Demand for shipping results from the final consumers’ demand for goods. Demand for shipping is not a direct demand but a derived demand. Demand for shipping is not for its own sake but is derived from the demand for the goods that are being transported except cruise shipping. Demand for shipping is dependent upon the amount of international trade generated between nations. Around 75% of the world trade volume is carried by sea. Level of demand for shipping is affected by:
- World Economic Activity
- Volume of Seaborne Trade
- External Factors
World Economic Activity
World economic activity is a major factor in the level of demand for shipping. In the long run, world economic activity is dependent upon elements such as:
- Level of world population
- Changes in standards of living
In the short run, world economic activity is dependent upon elements such as:
- Trade liberalization
- Transport cost reduction
World economic activity can be observed by checking individual countries:
- Gross Domestic Product (GDP)
- Gross National Product (GNP)
Gross Domestic Product (GDP) is a measure of the total flow of goods and services produced by the economy. Generally, Gross Domestic Product (GDP) is calculated on an annual basis. Gross Domestic Product (GDP) is obtained by adding together the value of output:
- Consumer consumption and investment goods
- Government consumption and investment goods
- Exports less imports
Gross Domestic Product (GDP) measures the level of economic activity within the national borders of a country. Gross Domestic Product (GDP) is gross because no allowance is made for the depreciation of capital goods and labor used in the production of those services. Hence, Gross Domestic Product (GDP) is often referred to as Gross Domestic Value Added.
Gross National Product (GNP) is the annual total of the goods and services produced in a country’s economy, valued at current market prices. Gross National Product (GNP) includes incomes accrued from investments abroad less incomes earned by foreigners in the domestic economy.
Gross National Product (GNP) = Gross Domestic Product (GDP) + Net Foreign Investment Earnings
Gross National Product (GNP) is national because it is a measure of all resources controlled by its citizens, irrespective of the physical location of those resources. Germany net earnings from assets in the Turkey, like Volkswagen, are included in Gross National Product (GNP) figures, but are not in Gross Domestic Product (GDP) figures.
Gross National Product (GNP) and Gross Domestic Product (GDP) are measured in two different ways:
- Current Market Prices
When Gross National Product (GNP) and Gross Domestic Product (GDP) are valued at current market prices, the year-to-year variation in value can be as much to do with changes in the price at which outputs are valued, rather than changes in the volume of output. Due to hyper-inflation in some countries, valuation of Gross National Product (GNP) and Gross Domestic Product (GDP) with current market prices might mislead and may not reflect the underlying performance of the economy, because all of this growth is generated by an increase in prices (inflation).
Changes in volume is obtained when Gross Domestic Product (GDP) and Gross National Product (GNP) are measured at constant prices. For example, the value of Turkey Gross Domestic Product (GDP) in 2010, 2011, 2012, 2012, 2014, 2015 at 2010 prices. Hence, any change in output between 2010 and 2015 would reflect changes in volume only, not changes in prices. Economists refer to this as real term measurement. Prices, used as the basis for this process, are quite arbitrary. Often the base is changed every five years or so. Thus 2015 Turkey Gross Domestic Product (GDP) measured in 2010 prices means that the growth in Gross Domestic Product (GDP) when using these figures would reflect the change in the volume of economic activity between 2010 and 2015. This is useful because volume changes in economic activity are better related to changes in physical activities, such as seaborne trade, than changes in the nominal or current prices series that incorporates changes in both volume and value.
Analysis of world trade is provided by two organizations:
- OECD (Organization for Economic Co-operation and Development)
- WTO (World Trade Organization)
OECD (Organization for Economic Co-operation and Development) is an economic organization that comprises 34 countries. In 2013, OECD (Organization for Economic Co-operation and Development) countries account for over 50% of all exports of merchandise trade. On the other hand, a group of fast-growing developing economies is the so-called BRIC countries: Brazil, Russian Federation, India and China. Including Hong Kong, the BRIC countries account for over 20% of world exports.
WTO (World Trade Organization) is an international organization on issues relating to world trade. WTO (World Trade Organization) has 160 member countries and a further 20 observer countries. WTO (World Trade Organization) publish data, statistics on world trade in merchandise and commercial services.
Volume of Seaborne Trade
Approximately 75% of world trade by weight moves by sea. So, maritime transport dominates international trade. Total volume of seaborn trade has more than doubled in the 20 years between 1995 and 2015, from 5,191 million tons in 1995 to 10,956 million tons in 2015. In last 20 years, particular commodities contributed to the change in total volume of seaborn trade:
- Crude Oil declined from 28% to 17%
- Major Dry Bulk Commodities (iron ore, coal, grain, bauxite/alumina and phosphate) increased from 21 % to 29%
- Containers increased from 7% to 16%
- General Cargo declined from 14% to 10%
Acceleration and deceleration in world trade over the last 25 years broadly mirrors the experience of the level of economic activity. Level of economic activity mirrors fairly closely in the demand for shipping and seaborne trade volumes. Growth during the 1990s was unsteady, with seaborne trade volumes slowing in 1993 and 1998. After an uncertain start in the early 2000s, volumes grew at between 5%-7% until the recession in 2008. 2008-2010 was notable for the recession which caused a 4% reduction in overall seaborne trade in 2009. Commodity trades most affected were crude oil, minor bulks (steel and forest products, metals, minerals and agricultural bulks) and containers. The trade in containers saw a 4% decline in TEU in 2008 and a further 10% decline in 2009. Since 2010, there has been a strong recovery. Economic analysis or forecast undertaken into the demand for seaborne trade needs to include the important individual components as follows:
- Oil Movements
- Major Dry Bulk Shipments
- Grain (Seasonal Movements)
- Minor Dry Bulk Shipments and Containers
- Freight Rates
- External Factors
Throughout the decades, change in the price of oil was the main influence on changes in volume of demand for seaborne trade. Arabian light oil price rose from $18 (per barrel) in mid-1979 to a long-standing peak of $34 (per barrel) through 1982 and much of 1983. Repercussions of this price rise resulted in the decline in oil movements in the early years of 1980s. Due to high oil prices, importing countries started to curtail their consumption and seek oil substitutes. Furthermore, high oil prices stimulated the opening of new fields closer to the market. Drastic rise in oil prices was matched by an equally dramatic decline in the mid-1980s and continuing, at a very low pace, until 1990. During 1990s oil prices varied in the region of $17.5 to $18 (per barrel). Low price of oil combined with exchange fluctuations favoring consumer countries and the deregulation of import controls on petroleum and petroleum products, served to encourage oil movements from 1986 onwards. In August 1990, Iraq’s invasion of Kuwait led to a sharp increase in the world price of oil, but OPEC (Organization of Petroleum Exporting Countries) member countries boosted production to offset the loss of Kuwaiti oil. In real terms, oil prices soon came down again to the pre-1973 crisis values. Crude oil prices stabilized at around $16 (per barrel) in the mid-1990s. Till the end of 1990s, oil prices increased gradually. After 2000, oil prices increased substantially to over $30 (per barrel). After 9/11 terrorist attacks on 11 September 2001, oil prices have risen dramatically till the mid-2000s. In 2006, annual average price of spot crude oil rose to around $60 (per barrel). In nominal terms, $60 (per barrel) is a very high figure, but in real terms the price of oil per barrel was below the equivalent values recorded in the 1977-1981 period. That is why high oil prices did not trigger a recession. In 2008, oil prices reached over $100 (per barrel), before tumbling down. Oil prices continued to tumble down for most of 2009 only to rebound sharply in 2011 to $110 (per barrel) where it remained until 2013. Crude oil real term prices between 2011-2013 were the highest ever and have led to significant shifts in motoring behavior as retail prices increased. In 2008, mortgage crisis triggered a major recession in most Western countries. Prevailing level of oil prices reflects here below facts:
- Oil demand levels are running close to present refinery capacity production limits
- High oil price triggered greater efforts at exploring and extracting oil
- High oil price triggered economizing on usage of oil
- Increased awareness of climate change (CO2 emissions), in long-term may trigger a decline in the intensity of use of oil products
- Increasing demand by the developing economies of BRIC countries (Brazil, Russia, India, China)
- Shipping industry adjusted to the high cost of bunkers by slow steaming
In 2014, crude oil prices tumbled down to below $100 (per barrel) due to a slack global economic activity in many developed economies and high OPEC output. In 2015, shale oil and gas production in the United States accelerated crude oil prices to fall around $50 (per barrel).
Major Dry Bulk Shipments
Iron ore and coal are the major dry bulk cargoes in shipping business. Hence, demand for steel and steel products is closely associated with iron ore and coal. Demand for steel has significant importance to the shipping industry, due to the movement of bulk raw materials necessary for steel production like iron ore, coking coal, steam coal. In the last 25 years, steel industry underwent important structural changes. Production by the steelmakers of America, Europe and Japan remained comparatively static. Steel producers expanded rapidly in China and Korea. In 1990, China steel production was about 60 million tons per year. In 1995, China steel production was about 90 million tons per year. In 2018, China produced 50% of 1,808 million metric tons total crude steel in the world, crude steel production by country:
- China 928 million metric tons
- European Union 168 million metric tons
- India 106 million metric tons
- Japan 104 million metric tons
- USA 86 million metric tons
- South Korea 72 million metric tons
Volume of iron ore and coal seaborne trade, closely follows crude steel production. In 2018, China imported two-thirds (2/3) of world iron ore output. Australia and Brazil are the top iron ore exporters to China. Australia and Brazil produce three-quarters (3/4) of world total output of iron ore. Volume of iron ore and coal seaborne trade continued to grow even during the 2008-2009 recession. Volume of iron ore and coal seaborne trade has been mainly driven by China’s growing economy., both volume of iron ore and coal seaborne trade grew at 7% per annum between 2007 and 2013.
Seaborne coal trade is of two types:
- Coking Coal (used in steel production)
- Thermal Coal (power generation)
Currently, Thermal Coal accounts for three-quarters (3/4) of total coal movements. Majority of Thermal Coal is destined for Asian countries (China, Japan, India, Korea). In India, coal-fired power stations has been tremendously increased and low international prices of thermal coal encouraged a healthy trade. Indonesia and Australia exports two thirds (2/3) of world total coal production.
Grain (Seasonal Movements)
Grain and coarse grain have several types, but in shipping business mainly carried grains are wheat, corn, barley, oats, rye, sorghum and soya beans. Rice is usually bagged and so rise is excluded from bulk shipping analysis. Grain is a significant factor in demand for bulk dry cargo tonnage. In the long-term, major factors affecting grain transportation:
- changes in the standard of diet
- growth in world population
- use of grain as animal feed
Against the level of total growth in grain production the percentage volume movement in seaborne trade appears to be at first sight insignificant. Seaborne grain trade is about 20% of total grain production in the world.
Long-run may indicate smooth grain movements, short-run experience is totally different. Grain production is influenced largely by weather conditions and varies from year to year. Government subsidized grain production in the European Union and United States have led:
- trade in agricultural products is heavily distorted
- lowered the world price of grain
- detriment of farmers in developing countries
In 2008, WTO (World Trade Organization) failed on the removal of agricultural subsidies. World grain trade is still subject to trade barriers that have long since been removed from other commodities. Due to trade barriers, grain trade could not grow rapidly in the past ten years. Year-to-year volatility in grain trade is due to:
- Crop failures
- Exceptional weather conditions
Year-to-year volatility in grain trade has generated significant shifts in the trading pattern of bulk carriers engaged in grain transportation. In United States, production of ethanol and biofuels consumes 25% of total grain crop. In other words, enough grain to feed 350 million people per year. United States has been trying to reduce its reliance on foreign oil imports has also altered trading patterns in the grain trade.
Minor Dry Bulk Shipments and Containers
Minor dry bulk shipments comprise general break-bulk cargo, Ro-Ro (roll-on/roll-off), unitized cargoes (containers). In the last 30 years, liner trade’s growth has been significant and 170 million TEU carried by sea in 2014. Liner trade’s growth mainly triggered by:
- Expansion in world trade
- China (major manufacturer of finished goods)
- Trade liberalization
Growing globalization of production has been facilitated by the development of the liner industry. Trade liberalization has contributed about 20% to growth in the liner shipping industry.
There is strong correlation between freight rates and growth of world trade. Fall in freight rates in real terms over the long term has made a significant contribution to the growth of world trade.
External factors that affects demand for seaborne trade include:
- Natural phenomena
- Changes in technology
- Economic shocks
- Political events
Any major breakthrough in railways, aircraft or pipelines would have a serious impact on shipping demand. Economic shocks can cause sudden changes in shipping demand, such as oil price rise or recession. Political events, like wars, would have more obvious and immediate impact on shipping demand. Natural events, natural disasters, like droughts which have an impact on grain harvests or frosts on coffee crops, would have a serious impact on shipping demand
Besides number of tons of cargo transported by sea, shipping distance is other important factor that affects demand for shipping. One metric ton of wheat to Germany from Australia via the Cape of Good Hope will generate three times (x3) the demand for tonnage as the same metric ton of wheat from North America. More precise measure of shipping demand is the weight multiplied by the distance that the metric ton was carried, in other words tonne-miles. For example:
- 100 tons of wheat carried 1,000 nautical miles will be 100 x 1,000 = 100,000 tonne-miles.
Shipping demand is affected by changes in cargo volumes and by changes in the average distance (haul) that the cargo is carried. Importance of distance for shipping demand can be illustrated by the example of the closure of the Suez Canal (1967-1975). Distance by sea between the Arabian Gulf and Europe increased from 6,000 miles (via Suez Canal) to 11,000 miles (via the Cape of Good Hope) due to closure of the Suez Canal. Closure of the Suez Canal triggered a freight market boom, because average shipping distance (haul) for crude oil increased significantly. In shipping business, between 2000 and 2015, total tonne-miles increased by 3.9% per annum and total tonnage increased by 3.8% per annum. Tonne-miles reflect both changes to tonnage and distance. As economist Martin Stopford stated, the key issue is often the balance between long-haul and short-haul suppliers. For example, some oil producers are located close to consuming markets, like:
- Libya and North Sea to Europe
- Mexico and Venezuela to the United States
Arabian Gulf is considerably further away from both United States and Europe, but alternative sources of oil are likely to be imported from Arabian Gulf. Average shipping distance (haul) in the oil trade therefore depends upon the balance of output between suppliers. Same trade relation also applies to the bulk trades. Iron ore sources from Scandinavia (Norway and Sweden) are unable to keep up with European demand. So, European countries import from Australia and Brazil. Hence, increase tonne-miles. Drought in North America constrains traditional grain exports to Asia which are compensated by exports from Argentina. 2019 trade war between United States and China, changed the grain trade route to alternative exporters like South America and changed tonne-miles. Instead of Australia, China imports of iron ore from Brazil which significantly increase tonne-miles. Due to Indonesia’s export ban for bauxite, China import bauxite from Guinea which increased tonne-miles.
Demand for shipping is an indirect demand (except cruise shipping). Shipping is not demanded for its own sake but for the contribution it makes to the production of final consumer goods and services. That is why shipping is a derived demand. For example, demand from the final consumers for gas to fill their cars in Athens, is a derived demand for tankers to carry the oil from Saudi Arabia to the refinery in Athens and then to the gas station. Demand for a cup of tea in Copenhagen is part of a derived demand for tonnage to transport tea from Sri Lanka to Denmark. Derived demand for dry bulk carrier carrying wheat comes directly from the final consumers’ demand for bread. In shipping business, derived demand is dependent on the ultimate demand for the final consumer product.
Price elasticity of demand is the responsiveness of buyers to a change in price. Elasticity can be defined as measure of the responsiveness of one variable to a change in another. For example, in the ferry service, degree of responsiveness of passenger traffic is measured with regard to changes in fares.
Lowering of fares increases the number of passengers travelling with ferry company, but total revenues actually decline as the increase in the number of passengers is more than offset by the fall in the average fare that each passenger pays. There are two crucial point in elasticity of demand:
- Forecast the effect on demand of a change in price
- Passengers have substitute modes of travel that they can easily utilize
|Price ($)||Demand (Q) (1,000)||Total Revenue (P*Q)||Marginal Revenue||% Change in Price||% Change in Quantity||Arc Elasticity||Point Elasticity|
On table here above, an important fare is that of $100. Lowering fares has the effect of raising both the quantity of ferry trips demanded by consumers and the ferry company’s total revenue, until the price is reduced from $120 to $100. Further reductions beyond that point cause total revenue to contract, even though the number of ferry trips continues to increase. It can be seen that marginal revenue changes from a positive to a negative. Any reduction below the $100 fare, like $80 or $60, causes a fall in total revenues, even though passenger numbers still rise. Because, percentage increase in quantity demanded is now smaller than the percentage fall in fares and therefore total revenue falls. Total revenue reduces from $500,000 at a fare of $100 to $420,000 at a fare of $60. When the price falls below $100, arc elasticity changes from being greater than unity (1) to becoming smaller than unity (<1). Unity value ignore the signs positive (+) or negative (-). When the price is $100, total revenues are maximized and cannot be made any larger at the price of $100 per ticket. Point of maximum revenue always corresponds to the own price elasticity having unit value (1). Marginal revenue switches from being positive at prices greater than $100, goes through zero at the price of $100. Marginal revenue becomes increasingly negative as prices fall below the $100 mark. Marginal revenues, total revenues and elasticity values are all related and are essentially different aspects of the same fundamental relationship derived when demand functions are linear in price and quantity. Point Elasticity (Marginal Elasticity) is the most accurate conceptual measure. Point Elasticity (Marginal Elasticity) is defined in terms of extremely small percentage change in price and the associated percentage change in quantity demanded that it brings about. Concept of elasticity does not just apply to price alone. Any variable can be measured in elasticity form. For example, income elasticity can be computed to determine the likely responsiveness of demand to changes in economic activity or real incomes. With elasticity impact of changes in the prices of substitute products can be measured, known as cross elasticity.
Derived Demand Elasticity
On here above ferry example, demand was for the final or ultimate consumer demand. Shipping is a derived demand and demand is derived from the consumers’ demand for the final product. Derived demand has a particular set of rules relating to its elasticity. Derived Demand Elasticity rules, which are known as the Marshall Rules (19th century English economist Alfred Marshall), have been adapted and modified to relate them to the derived demand for shipping and the factors which govern its elasticity in the short term.
- Derived Demand Elasticity Rule 1
There is almost no substitute for shipping. Most products in international trade require transportation by sea. 100,000 metric tons of iron ore from Brazil to China can not be transported by any other feasible transportation vehicle other than a ship.
- Derived Demand Elasticity Rule 2
There may be alternative sources of the product supplied, alternative sources also require transportation by sea. For example, while iron ore from Sweden could be an alternative to iron ore from Brazil, from the point of view of the European consumer. Alternative source also requires sea transport. Again, there is almost no substitutes.
- Derived Demand Elasticity Rule 3
Freight rates are a small proportion of final cost of a product. Freight rates are often insignificant proportion of the total cost of a product. Relatively large increase in freight rates makes relatively little difference to the price of the product to the final ultimate consumer. Freight rates are relatively minor proportions of the value of the final commodity.
- Derived Demand Elasticity Rule 4
Elasticity of demand for the final product will be an important factor in the elasticity of the derived demand for shipping. Lower or higher the price of elasticity of the final product. Lower or higher will be the price of elasticity for shipping. Many goods transported by sea have a low elasticity, this will be reflected in the low elasticity of demand for shipping.
Generally, derived demand for cargo shipping will be inelastic. On average, freight rate constitutes only one-tenth (1/10) of the import value of a commodity. For example, 50% rise in the freight rate will only increase the import cost by 5%. Even if the own price elasticity of demand for the imported commodity is high, derived demand elasticity of freight rate will almost certainly be very price inelastic. For crude oil, it can plausibly be argued that the freight rate elasticity is close to zero.