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Mirae Asset Korea Research

Fuel Efficiency & Ship Finance

Sokje Lee 82 2 3774 1781 sokje@miraeasset.com

June 2011


Mirae Asset Global Research

Key points

 Ship investment yields are determined by fuel efficiency  How to hedge the downside risks?  Fuel efficiency will wage a bigger power going forward  Positive long-term outlook

2


1990-2000 avg. bunker price at USD90/ton vs. current price at US$650/ton

Growing focus on fuel efficiency, as fuel costs amounted to 17-19% of revenue in 2010

In 2011E, the fuel cost is expected to reach 25% of revenue

Bunker price trends (Singapore 380CST bulker, USD/ton) vs. average ship earnings (USD/day) 800

60,000

700

50,000

600 40,000

500 400

30,000

300

20,000

200 10,000

100

Bunker price (USD/ton)

Feb-10

Sep-10

Jul-09

Dec-08

Nov-07

May-08

Apr-07

Feb-06

Sep-06

Jul-05

Dec-04

May-04

Oct-03

Mar-03

Aug-02

Feb-02

Jul-01

Dec-00

May-00

Oct-99

Mar-99

Aug-98

Jan-98

Jun-97

Nov-96

May-96

Oct-95

Mar-95

Aug-94

Jan-94

Jun-93

Nov-92

Apr-92

Sep-91

Mar-91

0 Jan-90

0 Aug-90

Mirae Asset Global Research

Fuel efficiency became everything

Ship earnings per day (USD/day, RHS)

Source: Clarksons 3


Mirae Asset Global Research

Discounted Cash Flow Analysis of Ship Investment •

Main purpose: peer comparison rather than assessment of each ship investments

Base case: expected IRR of 8.08 (3.075% 10 year treasury rate + 5.0% equity premium)

Initial investment of US$100mn, 80tons/day fuel consumption

Assumptions Vessel price (US$m) Bunker price (US$/ton) Avg. daily consumption of bunker (ton/day) Annual increase of bunker consumption Years of depreciation Inflation rates Annual increase of revenue Year to Dec. (US$m)

100 700 80 0.5% 20 3.0% 0.0% Year 0

Freight earnings - Bunker costs daily consumption of bunker (tons) - Diesel costs - Other costs (ports and others) - Depreciation - Operating costs Operating income (EBIT) Depreciation Gross cashflow Net CAPEX (maintenance, drydocking and others) Free Cashflow No. of years remained WACC (%) Discounting Factor PV of FCFF Discounted NPV Value

* * * * * *

Freight earnings are fixed throughout life time at USD36.8mn a year Owner with lower efficiency should assume bigger bunker costs and less profit Bunker consumption of 80tons/day (laden: 90tons/day, ballast: 70tons/day) Risk free rates = 3.075% (based on 10 year US treasury bond) plus equity risk premium: 5.0% Depreciation period: 20 years Yearly

1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

36.8

36.8

36.8

36.8

36.8

36.8

36.8

36.8

36.8

36.8

36.8

36.8

36.8

36.8

36.8

36.8

36.8

36.8

36.8

36.8

36.8

36.8

36.8

36.8

36.8

Scrap value

14.0 14.1 14.1 14.2 14.3 14.4 14.4 14.5 14.6 14.6 14.7 14.8 14.9 14.9 15.0 15.1 15.2 15.2 15.3 15.4 15.5 15.5 15.6 15.7 15.8 80.0 80.4 80.8 81.2 81.6 82.0 82.4 82.8 83.3 83.7 84.1 84.5 84.9 85.4 85.8 86.2 86.6 87.1 87.5 88.0 88.4 88.8 89.3 89.7 90.2 2.3 2.3 2.4 2.4 2.4 2.4 2.4 2.4 2.4 2.4 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.6 2.6 2.6 2.6 2.6 2.6 2.6 5.0 5.2 5.3 5.5 5.6 5.8 6.0 6.1 6.3 6.5 6.7 6.9 7.1 7.3 7.6 7.8 8.0 8.3 8.5 8.8 9.0 9.3 9.6 9.9 10.2 5.0 5.0 5.0 5.0 5.0 5.0 5.0 5.0 5.0 5.0 5.0 5.0 5.0 5.0 5.0 5.0 5.0 5.0 5.0 5.0 3.5 3.6 3.7 3.8 3.9 4.1 4.2 4.3 4.4 4.6 4.7 4.8 5.0 5.1 5.3 5.5 5.6 5.8 6.0 6.1 6.3 6.5 6.7 6.9 7.1 9.3 9.0 8.7 8.3 8.0 7.6 7.3 6.9 6.5 6.1 5.7 5.3 4.9 4.4 4.0 3.5 3.0 2.5 2.0 1.5 6.0 5.5 4.9 4.4 3.8 5.0 5.0 5.0 5.0 5.0 5.0 5.0 5.0 5.0 5.0 5.0 5.0 5.0 5.0 5.0 5.0 5.0 5.0 5.0 5.0 14.3 14.0 13.7 13.3 13.0 12.6 12.3 11.9 11.5 11.1 10.7 10.3 9.9 9.4 9.0 8.5 8.0 7.5 7.0 6.5 6.0 5.5 4.9 4.4 3.8 100.0

1.5

5.0

1.5

1.5

1.5

1.5

7.0

1.5

1.5

1.5

1.5

7.0

1.5

1.5

1.5

1.5

1.5

(100.0) 12.8 12.5 12.2 11.8 10.0 11.1 10.8 10.4 10.0

6.1

9.2

8.8

8.4

7.9

2.0

7.0

6.5

6.0

5.5

(0.5)

4.5

4.0

3.4

2.9

2.3

0.0

1.5

1.5

1.5

1.5

3.0

1.5

1.5

1.5

1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 9.0 10.0 11.0 12.0 13.0 14.0 15.0 16.0 17.0 18.0 19.0 20.0 21.0 22.0 23.0 24.0 25.0 8.1% 8.1% 8.1% 8.1% 8.1% 8.1% 8.1% 8.1% 8.1% 8.1% 8.1% 8.1% 8.1% 8.1% 8.1% 8.1% 8.1% 8.1% 8.1% 8.1% 8.1% 8.1% 8.1% 8.1% 8.1% 1.1 1.2 1.3 1.4 1.5 1.6 1.7 1.9 2.0 2.2 2.3 2.5 2.7 3.0 3.2 3.5 3.7 4.0 4.4 4.7 5.1 5.5 6.0 6.4 7.0 (100.0) 11.9 10.7 9.6 8.7 6.8 7.0 6.2 5.6 5.0 2.8 3.9 3.5 3.0 2.7 0.6 2.0 1.7 1.5 1.3 (0.1) 0.9 0.7 0.6 0.4 0.3

20.0 26.0 8.1% 7.5 2.7

0

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Mirae Asset Global Research

Fuel Efficiency Dictates Ship Yields •

10% less fuel efficiency implies 2.4%pt less IRR

10% better fuel efficiency implies 2.1%pt extra IRR

Ship Investment IRR depending on fuel efficiency

14.0% 12.15% 12.0%

11.19% 10.20%

10.0%

9.16% 8.08%

8.0%

6.93% 5.70%

6.0% 4.0%

4.38% 2.92%

2.0% 0.0% 20%

15% 10% Extra fuel consumptions by

5%

Base case

-5%

-10% -15% Saving of fuel consumption by

-20%

Source: Mirae Asset Securities 5


Mirae Asset Global Research

To Compensate for IRR… •

With 10% less efficiency from shipbuilder, ship owners can ask 15.5% discounted price

Shipbuilders, with superior fuel efficiency to average, can ask premium over market price, up to 15.5% (US$15.5m in our analysis)

Compensation/premium of ship prices according to fuel efficiency Bunker price (US$/ton) 500

550

600

650

700

750

800

850

900

68.0

-15%

60.8

51.4

42.0

32.6

23.2

13.8

4.4

(5.0)

(14.4)

72.0

-10%

55.3

45.3

35.4

25.4

15.5

5.5

(4.4)

(14.4)

(24.3)

Daily consumption 76.0

-5%

49.7

39.2

28.7

18.2

7.7

(2.8)

(13.3)

(23.8)

(34.3)

bunker

80.0

Base

44.2

33.2

22.1

11.1

0.0

(11.1)

(22.1)

(33.2)

(44.2)

(ton/day, %)

84.0

5%

38.7

27.1

15.5

3.9

(7.7)

(19.3)

(31.0)

(42.6)

(54.2)

88.0

10%

33.2

21.0

8.8

(3.3)

(15.5)

(27.6)

(39.8)

(52.0)

(64.1)

92.0

15%

27.6

14.9

2.2

(10.5)

(23.2)

(35.9)

(48.6)

(61.4)

(74.1)

96.0

20%

22.1

8.8

(4.4)

(17.7)

(31.0)

(44.2)

(57.5)

(70.8)

(84.0)

Source: Mirae Asset Securities 6


Mirae Asset Global Research

Bigger Gap is the Secondhand Market •

10% gap in fuel efficiency will result in 18.8% gap in secondhand vessel prices

•

For a 5 year old vessel, the contraction of ship value is estimated at 37% for 10% less efficient vessel (23% for average)

The gap in 5-year secondhand vessel prices (base = USD77mn)

Bunker price (US$/ton) 500

550

600

650

700

750

800

850

900

5.4%

-6.0%

-17.5%

-5.4% -17.5%

-29.6%

-3.4% -16.1% -28.9%

-41.7%

0.0% -13.4% -26.9% -40.3%

-53.8%

68.0 -15% 73.9% 62.5% 51.1% 39.7%

28.2% 16.8%

72.0 -10% 67.2% 55.1% 43.0% 30.9%

18.8%

Daily consumption 76.0

-5% 60.5% 47.7% 35.0% 22.2% Base 53.8% 40.3% 26.9% 13.4%

9.4%

6.7%

bunker

80.0

(ton/day, %)

84.0

5% 47.1% 32.9% 18.8%

4.7%

-9.4% -23.5% -37.6% -51.8%

-65.9%

88.0

10% 40.3% 25.5% 10.8%

-4.0%

-18.8% -33.6% -48.4% -63.2%

-78.0%

92.0

15% 33.6% 18.1%

2.7% -12.8%

-28.2% -43.7% -59.2% -74.6%

-90.1%

96.0

20% 26.9% 10.8%

-5.4% -21.5%

-37.6% -53.8% -69.9% -86.0% -102.2%

Source: Mirae Asset Securities 7


Mirae Asset Global Research

Projection of Secondhand Vessel Prices •

Secondhand vessel prices of less fuel efficient vessel is expected to have sharper contraction of price

Secondhand vessel price projection according to fuel efficiency (US$m, from US$100m new builds)

100

91.7

90 80

84.4 77.1 69.9

70

68.8

62.6

60 50

62.4

55.9

49.5

48.9

43.0

43.7

40

38.6

33.4

30

28.3

20 10 0 5 year

10 year 72

76

Base case (80 tons/day)

15 year 84

88

Source: Mirae Asset Securities 8


Mirae Asset Global Research

To Hedge the Downside Risks… (for ship finance) •

Energy Efficiency Design Index (EEDI) will be a key investment decision tool

Proper spread should be levied on new ship finance (eg. 350bp spread for 5 year loan)

To Hedge the Downside Risks… (for ship owners) •

Energy Efficiency Design Index (EEDI) will be a key investment decision tool

Ask for a price discount for less fuel efficient vessels

Secure new and fuel efficient vessels

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Mirae Asset Global Research

To be Considered… 1. Market Based Measure •

Market Based Measures (MBM) by IMO probably from 2018 or 2019

SOx and NOx emission regulations

Potential further hikes of oil prices GHG funds: Market-based measures

All ships

Carbon tax per bunker

GHG fund

e.g. US$700/ton bunker price + US$100/ton carbon tax = US$800/ton

Incentives

Efficient ships

USD200/ton incentives to fuel efficient vessels Realized bunker prices: US$600/ton vs. US$800/ton

Source: IMO, MEPC 59/INF.10 10


Mirae Asset Global Research

To be Considered… 2. EEDI •

Starting from 2015, new building contracts are subject to required EEDI verified from 3 rd party (10%, 20% and 35% reductions in 2015, 2020, and 2025)

Two risks for ship owners: 1. timely delivery, and 2. competition against new & efficient vessels

Development of required EEDI

New shipbuilding process

gram per ton per nm 6.0 5.5 5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 50,000

Contract

Orignal baseline

150,000

250,000 DWT

Source: IMO, MEPC 59/INF.10

350,000

Design

EEDI verification

Construc tion

Classification society

Test

EEDI verification

Delivery

Source: IMO, MEPC 59/INF.10 11


Mirae Asset Global Research

To be Considered… 3. Favorable Long-term Demand

Contraction of ship supply

Scrap of old vessels

Slow steaming is the first step to reduce CO2

10% reduction of ship speed implies 9~10% contraction of ship supply

Vessels over 20 years old amount to 30% of global fleet (42~43% for over 15 years)

Relatively big investment required to improve efficiency of old ships

New ship demand comes to transport same amount of cargo

Best solution is scrap

Big replacement & new demand is coming Global shipbuilding order book is only 30% of global fleet

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Mirae Asset Global Research

To be Considered… 4. Massive Restructuring •

2/3 of global yards has no orders for the past two years

Most 2nd and 3rd tiers are actually going under

No more new player thanks to EEDI regulations !!!

The number of yards with new building contracts is shrinking fast 6000

405

450

380

400

5000

350

4000

300 250

3000

190 162

2000

200 150 100

1000

50

0

0 2007

2008 No of yards with any contracts (yards, RHS)

2009

2010

No. of ship contracted (vessels, LHS)

Source: Clarksons, Mirae Asset Securities 13

Fuel Efficiency & Ship Finance - Sojke Lee  

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