Newbuildings and the ‘eco design’ debate

So far this year, the newbuilding market has been exceptionally active. There are many reasons for that, primarily because shipping is entering a long-awaited recovery but also because ‘eco design’ vessels with their economic efficiencies are expected to send non-efficient vessels to the scrapheap.   No doubt that competitive markets always navigate toward efficiencies eventually (whatever they may be) and the ‘new’ render the ‘old’ obsolete (one of the inimitable truths of nature); however, the level of newbuildings placed on order in most shipping segments, not only this year, but ever since the market crashed in 2008, assumes that older tonnage will just disappear and will find some corner of the world where they would go and die off quietly.

There is no doubt that, during peak years of the cycle, owners were ordering vessels that they were expected to be delivered fast and start earning (big) money as soon as possible. Attention to detail for engineering and design and attention to workmanship were secondary priorities since any floating device with cargo carrying capabilities was making (big) money. Especially in the dry bulk market where there was and there is no ‘honor system’ of ‘major approvals’ (vetted and approved by oil majors) and in the market for smaller tonnage where a river bank and a crane were sufficient credentials to start shipbuilding operations (‘greenfield yards’), there is an unknown amount of the existing world fleet that will never reach their design life of about twenty-five years.  It is difficult to quantify the percentage of the world fleet (primarily dry bulk and containership vessels, and again, smaller tonnage) that will have to get scrapped much sooner than later, but our own shipbrokerage experience and also anecdotal evidence suggests that in certain, particular asset classes more than 10% of the world fleet – again for certain market segments, may have to be scrapped in the next five years.

However, does accelerated technological obsolesce combined with efficient modern vessel designs justify a world fleet outstanding orderbook of 17% across all market sectors when, in general, the world fleet is newer than five-years old?

Let’s follow the industry practice: a charterer at any given market rate and at any given geographic location and within short chartering window (laycan) will charter on the spot market the best (commercial) vessel possible, that is the vessel with lowest fuel consumption and largest cargo carrying capacity for any given trade available at certain location and timeframe.  Nominally, a brand new, efficient vessel with cargo maximizing holds would get the charter at such rate; it’s logic and good business sense. However, a vessel that is a tad inferior in fuel consumption or in cargo capacity but with a lower cost basis (was cheaper at acquisition time, or has been written down through good freight rate markets or the mortgage bank eased off on claiming timely payments) can afford to underbid the competition (the top notch vessel) and accept a lower rate, just because her owner can afford to or because the owner is desperate enough. Thus, the ‘bad’ effectively drives down the market and gets the business from the ‘good’; and, even if the good vessel manages to get the business (charter) at market rate, still, they have not earned any premium over the market to compensate for the savings that can generate for the charterer; they have earned the preference of the charterer to earn their business, but no much premium over the market. For period charter market where vessels are employed for longer periods of time where financial calculations can be more rigorous and market transparency lower (and also vessel delivery location and charter window can be known well in advance and thus there is sufficient time to be addressed vs. the spot market), the charterer will give more consideration and preference for the modern vessel, but never really will pay much premium above market and definitely will not compensate dollar-for-dollar for the savings they will earn from a modern vessel. Likewise, for charterers / traders working on Contract of Affreightment (COAs) where the cost is predominantly seen as $/ton or $/bbl (vs $/d for time charters), efficiencies are more important and stronger preference for modern vessels; again, there is never dollar-per-dollar to the owner for savings reimbursement; just the preference of doing business with modern, more efficient vessels, but never an ‘obligation’ or definite commitment.  And, there always will be an owner with a lower cost basis or desperate enough to undercut the competition and any competitive advantage, and thus the whole ‘preference’ argument goes out of the window. Shipping is an almost perfect competition market, and there are very limited opportunities to earn a premium over market rate by providing superior product; shipping is a commodity business, a ‘need’ business and not a ‘want’ business like Apple’s (ticker: AAPL) where they charge for their latest cool phone exactly what the market can bear.

Another Newbuilding!

Another Newbuilding!

In the tanker market and the containership market where chartering standards and fuel efficiencies are a higher priority than in the dry bulk market, poorly designed and maintained tankers and containership vessels will become obsolete sooner than dry bulk vessels, ceteris paribus.  However, it does not mean that overnight, older tankers and containerships will become obsolete and magically disappear off the market. After all, the MT „EXXON VALDEZ’ accident in 1986 brought into effect OPA 90 regulations that forced single-hull tankers out of the market only in 2010, a cool 24-year later.  Usually, the charter market and the $ sign are more effective at driving the market than regulations, but again, scrapping a vessel, especially a modern vessel, is hard thing to do; it’s easier to give hell to competition and underbid the market first rather than irrevocably sell the vessel for demolition and take the loss.  For the dry bulk market, where charter and regulatory standards are lower and where there is a very, very long tail of charterers, those vessels can be kept profitably in the market for many, many more years to come.

MEWIS Duct Propeller (Image Source: Courtesy Becker Marine Systems)

MEWIS Duct Propeller (Image Source: Courtesy Becker Marine Systems)

Our argument is not against efficiencies (and savings and transparency) in shipping; we are strongly for it. However, we think that the newbuilding story has been taken to the extremes and accepted at face value. There has been the argument that equally commendable fuel efficiencies can be achieved by modifying existing quality vessels (with ducted / MEWIS duct propellers, etc) at a relatively low cost ($1-2 million per vessel, depending on vessel size), proposals that have been suggested or already implemented by companies like Danaos Corporation (ticker: DAC), Ardmore Shipping (ticker: ASC) and Euronav (ticker: EURN).

A potential side effect of the present newbuilding wave may be that market recovery may be longer in the offing than many market players would care to wish …

© 2013 Basil M Karatzas & Karatzas Marine Advisors & Co.  All Rights Reserved.

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