Monthly Archives: December 2015

Long-Term Transport Contracts Bring Benefits to Shippers, Too

Long-Term Transport Contracts Bring Benefits to Shippers, Too

 

BDI reached 498p, the lowest ever, on November 20th, and has since remained around 500-599p. Thanks to the continuing low freight rates due to an oversupply over an extended period, shippers are reaping benefits from lowered transport cost, whereas carriers have no choice but to operate their ships at the risk of sustaining a big loss due to a freight rate that fails to cover variable operation costs.

With low freight rates being protracted, the transport-related decision-makers with shippers even question the need for a long-term transport contract, which incurs a relatively burdensome cost. In turn, concerned about landing a low-rate long-term transport contract when their negotiation power over freight rates is compromised by an oversupply, some of the carriers negatively view the option.

All along, a long-term transport contract has been perceived as a standard method for averting volatility risk (such as change in freight rate). Moreover, since long-term transport contracts have greatly benefited carriers’ business as a basis for their stable income, shippers have been urged to sign a long-term transport contract with national carriers for the purpose of overriding the on-going depression.

Long-term transport contracts that appeal to shippers’ patriotism only may not be so sustainable to shippers who set great store by profitability. This means that a long-term transport contract can become valid only when it is recognized as a transport strategy that is economically reasonable from the perspective of actual experience in the shipping market.

 

Cost and volatility reduction with long-term transport contracts

The economic rationality of a long-term transport contract can be tested in various ways, and its validity can be demonstrated from the perspective of what it costs a shipper to get a vessel. For this purpose, we consider six-month charter a short-term contract and 3-year charter a long-term contract and have analyzed the data for time charter cost for a 150,000 DWT capesize vessel.

From 1992 through this year, the average cost for getting a ship lined up shows lower for a long-term contract than for a short-term contract. While the average cost for getting a ship through a three-year charter contract costs 23.24 million dollars for each of the three years, a six-month charter contract costs 29 million dollars.

The standard deviation in time charter cost shows 66% lower for a long-term contract than for a short-term contract. This shows that the volatility risk is smaller for a long-term contract than for a short-term contract.

<The three-year cost for getting a vessel for 6-month charter and 3-year charter between 1992 and 2015 (150,000 DWT vessel)>

The three-year cost for getting a vessel
for 6-month charter
The three-year cost for getting a vessel
for 3-year charter
Average cost
(million $)
29.00 23.24
Standard
deviation
24.26 14.60

 (source: Clarkson, KMI)

 

A long-term contract exerts greater effect during a boom

Meanwhile, for long-term and short-term contracts, the vessel acquisition cost varies with business cycle. As you see in the figure below, in the low-BDI period (in a depression), the vessel acquisition cost on a short-term contract (the vessel acquisition cost for a six-month charter) is relatively low, whereas in the high-BDI period (in a boom), the vessel acquisition cost on a short-term contract is relatively high.

In a nutshell, we can see that we find no big difference for the vessel acquisition cost in a depression between a long-term and a short-term contract, whereas we find that the vessel acquisition cost is significantly greater for a short-term contract that for a long-term contract.

<The 3-year trend along the boom-and-bust cycle for the vessel acquisition cost for 6-month charter and 3-year charter (150,000 DWT vessel)>
The 3-year trend for the vessel acquisition cost

(source: Clarkson, KMI)

 

The analysis shows that the vessel acquisition cost is lower for a long-term contract than for a short-term contract, which means that long-term contracts benefit shippers. Moreover, as it shows less volatility, a long-term contract is accompanied with less market volatility.

Meanwhile, it is true that bad times financially motivate shippers to reduce the vessel acquisition cost through a short-term contract. However, if supply is reduced through vessel overhauling and reduced orders caused by depression and a boom is thereby created, the vessel acquisition cost for a short-term contract may increase again.

In other words, from a broader perspective that encompasses both good times and bad times, the vessel acquisition cost can be reduced through a long-term contract, which will deliver benefits to shippers.

 

Achieving carrier profitability needs a measure for making up for cost of revenue

By the way, we should note that the above findings haven’t come out of a simple theoretical analysis or test but is grounded in the experience of the dry bulk carrier market. In other words, history and experience tell us that a long-term transport contract is an economically reasonable solution that provides shippers with the benefits of cost reduction and diminished volatility.

Meanwhile, while a carrier benefits from reduced market volatility caused by a long-term transport contract, the catch is that a contract concluded in bad times brings in a low freight rate, thus failing to achieve profitability. Carriers’ fear of a low-rate long-term transport contract is something that can be addressed by implementing a measure for making up for cost of revenue.

Thus, we may conclude that a long-term transport contract which includes an appropriate measure for recouping cost of revenue makes a win-win strategy for ship-owner and shipper.

 

 

 

Author: Jeon Hyeong-jin, Shipping Market Analysis Center Director
Source: KMI Shipping Market Trend Focus, No. 281

Implications of Maersk’s Restructuring for Shipping Market

Implications of Maersk’s Restructuring for Shipping Market

 

Maersk_logo

Maersk announces a restructuring plan

In early November, Maersk, the global leader in shipping, announced an aggressive restructuring plan to reduce cost by making its organization slimmer and reducing investment in new vessels for next two years. Maersk’s plan charted three things to do: manpower reduction, vessel investment reduction, and service route reduction.

Maersk plans to cut 4,000 employees out of its land-side operation staff of 23,000 people through attrition and through an organizational reshuffle by the end of 2017, while it plans to improve work efficiency and customer service through work automation and digitization. The company further expects to reduce costs by 400 million dollars (150 million dollars in 2016 and 250 million dollars in 2017 as selling, general and administrative expenses).

Maersk aims to reduce vessel capacity by giving up the option for constructing new vessels and delaying ship delivery. Maersk canceled its options in its contracts with Daewoo Shipbuilding & Marine Engineering (DSME) for building six 19,640 TEU vessels and with COSCO Shipbuilding Industry Company for building two 3,600 TEU feeder vessels, and postponed exercising its option in the contract with Hyundai Heavy Industries for building eight 14,000 TEU vessels.

Furthermore, Maersk recently suspended its four services of ME5, AE9, AE3, and TA4, which the company had provided in partnership with MSC, and is going to stop 35 more voyages in the fourth quarter. Moreover, the company considers laying up one 18,000 TEU vessel for six weeks and is mulling over a plan to idle more ultralarge vessels.

 

The foreboding outlook for shipping market in the backdrop

Maersk realized a better-than-expected profit in the first half-year, but saw a sharp decline in its performance in the second half-year, which seems to have prompted the establishment of the extraordinary plan. Maersk came up with such a massive restructuring plan, because the container market is expected to get worse, leading to a decline in profitability.

As a cost leader for global shipping market, Maersk has shown its determination to respond to oversupply by reducing vessel capacity and diminishing and reorganizing services instead of implementing restructuring just to reduce costs.

 

Strategic shift toward mitigating oversupply

A correct reading of this should be that having triggered cost-based competition by deploying the world’s first 18,000 TEU vessel, Maersk has thereby revised its erstwhile strategy which was focused on preempting the shipping market and maintaining its status as the industry’s leader. As Maersk’s cost leadership strategy has started the craze among its competing carriers for ordering ultralarge vessels and thereby instigated an oversupply in the global container shipping market, thus increasing the likelihood that the company will end up a victim of the cost-based competition. While Maersk has performed a leading role in changing the mode of competition in the global container shipping market, the company’s strategy has practically failed, in that the extreme cost-based competition has caused a depression in the shipping market that is the severest ever in history.

 

Strategy should be created for balancing demand and supply

For last several years, the global container shipping market has been involved in an extreme cost-based competition, which should be noted in that it has dragged the market through a bottomless depression. It takes spontaneous restructuring to safeguard the carriers’ interests in the current market which is dominated by shippers.

Especially, a restructuring shouldn’t stop at workforce reduction but has to be implemented with a view to achieving a significant balance of demand and supply by focusing on reducing vessel capacity and services and idling vessels.

 

 

 

Author: Jeon Hyeong-jin, Shipping Market Analysis Center Director
Source: KMI Shipping Market Trend Focus, No. 280