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Student number: SML S17099 Specialization: Shipping Management and Logistics (SML)

TYPE OF ASSIGNMENT: Individual Assignment Class of 2017 Term 1 Subject: MGM 104 Fundamentals of Shipping and Port Management – Topic1

Number of credits: 4 EC Date: 13 March 2017 Given by: Professor Devinder GREWAL

Word count: 2350 (Excluded table of contents and reference list)


Table of Contents Introduction ................................................................................................................................ 4 Supply and Demand Function of Sea Transport ........................................................................ 5 Bulk Market ............................................................................................................................... 9 Buffer of change ...................................................................................................................... 12 Conclusion ............................................................................................................................... 13 References ................................................................................................................................ 14

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“In shipping, success also involves a blend of skills, luck and psychology” Martin Stopford (2009).

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Introduction Supply, demand and freight are the components of the economic model in seaborne trade, which allows analyze and understand its cyclical behavior. Under the difficult conditions facing the market today with recurrent news like business strategies to keep the operational costs and revenue in the breakeven point. Liner companies declared bankrupt, refinanced of debts or news shipbuilding canceled, banks closing investment portfolios based on shipping and in general terms all the actors trying to survive. These are the challenges to be faced by professionals in the shipping and port management sectors. However, understanding only the economic theory is not enough, the knowledge of the external variables or endogenous factors that affect the behavior of the demand and supply are necessary to recognize the cycles of seaborne trade and their respective equilibrium points against the time function. The purpose of this assignment is to give a clear and practical explanation of the operation of the economic model, which is based on a perfect competition market through the description of the supply and demand function and the different options that exist in freight mechanism. Furthermore, the analysis of the behavior of freight rates in the tramp market in response to the constant fluctuation between supply and demand since 2006 was developed to observe the patterns in one of the most remarkable business cycles in the seaborne trade since its inception. Also, the most relevant global trends and drivers of change affecting the maritime market are described to explain the volatility of the maritime market. Finally, after understanding the economic model and comparing the historical figures that show the behavior of the tramp market, the assignment is concluded justifying the factors that directly influenced the marked fluctuations, and a forecast is made on the potential trend in the market.

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Supply and Demand Function of Sea Transport The transport of cargos by sea has several factors that influence and make their comprehension and analysis unique, complex and tough to forecast. Based on the perfect competition model, an original figure of Stopford (2009) risk management options in bulk shipping were adapted to precisely describe the supply and demand function (p.103). Thus, a scale was drawn to show the most relevant factors that affect demand and supply respectively. At the equilibrium, in the center of the graph, highlighted in purple appear the freight market, which is the dynamic link that responds to changes on both sides of the scale (Figure 1). .

Figure 1: Supply & Demand Function of Sea Transport. Elaborate by David Restrepo Note. Adapted from (Stopford, 2009, p. 103).

On the right side of the figure, highlighted in the red box, is the cargo owner and the five most important variables that increase or decrease market demand. It can be said that there is where the negotiation process begins because it is the cargo owner who has the need to transport cargo by sea. His trading strategy will depend on the correct analysis he makes of the variables and the level of risk exposure he is willing to manage. In the left side of the balance, highlighted in the green box, are the ship-owner, who fulfill the primary role in the supply function. The supply function is managed by four actors, the investors or owners who buy ships to operate them, the shippers or charters, the banks that

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provide the capital for the financing of the ships and finally the regulatory authorities (Stopford, 2009, p. 150). According to the decisions that these actors take, it will be the behavior of the supply. For this reason, the economic model is not governed by a standard pattern if certain conditions are presented. For this reason, the feeling and the intuition, based on the knowledge and the experience are required to be taken into account during the behavior of the model. Supply is measured in the tonnage available to meet demand for cargo. If the demand is high and the capacity available to move the shipments is reduced, the freight rate increases. If there is a surplus of supply and the amount of demand remains equal, the freight rate decreases because the shipper has more options to negotiate the lower cost of transportation. Therefore, cost reduction for the shipowner to be more competitive in the market is fundamental, and this is achieved by operating the vessels at a speed where the marginal costs are equal to the freight cost (Stopford, 2009). Therefore, the supply in the maritime transport is given as a function of the optimal speed in which a ship must operate to carry the cargo incurring the lowest cost. This function is provided by the following formula: !: *&+,-./ 1&22(

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ℛ 3∙&∙'∙(

ℛ: 345.62 782,6ℎ+ 8.+2 &: :8,;2 47 7<2/ ': 1ℎ,&`> 7<2/ ;4?>+.?+ (: @,>+.?;2

The concepts of speed, time in ports and optimization of dead weight are factors that allow manipulate the balance of supply and demand over time. For this reason, it is essential to consider this factor in the analysis; For instance, if the cargo owner has the need to transport a certain quantity of iron ore today, there are no substitute modes of transport in the market; therefore, the demand is elastic in the momentary equilibrium point. If the ship owner has the possibility to adjust the offer with measures such as lay-up, reactivation, slow steaming, etc. Then the breakeven point will be in the short run. Finally, if the demand for cargo is projected in the future market, the time needed for the offer to be modified through the delivery of newbuilding’s ships, or scrapping, then the break-even point is called as in the long-run point. Furthermore, the freight rate is the equilibrium point in the model. However, during the freight negotiation process are different options for agreement and fix the value. The first choice, (Figure 1), occurs when the cargo owner wants to control the transport process, for instance, Shell Oil Industry, buys ships and hires a company to operate their ships with their products,

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they handle the demand and supply with the own resources. In that case, a proper assessment and investment projection are necessary to mitigate the risk, because, under this option, the cargo owner is assuming all the risk of transport. The second option is the time charter market, this occurs when there is a reasonable certainty of the amount of cargo, and an independent ship-owner can reduce costs in a more efficient way. A daily freight rate is established, and the risk is shared, the longer the period, the more risk the cargo owner has to suffer losses or profits. Finally, the last option to achieve the equilibrium point in the supply and demand function is to negotiate the freight rate in the spot market. The ship-owner assumes all operational costs, and the cargo owner only incurs expenses when it has cargo. The Tramp market is usually contracted under this modality because the variation in quantities of primary commodities does not show a variation in the short term. Moreover, in tramp shipping, the vessels go from one place to another depending on the demand for transport, the freight is established in terms of negotiation that change every day (Lun, Lai & Cheng, 2010, p.4). Now in practice, the situation today in the intermediate tanker market in the Europe Union region for instance, according to Andersson, M. (2017, March 2). It's necessary to understand specific factors that driven the function of supply and demand in this market. Initially, exists an oversupply generate for the presence of Medium Range Tankers pushing the freight rates down. These tankers are fixed voyages in the spot market in the EU region because the oil prices are flat in the global market. This situation creates a No-Arbitrage situation so is no profitable put that vessels in other markets. Secondly, the intermediate tankers to break even during 2015 and 2016, needs at least USD$ 12.000 for Time Charter-Net (TC-Net), the freight rate was USD$ 16.000 TC-Net, then the Ship owners made great profits, and their reaction was built more ships. These new buildings orders are expected to the end of 2017 and 2018, and the freight rate will decrease again. However, the age of the fleet, is the third factor, because this variable allows balancing the supply. The oils major only trade dirty products in ships with ages up to 15 years, clean products until 20 and then the vessel is sent it to the East market. Figure 2A-2B show the supply and demand curve, driven from a regular demand D1, and the following reaction to D2, D3, and finally D4.

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The bulk market was selected to identify the main factors that affect supply and demand in seaborne trade, in the period between 2005 and 2016. Being an excellent opportunity to analyze on of the most challenging financial periods in the evolution of seaborne trade, due to the pasts year mark a milestone of difficult trading conditions and low freight rates dragged from the 2008 financial crisis.

Bulk Market The situation in 2006 marks the beginning of the best cycle of the dry market in its history. By the end of July, the Baltic Exchange Dry Index (BDI) exceeds the barrier of 3,000 points, the development of the Chinese economy is certainly a factor that drives de seaborne trade and thus the dynamic link â&#x20AC;&#x153;Freightâ&#x20AC;? increase. Despite the fact that all maritime transport indicators increased in 2006, the fleet productivity factor decreased to 7.1 tons per dwt. and 29.4 thousand tons-thousands per dwt. (UNCTAD, 2007, p.49). This behavior in supply was generated by the rapid rate of growth of the fleet. Additionally, the freight rates in the tramp, time and trip charter increased 60% due to two factors: a) the long-haul trade for energy commodities maintains the demand in the dry market. b) expectations for the growth of the Asian countries generate a positive sentiment in the market, increasing demand for primary commodities and raw materials, in particular for the cape-size, Panamax and Handysize sectors. The first quarter of 2007 shows a stable BDI, with an average of 4,661. The fleet expansion was 7.2%. The shipbuilding production marks a historical record with 222 million of dwt. in bulk carriers. This factor clearly shows the behavior of the market and the stages of a short cycle, being evident that for the following years the effect would be evidenced by unbalance in the supply (UNCTAD, 2008, p.31). At the same time, another variable factor of the demand enters the scene, the mortgage crisis of the United States in 2006, dragged the banking crisis in 2007 that later generated the great recession. However maritime transport remains stable due to the growth of 7.3% 8.4% of developing and transition economies respectively. By the end of 2007, the BDI stood at 9,854, with average growth of 121%.

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Slow steaming begins to be a recurring practice to decrease the operational cost, after the increase in the oil prices. This practice is a typical behavior of the supply function. However, for the bulk liquids sector, the high price of oil had a direct effect on the supply capacity. According to Review of Maritime Transport, the daily rate reported by a charter time was USD $ 102,000, that is, USD $ 43,100 more than in 2007 (UNCTAD, 2008, p.70). Besides, China recorded a total import of 380 million tons of iron ore and 4 million tons of coal per year. These quantities again generate confidence in the environment, and the newbuilding market enthusiasm goes up with orders above 5 million dwt. May 2008 records the highest historical peak of 11.793 points, (Clarkson Research, 2017) due to the constant and increasing steel production in Asia, despite the failure of the negotiations between the Chinese importers and the Australian producers of iron ore. The average haul is shown as a determinant factor in the demand, the producers want to increase the freight by taking competitive advantage they have against the Brazilian producers and generates some instability in the market. By the end of 2008 the global economy began an abrupt process of deceleration, the fall in demand in industrial production began to affect maritime transport in all its segments. Evidence of this slowdown is the BDI decline of 10.101 points from May to December 2008, closing the year at 743 points. To make the situation more complicated, the world fleet maintains its upward trend by 7.3%, due to the delivery of new ships ordered in 2006 and 2007 during periods of high profits. The over-supply is generated, and the scrapping indices are not sufficient to balance the supply and demand function. Ship-Owners prefer lay out the ships waiting for a recovery in the short term. Without a doubt, the most outstanding figure of 2008 is the surplus of tonnage, which increased 57%. Ton-miles performed per deadweight ton decrease too. The total average was 29,300 Once again slow stemming show in the modus operands of the ship operators to reduce cost. The production in terms of tons carried per dwt the dry bulk market decline of 1.8% (UNCTAD, 2009). The behavior of the BDI showed a moderate low trend from the beginning of 2010, and then after the trend has been constant, with an average of 1,266 points in the last six years. Relevant factors of this last cycle are plotted in Figure 3.

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Buffer of change The history of man is divided chronologically by in events or global trends that mark the before and after. These tendencies are called by many authors as the drivers of change. Maritime transport and therefore the function of supply and demand is also influenced by these drivers. In such a highly capital intensive business it is essential to evaluate these endogenous factors and to project the magnitude of the effects before making a decision. Globalization, for example, is one of the most important drivers of change; Globalization allows markets to expand, eliminate trade barriers and, consequently, increase trade (Lorange, 2010, p. 4). Directly related to globalization is the diversification of points of production, low labor costs in different countries have tilted the trade balance towards emerging economies. This change in production patterns is showed in figure 4, in 2000 developed contributed with 77% of total world GDP, emerging economies 21, 7%. Fifteen years later, the percentage of the developing economies increase to 19.3%. With an overall participation of 41% in the world GDP (UNCTAD Handbook of Statistics, 2016).

Figure 4: Developing Economies positive trend y total world GDP. Elaborate by David Restrepo Note. Adapted from (UNCTAD Handbook of Statistics, 2016, p. 222)


Technological advances are another factor of change highly related to maritime trade. From ship design, shipyard construction, operation and scraping are part of engineering, naval architecture, information technology and communications processes, which directly affect the function of supply and demand. More modern ships are more efficient, reduce costs and are more environmentally friendly

Conclusion Despite the fact that the 2008 financial crisis constitutes a random shock within the variables of demand in the maritime transport market model. The strength of the Chinese economy, the other emerging economies, and high oil prices maintained a balance in demand for shipping and thus exceptional conditions in the bulk market freight. These events show how unpredictable the maritime market is, the interaction of freight rates as a balance between demand and supply is influenced by factors like the cycles of the world economy, the average haul, transport costs and commodity markets on the demand side. The fleet, its productivity, the capacity to produce new ships and scrapping on the supply side. But although these factors may be measurable, the maritime business maintains a certain degree of uncertainty or intangibility called by various authors such as sentiment. The behavior of ship-owners and cargo owners interacting and risk managing to try to increase freight revenue and decrease transport cost respectively make seaborne trade one of the most fascinating and attractive markets. It can be clearly stated after the analysis of the last two cycles in shipping that the unbridled enthusiasm of ship-owners, financial institutions are the main causes of low freight rates. The surplus in the supply function will remain as long as the scrapping rate and laid up balance the market. The demand is expected to increase nevertheless it is not enough to achieve a more convenient equilibrium point to generate profits. Shipping managers must innovate and add value to their transport service. Their integration with ports, the use of information and communication technologies to improve processes and adapt to the drivers of change are urgent measures that must be implemented to survive in the current market, which does not show trends for change in the immediate future.

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References Andersson, M. (2017, March 2). Chartering. Lecture presented at Shipping Management & Logistics Field Studies in NAVIX Maritime Chartering, Gรถterborg. Clarkson Research. (2017, February 25). Baltic Exchange Dry Index. Retrieved February 25, 2017, from https://sin.clarksons.net/ Lorange, P. (2010). Part I. World shipping: The context. In Shipping Strategy (3rd ed., pp. 162). New York: Cambridge University Press. doi:978-0-521-76149-9 Lun, Y. H., Lai, K. H., & Cheng, T. C. (2010). Shipping and Logistics Management. London: Springer-Verlag. doi:10.1007/978-1-84882-997-8 Stopford, M. (2009). Maritime Economics (3rd ed.). New York: Routledge. doi:0-415-275571 UNCTAD. (2005). Review of Maritime Transport (Rep. No. E.05.II.D.14). New York: United Nations Publications. doi:92-1-112674-6 UNCTAD. (2006). Review of Maritime Transport (Rep. No. E.06.II.D.7). New York: United Nations Publications. doi:92-1-112699-1 UNCTAD. (2007). Review of Maritime Transport (Rep. No. E.07.II.D.14). New York: United Nations Publications. doi:978-92-1-112725-6 UNCTAD. (2008). Review of Maritime Transport (Rep. No. E.08.II.D.26). New York: United Nations Publications. doi:978-92-1-112758-4 UNCTAD. (2009). Review of Maritime Transport (Rep. No. E.09.II.D.11). New York: United Nations Publications. doi:978-92-1-112771-3 UNCTAD. (2010). Review of Maritime Transport (Rep. No. E.10.II.D.4). New York: United Nations Publications. doi:978 92 1 112810 9 UNCTAD. (2014). Review of Maritime Transport (Rep. No. E.14.II.D.5). New York: United Nations Publications. doi:978-92-1-112878-9 UNCTAD. (2015). Review of Maritime Transport (Rep. No. E.15.II.D.6). New York: United Nations Publications. doi:978-92-1-112892-5 UNCTAD. (2016). Review of Maritime Transport (Rep. No. E.16.II.D.7). New York: United Nations Publications. doi:78-92-1-112904-5

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UNCTAD. (2016). UNCTAD Handbook of Statistics (II ed., Vol. 6, D.6, Rep. No. TD/STAT.41). New York: United Nations Publications. Retrieved February 23, 2017, from http://unctad.org/en/PublicationsLibrary/tdstat41_en.pdf

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Fundamentals of Shipping and Port Management  

The purpose of this assignment is to give a clear and practical explanation of the operation of the economic model, which is based on a perf...

Fundamentals of Shipping and Port Management  

The purpose of this assignment is to give a clear and practical explanation of the operation of the economic model, which is based on a perf...

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