Part 1 – Introduction

  • Introduction
  • The Shipping Market
  • Shipping is Unique
  • The Risks of Ship Owning
  • Ship Owning Structures
  • Return to Index

Introduction


Shipping is one of the world’s most international and competitive industries. Maritime economics are influenced by the global economy, political decisions, technological advances and regulatory frameworks. Seaborne trade accounts for more than 90% of the total volume of goods and more than 60% of its total value. It is considered to be the most cost-efficient and most environmentally friendly mode of transportation. Other means of transportation, such as air freight and train transportation, although critical for certain industries and commodities, are only marginal in size when compared to shipping.

 

The purpose of this guide is to give a very brief insight into shipping, aimed at those new to the challenges and excitement of the maritime sector as well as anyone else looking for an overview of the industry. It explains some of the main issues surrounding shipping, with references and links to more detailed information where required. Topics discussed underline the industry’s uniqueness and cover subjects such as the different types of ships, how they trade and earn money, how  ship-owning risk is managed, together with a familiarization with landmark principals and regulations. Finally it provides practical terminology and some key statistics.

The Shipping Market


The modern international transport system consists of roads, railways, inland waterways, shipping lines and air freight services, each using different vehicles. In practice, the system falls into three zones: inter-regional transport covering deep-sea shipping and air freight; short-sea shipping, carrying cargoes short distances and often distributing those brought in by deep-sea services; and finally inland transport, which includes road, rail, river and canal transport.

 

Although a number of factors are increasingly redefining seaborne trade patterns, maritime trade flows continue to be largely determined by developments in the macroeconomic landscape. Seaborne trade volumes have generally moved in tandem with economic growth, industrial activity and merchandise trade, albeit at varied speeds.

Figure: OECD index of industrial production and world indices: GDP, merchandise trade and seaborne shipments, 1975-2016 (1990=100)

During the last few years, significant tonnage oversupply fuelled by a booming order book and limited demolition activity led to a freight rate collapse in some sectors. During this period world trade grew, although China, the world’s most important exporter, saw its export volumes declining. In order to support the dramatic supply-demand imbalance in those sectors, the growth of World Trade would have needed to be at unprecedentedly high levels, something that has not materialised. As a result, extensive market consolidation over recent years has transformed the global shipping industry, leading to mergers and acquisitions between lines, the reshuffling of shipping alliances and the expansion of shipping companies into port operations.

Figure: Container charter freight rates 2015-2018

The shipping market is cyclical, a true boom-and-bust market. This cyclicality is due to a number of reasons, some of the most important ones being:

 

  • the speculative attitude of a large number of maritime stakeholders,
  • the significant lag between a ship’s newbuilding order and her delivery (2-4 years) when shipyards are fully employed during boom times,
  • its international nature, e.g., an important geopolitical event in Australia or in the South China Sea may have very important consequences for shipping markets, and
  • the near perfect competition market conditions that prevail in the global maritime business world.
Figure: World tonnage on order 2000-2018 (‘000 DWT)

Shipping is Unique


Centuries ago, during the early stages of colonial rule, the British, to assist their sea trading activity, devised a standard form of contract covering the charter of a ship. This contract was then torn in two parts, one part being kept by the owner the other by the charterer, hence the term charter party (an anglicisation of the French word chartepartie, or “split paper“). Parts of these very early contracts survive to this very day and it is common for historical clauses, totally irrelevant to the subject of the actual transportation work that they support, to be found in today’s charter parties. This is simply another reality that underlines the peculiarity and uniqueness of this industry; even though the entire world’s development depends heavily on it, shipping sometimes seems to still function in archaic, outdated and unique ways, unlike any other industry. One however must never underestimate the effectiveness and appropriateness of this industry’s common practices, for they are born out of years of maritime wisdom and experience.

 

The business of sea-transportation is by and large a very difficult business to regulate, standardise and modernise in the sense of the natural process of evolution that other industries have gone through. Tramp-shipping in particular, where ships are like taxi-drivers chasing employment wherever they can find it, is difficult to manage in any predictably standard way and thus regulate. Tramp-shipping accounts for the vast majority of the world’s shipping activity. Finally, associated ship-owning risks always have been immense and, although the industry is changing in a way that steadily eliminates some of these risks, it still has a long way to go.

The Risks of Ship Owning


Figure: the 7,402 DWT Sea Bright, aground on the Kaleici Rocks in Turkey

Ship-owning is definitely not for the faint hearted. Equity analysts are quick to advise that investing into shipping stocks is not for “widows and orphans” but instead for seasoned investors. Shipping is a cyclical and volatile industry, heavily capital intensive with high inherent risks in most areas. It is not surprising that the oldest form of insurance is marine insurance used by the Greeks and Romans, possibly invented by Phoenicians whose trading around the Mediterranean began in the 12th Century BC, and developed significantly by the British in the 16th century, along with English maritime law – still the world’s predominant maritime legal system.

 

The following, albeit fictional and thankfully extreme example, gives a good insight to the risks involved with ship owning:

 

Imagine a multimillion dollar, 300m long Capesize ship (larger than a major factory), sailing the world’s oceans, manned by a tiny 22-person crew of varied nationality, that the owner has never personally met but must totally entrust to navigate his prized asset safely in treacherous seas and weather conditions in totally inhospitable areas.

 

This floating mega-asset cost its owner US$90m two years prior, but today is worth no more than US$50m due to depressed market conditions. The owner originally took a loan of US$60m, using its own capital to fund the balance of US$30m. This owner is already in trouble since the loan stipulates that the market value of the ship must at all times be no less than 120% of the loan outstanding. This means simply that with US$48m of the loan still outstanding after 2 years, and given the current market value of the ship, the owner is now in default of his loan obligation and must deposit a further US$8 million in cash to the lending bank in order to comply with the terms of the loan.

 

This US$90m ship has running costs (including the cost of finance) of around US$30,000 per day and current market conditions mean this ship only generates revenue of no more than US$10,000 per day. This results in the owner losing every day (assuming the ship is constantly employed) at least US$20,000, with the bank threatening repossession unless the additional security mentioned above is pledged or paid.

 

Amidst all these financial woes the owner has to deal with a very difficult chartering market, taking on occasion additional risks to secure employment. One such risk is loading out of certain South American ports because of drug trafficking; another is hiring the ship to other than a first class charterer. Faced with no other option, the owner finds employment to load out of one particularly risky port. He heads there and commences loading. The charterer has already paid an initial amount for the time charter hire of the ship but unfortunately and with loading complete, the charterer suddenly declares bankruptcy. The owner now not only has no income, but has at the same time an obligation to transport the cargo and deliver it to its rightful owner, financing the entire cost of the voyage himself (including bunkers and port expenses normally paid for by the charterer).

 

To make matters worse, as the ship is about to sail, the Master notices strange bubbles surfacing around the ship’s hull and suspects divers attaching contraband. He alerts the local authorities and a large consignment of drugs is discovered, stuck under water in the ship’s water intakes. The port police arrest the ship and its Master, pending investigation, even though the Master and crew discovered the drugs, reported the incident immediately and were not at all responsible. Local corruption and politics result in the prolonged arrest of the ship requiring vast amounts in financial guarantees to lift the arrest.

 

The owner heads to his office lost in the endless troubles, financial and otherwise that he is faced with only to find the ship’s officers’ family waiting outside his office demanding that their loved ones be repatriated at once, accusing the owner of mishandling the situation.

 

Not only that, there are TV reporters covering the drama. The owner is faced with no other solution but to submit to the financial and other stresses of the situation: faced with huge costs normally and extraordinarily due to the ship’s predicament and the cost of financing the trip under the owner’s obligation to the cargo receivers along with the cash injection his bankers need, the owner decides to forgo the right to ownership and loses the asset to the bank. Simply, the owner’s personal investment of perhaps well in excess of US$30m vanishes in a matter of a couple of years.

 

The aforementioned is extreme, but many parts are not alien to the industry. Ship owning risks are immense and unlike any other industry. Volatility and shipping appear to go hand in hand, bringing upsides as well as downsides. To illustrate this volatility, the recent imposition of US sanctions on COSCO, together with vessels being attacked in the Gulf, saw daily rates of some tankers surge to US$300,000, benefiting many of the stakeholders after what has been a challenging few years.

Ship Owning Structures


Ships, due to the nature and size of the risk carried, are often owned in ways that protect risk cross-contamination with other assets owned beneficially by the same owner, as well as to protect the personal wealth of the ultimate owner. For this, Special Purpose Companies (SPCs) typically domiciled in tax havens are often used to own vessels. Each SPC owns only one ship, hence also being known as Single Ship Companies.

 

Often SPCs are owned by other SPCs behind which a Trust may exist, thus making it sometimes very difficult to ascertain the identity of the true owner. The principal behind this is that shipping risk can be large enough to threaten an owner’s personal assets as well as spread, infecting other shipping assets.

All activities undertaken on behalf of the ships including the procurement of goods and services, port expenses, crew wages etc. are all typically made only in the name of the SPC that owns it, and not the owner or even the manager.

 

Typically, owners with a critical mass in terms of the number of ships have their own ship management company, often also owned by a separate SPC. To the ship manager all ship management activities are assigned separately by each respective SPC that owns each vessel under management. The ship management company carries significant risk and typically is often void of any real assets other than some office equipment and its reputation.

 

Listed companies tend to prefer time charter period employment for their ships as it carries less commercial risk than voyage charters and provides for a constant and predictable stream of earnings, and thus stable returns to investors.

 

It has become common for vessel owners to entrust management to third parties via ship management contracts at arm’s length. A new breed of ship owner has also materialized that is not keen on the actual management and operation of assets, but instead concentrates on the “asset-play” (i.e. the selling and buying of ships) rather than the more detailed and often less lucrative side of ship management.

A few words about CompassAir


Creating solutions for the global maritime sector, CompassAir develops state of the art messaging and business application software designed to maximise ROI. Our software is used across the sector, including by Sale and Purchase brokers (S&P/SnP), Chartering brokers, Owners, Managers and Operators.

 

Through its shipping and shipbroking clients, ranging from recognised World leaders through to the smallest, most dynamic independent companies, CompassAir has a significant presence in the major maritime centres throughout Europe, the US and Asia.

 

Our flagship solution is designed to simplify collaboration for teams within and across continents, allowing access to group mailboxes at astounding speed using tools that remove the stress from handling thousands of emails a day. To find out more, contact us via solutions@thinkcompass.io.