Shipping Risk

An important first step in understanding the shipping cycle is to recognize that it is there for a purpose. Cycles play a central part in the economics of the shipping industry by managing the risk of shipping investment in a business where there is great uncertainty about the future.The whole process starts from the question: ‘Who takes the shipping risk?’ A merchant ship is a large and expensive item of capital equipment. In a world where the volume of trade is constantly changing, someone has to decide when to order new ships and when to scrap old ones. If ships are not built but trade grows,eventually business will grind to a halt. Oil companies could not ship their oil, steel mills run put of iron ore and manufactured exports would pile up in the factories and ports. The lucky owners of the few available ships would auction them to the highest bidder and make their fortunes. However, if ships are built and trade does not grow, it is a very different story. With no cargo, the expensive ships sit idle while the unfortunate investors watch their investment rust away.

This, in essence, is ‘shipping risk’ and it is what the shipping cycle is all about.When the risk is taken by the cargo owner this leads to an ‘industrial shipping’business in which shipowners are subcontractors and cost minimizers. When the‘shipping risk’ is left to the shipowner, the business becomes highly speculative. It is the world’s biggest poker game, in which the ships are the chips. The analogywith poker is in some ways very appropriate. Players must know the rules,  we will touch on the shipping game later. However winning at the shipping game, like poker, also depends on probability, strategy,psychology and luck. Here is devoted to these commercial realities of the game.

When shippers are confident about how much cargo they will need to transport in future, or if they feel that transport is of too great strategic importance to be left to chance, they may decide to take the shipping risk themselves. Shipping operations may be carried out with an owned fleet, or by pre-construction time charters with independent shipowners, if this is found to be a more cost-effective solution. With the assurance of cargo, the owners purchase ships and try to make a living by keeping costs below the contract margins.

This type of operation is often known as ‘industrial shipping’. Raw materials such as iron ore, coal, bauxite, non-ferrous metal ores and coal for steel mills and power stations are shipped in this way. A common arrangement used by the Japanesein developing their heavy industry was the ‘tie-in’ ships or shikumisen. Japanese shipping companies arranged for ships to be built for foreign owners in Japanese yards. The companies then chartered the ships on a long-term basis.

Industrial shipping is a policy, not a requirement. The oil industry provides a good example of how policies can change with circumstances. In the 1950s and1960s it was the policy of the major oil companies to own enough tankers to cover between one-third and two-thirds of their requirements and to charter tankers long-term to cover most of the balance. This left only 5 to 10 per cent of their needs to be covered from the voyage charter market.

After the oil crisis in 1973 the oil trade became more volatile and much of the oil transport passed to oil traders who had little incentive to plan for the future. As a result of these changes oil shippers started to rely more heavily on the voyage market. The amount of oil cargo shipped in vessels hired on the freight market increased from 10–15 per cent in the early 1970s to 50 per cent by the late 1980s and the proportion of independent tanker owners trading as subcontractors (i.e. on time charter) fell from 80 per cent to about 25 percent.

Industrial shipping makes shipowners subcontractors rather than risk takers.This was the view of Xannetos (1972) who commented that ‘I know of few industriesthat are less risky than the oil tankship transportation business. Relatively predictabletotal requirements, time-charter agreements, and, because of the latter, availabilityof capital mitigate the risks involved in the industry.’

In this business the challenge is to win the contract and deliver the service at a cost which leaves the shipowner
with a profit. Although the shipowner is freed from market risk, that does not remove all risk. Charterers strike a hard bargain and the owner is subject to inflation, exchange rates, the mechanical performance of the ship and, of course, the ability of the shipper to pay his hire.

In some circumstances the shippers prefer to leave independent shipowners to take the shipping risk and to rely on hiring ships from the market when they are needed.There are many industries, notably agricultural cargoes such as grain and sugar,where shippers never know how many cargoes they will have in future or how many ships will be needed. So they go to the freight market and hire transportwhen they need it. They pay a price for this. Sometimes the freight is cheap and sometimes it is expensive, but at least the ships are available.

Shipowners trading on the spot market make their living by taking a ‘shipping risk’. They back their judgement that the ships they buy will be in demand and provide a worthwhile return on capital. With so much at stake, it is no surprise that the ‘shipping cycle’ occupies much the same position in the shipping market as the dealer in a poker game. It has the undivided attention of the players, dangling the prospect of riches at the turn of each card, as they struggle through the dismal recessions which have occupied much of the last century. For investors with a taste for gambling and with access to finance, it requires only an office, a telex, and a small number of buy,sell or charter decisions, to make, or lose, a substantial fortune.