Shipping Supply

In the long run, economists observe a strong correlation between the volume of world seaborne trade and stock of ships. Shipping is a cyclical business. So, world seaborne trade rise, peak, decline and rise again. World economic activity and trade recovered from the recession period of the late 1970s and early 1980s. World economic activity and trade moved into strong growth in the period between 2002-2008. In 2008, Lehman Brother collapsed and mortgage crises triggered recession in many economies. World merchant fleet size is affected by world economic activity and seaborn trade. Demand for shipping services should be reflected in long-term trends in the size of the merchant fleet. In order to analyze the behaviour of shipping supply, economists identify how shipowners and operators respond to changes in demand that might occur on a very short-term basis, as well as considering the longer-term view. Economists examine the many different facets of supply and analyze how supply can be adjusted to changes in demand. There are many distinct market sectors within the shipping industry. Despite the existence of different market segments, in the longer term, different market segments are all interrelated, so that different market segments in shipping tend to move in sympathy with each other.

Economists need to clarify what the shipping industry actually produces, in other words what is the output of a unit of shipping service:

  • Volume: shipping produces the act of moving cargo around the world from port to port. Calculating metric tonnes of cargo moved per time period would give a picture of activity generated by the working fleet in DWT (deadweight tonnage or carrying capacity of a ship). Cargo volume that determines how much carrying capacity is required, rather than cargo value.
  • Tonne-Mile: shipping produces nothing if ships do not move. Shipping output can be measured in terms of the movement of one tonne of cargo over distance in a given period of time. Tonne-mile is the multiplication of volume of cargo tonnes (metric tonnes) and distance (miles) cargo travels in a given period of time. For example, a fully laden 80,000 DWT panama bulk carrier from BIK (Bandar Imam Khomeini) to Antwerp via the Cape of Good Hope, will generate 11,169 nautical miles x 80,000 tonnes of cargo = 893,520,00 tonne-miles.

Changes in a route composition of demand can generate changes in the demand for tonne-miles, even if the cargo volume is the same.

Supply of shipping services can be altered in two principal ways:

  • Altering Stock of Ships
  • Altering way Existing Stock of Ships Employed

 

  •  Altering Stock of Ships

In the long run, shipowners can alter the output that is produced by ships, by altering the present stock of ships. Long run period in which the capital stock tied up can be varied. Ordering newbuilding and scrapping ships alter the long run level of output supply, but it takes a considerable period of time to implement. Designing, constructing, and commissioning a ship can take around two years. Boom years of 2004-2008 led to newbuilding deliveries extending much further into the future, in some cases up to four years as orderbooks expanded. Scrapping a ship takes less time, but if the ship is still committed to trade it may not necessarily happen quickly. Newbuilding ships minus scrapped ships, net change in the tonnage supply is clearly the result of the relative sizes of these two factors. During boom years, newbuilding ship deliveries will be at a high rate and scrapping rates will be low. During bad years, newbuilding ship deliveries will falter while the level of scrapping will tend to increase. Tonnage supply might fall even if there are some newbuilding deliveries. Newbuilding ships minus scrapped ships, alters the ship stock. In other words, fleet change over the period and is equal to the difference between the Rate of Delivery and the Rate of Scrapping.

  • Altering way Existing Stock of Ships Employed

Output from an existing stock of ships can be varied even if the present stock is unchanged. Assume that, no new ships are delivered and no ships are scrapped or lost for a period. There are five (5) ways that the existing stock of ships can be varied:

  1. Altering Storage Numbers
  2. Altering Lay Ups
  3. Altering Ship Speeds
  4. Altering Balance of Laden Voyages
  5. Altering Time at Sea and at Port

 

  • Altering Storage Numbers

Using existing ships as floating storage facility, 25 years ago using ships as ships as floating storage facility was unheard of. However, during the period of overcapacity, a number of different methods of using that capacity were developed. For example, large tankers were started to be used as floating oil stores. Large bulk carriers were started to be used as floating silos. Using a ship as storage facility is not always readily reversible as the ship’s hull may keep barnacles, may suffer significant corrosion or other long-term damage. After the ship is converted into floating storage facility, due to some degree of conversion may reduce their ability to be re-employed at sea. Using existing ships as floating storage facility reduces tonnage supply. Some ship types can be easily turned into storage facilities. Crude oil tankers are used for oil storage and bulk carriers are used for grain storage. In 2010, British government considered a new a proposal that some ships might be modified and used as floating prison. Using existing ships as floating storage facilities does have costs. Ship will suffer increased corrosion. Using existing ships as floating storage is a relatively expensive way of storing something compared to dedicated ground-based equivalents. But, if land is scarce and expensive like Manhattan, and ships are oversupplied and relatively cheap, using existing ships as floating storage may be feasible. For example, usable land is very scarce in Japan. BP regularly monitors the numbers of tankers used as storage tankers in Japan. Economists classifies storage tankers into semi-permanent and temporary. In 1985, 6.5% of the tanker stock was employed as floating storage tankers. In 1993, floating storage tankers had fallen to 3.5%. In 2010, number of floating storage tankers was dropped to 57. Floating storage tankers are not necessarily immediately available to move cargoes, as floating storage tankers may be hired out on long-term storage contracts. However, floating storage tankers are still a potential source of extra supply if demand grows more rapidly than anticipated.

  • Altering Lay Ups

Another method of altering the active tonnage supply is by laying up ships. A ship that stops trading temporarily is said to be laid up. If a shipowner or manager can no longer justify trading at the prevailing levels of freight rates, demand conditions, shipowner sees no sign of any future improvement, shipowner decides for laying up the ship. Shipowner usually put his ship in a safe anchorage, a skeleton crew retained to keep up essential maintenance and ship is left unemployed. There are special anchorage areas designated for lay ups where ships are left for considerable periods with a company providing management and maintenance services. In reality, there are additional costs to be met when preparing a ship for lay-up. By laying up a ship, some of the operational costs of a ship are avoided. Provided that engines and other sensitive equipment are maintained in good condition, there is no damage or deterioration of the ship. Ship is brought back into service when rates recover and market conditions improve. Ship lay up can be viewed as an investment decision by the shipowner. There are costs involved in making ships fully operational again. Ship activation costs are relatively small compared with the large losses that might be experienced if the ship trades at very low rates for any sustained period of time. Shipowners decide on lay-up according to present and future expectations of the market. If demand conditions are very poor and the outlook does not look promising for the next few years, economists observe a rise in the proportion of world merchant fleet that is laid up. Later on, when demand improves, laid up ships can be reactivated fairly rapidly and ship tonnage supply is increased quickly. When all available laid up ships are back in the active fleet, there is no possibility of further increases in supply from lay ups. On the one hand, shipowner can carry on trading, presumably at a loss. If shipowner carry on trading at unprofitable rates, a series of losses will be generated over a number of trading periods. Certain expenses are incurred in the act of laying up. Against this is the reduction in losses which would have been incurred if the ship continued to trade. While the cost of capital has to be met, other operational costs are clearly avoided in lay-up. Shipowner has to evaluate the net cost or benefit of deciding laying up a ship. Shipowner’s lay-up decision is clearly influenced by two principal factors:

  • Expectations that shipowner holds of the future levels of freight rates.
  • Actual cost of running the ship as a going concern.

If shipowner runs a high operating cost ship and has very pessimistic expectations about the future levels of rates, then ship lay-up may be considered. Lay-ups are a good barometer of shipping market conditions. Ship lay-ups are best expressed as a percentage of the world fleet. During the economic crisis of the 1980s, ship lay-ups reached 12% of world merchant fleet. Ship lay-ups declined during the late 1990s to very low levels. In 1982, tanker lay-ups soared to 18% but fell sharply during 1990s. Ship types other than tankers experienced very low levels of lay-ups. Ship lay-up rates fall to very low levels after 2000. Different shipping market sectors may face different market conditions. Period 2000-2011 was unprecedented in the existence of sustained high levels of employment in all the principal ship type segments, especially for the larger-size ships where lay-ups were virtually nil. Economists observe that after 2008 shipping market crises, more ships have again gone into lay-ups. Furthermore, in tanker sector there is a further consideration when shipowner decides to lay-up tanker. Tankers have to gain oil companies’ approvals (vetting) while tankers are trading, tankers are regularly inspected. After notorious oil pollution incidents, tanker charterers have insisted for high quality vetting process. Tankers that proceeds to lay-up, cease trading and lose the valuable approvals (vetting) from oil companies. When tanker market conditions improve, shipowner find it very difficult to find employment until new approvals (vetting) are gained.

  • Altering Ship Speeds

One of the best ways of altering the short-term supply of ships is by changing the speed of ships. If shipowners reduce ship speeds, reducing ship speed is called slow steaming, journey time is increased, so same ships can generate a smaller throughput of cargo volume moved in a period of time. At the shipyard, ships are constructed, designed and optimized for a particular speed. However, ships can steam in a range of speeds. Possible ship speed depends upon the technical design of a ship’s main engines, efficiency and balance. After the collapse of oil demand in the mid-1970s and the four-fold increase in the price of bunker fuel, a large number of tankers started to slow steam. Before 1973, most tankers were steaming around 14 knots. By 1975-1976, a large proportion of tankers were sailing at 10 knots. Slow steaming effectively reduced ship’s cargo-moving capacity by about 20% since half of the journey was in ballast. Slow steaming practice has also been widely adopted by major container lines to reduce supply following 2008 shipping recession and increasing bunker costs. Slow steaming a very effective way of reducing the tonnage supply in the short term, as well as being a sensible response to the rise in fuel input prices. Once a portion of world merchant fleet is slow steaming, changes in output can be generated by speeding up again. However, if lower ship speed is in fact optimal for the higher fuel price, it may need a very large increase in demand to generate this result. Between 2005-2006, a number of container ship operators suggested that it might be more economic to operate their service by reducing ship service speed from 24 to 18 knots. Container ship operators compensate for ship speed by adding an extra ship into service.

  • Altering Balance of Laden Voyages

Another way of altering supply of ships is by altering the proportion of laden voyages to ballast voyages. Most seaborne trades are unbalanced. Cargo volumes delivered in one direction may well be larger than flows in the opposite direction. For example, in dry bulk trades US Gulf to Far East or Richard Bay Coal Terminal (RBCT) to India. In tanker trade, most ship trips are laden in only one direction. For example, Arabian Gulf to China. In other words, 50% of the potential cargo-carrying space is wasted. Generally, it is too hard to find a backhaul cargo. But, if a backhaul cargo can be found, cargo throughput can be increased without any alteration in the tonnage supply. Altering the proportion of laden voyages to ballast voyages is driven by the nature of demand conditions, rather than supply. When ship demand patterns change, ship supply has to respond. Changing utilization of the fleet reflects changes in demand conditions.

  • Altering Time at Sea and at Port

Altering the proportion of time spent at port relative to time spent at sea can affect ship supply. When port turnaround times (TT) are reduced, ships can sail more frequently in a given time period and produce a larger output. When port turnaround times (TT) are increased or port congestion occurs, shipping supply is reduced. When proportion of trade on long-haul trades rises relative to short-haul trades, in other words ship spend more time at sea than at port, ship tonnage supply can be used more efficiently. Altering the proportion of time spent at port relative to time spent is driven by elements outside the shipowners’ control. When shipping demand is high or long-distance routes become more important in a trade, ships employed in that trade will spend proportionately more of their time at sea, and overall productiveness of the fleet can rise. When shipping demand is low relative to existing ship capacity, port turnaround times and waiting times may lengthen, productivity is reduced, as ships will spend a greater proportion of their time in port.

In dry bulk market, port time alterations are not strictly in the control of the shipowners, as port time alterations depend upon the port or terminal operator. However, in other shipping segments, like tankers and containers, many terminal operations are now controlled by shipping companies. For example, oil terminals are often controlled by the oil companies who also operate their own ships. Container operator, like Maersk which is largest container operator in the world, has a dedicated terminals operator division.

Ship Supply in the Very Long Run

Altering Stock of Ships occurs in the Long Run. Altering way Existing Stock of Ships Employed occurs in the Short Run. Theoretically, in both Long Run and Short Run, certain elements are kept as constants, like level of technology available to the suppliers and prices of the inputs used in providing those services. Ship Supply in the Very Long Run is affected by:

  • Level of Technology
  • Changes in the Price of Inputs

 

  • Level of Technology

In the Very Long Run, technological progresses are made, technical know-how changes, new things are discovered. In the Very Long Run, new ideas are implemented to improve the products and service. For example, in ship construction stronger steels, composite materials can be used with laser which may reduce ship’s weight without reducing tensile strength. New engines might be designed to generate more power with lower fuel consumption. New ways of organizing cargoes, like containers which revolutionized the shipping, reduce port time. In the Very Long Run, technological progresses are all added up to the ability to deliver more output with less input.

  • Changes in the Price of Inputs

In the Very Long Run, ship supply might be influenced by alterations in the cost of key inputs. For example, an increase in bunker costs. One way of offsetting bunker costs is to reduce the speed of the ship. Reducing ship speed leads to lower fuel consumption, but reducing ship speed also leads to lower output, lower ship supply. In some shipping segments, economists might expect to observe, where it is feasible to reduce ship speeds when fuel prices are high and to restore of speed when bunker prices fall again. On the other hand, in liner trades, keeping to a timetable is important and the option of changing speed is not always available. Shipowners have to find other methods of insuring themselves against fluctuations in the bunker fuel price.

World Merchant Fleet 1970-2014

Defining the world’s merchant fleet is a complex task. First, economists should establish the smallest size of ship that should be included in world merchant fleet. Lloyds Register (LR) uses 100 gross tons (GT) but other industry analysts use different criteria like 10,000 DWT (deadweight tonne) as the minimum size of ship. Second, United States has a fleet of ships held in reserve for strategic purposes. Furthermore, there are lake-fitted ships that trade exclusively in Great Lakes. Usually, economists exclude lake-fitted ships from the analyses of the world fleet. However, Lloyds Register (LR) published by IHS Fairplay, includes lake-fitted ships in world merchant fleet. Over the period 1970-2014, world merchant fleet annual growth rates are 3.7% for both gross tonnage (GT) and deadweight tonnage (DWT). Annual growth rate has quadrupled the deadweight of the world fleet in last four decades. World merchant fleet has doubled since 2002. In long-run, shipping capacity and demand growth appear to be quite closely related. However, in short-run, shipping capacity and demand growth shows quite different story.

Over the period 1970-2014, strongest growth rates are to be found in the period 1971-1977 and between 2002-2011. Annual growth rate of period 1971-1977, averaged around 8.1% for gross tonnage (GT) and 10% for deadweight (DWT). Between 2002-2011, growth average is over 7% per year. 2002-2011 period high recent growth rates suggest that market conditions have been good for shipowners. However, shipping market conditions have changed radically since late 2008. After the collapse of Lehman Brother financial crises, economic downturn and recessions started in many western countries. Over the period 1970-2014, if an economist check world merchant fleet growth, economist would observe that in the 1980s, ship tonnage supply actually declined. In 1982, a peak of 424 million gross tonnage (GT) was reached. In 1983, a peak of 690 million deadweight (DWT) was reached, followed by several years of decline. In the beginning of 1980s, ship newbuilding rate was lower than scrapping rate which triggered crises in shipping and shipbuilding. This process continued throughout the 1980s, coming to an end in 1989. In 1989, shipping market recovery started. In the period 1980-1989, average annual growth rate was -0.4% for gross tonnage (GT) and -0.9% for deadweight (DWT), which generated a cumulatively significant decline in ship tonnage supply by the end 1980s. On the other hand, beginning of 1990s were years of relatively steady expansion in shipping markets. World merchant fleet growth rates recovered to around 2% per year in the 1990s. World merchant fleet growth rates have risen more rapidly since 2002. Between 2002-2011, world merchant fleet annual growth rates were 7.1 % for gross tonnage (GT) and 7.3% for deadweight (DWT). 2002-2011 period can be interpreted as the first boom of the world shipping markets since the 1970s. Process of rapid expansion, overcapacity, decline, and recovery has been tied to the cyclical fashion of most shipping markets.

Greatest increase in world merchant fleet capacity occurred in 1970-1975 due to three (3) factors:

  1. World trade had boomed in the late 1960s and world trade continued to boom until October 1973 when the Arab-Israeli conflict triggered a 400% increase in the price of crude oil. World trade boom led to optimistic expectations about the future and large numbers of ship orders were placed.
  2. After the Six-Day War between Egypt and Israel, Suez Canal was closed in 1967 which had triggered a large increase in demand for tankers. Closure of Suez Canal caused a significant increase in ship sizes and huge wave of optimism engulfed the shipping world. Only in 1973, shipowners ordered newbuilding tankers which was equivalent to about 20% of the existing world tanker stock.
  3. Wrong predictions of shipowners and fanciful view of shipping market was shattered by the rise in the price of crude oil. Rise of crude oil price slowed down the growth of all major world economies and so the growth of world trade. Large increases in ship tonnage supply arrived at the time when demand growth faltered, a combination that generated depression in the shipping markets for some years.

World trade demand began to pick up in the late 1980s. World trade volumes only recovered to 1970s’ levels at the beginning of 1983. World merchant fleet reached 1983 peak level in deadweight terms in 1983. World merchant fleet has continued to grow ever since 1983. In 2000s, strong growth in shipping markets started primarily from demand resulting from Chin and other developing economies. Globalization spurred the demand for ultra large container ships. After the recession in 2008, shipping tonnage supply continued output until peaking in 2011.

On a year-to-year basis, there is a different rates of world merchant growth of gross tonnage (GT) and deadweight (DWT). Bulk carriers and tankers have a much larger carrying capacity when expressed in deadweight (DWT) terms than when expressed in gross tonnage (GT). Other ship types have a closer correlation between gross tonnage (GT) and deadweight (DWT). Expansion in the early 1970s is accompanied by deadweight (DWT) growth rates that are higher than those of gross tonnage (GT) because in early 1970s, average size of bulk carriers and tankers grew rapidly

Over the period 1970-2014, world merchant fleet growth average is nearly 4% annually. Economists observe that

  • World merchant fleet grew in the early 1970s
  • World merchant fleet declined in the early 1980s
  • World merchant fleet recovered in the 1990s
  • World merchant fleet boomed between 2004-2011

Boom in shipping markets can be clearly seen in the higher-than-average growth rates, reaching levels last seen in the 1970s.

Ship Newbuilding 1970-2014

Economists observe the world merchant fleet change in size by newbuild and scrapping rates. Over the period 1995-2014, economists observe that rate of newbuilding ship deliveries is strongly affected by expectations about the future which is conditioned by market knowledge at that time. In ship newbuilding markets, variations can be quite large annually. In in 1980s, ship newbuilding deliveries were very low, at just over 2.5%. Confidence in the future of shipping was very low and very small numbers of ships were being delivered. By 1990, ship newbuilding deliveries were increased to over 3.5%. In the beginning of 1990s, absolute amount of available ship tonnage was falling.

Ship capacity is measured in three (3) main ways:

  1. Deadweight Tonnage (DWT): total weight in metric tonnes (1,000 kg) of cargo, stores, fuel, passengers and crew when loaded in sea water to maximum draught under winter, summer or tropical load-lines. Deadweight (DWT) is the best measure of cargo-carrying capacity of a ship.
  2. Gross Tonnage (GT): ship’s volumetric Gross Tonnage (GT) is the internal volume of all enclosed spaces in the ship. Gross Tonnage (GT) is measured in cubic meters and multiplied by a constant. Gross Tonnage (GT) has no units. Usually, Gross Tonnage (GT) is used as a basis for payments, like Protection and Indemnity (P&I) Clubs.
  3. Net Tonnage (NT): ship’s is volumetric capacity. Net Tonnage (NT) is the measurement of ship’s cargo-carrying spaces. Net Tonnage (NT) is measured in cubic meters and multiplied by constants. Net Tonnage (NT) also has no units. Usually, Net Tonnage (NT) is used to assess port and terminal dues.

After 2000s, world merchant fleet increased rapidly and more ships are being delivered. After 2005, ship newbuilding deliveries were around or above 8%. Very high ship newbuilding delivery percentages for 2010-2011 of 12% can be explained by delays between the order being placed and the actual delivery of the ship. When ship newbuilding orders rise rapidly, shipyards inevitably build up a backlog and economists observe the time elapsed between order and delivery increase.

Cyclical pattern of the shipping industry is clearly illustrated as newbuilding delivery numbers and deadweight (DWT) delivered declined in the 1980s. Recovery took place in the early 1990s. In 1997, newbuilding ship deliveries were greater than those in 1980 in terms of numbers and twice as high in terms of deadweight (DWT). Bulk carrier newbuilding deliveries were significantly higher after 2001. In the period 2005-2014, newbuilding deliveries exceeded 70 million deadweight (DWT) per year. In 2010, 3,748 newbuilding ships were delivered which is over five times the number of newbuilding ships delivered in 1990. During the boom in 2005-2011, shipowners ordered newbuilding ships, expansion of newbuilding ship deliveries continued afterwards from shipyards. This situation illustrates the clear evidence of the cyclical nature of the shipping market. Between 1995-2014, annual average rate of newbuilding ship delivery is 7.3%. However, between 2005-2012, 7.3% has been exceeded every year.

Ship Scrapping 1970-2014

Economists observe very low ship scrapping levels between 2005-2007. After 2008, as the shipping recession deepened due to financial world trade crises, more ships were sent to demolition in an attempt to reduce overcapacity. Peak for ship scrapping was in 2012 with nearly 60 million deadweight (DWT) tonnes scrapped, over half of which were dry bulk ships. Scrapping a ship depends on each specific ship’s particular circumstances. Economists distinguish between the economic life and technical life of ships. Ship’s economic life is determined by economic conditions. Ship is considered to be reached the end of its economic life when a replacement ship can be operated at lower overall unit or average cost than the present ship. Two principal drivers determine the critical point of ship’s economic life:

  • Rate of depreciation of the capital tied up in the existing ship
  • Level of operating cost required to maintain and operate the existing ship

Ship’s rate of depreciation tends to decline with ship age, while level of operating cost rises with ship age. Furthermore, profitability of the ship also affects the scrapping decision. When freight rates are high, tight market conditions, it is feasible to extend the economic life of ships, providing ships are still compliant with existing regulations. Period between 2004-2008, low scrapping rates of bulk carriers, reflected the buoyant shipping freight markets. Even old and high operating cost ships can be profitable in such high market. Regulations have a large influence on limiting the economic lifespan of a ship. For example, double-hull requirements for tankers by IMO (International Maritime Organization). At some point, it becomes worthwhile to replace an older ship with a new ship. Newer ships will have advances in engine design and automotive technology, with lower fuel consumption and so on. On the other hand, older ships have the advantage of being fully depreciated, but with higher operating costs. Shipowner has to balance these pros and cons. Economic life of a ship may well be around 15-20 years. In 2010, the average age for a scrapped ship was 29 ½ years.

Ship’s technical life may well be considerably more than economical life. Ship’s technical life could be 30-40 years or more. Ship’s technical life is the maximum length of life that it is possible to extract from the ship by repair and replacement of parts. However, as the ship ages such repairs become increasingly expensive. Legislative changes may make the design technically obsolete. Ship scrapping is usually determined by the economic life rather than the technical life of a ship.

Ship Productivity 1970-2014

Economists observe that lately ship productivity appeared to be lower than it was in 1970, when expressed in terms of tons of cargo carried per deadweight (DWT). 1970 ship productivity was only surpassed in 2005 as similar boom conditions existed. 1970 was a boom year and a year in which capacity was stretched to meet prevailing demand. Between 2000-2008, appear to present similar conditions in ship productivity to those that existed in 1970. Similarly, bust following the boom in 1970 has occurred for the boom of the period following 2008.

Ship Tonnage Surplus and Active Fleet  

Economists produced estimates of ship tonnage that is surplus to demand requirements annually. During their estimation process, economists calculate number of ships that are idle, laid up or slow steaming. Crude way of measuring the degree of slack in the system. Economists measure the amount of spare capacity that is readily available to meet unexpected increases in demand. Economists calculate the surplus ship tonnage measured as a proportion of the world fleet annually. Since the high of 1990, unemployment of ships has steadily dropped and remained around the 1%-2% of world merchant fleet. Ship tonnage surplus saw a rise in 2008 but dropped again to just over 1% in 2009-2010. This was probably caused by increased scrapping and continued slow steaming.

According to shipping economists, it is unlikely that the percentage of unemployment of ships will ever drop to zero. Underlying this calculation is the implicit assumption that somehow, the volume of shipping demand in any one year must match the volume of shipping capacity supplied. Since shipping demand has to be forecast it seems extremely unlikely that this would ever occur. If we assume that shipping is short capacity and cost of always being short of capacity would be high. Inability to move cargoes in sufficient volumes in the right time periods would generate large losses of sales further up the supply chain, while having some ship surplus means that unexpected variations in demand can usually be met. Output of shipping cannot be stored. Surplus of ships is one way of creating an inventory of available extra ship output if it is needed. As ships represent a huge capital investment, too many idle ships mean too much capital tied up in non-income earning assets. Feasibly, there is some range of surplus ship tonnage which is optimal, balancing the cost of lost output against the cost of idle capital. Amount of surplus tonnage may well be affected by the underlying unit costs of labor, capital and bunkers.

Segmented Ship Supply

World merchant fleet has been examined as a whole and it has been assumed that conditions are similar in all sectors. Essentially, world’s shipping fleet can be divided into seven (7) segmets:

  1. Ships employed in serving the wet trades (tankers)
  2. Ships employed in the dry bulk trades (bulk carriers)
  3. Ships employed in the unitized trades (container ships)
  4. Ships employed in non-unitized liner trades (general cargo ships, MPP)
  5. Ships employed in the shortsea trades (ferries)
  6. Ships employed in the cruise trade (cruise ships)
  7. Ships employed in specialized areas (offshore supply ships and drilling rigs)

Certain ships are better adapted to certain trades. Local demand conditions can generate quite different supply behaviour between shipping segments. Most of the surplus tonnage is in fact concentrated in the tanker market. For example, in 2002, over 88% of the surplus ship tonnage was situated in the tanker market. In 2002, bulk carrier surplus ship tonnage was 13.49% and general cargo surplus ship tonnage was 3.26%. In 2006, surplus ship tonnage had changed to 60.4% for tankers, 33.66% for bulk carriers and 5.94% for general cargo. World merchant fleet appear to be tied together by common long-term trends. However, there are often quite important variations from this trend in the shorter term in shipping segments.

Short-Run Supply of Shipping Output

In the short-run, it might be assumed that, since the stock of ship tonnage has been held constant, there can be no variation in the supply of shipping output. However, this assumption is incorrect, if shipping output is measured in terms of tonne-miles of cargo moved per time period. Shipping output can be varied, literally from zero with all ships idle, to a maximum value, determined by the present fleet size, its productivity and ships’ speeds. In other words, in the short-run, shipping output can be changed by altering way existing stock of ships employed.

Assume for a moment that an economist could be able to rank ships in order of low cost to high cost according to each ship’s cost per tonne-mile of cargo. Ship supply could be permitted to increase. Cheapest way to increase supply would then be to use the low-cost ships first which is the most profitable. Raising freight rates when many more ships will become profitable to operate. This imaginative ship supply process can continue until all ships are utilized. Once all available world merchant fleet are in use, only way of producing more ship output is to make ships go faster. However, faster ships require higher rates still as fuel consumption is increased. As figure below which is broad J-shaped curve, no matter how much further freight rate is increased, there is no possibility of supplying more tonne-miles of ship output from the given tonnage supply.

Availability of a large stock of under-utilized ships means that tonne-mile supply can be increased rapidly in response to a small increase in rates. However, when demand approaches full capacity, further increases in rates do nothing to stimulate short-term ship supply increases. Hypothetical supply curve for shipping output, derived from a fixed stock of ships. This situation acts as a signal to shipowners and encourage further investment in shipping.

Long-Run Supply of Shipping Output

In the long-run, supply of tonnage will increase if deliveries exceed scrapping, or vice versa. In the long-run, supplied new ships will be more efficient and cheaper to operate than the scrapped ships. Hence, entire ship supply curve shift to the right in the case of an expansion or to the left in the case of a contraction.

Elasticity of Shipping Supply

Response of ship supply to a change in demand conditions differs depending upon the amount of slack in world merchant fleet. Elasticity of shipping supply is the responsiveness of tonnage supply to a change in freight rate.

Supply Price Elasticity =  % change in supply / % change in price (freight rate)

Price Elasticity of Supply is expected to be positive or zero, but never negative. Price Elasticity of Supply will be positive if the supply of tonne-miles or cargo tonnes moved per unit time period increases with an increase in the freight rate. Price Elasticity of Supply will be zero if, despite the increase in the freight rate, there is no observable increase in tons of cargo moved or tonne-miles performed.

Price Elasticity of Supply Examples:

When the freight rate was to rise from $100 per mton to $120 per mton, 20% increase in freight rate. Cargo carried rose from 480,000 mtons to 560,000 mtons, 16.6% increase in cargo. Price Elasticity of Supply would be 0.83. Inelastic, because 0.83 is less than unity (1).

On the same example above, if the cargo carried rose from 480,000 mtons to 960,000 mtons. Price Elasticity of Supply would be 5. Elastic, because 5 is bigger than unity (1).

Ship Supply Elasticity and Time

Responsiveness of shipping supply to changes in freight rates is influenced by the time period allowed for that response. When economists permit the stock of ships to alter, supply is more flexible than it is in the period when the stock of ships is fixed.

Assume that a charterer wants a ship to transport cargo at very short notice like 24 hours from port. If there is only one ship available for cargo in the time available, shipowner may bid the maximum freight rate that the charterer is prepared to pay. However, 24 hours later, when other ships arrive in the area. Tonnage supply immediately shifts the balance towards the charterer as ship owners compete for the cargo. Ship supply responsiveness (elasticity) is more or less zero in the first 24 hours, but getting progressively larger as more time for greater supply reaction is allowed.

Here above figure shows the long-run response to demand changes in shipping. Demand increases from D1 to D2. Short-run supply curve S1 and price rises to point C. This induces greater profits and increases in ship ordering and then deliveries of new ships. Higher deliveries mean an increase in the world merchant fleet size. Short-run model assumes the ship stock is fixed, so the short-run supply curve shifts out to the right. If shipping demand remains at D2, prices now fall to B. Overall change in induced supply is therefore the move from A to B, which implies a smaller price change and larger quantity change than the move from A to C. Long-run supply elasticity (responsiveness to freight change) must be higher than the short-run supply elasticity. Percentage change in price will be lower and the percentage change in quantity will be higher in the long run compared to the short run.