Shipping Operations Strategies - Essay Example

The Board of Directors Fleet Manager Feasibility of the Proposed Acquisition of Six LNG Tankers March 23, Report Tableof Contents Executive Summary Introduction Technical Strategies Commercial Strategies Assessment and Evaluation of Technical Strategies Assessment and Evaluation of Commercial Strategies Conclusion and Recommendations References Executive Summary The purpose of this report is to provide advice on the feasibility of purchasing six LNG tankers, each of which is less than three years old, and which have been trading intermittently during the recession. This report provides the following information: Technical and commercial strategies that would be beneficial to the company An analysis and evaluation of various support mechanisms that could be chosen for the technical support of the carriers and of the commercial approach chosen, in terms of the markets that could be exploited. The growth in the LNG trade is expected to continue for some time. This, as a number of new sources is being exploited, or is in the process of being exploited. This has resulted in an increase in the demand for LNG carriers and an increase in activities in various ship yards around the world. While research suggests an increase in business for firms in the supply chain, there are a number of ships that were idle throughout 2008 to 2010. This has been so, even with the substantial increase in importation in Japan, Korea and Spain. However, while their imports are increasing, those of North America and Europe have not shown any significant changes. LNG is required for heating and cooking purposes. In some countries it is used to generate electricity. It is also said to emit less carbon dioxide than other fossil fuel such as coal and oil. This makes it a popular commodity in most countries. According to Jensen (2004, p5) prior to the development of liquefied natural gas (LNG) technology, its use was limited to areas that could be served by pipelines. However, the development of LNG along with improvements in technology and cost has changed all of that and so gas is rapidly becoming an internationally traded commodity. LNG is condensed natural gas. The volume of which has been reduced by a factor of 600 for storage and transportation (Audun Brands?ter 2010). It is transported by LNG carriers that are capable of safely transporting LNG from liquefaction plants to LNG terminals for storage and re-gasification. Some carriers are specially equipped to allow for the capability of re-gasification on board the vessel. Introduction A number of factors have to be considered in making the decision of whether to buy 6 LNG Tankers. These are technical as well as commercial considerations, which demand an understanding of the product and the market. LNG Carriers form the link between the liquefaction plan and the LNG terminal and so it forms an important part of the supply chain (GIIGNL Technical Study Group n.d.). Supplies of LNG are imported primarily from countries such as Algeria, Trinidad, Venezuela, Nigeria, Norway, Qatar, Oman and Australia. These represent areas where large discoveries have been made. Some LNG is also produced in Alaska. LNG is a viable export commodity for these countries because they cannot use all the natural gas that they produce. (DOM n.d.) Liquefied natural gas (LNG) is natural gas which has been converted to liquid to facilitate its storage and transportation. According to MAGALOG (2008) LNG is a space efficient way to store and transport natural gas when pipelines are not a feasible solution. This conversion is, however, of a temporary nature and involves a number of processes. After the gas is extracted, it is taken to a plant for processing, where it is purified by removing water, oil, mud and gases including CO2 and H2S, thereby allowing for its condensation. The gas is condensed into a liquid at close to atmospheric pressure by cooling it to approximately -162oC (-260oF). The LNG is then stored into tanks, after which, it is loaded onto ships. LNG consists mainly of methane and has small amounts of ethane, propane, butane and some heavier alkanes. The purification process can be done so that it is almost 100% methane. LNG is odourless, colourless, non-toxic and non-corrosive. However, it is flammable, freezes easily and may also result in suffocation. LNG takes up to 1/600th of the volume of natural gas in its gaseous state. This reduction in volume makes it easier to transport over long distances where pipelines do not exist. It is normally transported by specially designed cryogenic LNG carriers or road tankers. One of the risks of transporting LNG by LNG tankers is rapid phase transition (RPT). RPT occurs when cold LNG comes into contact with water. This is a very rare event but needs to be considered in the transportation of LNG on water. According to iMosaic Corporation (2006) RPT is the rapid generation of vapor as the LNG, which is cold becomes vaporized as a result of the heat from spill on the surface or from a large volume of water that comes into contact with LNG in a storage tank. The vapor evolves rapidly and so an area of pressure is created which is sometimes referred to as an explosion. So far, the transportation of LNG by LNG Carriers has been accident free, however, caution is still required and so all safety guidelines need to be followed. For this reason specially trained personnel is important on all voyages involving the transportation of LNG. According to Audun Brands?ter (2010) there were approximately 350 LNG tankers in 2010, consisting of a mixture of old and new tankers of varying sizes. Some are used on long-term contracts, others for medium-term and short term contacts involving spot charters. During 2008 to 2010, there was an excess of LNG Tanker capacity on the market and this resulted in some not being used during the period. Technical Strategies The process of assessing ship quality includes the operational standards of the vessel including the competency of crew members, training as well as the ships physical condition. The information on the quality of the LNG carrier can be obtained from many sources, including vessel inspections from many sources as vessel inspections on behalf of ship companies, owner assessments, terminal and operational feedback, market intelligence, casualty data, reputation and questionnaires. The Company is already operating in the shipping industry. However, there are specific requirements in the SOLAS convention as it relates to vessels carrying LNG. If the company decides to purchase the six LNG tankers, a special crew will therefore be required for the fleet of LNG tankers. In addition to recruiting additional staff the company could consider training its current crew members on its cargo liners so that they would be flexible to work on either cargo liners or LNG tankers. Another strategy is to employ an entirely new set of crew members who are already trained to work on just LNG tankers. According to Beale (2006) there are three (3) types of LNG carriers. They are Self-Supporting Spherical, Supporting Prismatic Shaped tanks, and Membrane tanks. Beale (2006) noted the importance of understanding the similarities and differences of these tanks in order to determine the one which may result in the greatest volume of spillage of LNG in the least time frame. The typical LNG carrier is capable of transporting about 125,000-138,000 cubic meters of LNG, 23 which will provide about 2.6-2.8 billion standard cubic feet of natural gas (Uddin 2009, p. 25). LNG Carriers are double hulled ships with insulated tanks. They are referred to as the cargo containment systems, inside the inner hull. The design and construction of these tankers are governed by international codes which vary with the type of cargo the ship carries. These codes are laid down by the International Maritime Organisation (IMO) under the Safety of Life at sea (SOLAS) Convention. The ship’s crew has to be properly trained and therefore be in receipt of the necessary certification to work on LNG carriers. According to Germanischer Lloyd (nonstop 2007) a minimum of ten (10) crew members are required to provide proof of special training on each ship. The IMO’s Standards of Training, Certification and Watchdog (STCW) Convention provides guidelines on training. In conjunction with the SOLAS provisions governing the safe manning of ships, the STCW Convention and Code lays down the details of the training courses and content that has been stipulated for the crew members. The code also covers the requirements that affect the use of simulators. In order to have courses and teaching systems of training providers recognised internationally it is important that they are in conformity with international guidelines. This has to be verified by an independent expert. Having found that the programmes meet international standards, the relevant certificates that are issued to participants are accepted as proof of having met the required standard of training. Germanischer Lloyd is one such expert. The ship’s crew members have to be able to ensure that the quality of the LNG that is being transported is of a particular standard and that it is delivered to the customer in the proper condition. The captain of the ship has this responsibility. An additional responsibility is to be able to indicate any reason for any loss of the product. The ships are not new but are under three (3) years and therefore the operators should be able to provide relevant certification on matters dealt with by the SOLAS convention that are applicable to LNG carriers. The physical condition of a LNG ships are normally tested every year but anything can happen within that time and so before purchase, the purchaser would need to ensure that the carriers are functional and will be able to pass any test. These tests have to be conducted in accordance with Oil Companies International Marine Forum (OCIMF). Reports on the technical and survey status of ships are available through the OCIMF Ship Inspection Report (SIRE) Programme, the ship’s classification society and the ship owner. However, any buyer needs to have technical expertise on hand that is able to assist with the technical appraisal of the ships. Macalister 2005 reported that a fleet of new ships that was delivered to a British company was hit by defects related to leaking tanks. This is an indication that the age of the ship is not very important when it comes to the problems that may occur. The terms of the warranty agreement is therefore of major importance in this context as the cost of repairs may be exorbitant. It is important that the contents are transported by a crew that is familiar with the product and are aware of quality standards. According to The SGS Group (2009) several special leak test methods are available to test the integrity of the membrane cargo tanks on LNG vessels. There is a special one called the Helium Leak Test which is performed by introducing helium gas into the membrane of the cargo tank and pressurising it slightly. The gas (helium) flows through any cracks or small holes that may be formed at welding seams. The leaking helium gas is “sucked in a helium mass spectrometer” on the other side of the membrane. When the gas becomes ionized an amplified signal is sent to the indicator by the helium ion collector. Special procedures have been designed for LNG tanker inspections (The SGS Group 2009). The life of a ship is approximately 40 years. These ships are under three years old and are therefore fairly new. However, checks need to be done to determine if the ships were properly maintained by the previous owners and to ensure that they are adequately insured for the life of the crew and the cargo that they propose to carry. The price of the ships along with their features should be compared with those that are currently being sold. Attention should be paid to the technical specifications, the size, and the features when compared with the ones that are being manufactured currently, as well as the performance of the ships in that particular class. According to Rigzone (2010) a recent agreement was reached between Teekay LNG Partners and Exmar for Teekay to acquire a 50% stake in Exmar’s two LNG carriers. This resulted in the passing of $70 million to Exmar and the assumption of 50% of the $100 million debt which is secured on the company’s assets. One of the LNG carriers is a 2002 built Excahbur – a conventional LNG carrier and the other is a 2005 built Excelsior, which is a special gas carrier that can both transport and re-gasify LNG onboard. Both vessels are on the long-term, fixed rate charter contracts for firm periods until 2022 to 2025. This transaction gives an idea of the current cost of used LNG ships. It is also important to determine any additional costs that may be incurred in order to make the LNG tankers consistent with the IMO’s regulations whether in regards to SOLAS or MARPOL. According to Metal Safe Sign International (n.d.) SOLAS provides a list of various certificates that have to be provided by the flag State. These certificates provide evidence of ship inspection and compliance with the requirements of the SOLAS Convention. These certificates include Cargo Ship Safety Construction, Cargo Ship Safety Equipment and Cargo Ship Radio Certificates. Whenever an exemption is granted by the flag State, an Exemption Certificate is issued, indicating the specific requirements from which the vessel is exempt. These control procedures are primarily designed to make it possible for port State Officers to ensure that foreign ships that call at their ports are in possession of valid certificates. The ability to present these certificates is evidence that the vessel complies with the requirements of the SOLAS Convention. If the port State Officer have clear reasons to believe that the condition of ship or equipment or both does not correspond in a substantial way with the particulars of any certificate presented then the Officer is empowered to take further action in keeping with the regulations. According to Gas LNG Europe (2004) before the ship is able to transport goods to a terminal certain vetting procedures are carried out to ensure the ships suitability of entering the terminal. At the end of the procedure the terminal operator will determine whether the ship meets the requirements to transport goods to the terminal and what corrective measures need to be carried out to enable the LNG tanker to unload cargo at the terminal. Only those ships which successfully went through the procedure will be authorised by the terminal operator (TO) to unload their LNG cargo at the terminal. Thus any Shipper requesting access shall either make use of LNG vessels that are already authorised or submit vessel for approval. Commercial Strategies There are varies strategies that can be employed in the LNG Carrier market. The company could opt for long term contracts only or it could consider a mix of long-term, medium term, short term and spot. Some operators prefer to have long term contracts while having a few ships that deal with spot charters. This strategy may be attractive, especially in instances where loans have to be repaid as it provides some level of stability in cash flows. However, having a mix is of great importance so that in the event that an LNG carrier is required to replace one that is used for a long-term charter there is a cost effective replacement. Having to charter vessels from other operators, who are also competitors, to fill gaps related to long term contracts can be very costly. Macalister (2005) points out that when the Methane Kari Elin was detected to have a leak in 2005 shipbrokers indicated that it would cost the British Company to whom the ship belong approximately ?20,000 per day to charter a vessel to replace it as the Builders indicated that it would take up to six months to repair. Even though this is a long time ago and the rates might have increased or decreased, the fact is that, the daily charter rate on a long term contract would be much less than on a spot charter. However, there will be times when the rates on long term contracts may be much better than spot rates. There are varying views on the LNG carrier market as it relates to the demand for LNG and therefore the demand for LNG carriers and the price of chartering vessels. Jenson and Associates (2007) indicates that during the period 1995 to 2005 there was an annual increase of 7.4% in the demand for LNG. Looking at various scenarios based on various levels of demand Jenson and Associates (2007) sees this trend of substantial growth continuing into 2020. According to PriceWaterhouseCoopers (n.d.) LNG represents one of the fastest growing energy markets in the world. This is so, based on the number and magnitude of new LNG projects that have proposed or under construction. The worldwide capacity to produce LNG could double by the end of the decade. However, reports show that the price of charters has declined significantly between December 2010 and January 2011. The demand for LNG is expected to increase dramatically based on the environmental qualities that it possesses. According to Cook (2005) LNG like all other natural gas is cleaner than coal and oil and offers users the opportunity to diversify energy supplies. There are various markets that the company could consider tapping into. There is the European Market, the North American Market and the Asian Market. The Asian Market is considered very attractive as the countries in that geographic region import all their natural gas in the form LNG. While the North American and European markets have not seen any major increases in their importation of LNG, the Asian markets have shown year on year increases. According to the International Group of Natural Gas Importers – GIINLG (2008) Japan has retained its position as the leading importer of LNG in 2008 with 39.9% of all LNG imports, followed by Korea with 16.8% and Spain with 12.9%. It most also be noted that while there was an increase in the importation of LNG in Spain, this was not the same for some other European countries as they recorded declines in the importation of LNG. There was however a net increase in LNG importation for Europe of approximately 1.6% (GIINLG 2008). Therefore, the most lucrative route in terms of charters may be routes between the source and Japan/Korea where demand has been on a continual increase, with projections for a continuation of this trend. The recent earthquake in Japan will see an increase in the demand for LNG. According to Milmo (2011) the recent earthquake in Japan has resulted in the shut down of 11 of the countries nuclear power plants. Forsyth (qtd in Milmo 2011) indicated that because of requests for extra shipment of LNG cargo, ships may be diverted away from other destinations to go to Japan. This suggests that there will be a substantial increase in LNG importation on that side of the world for some time. Analysis and evaluation of technical strategies In deciding what technical strategies in terms of hiring of crew will be feasible the company needs to hire a consultant to carry out a survey of the cost of training and the level of salaries that are currently being paid to ship captains and other crew members. Germanischer Lloyd (2008) suggested that by the year 2015 over 400 LNG tankers are expected to be in operation. Taking into consideration back up crew, vacation and sick leave, there might not be enough skilled crew members at sea. Germanischer Lloyd (2008) also indicated that current demand for training exceeded training capacities and so even if enough persons are available for training facilities are not available for this to happen. The minimum monthly wage for Ship captains have also increased by 331/3 % from $12,000 to $16,000. Magazinovic - a Croatian Crew Manager (qtd. in Germanischer 2008) indicated that ship owners will now have to pay him a transfer fee in order to hire any of his officers. This situation he likened to football. The high salaries that may need to be paid when combined with the commercial strategy could result in serious consequences for the Company. Therefore, using a mixture of staff would be more cost effective and therefore beneficial. Additionally, if the original crew members possess the necessary skills and are available, the company could consider employing some of them. In terms of ship inspection and approval the company needs to ensure that the necessary certificates as it relates to SOLAS convention is in place and that it is possible for the ships to start operations right away. These should be in the possession of the ship owner. Both the ships and crew members should have the necessary approval to operate at the relevant terminals. Any additional costs to be incurred should be at a minimum. Any of the LNG tankers have not met the necessary requirements then they should not be purchased Assessment and evaluation of commercial strategies Financing the purchase of these LNG tankers is of major importance. The strategy adopted would have to ensure that based on a worst case and other scenarios the company will be able generate enough funds from the operation of the vessels to pay back the loan. Eze (n.d) suggests that financiers face a number of risks inclusive of construction risk. If the vessel is made up of sub-standard materials then the life of the ship will be shortened. However, of importance is the fact that financiers are seeking to match the length of the loan repayment period with the length of long-term or medium-term contracts. This suggests that having long-term contracts is of major importance as it ensures some level of stability in the company’s cash flow. However, there are drawbacks as mentioned, when ships may have to be chartered from a competitor in order to fulfil an obligation. The company should consider exploiting the Asian market. Japan and Korea has shown strong demand for LNG while the once dominant importers such as Europe and the United States are showing weak demand. While it is good to consider lucrative markets the European and North American market will rebound in the future as they seek to reduce the level of carbon emission in the environment. Market conditions may not be as suggested by the amount of activity in the industry and according to Sethuraman (2009) tanker rates have fallen by 17% for tanker vessels on short term haul. In an article written by Petroleum Economist (2011) the point was made that daily spot rates on long haul routes had decline to US$15,000 per day in February 2011 down from approximately US$18,000 in December 2010. This suggests that the daily spot rates may be lucrative at times and at other times it may not be as lucrative. Conclusion and recommendations A number of methods are available to determine whether the project will be profitable. However, the company will need to obtain charters to be able to obtain finance for the acquisition of the LNG Tankers. It is therefore important to determine if the current time specific charters are part of the agreement for sale. Familiarity with the spot and time charter markets are of extreme importance and so the need arises for experienced commercial charterers who will be able to establish close relationship with potential customers and other third parties such as ship brokers, seeking charter vessels on both the spot and time charter markets. The operations team needs to be located in key areas where LNG is imported and exported. A reputable consulting firm will be able to assist in this respect. Currently, there is a move towards short-term contracts instead of the long-term contracts which were usually for approximately 25 years. The medium-term contracts generally range from 1 to 4. It therefore means that financiers would want to ensure that any loans received to finance such projects are paid back over that period. An additional problem is the fact that the LNG tankers are usually dedicated to transporting LNG and cannot be used for anything else. However, there are some that allow for the stowage of other items. Before the ships can be connected to a terminal it has to provide a number of certificates which will indicate whether or not it is fit to operate. LNG carriers have to be registered in a country which then becomes the “Flag State”. In addition to international codes, all countries have rules and regulations governing operation of ships in their waters. All LNG carriers must comply with regulatory requirements including those of the International Maritime Organisation (IMO’s). These include the International Gas Carriers Code (IGC), the International Safety Management (ISM), the Standards of Training, Certification and Watchdog (STCW) Convention, as well as the United States Coast Guard (USCG). In the past charters were of a long term nature. However, this has changed somewhat to being of a short term nature. For a project to be feasible it must be able to pay for itself over a prescribed period. It therefore means that adequate funds have to be generated from the Carriers and so there has to be some long term contracts in place for some of the Tankers. Ships have to be properly insured before they are allowed to trade. Marine quality for assurance is provided through a process called vetting. Through this process the quality of the ship is assessed to determine if it meets the required standards to be accepted for use. Assessments in relation to international conventions such as the IGC, the International Convention for the Prevention of Pollution from Ships, Guidelines in the International Safety Guide for Oil Tankers and Terminals (ISGOTT) and the Society of International Gas Tanker Terminal Operators (SIGTTO) are pertinent to LNG Carriers. The cost of acquisition along with any relevant expenses to be incurred over the period of operations needs to be matched with the expected revenue over the life of the vessel. A simple payback method could be used but it is suggested that either the discounted cash flow or the Internal Rate of Return be used as these methods take into consideration the time value of money. Not to be outdone, however, is the importance of inspection and skilled crew members to operate the vessels. References Beale, J.P. (2006). The Facts about LNG. Retrieved: http://ch-iv.com/pdfs/riley_debunk.pdf. Last accessed 18th March 2011 Brands?ter, A. (2010). Safety requirements for LNG ships. Retrieved http://www.smtf.se/LinkClick.aspx?fileticket=2rw_7Wsv4GI%3D&tabid=293. Last accessed 17th March 2011 Cook, L. (2005). The role of LNG in a global gas market. Retrieved http://www-static.shell.com/static/media/downloads/speeches/lcook_speech_oilandmoneyconf.pdf. Last accessed 19th March 2011 DOM (n.d.) LNG Questions and Answers. Retrieved: http://www.dom.com/business/gas-transmission/cove-point/questions-and-answers.jsp. Last accessed 18th March 2011 Eze, E (n.d.) What Is The Risk Implication To The Lender In Financing LNG Tankers In A Transforming LNG Trade? Retrieved: http://www.dundee.ac.uk/cepmlp/car/html/CAR10_ARTICLE22.PDF. Last accessed 17 March 2011 Gas LNG Europe. (2004). LNG Ship Approval Procedure. Retrieved: http://www.gie.eu.com/adminmod/show.asp?wat=GLE%20LNG%20Ship%20Approval%20Procedure.pdf. Last accessed 20th March 2011 Germinischer Lloyd. (2008) LNG Tanker: Brimming With Energy. Nonstop: February 2008. Retrieved: http://www.gl-group.com GIIGNL. (2008). The LNG industry. Retrieved: http://www.giignl.org/fileadmin/user_upload/flipbook2008/pdf/lng_industry.pdf. Last accessed 17 march 2011 Gladstone Economic Industry Development Board (2009). LNG: Energy of the Future. Retrieved: http://www.gladstoneindustry.org.au/wp-content/uploads/Complete-GEIDB-LNG-Liftout_Jun09Web1.pdf. Last accessed 19th March 2011 Jenson and Associates (2007) The Outlook For Global Trade In Liquefied Natural Gas Projections To The Year 2020. 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Last accessed 20th March 2011. PriceWaterhouseCoopers. (n.d.) Fast paced growth in LNG. Retrieved: http://www.pwc.com/gx/en/oil-gas-energy/liquefied-natural-gas/publication-fast-paced-growth-lng-liquefied-natural-gas.jhtml. Last accessed 19 March 2011 Rigzone. (2010). Teekay LNG to Purchase Interest in LNG Carriers. Retrieved: http://www.rigzone.com/news/article.asp?a_id=99767. Last accessed 17th March 2011 Sethuraman, D. (2009). LNG Tanker Rates Fall 17% on Increase in Vessels. Retrieved: http://www.lngpedia.com/lng-tanker-charter-rates-fall-17/. Last accessed 20th March 2011 The SGS Group (2009) LNG Carrier Leak Test Completed Outside Korea. Retrieved: http://www.oilandgasonline.com/article.mvc/LNG-Carrier-Leak-Test-Completed-Outside-Korea-0001?VNETCOOKIE=NO. Last accessed 20th March 2011 Uddin, J. (2009) A Proposed Guide Line for Liquefied Natural Gas (LNG) Policy for Government Of People’s Republic Of Bangladesh: Ministry Of Power Energy And Mineral Resource. Retrieved: http://www.tek-energy.com/PROPOSED_LNG_GUIDELINE_FOR_BANGLADESH_2009%20Final.pdf Read More