. where, when and on what terms) and lays down certain contractual rights, such as the right of the buyer to inspect Class Society records.A summary of the key points covered in sales form documents. At this stage the memorandum is not generally legally binding, since it will include a phrase to the effect that it is ‘subject to…’.
4) Inspections.
The buyer, or his surveyor make any inspections which are permitted in the sales contract. There will probably be a physical inspection of the ship, possibly including an underwater inspection by divers. There will also be an inspection of the Classification Society records for information about the mechanical and structural history of the ship. Sales often fail at this stage if the buyer is not happy with the results of the inspections.
5) The closing.
Finally the ship is delivered to its new owners who simultaneously transfer the balance of funds to the seller’s bank. At the closing meeting representatives of the buyer and seller on board ship are in telephone contact with a meeting ashore of representatives of sellers, buyers, current and prospective mortgagees and the ship’s existing registry.
This four page pro-forma contract has 15 clauses covering the issues which can be problematic in selling a ship. The following summary refers to the MOA as drafted, individual clauses are generally modified during the negotiation, with terms added or removed.
Preamble:
At the top of the form are spaces to enter the date, the seller, the buyer and details of the ship, including the classification society, year of build, shipyard,flag, etc.
1) Price:
The price to be paid for the vessel. where.
2) Deposit:
States the deposit paid by the purchaser, when it must be paid
3) Payments:
The purchase money (amount and bank details stated) must be paid on delivery of the vessel, but not later than three banking days after the buyer has been notified that the vessel is ready for delivery.
4) Inspections:
The buyer can inspect the vessel and its class records. The clause states where and when the vessel will be available and restricts the scope of the inspection (no‘opening up’). After inspection the buyer has 48 hours to accept in writing, after which the contract is null and void. (N.B. In practice buyers generally inspect the ship before the MOA is drawn up, in which case this clause does not apply).
5) Place and time of delivery:
States where the vessel will be delivered and when, usually a range of ports over a period of time. The buyer can cancel the purchase if the ship is not delivered by the stated date.
6) Drydocking:
The seller is to drydock the vessel at the port of delivery for thebottom inspection. Any defects which affect the vessel’s class must be rectified. It states who is responsible for the various expenses. (N.B. Nowadays it is more common to use divers.)
7) Spares/Bunkers etc:
Names moveable items included in the sale of those which the seller can take ashore. Bunkers and lubricating oils are handed over at the market price.
8) Documentation:
The seller must provide a notarially attested bill of sale; acertificate stating that the vessel is free from registered encumbrances; a certificate demonstrating that the vessel has been deleted from its current registry; and all class papers
9) Encumbrances:
The seller warrants that the vessel is free from any third party claims which could damage its commercial value. Any claim arising subsequently but incurred before delivery, must be paid by the buyer.
10) Taxes:
Buyers and sellers are responsible for their own costs of registration etc.
11) Condition on delivery:
The ship must be delivered in the condition in which it was inspected; it must be in class, and the class society must have been notified of anything which could affect its class status.
12) Name/Markings:
On delivery the buyer must change the name of the vessel and all funnel markings (i.e. so that it is clear that it is not still trading under theprevious owner).
13) Buyer’s default:
If the buyer defaults and the deposit has not been paid, the seller can claim his costs from the buyer. If the deposit has been paid, but the purchase money is not paid, the seller can retain the deposit and claim compensation for losses, with interest.
14) Seller’s default:
If the seller fails to deliver the vessel with everything belonging to her by the agreed date, the buyer can cancel the contract and receive interest and compensation for expenses.
15) Arbitration:
Sets out the terms under which arbitration will be carried out.
How ship prices are determined
The sale and purchase market thrives on price volatility. ‘Asset play’ profits earned from well timed buying and selling activity are an important source of income for shipping investors. Bankers are just as interested in ship values because a mortgage on the hull is the primary collateral for their loans.
There has always been plenty of volatility to attract investors and worry bankers.Early in the twentieth century Fairplay monitored the price of a ‘new, ready 7,500ton cargo steamer’. The price of this vessel increased from £48,000 in 1898 to £60,750 in December 1900, and then fell by one-third to £39,250 in December 1903.
The same vessel was worth £232,000 in 1919, £52,000 in 1925 and £48,750 in 1930. In the 1970s and 1980s we find much the same pattern. For example the price of a 60,000 dwt bulk carrier fell to $6 million in December 1977. Three years later December 1980 the price had increased by 60 per cent to $22 million. Within two years the price was down to $7 million, and did not reach $22 million again until late 1989, after which it was steady for several years.If we express the price of a 30,000 dwt bulk carrier as a percentage deviation from a linear regression trend fitted over the period 1976–94, the extent of the volatility becomes clear. In 1980 the price reached a peak 70 per cent above the trend, while in 1986 it fell 70 per cent below trend. Obviously selling a ship at the bottom of a market cycle is disastrous, and a great bargain for the buyer. No shipping company follows this suicidal course of action by choice.‘Distress’ sales during market troughs are generally driven by cash flow pressures.The seller might be a shipowner who cannot pay his bunker bill, or a banker who has foreclosed on his client and taken posession of the fleet. Fortunately the extreme price fluctuations are relatively uncommon and the more limited volatility which occurred between 1987 and 1997 is more common. It all dependson the underlying cashflow of the industry.Movements in the price of different ship types tend to be closely synchronized.
Over the twenty-year period 89 per cent of the price movements of a 65,000 dwt bulker and a 30,000 dwt bulker were correlated. The relationshipis slightly weaker for the 30,000 dwt and 280,000 dwt tankers, with 75 per cent of the price movements correlated. Even tanker and bulk carrier prices show acorrelation coefficient of 67 per cent for the small vessels and 68 per cent for large vessels. Considering the different character of the markets, the relationship is remarkably close. It raises an interesting question. If the prices of different types of ships are so highly correlated, does it really matter what ship type asset players buy? For really major swings in prices it probably does not matter because cash flow pressures work their way from one sector to another. However there is plenty of room for independent price movement during the more moderate cycles. For example, between 1991 and 1995 bulk carrier prices held steady, while the price of large tankers fell. This is where the choice of market really does make adifference.
Price dynamics of merchant ships
In the circumstances outlined above it is natural that second-hand prices play a major part in the commercial decisions of shipowners—very large sums of money are involved. What determines the value of a ship at a particular point in time?There are four factors which are influential: freight rates, age, inflation andshipowners’ expectations for the future.
Freight rates are the primary influence on ship prices. Peaks and troughs in the freight market are transmitted through into the sale and purchase market, price movements from 1976–93 for a five-year-old bulk carrier, comparing the market price with the one-year time charter rate. The relationship is very close, especially as the market moves from trough to peak.When the freight rate fell from $8,500 per day in 1981 to $3,600 per day in 1985,the price fell from $12 million to $3 million. Conversely, when the freight recovered to $8,500 per day, the price increased to $15 million. This correlation provides some guidance on valuing ships using the gross earnings method. Analysis of the past relationship between price and freight rates suggests that when freight rates are high the S&P market values a five-year-old ship at about six times its current annual earnings, based on the one year time charter rate. For example if it is earning $4 million per annum it will value the ship at $24 million. When the market drops,so does the earnings multiple. In recessions the value may fall as low as three time earnings.
The second influence on a ship’s value is age. A ten-year-old ship is worth less than a five-year-old ship. The normal accountancy practice is to depreciate merchant ships down to scrap over 15 or 20 years. Brokers who value ships take much the same view, generally using the ‘rule of thumb’ that a ship loses 5 or 6 per cent of its value each year. As an example of how this works out in practice, the price of a 1974 built products tanker over the 20 years to 1994. The slope of the depreciation curve reflects the loss of performance due to age, higher maintenance costs, a degree of technical obsolescence and expectations about the economic life of the vessel. For a specific ship the economic life may be reduced by the carriage of corrosive cargoes, poor design, or inadequate maintenance. When the market value eventually falls below the scrap value the ship is likely to be sold for scrapping. The average age of tankers and bulk carriers scrapped in 1995 was 23–25 years, but in protected trades, such as the US domestic trades, the average scrapping age in the mid-1990s was about 35 years.
Ships operating in fresh water environments such as the Great Lakes last much longer.In the longer term, inflation
affects ship prices. Inflation of asset values accounted for about half the return on bulk shipping in the 1970s and 1980s. To illustrate the effects discussed above we can look at past behaviour of the price of a second-hand bulk carrier as the ship grows older. The development of a second-hand price for a 35,000 dwt bulk carrier built in 1965 was calculated by taking the reported resale price of the ship in dollars, deflating it to remove the effects of inflation using the OECD consumer price index and fitting a linear trend to the deflated data. The trend line thus presents a rough estimate of what the resale price of the ship would have been if there had been no market cycles and no inflation during the life of the vessel. After 10 years the trend resale value of the 35,000 dwt vessel has fallen by 49 per cent relative to its new value. This suggests that, if this vessel is typical, leaving aside the effects of market cycles and inflation, we would expect that after 10 years the vessel would have a market resale value of about 50 per cent less than the original new building value. However, inflation seems to have a very significant effect and, as time passes, the market price line moves progressively further above the deflated price line. After a few years, even during depressions the market price does not fall below the trend value.
The fourth and in some ways most important influence on second-hand prices is expectations. This accelerates the speed of change at market turning points. For example buyers or sellers may first hold back to see what will happen, then suddenly rush to trade once they believe the market is ‘on the move’. The market can swing from deep depression to intensive activity in the space of only a few weeks, as the following newspaper report demonstrates: A very large crude carrier damaged in a Persian Gulf missile attack and destined to be broken up has become the subject of one of the year’s most remarkable sales deals. Market sources believe that the buyer has paid $7 million for the tanker which, until the recent surge in demand for large tonnage, appeared to have no future. The rescue of the Volere is indicative of the continuing shortage of large tankers which has prompted many vessels to break lay-up. A month ago the 423,700 dwt Empress was brought from Taiwanese interests after being towed half around the world for intended demolition.(Lloyd’s List, 4 July 1986). The Volere was resold two months later for $9.5 million and second-hand tonnage was in very short supply as owners held back on sales to see how prices would develop. In short, although there is a clear correlation between second-hand prices and freight rates, the movement of prices is often not a leisurely process. Peaks and troughs tend to be emphasized by the behaviour of buyers and sellers.
Valuing merchant ships
Valuing ships is one of the routine tasks undertaken by sale and purchase brokers.There are several reasons why valuations are required. Banks lending against a mortgage need to value the collateral and will probably continue to monitor the ship’s value over the term of the loan. Prospectuses for public offerings of equity generally include a valuation of the company’s fleet, as do the annual accounts of public companies. Finally, leases often require a view on the ‘residual value’ of the ship at the end of the loan period. This is a much more complex and difficult task than simply appraising the current value.Valuing a merchant ship involves a mixture of procedure, market knowledge and judgement. First the broker consults his records to check the physical characteristics of the ship and recent sales of similar vessels. He will pay particular attention to the ship type, size, age, yard of build, survey status, equipment and specification. Most of these are self evident, but some deserve comment. Bigger ships are generally worth more than smaller ships, but the relationship varies with the freight cycle. For example, in the distressed market of the 1980s a 250,000 dwt tanker could be bought for the same price as an 80,000 dwt vessel, whereas at the market peak in 1989 the 250,000 dwt vessel was worth twice as much. We have already discussed age and the ‘rule of thumb’ that ships lose about 5 per cent of their value each year. This is a useful guideline, but it is not always reliable,especially for very new or very old ships. The yard of build is important because ships built in some marginal yards sell at a discount, so care is needed. Equipment is sometimes important. Shipowners prefer ships with standard machinery, so any ship with an unusual engine or auxiliary equipment is likely to be discounted. Some ships are better specified than others and owners are keen to see this reflected in the valuation. A double hull tanker, above average cargo handling gear, tank coatings, good fuel economy, high speed, pallet capability (in reefers),automated engine room all make the ship more desirable. However, like ‘extras’on motor cars, these features make the ship easier to sell but do not always increase its value. Sometimes an ‘extra’ is not an advantage. For example, small bulk carriers frequently require cargo handling gear, and a geared ship is worth more. In contrast Panamax bulk carriers are not generally geared, so a geared Panamax may not attract a premium.
Physical condition certainly affects the price of a ship, but this is something which brokers are not in a position to evaluate. For valuation purposes the ship is generally assumed to be ‘in good and seaworthy condition’. The responsibility for establishing the physical condition of the ship lies entirely with the purchaser/owner/banker. Survey status is another matter. If the ship is old and a special survey is imminent, this will be taken into account. Although the valuer does not know how much the ship will need spending on it, he knows how the market treats ships in this situation, and will take that into account.Ultimately the valuation is the broker’s judgement of what the vessel would fetch if put on the market on a ‘willing buyer, willing seller’ basis. This qualification is important, because if no ‘willing buyer’ is available, normal prices may be heavily discounted. Although the broker will take into account ‘last done’, the ship is normally valued at what it would sell for today. In a rising market, the valuation will be above recent reported sales and lower in a falling market. Sometimes a broker may be asked to value a ship of a type for which there has been no recent sale. In this case the valuation is entirely judgemental. Three brokers may arrive at three different prices, depending on how they feel the market would respond to the sale of a ship of this type.In view of the large sums of money involved, it is to be expected that there will be disputes over what a ship is really worth. For example a bank may produce a valuation showing that the collateral cover on a loan is inadequate due to the falling value of the mortgaged ships, but the borrower produces his own higher valuations. When prices are falling there is often little business transacted, so the valuation is particularly subjective, with the result that different brokers take different views. A panel of valuers is the usual solution to this difficulty.Another common problem is the charter status of the ship. What happens if the ship has a time charter? One possibility is to carry out a present value calculation,based on the charter revenue and projected operating costs, but this raises the difficult question of whether the charterer is credit worthy and how to value the ship at the end of the charter. Most brokers value vessels charter free.There may also be problems valuing ship types that are rarely sold. This is often a problem with specialized ships such as chemical parcel tankers, LNG tankers, big container ships,etc. Because the market for these vessels is so thin, brokers find it very difficult to value them. To deal with this problem more than one shipbroker may be asked to value the vessel.Finally, there is the question of quality. Owners often argue that their ships are of superior quality and should be valued above the average market rate. In general valuers are unwilling to fall in with this line of thought. Quality ships sell more easily, but this is not something which can be quantified accurately. For this reason most valuers still insist on the ‘average market condition’ clause, despite today’s quality consciousness in the shipping industry.Valuing a ship for scrap starts with the lwt tonnage of the ship. This is the physical weight of the vessel (i.e. the amount of water it displaces). Scrap pricesare quoted in $/lwt ton. for example a VLCC might have a lwt of 36,000 tons. At$180 per ton its scrap value is $6.48m. In practice scrap prices are almost as volatileas second-hand ship prices. During the last 10 years the scrap price of tankers has swung between $100/lwt and $240/lwt.
Initial cost of vessel US$28 million
Depreciation Rate (percent per annum) 5%
Book value after 10 years 14
Inflation Rate (percent per annum) 3%
Replacement cost after 10 years 18.8
Value at cylical trough:
Cylical trough margin, say -70 percent
Resale value at trough 5.6
Cylical peak margin, say 70 percent
Resale value at peak 32
Calculating the residual value of ships
So much for the current value of a ship, but what will it be worth in future, for example at the end of a 10-year lease? The basic methodology is to use the three determinants of a ship’s price: the depreciation rate, the rate of inflation and the market cycle. Take as an example a new bulk carrier costing $28 million in 1996. If we assume that vessel depreciates at 5 per cent per annum on a straight line basis during the first 10 years of its life, by the end of 10 years its book value will have fallen to $14 million. However, during this time we assume that shipbuilding prices have increased by 3 per cent per annum, so the replacement cost after 10 years would be $18.8 million. This is the most likely value. However,we need to take account of the market cycle, which we have seen can affect there sale price by plus or minus 70 per cent, if we take the most extreme price movements.A sale at the top of the market could bring a price of $32 million, which is higher than the initial purchase price of the ship. If, however, the sale occurs at the bottom of a trough and we allow for a price 70 per cent below the trend value, the minimum resale value would fall to US$5.6 million, which is 20per cent of the initial cost.This approach has many pitfalls. Depreciation rates and inflation are difficult enough to predict, but the market cycle is the real challenge. The cyclical value range of $5.6 million to $32 million is so wide that a view has to be taken on what intensity of cycles might lie ahead. This is pure shipping risk and it is up to the investor to decide what level of risk he is prepared to accept. For example the analysis above is based on one of the most extreme market cycles of the century. The view might be taken that this is unlikely to happen in the period under consideration, so a smaller residual value range would be appropriate.
The newbuilding market
Although the shipbuilding market is closely related to the sale and purchase market,its character is quite different. Both markets deal in ships, but the newbuilding market trades in ships which do not exist. They must be built. This has several consequences. First, the specification of the ship must be determined. A few shipyards sell standard vessels, but most merchant ships are designed, at least to a certain extent, to the buyer’s specification. Second, the contractual process for such a major undertaking is more complex. Third, the ship will not be available for 2 or 3 years from the contract date, by which time conditions may have changed.
The purchaser entering the newbuilding market may have several different motives. He may need a vessel of a certain size and specification and nothing suitable is available on the second-hand market. This often happens when market conditions are firm and the supply of good quality ships is restricted. Second hand prices may even be higher than the price of a newbuilding. Another possibility is that the ships are needed for an industrial project. Steel mills, power stations, LNG schemes and other major industrial projects are generally developed with specific transportation requirements met by newbuildings. Some large shipping companies have a policy of regular replacement of vessels but this is less common than it used to be years ago when British shipping companies would replace their fleets at 10 or 15 years of age. Finally, speculators may be attracted by incentives offered by shipbuilders short of work—low prices and favourable credit are examples.The shipyards form a large and diverse group. There are about 250 major shipyards in the world. Their size and technical capability ranges from the small yards with a workforce of less than 200 employees building tugs and fishing boats to the major South Korean yards employing 15,000 workers building container ships and gas tankers. Although some shipyards specialize in one particular type of ship, most are extremely flexible and will bid for a wide range of business. In adverse markets major shipyards have been known to bid for anything from floating production platforms to research vessels.The negotiation is complex. Occasionally an owner will appoint a broker to handle the newbuilding, but many owners deal direct. The buyer may approach the shipbuilding market from several different directions. One common procedure is to invite tenders from a selection of suitable yards. The tender documentation is often very extensive, setting out a precise specification for the ship. Once tenders have been received the most competitive yards are selected and, following a detailed discussion of the design, specification and terms, a final selection is made. This whole process may take anything from six months to a year. In a sellers market the tender procedure may not be possible. Buyers compete fiercely for the few available berths and shipyards set their own terms and conditions. Often shipyards take advantage of a firm market to insist upon the sale of a standard design.
The contract negotiation can be divided into four areas on which negotiations focus, the price, the specification of the vessel, the terms and conditions of the contract, and the newbuilding finance offered by the shipbuilder. In a weak market buyers will seek to extract the maximum benefit from their negotiating position in each area. Conversely in a strong market the shipbuilder will negotiate for the maximum price possible on a standard vessel, with favourable stage payments.Price is the most important. Usually ships are contracted for a fixed price, payable in a series of ‘stage payments’, which spread payment over the construction of the vessel. The shipbuilder’s aim is to be paid as he builds the ship, so that he does not need working capital and will aim for stage payments along the lines.The pattern varies. In a seller’s market the builder may demand 50 per cent on contract signing. In a weak market the buyer may insist on payment on delivery.The specification of the vessel is also important, because modifications to the design may add 10–15 per cent to the cost. There are many negotiable elements in the contract, as discussed below. Finally, the provision of finance by the shipbuilders is a long established way of securing business, especially by shipyards who are uncompetitive on price, or during recessions when customers find it difficult to raise finance.
Typical pattern of shipyard stage payments
Stage in production Payment due
Signing of contract 5per cent
1,000 tons steel delivered 5per cent
Commencement of steel fabrication 15per cent
25 per cent steel erected 20per cent
75 per cent steel erected 20per cent
Steel erection complete 15per cent
Launch 5per cent
Delivery 15per cent
The shipbuilding contract
Once the preliminary negotiations are complete, a ‘letter of intent’ is often drawn up as a basis for developing the details of the design and the construction contract.At this stage the letter of intent is not generally legally binding, though this can become a delicate issue if the shipyard is devoting significant resources to working up the design. The cost of developing a detailed design for a ferry or a containership can exceed $1 million.The shipyard contract is often drawn up on a standard form. Two commonly used forms are the AWES form and the SAJ form. These are much more detailed than the sales for used for second-hand transactions. The AWES form runs to thirty pages containing a preamble and nineteen articles.
Article 1: Subject contract
A detailed description of the ship, it’s yard number,registration and classification.
Article 2: Inspection and approval
Important section covers the rights of the purchaser to inspect the vessel during construction. The purchaser is required to approve three copies of the drawings and technical information for machinery and equipment to which the vessel must be built. The shipyard may sub-contract work subject to the purchaser’s approval.
Article 3: Modifications
Lays down the rules for any modifications to the design requested by the purchaser after the contract date, or to meet changing regulatory requirements. It gives the builder the right to charge for any changes and modify the building programme if necessary.
Article 4: Trials
Specifies the terms under which sea trials will be carried out, including the conditions under which tests will be carried out and the right of the contractor to repeat trials or postpone them if necessary.
Article 5: Guarantee for speed, cargo carrying capacity and fuel consumption
Sets out the compensation which will be paid if the speed, deadweight,cargo capacity and fuel consumption measured on the sea trials do not exactly comply with the terms of the contract.
Article 6: Delivery of the vessel
States where the vessel will be delivered, sets out the liquidated damages and premiums for late/early delivery and defines ‘force majeure’ which may be acceptable reasons for late delivery. The latter include strikes, extreme weather conditions, shortage of materials, etc.
Article 7: Price
Specifies the contract price, the instalments and the method of payment for modifications, liquidated damages and premiums.
Article 8: Property
Defines who owns the plans, the working drawings and the vessel itself during construction. Three alternative formats are offered. The first specifies that the vessel belongs to the contractor until delivery; the second makes it the property of the purchaser, but gives the contractor a lien for any unpaid portion of the price; the third lays out a procedure for marking parts which become the purchaser’s property held as securtity against instalments paid.
Article 9: Insurance
The builder is responsible for insuring the vessel and all associated components.
Article 10: Defaults by the purchaser
Defines the interest rate at which late payments will be charged and defines the terms under which the contractor can rescind the contract and sell the vessel. Four alternative clauses are offered.
Article 11: Defaults by the contractor
Defines the rights of the purchaser to be repaid with interest if the contractor defaults. Two alternatives are offered.
Article 12: Guarantee
Sets out the terms and period over which the vessel is guaranteed against defects due to bad workmanship or defective materials.
Article 13: Contract expenses
Allocates payment of taxes, duties, stamps and fees between the contractor and the purchaser.
Article 14: Patents
Makes the contractor liable for any infringements of patent on his own work, but not on the work of suppliers.
Article 15: Arbitration
Nominates the legal regime, and sets the conditions for appointing a technical expert to resolve any disputes over the construction of the vessel and the arbitration regime for any contract disputes.
Articles 16–19
Deals with various technicalities, including the terms on which the contract becomes binding, legal domicile of the purchaser and contractor, the purchaser’s right to assign the contract to a third party, and addresses for correspondance.
Shipbuilding prices
Shipbuilding prices are just as volatile as second-hand prices and are closely correlated with them. Like second-hand prices they are determined by supply and demand. However, in this case the sellers are not other shipowners, but shipyards. On the demand side, the key factors are freight rates, the price of modern second-hand ships, financial liquidity of buyers, the availability of credit and, most importantly, expectations. From the shipyard supply viewpoint the key issues are the number of berths available and the size of the order book. A yard with three years’ work cannot offer a realistic delivery, while another yard with only the ships under construction on order will be desperately keen to find new business. This balance is what drives shipyard prices. During booms when the yards have built up long order books and many owners are competing for the few berths available, prices rise sharply. In a recession the opposite happens. Shipyards are short of work and there are fewer buyers, so the yards have to drop their prices to tempt in buyers.
The demolition market
The fourth market is demolition. This is a less glamorous but essential part of the business. The mechanics are simple enough. The procedure is broadly similar to the second-hand market, but the customers are the scrap yards rather than ship owners. An owner has a ship which he cannot sell for continued trading, so he offers it on the demolition market. Usually the sale is handled by a broker and large broking companies have a ‘demolition desk’ specializing in this market. These brokers keep records of recent sales and, because they are ‘in the market’, they know who is buying at any point in time. When he receives instructions from the owner the broker circulates details of the ship, including its lightweight, location and availability to interested parties.The ultimate buyers are the demolition yards, most of which are located in the Far East, for example in India, Pakistan, Bangladesh and China. However the buying is usually done by cash speculators who act as intermediaries, buying the ships for cash and selling them on to the demolition yards. Prices are determined by negotiation and depend on the availability of ships for scrap and the demand for scrap metal. In Asia much of the scrap is used in local markets where it provides a convenient supply of raw materials for mini-mills, or cold rolled for use in construction. Thus, demand depends on the state of the local steel market, though availability of scrapping facilities is sometimes a consideration. Thus prices can be very volatile, fluctuating from a trough of $100/lwt in the 1980s to more than $200/lwt in the 1990s. The price also varies from ship to ship, depending its suitability for scrapping.As offers are received, the price firms up and eventually a deal is made. Although a standard contract such as the Norwegian Sales Form is sometimes used, so few of the clauses are relevant to a demolition sale that brokers tend to use their own simplified contract. On completion the purchaser takes delivery of the ship and, if he is an intermediary, makes the arrangements for delivering the ship to the demolition yard.
