Where Are the Indices Going From Here? What Are the Consequences?

As of March 20, 2017, the Baltic Exchange’s main sea trade index, utilized for tracking freight rates for ships carrying dry bulk commodities, rose to a three-month peak.  This is the best level reached since December 2016.  What do these movements tell us about the current state of the bulk shipping industry, and what do they mean for ship operators?  Some in the shipping industry may readily undertake to address these questions.  And others, looking back at the more recent history of the shipping indices, would not undertake to do so.  Some are likely to be answering these questions with their own money or that of others; some are still hesitating; and still others are limiting their roles.

What factors influence these choices?  The most obvious is the outlook for that of the longer term balance of the supply of cargoes versus the amount of available vessel tonnage (i.e., supply and demand) appears to be improving.  But there are intervening circumstances which should be taken into account in any rational assessment of where the market is likely to go.

The first factor which needs to be taken into account is something we can term “lag.”  In an era when maritime interests have been wary of building additional tonnage and/or replacing existing tonnage, there is always “lag.”  Some of the reasons for “lag” are obvious; others are not.  For example, shipbuilding requires available and suitable capacity; few shipyards can immediately turn to producing ships in relatively short periods of time; technical requirements have altered the types of ships that can or should be built; the ability of yards and component manufacturers to produce ships capable of meeting regulatory requirements is circumscribed by technical issues, particularly with regard to waste water and emissions; not all of the shipbuilding capacity is prepared to turn out the current (or in the future) types of vessels required and the features that those vessels are mandated by law to have.  Not all of the financial facilities are able to respond within the time required to expeditiously support the production of new tonnage; and shipyard congestion and lack of yard upkeep provides a very real restraint on elasticity.

In simple terms, creating new tonnage reflects a sequence of short-term wagers or decisions one piled atop the other with no certainty as to the duration and amount of the wager and how the market will perform before and during the periods required for the ship to be built.

Meanwhile, other factors can intervene, existing tonnage can be repaired, modified, converted, or otherwise made available to carry cargo beyond that for which it was originally suited.  Similarly, alternate means of transport may be brought into play; barges and ATBs may be employed in lieu of types of conventional vessels; fleet carrying capacity can be expanded or shrunk by virtue of changes in speed or propulsion; some vessels can be converted into more efficient platforms; shipbuilders can accelerate deliveries through overtime, labor recruitment, prefabrication, and design changes.  All of this influences elasticity, and thus changes in capacity and supply in the world of shipping.  Hence, elasticity being influenced by a myriad of factors is difficult to estimate and reflects a risk which effects the balance between supply and demand for tonnage and is difficult to assess over relatively short periods of time.  The obvious point is that so long as elasticity plays a role, it reflects the risk which shipowners and their financiers may not be apt to tolerate over short-term horizons.

So, at each stage of the creation of new tonnage and the scrapping or elimination of the older vessels, there are a series of hurdles which confront each participant contemplating an investment in new tonnage.  At the same time, some operators have or will learn to become more efficient in the management of their existing tonnage, and this also has an effect on the elasticity of supply.  In other words, the more elasticity that applies; the less risk that may attach to investment in new tonnage.

So it is not just a simple matter of predicting that demand will increase and rates will rise.  There is a whole panoply of factors which need to come into play to determine the behavior of shipping indices and the strength of the movements reflecting the value and pricing of such tonnage.

It is not just a matter of “reading the charts.”  There may be all sorts of factors bearing on the behavior of shipping indices and the thousands of individual decisions necessarily leading to the creation of the additional supply of tonnage or, by the same token, decisions leading to the reduction in demand at other points in time.

Presently, there is a chorus of voices in the shipping world warning against the consequences of a rise in the indices.  The concern behind this chorus is that rising rates will prompt ship operators to “take a chance” and commit to the building of additional tonnage.  The fear is that the building of additional tonnage will spawn another imbalance as between tonnage and cargo demand, and that the indices will again move lower as the effects of new tonnage will be experienced and older tonnage will linger on the market in order to enjoy the improved rates.  The worry is that the “same old cycle” will put us into trouble again.

But how much of such a scenario reflects an actual risk that rates and shipping values will again fall.  Now, this is where our old friend “lag” is supposed to come in.  According to recent comments from experts, it now takes nearly two years from planning to delivery to produce a new vessel.  New technical requirements are more, rather than less, likely to extend the process.  Moreover, some of the ship building capacity which has left the market may not return in the same way as the shortage of work in certain markets appears to have precipitated a trend toward more specialized and more complex vessels, and new shipbuilding capacity may not have returned to service the same markets.  Thus, any shortages of tonnage which may have developed may be accompanied by strengthening rates but not newbuildings to the same degree.  A happy balance may be the result, and less volatile rates could well be experienced by most.

Mark M Jaffe is a member of Hill Betts & Nash LLP, a full-service general practice law firm founded in 1898 with specialties in admiralty, aviation, arbitration, bankruptcy, commercial, construction, corporate, finance, insurance, international, litigation, surety, and tax.
 
In his career with the firm, Mr Jaffe has been active in many of the firm's practice areas. He served as lead counsel in many major marine casualty cases and other complex litigations handled by the firm, as well as many insurance matters. He has acted as regular counsel to various shipping interests in the container, bulk and cruise trades, as
well as to ship builders and repairers, marine terminals and construction equipment companies. He has been responsible for numerous transactions in the maritime industry, including equipment leases and financings, mergers and acquisitions, and restructurings. Mr Jaffe has been a director of public and privately held companies in the shipping, marine terminals, computer service, and real estate industries.
 
Mr Jaffe has authored and delivered papers to the maritime community on various subjects of interest including, among others, the taxation of shipping, third-party liability and sales and use tax issues relating to the operation of chassisand other container equipment, oil pollution, Panama Canal issues, maritime insolvencies, and the evolution of ownership structures in the shipping industry.
 
Mr Jaffe holds a BS in economics from the Wharton School of the University of Pennsylvania and a Juris Doctor from Columbia University. He is also a graduate of the US Naval Justice School. He is a member of the Louisiana State, New York State, New Jersey State and American Bar Associations; Maritime Law Association of the US; and

during various terms has been a member of the Admiralty Committee of the New York City Bar Association. Mr Jaffe served as a lieutenant, law specialist, assistant district legal officer and merchant marine investigating officer on active duty in the US Coast Guard Reserve.

Mark can be contacted on +(212) 589-752 or by email at mjaffe@hillbetts.com