Decisions Facing Ship Owners

A shipowner had a difficult decision to make. He had ordered two 280,000 dwt VLCCs which an oil company was prepared to charter for five years at $33,000 per day. This would guarantee revenue to cover his finance costs for the first five years of the ship’s life, but the return on his equity worked out at only 6 per cent per annum. Not much for the risk he had taken in ordering the ships. In addition,the time charter would shut him out from the tanker boom he felt sure would happen in the next few years.He decided to wait and trade the ships on the spot market. To begin with this looked like a good decision, since the ships were delivered into a rising market.Unfortunately the next three years proved to be very poor and the vessels earned only $15,000 per day each. To meet bank payments the owner was forced to sell three old combined carriers. Since there were no offers from trading buyers heeventually sold them to a breaker for $5 million each. Two years earlier they had been valued at $23 million each.In this example the shipowner trades in four different markets:

1.The newbuilding market where he ordered the ships;

2.The freight market where he chartered them;

3.The sale and purchase market where he tried to sell the combined carriers; and

4.The demolition market where he finally sold them.

We seek to explain how the four markets work from a practical viewpoint and to identify the differences between them. How are ships chartered?How does the sale and purchase market operate and what determines the value of a ship? What is the difference between buying a new ship and buying a second-hand one? How did selling the ship for scrap differ from selling it for continued trading? An understanding of these practical questions lays the foundation for our discussion of the economic principles that covers the maritime industry.

Jevons, the nineteenth century economist provided a definition of a ‘market’ which,a century later, still serves very well for shipping. He says: Originally a market was a public place in a town where provisions and other objects were exposed for sale; but the word has been generalized, so as to mean any body of persons who are in intimate business relations and carry on extensive transactions in any commodity. A great city may contain as many markets as there are important branches of trade, and these markets may or may not belocalized. The central point of a market is the central exchange, mart or auction rooms where traders agree to meet and transact business… But this distinction of locality is not necessary. The traders may be spread over a whole town, or region of country and yet make a market if they are…in close communication with each other.

In shipping there are four shipping markets trading in different commodities. The freight market trades sea transport, the sale and purchase market trades second-hand ships, the newbuilding market trades new ships and the demolition market deals in scrap ships. Beyond this there is no formal structure. This is an important point which calls for a warning. We will discuss the economics of the shipping markets. While this analysis provides guidance on how the markets operate, we are not dealing with immutable laws. The fact that market traders have behaved in a particular way in the past is no guarantee that they will do so in future. Because markets consist of people going about their business, the best commercial opportunities often arise when the market behaves inconsistently.For example, ordering ships at the top of the market cycle is usually bad business,but if for some reason few ships are ordered, the rule will not apply. Commercial judgements must be based on an understanding of market dynamics, not economic principles taken out of context.Because the same shipowners are trading in all four shipping markets their activities are closely correlated. When freight rates rise or fall the changing sentiment ripples through into the sale and purchase market and from there into the newbuilding market. The markets are also linked by cash. Cash flows back and forth between the industry’s bank account and the four shipping markets. Cash which changes hands from one ship owner to another, but does not change the cash balance of the industry as a whole.The main cash inflow is freight revenue. This goes up and down with freight rates and is the primary mechanism driving the activities of shipping investors.The other cash inflow comes from the demolition market. Old or obsolete vessels sold to scrap dealers provide a useful source of cash, especially during recessions.The sale and purchase (S&P) market has a more subtle role. Investing in a second-hand ship involves a transaction between a shipowner and an investor. Because the investor is usually another shipowner money changes hands, but the transaction does not affect the amount of cash held by the industry. The sale of a tanker for $20million just transfers $20 million cash from one shipping bank account to another,leaving the aggregate cash balance unchanged.

In this sense the sale and purchase market is a zero sum game. For every winner there is a loser. The only real source of wealth is trading cargo in the freight market.

In the case of the new building market the cashflow is in the opposite direction. Cash spent on new ships flows out of the shipping industry because the shipyard uses it to pay for materials, labour and profit.Waves of cash flowing between the four markets drive the shipping market cycle. At the beginning of the cycle freight rates rise and cash starts to pour in,allowing shipowners to pay higher prices for second-hand ships. As prices are bid up investors turn to the newbuilding market which now looks better value. With the confidence created by bulging wallets they order many new ships. A couple of years later the ships arrive on the market and the whole process goes into reverse.Falling freight rates squeeze the cash inflow just as investors start paying for their new buildings. Financially weak owners who cannot meet their day-to-day obligations are forced to sell ships on the second-hand market. This is the point at which the asset play market starts for those shipowners with strong balance sheets.In extreme circumstances like 1932 or 1986 modern ships change hands at bargain prices. For older ships there will be no offers from trading buyers, so hard pressed owners are obliged to sell for demolition. As more ships are scrapped the supply falls, freight rates are bid up and the whole process starts again.

The whole commercial process is controlled and co-ordinated by cash flow between markets. Cash is the ‘stick and carrot’ which the market uses to drive activity in the required direction. Whether they like it or not, shipowners are part of a process which controls the price of the ships they trade and the revenue they earn.

Shipping Market Cycles

Cycles are not unique to shipping. They occur in many industries and in the economy as a whole. Economic historians have devoted much effort to analysing and classifying cycles into categories, usually focusing on their length. Many different types of cycle have been identified. The Kitchen is a short cycle of 3–4 years; the Juglar lasts 6–8 years; the Labrousse can last 10 or 12 years; the Kuznets lasts 20 years, while a Kondratieff spreads over a half century or more.

In shipping the existence of cycles has long been accepted as part of the shipping business. In January 1901 a broker noted in his annual report that ‘the comparison of the last four cycles (10 year periods) brings out a marked similarity in the salient features of each component year, and the course of prices’. He went on to observe that the cycles seemed to be getting longer ‘a further retrospect shows that in the successive decades the periods of inflation gradually shrink, while the periods of depression correspondingly stretch out’.

 

 

Although the length of cycles is of great interest, it soon became evident to observers of the shipping business that the cycles were far more complex than a sequence of regular fluctuations in freight rates. Kirkaldy (1913), 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:

 

With the great development of ocean transport, which commenced about half acentury ago, competition became very much accentuated. As the markets became increasingly normal, and trade progressively regular, there was from time to time more tonnage available at a given port than there was cargo ready for shipment. With unlimited competition this led to the cutting of rates, and at times shipping had to be run at a loss. The result was that shipping became an industry enjoying very fluctuating prosperity. Several lean years would be followed by a series of prosperous years. The wealthy ship-owner could afford to put the good years against the bad, and strike an average; a less fortunate colleague after perhaps enjoying a prosperous time, would be unable to face the lean years, and have to give up the struggle.

Viewed in this way, shipping market cycles have a purpose. They create the environment in which weak shipping companies are forced out, leaving the strong to survive and prosper, fostering a lean and efficient shipping business.

While Kirkaldy dwelt on the competition between owners and the part played by cash flow pressures, E.E Fayle (1933) had more to say about the mechanics of the cycle. He suggested that the build-up of a cycle is triggered by the world business cycle or random events such as wars which create a shortage of ships. The resulting high freight rates attract new investors into the industry, and encourage a flood of speculative investment, thus expanding shipping capacity: The extreme elasticity of tramp shipping, the ease with which new-comers can establish themselves, and the very wide fluctuations of demand, make the ownership of tramp steamers one of the most speculative forms of all legitimate business. A boom in trade or a demand for shipping for military transport (as during the South African War) would quickly produce a disproportion between supply and demand; sending freight soaring upwards. In the hope of sharing the profits of the boom, owners hastened to increase their fleet and new owners come into the business. The world’s tonnage was rapidly increased to a figure beyond the normal requirements, and the short boom was usually followed by a prolonged slump.

This perception of the cycle suggests a sequence of three events, a trade boom, a short shipping boom during which there is overbuilding, followed by a ‘prolonged’slump. However Fayle is not confident about the sequence, since he says the boom is ‘usually’ followed by a prolonged slump. He thought the tendency of the cycles to overshoot the mark could be attributed to the lack of barriers to entry. Once again the cycle is more about people than statistics.Forty years later Cufley (1972) also drew attention to the sequence of three 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.

The main function of the freight market is to provide a supply of ships for that part of world trade which, for one reason or another, does not lend itself to long-term freighting practices. In the short term this is achieved by the interplay of market forces through the familiar cycle of booms and slumps. When a shortage of ships develops rising freights lead to a massive construction of new ships.There comes a point either when demand subsides or when deliveries of new vessels overtake a still increasing demand. At this stage freights collapse, vessels are condemned to idleness in laying up berths.

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 booms and slumps. However, Cufley is convinced that the cycle is too irregular to predict. He goes onto say: Any attempt to make long-term forecasts of voyage freights (as distinct from interpreting the general trend in growth of demand) is doomed to failure. It is totally impossible to predict when the open market will move upwards (or fall),to estimate the extent of the swing or the duration of the phase.


Finally Hampton (1991) in his analysis of long and short shipping cycles emphasizes the important part played by people and the way they respond to price signals received from the market: In today’s modern shipping market it is easy to forget that a drama of human emotions is played out in market movements… In the shipping market, price movements provide the cues. Changes in freight rates or ship prices signal the next round of investment decisions. Freight rates work themselves higher and trigger orders. Eventually excess orders undermine freight rates. Lower freight rates stall orders and encourage demolition. At the low point in the cycle, reduced ordering and increased demolition shrink the supply and set the stage for a rise in freight rates. The circle revolves.


Hampton goes on to argue that market sentiment plays an important part in determining the structure of cycles and that this can help to explain why the market repeatedly seems to over-react to the price signals.In any market including the shipping market, the participants are caught up in a struggle between fear and greed. Because we are human beings, influenced to varying degrees by those around us, the psychology of the crowd feeds up on itself until it reaches an extreme that cannot be sustained. Once the extreme has been reached, too many decisions have been made out of emotion and a blind comfort which comes from following the crowd rather than objective fact. All these descriptions of the shipping cycle have a common theme. They describe it as a mechanism devoted to removing imbalances in the supply and demand for ships. If there is too 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. Looked at in this way the length of the cycles is incidental. They last as long as is necessary to do the job. It is possible to classify them by length, but this is not very helpful as a forecasting aid. If investors decide that an upturn is due and decide not to scrap their ships, the cycle just lasts longer. Since shipowners are constantly trying to second guess the cycle, crowd psychology gives each cycle a distinctive character.Yet another reason why the cycles are irregular.

Stage 1: Trough

We can identify three characteristics of a trough. First, there will be evidence of surplus shipping capacity. Ships queue up at loading points and vessels at sea slow steam to save fuel and delay arrival. Secondly freight rates fall to the operating cost of the least efficient ships in the fleet which move into lay up. Thirdly, sustained low freight rates and tight credit create a negative net cash flow which becomes progressively greater. Shipping companies short of cash are forced to sell ships at distress prices, since there are few buyers. The price of old ships falls to the scrap price, leading to active demolition market.

Stage 2: Recovery
As supply and demand move towards balance, the first positive sign of a recovery is positive increase in freight rates above operating costs, followed by a fall in laid up tonnage. Market sentiment remains uncertain and unpredictable.Spells of optimism alternate with profound doubts about whether a recovery is really happening. As liquidity improves second-hand prices rise and sentiment firms.

Stage 3: Peak/Plateau
When all the surplus has been absorbed the market enters a phase where supply and demand are in tight balance. Freight rates are high, often two or three times operating costs. The peak may last a few weeks or several years,depending on the balance of supply/demand pressures. Only untradeable ships are laid up; the fleet operates at full speed; owners become very liquid; banks are keen to lend; the press report the prosperous shipping business; there are public flotations ofshipping companies. Second hand prices move above ‘book value’
and prompt modern ships may sell for more than the newbuilding price. The shipbuilding orderbook expands,slowly at first, then more rapidly.

Stage 4: Collapse
When supply overtakes demand the market moves into the collapse phase. Although the downturn is generally caused by fundamental factors such as the business cycle, the clearing of port congestion and the delivery of vessels ordered at the top of the market, all of which take time, sentiment can accelerate the collapse into a few weeks. Spot ships build up in key ports. Freight rates fall, ships reduce operating speed and the least attractive vessels have to wait for cargo. Liquidity remains high.Sentiment is confused, changing with each rally in rates.

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.

The Role of Port

There is a crucial component in the transport system which is just as important as the merchant fleet. Ports are the crucial interface between land and sea. It is here that much of the real activity takes place. In the days of cargo liners and tramps the activity was obvious. Ports were crowded with ships and bustling with dockers loading and unloading cargo. Artists loved to paint these busy scenes and the waterfronts were famous for the entertainment they provided to sailors during their long portcalls. Anyone could see what was going on. Modern ports are more subtle.Today, ships make fleeting calls at highly automated and apparently deserted terminals, sometimes stopping only a few hours to load or discharge cargo. The activity is less obvious but much more intense. Cargo handling speeds today are many times higher than they were twenty or thirty years ago. Before discussing ports we must define three terms ‘port’, ‘port authority’ and‘terminal’.

A port is a geographical area where ships are brought alongside land toload and discharge cargo—usually a sheltered deep water area such as a bay orriver mouth. The Port Authority is the organization responsible for providing the various maritime services required to bring ships alongside land. Ports may be public bodies, government organizations or private companies. One Port Authority may control several ports, e.g., Saudi Ports Authority. Finally, terminal is a section of the port consisting of one or more berths devoted to a particular type of cargohandling. Thus we have coal terminals, container terminals, etc. Terminals may be owned and operated by the port authority, or by a shipping company which operates the terminal for its exclusive use.Ports have several important functions which are crucial to the efficiency of the ships which trade between them. Their main purpose is to provide a secure location where ships can berth. However, this is just the beginning. Improved cargo handling requires investment in shore-based facilities. If bigger ships are to be used, ports must be built with deep water in the approach channels and at the berths. Of equal importance is cargo handling, one of the key elements in system design. A versatile port must be able to handle different cargoes—bulk, containers, wheeled vehicles, general cargo and passengers all require different facilities. There is also the matter of providing storage facilities for inbound and outbound cargoes. Finally, land transport systems must be efficiently integrated into the port operations. Railways, roads and inland waterways converge on ports and these transport links must be managed efficiently. Port improvement plays a major part in reducing sea transport costs. Some of this technical development is carried out by the shipping companies who construct special terminals for their trade, or shippers such as oil companies and steel mills. For example, the transfer of grain transport from small vessels of 20–30,000 dwt to vessels of 60,000 dwt and above depended upon the construction of grain terminals with bulk handling and storage facilities. Similarly the introduction of container services required container terminals. However the port industry provides much of the investment itself. It has its own marketplace which is every bit as competitive as the shipping markets. The ports within a region are locked in cut-throat competition to attract the cargo moving to inland destinations or for distribution within the region. Hong Kong competes with Singapore for the Far East container distribution trade. Rotterdam has established itself as the premier European port in competition with Hamburg, Bremen, Antwerp and, in earlier times, Liverpool. Investment in facilities plays a key part in the competitive process. The facilities provided in a port depend on the type and volume of cargo which is in transit. As trade changes, so do the ports. There is no such thing as a typical port. Each has a mix of facilities designed to meet the trade of the region it serves. However, it is possible to generalize about the type of port facilities which can be found in different areas. In very rough terms, the blocks in these diagrams represent, in width, the number of facilities or length ofquay wall, and in height, the annual throughput of each.

 

Type 1 Small local port:

Around the world there are thousands of small ports serving local trade. They handle varied cargo flows, often serviced by shortsea vessels. Since the trade volume is small the facilities are basic, consistingof general purpose berths backing on to warehouses. Only small ships can be accommodated and the port probably handles a mixture of containers, break-bulk cargo plus shipments of commodities in packaged form (e.g. part loads of wheat in bags, or oil in drums) or shipped loose and packaged in the hold prior to discharge. Cargo is unloaded from the ship on to the quayside and stored in the warehouses, or on the quayside until collected. Ports like this are found in the developing countries and in the rural areas of developed countries.

Type 2 Large local port:

When cargo is higher, special investment becomes economic. For example, if the volume of grain and fertilizers increases a drybulk terminal may be constructed with the deeper draft required to handle bigger bulk carriers (e.g. up to 35,000 dwt), a quayside with grab cranes, apron space to stack cargo, railway lines and truck access. At the same time the break-bulk facilities may be expanded to handle regular container traffic, for example, by purchasing container handling equipment and strengthening thequayside.

Type 3 Large regional port:

Ports handling high volumes of deep sea cargo require heavy investment in specialized terminal facilities. Unit loads such as pallets, containers or packaged timber are handled in sufficient volume to justify a unit load terminal with cargo handling gear such as gantry cranes, fork lift trucks and storage space for unit load cargo. For high volume commodity trades, moving in volumes of several mt a year, special terminals may be built(e.g. coal, grain, oil products terminals) capable of taking the bigger ships of 60,000 dwt and above used in the deep sea bulk trades.

Type 4 Regional distribution centres:

Regional ports have a wider role as distribution centres for cargo shipped deep sea in very large ships, and requiring distribution to smaller local ports. This type of port, of which Rotterdam, Hong Kong and Singapore are prime examples, consists of a federation of specialist terminals, each dedicated to a particular cargo. Containers are handled in container terminals; unit load terminals cater for timber, iron and steel and ro/ro cargo. Homogeneous bulk cargoes such as grain, iron, coal, cement and oil products are handled in purpose built terminals, often run by the cargo owner.There are excellent facilities for trans-shipment by sea, rail, barge or road.

 

Ports and terminals earn income by charging ships for the use of their facilities. Leaving aside competitive factors, port charges must cover unit costs and these have a fixed and variable element. The shipowner may be charged in two ways, an ‘all in’ rate where, apart from some minor ancillary services, everything is included; or an ‘add-on’ rate where the shipowner pays a basic charge to which extras are added for the various services used by the ship during its visit to the port. The method of charging will depend upon the type of cargo operation but both will vary according to volume, with trigger points activating tariff changes.

Nature of Sea Transport

The primary task of the shipping industry is to move cargo around the world. Although this is the correct starting point for studying ship demand, as an economic definition it is too narrow. From the customer’s viewpoint, shipping is a service. Saying that the shipping companies move cargo around the world, is rather like saying that restaurants cook food. There are sandwich bars, fast food chains andcordon bleu restaurants. Like the restaurateur, shipping companies provide a variety of services to meet the specific needs of customers. These needs may involve a whole range of factors, of which the most important are:

1. Price:

The freight cost is always important, but the greater the proportion offreight in the overall cost equation, the more emphasis shippers are likely toplace on it. For example, in the 1950s the cost of transporting a barrel of oilfrom the Middle East to Europe represented 49 per cent of the CIF cost. As aresult, oil companies devoted great effort to finding ways to reduce the cost oftransport. By the 1990s the price of oil had increased and the cost of transporthad fallen to just 2.5 per cent of the CIF price so transport cost became less important.

2. Speed:

Time in transit incurs an inventory cost, so shippers of high-value commodities value speed. The cost of holding high-value commodities in stock may make it cheaper to ship small quantities frequently even if the freight cost is greater. On a three-month journey a cargo worth $100,000 incurs an inventory cost of $2,500 if interest rates are 10 per cent per annum. If the journey time can be halved it is worth paying up to $1,250 extra in freight. Speed may also be important for commercial reasons. A European manufacturer ordering spare parts from the Far East may be happy to pay ten times the freight for delivery in three days by air if the alternative is to have machinery out of service for five or six weeks while the spares are delivered by sea.

 

3. Reliability:

With the growing importance of ‘just in time’ stock control systems,transport reliability has taken on a new significance. Some shippers may beprepared to pay more for a service which is guaranteed to operate to time andprovide the services which it has promised.

4. Security:

Loss or damage in transit is an insurable risk, but raises manydifficulties for the shipper, who may well be prepared to pay more for securetransportation of his product without risk of damage.

 

Each part of the business provides for a different combination of needs. In studying how this business is carried out, we need to be aware of the different demands which commodities place on the transport system, and to understand how the system has evolved to meet these needs.

Shipping Markets

To understand the economic mechanisms that have brought about these changes one must step warily. While the shipping market is in some senses a single economic unit, there are important subdivisions. We have already referred to the liner and bulk industries, and probably the most striking aspect of the shipping business to an outsider is the totally different character of the companies in these sectors. Liner companies and bulk shipping companies belong to the same industry, but they seem to have little else in common. The Rochdale Report commented on these divisions within the industry as follows:

Shipping is a complex industry and the conditions which govern its operations in one sector do not necessarily apply to another; it might even, for some purposes, be better regarded as a group of related industries. Its main assets, the ships themselves, vary widely in size and type; they provide the whole range of services for a variety of goods, whether over shorter or longer distances. Although one can, for analytical purposes, usefully isolate sectors of the industry providing particular types of service, there is usually some interchange at the margin which cannot be ignored.

This suggests that there are several important ground rules for approaching shipping economics. First, it emphasizes the importance of the commercial divisions within the shipping market—the liner business carries different cargoes, provides different services and has a different economic structure from bulk shipping. Second, it acts as a reminder that shipping is in another sense a single market. Some shipping companies are active in both the bulk and liner markets and many ships are designed to operate in several different markets; indeed, this is one of the important shipowning decisions that we shall discuss. Consequently, we cannot afford to treat the market as a series of isolated compartments. We must recognize that, particularly in a depressed market, owners can move their investment from one market sector to another in order to avoid problems.

As a result supply/demand imbalances in one part of the market can ripple across to other sectors.The final point is that, however hard we might try to develop the analysis in economic terms, shipping is an international business and the economic forces that make it so significant in economic terms also make it the subject of national and international political intervention. The Rochdale Report concluded its definition of the shipping industry with the comment that ‘Most of the industry’s business is concerned with international trade and inevitably it operates within a complicated world pattern of agreements between shipping companies, understandings with shippers and policies of governments.’ Such matters cannot be ignored. Since the mid-1960s the maritime industry has seen an escalation of political involvement, ranging from the efforts of the Third World countries to gain entry to the international shipping business through the medium of UNCTAD, to the subsidizing of domestic shipbuilding; the regulation of liner shipping and the increasing interest in safety at sea, pollution, and crew regulations. Just as these subjects cannot easily be understood without some knowledge of the maritime economic framework within which the game is being played out, an economic analysis cannot ignore the politicalinfluences on costs, prices and free market competition.

Shipping

The idea of shipping as the catalyst of economic development is not new. AdamSmith, often regarded as the father of modern economics, saw shipping as one ofthe stepping stones to economic growth.

The Wealth of Nations, heargued that the central economic force in a capitalist society is the division oflabour, and the extent to which this can be practised depends crucially upon thesize of the market. A business working in a country town without links to theoutside world can never, he argued, achieve high levels of efficiency because itsvery small market will limit the degree of specialization.Adam Smith saw shipping as the source of cheap transport which can open upwider markets to specialization, by offering transport for even the most everydayproducts at prices far below those that can be achieved by any other means. Thisproved to be a profound insight. Economic development has gone hand in handwith sea trade for sound economic reasons, a process which Adam Smith explainsin the following way:

As by means of water carriage a more extensive market is opened to every sortof industry than what land carriage alone can afford it, so it is upon the sea-coast, and along the banks of navigable rivers, that industry of every kind naturallybegins to subdivide and improve itself, and it is frequently not until a long timeafter that those improvements extend themselves to the inland parts of thecountry…a broad wheeled wagon attended by two men and drawn by eighthorses in about six weeks time carries and brings back between London andEdinburgh nearly 4 tons weight of goods. In about the same time a ship navigatedby six or eight men, and sailing between the ports of London and Leith, frequentlycarries and brings back 200 ton weight of goods. Since such, therefore, are the advantages of water carriage, it is natural that the first improvements of art andindustry should be made where this conveniency opens the whole world to amarket for the produce of every sort of labour.

Technology has moved on since Adam Smith wrote these words in 1776, and theeconomically developed countries now have a massive inland transportinfrastructure, but technology in the shipping industry has more than kept pace.Since the mid-1960s, two dramatic developments in the economic organization ofthe shipping business—unitization and bulk shipping—have played a major partin opening up a truly global market for both manufactures and raw materials.

The most important technical development was the unitization of the liner shippingbusiness. During the 1960s the traditional system of ‘break bulk’ liner shippingbecame increasingly unable to cope with the escalating volume of world trade, andindustry observers could see that ‘the old methods had reached the end of theline’.

To overcome these problems, palletization and containerization wereintroduced to speed up the flow of cargo. Putting general cargo into standard unitshad more wide-ranging effects than even its most ardent advocates anticipated. Inthe early 1960s, goods shipped from Europe to the United States could take months to arrive, but twenty years later, just a few days after leaving the factory in theMidlands of England, a container wagon could be arriving at its destination in East Coast USA with its valuable cargo safe from damage or pilferage and readilytransferable to rail or barge with the minimum of delay or manual effort. In short,the shipping industry used organization to solve its own fundamental problemsand, in doing so, opened the floodgates for the development of the global economy.The bulk shipping revolution was no less wide-ranging in its effects. Bulktransport of raw materials by sea was, for the first time, viewed as part of anintegrated materials handling operation in which investment could improveproductivity. By employing economies of scale, investing in high speed cargohandling systems and integrating the whole transport systems, bulk transport costswere reduced to such an extent that it is often cheaper for industries to import rawmaterials by sea from suppliers thousands of miles away than by land from suppliersonly a few hundred miles away—for example the rail freight for a ton of coal fromVirginia to Jacksonville, Florida, was almost three times the sea freight fromHampton Roads to Japan, a distance of 10,000 miles.

Bigger ships played a centralpart in this process. Over a period of 50 years from 1945 to 1995 oil tankers became twenty times bigger and dry bulk vessels ten to fifteen times bigger. Improved cargo handling in ports and better integration with land transport completed thetransformation.