The Four Shipping Markets Economics Essay

Shipping industry’s playground is a unique similar in some structure of other markets where commodities are sold or purchased on one platform. Shipping market structure is distinct .

The structure of the market is determined by its characteristics like “the supply of service being offered,the type of the product,the number of operators,the barriers to entry or exit,the number of consumers demanding the service.”(Mc Conville 1999).

Some theories describe these market forms using different models ranging from perfect competition to Monoply.

Shipping services is provided by four closely related markets,although trading in different commodities. Even though the segments vary in character and purpose, they still

compete for cargo and they all operate within the Four Markets of Shipping (Stopford, 2009).

The unique mechanism of this market is that it is almost unpredictable,however ” the best commercial opportunities often arise when the markets behave inconsistently”. (Stopford, 2009)

The four shipping markets

According to Stopford (1997) the shipping industry can be divided into four markets, the:

1. Newbuilding market – where ships are being ordered

2. Freight market – where they are being chartered (used for transportation)

3. Sale and purchase market – where they are being sold to other ship-owners

4. Demolition market – where they are being sold to scrap yards

Key features of shipping markets:-

The Newbuilding market

The new building market brings new ships into the shipping industry and sends cash out of

the market as materials, labour and profit. The newbuilding market is trading ships that are not yet built in other words the ship’s keel may have been laid.

Hence, once a ship is ordered, it will take up to four years to get ready for its sea trials. By this time the entire market conditions may have been changed. It is therefore important to have

good prediction of the future before ordering.

Reasons for a buyer to choose to order a new vessel instead of buying a pre-owned one can vary, but in most cases it depends on the prices and also depends on the owners design criteria.

The prices of the newbuilding market seems, according to stopford(2009), to be just as volatile as the sale and purchase market, hence at some occasions the newbuilding market can have lower prices than the second-hand market.

The freight market

The freight market is seen as one single international market divided into sub markets for different types of ships . According to Stopford (2009), there are two different types of transactions in the freight market, the:

Freight contract where the shipper buys transportation from ship-owners at a fixed price per ton of cargo.

Time charter where the ship is hired on a day-to-day basis

Depending on which sector the shipowner and cargo holder meet in, there are different types

of contractual agreements used when “sealing the deal”. How the costs and responsibilities

are shared between the shipowner and shipper will settle the type of contact to be used

(Stopford, 2009).

·€ Voyage charter: The shipowner transports the shippers‟ cargo from A to B for a fixed

price per ton.

·€ Contract of affreightment: The shipowner transports a series of cargo parcels for a

fixed price per ton.

·€ Time charter: The charterer is given operational control of the vessel carrying his

cargo while the shipowner still has ownership and control over the management of the

ship. This can either be arranged for a single trip or as a period charter.

·€ Bare boat charter: The charterer has full operational control of the vessel, but does not

own it. This is usually arranged for longer periods (10-20 years).

·€ Freight derivative contract: The contract is arranged against an agreed future value of a

freight market index.

The ship is fixed after all the formalities of type of contract and when the freight rate is agreed between the two parties.The procedure is simple, a ship-owner has a vessel for hire, a charterer has a cargo to transport, and a broker puts the deal together. (Stopford, 1997)

The Sale and purchase market

The remarkable key feature of this market is that the second-hand ships are traded like sacks of potatoes at a country market. The participants are a mix of shippers, shipping companies and speculators and shipbrokers play an important role in dealing with transactions.

Trade is between the ship owner and an investor who usually is another ship owner so the cash does not leave this market and therefore from the industry.

The ships may be for sale because they are too old or do not comply with industry’s regulations, or the owner may be cash strapped or has decided to change company’s portfolio.

Ship prices are very volatile, and the value depends on the freight rates, age ,inflation and expectations.

The Demolition market

It is the recycling market of the shipping industry. This market can be compared to the sale and purchase market, but the difference here is that the buyer is a demolition yard and not a shipowner. When a ship-owner is no longer able to sell a ship S& P, they will turn to the demolition market which is not, according to Stopford (2009), a less glamorous market, however an essential part of the entire industry. This market can be compared to the sale and purchase market, but the difference here is that the buyer is a demolition yard and not a ship owner, here as well ship broker plays an important role.

As the freight market this market is also a source for cash to the industry,here the buyers of the obsolete ships are the scrap yard who demolish the ship and trade in the stell and other important equipment and spare parts.

This is especially an important source of cash in a recession and also in order to

keep balance between supply and demand.

These four markets are seen to be closely correlated, since the activities in each of these markets heavily affect all these four markets. These four markets work together linked by cash flow. (Stopford,2009)

Outside of these four markets are additional closely related markets, like the brokers, financing, insurance, etc.

This makes the entire shipping industry complex where every party is important for the entire shipping industry, since they are affecting one and another so as to work closely to each other.

Even though each market trade in a different commodity, we find the same shipowners trading in all 4, and their activities are closely correlated. They all respond to cycles in trade, and as shipping companies‟ trade in all four markets, the cash flows in and out of the market is what drives the shipping market cycle (Stopford, 2009).

Shipping Market Model & Shipping Cycle

The maritime economics is extremely complex subject as Stopford asserts because of its “wavy nature”(COSCO Summit 2007) , so one has to understand its model by highlighting those factors that are most important.The economics here is no different than others which take into account the demand and supply.Here It is the market mechanism which regulates supply and demand.

The primary demand and supply driver in the shipping industry is freight rates, which determines the revenue of shipping companies.

Other drivers of the shipping industry are:

Trade growth

Geographical concentration of trade

Threat of wars, piracy, storms and hurricanes

Government sanctions on shipment

Access to and suitability of other modes of shipment

The supply drivers of the industry include:

Demand for oil and dry bulk

Climatic conditions (rains, storms and tides)

Government restrictions on shipment

http://www.maersktankers.com/PublishingImages/Illustrations/tankermarket_illustration.gif

Source: http://www.maersktankers.com/PublishingImages/Illustrations/tankermarket_illustration.gif

Stopford(2009) presents Ten variables in the shipping market modelfive each on the demand and supply side namely

Demand                                     Supply

1. World Economy                     1. World Fleet

2. Seaborne Commodity Trade   2. Fleet Productivity

3. Average Haul                         3. Shipbuilding Production

4. Political Event                        4. Scrapping and losses

5. Transport Cost                      5. Freight rates

Ten variables in the Shipping Market Model

Source: Stopford, 2009

This Model , he breaks down into three components namely Demand,Supply and

Freight market, Any imbalance feeds through into the third part of the model which links the other two through cash flows.

Overview of the Dynamics (As deduced from stopford 2009)

When ships are in short supply,freight rates((i.e., price of sea transport) are bid up and cash flows into the bank accounts of ship owners.Eventually the increased cash flow starts to affect the behaviour of both the shippers and shipowners.

Although the freight rate is not the only factor that affects shipping, it is just a benefit that the shipper gains from a combined transport operation (Branch, 2007). Other cash inflows come from the demolition market.

The shipowners will probably start ordering new ships, while the shippers look for ways to cut their transport costs by delaying cargoes, switching to closer suppliers or using bigger ships. When there are too many ships, rates are bid down and shipowners have to draw on reserves to pay fixed costs such as repairs and interest on loans. As reserves diminish some owners are forced to sell ships to raise cash. Prices of ships fall to a level where shipbreakers offer the best price for the older ships, reducing supply.Changes in freight rates may also trigger a change in the performance of the fleet,through adjustments to speed and layup. This link between market balance and freight rates is one of the most important economic relationships in the model and it is controlled by shipowners who decide how to respond. This model gives shipping market cycles their characteristic pattern of irregular peaks and troughs. This is the market model outline which controls shipping investment.

The four mar-kets drive the shipping market cycle. When the freight rates in the beginning of the cycle starts to raise the cash will flow into the shipping industry, leading to higher prices for second-hand ships. As prices continue to rise, this will lead investors into the newbuilding market. When ship-owners have ordered sufficient of new ships, the cycle is usually at its peak, and eventually the process will go into reverse. When freight rates start to decline leading to less cash inflows, this will have a negative impact on ship-owners, since in this stage they will start to pay for their newbuilding ships. If ship-owners do not have enough liquidity this will force them to sell their ships on the second hand market for scraps. If there are enough new ships supplied in the second hand market to low prices, the older ships will not get any offers and the owners are forced to send them to the demolition market. As more ships are scrapped the supply of ships will go down and freight rates will once again start to rise and the whole market cycle will start from the beginning. (Stopford, 1997)

Freight rate mechanism

The supply of sea transport is influenced by the freight rate. This is a mechanism that the market uses to motivate decision makers to adjust capacity in the short term and to find ways to reduce costs in the long run.

Supply and demand are linked together through the freight market and according to the

balance of available ships and cargo in the market, shipowners and shippers negotiate and try

to establish a freight rate which best reflects this; when there is a surplus of ships the rates are

low and when there is a shortage of ships the rates are high (Stopford, 2009).

On the demand side,the demand function shows how shippers adjust to changes in the freight rate. For an individual ship the supply function describes the amount of transport the owner can

provide at each level of freight rates In response to freight rates the supply function works by movingships in and out of service. There are three factors affecting the slope of the short-term supplycurve. First, the age of the vessel, an older ship usually has higher operating costs, so lay-up will occur at a higher freight rate than for newer ships. Second, the size of the ship; larger

ships have lower transportation costs per ton of cargo. Third, is the relationship between speed and freight rates, which can be defined from economic theory; if the market is perfectly

competitive, the ship will be operated at the speed at which marginal cost equals the freight

rate (Stopford, 2009).

Sellers and buyers transact in the market and their supply and demand requirements

cause the price to move. The “going price” is an equilibrium value of the

price. This can be explained if we combine the demand and supply curve diagrams.

The sea transport demand function shows the quantity of sea transport shippers

would purchase at each level of the freight rate. The sea transport supply function

shows the quantity of sea transport carriers would offer at each level of the freight

rate. The supply and demand curves intersect at the equilibrium price in the shipping

market, which determines the freight rate at which the quantity demanded by

shippers for shipping services is equal to the quantity supplied by carriers. At this

point, both shippers and carriers reach a mutually acceptable freight rate level.

Figure illustrates the freight rate mechanism.

In effect the freight rate mechanism is the ‘switch box’ which controls the amount of money paid by shippers to shipowners for the transport they supply.(Stopford 2009)

Characteristics of Shipping Cycles

Overall, shipping is a cyclical, seasonal and volatile business. Global economic conditions and political developments affect the demand side, while the size and availability of the global fleet affect the supply side. Imbalances between demand and supply affect asset values, freight rates and earnings.

The purpose of shipping market cycles is to remove the weak actors, leaving only the strong

to survive and grow. This will in the long-run create an efficient and competitive shipping

business (Stopford, 2009).

Economists like Fayle (1933), suggested that the shipping cycle starts with a shortage of ships. The increase in the freight rate stimulates overordering of new buildings. Finally, it leads to market collapse and a prolonged slump. The shipping cycle is a mechanism to balance the supply of and demand for ships. If excessive demand exists, the market rewards investors with high freight rates until more ships are built. If there is excessive supply, the market squeezes the revenue with low freight rates until ships are scrapped.

What Causes the Shipping Cycle?

The shipping market is driven by a competitive process in which supply and demand

interact to determine the freight rate. Excessive demand leads to a shortage

of ships, which in turn increases the freight rate. On the other hand, excessive

supply of ships leads to a reduction in the freight rate.

In general, the shipping cycle is unique, comprising the following characteristics

(Stopford 2004):

The shipping cycle is a mechanism to coordinate supply and demand in the

shipping market.

A complete shipping cycle has the following stages: trough, recovery, peak,

and collapse.

There are no set rules about the length of each stage.

There is no formula to predict the pattern of the next shipping cycle.

Business cycles are directly proportional to shipping cycles,these are the cause of fluctuations in seaborne trade and ship demand and these do not follow any set pattern therefore predicting them becomes a very complex task.