The Dry Bulk Freight Market - Case Study Example

Introduction The Shipping industry today is the world carrier of our goods from one continent to another. It is estimated that more than 90% of goodsare transported by sea. In the 1990’s, it is estimated that some 31btm of cargo was transported by air, 3,853btm by rail and some 12,056btm by sea making sea transport the most widely used means of transportation (Martin, 2005, p. 8). The shipping industry is widely considered to be one of the most complex industries with ever changing conditions governing the industry, but at same time, its services are the most homogeneous making it a perfectly competitive market. The industry has also over the years witnessed some technical changes. Due to the ever increasing level of world trade from the 1960’s, it became abundantly clear to the industry observers that the traditional “break bulk” shipping will not be able to carry around the world the increasing cargo. This therefore led to the palletization and containerization was introduced to resolve these problems. Another revolution that took place was the increasing use of bigger ships. Over a period from 1945 to 1995, oil tankers increased by size of almost twenty times while dry bulk vessels became almost some fifteen times bigger. This increase in ship sizes led to a great reduction of shipping costs that industries increasingly preferred using ships than to the old rail road methods. The reduction in cost was of great advantage to industries to carry around their raw materials (e.g. this led to the cost of transporting coal by sea from Virginia to Jacksonville, Florida almost three times cheaper than by rail) (Chrzanowski, 1985). The dry bulk freight market The shipping industry consists of different market structures and decisions within these markets are taken distinctly by all the market players. The dry bulk freight market falls under the category of a perfect competitive market consisting of individual sellers, the shipowners on the supply side, and a large number of individual buyers, the shippers or charterers on the demand side. The dry bulk freight market participants are in the most part price takers in that they accept the ruling freight rate as axiomatic. The market is an open market comprising of numerous individual firms of shippers and similarly large numbers of shipowners offering common carrier bulk transport services. The following assumptions hold true for this kind of market: The market consists mostly of a large number of small firms of both shippers and shipowners. This means that each firm or player in the market produces or consumes a level of output which is extremely small in relation to the total quantity of the industrys production, thereby leaving no one player with the power to be able to influence the level of freight rates on the market since no one individual firm is capable of affecting the freight rate by varying their own output levels or their demand for tonnage, since what the individual supplies or demands is insignificant in terms of the industry as a whole. The market leaves individual shippers with that decision to easily take their businesses to other competing shipowners asking the lower market freight rate since all shipowners are offering homogenous services. Therefore, no one shipowner has that monopoly to decide on freight rates or offer tonnage at a rate lower than that pertaining in the freight market especially as it may have serious consequences on the firm’s profits. The dry bulk freight market is such that no particular individual is impeded from entering or exit from the market especially as they are not much great capital cost and other costs that may stop individuals from entering. But on the contrary, exit from the market is easy for firms since they can sell their tonnage, send their vessels for scrap or temporarily withdrawal by laying up their vessels. But without these barriers some firms grow in size that they try to influence freight rates on the market, but as usual, the market forces acts such that the rates are pushed back to equilibrium. During periods that freight rates may be high, the market attract more firms (be it on the shippers side or the shipowners side) to enter the market thereby pushing profits to normal levels. In this market, no particular shipper or shipowner can take advantage of finding a particular ship for particular cargo or find an advantageous cargo since all market actors have a full knowledge of the existing freight rates. This is because, all freight rates, be they past or current are available to all. They are limited government interferences be they at the level of flag states, subsidies to particular ships since the government allows the forces of demand and supply to act on the market independently. Demand and supply factors affecting the dry bulk freight market Generally speaking, the dry bulk freight market as well as other shipping markets is affected by ten variables, five for demand side (world economy, seaborne commodity trade, average haul, political events, and transport costs) and five for the supply side (world fleet capacity, fleet productivity, shipbuilding production capacity, time to scrapping and losses, and market freight rates). On the demand side, world wide economy through the various activities of her industries may develop particular sectors that may modify the general trend of goods that need sea transportation (e.g. the oil price that greatly influences demand for oil). On the supply side, in the short term, the fleet capacity going through our seas may represent a fixed stock of ships. This is affected by scrapping, new building inadequacies, or lay off. But certainly, fleet size will increase by 2030 considering the fact the export levels are expected to increase from $9 trillion to $27 trillion and world population expected to increase by 1,5 billion (Gary, 2008). But at the level of individual firms, what affects the supply is their ability to cover their variable costs. Any firm that realizes that she will be unable to cover her variable costs will not be willing to supply and in effect, it will have an influence on the freight rates. But the demand curve for any individual firm is horizontal since they are price takers and will carry any tonnage at the market freight rates. Seaborne trade has witnessed an increase for the period 1987 – 1994 passing from 679 to 875 for dry bulk carriers of over 50,000 tons and 570 to 579 for dry bulk carriers of less than 50,000tons. But this increase has not witnessed same in freight rates. Instead, freight rates have undergone a lot of volatility over the period 1869 - 1994. Using years from 1869 to 1937 and 1950 to 1993, volatility annual change that was concentrated in the 4 per cent range to 10 percent range suddenly moved so that only 25 per cent of these years fell between the 4 per cent to 10 per cent range from 1950 to 1994 (Martin, 2005). Even though this may not be a right prediction for volatility in freight rates to allow shipowners to move away from dry bulk transportation, it at least gives some insight on how the market had become more uncertain. However, these and the increase technical developments the industry is undergoing should give a shipowner to rethink what the future should hold for him. Short sea container feeder market The short sea container feeder market today has become fashion as much is now settled around acquisitions and mergers due to falling freight rates and escalating charter costs. Many shipping companies have had to come with acquisitions so as to be able to amass profits on the market. Some have gone as far as providing feeder services for their ships thereby made life very difficult for small independent feeder operators, since they are now left with the parts that are more expensive to carry, and will therefore need everybodys volumes to keep their overall costs down (Beddow, 2007). The market is becoming more competitive as road haulage operators who offer low haulage rates have started to offer door-to-door services that were mostly part of the feeder ship operators. The situation is further getting worst as many countries such as the new EU members are opening their borders that allow free flow of transport. Trailer operators offer a rate of GBP1,250 (USD2,375) from Warsaw to Manchester, meaning that a shipping company like MacAndrews with 45ft containers to compete with them will have to offer the same service at GBP50 (USD 100) cheaper than the trailer operators so as to stay in business. In business, time factor also counts much for a customer especially with the just in time principle today. This has pushed other means of intermodal transport operators to offer services which were else seen to belong to the short sea feeders. A typical example of such intermodal operators is the rail transport operators who have joined the transportation of cargo. According to one short sea feeder operator, Smith “New intermodal operators often start off by saying that their main competitor is road haulage, so they will only be alleviating road traffic congestion, but, in practice, they usually end up competing with established short sea operators like us as well.” (Beddow, 2007) Demand side factors affecting the short sea feeder market With the open borders in the EU and increase competition from road haulage operators and rail road operators, and major acquisitions and mergers in the market today, the demand for the short sea feeders is gradually falling as shippers will prefer cheaper services. Another factor that will obviously affect demand for the feeder short sea services is the growing rate of bigger ships entering the industry. Most of the bigger ships entering the industry are equipped with feeder services that leave a great gap for demand of independent feeders. This means that, the bigger ships will prefer to give cargo to their already acquired feeders for transportation into the hinter land and most often, with some doing delivery 6 times a week and we realize feeders of up to 1,700 TEU for Team Lines owned by Delphis. This lays importance on the concept of just in time, where some shippers may prefer to pay high costs for their cargo in as much as there is reliability that their cargo will be delivered and on time. Time in transit is an inventory cost. Thus shippers of high cost commodities will value speed and would therefore prefer to ship their goods in smaller quantities even if that will increase them freight cost. For example, a three month cargo worth $100,000 will incur an inventory cost of $2,500 if interest rates for the period are 10 per cent per annum. But a shipper may prefer to pay $1,250 as extra freight provided the journey time is halved. This seriously will affect demand for short sea feeder services. Security affects demand for short sea feeder services since a shipper may prefer to pay a high freight provided he is sure that the goods will arrive without that risk of damage or loss. But remember that loss or damage is an insurable risk, but often raises many difficulties for the shipper when confronted with such a situation. Factors affecting supply of short sea feeders The most important supply factor affecting the short sea feeder is cost. Charter rates for most vessels are increasing since these vessels are hired in as and when needed, making the market too unstable. Short sea feeders obviously do incur much cost since even though as small as they are, they have to organize for many small parcels by using a large shore-based staff capable of dealing with the shippers and their needs. The staff has also to plan the ship loading, handling of documentation, and transport operations. Another area of cost for feeders is that, since they deal with small parcels, they is obviously high cost in handling and packaging of the small parcels. For example, the cost of transporting crude oil from the Arabian Gulf to the USA using a 280,000dwt is less than $1 per barrel, whereas the cost of transporting a ton of lubricating oil from Europe to Singapore in small parcels can be over $100. References Beddow Matthew (2007): Make or Break. Containerization International, London, pg 36 – 39 Chrzanowski I. (1985): An introduction to shipping Economics. London, Fairplay Publications Gary Morgan (2008): Global Economics, shipbuilding and new construction outlook. Lloyd’s Register of shipping Maritime transport Research (1977): Dry Cargo ship demand to 1985, Vol 6. London, Graham and Trotman Martin Stopford (2005): Maritime Economics. Ponting-Green Publishing Services, Chesam, Buckinghamshire McConville James (1999): Market Structures; Economics of Maritime Transport. Institute of Chartered Shipbrokers, London, pg 149 – 172 Moyer Raymond (1984): “The futility of forecasting”, Long Range Planning, Vol 17(1), pg 65 – 77 The Tramp Shipping Market (2007). Clarkson Research studies Read More