CEO Series Towards a General Theory: Part I An Integrated Dynamic Model of the Main Functions of the Maritime Sector. By Alkis John Corres

This is the first presentation out of three which aim at explaining how the maritime markets adjust the fleet level to the demand for shipping services in the global markets and which are the principal determinants of investment decisions.

Classic economic analysis only considers simultaneous alternative pairs of values. Here we need to introduce the time element by replacing curves with time series.

Let us borrow a graph from the oil industry to illustrate the case Let us borrow a graph from the oil industry to illustrate the case. Here, the blue lines show the balance between the demand and the supply of crude oil, and the red line the actual market price. One clearly observes oil prices to go up when supply is short and vice versa. The same thing happens in freight markets. Let me start with a graph borrowed from the oil industry. The blue line

Let us now transpond this phenomenon to a maritime context and consider the black line to represent the demand for shipping services and the blue line the supply. Two observations. First, the points of equilibrium where D=S are momentary. Second, inferring from the previous graph, when D>S freight rates will be high, and the opposite when D<S.

Freight rate indices (the equivalent to Price) are calculated on basis of reported fixtures by committees of shipbrokers on regular intervals. There are no official statistics in the form of a time series for the levels of demand for shipping services and proxies are used instead ( e.g. Production statistics, sales, exports etc).

The approximation of the level of supply of shipping services in the form of a time series is even more difficult. The size of the fleet (e.g. the total tonnage capacity of the dry panamax fleet) although readily available is a poor proxy for the level of supply at a given point in time and it is even poorer without origin/destination data.

Let me pause for a second and consider what we have so far. We have well documented freight rate indices by ship type and size at various time intervals . We have – usually yearly - fleet size estimates per ship type. We have new ship deliveries and ships on order data. We also have general ship breaking prices and tonnage data. We would love to have : reliable quarterly shipping demand data in ton/miles per major trade and area and .. ..the corresponding shipping supply data by trade and area. Sadly, that is not the case, so we are left with the first two items at the top. Therefore one must concentrate on the freight rate level as the chief indicator of the current demand/supply balance as most ship owners do.

The current value and the development path of the freight rate levels in previous points in time indicate the Demand/Supply balance and drive ship owners expectations (as forecasts are less relied on).

Ship owners have a pivotal role in the system: Their decisions to invest (in new) or divest (scrap) ships directly impact on the fleet size. Complex decisions taken under uncertainty must be taken on basis of limited information, such as: Order new ships? If so, what type and size? Are present new building prices attractive? What will these look like in a year’s time? Or, sell tonnage or scrap. At what prices? Sell now, or later? How do we expect ship breaking prices to develop? It the market going up, or down? What are the production prospects in major trades? Borrow, or lease? Do we go for time charters, or stay in voyage business? Do we trust freight futures to guide our decisions?

Fleets are stock variables which means they can only change through changes in the associated flow variables. A fleet increases in size with new ship deliveries and decreases when ships are either lost or scrapped. Ship losses are accidental in the sense that are not subject to a business decision on the part of the ship owners. Ship losses nowadays are few and far apart so their impact can be considered not significant to the fleet level. Ship scrapping is a considered business decision of the owners and it has an immediate effect on the fleet size and capacity.

Seen in a time perspective one can see changes in the fleet level taking place only as the result of changes in the rates of the flow parameters. At the end of any given time period the fleet level will increase if new ship deliveries are more than ship sales for scrap (+ accidents resulting into ship loss). The mechanics are the same as applicable to populations. Seen over a longer period, the fleet size will be showing an increase when the rate of new ship deliveries exceeds the rate of ships scrapped and it will be staying level if the two rates are equal to one another. Second hand sales have no effect as these are mere transfers of ownership.

Research has shown the following: The prospects of more business, bigger market share, more profits and so on fuel decisions to order new tonnage. Rises in fleet level are therefore not natural phenomena, nor Acts of God, but the outcome of many different business decisions coordinated by the levels of the freight market. Research has shown the following: Continued rises in the freight rate level for a period longer than two quarters are manifested in new ship orders. New ship orders placed in shipyards over time tend to move in opposite directions to ship scrapping. Rising new orders placed and falling sales for scrap are as a rule observed when the freight market booms. On the contrary, during low freight market periods there are generally few orders for new ships and many more sales for scrap.

So, the sector as a whole does show evidence of an overall logic in its function to serve international trade and it does so by taking action to curb freight rate excesses. The addition of tonnage at times of boom will eventually increase the supply of shipping services offered, thereby impacting negatively freight rate levels. The withdrawal of tonnage through scrapping has the opposite effect, as the level of supply is reduced. However, there are imperfections on the inflow side. A ship order placed today will probably result into a new ship delivery after 2-3 years. In shipping none has the faintest idea where the freight market will be at the expected date of delivery. Therefore, the vast majority of new ship orders are placed in hope of a future freight market level which will allow for profitable operation. On the contrary, ship scrap sales have an immediate effect. Once a ship is sold for scrap it is permanently removed from the fleet.

Therefore there is an observed asymmetry in the regulation of the supply side. Nevertheless, these flow parameters do come under the control of ship owners even in a less than perfect way. On the other hand, there is absolutely no control over changes on the demand side which is an external variable to the maritime system. The demand for shipping services is derived from international trade. Following sale, cargoes in need of sea transportation are entering the market in search of ships following the conclusion of commercial transactions. Ship owners have absolutely no means to influence this activity, therefore to them, demand remains an externality.

While the development of the fleet follows a rather leisurely development path…

…demand for shipping services has its own logic influenced by different parameters such as climatic conditions, size of crops, production and distribution needs, economic conditions etc .

As a result freight market developments are always sensitive to changes in the level of the demand for shipping services, especially in the short and medium term.