The shipping industry has undergone dynamic changes over time. The shipping trade has started approximately 5000 years ago. In 1776, Adam Smith wrote in his book Wealth of the Nations about the importance of shipping for the global economy (cited in Brooks 1990). While the popularity of air transport has been much more pronounced in the recent times, shipping still dominates in world transportations, having statistical averages of 90% of total international transports. This fact is driven, among other things, by its economy and safety. Ship transport is more economical than air transport when large scale cargo is in consideration. In addition, it often is the only option when bulky cargo is to be transported. Shipping is, therefore, a key industry in the world trade.
Shipping Market Categorization
In order to clearly model the shipping industry and understand the forces that drove the shipping industry in the crisis period, it is necessary to view the market segmentation in these four categories:
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Freight;
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Sale and purchase;
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Demolition;
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New building.
Freight
The freight market is mainly the sea transport market. This market involves hiring ships to ferry cargo either by the day (time charter), or by the ton (freight contract). Freight charter is the easier arrangement in which the customers just pay by the contract for the tonnage, and the shipping company handles all logistics. The time charter is often left to more experienced shipping agents who can pay for days of operation while they manage the freight logistics.
Sale and Purchase Market
The sale and purchase market is the market in which basically sales and purchases of used ships happen. Different reasons why ship owners may sell fleet include: distress sales (sale in order to pay debts), fleet upgrade, mergers, and re-alignments.
New Building Market
This market deals with new ships. When ship owners want to purchase ships, they place orders to the ship building companies. This market segment is as important and as robust as the others, especially, due to the very high financial commitments required. It is a very sensitive segment, especially, because time lags between orders and delivery of new fleet may mean capital losses due to the season changes in the shipping industry. All categories of financers are faced with the delicate balancing processes in order to survive, as losses become imminent if proper care is not taken in the financial planning and risk preparedness.
Demolitions Market
This market targets old un-usable vessels that must be demolished and re-cycled mainly by the steel scrap yards. The sellers, typically, include old ship owners while buyers are steel recycle yards. Intermediary organs perform brokerage activities as buyers and sellers are few.
Finance Parameters used in the Shipping Industry
Basically, financing covers the way shipping companies access and manage the funds while running their operations. A shipping company may obtain funds through the issuance of shares, mortgaging, or even leasing. Certain parameters are typically used in order to describe a company’s position and status, and these parameters may also suggest the company’s future. This section will discuss the parameters.
Gearing
This term refers to a company’s ratio of debt to total assets. It indicates what percentage of a company’s resources actually belongs to it and, therefore, how easily the company would survive instances where its assets lost value, as in the case of the global crisis. A company with a high gearing, say of 7, would be declared insolvent if a relatively low devaluation of 14% in asset value ensued. In the shipping industry, some of the major companies have large gearing ratios, meaning most of their resources are borrowed. While such an arrangement may have certain advantages, it adversely affects the company in cases of crises. Commercial banks, lending money to the shipping companies, usually impose restrictions on the maximum gearing acceptable before a bank can access funding, because the high gearing means more speculation, a scenario that is risky and unfavorable. It follows, therefore, that a lot of companies fail to meet the banks requirement for funding, which makes companies look for alternative funding).
Return on Capital
This is the ratio of total profits per investment unit. More specifically, it is obtained as
Return on Capital = Financial Income / Total Average Capital
This parameter is often used to predict the time it will take the investment to payback.
Debt to Equity Ratio = Total Debt/ Total Eequity
This parameter is similar to gearing.
Financial lease is the term that refers to a scenario where a ship owner (lessor) leases a ship to a user (lessee), who assumes all responsibility of the asset, such as wear and tear or loss during its use. The lessee also maintains the vessel, while the lessor gains through returns on capital investment. Many companies have this arrangement, usually with a subsidiary dedicated to lease financing.
Operating lease is different from the financial lease in that the lessee just rents the use of the asset and pays for its use for the duration he / she holds the vessel. Ownership remains with the lessor.
Baltic dry index is used in the shipping industry to indicate the status of routes available for cargo freight. Currently, there are more than 53 routes for dry bulk and tanker routes. These indices help parties to a shipping contract agree on the viable rates.
The Crisis in the Shipping Industry
Following the decline in the financial markets in 2008/2009, many other sectors collapsed, as well. The shipping industry was greatly affected as its profits are invariably tied to the global economy. According to the IMF, the global economy rose by 3% in 2008 but reduced to -0.6% in 2009, while the world trade declined by 10.7% in 2008/2009. The advanced economies mainly contributed to this downfall with an import decline of 1.5% and export decline of 8% between 2008 and 2009. The global trade index plummeted in 2008 right after its highest point in a decade, causing catastrophic downturns in many sectors.
The industrial production, the main backbone of sea transport, also greatly declined from an increase in 20% in 2007 to a fall of - 30% in 2008. It was a double tragedy for shippers, because most of them had acquired huge financing, being encouraged by the stable rising trend in sea transport for the previous decade. The decline meant that they were unable to pay up their loan premiums. In addition, they had no cargo to transport due to the falling industrial production.
The world fleet of ton-mile per deadweight had been in the decline too. This means that less cargo was transported in 2008 as compared to 2007 and 2006. Below, there is data for some of the world’s busiest ports for the crisis period. The table shows declines of between 13.7% in Singapore and 27% in Long Beach, USA. It may be noted that the trend before 2008 was in the increase by an average of 8% in all the major ports. Shipping companies were not warned about the impending danger in 2008, and, therefore, they were caught un-aware when the global finance collapsed in 2008/2009. The absence of cargo meant that most ships sat idle at the docks, while the loan interests and penalties continued rising. In 2009, global shipping rates declined to 74%. In 2009, 24.3% of the reefer fleet was in layup. Most ships were in a layup outside the major ports, such as Malaysia and Philippines, where the anchor fees were low.
Even major fleet companies, such as Senator Lines and Maersk, were forced to cut back their expansion plans till later after 2009.