- Tonnage – is a volume measurement relating to ships. In particular, we are concerned with a ship’s Net Register Tonnage (NRT) which is the volume of cargo a ship can carry.
- Miles are a measure of distance the cargo is being transported over.
- Ton Miles –the amount of cargo multiplied by the distance transported. In fact, the acronym MTM/D is often used to describe this. MTM/D is defined as Million Ton Miles / Day. A similar acronym exists for a yearly basis as MTM/Y.
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When route distances grow, this increases ton miles just as surely as when the demand for goods increases. Distances may grow based on the following factors:
- New supply is available but from a more remote area
- Demand for goods is rising in a remote area
- There is a shift in supplier/consumer dynamics.
An example of the latter would be when Venezuelan President Hugo Chavez stated they would not supply oil to the United States. That oil can instead be shipped to refineries outside of the U.S. or even to a depot location. U.S. refineries have to buy crude from other sources and the tanker routes are longer to transport that crude. Another country that needs the crude and has the refining capability to process the very sour Venezuelan crude oil must transport the oil from Venezuela to their refinery half way around the world. Finally, the depot location that Venezuelan crude arrives at could actually load that oil on another tanker bound for the U.S., rather than refine it. You can see that this is highly inefficient, but oil is a fungible commodity. If it can be processed, it can be used. It is only a matter of refining capacity and the cost to buy and transport the crude.
For any of the above examples, ton miles are increased, which places further demands on fleet capacity, even if the amount of oil being transported doesn’t increase.
The Boom to Bust Cycle of Maritime Transport
The Boom bust cycle in shipping is all about supply and demand and the relatively long time it takes to increase the size of a fleet by producing new ships. Fleet capacity is a factor that is not localized but rather is responsible for long term trends. This is a combination of fleet size and the capacity of individual vessels.
We have reviewed that spot rates vary by the number of vessels available to transport goods, and that operating costs can vary significantly over time, and even by each voyage, depending on operating speed. What we haven’t looked at is the long term model of having demand for goods trending upward or downward, while the supply of ton miles / day is not elastic.
Let’s examine what we know.
- It takes a couple of years (or more for complicated vessels) to produce a new ship.
- Shipyard capacity is limited and doesn’t grow quickly.
- The average service life of ocean going transport ships varies but is generally around 25 years. Ship owners will order replacement vessels in anticipation of current vessels reaching the end of their service life.
- Demand for goods varies locally and grows during economic expansions and slows or declines during periods of economic weakness. Economic cycles are long term but the exact start and end of these cycles is difficult to predict.
Based on the above, we can review local economies and determine when they are expanding, stable, or contracting. Expansion signals a greater need for transport because demand will grow as well as production capacity, although not necessarily in the same local areas, or by the same amounts.
So, it seems simple for ship owners. When demand shifts from one area to another, shift your available resources to where there is demand. What happens when there is a significant expansion in most/all areas? Prices get bid up by shippers desiring to move goods while the fleet capacity can’t be readily expanded. Ship owners enjoy higher rates and put all available resources into meeting demand. This means that they initially delay scrapping ships that have reached the end of their service lives. Even though these ships may need to be repaired or cost more to run on a daily basis, it is worth it if ship owners are receiving a significant premium. The other way ship owners can temporarily increase fleet capacity is by delaying maintenance, such as dry docking, that would take their ships out of service temporarily.
Once these options are employed, if demand continues to rise, prices continue to go up as ship owners pressure ship yards to deliver ships they have ordered as quickly as possible and begin to order additional vessels. Ship yards begin to raise prices as their capacity becomes fully utilized. The market for existing vessels sees prices sky rocket as desperate shippers and ship operators attempt to secure transport resources. Still, the fleet capacity only begins to rise slowly with the two year timeframe to produce new vessels making supply somewhat inelastic even as demand continues to rise. Spot prices continue to rise and new players emerge as ship owners and operators trying to cash in on the significantly higher prices now being paid to transport goods.
Finally, supply catches up with demand and prices paid to transport goods come back to a normal range. Perhaps fleet capacity rises to meet demand, or perhaps demand drops. The worst case scenario for ship owners is that just as fleet capacity is rising to meet demand, demand collapses. Now, the fleet actually has excess capacity but the ship yards are full of new vessels being produced and have back orders to produce even more vessels.
Undercapitalized operators who paid ship owners top dollar to lease their vessels give the ships back to the owners as it is no longer economically viable to pay the leasing costs for those vessels, based on the returns provided by spot rates. Owners choose to schedule their vessels for maintenance and take them out of service awaiting higher spot rates before agreeing to a fixing. Owners of older vessels choose to send them to the scrap yards in India and Bangladesh to take the last profits from these vessels that reached the end of their service life years earlier.
Note: There is a lot of steel that comes from breaking up these ships. This necessarily adds to world supplies of steel, which depresses steel prices for some time as the inventories are worked off. This is an important factor in the metals supply chain, in particular for steel.
Eventually, more new vessels continue to enter the market. Some of the backlog at the ship yards is worked off and other orders are cancelled as the vessels aren’t needed in the already swollen fleet. Weaker operators have now left the market and financially weak owners are on the brink of insolvency and banks will not extend credit. These owners, overextended and unable to secure fees that enable them to meet their financial obligations begin to fail. Some of them are acquired before they are insolvent while others are allowed to fail and their assets are picked up at significantly lower prices than new ships can be built for. The smartest of the ship owners are now feasting on the corpses of their less wary competitors, like sick or weakened members of a herd are cut out by predators.
Eventually, the cycle repeats itself as a new economic cycle begins. The question is not whether it will occur again, but rather, how do you pick the winners in the shipping supply chain?