ICS Economics of Sea Transport and International Trade 2015

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S h ip b r o k e r s 2015 Edition
ECONOMICS OF SEA TRANSPORT
AND INTERNATIONAL TRADE
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C h a rte re d
Shipbrokers
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MÒNG OH HÀNG HAI VIÉI NAM
TÀI LIỆU THƯVIỆN

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Institute of Chartered Shipbrokers 2015
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ii Institute of Chartered Shipbrokers

Technical Input
John H o a r
Contributing Editor
John Hoar spent I I years at sea as deck oíĩicer on tankers, dry bulk, liquified natural gas, general cargo,
reeíer and cruise ships. He was also a lieutenant in the Royal Navy Reserve. After gaining his Master
Mariner Certificate of Competency he attended Cardiff University for a BSc in Maritime Studies.
He then vvorked in London as a claims negotiator for a marine Insurance broker, and for a weather
routeing company.
John began his teaching career at the Warsash maritime college and later at Southampton Solent
University on the maritime studies degree programme. He gained his MSc in International Studies from
Southampton University. His academic activities have taken him to Athens, Oslo, Antwerp and Brussels.
He currently teaches maritime economics on the MSc Maritime Operations and Management course at
City University.
John is a liveryman o f the Honourable Company o f Master Mariners and lives in Hampshire on the South
coast. He and his wife Marilyn have three sons - an RN helicopter pilot, a commercial airline captain and
a solicitor who vvorks in the City. A recent reunion with those with whom he started his sea career made
him appreciate how diverse and rewarding a career in the shipping industry is.
Economics of SeaTransport and International Trade iii

Foreword
Foreword
While working as a young business reporter employed by the Reuters
news agency, I was once take aside for some advice by one of the
grizzled old hands on the newsdesk who had heard I had a little
specialist knovvledge o f maritime markets.
“ Son,” he said,“just remember; ali o f human life is in shipping - heroes,
rogues, billionaires, bankrupts, triumphs and tragedies - so theres
always a great story to be told."
ĩ It was a sage comment that has stayed vvith me dovvn the years. And
since ail o f human life is in shipping, then at its centre, at its heart, is
maritime economics.
Despite the maritime vvorld being a generally convivial place, vvhere
people often put down roots which last a liíetime, it is alvvays
important to remember that fìrst and íoremost shipping is a business.
Julian Bray And as in all business, to períorm at one's best a vvorking knovvledge
editor-in-chief,Tradewinds o f economics is vital.
Economic íactors such as scarcity o f resources and demand for services are fundamental drivers not
just o f the ebb and flow o f íreight rates.They iníluence shipbuilding capacity, labour supply and íìnance
availability, to mention just a few.
Knowledge o f the basic íorces that affect price and availability should give coníìdence to support decisions
íuelled by experience and the need to seize the right opportunity.
However, never íorget that economics has been burdened for over 150 years vvithThomas Carlyle's label
'the dismal Science’.
Despite their detailed professional knovvledge, few economists predicted the severity o f the global íìnancial
crisis that took hold in 2007, and they continue to struggle to accurately íorecast economic prospects to
this day.
Nevertheless the study o f maritime economics is a great asset. It will help everyone who is invoived
in shipping - from those working in ĩinance departments, to those more íocused on operations - to
make better-informed decisions, vvhich will provide a platform for a successíul career, vvhatever direction
you choose.
iv Institute of Chartered Shipbrokers

A c k n o w le d g e m e n ts
Acknovvledgements
First and íoremost we vvould like to thank Julian Bray for his support and encouragement in the revision
of this bookVVe must also acknowledge the contribution o f several industry proíessionals, among them
John Hoan who has shared his vvealth o f knowledge and experience with the Institute.
Special thanks are due to PatrickTye, Dn Mervyn Rowlinson, Anne Cowne, Dhanvi Bosamia, Pooja Sharma,
Jan Hoffman, Wendy Juan, D r Alexander Geisler; Crispin Eccleston, Captain Suryanarayanan Pullat, Tim
Reardon and Robert Merrylees ío rth e ir eííorts in the review o f this book.
Acknowledgement must also go to Andrevv Lansdale and Costas Lambrou for their assistance in the
updating o f this book and to Philip Moore and Dinah Bromwich for their efforts in improving the quality
of the text.
The illustrations have been sourced from across the industry but with particular thanks to Danny
Cornelissen o f Port Pictures NL. The artistry o f their images raises the stakes in the appearance and
presentation o f our maritime text books,
Economics of SeaTransport and International Trade

C o n te n ts
Contents
Contributing editor iii
Foreword iv
Acknovvledgements V
1 The basic to o l k it I
I. I A DEPINITION OF ECONOMICS AND MARITIME ECONOMICS 2
1.2 PACTORS OF PRODUCTION 2
1.3 UTILITYAND PRICE 3
1.4 OPPORTUNITT COST 5
1.5 THE PRICE MECHANISM 6
1.6 DYNAMICADJUSTMENT 14
1.7 CONCLUSION 14
2 Demand fo r shipping 15
2 INTRODUCTION 16
2.1 AN ECONOMIC ANALYSIS OFTHE DEMAND FOR SHIPPING 16
2.2 DISTANCEANDTHECONCEPTOFTONNE-MILES 23
2.3 DERIVED DEMAND PORSHIPPING 26
2.4 EƯ\STICITY OF DEMAND 26
2.5 DERIVED DEMAND Eư\5TICITY 31
2.6 CONCLUSION 33
3 T h e s u p p iy o f sh ip p in g services 35
3 INTRODUCTION 36
3.1 A BROAD PERSPECTIVE 36
3.2 A FRAMEWORK FOR ANALYSINGTHE SUPPLY OF
SHIPPING SERVICES 36
3.3 TRENDS IN THE WORLD MERCHANT FLEET 1970-2014 41

3.4 PACTORS AFFECTiNGTHE SHORT-RUN SUPPLY OF
SHIPPING SERVICES 49
3.5 PRODUCTIVITYTRENDSANDSUPPLYCONDITIONS 52
3.6 SURPLUSTONNAGE A N D TH E CONCEPT OFTHE ACTIVE FLEET 53

3.7 SEGMENTED SUPPLY 56
3.8 REƯ\TINGTHEORYTO EMPIRICALEVIDENCE 56

3.9 MEASURING SUPPLY RESPONSIVENESS:THE CONCEPT OF
ELASTICITY OF SUPPLY ■ 58
3.10 CONCLUSION 60
vi Institute of Chartered Shipbrokers

C o n te n ts
4 S h ipp ing c o s t analysis and e con om ies o f scale 61

4 INTRODUCTION 62
4 .1 AN OUTLINE OF BASIC COST CONCEPTS 62
4.2 THE CONVENTIONAL ANALYSIS OFVESSEL OPERATING COSTS 67
4.3 SPECIPIC PACTORS AFFECTINGTHE RELATIONSHIP BETWEEN
COSTS A N D SHIPPING OUTPUT 68
4.4 LONG-RUN VESSEL COSTS: ECONOMIES OF SCALE A N D
OPTIMAL SHIP SIZE 73
4.5 THE EFFECT OF DIFFERENT PISCAL REGIMES O N COSTS 79
4.6 THE EFFECT OF FLAG OF REGISTRY O N COSTS 80
4.7 COSTS A N D QUALITYiTHE PROBLEM OF SUB-

STANDARD SHIPS 82
4.8 THE EFFECT OF DEMAND A N D INVENTORY O N OPTIMAL
SHIPSIZE 83
4.9 TRENDS iN SHIP SIZE AN D TH E CONCEPT OFTHE OPTIMUM
SIZE OPVESSEL 85
4.10 CONCLUSION 88
5 C o m p e titív e s h ip p in g m a rk e ts : d ry b u lk cargo 91
5 INTRODUCTION 92
5.1 DEPINITION OFTHE DRY CARGO SECTOR 92
5.2 MARKET CHARACTERISTICS 94
5.3 DRY BULK MARKET DEMAND STRUCTURE ANDTRENDS
OVERTHE PAST 20YEARS 95
5.4 AN ANALYSIS OFTHE COST STRUCTURE OPTRAMP
SHIP OPERATORS 97
5.5 THE USE OF BREAKEVEN ANALYSIS IN DETERMINING
MINIMUM PREIGHT RATES 99
5.6 MODELLINGTHEDRYCARGOMARKET 101
5.7 DETERMININGTHEEQUILIBRIUMPREIGHTRATE 105
5.8 CONPRONTINGTHE MODELVVITHTHE EVIDENCE 106
5.9 DYNAMIC CONSIDERATIONS 1I I

5.10 CONCLUSION 115
APPENDIX 115
6 C o m p e titiv e sh ìp p in g m a rk e ts : ta n k e rs i 17
6 INTRODUCTION I 18
6.1 SEABORNETRADE IN CRUDE OIL A N D OIL PRODUCTS I 18

6.2 CHANGES INTHETANKERPLEET 129
6.3 THE RELATIONSHIP BETWEENTANKER A N D DRY
CARGO MARKETS 132
Economics of SeaTransport and International Trade v ii

C o n te n ts
6.4 THE STRUCTURE OPTHETANKER MARKET 132
6.5 SEGMENTED SUPPLY 137

6.6 MODELLING DEMAND 137
6.7 MODELUNG SUPPLY 138

6.8 THE MARKET MODEL 138
6.9 PLUCTUATIONS IN MARKET PREIGHT RATES 14 1

6.10 ENVIRONMENTALISSUES 141
6.11 CONCLUSION 142
7 T h e lin e r tra d e s 143

7 INTRODUCTION 144
7.1 DEPINITION O F A LINERSHIPPING SERVICE 144

7.2 SHIPTYPES SERVING INTHE LINERTRADES 147
7.3 THE NATURE OF DEMAND FOR DEEPSEA LINER SERVICES 150
7.4 THE CONTAINER REVOLUTION 15 1
7.5 CONTAINER LINER SERVICES A N D FLEET DEPLOYMENT 152
7.6 CONTAINER LINER MARKET STRUCTURE 153
7.7 THE DIFFERENCES BETVVEEN BULK A N D GENERAL
CARGOTRADES 154
7.8 THE PRINCIPLES OF LINER SERVICE ECONOMICS 155
7.9 PRICING LINER SERVICES 156

7.10 THE PRINCIPLES OF LINER PRICING 158
7 .1I CASE STUDY: GAMETHEORỴ A N D COMPETiTION 16 1
7.12 INDEX-LINKED CONTAINER CONTRACTS 161
7 .13 LINER CONPERENCES A N D CO-OPERATIVE AGREEMENTS 162
7.14 CONCLUSION 163
APPENDIX I i64
8 PortSy sea canals and w a te rw a y s 169

8 INTRODUCTION 170
8 .1 DEPiNITION OF PORTS A N D HARBOURS 170
8.2 THE PUNCTION OF PORTS 170
8.3 PORTCOSTSAND SHIPSTIME 172
8.4 PORT COST STRUCTURE 177

8.5 THE AIMS OR PRINCIPLES OF PORTTARIFFS 180
8.6 PORT PRIVATISATION: OVVNERSHIP A N D EFFICIENCY 18 1
8.7 PORT COMPETITION 182
8.8 PORTS IN THE LOGISTICS SUPPLY CHAIN 182
v lii Institute of Chartered Shipbrokers

C o n te n ts
8.9 SEA CANALS, IN Ư \N D WATERWAYS A N D LANDBRIDGES 183

8.10 CONCLUSION 186
9 S h ip p ín g a n d in te rn a tio n a l tra d e 187

9 INTRODUCTION 188
9 .1 THE GROW TH A N D PATTERN OF WORLDTRADE 188
9.2 T R A D E A N D ECO NO M ICG RO W TH 193
9.3 TYPES OPTRADE FLOWS: INTRA-INDUSTRYTRADE A N D

INTER-INDUSTRYTRADE 196
9.4 TRADE GROWTH A N D THE DEMAND PORSHIPPING SERVICES 196
9.5 ECONOMIC MODELS OPTRADE FLOWS 197

9.6 THE BENEPITS A N D COSTS OF PREETRADE 206
9.7 PREETRADEVERSUS PROTECTIONISM 207
9.8 METHODS OF PROTECTION 209
9.9 TRANSPORT COSTS A N D INTERNATIONALTRADE 2 14
9 .10 DEVELOPING FREE INTERNATIONALTRADE:THE ROLE OF
THEW ORLDTRADE ORGANIZATION 216
9.11 CONCLUSION 216
10 T h e b a la n ce o f p a y m e n ts and exchange ra te s 2 17
10 INTRODUCTION 218
10 .1 DEPINITION OFTHE BALANCE OF PAYMENTS 2 19
10.2 THE STRUCTURE OFTHE BALANCE OF PAYMENTS 2 19
10.3 EXCHANGERATESANDTHEBAƯ\NCEOFPAYMENTS 230
10.4 DEALING W ITH A BAƯ\NCE OF PAYMENTS DEPICIT:

FIXED EXCHANGE RATES 233
10.5 DEALING W ITH A BAƯ\NCE OF PAYMENTS DEPICIT:
PLOATING EXCHANGE fW E S 234
10.6 EXCHANGE RATESAND SHIPPING 234
10.7 CONCLUSION 235
Economics of SeaTransport and International Trade ix

C o n te n ts
Institute of Chartered Shipbrokers

Chapter I
The basic tool kit
I Shipping m arkets are highly co m p e titiv e . T h ey satisíy m o st

o f th e characteristics o f a ‘p e ríe c t c o m p e titiv e m a rk e t’ .
S -
C h a p te r I
1.1 A D E P IN IT IO N OF EC O N O M IC S A N D M A R IT IM E
EC O NO M ICS
There are numerous deíìnitions in economics, all o f which agree that the subject contains
three eiements:
• scarcity;
• demand;
• choice.
The economic challenge is that there is a scarcity o f resources to meet the limitiess demand.
This scarcity means considerable care must be taken in choosing the way resources are to be
employed. Since resources can be used in many ways, the question that needs to be asked is:
W hat is the best use of these resources to meet demand?
As some authors refer to economics as the Science o f choice, others reíer to it as a ‘dismal'
Science because its essential problem is scarcity.To attem pt a tentative deíìnition, economics is a
study o f the allocation of scarce resources that have alternative uses to satisíy demand.
Maritime economics is the application o f economic analysis to all the íunctions involved
in moving goods and people by sea. As one author put it, ‘‘Maritime Economics is a field of
study concerned with the manner in which scarce productive resources are used to bridge the
spatial separation o f international trading countries most effectively." (McConville, Economics of
Maritime Transport, 1999). Such a defỉnition serves to illustrate how broad the subịect is and how
imprecise are its boundaries.
1.2 PACTORS OF P R O D U C T IO N
Scarcity arises from the shortage of resources. Economists call resources Tactors of production’.
Resources have to be understood to mean not just raw materials, but also services, inírastructure,
Capital, w o rk force and anything else needed to produce goods. All íactors o f production are
combined together in an economy to produce a range o f goods and services to satisíy demand.
The íactors o f production are generally divided into:
• land;
• labour;
• Capital;
• enterprise.
Land
The term land includes all natural resources which have been termed gifts o f nature. In this
context, natural resources include mineral deposits such as oil, coal or iron ore, agriculturai
land, íorests and buiiding sites. Hence it comprises both the space required for production and
specific ravv materials.These resources are in iimited quantities at any given time. Land, thereíore,
can be deíìned preciseiy as the iimited source o f raw materials and the area in vvhich production
can be organised.
Labour
This is the íundamental íactor o f production, being the human physical effort, skill and intellectual
power that people apply to the production o f goods and services. Labour, thereíore, may be
deíìned as the peoples physical and mental contribution to production.

T h e basic to o l k it
The quantity and quality of labour will vary from nation to nation. It will depend on such things
as the age proĩile o f the population.the availability o f educational opportunities and the political,
social and cultural structure o f particular societies. In a similar way to land, labour will be limited
in both quality and quantity at any given time.
Capital
Capital, or Capital assets, is the stock of all material goods or material resources used in
production. It is a characteristic o f C a p ita l goods that they are not usually wanted for their
own sake, rather for the contribution they make to production. It is the stock o f machinery,
equipment, buildings, roads, coal mines, oil wells, ships and so on. Capital is created by the use
o f resources to increase the value or productivity of land and labour resources Capital can also
reíerto financial Capital, the investment necessary for production to occur.
Enterprise
As production processes have become more and more complex, the need for better
organisation is more and more apparent. Enterprise combines the previous three íactors into
one working production process.Without it, production might not be possible.The entrepreneur
provides the structure for production and brings together the needed raw materials, labour
and Capital.
The total stock of the factors o f production, or resources, determines what an economy can
produce. Each country has varying totais o f resources.This must be seen against the fact that
very few productive processes require a strictly íìxed proportion o f each íactor.The proportion
o f íactors o f production used in a particular process usually depends upon which íactors are
most abundant, such as the cheapest.
Take, for example, the building o f transport inírastructure in N orth America. There, large
amounts o f Capital will be involved, vvhile in China it will more likely be built using large amounts
o f laboun the least expensive resource.To use another example, labour accounts for 40/Ố-509Ố
o f the cost of building a new ship. One reason why shipbuilding has shifted from Japan and
Korea to China, is due to the average shipyard wage in China being one-tenth that o f Korea
(2009). Even after taking into account relative labour productivity, Chinas unit labour costs are
still one-third that o f Korea, a signiíìcant competitive advantage.
1.3 U T IL IT Y A N D PRICE
Resources are used in production to create what economists call utility.This is attributed to any
commodity capable of creating human satisíaction. In a broad sense, it is the povver of goods
or services to give pleasure, satisíaction or what is termed 'real need’ fulfilment. It is a purely
subjective idea incapable o f direct measurement. The objective o f the process o f production
is to increase the amount o f goods and services available to satisíy human desire, that is, to
create utility.
When you buy something, and say it is value for money, what you are really saying is that the
utility you have obtained from the goods or services purchased was worth at least the price
you paid. If instead, you feel that something is a bargain, vvhat you are saying is that you value this
product more than the price that you paid for it; you would have been prepared to pay more,
but you did not need to. A bargain thereíore illustrates the difference between price, what you
have to pay for a product, and utility, vvhat you subịectively feel that the product is vvorth to you.
Shipping and the maritime industry as a vvhole is an important element in the process of
creating utility. It is involved in creating utility in a number o f ways. For example, place utility:the
accessibility of goods at a certain place, such as potatoes shipped from Egypt to a vegetable
shop in a small town in Holland.Time utility is the accessibility o f goods at a certain time, for

C h a p te r I
example, heating oil from West Aírica or the Middle East to the storage tank o f a small house in
Norvvay in midvvinten
Other forms o f utility are also contributed to by shipping or transport, such as the act
o f providing a Service. It is also im portant in the im port and e xp o rt o f goods o r the act o f
exchange. Thereíore, shipping is a major íactor in creating utility. In other words, creating the
entire amount o f satisíaction obtained from consuming various amounts o f a commodity in a
given time period and place.
1.3.1 Real and n o m in a l prices

To be able to compare any iníormation a common Standard is needed. In economics, the results
are often values and can be compared on face value; but, if a comparison is made in monetary
terms over different periods, the face value (or nominal value) will lead to wrong conclusions.
Nominal values do not take changes in price into consideration. Because o f inílation the most
recent values will oíten be the highest, but will not necessarily be the largest if we compensate
for inílation.The values obtained after corrections for inílations are knovvn as real values.
To be able to calculate the nominal value (N) o f a commodity, we require the price (P) for a unit
o f that commodity and the quantity (Q).
Ni = Pi X Qi
The calculation o f the reai value is a bit more complex as we will need a priceindex for every
year we are comparing, Porthe rest.the caiculation is rather simple aswe just divide the nominal
value in a speciíìc year (t) by the price index o f the same year (PtV
Rit = N it / Pt = (Pit X Q it) / Pt
For example, the graph and table below represents the nominal value and real value for a tonne
ofcoal from 1995-2012,
Pigure I . I Nominal and real value coal trade.

T h e basic to o l k í t
As can be seen clearly from the table and graph above, the nominal value and real values
vary quite a bit due to compounding inílation.The real value allows us to compare the price
o f a tonne o f coal over different years and draw conclusions on the change in value o f the
commodity.
For instance, if we compare the nominal value for a tonne o f coal between 2007 and 2 0 1I ,
the price seems to have nearly tripled.The real value tells us that the price actually more than
quadrupled. In real money terms this means that a company had to pay four times more for a
tonne o f coal in 201 I than in 2007.
Year Price per Index N om inal value Real value

tonne
1995 37.1 0.9829 37.1 36.47
1996 39.37 0.9879 39.37 38.89
1997 35,23 1.0854 35.23 38,24
1998 31.4 0.8581 31.4 26,94
1999 26,1 0.7282 26.1 19.01
2000 25.1 1.0000 25,1 25. i
2001 32.1 1.0406 32.1 33.4
2002 29,1 0,8415 29.1 24.49
2003 26,68 l.l 142 26.68 29.73
2004 40.45 1.2071 40.45 48.83
2005 56.83 1.4546 56,83 82.66
2006 46.27 1.8957 46,27 87.71
2007 54.95 1.8972 54.95 104.25
2008 98.3 2.7231 98,3 267,68
2009 85.71 1.7196 85.71 147.39
2010 103,93 2.4503 103.93 254.66
201 1 141,94 3.0506 141,94 433
2012 124.18 3.1580 124.18 392.16
Table I . I Nominal value and real value for a tonne of coal from 19 9 5 -2 0 12
1.4 O P P O R T U N IT Y COST
Scarcity o f resources for production and insatiable demand íorces the making o f choices. Every
time a choice is made something must be íoregone or sacriíìced.
For example:
In an economy vvhich can only produce two goods, ships or cotton, shipbuilding will use a
certain amount o f the available íactors o f production.This means that they cannot be used in
the production o f cotton. So an amount o f cotton that could have been produced has been
foregone. Now let us assume that cotton is the best alternative to ships using the same amount
o f the íactors o f production available. The opportunity íoregone or sacriíiced by the use o f
resources in one way rather than another is the Central idea o f cost in economics.
Opportunity or alternative cost doctrine defines the utility of what has been produced, in our
example, ships, by measuring the utility o f the best alternative production given up, vvhich is
cotton. Put simplỵ the cost o f producing a unit ofY is the utility o f the unit o f X that as a result
must be given up.

C h a p te r I
Case s tu d y : Pactors of production

A shipowner ordering a new ship at a shipyard will need to have money to pay for this
nevvbuild. Hence it will be using one íactor o f production: íinancial Capital.
To build the ship, the shipyard will need the íacilities to build the ship (more Capital).
Purther, all the buildings and slipvvays in the shipyard physically exist, vvhich means they use
the other factor o f production: land.
Apart o fth e physical buildings.the shipyard will also need manpovverto constructthe ship.
This constitutes another íactor o f production: labour.
The modern vessels o f today are complicated pieces o f machinery and their construction
requires a high ievel o f expertise and co-ordination o f many components. A careíul
planning o f the work process requires co-ordination and management (enterprise).
1.5 T H E PRICE M E C H A N IS M
The price mechanism is a Central íeature o f price theory or how prices are set.The two basic
components o f the price mechanism are demand and supply. These are governed by what
are knovvn as economic laws and coníirm a general tendency in everyday activity.The iaw of
demand states:The demand for goods or services falls when the price increases, and rises when
the price decreases, all other things being equal.To put it another way, demand and price are
inversely related.
The law o f supply states;The higherthe phce the greaterthe quantity supplied by the producer,
the lower the price the smaller the quantity the producer wili supply, all other things being
equal.’ In other vvords, the supply o f goods increases or decreases in relation to the increase or
decrease o f the price, so price and quantity supplied are directly related.
The phrase 'other things being equal' is used to isolate or concentrate on particular effects, as
it is impossible to study all economic changes at the same time. In the present case, It IS only
possible to concentrate on the relationship betvveen supply and demand o f a commodity and
its price or price changes by assuming all other iníluences remain unchanged. It isolates the
effect o f any changes that are being examined by holding all other relevant íactors constant.
Having looked at the basic law o f the tw o sides o f a price mechanism, each side will now be
considered in more detail.
i .5 .1 D em and
The concept o f demand in economics is not just need, desire or vvant. It is all these things
backed up by a willingness and abiiity to pay the price.This is known as effective demand, but
is generally reíerred to simply as demand. It expresses the quantity o f a commodity which
consumers are prepared to buy over a range o f prices.The tw o íactors o f primary interest are
the price and quantity demanded.
Let us take as an example the international cruise market. A demand schedule can be drawn up
vvhich records how much consumers, in this case potential passengers, are prepared to pay for a
cruise at different prices. SeeTable 1.2.

T h e basic to o l k i t
Price o f cruise ($) Q u a n tity N e w higher level o f N e w lo w e r level o f

demanded demand (passenger demand (passenger
(passenger trips) trip s) ( D I ) trips) (D 2)
(D )
15,000 9,000 10,000 7,000
14,000 10,000 12,000 8,000
13,000 1 12,000 15,000 10,000
12,000 15,000 18,000 12,000
10,000 20,000 22,000 15,000
9,000 25,000 27,000 16,000
Table 1.2 Market demand schedule for cruises
The schedule serves to illustrate the law o f demand.As phce falls in column one.the quantity
demanded increases in column two, and vice versa. Columns three and four wiil be discussed
further in this section.
A t any price, for example, $14,000, there is a definite quantity demanded o f 10,000. The
schedule gives the diííerent quantities demanded at six selected price levels. The iníormation
given in the market demand schedule can be represented as in Pigure 1.2.
u
Q.
9 10 12 15 20 25 Passenger numbers (OOOs)
Pigure 1.2 Market demand curve for cruises
The vertical axis shows the possible prices. The horizontal axis shows the quantity o f the
commodity that can be demanded. It should be noted that normally price is shown on the
vertical axis and quantity on the horizontal axis. The negative slope for the demand curve,
down to the right, reílects the demand and price/quantity relationships. In other words, the
negative slope illustrates that a reduction in price o f cruises leads to an increase in the quantity
demanded. Similarly, an increase in the price results in a fall in the quantity demanded.
It has already been shovvn that the higherthe price the lowerthe quantity demanded, and vice
versa. Other íactors have to be assumed to remain constant.The other íactors which will aíĩect
the levels o f demand are:

C h a p te r i
Income
Normally it is expected that any change in income will create a change in demand. If people
have more money to spend they will buy more; if the money they have to spend falls they will
buy less. Historically, an increase in income has been a íactor raising the demand for cruise trips.
Taste
This term is used in economics to represent all other factors vvhich iníluence demand.There can
be many iníluences on taste and it can change quite suddenly. For example, a serious disaster
involving a cruise vessel vvould change demand levels in one direction vvhile a successíul publicity
campaign could change it in anothen
1.5.1.1 Prices o f o th e r co m m o d itie s

The prices o f commodities are often interrelated and a change in the price o f one commodity
might well iníluence the level o f demand for another commodity. This relationship exists in
respect of complementary goods and substitutes.
The price o f complements: items o f goods are a complement if consumers purchase them
jointly with another product such as milk and tea, milk and coffee, sugar and tea. in the present
example, assume a cruise ship entails an air ílight before joining the vessel. A change in air fares
would have a positive or negative effect on the demand for cruise trips.
The price o f substitutes: an item o f goods is a substitute if consumers purchase it instead of

another product. Simply put, when the price increases for one item, the demand increases for
the substitute item. Hence the price o f any commodity which has many substitutes is very
sensitive to change. For example, ịf the prices o f other comparable forms o f holiday were to
change.this would have an impact on the cruise market.
If it is assumed that there is a rise in income.this would create an increase in demand, all other
things being equal.This is shovvn in columnThree o f theTable 1.2, and the efíect would be to
shiít the demand curve to the right as shown in fìgure 1.3 below, from D to D I .
On the other hand, a reduction in income would cause the opposite effect, a fall in the number
of trips demanded at any possible price, all other things being equal.This is shown in column
four oíTable 1.2, and the corresponding leitvvard shift o f the demand curve is shown in Pigure
1.3, írom D to D2.
L.
ÕL
Pigure 1.3 Shifts in the conditions o f demand.
8 Institute of Chartered Shipbrokers

There are two distinct movements in demand.

a. A movement along the curve in any direction known as changes in the quantity demanded.
b. A shiít o f the vvhole curve bodily to the left or the right is known as a shift in conditions of
demand.
1.5.2 S u p ply
This reíers to the quantity o f a product that will be offered on the market at a given price during
a particular time period.The law o f supply states that more o f a commodity will be supplied at
a higher price than at a lovver one. It is important to note here that the supply schedule derived
in this section is based upon the assumption that the market is a períectly competitive one.
While accepting that the cruise industry does not fit this model perTectly, it is still a useíul model
to develop because it is one o f the few shipping markets that impinges directly upon the fìnal
consumer
A supply schedule is a table shovving the different quantities the sellers are willing to oíĩer on the
market at various prices at a given time.
Price per Q u a n tity supplied Increase in quantity Decrease in

passenger trip passenger trip s supplied passenger quantity supplied
trip s passenger trip s
($) (S) (SI) (S2)
15,000 25,000 27,000 21,000
14,000 20,000 22,000 17,000
13,000 18,000 20,000 15,000
12,000 15,000 18,000 12,000
10,000 12,000 15,000 10,000
9,000 10.000 12,000 8,000
Table 1.3 Market supply schedule for cruises
In a similar way to demand, the supply schedule serves to illustrate the law o f supply. As price
increases in column one the producers (which are the cruise companies) increase the numbers
of trips offered, as shown in column two. A t each price there are related quantities supplied; for
example, at a price o f $1 3,000, 18,000 passenger voyages or trips are supplied. Once again, a
graph can be constructed for supply.As usual.the vertical axis indicates price and the horizontal
axis indicates quantity offered.
The positive slope o f the supply curve, upvvard to the right, reflects the law o f supply and the
direct relationship o f price to quantity. In other words, the positive slope illustrates that an
increase in the price o f a cruise leads to an increase in the quantity supplied, all other things
being equal. Similarly, a fall in the price means a fall in the quantity offered. Alternative price
quantity combinations are represented by the various points o f the supply curve. For example,
at price $9,000 per trip the quantity supplied is 10,000 trips, point H on the curve.

C h a p te r I
Vị
p.
Q
Pigure 1.4 Market supply curve for cruises
A t point E, the price has increased to $ I 3,000 and the quantity offered to 18,000 trips, vvhile at
point B the price is $15,000 and 25,000 trips are ofíered,As with demand.the supply schedule is
based on the assumption that during the period under consideration the assumptions underlying
the schedule remain constantThe íactors affecting supply are as follows;
1. Costs of the íactors o f production: changes in the costs o f production would iníluence the
quantitỵ supplied at any particular phce. A major modiíìcation in crew costs would have an
impact on the cost o f operating a ship and hence on the amount o f cruises oííered.
2. Changes in the method o f production: new inventions or technologies can reduce costs of
production and so change producers' or suppiiers’ attitudes to price. In the cruise market a
breakthrough in engine or hull design would result in a lovvering o f the price.
3. Inventory or stock levels: if there is a substantial amount o f tonnage laid up o r under-utilised,
owners o f vessels might accept lovver prices for their cruises.They might oíĩer discounts, or
special offers such as two travelling for the price o f one.
4. Expectations of future pnce: if there IS an expectation o f a rise in price, owners or the
suppliers may be reluctant to sell tickets for their next cruise in the hope that the expected
market price rise comes through.
To return to the cruise example, if it is assumed there has been a substantial fall in bunker prices,
afFecting the costs o f production, this would create an increase in supply, all things being equal.
This is shovvn in column three ofTable i .3 and the etĩect vvould be to shift the supply curve to
the right as shovvn in ílgure 1.5 belovv.

T h e basic t o o l k it
S2
§
ỉ.
10 12 15 18 20 25 27
Passenger numbers (OOOs)
Pigure 1.5 Alterations in supply conditions
As can be seen, the supply curve, s, has moved as a whole to the right, to s I , In this new
situation, 12,000 trips are supplied at the price o f $9,000, and 15,000 trips are offered if the
price is $10,000, and so on, up to the point vvhere 27,000 trips are oííered at the price of
$ 15,000. Joining these points up on a graph generates the new supply schedule s I .
Column four oíTable 1.3 showed the effect o f a fall in quantity supplied at any possible price,
and is shown as S2 in Pigure I.S.This schedule shows the fact that supply will be less at any
possible phce, compared to the original schedule s.
This brings us to two different and distinct movements in supply:
a. A movement along the curve in any direction is known as changes in the quantity supplied.
b. A shift o f the vvhole curve bodily to the left or the right is known as change in conditions
of supply.
1.5.3 T h e basic m a r k e t m o d e l, b rin g in g d e m a n d and su p p ly

to g e th e r
Up until now each side o f the market, in this case the imaginary cruise market, has been
analysed separately.
Neither demand nor supply can by themselves decide the market price o f any product nor
the quantity of the product sold.This is because individually, demand and supply only indicate
consumers’ and producers’ intentions.The next stage is to bring the intentions into reality, so
demand and supply must be combined in a single schedule as shovvn inTable 1.4 belovv.
Economics of SeaTransport and International Trade II

C h a p te r I
Table 1.4 Cruise market: demand and supply equilibnum
It will be recognised that the above is based on the demand and supply schedules used earlier in
this chapter. Such schedules reỉen o f course.to a particulartime period.
Column one is a list o f prices a cruise passenger could be asked to pay. Column two is the
quantity passengers would demand at those different price levels. Column three is the quantity
cruise operators vvould offer at different price levels. Columns four and five highlight the
differences betvveen the tw o earlier columns o f demand and supply. A t the higher prices there
is a positive difference or an excess o f quantity supplied. A t the lower prices o f $10,000 and
$9,000 there is a negative difference or an excess o f demand. But at the price o f $ 12,000, the
intention o f passengers and the cruise operators are exactly matched. A price where there is
neither an excess o f supply nor demand is knovvn as the equilibrium price o rth e market clearing
price.This is the point where the opposing íorces o f demand and supply are in períect balance
and there is no net tendency for market prices to change.To put it another way, a point where
the quantity demanded o f a commodity equals the quantity supplied, causing market clearance.
Once obtained, there will be a tendency for the equilibriunn point to persist. Changes wili only
occur if the basic conditions o f either demand or supply, or both, are disturbed. For instance, if
any o f the íactors vvhich have been held constant actualiy change.The above schedule includes
the two criteria o f price and quantity and thereíore can be represented in a market model as in
Pigure 1.6.
8
ọ
V
a.
Pigure 1.6 Equilibrium in the passenger cruise market

The individual demand curve and supply curve are brought together in a market model.The
demand curve shows the passengers' intentions or plans to purchase at each level or price
following the law o f demand. As prices fall, the quantity demanded increases.The curve slopes
downwards fronn left to right.The supply curve shows the quantity cruise operators plan to sell
at each level o f phce. Once again, the law o f supply is in evidence.The producers offer more
at a higher price.The supply curve moves upwards from lelĩ; to right. Only at an equilibrium
price o f $ 12,000 are the intentions o f the passengers and cruise operators exactly meshed
together. A t a price above $ 12,000 there is a surplus, and market pressures íorce prices to
fall. Suppliers will vvithdravv from the market. A t prices belovv the equilibrium value, there is a
shortage, and market pressure develops for the prices to rise.The quantity demanded will fall,
while the quantity supplied will increase, reducing the excess o f demand over supply.The excess
demand disappears at $ 12,000.
In the following diagram, Pigure 1.7, the above argument is represented in a different form.
o.
Passenger numbers (OOOs)
Pigure 1.7 Simpliíied model o f cruise market
In the model, equilibrium price is p with quantity Q. A t the higher price p I , quantity demanded
stands at Q1 and quantity supplied is Q2. Thereíore, there is an excess o f quantity supplied
over the quantity demanded at price p I , vvhich creates downward pressure on the price, íorcing
it towards equilibrium price R Comparing p to p I , iess is supplied but more is consumed.These
two processes both help to eliminate the excess supply that exists.
A t the lower price P2, the quantity supplied would be Q3, while buyers wish to purchase Q4.
This means that at price P2,there is an excess o f quantity demanded overthe quantity supplied.
A shortage exists at price P2, and pressure will be built up to íorce the price up, to return to
market equilibhum R
Economics of SeaTransport and International Trade 13

C h a p te r I
1.6 D Y N A M IC A D J U S T M E N T
The model described above is the simplest possible model o f competitive market price
determination. It is a static model, in that the effects o f shifts in supply and demand on the
modei are not really considered. Indeed, there is an assumption that all transactions that take
place in the market do so only at the equilibrium price, such as the price p in Pigure 1.7. No
transactions are permitted to take place at disequilibrium prices.
W hile a useful model in many waỵs, it also has some drawbacks. Perhaps the most significant is
the failure to allow for the fact that there may be a considerable period o f time for the required
adjustments in supply to take place. For example, the shipping markets went through a crisis
o f severe overcapacity o f tonnage in the early I980s. This problem did not resolve itselí for
several years.The market model described above vvould thereíore have to be modiíied to allow
for this problem.
1.7 C O N C L U S IO N
This chapter has been aimed at providing students with knowledge o f some of the basic
concepts o f economics. The key concepts o f opportunity cost, utility and price have been
discussed. Second, a model o f demand and supply and price determination in a competitive
market was developed. It is very important that all readers grasp these basic concepts, and the
analysis o f demand and supply, because they wiil be heavily used in the following chapters.

ĩ'Wề
Demand for shipping

C h a p te r 2
IN T R O D U C T IO N
Demand for shipping, like that for all íorms o f íreight and passenger transport, results from the
final consumers' demand for goods. It is not a direct demand but a derived demand. Shipping is
a factor that is not in demand for its own sake but is derived from the demand for the goods
that are being transported. This discussion does not include any consideration o f the cruise
trade.This demand is closely related to the grovvth in world income, particularly o f that o f the
developed world, which is the major iníluence on the level o f seaborne trade. The average
distance o f hauls, costs of transportation, and other factors, particularly international crises, have
an important impact on the levels o f derived demand for shipping. In this chapten empihcal
evidence o f trends in the level o f seaborne trade, and íactors iníluencing it, will be related to a
theoretical analysis o f demand.
2.1 A N E C O N O M IC A N A LY S IS OF T H E D E M A N D FOR
S H IP P IN G
The demand for shipping is dependent upon the amount o f international trade generated
between countries. Seaborne trade accounts for the bulk o f international movements. About
75% o f the vvorld trade volume is carried by sea. The level o f demand is dependent on a
number o f factors, the most important o f which are:
• the level o f w orld economic activity;
• the voiume of seaborne trade generated and its major commodities;

• the distance over which the cargo is hauled;
• external íactors and events.
These íactors will be examined individually in the light o f their importance in an economic
analysis of shipping demand.
VVorld econom ic activity
This is a maịor íactor in the level o f demand for seaborne trade. In the long run, it is dependent
upon elements such as the ievel o f vvorld population and changes in standards of living. In
the short run, a diversity o f elements can be, and are, important. One study o f the relative
contributions o f economic growth, trade liberalisation and transport cost reduction found that
70% o f the observed increase in vvorld trade was solely due to simple economic growth in the
relevant economies.
The best guides to changes and trends in the economy o f the world or that of individual
countries are gross domestic product (GDP) and gross national product (GNP).
GDP is a measure o f the total flow o f goods and services produced by the economy, normally
calculated on an annual basis. It is obtained by adding together the value o f output, that is, the
íinal consumption, investment goods, government consumption and investment and exports
less imports, at current market prices. It measures the level o f economic activity vvithin the
national írontiers o f a countrỵ. It is gross because no allowance is made for the depreciation of
Capital goods and labour used in the production o f those services.This explains why it is often
reíerred to as gross domestic value added.
GNP is the annual total o f the goods and services produced in a countrys economy, valued
at current market prices. It includes incomes accrued from investments abroad less incomes
earned by íoreigners in the domestic economy. It is gross domestic product plus net íoreign
investment earnings earned on overseas assets ovvned by that countrys residents. It is national
because it is a measure o f all resources controlled by its citizens, irrespective o f the physical

D e m a n d f o r s h ip p in g
location o f those resources. For example, UK net earnings from assets in the USA are included
in GNP figures, but are not in GDP figures.
Case s tu d y : Price mechanism for demand and supply

VVhen there are several vessels available to carry one cargo (there is excess supply), the
íreight rate will be low as shipowners compete by lovvehng the cost forthe charteren that
is, the freight rate.
In the reverse case, when there are several cargos for one vessel (excess demand) the
íreight rate will be higher as charterers try to insure transport for their cargo by offehng
higher rates.
In the shipping industry, hovveven it is im portantto keep in mind thatthese prices can have
long-term effects.When shipovvners observe the first case in a systematic way, they will
order fewer ships in an effort to limit the supply o f shipping capacity and over time push
rates highen A t low prices, production (shipping capacity) gets limited.
In a converse way, if shipovvners find themselves systematically in the second case, high
íreight rates will encourage owners to order more ships and increase shipping capacity.
Over time, this will stabilise and possibly reduce rates. A t higher prices, production gets
increased.
GNP and GDP are measured in two diíĩerent ways. VVhen 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, ratherthan changes in the volume o f o u tp u tA good example is the case o f
Zimbabwe in 2007.W ith a reported inílation rate o f 3,000% per yean GDP in nominal terms will
increase by 3,000%.This does not reílect the underiying períormance o f the economy, because
all o f this growth is generated by an increase in prices. A better indicator o f changes in volume is
obtained when GDP and GNP are measured at constant phces, which simply means measuring,
for example, the value o f UK GDP in 2004, 2005 and 2006 at 2004 prices.This means that any
change in output between 2004 and 2006 vvould reílect changes in volume only, not changes
in prices. Economists reíer to this as real term measurement Prices, used as the basis for this
process, are quite arbitrary. Often the base is changed every fìve years or so.Thus 2007 UK
GDP measured in 2005 prices means that the grovvth in GDP when using these Tigures would
reílect the change in the volume o f economic activity betvveen 2005 and 2007. This is useíul
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. In this chapterthe main indicators o f growth in all countries
o f the world, GDP or GNR are simply added together and so a crude indicator o f the level o f
international activity is obtained.
Analysis o f world trade is provided by two organisations: the Organisation for Economic
Co-operation and Development (OECD) and the VVorld Trade Organisation W TO). The
OECD is an economic organisation o f 34 marketeconomy countries, whose members consist o f
Scandinavia, most European countries plusTurkey, North America, Japan and Korea.and Australia,
New Zealand and Chile. OECD countries account for over 50% o f exports o f merchandise
trade in 2 0 13. Seven o f the 10 leading exporters are OECD countries, as are half o f the top 50
leading exporters.
A group o f fast-growing developing economies is the so-called BRIC countries: Brazil, Russian
Pederation, India and China.The elevation o f China to the number one exporter o f merchandise
exports is well known. Including Hong Kong, the BRIC countries ạ^puntt ĩơ[_ over 20% o f
vvorld exports.

C h a p te r 2
The VVTO, as the international organisation on issues relating to world trade, is pre-eminent with
160 member countries (more strictly 'customs territories') and a further 20 observers (who in
time will become W TO members).The W TO publishes data on world trade in merchandise
and commercial services by value in us$ in WTO Internaớonơl Trơde Statistics.
2 .1. 1 S eaborne tra d e

Maritime transport dominates international trade. It has been estimated that approximately
75% o f vvorld trade by vveight moves by sea, but, when measured in terms o f value, the share
falls to approximately 60%.
The total volume o f trade has more than doubled in the 20 years between 1995 and 2015,
from 5,191 million tonnes to 10,956 million tonnes. Against the background o f this increase
were changes in particular commodities’ contribution to the total. Crude oil declined írom 28%
to 11% o f the total.The fìve major dry bulk commodities (iron ore, coal, grain, bauxite/alumina
and phosphate) increased their share from 2 1% to 29%. The most noticeabie change is that
of containers, which doubled its share from 1% to 16%, while other dry, mainly general cargo,
declined from 14% to 10%.
The 2015 shares are shown in Pigure 2.1.Table 2.1 provides detailed information on the
development o f seaborne trade over the period 19 90 -2 0 15, measured in millions o f tonnes of
cargo.The data has been obtained from Clarksons Research Services and the United Nations
Coníerence on Trade and Development (UNCTAD) publication, Review o f Mơritime Transport.
The Review of Maritime Transport contains a weaith o f data on shipping demand and supply, and
the íreight markets; and is published annually and is free to download.
Seaborne trade 2015

(tonnes)
Gas & Chemicals
6%
Products
9%
M inor bulks
13%
Pigure 2 .1 Percentage shares o f major seaborne commodities (tonnes) (source: derived íromTable 2 .1).

Year Crude oil Oil Major Minor Containers Other dry Total Annual
products bulks bulks trade change
1990 1,133 432 999 708 237 633 4,333 5%
1991 1,217 390 1,019 701 259 660 4,442 3%
1992 1,339 396 1,003 721 283 682 4,623 4%
1993 1,326 430 1,019 735 31 1 697 4,730 2%
1994 1,402 427 1,039 793 345 703 4,934 4%
1995 1,455 449 1,105 831 376 741 5,191 5%
1996 1,488 492 1,1 19 834 416 819 5,415 4%
1997 1,584 488 1,191 853 454 888 5,718 6%
1998 1,537 477 1,189 849 487 894 5,696 0%
1999 1,591 509 1.191 854 542 874 5,844 3%
2000 1,677 572 1,303 890 607 918 6,269 7%
2001 1,667 552 1,345 893 628 922 6,31 1 \%
2002 1,634 559 1,393 917 692 975 6,492 3%
2003 1,760 587 1,477 975 802 915 6,857 6%
2004 1,848 648 1,604 1,045 91 1 894 7,307 7%
2005 1,878 71 1 1,71 1 1,084 1,002 876 7,638 S7o
2006 1,891 769 1,824 1,163 1,091 865 8,007 s%
2007 1,912 798 1,975 1,243 1,216 789 8,363 4%
2008 1,902 823 2,080 1,231 1,271 830 8.573 3%
2009 1,815 833 2,120 1,097 1,134 811 8,259 -4%
2010 1,868 888 2,384 1,221 1,291 874 9,031 9%
201 1 1,851 915 2,540 1.301 1,405 881 9,440 5%
2012 1,901 923 2,743 1,355 1,454 909 9,839 4%
2013 "l,833 ” 959 2,923 1,408 1,531 953 10,175 3%
2014 1,809 980 3,072 1,432 1,629 1,012 10,521 3%
2015 1,835 1,013 3,189 1,479 1,743 1,079 10,956 4%
Average growth rates
1.9% 3.5% 4.8% 3.0% 8.3% 2.2% 3.8%
Table 2 ,1 Development o f world seabome trade (million tonnes), 1990- 2 0 15 (source: Clarksons
Research Services)
Note 1:2014 and 2 0 15 data are based on estimates. Note 2:Totơl trade tonnoge includes gas and
chemical trades.
The acceleration and deceleration in world trade over the last 25 years broadly mirrors the
experience o f the levei o f economic activity. This is reílected íairly closely in the demand for
shipping and seaborne trade volumes. Growth during the I990s was unsteady, with seaborne
trade volumes slovving in 1993 and 1998. A lter 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
vvhich caused a 4% reduction in overall seaborne trade in 2009.The commodity trades most
aíĩected were crude oil, m inor 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 then there has been a strong recovery.

C h a p te r 2
Any practical economíc analysis or íorecast undertaken into the demand for seaborne trade
needs to include the important individual components evident inTable 2 .1These are as follows:
• the volume o f oil movements:
• shipments o f major dry bulks, in particular iron ore and coal fo r Steel production;
seasonal movements o f grain;

changes to other dry cargo, especially Container trades;
íreight rates;
• other íactors.
To look at each component individually:
O il movements
The change in the price o f oil was the main iníluence on changes in volume throughout the
decades. Looking at the phce movement using official Arabian light oil in dollars per barrel, the
price rose from $18 in mid-1979 to a long-standing peak o f $34 through 1982 and much of
1983. The impact o f this price rise resulted in the decline in oil movements in the early years
of the decade. Such price levels encouraged importing countries to curtail their consumption
and seek oil substitutes, and stimulated the opening o f new tìelds closer to the market. This
dramatic rise in oil prices was matched by an equally dramatic decline in the mid-l980s and
continuing, at a very low pace, until 1990. During much o f this period offìcial prices varied in the
region o f $ 17.5 to $ 18 per barrel.The low price, combined with exchange Auctuations íavouring
consumer countries and the deregulation o f im port Controls on Petroleum and Petroleum
products, served to encourage oil movements from 1986 onwards.
Iraqs invasion o f Kuvvait in August 1990 led to a Sharp increase in the world price of oil, but
other oil-exporting countries, particularly Saudi Arabia, boosted production to offset the loss o f
Kuvvaiti oil. Prices soon came down again, reaching levels that were similarto the pre-1973 chsis
values, when adjusted for inílation, W orld crude oil prices stabilised at around $16 per barrel
in the mid-l990s.There were some decreases in the supply at the end o f the decade and into
the year 2000 which caused oil prices to increase substantially to over $30 per barrel.
100 Nominal priCG spare capacity, crude oucages in Nigeria, iraq, l^rth Sea
90
Real price, 1970 u s Dollars
80
_ 70
ỉ 60 Itaq-lran war
ỉQ, 50
Iranian Revolution
40
30
20
10
1970
Pigure 2.2 Nominal spot pnce o f crude oil, 19 7 0 -2 0 10 ($/bbl) (source: BP Worl(jwide Review o[
Energy 201 I)
Notes: I . Price is Arab Light, 1972-1985: 198Ó-2010 Dubai dated. 2. Price IS nominơl per bơrrel. Nominal
means measured in that years prices. No adjustment made for changing value o f the dollar over time.

Oil prices have risen dramatically since the mid-2000s, following the events o f I 1 September
2 00 1, Pigure 2.2 shovvs that the annual average price o f spot crude oil, vvhich itselí hides large
daily íluctuations, rose to around $60 per barrel in 2006. In nominal terms, this is a very high
íìgure, but in real terms the price was below the equivalent values recorded in the 19 7 7 -19 8 1
period.This may explain the fact that high oil prices did not trigger a recession. In late 2007, oil
prices again accelerated, reaching over $ 100 a barrel in 2008, before íalling backThe price o f oil
continued to fall for most o f 2009 only to rebound sharply in 201 I to $1 10 where it remained
until 2 0 13.
The 201 1-2013 real term prices were the highest ever and have led to significant shifts in
motoring behaviour as retail prices increased. The íìnancial crisis caused by the sub-phme
mortgage crisis triggered a major recession in most Western countries. Nevertheless, the
prevailing level o f oil prices reílects the fact that the industry demand levels are running close
to present reíinery capacity production limits. The high oil price triggered greater efforts at
exploring and extracting oil, as well as economising on its use. Increased awareness of climate
change and the role o f hydrocarbons in C O 2 emissions, means that there may be a long-term
decline in the intensity o f use o f oil Products, offset to some e xten t by increasing dem and by th e
developing economies o f Brazil, Russia, India and China (the BRIC countries).
Yet, as the shipping industry adjusted to the high cost o f intermediate fuel oil, diesel and marine
gasoil prices, including slow steaming, there was a fall in the oii price to belovv $IOO/bbl in
2014 due to a slack global economic activity in many developed economies and continued
high Organisation o f Petroleum Exporting Countries (OPEC) output (despite limited output
from Libya and Iraq). Purthermore, shale oil and gas production in the USA accelerated this fall,
reaching a low o f $50/bbl in early 2 0 15.
Iron o re and coal shipments

The trend in demand for Steel and Steel products is closely associated vvith other bulk cargoes.
This makes demand for Steel o f considerable importance to the shipping industry, as it means
not only an increase in the movement o f crude Steel, but also in iron ore, coking coal, steam coal
and other bulk Products necessary fo r its production.
During the period under consideration, the Steel industry undewent important structural
changes.To simpliíy a complex situation, production by the steelmakers o f Europe, America and
Japan remained comparatively static. Capacity expanded rapidly in the developing economies
such as China and Korea. China increased its Steel production from about 60m tonnes per year
in 1990 to 90m tonnes in 1995, an increase o f 50%. By 1996 China was the leading producer
o f crude Steel production, exceeding the EU (27) in 2003. In 201 3, China produced nearly 50%
of world Steel. Next behind China,Japan produced 1% and the USA 5% o f vvorld Steel in 201 3.
The volume o f seaborne trade in iron ore and coal, essential components o f Steel production,
closely follows crude Steel production. China now imports two-thirds o f vvorld iron ore output,
o f which tw o countries, Australia and Brazil, provide most o f Chinas needs. Togethen these
tw o countries were responsible for three-quarters o f world output o f iron ore in 2013. The
seaborne trade in iron ore and coal continued to grow even during the 2008-2009 recession,
driven by Chinas grovving economy. Betvveen 2007 and 2013, both seaborne trades grew at
7% per annum. Despite a slowdown in Chinas economic expansion to around 7%, in part
due to a shift from investment to consumption, which requires less trade in raw materials,
urbanisation, inírastructure developments, including transport and ongoing energy needs, drive
these seaborne trades.
Trade in coal is o f two types: coking coal used in Steel production and thermal coal for power
generation.Thermal coal accounted for three-quarters o f coal movements in 2 0 13. Again, the
majority was destined for Asia, including China,Japan, India and Korea.The increase in coal-fired
power stations in India and low international prices encouraged a healthy trade. Nearly two-
thirds o f coal exports come from Indonesia and Australia.
Economics of Sea Transport and International Trade 21

C h a p te r 2
G rain
There are numerous definitions of grain and coarse grain. Generally, in maritime transport, both
cargoes are based on several types of grain such as vvheat, barley, oats, rye, sorghum and soya
beans. Rice is usually bagged and so excluded from this analysis. Grain is a signiíìcant íactor in
demand for bulk dry cargo tonnage. In the longerterm, changes in the Standard o f diet and the
grovvth in vvorld population are major íactors, as is the use o f grain as animal íeed.The balance
o f demand and supply is in the main covered by the production o f North America. Here tw o
points should be made.
First, against the level o f total growth in grain production the percentage volume movement
in seaborne trade appears to be at íìrst sight insignificant. According to íìgures from the
International Grain Council the estimated world production o f grain in 2 0 13 -2 0 14 was 1,993
million tonnes yet the seaborne trade was only 384 million tonnes, about 20% o f production.
Second, vvhile the long run or lO-year Tigures may indicate smooth movements, short run
experience IS totally diíĩerent To State the obvious, grain production is iníiuenced largely by
vveather conditions and varies from year to yean
The subsidised íarming arrangements in the EU and the USA have led to accusations that the
trade in agricultural Products is heavily distorted and has lovvered the w orld price o f grain, to
the detriment o f farmers in developing countries. This debate has been Central to the Doha
round o f negotiations at the WTO.The Doha round has dragged on since 2001, and is still not
completed. The meeting in 2008 failed on the removal o f agricultural subsidies. It is the case
that vvorld trade in grain, and in other agricultural products, is still subịect to trade barriers that
have long since been removed from other commodities.The failure o f the grain trade to grow
rapidly in the past 10 years may be due to this fact. But it is still the case that wars, famines and
crop íailures due to exceptional vveather conditions are still íactors in explaining the year-to-
year variations in grain trading that occurs. Such changes have generated signiíìcant shifts in the
trading pattern o f vesseis engaged in grain transportation.
The production o f ethanol and bioíuels in the USA consurnes 25% o f that countrys grain crop.
Enough grain to feed 350m people per year was pumped into transport vehicles in 20l0.This
eíĩort to reduce the USA’s reliance on íoreign oil imports has also altered trading patterns in
the grain trade.
O th e r d ry cargoes
This includes the minor bulks, generai break-bulk cargo, roll-on/roll-off and unitised cargoes.
The latter has seen multiple changes, especially the vast increase in containerisation.The liner
trade's growth has been spectacular in the past few years, with 170 million teu carried by sea in
2014, encouraged by the expansion in world trade.The roie o f China, as a major manuíacturer
o f finished goods, in driving the growth o f the Container trade cannot be overemphasised.The
grovving globalisation o f production has been facilitated by the development o f the liner industry.
Containerised traffic has been given a significant boost by greater trade liberaiisation and by
economic grovvth. It is estimated that the liberalisation o f trade has contributed about 20% to
growth in the liner industry.The largest íactor contributing tc the success o f the liner indưstry
is still economic growth and overcapacity, hence the recent problems the liner market is íacing
since the economic downturn following the financial chsis.
Preight rates
Preight rates vvill be discussed in some detail belovv and in later chapters. Empirical evidence
has shovvn that the fall in íreight rates in real terms over the long term has made a signiíìcant
contribution to the grovvth o f world trade. A t the level o f individual trading companies, such
prices are seen as key to their success.

External íactors
These include natural phenomena, changes in technology, economic shocks and political events.
For example, any major breakthrough in railways, aircrait or pipelines vvould have a serious
impact on shipping demand. Economic shocks, not to be coníused with business cycles, can
cause sudden changes in shipping demand, such as oil price rise or recession. A more obvious
and immediate impact would be political events, the most proíound being vvars, which change
demand criteria overnight.
Pinally, natural events, especially natural disasters, such as droughts which have an impact on
grain harvests or írosts on coffee crops, result in alterations in the demand for shipping.The
Boxing Day tsunami that struck Indonesia, India and Sri Lanka in 2004 disrupted shipping and
affected rates in the region.The Japanese earthquake and tsunami in March 201 I shut down all
but one o f Japan's 54 nuclear plants, closing out 30% o fth e countrys power production.This has
been replaced by íossil fuels such as coal and natural gas, causing an increase in demand for coal
and LNG at a time when rates in these sectors were under pressure.
2.2 D IS T A N C E A N D T H E C O N C E P T OF T O N N E -M IL E S
It has already been argued that the demand for shipping space is largely determined by the level
of economic activity, which is closely related to the quantity and nature o f the commodities
offered in seaborne trade.This is based on the number o f tonnes o f cargo transported. The
other important íactor is shipping distance. One tonne o f wheat to Europe from Australia via
the Cape will generate three times the demand for tonnage as the same tonne o f vvheat from
Canada. Thereíore, a more satisíactory measure o f demand is the weight multiplied by the
distance that the tonne has travelled.This is known as tonne-miles. For example;
8 tonnes o f cargo are carried 500 nautical miles.The tonne-miles will be 8 X 500 = 4,000 tonne-
miles.
Table 2.2 provides the trends in selected trades between 1990 and 2015 in tonne-miles.This
differs from data measured in tonnes o f cargo to the extent that demand is affected by changes
in cargo volumes and by changes in the average distance that the cargo is carried or average
haul.The importance o f distance can be illustrated by the example o f the closure o f the Suez
Canal betvveen 1967 and 1975.The closure almost doubled the distance by sea between the
Arabian Gulf and Europe írom 6,000 miles (via Suez) to I 1,000 miles via the Cape o f Good
Hope.This important oil route contributed to the grovvth in the average haul for crude oil from
about 5,000 miles in 1967 to 7,000 miles in 1975 and resulted in a íreight market boom.

C h a p te r 2
Year Crude oil Oil LNG Iron ore Coal Grain Container Total
Products
1990 5,355 1,285 n/a 1,874 1,823 1,31 1 1,238 n/a
i99l 5,750 1,155 n/a 1,902 1,971 1,306 1,350 n/a
1992 6,344 1,180 n/a 1,796 1,973 1,333 1,474 n/a
1993 6,257 1,283 n/a 1.895 1,922 1,268 1,623 n/a
1994 6,610 1,255 n/a 2,051 1,986 1,212 1.799 ^ n/a
1995 6,945 1,351 n/a 2,166 2.146 1,418 1,961 n/a
1996 6,954 1,478 n/a 2,1 10 2,186 1,376 2,170 n/a
1997 7,441 1,370 n/a 2,315 2,299 1,429 2,369 n/a
1998 7,228 1,280 n/a 2,184 2,385 1,300 2,538 n/a
1999 7.651 1,413 264 2,195 2,330 1,449 2,824 n/a
2000 8,056 1,575 321 2,446 2,519 1,551 3,171 30,813
2001 7,799 1,554 348 2,533 2,606 1,667 3,272 30,948
2002 7,402 1,569 365 2,685 2,629 1,640 3,601 31,264
2003 8,023 1,675 403 2,875 2,813 1,778 4,216 33,299
2004 8,529 1,864 440 3,301 2,971 ^ 1,814 4,785 35,769
2005 8,606 2,123 457 3,715 3,088 1,844 5,269 37,267
2006 8,818 2,218 549 4,080 3,248 1,929 5,758 39,383
2007 8,725 2,287 631 4,520 3,4iO 2,061 6,422 40,754
n 1
2008 8,840 2,360 684 4,827 3,526 2,158 6,734 41,919
2009 8,121 2,501 689 5,365 3,441 2,221 6,030 40,090
2010 8,61 1 2,625 876 5,854 4,045 2,460 ^6,833" 44,364
201 1 8,707 2,711 1,059 6,337 Ị 4,318 2,404 7,428 46,609
2012 9,158 ^,745 1,046 6,720 4,852 2,587 7,617 48,865
2013 8,938 2,831 1,032 6,896 5,029 2,759 7,981 50,321
2014 ~9,055^ 2,895 1,077 7,566 ^5,137 “ 2,883 8,476 52,536
2015 9.284 3,022 1 1,150 7,960 5,254 2,954 9,057 54,838
Average grovvth r-ates
2.7% 3.5% 6,1% 6.0% 4.3% Ị 3.3% 8.3% i 3.9%
Table 2.2 Seaborne trade for selected commodities (billion tonne-miles) (sources; Clarksons Research
Services, 2 0 15; UNCTAD Revievự of Mantime Trơnsport 2 0 14).
Pigure 2.3 shows the percentage share o f the main commodities to total seaborne trade based
on tonne-miles in 20l5.These percentage shares are not signiíicantly different from those
for cargo tonnes in Pigure 2.1. N or is the average annual change, between 2000 and 2015,
with tonne-miles increasing by 3.9% per annum and tonnage increasing by 3.8%. Hovveven
aggregation o f individual commodities into broad groups hides diíĩerences between them and
changes over time.

D e m a n d f o r sh ìp p in g
Seaborne trade 2 015

(tonne-m íles)
Gas & Chemicals
5%
Products
5%
Pigure 2.3 Percentage share o f major seaborne commodities (tonne-miles). (source: derived from
Clarksons Research, 2 0 15).
As the tonne-miles reílect both changes to tonnage and distance, the average haul for a
commodity can be determined by dividing the tonne-miles for a particular commodity by the
tonnage. Pigure 2.4 presents the trends in the average haul for selected commodities between
2000 and 2015.
Average haul 2 0 0 0 -2 0 15
-Crude
-ư iG
-Ironore
-Coal
-Grain
•Steel
-Forest
Year
Pigure 2.4 Development o f average haul for selected commodities, 2000-2015 (source: denved from
table 2.2)
Notwithstanding the diffìculties in collecting accurate seaborne trade data in tonnes and tonne-
miles, analysis o f average haul can be more challenging, although the reasons for maịor changes
can oíten be readiiy explained. Stopíord {Mahtime Economics, 2009, pp 146-7) states that 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, such as, Libya and
the North Sea to Europe, or Mexico and Venezuela to the United States o f America. Alternative
sources o f oil are likely to come from the Middle East, vvhich is considerably íurther away from
both the USA and Europe.The average haul in the oil trade therefore depends upon the balance
o f output between these two groups o f suppliers.

C h a p te r 2
The same also applies to the bulk trades. For example, as iron ore sources from N o w a y and
Svveden are unable to keep up vvith European demand, supplies from Australia and Brazil are
obtained.
Contemporary examples include:
• interruption oí crude oil supplies from Libya due to civil war are compensated by supplies
to Europe from West Aírica and the Black Sea;
• closure o f refineries in Europe results in more oil Products being sourced from the USA
and the Arabian Gulf;
• drought in the USA constrains traditional grain exports to Asia, vvhich are compensated by
exports from Brazil;
• China increasing im p o rts o f iron ore írom Brazil in preíerence to Australia;

• Indonesias export ban o f unprocessed mineral ores, such as bauxite, means China sourcing
their requirements írom Aírica and the Caribbean.
2.3 D ER IVED D E M A N D FOR S H IP P IN G

Earlier it was argued that normal effective demand was an expression o f the quantity that
consumers are prepared to buy over a range o f products, supported by the ability to pay.This
discussion examined the case o f an imaginary cruise market vvhere the consumers’ objective
was to have an enjoyable holiday, including in it a sea voyage back to the original point o f
embarkation. Sea cruises are the exception and not to be coníused with the pure transport
activity o f the rest of the shipping industry. Demand for shipping is an indirect demand. Shipping
IS seen as an element in the process o f production; demanded not fo r its own sake but fo r the
contribution it makes to the production o f fìnal consumer goods and services.
We illustrate the concept o f derived demand with exampies:
The demand from the final consumers for petrol to fìli their car or m otor cycle in Singapore.
This is related to the earlier derived demand íortankers to convey the oil from the producer in
Kuwait to the refìnery and then to the distribution point.
The demand for a cup o f coffee at the end o f a meal in a restaurant in Glasgovv is part o f a
derived demand íortonnage to transport coííee from Brazil to the United Kingdom.
This is the essential diíĩerence írom the cruise passenger market, whose fìnal demand was a
satisíactory holiday on a cruise ship.To restate the defìnition, the derived demand for a íactor
like shipping is dependent on the ultimate demand for the finai consumer product.The derived
demand for dry cargo tonnage in conveying vvheat comes directly from the final consumers'
demand for bread. Students will have perceived that the theoretical economic concept o f
derived demand underlies much ofthe previous discussion o fth e importance ofthe relationship
between increased economic activity and the level o f international seaborne trade.
2.4 E L A S T IC IT Y OF D E M A N D
Many company executives use the concept o f price elasticity o f demand. Consider the managing
director of a íerry company that is losing money.The problem is what will happen to passenger
revenues when fares are lovvered? There are three possibilities to be considered.The situation
could be that, with a lowering o f íares, more passengers travel by ferry and the total revenue
increases.Total revenue is defined as price multiplied by quantity, which in this case is identical to
the product o f the íare multiplied by the nutnber o f passengers.

Price Ferry Total Marginal % Change % Change Arc Point

(í) (P) passéngers revenue revenue in price in quantity elasticity elasticity
demand (TR) (£000) (MR) (£) (Note 2) (Note 2) (col 6/cól 5) (Note 4)
(000) (Q) ( P x Q) (Note 1) (Note 3)
200 0 0 0 - - -
180 1 180 180 -10.5 200.0 -19.0 -9,0
160 2 320 140 -1 1.8 66.7 -5.70 -4.0
140 3 420 100 -13.3 40.0 -3,00 -2.3
120 4 480 60 -15.4 28.6 -1.86 -1,5
100 5 500 20 -18.2 22.2 -1.22 -1.0
80 6 480 -20 -222 18,2 -0.82 -0.7
60 7 420 -60 -28.6 15.4 -0,54 -0.4
40 8 320 -100 -40.0 13.3 -0.33 -0.3
20 9 180 -140 -Ố6.7 1 1.8 -0.18 -0.1
Table 2.3 Pnce elasticity o f demand for a ferry Service (daily trip numbers)
Notes:
1.Total revenue (col 3) is the product o f price and quantity. Marginal revenue (col 4) IS the extra totơl revenue
earned by selling One extra unit o f output, that IS. one more pơssenger [are. MR - ATR/AQ.
2. Percentơge changes are here defined relative to the average o f the initial and (tnal values for the change. For
example.the I0.5% fallin price is derived from -20/((200 + l80)/2) = -20 /19 0 = -10.5%.
3. The Arc elasticity Is measured as the ratio o f the percentage change in quantity demand divided by the
percentage change in prices, as defined in note 2.
4. Point elasticity is the ratio (P/Q) X dQ/dP, which is P/Q X (-0.05), as dQ/dP = l/(dPỉdQ) = l/(-2 0 ) = -0.05.
The lovvering o f fares leaves the number o f passengers unchanged; this vvould also serve to
reduce total revenue.
The lowering o f fares increases the number of passengers travelling with the company, but total
revenues actually deciine as the increase in the number o f passengers is more than offset by the
fall in the average fare that each passenger pays,
An important point arises from the above analysis.The importance o f being able to íorecast
the effect on demand of a change in price, and vvhether or not the passengers have substitute
modes o f travel that they can easily utilise, is crucial.The Central point here is the responsiveness
of buyers to a change in price.This is knovvn as the price elasticity o f demand, or simply elasticity
of demand. In general terms, elasticity can be defined as a measure o f the responsiveness o f one
variable to a change in anothen
In the íerry Service example.the degree o f responsiveness o f passenger traíĩic is nneasured with
regard to changes in íares.The íerry situation is set out inTable 2.3, from which a number o f
observations can be made.
An important fare in the table is that of £ 100. Lovvering íares has the effect o f raising both the
quantity of ferry trips demanded by consumers, and the ferry companys total revenue, until the
price is reduced from £120 to £100. Purther reductions beyond that point cause total revenue
to contract, even though the number of íerry trips continues to increase. It can be seen that
marginal revenue changes from a positive to a negative. Any reduction below the £100 fare,
for example, to £80 or £60, causes a fall in total revenues, even though passenger numbers stili
rise.The percentage increase in quantity demanded is now smaller than the percentage fall in
íares and thereíore total revenue or price times quantity falls. It reduces from £500,000 at a fare
o f £100 to £420,000 at a íare o f £60. The table highlights the importance o f the relationship
between percentage changes in the number o f passengers and the percentage changes in fares
and the effect this will have on total revenue.

C h a p te r 2
It has already been pointed out that when the price falls below £100, íurther decreases in
price lead to a fall in revenues.You will note that at this point, the arc elasticity changes from
being greater than unity to becoming smaller than unity. In fact, total revenues are maximised
and cannot be made any larger at the price o f £ 100 per ticket.This point o f maximum revenue
always corresponds to the own price elasticity having unit value.You will aiso note that marginal
revenue switches from being positive at prices greater than £ 100, goes through zero at the
price o f £100, and becomes increasingly negative as prices fall below the £100 markThis is no
accident. It can be shown, in general terms, that marginal revenues, total revenues and elasticity
values are all related, and are essentially different aspects o f the same íundamental relationship
derived when demand íunctions are linear in price and quantity.
Column eight o fT able 2.3 provides a diíĩerent measure o f price elasticity o f demand, known
as point elasticity or marginal elasticity. This is the most accurate conceptual measure, as it is
deíined in terms o f a very, very, small percentage change in price and the associated percentage
change in quantity demanded that it brings about.
The above results are laid out in table 2.4.
lf demand Symbolically Means that VVhen price falls May imply

is presence of
Price elastic Ed > 1 % change in Q > % Total revenues rise Substitute
! change in p products
Unit price E d=v~~ % change in Q = 9Ố Total revenues
elastic change in p remain unchanged
Price inelastic Ed < 1 % change in Q < % Total revenues fall Few or no close
change in p substitutes
Períectly Ed = 0 % change in Q = zero Total revenues fall No substitutes
price inelastic by the percentage at all
fall in price
Table 2.4 Elasticity o f demand and total revenue
Q stands for quantity demanded. p stands for unit price.
Note:Vaiues are caiculated Ignoring the sign of the price elasticity. If the signs are induded, the inequalities
would have to be reversed.
Consider the importance o f elasticity, not in the case o f a passenger ferry but, as an example, in
relation to dry cargo freights.A simple model can be constructed around a group of dry cargo
shipowners who need to be able to calculate what eíĩect the fall in ĩreight rates vvouid have on
theirtotal revenue.
Let us consider three difFerent situations:
Situation I : Elasticity > I (Elastic)

Onginal íreight rate perton = $ IO (F I)
Number o f tonnes which shippers demanded = 9,000 (Q l)
Total revenue is = $90,000 (O FIQ I)
Preight rate contracts to = $8
(F2) Number o f tonnes shippers' demand increases to = 15,000 (Q2)
Total revenue increases to = $120,000 (0F2 E2Q2)

ĩ
00
s
. 1-
Pigure 2.5 Elastic ĩreight market.
Total revenue area 0FI EI Q I < area 0F2 E2 Q2.

In this situation, despite the contraction in the freight rate, shippers receive an increase in the
amount o f total revenue.
In terms o f arc elasticity, the calculated value o f the above example is íound as follows:
% change in Q = ( 15,000 - 9,000) / ( ( 15,000 + 9,000)/2) = 6,000/12,000 = + 1/2.
% change in p = ($8 - $ 10) / (($8 + $ 10)/2) = -2/9.
Elasticity = (1/2) / (-2/9) = (1/2) X (-9/2) = -9/4 = -2.25,
This is an elastic value, as it exceeds unity (ignoring sign).
Situation 2; Elasticity < I (Inelastic)

Original íreight rate = $6 (Fl)
Number o f tonnes which shippers demanded = 20,000 ( Q I )
Total revenue is = $120,000 (OFI Q l)
Preight rate contracts to = $4 (F2)

Number o f tonnes shippers’ demand increases to = 25,000 (Q2)
Total revenue contracts to = $100,000 (0F2 Q2)

C h a p te r 2
ĩ
ọọ
ỉ
Pigure 2.6 Inelastic íreight market
Total revenue area 0FI EI Q I > area 0F2 E2 Q2.

In this situation, a fali in the íreight rate has resulted in a contraction in total revenue despite the
fact that an inelastic demand implies that there are no, or few, substitutes available.
In terms o f arc elasticity, the calculated value o fth e above example is íound as follows:
% change in Q = (25,000 - 20,000) / ((25,000 + 20,000)/2) = 5,000/22,500 = 50/225

= 2/9
% change in p = ($4 - $6) / (($4 + $6)/2) = -2/5,

Elasticity = (2/9) / (-2/5) = (2/9) X (-5/2) = -0.556,
This is an inelastic vaiue, as it is less than unity (ignoring sign).
Situation 3: Elasticity = I (U nity)

Original freight rate = $8 (Fl)
Number o f tonnes shippers’ demanded = 15,000 (Q l)
Total revenue is = $120,000 (OFI El Q l)
Preight rate contracts to = $6 (F2)
Number o f tonnes shippers’ demand increases to = 20,000 (Q2)
Total revenue remains the same at = $ 120,000 (0F2 E2 Q2)

ĩ
Ổ
ế
'õ
ỉ_
Figui'e 2.7 Unitary elasticity
Total revenue area 0FI EI Q I = area 0F2 E2 Q2.

In terms o f arc elasticity, the calculated value o f the above example is found as follows:
% change in Q = (20,000 - 15,000) / ((20,000 + 15,000)/2) = 5,000/17,500 = 5 0/175 = 2/7.
% change in p = ($6 - $8) / (($6 + $8)/2) = -2/7.
Elasticity = (2/7) / (-2/7) = - 1.0.
This is a unit elasticity value, as it is exactly unity (ignoring sign).
Pinally, it should be pointed out that the concept o f elasticity does not just apply to price
alone. Any variable that is measurable, and aíĩects the demand for goods and services, can be
measured in elasticity form. For example, income elasticity can be computed to determine the
likely responsiveness o f demand to changes in economic activity, or real incomes. Similarly, the
impact o f changes in the prices o f substitute Products can be measured.This is known as cross
elasticity; for example, the effect o f a 10% rise in the price o f crude oil on the demand for coal,
given that oil and coal are alternative forms o f energy for power stations. Estimating elasticity
and using them in proịections is one o fth e more useíul tools in the economists tool kit.
2.5 D E R IV E D D E M A N D E L A S T IC IT Y
You will have noted in the above discussion that demand was forthe finai or ultimate consumers,
as in the case o f ferry passengers.This was done to develop the discussion o f elasticity in a
logical way.What was overlooked or ignored was that all íreight shipping is an intermediate part
o f a process o f production and the demand for shipping, like the demand for raw materials or
intermediate goods, is a derived demand.The demand is derived írom the consumers’ demand
ío rth e final product.

C h a p te r 2
Derived demand has a particular set o f rules relating to its elasticity. These rules, vvhich are
known as the Marshall Rules after Alfred Marshall, a I9th century English economist, 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.
Rule I
There are few, if any, substitutes for shipping. The argument here is that most products in
international trade require transportation by sea, for which there is not a close substitute.
R u le 2
Although there may be alternative sources o f the product supplied, these too will normally
require transportation by sea. Again, it is a case o f there being no substitutes. For example, while
coffee from Africa could be an alternative to coffee from South America, from the point o f view
o f the European consumer all wiil require sea transport, Again, it is a case o f there being no
substitutes.
R ule3
Preight rates are a small proportion o f íìnal cost. In terms o f the value o f cargo carried, íreight
rates are a small, often insignificant, proportion o f the total cost; hence a relatively large increase
in íreight rates makes relatively little difference to the price o f the product to the íìnal ultimate
consumenTable 2.5 illustrates this point.
Table 2.5 Preight cost as a percentage o f value o f imports (source: UNCTAD, Revíevv ofMaritime
Transport 2012)
This table serves to coníìrm the general conclusion that íreight rates are relatively minor
proportions o f the value o f the final or tìnished commodity.
R u le 4
Tlie elasticity o f demand for the íinal product will be an important íactor in the elasticity of
the derived demand for shipping.The lower or higher the price o f elasticity o f the íinal product,
the lovver or higher will be the price o f elasticity for shipping. Since many goods transported
by sea have a low elasticity, this will be reílected in the low elasticity o f demand for shipping. A
simplified model o f the whole idea can be put into the following words:
The derived elasticity Elasticity of demand

Transport cost as a
of demand for
shipping
—
íraction of final price X for the final
consumer goods
The model combines the ideas o f lack o f substitution and confirms that, in general, the derived
demand for cargo shipping will be inelastic. Given that on average, íreight rate constitutes only
one-tenth of the import value of a commodity, it follows that a 30% rise in the íreight rate will
only increase the import cost by 3%. From the Marshall Rules, it follows that even if the own

price elasticity o f demand íorthe imported commodity is high.the derived demand elasticity of
íreight rate will almost certainly be very price inelastic. Indeed, for crude oil, it can plausibly be
argued that the íreight rate elasticity is close to zero.
2.6 C O N C LU S IO N
This chapter has been aimed at relating the theory o f derived demand to the experience
o f the shipping industry over the last few decades. International trade was looked at both in
the vvidest sense, and in terms o f speciíic trades.These make up the essential components of
shipping demand and assist in analysing not only what has happened, but are part of creating
expectations about what will happen.

.
Chapter 3
The supply of shipping services
Supply is the am ount o f resources available.

C h a p te r 3
3 IN T R O D U C T IO N
In this chapter we will introduce the idea o f the supply o f shipping services.The íirst part of
the chapter provides a broad perspective on supply, and trends in the world merchant fleet
are examined. Purthen the concepts o f supply are reviewed and related to the data analysed
previously. Pinally, the concept o f supply eiasticity is discussed.
3.1 A B R O A D PERSPECTIVE
In the long run, one would expect to observe a correlation between the volume o f world
seaborne trade, measured in either tonne-miles per time period or cargo tonnes moved per
yean and the stock o f vessels employed in that activity.
It has already been observed that cargo volumes rose, peaked, declined and rose again, as world
trade and economic activity recovered from the recessionary period o f the late I970s and
early I980s. It moved into strong growth in the period 2002-2008. If the fleet size is atĩected by
market íorces, these changes in demand for shipping services should be reflected in long-term
trends in the size o f the merchant fleet.
But analysing the behaviour o f shipping supply is a much more complex taskThere is a need to
be able to 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.To do this, a clear
framework within which to examine the many different facets o f supply behaviour is required,
along with an analysis of how suppiy can be adjusted to changes in demand.
Having outlined a suitable framework, the statistical evidence concerning the world merchant
shipping fleet is reviewed, and then a simple theoretical model o f short- and long-term supply
responses to changing market conditions is constructed.
It is important to note that, for the purpose o f this analysis, there is an assumption that in eíĩect
there is only one market for shipping services. This is, o f course, completely false. There are
many distinct market sectors vvithin the shipping industry. Although the assumption is false, it is
nevertheless a useful One to make at this point.To a certain extent it can be deíended. Despite
the existence o f market segments, there is strong evidence that in the longerterm at least, those
markets are ali interrelated, so that they tend to move in sympathy with each othen
3.2 A F R A M E W O R K FOR A N A L Y S IN G T H E SUPPLY OF

S H IP P IN G SERVICES
3.2.1 M ea suring o u tp u t
To deíine supply properly, one needs to clariíy what the shipping industry actually produces. For
example, one should examine what is the output o f a unit o f shipping Service.There are, in fact,
two possible ansvvers to this question, as was touched on earlier in respect of demand.
First, shipping produces the act o f moving cargo around the world from p ort to port and from
terminal to terminal. Adding up the tonnes o f cargo moved pertim e period such as per day, per
week or per year gives a picture o f activity generated by the vvorking fieet. It should be noted
that outpưt is measured in volume terms, and not by cargo value. It is volume that determines
how much carrying capacity is required, ratherthan its value. Cargo volume is generally measured
in cargo tonnes, which can be related to the deadvveight tonnage or carrying capacity o f a ship.
Second, shipping produces nothing if ships do not move.This obvious point means that output
can be measured in terms o f the movement o f one tonne o f cargo over distance in a given
period o f time.This measurement is called the tonne-mile, the product o f the volume o f cargo
tonnes and the distance it travels in a given period o f time.Thereíore, a íully laden 250,000-tonne

T h e s u p p ly o f sh ip p ìn g se rvice s
capacity tanker carrying crude oil from the Arabian Gulf to Rotterdam via the Cape o f Good
Hope, will generate I 1, 169 nautical miles X 250,000 tonnes o f cargo = 2,792,250,000 or nearly
2.8 billion tonne-miles.
The distinction betvveen the tw o measures of output is important íortvvo reasons. First, changes
in a route composition of demand can generate changes in the demand fortonne-miles, even if
the cargo volume appears unchanged. Considerthe following example:
Case B
Cargo volume Route distance Time taken (days) tonne/miles
generated
150 22,238 93.1 1,675,350
50 10,348 43.1 258,700
200 1,934,050
Table 3.1 Eííect o f a change in route volumes on tonne-miles produced
By simply svvitching cargo volume írom one route to another, but keeping the total constant at
200 tonnes, an increase in tonne-miles has been generated.
3.2.2 A sch em atíc re p re s e n ta tio n o f th e s u p p ly o f ship p ìng

The supply o f shipping services can be altered in two principal ways; íìrst, by altering the stock o f
vessels and second, by altering the way that the existing stock o f vessels is employed,
3 .2 .2 .1 A lte rin g th e s to ck o f vessels

Beíore data on the stock o f shipping is examined, it may be helpíul to lay out schematically the
diííerent ways in which shipowners can alter the output that is produced by ships, vvhether
measured in terms o f tonne-miles or tonnes o f cargo.Table 3.1 illustrates the diííerent ways o f
altering the present stock o f vessels.This vvould be equivalent to the economists concept o f
the 'long run’ period; the period in vvhich the Capital stock tied up in a firm o r industry can be
varied. Such changes alterthe long run level o f output supply.This is because the items identiíìed
in the figure take a considerable period o f time to implement. Newbuild merchant ships need to
be designed, constructed and commissioned beĩore coming into Service, and this can take tw o
years or more.The boom years o f 2004-2008 led to deliveries extending much íurther into the
future, in some cases up to four years as orderbooks expanded. Scrapping a vessel takes less
time, but if the ship is still committed to trade it may not necessarily happen quickly.

C h a p te r 3
Pigure 3.1 Altering the stock o f vessels
The net change in the tonnage supply is clearly the result o f the relative sizes o f these two
íactors. In good times, deliveries wili be at a high rate, and scrapping rates will be low. But in bad
times, the flow o f deliveries will faiten vvhile the level o f scrapping will tend to increase.This will
be seen in the data presented later in the chapter It is worth mentioning here that the tonnage
supply can fall even ịf there are some deliveries: it is the difíerence between the tw o that alters
the stock.
Pormally, the above statement can be written as:

S., = D .- s c R + S ,
vvhere:
s is the stock at the beginning o f the next period;

D is the volume o f nevvbuildings delivered during the period;
scR is the tonnage scrapped.
It is clear that the diíĩerence measures the íleet change over the period and is equal to
the difference between the rate of delivery and the rate o f scrapping.
Case s tu d y : Opportunity Cost

An entrepreneur has $500 million to invest and she faces tw o possible options: to invest
in one ultra large ore carrier o f 350,000t or to invest the money in a íinancial fund with a
set return o f 3%.
After careíul consideration o f the markets, the entrepreneur decides to invest in a new
ship and, thereíore, becomes a shipovvnen
When the shipovvner does her cost calculation for the new vessel, she will need to consider
all the costs of running the vessei but aiso the compensation that she vvants to obtain for
its investmentThis compensation needs to be at least the money she could have earned
by depositing the money into the fund with fìxed return. OthenA/ise, she vvould have
been better off by not buying the ship and keep the money in the financial fund with a
fìxed return.
In our example this means that the shipovvner should obtain $15 million in one year to
compensate for the íoregone opportunity (that is, interest from the fund).
In the daily running cost o f the ship she should include an opportunity cost o f about
$ 4 1,000 or an opportunity cost o f $ 0. II 74/tonne/day.

T h e s u p p ly o f sh íp p in g s e rv ic e s
3.2.2.2 A lte r in g th e w ay th a t th e e x is tin g s to c k o f vessels is used
Pigure 3.2 illustrates the principal ways in which the output from a given stock o f vessels can
be varied even if the present stock is unchanged. Imagine, for the moment, that no new ships
are delivered and none is scrapped or lost. It may appear that the supply o f shipping services is
thereíore fìxed, but this is an incorrect assumption.
Pigure 3,2 Altering the supply with a ĩixed stock o f vessels
As can be seen from Pigure 3.2, there are a number o f ways in vvhich the availability o f the
shipping stock can be varied, even when the numbers remain unchanged.
One method is to convert vessels to alternative use, such as a íloating storage íacility.This was
unheard o f 25 years ago but, during the period o f overcapacity, a number o f diíĩerent methods
o f using that capacity were developed. Large tankers have been adapted for use as Aoating oil
stores. Large bulk carriers can be used to store grain, acting as Aoating silos. It is vvorth drawing
attention to the fact that such a decision is not alvvays readily reversible as the ship may suffer
signiíìcant corrosion or other long-term damage.There may also have been some degree o f
conversion which would reduce their ability to be re-employed at sea. Nevertheless, this is a
method o f reducing tonnage supply. Once a stock o f storage vessels exists, it can be added to
or reduced overtime.
The second method o f altering the active tonnage supply is by laying up vessels.The ship is
usually put in a safe anchorage, a skeleton crew retained to keep up essential maintenance, and
is left unemployed. In parts o f the world there are special areas, such as Scottish lochs, where
ships are ieft for considerable periods with a company providing management and maintenance
services. It should be clear that there are in fact additional costs to be met when preparing a
vessel for lay-up; and there are costs involved in making them fully operational again. But these
costs are relatively small compared with the large losses that might be experienced if the vessel
trades at very low rates for any sustained period o f time. Shipowners will have due regard for
the present and future State o f the market when deciding on lay-up.
When demand conditions are very poor and the outlook does not look promising ío rth e next
few years, one would expect to see a rise in the proportion o f the merchant fleet that is laid
up. When demand improves, these vessels can be reactivated íairly rapidly and tonnage supply
expanded quickly. Once all available vessels are back in the active fleet, there is no possibility o f
íurther increases in supply from this source.
The third method o f altering the short-term supply o f cargo tonnes ortonne-miles per year or
per day is by changing the speed o f vessels. By altering speed dovvnvvards, ịourney times can be
increased, so the same fleet size can generate a smaller throughput o f cargo volume moved in a
given period o f time.This practice is commonly reíerred to as slow steaming.The range o f speed
variation that is possible depends upon the technical design o f a ship's main engines. It is limited
at the top end by maximum engine revs, and at the lovver end by considerations o f engine

C h a p te r 3
effìciency and balance.There is usually a range o f speeds that are available, aithough the ship is
often designed and optimised for a particular speed.
Pourth, it may be possible to alterthe amount o f cargo throughput generated by the fleet overall
by altering the proportion o f laden to ballast voyages. Many seaborne trades are 'unbalanced’,
in the sense that cargo volumes delivered in one direction may well be larger than flows in the
opposite direction. An extreme case exists in the tanker trade, where most journeys are laden
in only one direction.This implies that 50% o f the potential cargo-carrying space is vvasted. If a
backhaul cargo can be found, cargo throughput can be increased vvithout any alteration in the
tonnage supply.
But it should be noted that the ability to achieve improvements in this area is driven by the
nature o f demand conditions, ratherthan supply.As demand patterns change, with new sources
o f production Corning on-stream o r new sources o f consumption becoming m ore significant,
supply has to respond. The changing utilisation o f the fleet reílects these changes. The ship
manager must aivvays be on the lookout for new ways o f utilising vessels.
Pinally, altering the proportion o f time that vessels spend in port relative to time spent at sea
can aíĩect supply. If port turnaround times are reduced, ships can sail more írequently in a
given time period and produce a larger output. If they lengthen, or if signiíìcant p o rt congestion
occurs, shipping supply is reduced. If the proportion o f trade on long-haul trades rises relative
to short-haul routes, the ship tonnage supply can be used more eííìciently, as it can spend more
o f its time at sea. Again, this íactor is partly driven by elements outside the shipovvners’ control.
Generally speaking, ports are operated independently o f shipovvners, so decisions affecting port
effìciency and organisation are made free o f iníluence by owners.
VVays in which the tonnage supply can be manipulated are covered in more detail in 3.3.
3.2.3 S upply in th e v e ry lon g ru n

So fan a number o f ways in which the supply o f shipping can be altered have been discussed.
Section 3.2.2.2 discussed what could be done even when the availability o f vesseis was
unchanged; a position that economists would describe as ‘the short run'. In 3.2.2.1 we considered
how supply is altered when the stock is allovved to change, which is detìned as the long run. In
both these cases, economic theory still keeps certain elements fixed, at least in theory.These
factors are the ievel o f technology available to the suppliers, and the prices of the inputs used in
providing those services.
The level o f technology
This phrase is the economists shorthand to describe the prevailing set o f technical know-how,
organisational knovvledge and management structures that are currently available to the industry.
Technical progress is the name given to the idea that, over time, new things are discovered.These
new ideas are implemented to improve the Products and services produced. New, stronger
steeis can be employed to reduce vveight vvithout reducingtensile strength. New engine designs
generate the same power output fronn a smailer engine with lower fuel consumption. New
ways o f organising cargoes, from pallets to containers, reduce port time. Some o f these changes
occur suddenly, others are gradual, but incessant.They all add up to the ability to deliver more
output with less inputT he most dramatic example o f this process in shipping is the Container
revolution; each Container vessel can generate the equivalent output o f tw o to three general
cargo vessels o f equivalent size, so output can be maintained with less input.
Changes in the price o f inputs

Supply can be inAuenced by alterations in the cost o f key inputs such as an increase in bunker
fuel costs. One way o f offsetting this is to reduce the speed o f the vessel.This leads to lovver

T h e s u p p ly o f s h ip p in g se rvice s
fuel consumption, but it also leads to lower output, given our discussion above. One might
expect to observe, in those trades where it is íeasible to do so, a reduction in vessel speeds
when fuel prices are high, and a restoration o f speed when prices fall again.The proviso is key; in
liner trades, keeping to a timetable is im portant and the option o f changing speed is not always
available. So suppliers have to find other methods o f insuring themselves against Auctuations in
the bunker fuel price.
To summarise, the supply o f shipping services can be varied in many diíĩerent ways. In the short
run, the principal means o f doing this is to alter the proportion o f the fleet that is laid up, or
where possible, to alter the vessel speeds. In the longer run, the tonnage supply can be altered
by delivering newbuilds o r scrapping some o f the present units. Pinally, in the very long run, the
eíRciency o f supply can be altered by technology change and input price movements.
3.3 T R E N D S IN T H E W O R L D M E R C H A N T FLEET, 1970-2014

Deíining the world's merchant fleet is not an easy task. Pirst, one must establish the smallest
size o f vessel that should be included. Lloyds Register o f Ships uses 100 gross tons (gt), but
other industry analysts use difTerent criteria. For example, bulk market analysts use I0,000dwt
as the minimum size o f vessel that fits into this category. Second, the United States o f America
has a íleet o f vessels held in reserve for strategic purposes.There are also vessels that trade
exclusively on the u s and Canadian Great Lakes. Oíten these are excluded from the analyses o f
the world fleet since they are effectively limited in their purpose or their scope o f operations.
Howeven Lloyds Register o f Ships, published by IHS Pairplay, includes them.
Table 3.2 illustrates the development o f the world fleet, as deíìned by IHS Pairplay, over the
period 19 70 -2 0 14. The table shovvs the merchant fleet in both gross tons and deadvveight
tonnes, and the annual percentage change in those categories. These tw o measures reílect
slightly ditĩerent aspects o f a vessels carrying ability, as noted earlien Both measures will be
reíerred to in the following discussion.
The annual growth rates are 3.7% for both gross tonnage and deadvveight tonnage. Such a
grovvth rate has quadrupled the deadweight o f the world fieet over 40 years as shown by the
table. Purthermore, the vvorld fleet has doubled since 2002.
Although the long-run trends o f capacity and demand growth appear to be quite closely related,
short-term variations tell quite a diíĩerent story.The strongest growth rates o f the period are
to be found in the period 1971-1977 and betvveen 2002 and 201 I.The grovvth rate for the
íorm er period averaged around 8.1% per year for the period in gt terms, and nearly 10% for
deadweight. In the period 2002-201I , th e average is over 7% per yeanThe high recent grovvth
rates suggest that market conditions have been good for shipovvners since 2002. But market
conditions have changed radically since late 2008, following the íìnancial crisis and the economic
downturn and recessions for many Western countries.
In the I980s, the tonnage supply actually declined. In 1982, a peak o f 424.7m gt was reached.
Deadweight actually peaked in 1983 at 690.Im, followed by several years o f decline. The
newbuild rate o f delivery was lovver than the scrapping loss rate in this period, which was one
o f crisis, both in shipping and shipbuilding.This process continued throughout the 1980s, coming
to an end in 1989, a year o f recovery.The average annual growth rate in the period 1980-
1989 was -0.4% for gt and -0.9% for dvvt.This generated a cumulatively significant decline in
tonnage supply by the end o f the decade. In contrast, the 1990s vvere years o f relatively steady
expansion. Growth rates recovered to around 1% per year in the 1990s, and have risen more
rapidly since 2002. From 2002 to 2 0 1I tonnage increased by 7 .1% for gt and 7.3% for dvvt.This
can be interpreted as the fìrst boom o f the world shipping markets since the 1970s.
The process o f rapid expansion, overcapacity, decline, and recovery has been tied to the cyclical
íashion o f most shipping markets.

C h a p te r 3
The greatest increase in capacity occurred in 1970-1975, vvhere three íactors were at work,
First, trade had boomed in the late I960s, and continued to do so until October 1973 when
the Arab-lsraeli conAict triggered a 400% increase in the price o f crude oil.The boom in trade
led to optimistic expectations about the íuture and large numbers o f vessel orders were placed.
Second, the closure o f the Suez Canal in 1967, following the Six-Daỵ W ar between Egypt and
Israel, had generated a large increase in demand for tankers. Coupied with this was a significant
increase in tanker sizes and in the size o f large bulk carriers from 1970 onvvards. A huge wave o f
optimism engulíed the shipping vvorld. In 1973, for example.the total number o f orders for new
tankers was equivalent to about 20% o f the existing world tanker stockThis rather fanciful view
o f the market was shattered by the rise in the price o f crude oil.The effect was to slow down
the grovvth o f all maịor vvorld economies, and so the growth o f vvorld trade. Large increases
in the tonnage supply arrived at the time when demand growth íaltered, a combination that
generated depression in the shipping markets for some years.
Ships are long-lived assets; they have technical lives o f 30 years or more. A few bad years can
always be expected. Ovvners and operators found ways o f matching supply to demand, as
discussed earlier, but scrapping was, and still is, seen as a ‘last resort’.
Year M illion gt Annual change M illion d w t Annual change

1970 i 227.5 338,8
1975 342.3 10.0% 553.4 12,0%
1976 372.0 8.7% 608.3 9.9%
1977 393.7 5.8% 648,8 6.7%
1978 406.0 3.1% 670.4 3.3%
1979 413.0 1.7% 681.5 1.7%
1980 419.9 1.7% 672.1 -1 A%
1981 420.8........ . 0.2% 1
i 679.7 1.1%
1982 424.7 0.9% 1686.0 0.9%
1983 422.6 -0.5% ■690.1 0.6%
1984 418.7 -0.9% 681.5 -1.2%
1985 41673 -0.6% 668.1 -2.0%
1986 404.9 -2.7% 654.3 -2.1%
1987 403.5 -0.3% 632,2 -3.4%
Ỉ988 399.5 -1.0% 62.5,1 -1,1%
1989 404.9 1.4% 620.7 -0.7%
1990 426.0 5.2% 630,0 1.5%
i99l 436.3 2.4% '6 5 L Ỉ 3.4%
1992 445.2 2.0% 674.4 3.5%
1993 457.9 2,9% 683.6 1.4%
1994 475.9 3.9% 699.8 2.4%
1995 490.7 3.1% 719.2 2.8%
1996 507,9 3.5% 731,9 1.8%
1997 522.2 .................. 2.8% 755.3 3.2%
1998 532.2 1.9% 772.8 23%
1999 515.4 -3.2% 777.8 0.6%
2000 528.8 2.6% 792.4 1.9%
2001 544.9 3.0% 812.9 2.6%
2002 554.6 1.8% 821.6 1.1%
2003 573.2 3.4% 846.7 3.1%

T h e s u p p ly o f sh ip p ín g se rvice s
2004 601.7 5.0% 889.3 5.0%

2005 642.7 6 .8 % 950.5 6,9%
2006 688.0 7.0% 1,014.6 6,7%
2007 737.3 11% 1,084.4 6.9%
2008 791.1 7.3% 1,156.7 6.7%
2009 840.6 6.3% 1,238.1 7.0%
2010 910.1 8.3% 1,349.4 9.0%
201 I 991.2 8,9% 1,483,1 9.9%
2012 ”l ,027.0 3.6% 1,543.4 4.1%
2013 1,067.1 3.9% 1,606.9 4.1%
2014 1,107,8 3.8% 1,665,4 3.6%
Average annual growth rate 3.7% 3.7%
Table 3.2 Development o f the world merchant fleet, 1970- 2014 (sources: UNCTAD Revievv of Maritime
Transport ( 1970 1998); Lloyds Register IHS/Faiiplay VVor/d F/eeí Statistics ( 19 9 9 -2 0 14); estimates are
mid-year until 1992 and year-end therealĩer.)
Trade demand began to pick up in the late I980s. Trade volumes only recovered to I970s’
levels at the beginning o f 1983 as fleet statistics show. The world íleet exceeded the 1983
peak in deadweight terms in the same period. The world merchant fleet has continued to
grow ever since. The strong growth in the new millennium resulted primarily from demand
resulting from Chinas need for commodities such as iron ore, coal and grain, and from other
developing economies. Continued globalisation also spurred the demand fo r larger Container
ships. Shipbuilding deliveries matched this demand but inevitably after the recession in 2008,
continued increasing output o f tonnage until peaking in 201 I (Pigure 3.3).
One point worth noting íromTable 3.2 is the implication o f the different rates o f growth o f gt
and dwt on a year-to-year basis. Vessels such as bulk carriers and tankers have a much larger
carrying capacity when expressed in deadweight terms than when expressed in gross tonnage.
Other vessel types have a closer correlation.The expansion in the early I970s is accompanied
by dwt grovvth rates that are higher than those o f gross tonnage.This is the period in which
the average size o f tankers and bulk carriers grew rapidly, and it is this fact that explains the
difference. in later years, the difference has not been so marked.
•G row th rates in dwt
14 .0 %
- 6 .0 %
Year
Pigure 3.3 Annual growth rates o f world merchant fleet, 1970-2014 (source; derived from table 3.2)

C h a p te r 3
Pigure 3.3 shows the variability that exists in the growth rate o f the world merchant fleet,
when measured in terms o f dwt growth. Given that the trend average over the past 45 years
is nearly 4%, it is clear that the fleet grew faster than trend in the early I970s, declined in the
early 1980s, recovered in the 1990s and has experienced a boom from 2004-201I The boom
in shipping can be clearly seen in the higher-than-average growth rates, reaching levels last seen
in the 1970s.
3.3.1 N e w b u íld tre n d s

It has been shown that the change in fleet size is given by the net position o f nevvbuild and
scrapping rates. Table 3.3 and Pigure 3.4 shows trends in newbuilds by vessel types for the
period 1995-2014 expressed as a percentage o f the existing fleet the previous yeanThe rate
o f deliveries is strongly affected by expectations about the íuture, conditioned by market
knowledge at that time.The individual íìgures are not in themselves particularly useíul, as year-
to-year variations can be quite large.

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C h a p te r 3
Nevvbuild deliveries were very lovv in 1980, at just over 2.5%, and increased to over 3.5% by
1990. Note that this allows for the fact that the absolute amount o f available tonnage was falling
at the time. Coníìdence in the íuture o f shipping had reached low ebb in the 1980s, and very
small numbers o f vessels were being delivered.
It should be explained at this stage that ship capacity is measured in three main ways. A
ships deadweight tonnage (dwt) is the total weight in tonnes ( 1,000kg) o f cargo, stores, fuel,
passengers and crew when loaded in sea w a te rto maximum draught under winter; summer or
tropical loadlines. Gross tonnage (gt) describes a ships volumetric capacity, that is, the internal
volume o f all enclosed spaces in the ship, measured in cubic metres and multiplied by a constant.
Gross tonnage has no units. Net tonnage (nt) is volumetric capacity o f a ships cargo-carrying
spaces, measured in cubic metres and multiplied by constants. Net tonnage also has no units.
Gross tonnage is oíten used as a basis for payments, such as to protection and indemnity (P&l)
clubs, vvhilst nt is used to assess port and terminal dues. Deadweight is the best measure of
cargo-carrying capacity.
it is from 2000 that the market seems to be picking up speed and more ships are being
delivered. Especially from 2005, the growth measures around or above 8%.The very high delivery
percentages for 2010 and 201 I o f 12% can be explained by delays between the order being
placed and the actual delivery o f the ship.VVhen orders rise rapidly.the shipyards inevitably build
up a backlog and One sees the time elapsed between order and delivery increase.
The cyclical pattern of the shipping industry is clearly illustrated as the numbers and dwt
delivered declined in the I980s. Recovery took place in the early I990s; by 1997, deliveries
were greater than those in 1980 in terms o f numbers, and twice as high in terms o f dwt,
Bulk carrier deliveries were significantiy higher aíter 2001. In the period 2005-2014, deliveries
exceeded 70m dwt per year. The 3,748 vessels delivered in 2010 were over fìve times the
numbers delivered in 1990 (723). The expansion o f deliveries continues as shipyards are
vvorking through their orderbooks, built up during the boom in 2005-201 I.This gives clear
evidence o f the cyclical nature o f the shipping market. The annual average rate o f delivery
between 1995 and 2014, expressed as a percentage o f the existing fleet, is 7.3%. It is clearthat
betvveen 2005 and 20 i 2 this has been exceeded every yean
■ Deliverìes tonnes dwt
180,000,000
160,000,000
140.000.000
120.000.00 0 --
100.000.000
80,000,000
60.000,000
40.000.000
.
20 000.000
0-i-l
Year
Pigure 3.4 Development o f deliveries, selected years 1980-2006 (source: derived íromTable 3.3).

T h e s u p p ly o f s h ip p in g service s
Case s tu d y : Sources of shipbuilding fìnance post-2008

Prior to 2008, shipping finance was vvidely available during a period o f sustained growth
and high íreight rates, Bank loans were easily accessible, up to 80% loan-to-value for new
vessels with most o f the new vessels scheduled for delivery in the years following the
íìnanciai crisis o f 2008. After 2008, ship values collapsed, leaving the shipping industry to
deal with losses, loan deíaults and bankruptcies. In addition, there was the need to find
íinancing for nevvbuild vessels under yard contracts that could not be assigned or cancelled.
In turn, the banking sector struggled with deíault payments and decreased value for the
collateral that secured their loans. In 2 0 13, there were about $500 billion in shipping
debts. In an effort to protect their existing assets, traditional banks started restricting
their íìnancing or pulling out írorn íinancing the industry. The top 10 banks in shipping
have reduced their shipping loan books by over $50 billion since 2008.This has made the
shipping market more diíRcult and inAuenced íurther price downturns for secondhand
ships.Yet as many traditional European banks are downsizing their shipping exposure, other
mainly non-European banks are entering the market.
In the íuture, banks may not íìnance the shipping sector to the same extent as in the
past. Traditional ĩinance may be available but subject to more stringent requirements
imposed by Basel III (the Third Basel Accord), a global voluntary regulatory framework
on bank Capital adequacy, stress testing and market liquidity hsk, developed in response
to the íìnancial crisis in 2007-2008. A stress test is an analysis to determine vvhether
a bank has enough Capital to vvithstand the impact o f uníavourable developments.
The European Banking Authority has carried out EU-wide stress testing since 2009.
In addition, the European Central Bank (ECB) is reviewing the quality o f the collateral
held by ship finance banks as security for these loans. Once the ECB's review is
complete, many banks may need to strengthen their balance sheets and oíĩload
risky assets.
European banks account for approximately three-quarters o f the world’s ship íinancing
portíolio o f approximately $475 billion, with German banks having by far the highest
exposure followed by banks in Scandinavia and the UK. In the 2014 round o f stress tests,
the ECB survey o f Eurozone banks, 24 íailed and were found to be more than $30 billion
short o f what it would take to come through another period o f serious financial turmoil.
But, none o f these banks had major shipping industry exposure. An important source o f
shipping finance is the German limited partnership, knovvn as KG (Kommanditgesellschaft).
KG funds are tax-driven structures that acquire íunds from private investors participating
in single-purpose companies. The KG structure is exempted fronn corporate tax and
considered to be a cheaper source o f financing than banks. It has been estimated that
around one-third o f the world's Container ships was financed by such partnerships.
Hovveven following the shipping downturn, more than 150 KG single-ship íunds filed for
bankruptcy in 2 0 12, and a íurther 500 to 1,000 risk insolvency, according to some estimates.
The retreat o f traditional bank lending reiníorced the role o f export credit agencies and
export-im port banks in the sector Credit and guarantee agencies in Japan, Korea, Brazil,
Germany and Norvvay have íìnanced deals and the Export-lmport Bank o f China has
allocated a bigger share to ship finance to help shipovvners weather the current crisis.
Private equity funds have also taken the opportunity to invest in ships and shipping
companies. In 2 0 13, private equity investments purchased shipping loan books from banks
to the value o f about $5 billion. The main equity funds are those looking to make high
returns on short or medium-ternn investments (three to seven years). Besides Capital, the
investors become active ovvners and vvould usually provide the companies with strategic
and managerial supportto create value and resell at a higher price.

C h a p te r 3
The grovvth o f private equity tìnance assists the shipping market in several ways: by íìlling
the gap in íunding new shíps and the sale and purchase o f existing vessels, by accelerating
consolidation in the industry, and encouraging vertical integration o f shipping into the
transport value Chain and logistics. Howeven there is concern that this investment has
resulted in the placement o f a large number o f orders for new ships at a time when there
is still oversupply, thus deepening the imbalance betvveen supply and demand.
(Source: UNCTAD, Rew'ew o f Maritíme Transport 2 0 13, pp 78-82.)
3.3.2 S crapping tre n d s

Data on the behaviour o f scrapping in the last decade is shown in Table 3.4 and Pigure 3.5.
These íìgures do not include losses.The table presents iníormation on the numbers and dwt o f
the basic vessel types that have been scrapped over the past decade, and shows the total dwt
scrapped per yean
In the volume scrapped we can clearly see again the same trend as beíore, with very low
scrap levels betvveen 2005 and 2007. From the data after 2008, it is clear that, as the recession
deepened, more vessels were sent to scrapyards in an attempt to reduce overcapacity.The peak
for scrapping was in 2 0 12, with nearly 60 million tonnes dwt scrapped, over half o f vvhich were
dry bulk vessels.
An intelligent question is 'when is the best time to scrap a vessel’?This is not an easy question to
answen as it depends on each specific vessels particular circumstances. But economists make a
distinction that is very useful in considering the ansvvenThey distinguish between the economic
life and the technical life o f any asset.
An assets economic life is, as its name implies, determined by economic conditions. Essentially,
an asset has reached the end o f its economic life when a replacement for it can be operated at
a lower overall unit (or average) cost than the present one. A t that point, it is worthwhile for
an assets ovvner to replace the existing asset with a new one.There are usually two principal
drivers that determine the criticai point.The fìrst is the rate o f depreciation o f the Capital tied up
in the existing assetthe second is the level o f operating cost required to maintain and operate
it. Put crudeiy, the íormer tends to decline with vessel age, vvhile the latter rises.
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
1 1
Tankers 7.2 3.9 2.4 33 J 6.3 iO.4 6.2 11.4 10.5 6.8
Dry bulk 1,1 0.7 2.1 0.3 1T 4 'lO,8 4.8 22.8 J 20.4 15.1
General 0.8 0.2 0,7 0.4 0,7’ " ^ 4.0 4.2 4.5 3.1 2.4
cargo 1
Container 0.1 0.0 0.4 0.3 1.3 5.8 2.2 l'l 4.6 6.0 5,6
Others Ị 1.7 0.7 1,0 1.9 2.1 5.2 T1 s,6 5.0 5.8 5.5 [4,0
TOTAL 10.9 i 5.5
1i . . .
6.6 5.7 10.9 32.1 i 25T2 39,2 158.8 45.6 ị 33,9
Table 3.4 Scrapped tonnage, 2004-2014 (soui'ce: Lioyds Register IHS/Fairpiay, VVoiid Fleet Statisiics)
Note' Dwt in million tonnes.

T h e s u p p ly o f s h ip p in g servíces
■ Tankers ■Bulkdry ■ General cargo ■Container ■Others
70.000.000
60.000.000
50.000.000
I 40,000,000
8
I 30,000,000
IIII
20 000.000
10,000,000
IiT T ^
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Year
Pigure 3.5 Scrapped tonnage o f vvorld merchant fleet 2004-2014 (source: derived íromTable 3.4)
Apart from cost considerations, the profitability o f the vessei also affects the scrapping decision.
W ith tight market conditions and high rates, it becomes íeasible to extend the economic life
o f vessels, providing they are still compliant with existing regulations.The low scrapping rates o f
bulk carriers between 2004 and 2008 reílected the buoyant markets they faced. Even old and
high operating cost vessels can be profitable in such a market. Also, regulation can have a large
iníluence on limiting the economic lifespan o f a ship. A good example is the introduction o f
double-hull requirements íortankers.
A t some point, it becomes worthwhile to replace an older vessel with a newer one. Nevver
vessels will have advances in engine design and automotive technology, with lower fuel
consumption and so on. Older vessels have the advantage o f being fully depreciated, but with
higher operating costs.The ovvner has to balance these two aspects.
This economic life o f a ship may well be around 15-20 years, but many passenger vessels
have lives considerably in excess o f this, particularly cruise vessels. It is remarkable to note that
according to the UNCTAD report on shipping, the average age for a scrapped vessel in 2010
was 29/2 years.
The vessels technical life may well be considerably more. Essentially, it is the maximum length
o f life that it is possible to extract from the vessel. Since most parts o f a vessel can be repaired/
replaced, this could be 30-40 years or more. But such repairs become increasingly expensive
as a vessel ages. Purthermore, legislative changes may make the design technically obsolete.
The crucial point is that scrapping is usually determined by the economic life, rather than the
technical life o f a vessel.
3.4 PACTORS A F F E C T IN G T H E S H O R T -R U N SUPPLY OF

S H IP P IN G SERVICES
The previous section examined data relating to the elements for altering the tonnage supply o f
vessels. Attention is now turned to the trends in íactors that affect that supply, even when the
stock o f ships might be fixed.

C h a p te r 3
3 .4 .1 Use o f vessels f o r s to ra g e
Certain vessel types can readily be turned into storage facilities.The obvious ones are the use of
crude oil tankers for oil storage, and bulk carriers for grain storage. In 2 0 10, the UK government
considered a new a proposal that some vessels might be modiíìed and used as Aoating prisons,
to deal with the overcrowding in jails.
Using ships as íloating storage devices does have a cost, however,The vessel will suíĩer increased
corrosion, and it is a relatively expensive way o f storing something compared to dedicated
ground-based equivalents. But if land is scarce, and thereíore expensive, and ships are
oversupplied, and therefore relativeiy cheap, it may be íeasible. Japan, in fact, holds a strategic
stockpile o f crude oil in just such a íashion. Usable land is very scarce in Japan. BP regularly
monitors the numbers o f tankers used in this way, and classifies them into semi-permanent,
and temporary. In 1985, 6.5% o f the tanker stock was employed in this way; by 1993, the
Tigure had fallen to 3.5%. In September 2010, it was reported only 57 tankers were involved in
íloating storage.
These tankers are not necessarily immediately available to move cargoes, as they may be hired
out on long-term storage contracts. Nevertheless, they are still a potential source o f extra
supply if demand grows more rapidly than anticipated.
3.4.2 Laying u p /re a c tív a tin g vessels

A vessei that stops trading temporarily is said to be laid up.This happens vvhen the shipowner
or manager can no longer justify trading at the prevailing levels o f íreight rates and demand
conditions and, presumably, sees no sign o f any íuture improvement. By laying up, some o f the
operationai costs o f a vessel are avoided. Provided that engines and other sensitive equipment
are maintained in good condition.there is no damage or deterioration o f the vessel.
The basic idea is simple.The vessel is brought back into trading when rates recover and market
conditions improve, so that the vessel can trade as a going concern, Essentially, this can be
viewed as an investment decision by the operator or ownen On the one hand, the owner can
carry on trading, presumably at a loss. If they carry on trading at unproíìtable rates, a series of
losses will be generated over a number o f trading periods.
On the other hand, certain expenses are incurred in the act o f laying up. Against this is the
reduction in losses which would have been incurred if the vessel continued to trade.VVhile the
cost o f Capital has to be met, other operational costs are clearly avoided in lay-up.The owner
has to evaluate the net cost or beneíìt o f deciding One way or the otherThe decision is clearly
influenced by tw o principal íactors:
1The expectations that the ovvner holds o f the íuture levels of íreight rates.
2.The actual cost o f running the vessel as a going concern.
If the ovvner runs a high operating cost vessel, and has very pessimistic expectations about the
íuture levels o f rates, then lay-up may be considered.
Lay-ups vary overtime, and are a good barometer o f market conditions.They are best expressed
as a percentage o f the world fleet, in the same way that many countries publish their statistics
on unemployed labourThe absolute number is afĩected by trends in the labour íorce, so using
percentages compensates íor this. In fact, most published shipping data concentrates on the
absolute numbers o f vessels and dwt, and this can be misleading,
During the economic crisis o f the 1980s, iay-ups reached 12% o f the fleet; then declined during
the late 1990s to very low levels. Note the difference in behaviour o f tankers from other vessel
types. In 1982, tanker lay-ups soared to 18% but fell sharply duhng the following decade.

T h e s u p p ly o f sh ip p ín g service s
Tankers D ry bulk General cargo Containers

% Fleet d w t % Fleet dwt % Pleet dw t % Fleet
1990 41,0 15,4% 19.3 8.4% 2,1 3.3% 0,5 1.3%
1995 28,8 ]0 A % 17.9 7.1% 2.0^ 3.2% 0.7 1,3%
2000 13.5 4.8% 3.8 1.5% LI 1.9% 0.0 0 ,0%
2005 4.5 1.4% 2,0 0 .6% 0.7 1. 6%
2006 6.1 1.7% 3.4 0.9% 0.6 ' 1,3%
2007 7,8 " 2 . 0% 3.6 0.9% 0.7 1.6%
2008 14,4 3.5% 0.9% 22. %
2009 85 2 .0% 2,6 0 .6% 0.8 2 . 0%

2010 10.5 2.3% 2.9 0.5% 0.8
201 I 7.0 1.5% 2.9 0.5% 3.0%
Table 3.5 Laid-up tonnage and rates (million tonnes dwt and percentage) 19 9 0 -2 0 1 I (source: UNCTAD,
Revievv o[Mantime Transport).
Ship types otherthan tankers experienced very low levels o f lay-ups, even in 1990. Since 1997,
all ship types have experienced improving market conditions, with rates íalling to very low levels
after 2000. For tankers o f more than 10,000dwt, unemployment rate has been virtually zero
since the late 1990s. It should be clear from this that different market sectors may face different
market conditions, even if they are often treated as a complete whole.The period 2000-201 I
was unprecedented in the existence o f sustained high levels o f employment ín all the principal
ship type segments listed, especially for the larger-size vessels where lay-ups were virtually nil. It
is safe to assume that since the economic downturn from late 2008 more ships have again gone
into lay-up.
It is worth noting here that in the tanker sector there is a íurther consideration to bear in
mind when an owner looks at lay-up. Oil tankers gain oil companies' and oil traders' approvals
vvhile they are trading and being regularly inspected. Some high-profile oil pollution incidents
have been linked to poorly-performing vessels. Since then, charterers have insisted that tankers
vvishingto be employed by them must be o f high quality, both in períormance and operationally
in the management structure. A tanker that proceeds to lay-up will cease trading and will lose
the valuable approvals it has earned. When market conditions improve, an ovvner will find it
very difficult to find employment for his/her ships until new approvals are gained.
3.4.3 V a rìa tio n s in vessel speed

It was pointed out earlier that output can be increased by the simple device o f making vessels
go íaster or slower.The range o f speeds that can be used depends on engine design; as noted
earlier.the limits are given by the maximum speed o f the vessel and the speed below which the
engines can be damaged or the vessel loses steerage way. But this range can still be important.
Small changes, if applied to every vessel in a fleet, can bring about significant alterations in its
cargo-carrying capability. Following the collapse o f oii demand in the mid-l970s and the four-
fold increase in the price o f bunker fuel, a large number o f tankers started to slow steam. Prior
to 1973, most tankers ran at their design speed, usually around 14 knots. By 19 7 5 -1976, a large
proportion o f tankers were sailing at 10 knots, effectively reducing their cargo-moving capacity
by about 20% since half o f the journey was in ballast.This practice has also been vvidely adopted
by major Container lines to reduce supply following the recent recession in many Western
countries and increasing bunker costs.
This is a very effective way o f reducing the tonnage supply in the short term, as well as being a
sensible response to the rise in fuel input prices.This change can happen very quickly, provided,

C h a p te r 3
o f course, that the fleet starts at full employment and a negative shock is experienced. Once a
portion o f the fleet is slow steaming, changes in output can be generated by speeding up again.
But if the new, lower vessel speed is in fact optimal for the higher fuel price, it may need a very
large increase in demand to generate this result.
In the years 2005 and 2006, a number o f Container operators suggested that it might be
more economic to operate their Service by reducing Service speed from 24 to 18 knots, and
compensate for the lost Service by adding an extra ship into the trade. In other words, they
were suggesting that the fuel savings from operating, say, six vessels on a Container Service at
a lower speed is greater than the Capital and operating cost o f employing one less vessel to
maintain the same írequency o f Service, that is, operating fìve vessels at 24 knots.This would
only apply if fuel prices are very high.
3.4.4 V a ria tio n s in p o r t tím e

Short-run supply can also be altered by varying the proportion o f time that a vessel spends in
p o rt A vessel that reduces port and idle time to a minimum will produce a higher volume of
output in the same time period than one that does not.VVhen demand is low relative to existing
capacity, port turnaround times and vvaiting times may lengthen; the productivity o f the system,
output relative to total input, will fall and rise accordingly.
One way in which time in port is affected is by changing the composition o f demand. VVhen
long-distance routes become more important in a trade, vessels employed in that trade will
spend proportionately more o f their time at sea, and the overall productiveness o f the fleet
can rise.When the opposite happens, productivity will be reduced, as ships will spend a greater
proportion o íth e irtim e in port.
It might be argued that such alterations are not strictly in the control o f the shipowner/operator,
as they depend upon the port or terminal operaton But many terminal operations are now
controlled by shipping companies themselves. For example, oil terminals are often controlled
by the oil companies who also operate their own vessels, and Maersk, the largest Container
operator in the world, has a dedicated division which operates its own terminals.The difference
in objectives may not be as marked as it might appear.
3.5 P R O D U C T IV IT Y TR E N D S A N D SUPPLY C O N D IT IO N S
Table 3.6 provides details o f some simple measures o f productivity o f the v/orld merchant fleet.
Beíore the table is discussed in detail, it should be pointed out that these productivity measures
are the result o f the interaction o f the present level o f demand and the current stock position;
they should not be taken as simply measuring the effìciency o f suppiy on its own.
One should recall that changes in fuel input prices can atTect a vessels Service speed. If demand
remained unchanged, the optimal vessels speed would tend to be reduced, in markets where
this is íeasible, and output per dwt will fall. So some o f the reduction that occurs can be linked
to this change; it does not imply a fall in eíĩiciency. In fact, it is an optimal response. If the price of
íuel goes In the other direction, one nriight expect the trend to be reversed.
Table 3.6 thereíore needs to be interpreted with some care. Ideally, one should compare years in
which demand levels, fleet sizes and fuel prices are all similar beíore one makes any comparisons.
These remarks notwithstanding,the broad trend o f the figures are still worth commenting upon.
Pirstly, ship productivity appeared to be lovver than it was in 1970, when expressed in terms
o f tons o f cargo carried per dvvt.The 1970 íìgure was only surpassed in 2005 as similar boom
conditions existed. 1970 was a boom yean and a year in vvhich capacity was stretched to meet
prevailing demand.The years from 2000 to 2008 appearto present similar conditions to those
that existed in 1970. The parallel can be drawn even íurther and. also, the bust following the
boom in 1970 has occurred for the boom o f the period following 2008.

T h e s u p p ly o f s h ip p in g servìces
Tanker Bulk ca rrie r

Year Fleet Cargo Tons per Fleet Cargo Tons per
dwt dw t
1970 148.0 1,442 9.7 72.0 448 6.2
1980 337,9 1,704 5,0 186.0 796 4.3
1990 235,8 1,565 6.6 223.2 1,706 7.6
2000 283.5 2,249 7,9 270.0 2,194 8.1
2005 317.0 2,589 8.2 331,0 2,795 8.4
2006 331.8 2660 8.0 352,3 2,987 8.5
2007 347.2 2,709 7.8 374.2 3,218 8,6
2008 356.6 2,725 7.6 399.1 3,31 1 8.3
2009 380,7 2,648 7.0 437.3 3,217 7.4
2010 392.6 2,756 7.0 513.3 3,605 7.0
201 1 418,9 2,766 6,6 604.0 3,841 6.4
2012 432.5 2,824 6.5 647.5 4,098 6.3
2013 439.5 2,792 6.4 688.1 4,331 6.3
2014 443.1 2,789 ị 6.3 721.2 4,668 6.5
C o n ta in e r Total fle e t
Year Fleet Cargo Tons per Fleet Cargo Tons per
dwt dwt
1970 326.1 2,566 7.9
1980 10.3 99 ~9J 672.1 3,704 5.5
1990 23.6 237 lOữ 630.0 4,333 6.9
2000 69.1 1607 8.8 793.8 6,269 7.9
2005 111,7 ! 1,002 j 9.0 950.5 7,638 8,0
2006 128.3 1,091 8,5 1,014.6 8,007 7.9
2007 144,7 1,216 8.4 1,084,4 8,363 7.7
2008 161.9 1,271 7.9 1,156.7 8,573 7.4
2009 169,1 1,134 6.7 1,238,1 8,259 6.7
2010 183,9 1,291 7,0 1.349.4 9,031 6.7
201 1 198,0 1,405 7.1 1,483.1 9.440 6.4
2012 206.1 1,454 7.1 1,543,4 9,839 6.4
2013 215.4 1,531 7.1 1,606.9 10,175 6.3
2014 228.4 1,629 7.1 1,665.4 10,521 6,3
Table 3.6 Productivityofthevvorld merchantfleet,selected years 19 7 0 -2 0 14 (íleetand cargo in milliontonnes)

(sources: Lloyds Register IHS/Fairplay, World Reet Statistics; Clarksons Research Services)
3.6 SURPLUS T O N N A G E A N D T H E C O N C E P T OF T H E
A C T IV E PLEET
Shipping economists have produced estimates o f the tonnage that is surplus to demand
requirements in a particular yearThey do this by allowing for those vessels that are idle, laid up
o r slow steaming.This is a crude way o f measuring the degree o f slack in the system: in a sense
it measures the amount o f spare capacity that is readily available to meet unexpected increases
in demand.The data is shown inTable 3.7 and Pigure 3.7.The key statistic to note is the measure

C h a p te r 3
of the surplus tonnage measured as a proportion o f the vvorld fleet. Since the high o f 1990,
unemployment o f ships has steadily dropped and remained around the l%-2% mark. It saw a
rise in 2008 but dropped again to just over 1% in 2009 and 20l0.This was probably caused by
increased scrapping and continued slow steaming.
It seems unlikely that the percentage o f unemployment o f ships will ever drop to zero. Underlying
this calculation is the implicit assumption that somehow, the volume o f demand in any one year
must match the volume o f shipping capacity supplied. Since demand has to be íorecast, it seems
extremely unlikely that this vvould ever occur. Now consider the cost o f alvvays being short o f
capacity. The inability to move cargoes in suffìcient volumes in the hght time periods vvould
generate large losses o f sales íurther up the supply Chain, while having some surplus means that
unexpected variations in demand can usually be met.
An analogy might be useful here.The 'normar level o f output from a íactory is not 100% o f
capacity; it is usually set at 85%-90%.The spare can be used to meet unexplained variations
in demand. Rememben also, that the output o f shipping cannot be stored. Once lost, it is lost
íoreven In a sense, a surplus o f ships is one way o f creating an inventory o f available extra ship
output if it is needed.
O f course, this argument can be taken too far As ships represent a Capital investment, too many
idle ships means too much Capital tied up in non-income earning assets; so there is probably
some range which is optimal, balancing the cost o f lost output against the cost o f idle Capital.
There is one final point to note about this concept; the amount o f surplus tonnage may well
be aíĩected by the underlying unit costs o f laboun Capital and fuel. It has already been noted
that slow steaming is related to high fuel prices, and it may be that slow steaming is an optimal
response.To assume that vessel speeds are constant, and compute the required tonnage balance
accordingly, might well be a mistake.
■ Tanker ■ Dry bulk ■ General Cargo ■ Container
250 T-
Year
Pigure 3.6 Laid-up tonnage and ship type, 1980-201 I (source: denved ĩromTable 3.5)

T h e s u p p ly o f s h ip p in g services
■ Surplus percentage
1 97 0 19 8 0 19 9 01 9 91 1 99 2 19 9 3 1 99 4 19 9 5 1 9 9 6 1 9 9 7 1 9 9 8 1 9 9 9 2000 20012002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Year
Pigure 3,7 VVorld fleet unemployed, 1970-201 I (source: derived íromTable 3.7)
Year VVorld fle e t Surplus A ctive fle e t % Unemployed

tonnage
1970 360.2 0.6 359,6 0.2%
1980 680,2 97.1 583.1 14.3%
1990 658.4 63.7 594,7 9.7%
1991 683.5 64.2 619,3 9.4%
1992 694.7 71.7 623.0 10.3%
1993 710.6 72.0 638,6 10.1%
1994 719.8 63.4 656.4 8.8%
1995 734.9 50.8 684.1 6.9%
1996 758.2 48.8 709.4 6.4%
1997 775,9 29.0 746.9 3.7%
1998 788.7 24,7 764.0 3,1%
1999 799.0 23.7 775,3 3.0%
2000 808.4 18.4 790.0 2.3%
2001 825.6 21.5 804.1 2.6%
2002 844,2 21.7 822.5 2,6%
2003 857,0 10.3 846,7 1.2%
2004 895,8 6.2 889.6 0.7%
2005 960.0 7,2 952.8 0.8%
2006 i ,042.3 lO.I 1,032.2 1.0%
2007 1,1 17.8 12.1 1,105.7 1.1%
2008 1,192.3 19.0 1,173.3 1.6%
2009 1,276.1 12.0 1,264.1 0.9%
2010 1,395.7 14,1 1,381.6 i.0%
201 1 1,534,0 10.7 1,523,3 0.7%
Table 3,7 Surplus tonnage and active fleet, selected years 19 7 0 -2 0 1I (source: UNCTAD, Revíevv of
Maritime Trơnsport).

C h a p te r 3
3.7 SEG M EN TED SUPPLY

Until this point the data for the world merchant fleet has been examined as a whole and, apart
from the comments about the tanker market, it has been assumed that conditions are similar
in all sectors. While this is a convenient simpiiíication, it may give the reader a íalse impression:
quite significant differences exist in market supply behaviour between the shipping sectors.
Essentiallỵthe world's shipping fleet can be divided into seven broad categories:
1. vessels employed in serving the wet trades;
2. vessels employed in the dry bulk trades;
3. vessels employed in the unitised trades such as Container ships;
4. vessels employed in non-unitised linertrades such as general cargo;
5. vessels employed in the shortsea trades, such as shortsea íerries;
6. vessels employed in the cruise trade;
7. specialised or dedicated vessels such as offshore supply ships and drilling rigs.
Since certain vessels are better adapted to certain trades, and not to others, local demand
conditions can generate quite diíĩerent supply behaviour betvveen the segments. Most o f the
surplus tonnage reíerred to above is in fact concentrated in the tanker market. For example,
in 2002, over 88% o f the surplus tonnage o f that year was situated in the tanker market, In the
same year, the bulk and general cargo market had a surplus o f 13.49% and 3.26% respectively.
But by 2006, the percentages had changed to 60.4% for tankers, 33.66% for bulk and 5,94%
for general cargo.This illustrates the point that, while the markets appear to be tied together
by common long-term trends, there are often quite important variations from this trend in the
shorterterm.
3.8 R E LA T IN G T H E O R Y T O E M P IR IC A L EV ID EN C E
To relate the empirical evidence presented to the theoretical íramevvork o f supply and demand
is one way to make sense o f the changes in the shipping market.
Demand has already been discussed, but the supply curve o f shipping services has yet to be
deíìned.To do this, a distinction will be made betvveen the short run, which is defined as the
period in which the tonnage supply o f vessels is unchanging, and the long run, in vvhich the
supply is allowed to alter.
3.8. i T h e s h o r t- ru n su p p ly o f sh íp p in g o u tp u t
It might be imagined that, since the stock o f vessel tonnage has been held fixed,there Cản be no
variation in the supply o f output. But, o f course.this is incorrect íorthe reasons discussed earlier.
If output is measured in terms o f tonne-miles o f cargo moved per time period (a day, a month
or a year) then output can be varied, literally from zero with all ships idle, to a maximum value,
determined by the present fleet size, its productivity and vessels' speeds.
Imagine for a moment,that all the necessary iníormation needed to work out each vessels cost
per tonne-mile o f cargo was available. One could rank these in order o f low cost to high cost.
Then supply could be permitted to increase.
The cheapest way to increase supply vvould then be to use the low-cost vessels first, as this is
the most proíitable. Now imagine raising rates a iittle when many more vessels will become
proíìtable to operate.This process can continue until all vessels are utilised. Once they are all in
use.the only way o f producing more output is to make them go íasten but this requires higher
rates still as fuel consumption is increased. A t some point, all possibilities are exhausted and, no
matter how much íurther the rate is increased, there is no possibility o f supplying more tonne-
miles o f output from the given tonnage supply.

T h e s u p p ly o f s h ip p in g service s
The general idea can be illustrated with the supply curve drawn in Pigure 3.8. It has been drawn
as a broad J-shaped curve.This is because, for much o f its range, the availability o f a large stock
of under-utilised vessels means that tonne-mile supply can be increased rapidly in response to
a small increase in rates. But when demand approaches full capacity, íurther increases in rates
do nothing to stimulate short-term supply increases.They act as a signal to encourage íurther
investment in shipping.
When the rate, expressed as dollars per tonne-mile o f cargo carried, hses from $1 to $1.50,
there is a considerable expansion in supply. But when the rate rises again, to $2, there is not
such a íurther increase in the quantity supplied.
Ị
<ù
c
c
8
!
s?
Pigure 3.8 Hypothetical supply curve for shipping output, derived from a íixed stock o f ships,
3.8.2 T h e io n g -ru n s u p p ly o f sh ip p íng o u tp u t

In the longer term, the supply o f tonnage will increase if deliveries exceed scrapping and losses,
or reduce if the reverse is the case.The new vessels will be more eíĩicient and, hopeíully, cheaper
to run than the scrapped ones.This will make the entire schedule shift to the right in the case o f
an expansion, or to the left in the case o f a contraction.
The shift is unlikely to be parallel; the eíĩiciency gain is, on average, likely to be no more than
l% -3% per year, so the ‘flat’ section o f the supply schedule vvill not shift down by much.The real
diíTerence lies in the vertical section, vvhich can shift out to the right quite sharply if, for example,
increases are 10% o f the existing fleet size. Such a situation is shown in Pigure 3.9.

C h a p te r 3
Pigure 3.9 Effect o f an increase in the stock o f ships on the supplỵ curve
The model o f supply that has now been constructed will be combined with assumptions about
demand and used to analyse the behaviour o f major bulk markets in the following chapters. it
is very important that one grasps the concept o f the supply curve, because it has already been
implicitly used when the empirical evidence was discussed in earlier sections.
Case s tu d y : Elasticity of demand

As we have seen beíore, as prices rise demand drops. Elasticity is the measure commonly
used to expresses the strength o f the change in demand with each price increase (or
decrease).
For example, the elasticity o f demand o f cars is estimated to be around -1.2. This
means that for every I % increase in price, demand drops 1.2%. W ith that elasticity, if we
assume a situation vvhere the price for cars is £10,000 and the demand 100,000, an
increase to a price o f £1 i,000 (10% higher) will bring a reduction in demand for cars to
88,000 (12% lovver).
3.9 M E A S U R IN G SUPPLY RESPONSIVENESS: T H E

C O N C E P T OF E L A S T IC IT Y OF SUPPLY
It was pointed out that the response o f supply to a change in demand conditions, as measured
by an increase in the íreight rate, differs depending upon the amount o f slack in the systeni.
Just as the responsiveness o f demand to a change in price or the íreight rate can be íormally
measured, so can the responsiveness of supply.
The íormal definition o f supply elasticity is:
% change in the suppiy o f shipping services

Own price elasticity o f supply =
% change in price (freight rate)

T h e s u p p ly o f s h ip p in g services
The number that is obtained from this calculation is expected to be positive or zero, but
never negative.
It will be positive if the supply o f tonne-miles or cargo tonnes moved per unit time period
increases vvith an increase in the íreight rate.
It will be zero if, despite the increase in the íreight rate, there is no observable increase in tons
o f cargo moved ortonne-miles períormed.
Examples:
lf the íreight rate was to rise from $ 10 per ton o f cargo moved to $ 12, a 20% increase in price,
and cargo tonnage litted rose from 48,000 to 56,000, a 16.6% increase, then the elasticity of
supply would be about 0.83, or inelastic, because the number is less than unity.
If, on the other hand, the same rise in the íreight rate were to bring íorth an increase in cargo
liíting from 48,000 cargo tonnes to 96,000, a 100% increase, the computed elasticity vvould be
100/20 = +5, which is very elastic.
Pigures 3.8 and 3.9 illustrate both types o f responses. A very price-elastic supply curve appears
relatively flat and nearly parallel to the axis that measures output. A highly inelastic supply
schedule has an almost vertical appearance, being almost parallel to the price or vertical axis.
The short-run supply o f shipping possesses both o f these properties over different ranges of
supply output.
3.9.1 S u p ply e la s tic ity and tim e

The above discussion implies that the responsiveness o f supply to changes in íreight rates is
iníluenced by the time period allovved for that response. By permitting the stock o f vessels to
alter; supply is more ílexible than it is in the period when the stock o f vessels is fìxed.
One extreme case o f this is to imagine how the shipping markets respond in an even shorter
time frame. Supply might even be períectly inelastic, íor instance, having a supply price elasticity
o f zero. Suppose a charterer wants a vessel to transport a particular cargo at very short
notice from a particular port. It must be moved within 24 hours, for example. Contacts with
brokers establish that there is only one vessel available for this cargo in the time available. If the
shipowner knows this, he or she can extract the maximum price that the charterer is prepared
to pay. But 24 hours laten other vessels arrive in the area, free of contract.This immediately shifts
the balance tovvards the charterer as vessel owners compete íorthe business.This potential to
exploit the market ís thus very transient, given the mobility o f vessels. Nevertheless, the supply
responsiveness is more or less zero in the fìrst 24 hours, but getting progressively larger as more
time for greater supply reaction is allowed.
This idea is illustrated in the simple model belovv.

C h a p te r 3
Pigure 3.10 Long-run response to demand changes
in Pigure 3 .10, demand increases from DI to D2.The initial response is given by the interaction
with the short-run supply curve SI and price rises to point C.This induces greater proíìts
and increases in ship ordering and then deliveries o f new ships. Higher deliveries mean an
increase in the fleet size. Our short-run model assumes the stock is fìxed, so the short-run
supply curve shifts out to the right. If demand remains at D2, prices now fall to B.The overall
change in induced supply is thereíore the move from A to B, vvhich implies a smaller price
change and larger quantity change than the move from A to c. But this means that the long-run
supply elasticity must be higher than the short-run supply elasticity; because o f the deíìnition o f
eiasticity, the 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.
3.9.2 E m p iric a l e vidence

Beenstock andVergottiss masterly study ofthe world tanker and dry cargo markets, Econometnc
Modelling ofW orld Shipping (1993), estimated that the short-run supply elasticity o f tonne-
miles with respect to the íreight rate was 0.24 for tankers, a number vvhich implies an inelastic
response.They pointed out that this number vvould be much greater when large numbers of
laid-up vessels vvere presentThis íìnding is consistent with the shape o f the short-run supplỵ
curve o f shipping services shown in figures 3.8 and 3.9 above.
They also íound that the long-run elasticity vvith respect to the stock o f ships was unity; in other
words, in the long term a broadly proportional response o f supply tonnage to long-term trends
in demand is to be observed.
This chapter has analysed the basic idea o f the supply o f shipping services. Data on supply trends
over recent decades was analysed and the idea o f a supply curve for shipping was introduced.
Finally,the term ,‘own-phce elasticity' o f supply was introduced.

' ' Qent^L
ẩ y
Chapter 4
Shipping cost analysi

economies of scale
Economies o f scale have been satisfied by the increased size

w o f ships to the o p tim u m level.
C h a p te r 4
This chapter discusses the important area o f ship costs. One common theme that occurs in
shipping is the role o f economies o f scale in iníluencing important commercial decisions, such as
the most suitable size of ship to use.The determinant and structure o f shipping costs is the focal
point o f this chapter.
4.1 A N O U T L IN E OF BASIC COST CO N C EPTS

Economic theory discusses cost determinants with specifìc reíerence to a company type vvhich
produces just one type o f output. In the shipping business, the output can be measured either
by:
• the volume o f tonnes o f cargo moved per day, per trip or per year; or
• the volume o f tonne-miles produced by the vessel per day, per trip or per year.
The nature o f the cargo carried is really immaterial to cost analysis: the focus is on measuring
either the total cost o f moving a given quantity o f output, or on the average totai costThis is the
total cost divided by the volume o f cargo carried.The latter is reíerred to as the average cost
per tonne. Distinction is made between average cost and unit cost, per tonne or containerThe
average cost pertonne is based on the quantity o f cargo being carried on any voyage.The unit
cost is based on the maximum quantity o f cargo the ship is designed to carry.
Costs measured per tonne o f cargo are very useíul, since the íreight rate is usually expressed
in dollars per tonne o f cargo, especially in bulk trades. In the Container business, costs are often
expressed per teu, an abbreviation o f Twenty-foot Equivalent Unit, again because rates are
expressed per Container or box. It is clearly very important to be able to express prices and
average costs in the same way, so that surplus can be measured.
4.1.1 S h o rt-ru n costs

in the short run, the ability o f any company to vary production or output is limited, because
some o f the inputs which are used in producing that output are fixed in quantity.
Economists define two categories o f costs in a short-run period.These are;
Fixed costs, or indirect costs, and vanable costs, or direct costs, sometimes called avoidable costs.
Fixed costs are deíìned as ail those expenses which have to be met when producing the output
o f goods or Services, but vvhich do not vary with the level o f production o f that output. Basically,
they are costs vvhich are necessarily incuired, but their level is unaffected even if production íell
to zero.
Variable costs are deíìned as those items which do vary with the production o f output.These
may be quite a small proportion o f the total cost o f production, depending upon the business
that one is examining.
It is important to note that this distinction is only valid in the short run. Indeed, it deíìnes the
short run, since its deíìnition is not determined by a penod o f calendar time.
For example, the short-run time period for a ship operator may in eíĩect be a matter of a
few months. In most shipping situations, the largest cost item is the Capital tied up in the ship.
VVhile the company is committed to owning that ship, it has to meet the irnplied Capital cost
o f ovvnership, or opportunity cost. The company expects to receive a return on the Capital
invested in the vessel.The Capital cost, in many cases the mortgage repayment, is a fixed cost
for the simple reason that it does not vary with the output that the ship produces. it does
not matter whether the ship sits at a lay-up berth for six months, producing no output, or is
actively trading; the daily Capital cost has to be recovered.This cost is clearly íìxed, as long as the
operator owns the ship or until the mortgage is fully paid off.

S h íp p in g c o s t analysís a nd e c o n o m ie s o f scale
On the other hand, it is clearthat fuel consumption, and hence bunkering expenses, are directly
related to producing output. In other vvords, tonnes of cargo moved, or laden tonne-miles
produced. Such items are, thereíore, deíìned as variable costs.
4.1.2 T h e b e h a v io u r o f to ta l costs and o u tp u t in th e s h o rt ru n

Describing the link between total costs and output in the short run is not at ali straightfonA/ard.
Fixed costs are unaffected by the change in the levei o f production. Hence it can be argued that
they can be treated as a constant, independent o f the level o f output.
Pigure 4 .1 shows such an example, in the context o f shipping.Assume,for example.thatthe daily
overhead costs attributed to a 50,000dwt dry cargo vessel have been calculated by its owners
as being $ 10,000 a day.The vessel is to be used to trade from the UK to Montreal and back, a
round-voyage distance o f some 6,000 nautical miles.The output produced by this journey can
vary between zero and 150 million tonne-miles, assuming it is laden one way. Assuming the
round trip takes 17 days, the total íìxed cost attributed to the trip is $ i 70,000.
Variable costs
The principal variable costs will be voyage-related costs. Fuel consumption, both at sea, and in
port, must be accounted fon In addition, there will be port and canal dues, vvhere appropriate,
and stores and provisions ío rth e crew. In addition, there may be loading and discharge costs to
considen Fuel consumption will rise as the laden weight o f the vessel rises, but port and cargo-
handling charges will increase with the volume o f cargo being moved. If these increase at a
constant rate per tonne, a line showing the relationship between total variable costs and cargo
volume produced can be dravvn, as in Pigure 4. i below.
Total costs and o u tp u t

Adding the total fìxed cost to the total variable cost generates total cost, for any given volume
o f cargo delivered, from zero to a full load, under our assumptions.This diagram assumes that
the relationship betvveen variable costs and output is a simple, constant proportional one,
Pigure 4 .1Total costs and output relationships in the short run
Pigure 4 .1 will be used as the basis for a breakeven analysis, introduced in Chapter 5.

C h a p te r 4
Average costs
While examining total costs may be useíul, market prices are not expressed this way. Market
rates are expressed pertonne o f cargo delivered. It is thereíore useful to translate the total cost
o f producing output into its average costs equivalent. Average costs are easily deíìned.The total
cost of producing output is simply divided by the output being produced. In the example above,
the average total cost per tonne o f cargo delivered can be íound by dividing the total costs o f
delivering the cargo by the quantity o f cargo delivered.
Similar calculations can be made for average fixed costs and average variable costs. But now,
their behaviour vvill be quite different In the example, average fixed costs will decline steadily,
from $ 170,000 per tonne when only one tonne o f cargo is delivered, to $3.40 per tonne when
50.000 tonnes are delivered.This implies that the average fìxed cost value declines steadily, and
is aiways minimised when the maximum output is produced.
The behaviour of average variable costs is quite different in this case.With a íìxed journey length
and fìxed vessel speed, plus the assumption o f a fixed cargo-handling charge per tonne o f cargo
delivered, average variable costs will be constant They are the same vvhether one tonne or
50.000 tonnes is discharged. Note that total variable costs will increase. It is the average variable
cost that is constant.
Adding the constant average variable cost with the average íìxed cost yields average total cost.
In this case, it reaches its minimum at the maximum cargo voiume which can be carried.This is
inevitable, given the assumptions, but is not always the case in shipping, and it is definitely not the
case in many other industries.
Plgure 4.2 Average cost and output relationships
4.1.3 T h e g en era l re la tio n s h ip b e tw e e n s h o r t- r u n co sts and

o u tp u t
In many circumstances, the linear relationship developed between output and costs is not an
accurate one. Indeed, it is possible to find a more complex interrelationship in shipping, vvhich
we will come to later in this chapter. In general terms, economists do not expect total variable

S h ip p in g c o s t a n a lysis and e c o n o m ie s o f scale
costs to rise proportionately with outputThis is because o f the fact that variable inputs, such as
the quantity o f fuel in shipping, into the production process are combined with a fìxed quantity
o f another input such as the ship.
The law o f variable proportions states that there is an optimal combination o f these inputs.
This implies that if the mix o f inputs is not optimal, efficiency is reduced and average variable
costs are higherthan can be achieved at a different level o f output.There will be, for any given
size o f Capital, a most eíTicient level o f output. Eíĩìciency here is being measured in terms of the
lowest average total cost. In this situation, average variable cost falls at low levels o f output and
then begins to increase at higher levels o f output. For example, a fully-laden ship going íaster will
increase output but at a higher fuel cost.
Since average total cost is the sum of average fixed and average variable cost, this generates a
U-shaped average total cost curve.The reason is simple: at low levels o f output, íìxed costs are a
very large share o f total costs.They fali sharply in share when output increases. When combined
with a íalling average variable cost curve, average total costs must fall. As output continues to
increase,two things happen:
• The relative importance o f the íìxed cost element declines, and its rate o f fall declines;
• Average variable costs, vvhich are now a larger share o f overall costs, start to rise rapidly.
This makes the average total costs rise.
If average costs have this U-shape, there must be a range o f output over which unit total costs
are at their lowest.This range, or specific level o f output, is the most efRcient level of output
associated with the quantities o f Capital, labour and the other inputs used in the production
process.
Pigure 4.3 shovvs the typical cost relationships that are expected.
AC = average total cost

MC = marginal cost AC
•ớ
0
0
Ị (ú
Output
Pigure 4.3Traditional cost output relationships

C h a p te r 4
4 . 1.4 T h e c o n c e p t o f m a rg in a l, o r ìn c re m e n ta l, c o s t
The last cost concept to be introduced is very important for decision-making.This is the concept
o f marginal or incremental cost. Marginal cost is defìned as the change in total costs generated
by the production o f an extra unit o f output. In the short run, marginal cost must be related
to variable costs, since b / the deíìnition o f short run, íixed costs cannot be altered.The only
changes in total costs that can be generated are generated through the change in total variable
costs associated with the change in output.
In the example used above, marginal cost is in fact the same value as average variable cost,
because o f the assumption that the cargo-related costs are independent o f the volume o f
output carried. But this is not alvvays the case. When average variable costs rise, marginal costs
will be rising even faster; when average variable costs fall, marginal costs vvill be lovver than
average variable costs.
The measurement o f marginal cost itseií can vary; it has to be deíìned very careíully. For example,
what is the marginal cost o f carrying an extra passenger on a bus or a train, or o f taking an extra
tonne o f cargo on a vessel about to depart? If the carrying units are not already fully laden, the
ansvver is usually an extremely small number. But this example is rather extreme. Now consider
the same situation, this time assuming that the bus, train, or ship is íully loaded.The answer to
the question is now quite diíĩerent, since the costs incurred will constitute those associated with
providing an extra train, an extra bus or an extra ship. In effect, assuming, on average, in the long
run.that capacity utilisation is close to 100%, the lattertype o f marginal cost is a measure of the
long-run total cost o f meeting that extra demand. On the other hand, if capacity ís idle, the same
marginal cost can be measured as a very small number, relative to the total costs involved.
It is often the case that the change in output vvhich is being considered is not just one extra
unit, It may be several thousand tonnes o f cargo, vvhich íorms a consignment which a charterer
vvishes to move. In this case, the appropriate measure is the extra costs associated with
accepting that consignment. This may be converted to a per tonne measure by dividing the
estimated additional total costs related to the movement o f the consignment by the tonnage
o f the consignment, to arrive at a per tonne figure for the incremental cost o f accepting the
business. This íìgure can then be compared with the extra revenue that the cargo brings. It
should be clear that if the consignment generates additional revenues which exceed the extra
costs incurred, the shipowner or operator will be better off by accepting the business.
4.1.5 Long>run costs in e c o n o m ic th e o r y

The long run is deĩined as the penod o f time in vvhich it is possible to vary all the input quantities
used in producing a given level o f output. It is assumed that the unit prices o f those inputs
remain unchanged.Thereíore.the amounts o f Capital, land,fuel and labour required to produce a
given level o f output can all be varied.
In the long run, by definition, fìxed costs do not existThis is because every element used in
the production process can be varied. In shipping, one o f the key determinants o f the output
produced by a vessel trading on a particular route at a given speed is its size. O ther things being
equal.the largerthe size, the largerthe cargo volume, cargo tonne/miles or passenger numbers
carried per time period. The long-run period for a shipping operator is thereíore the period
long enough for the size of vessels to be considered as a variable.
Given that there are no fixed costs, long-run costs can be described thus: the long-run average
cost measures the average cost o f producing a given level o f output, given the prices o f the
inputs employed in the production process,

Long-run average costs can be related to output in three different ways:

• Long-run average costs may fall, as output levels rise.VVhen this occurs, economies o f scale
are said to exist. Put bluntly, their existence implies that the larger the volume o f output that
can be achieved, the lower the average cost o f production.
• Long-run average costs may remain unchanged as output levels change. In this case, constant
returns to scale are said to exist. Average costs are the same, irrespective o f the level of
production.
• Long-run average costs may rise as output levels rise.This situation is deíined as one in
which diseconomies o f scale are present Basically, this implies that it may be more effìcient
to produce lower levels o f output, because average costs wiil be less.
These categories are illustrated in the long-run cost curve shown in Pigure 4.4 belovv.
Pigure 4.4 Long-run average costs and returns to scale
4.2 T H E C O N V E N T IO N A L A N A LY S IS OF VESSEL
O P E R A T IN G COSTS
Vessels’ costs are often classiíìed into three distinct categories, defined for a particular ship size.
In a sense, the trade analysis is a short-run framework, but vvhen several different sizes o f vessel
are considered, the iníormation could be related to the long-run period discussed earlier.
The three distinct categories that are employed are;
4.2.1 C a p ita l - re la te d costs

These are the cost items incurred by the shipowner which can be attributed to the ownership
o f the ship itselí.The principal items are:
a) repayments o f the loan principal, if a mortgage or other íìnancial instrument has been used
to purchase the vessel;
b) payment o f interest on the outstanding balance o f any loan or mortgage.
Both o f the above would be regular cash payments;

c) the cost o f Capital for having the shipowner's Capital tied up in the ship. These are not
necessarily cash payments, but they are a legitimate cost item because they measure the
value o f the opportunities íorgone, also called opportunity cost.

C h a p te r 4
Many shipping consultants include a notional 8% on the Capital value o f the ship to represent the
cost o f Capital, as they assume the shipovvner would have such a return on its Capital investment.
4.2.2 D ire c t o p e ra tin g costs

These are items vvhich are necessarily incurred in the running o f the vessel, but vvhich do not
vary with the vessels use.They include such items as hull and machinery Insurance, p&l coven
cargo Insurance, crew costs, lubrication costs, repairs and maintenance expenditures, stores, and
so on.Table 4 .1 lays out the major cost items.
4.2.3 V oyage> reiated costs

Voyage-related costs are those items which can be avoided if a voyage is not made.The major
component is fuel costs, which are determined by the fuel consumption o f the vessel on a
particular journey and, o f course, the price o f bunkers. Fuel consumption is often computed at
a particular vessel speed.Variations in a vessels speed can have signiíìcant eíĩects on the rate o f
fuel consumption, so assumptions about speed have to be made.
Other components o f voyage-related costs include port and canal dues, pilotage and tovvage, and
cargo-loading and discharging charges.The relative importance o f these tw o cost components
will be afFected by the journey distance. Short-haul trips will mean a large proportion o f vessel
time spent in port, with a greater weight for port dues and similar charges. Long-haul trips will
mean a longertime at sea, less port time and a greater vveight for fuel consumption at sea.
Capital cost D ire c t operating costs Voyage-related costs

! . . .
Interest on loans Insurance Fuel costs
Repayment of loan interest on Hull & Machinery Canal dues
equity taxation
Protection & Indemnity i Port dues
War risks, crew costs Cargo-handling costs
Repairs and maintenance Crew provision
Stores
Administration expenses
1
1
Table 4 ,1Typical cost structure
Recalling the discussion o f the economic theory o f costs, it is clear that coiumns one and tw o of
the above can be viewed as consisting o f íìxed costs; they are given no matter what the level o f
output produced by the vessel.The voyage-related costs then become the variable costs, in the
model developed earlien
4.3 SPECIFIC PACTORS A F F E C T IN G T H E R E L A T IO N S H IP

B E T W E E N COSTS A N D S H IP P IN G O U T P U T
A number o f assumptions have been made in section 4.2. Pirstly, vessel size has been taken as
fixed.AH costs are calculated with that assumption in mind. Secondly, the total and average cost
of delivering the cargo to a speciíìc port requires additionai assumptions about:
a) the cargo load factor;
b) vessel speed at sea (affects ti me spent at sea relative to in port);
c) voyage distance (aíĩects time spent at sea relative to in port);

d) cargo-handling rates (affects time spent in port relative to time at sea);

S h ip p in g c o s t analysìs and e c o n o m ie s o f scale
e) the proportion of the journey spent in bailast;

f) the size o f the vessel itselí
These items interact with each other; if speed is increased, fuel consumption rises. On the other
hand, time spent at sea will fall, so the amount o f overhead allocated to a speciíic cargo trip will
fall.Whetherthe cost pertonne o f cargo delivered íalls or rises becomes an interesting question.
One way o f analysing the effects o f these changes is to allow only one íactorto change, keeping
all the other possible changes constantThis is what is done in the following analysis.
4 .3 .1 Changes in th e vessel load fa c to r

Variations in the vessels average load factor will affect the average cost per tonne of cargo
delivered. Increases in load íactors will lower average costs, decreases will raise them. Attempting
to increase a load íactor may be One o f the key goals in certain sectors o f the shipping business.
As we have seen, industries with very high fixed costs and low variable costs will experience
sharply falling average unit costs in the short run, because the overhead can be spread over
greater output volumes.The containerised liner trades are a good example. Shipping lines sail
accordingto published timetables.The short-run average cost is minimised at a 100% utilisation
rate.The lines are continuously striving to raise the load factor o f their vessels, as this generates
more revenue and lowers average costs.
In the tramp trades.the load íactor is not really an issue. Operators will be seeking cargoes that
match their capacity, and usually they sail with full cargoes. In oil trades, the cargo flows are very
unbalanced; usually one leg o f the journey is carried out in ballast.
Until the mid-1970s, all tankers sailed fully laden. During the 1973 oil crisis and immediately aften
part cargoes became much more common, being a means o f employing tanker tonnage that
would otherv/ise be idle. As the tanker market recovered from this shock, part cargoes became
less common again.
Case s tu d y : Distance and concept of cost per tonne-mile

Distances at sea are measured in nautical miles and the speed o f a vessel is measured in
knots. Since a knot is a certain amount o f nautical miles per hounthe journey time is easily
obtained by dividing the distance by the amount o f knots.
So a ship travelling at 16 knots will cover a distance o f 2,500 sea miles in 6.5 days.
To be able to compare cost/earnings o f diíĩerent journeys, shipowners need to take into
account that the journeys cover diíĩerent distances and, thereíore, have different cost
structures.To account forthis,they calculate the cost/income pertonne-mile.
Following our example, let's assume that the ship travelling 2,500 nautical miles carries
50,000t o f coal with a daily running cost o f $30,000.
Thereíore, in the 6.5 days that it needs to coverthe 2,500 nautical miles.the ship will incur
a cost o f $ 195,000. Given that the journey generates 125 million tonne-miles,the cost per
tonne-mile is then $O.OOI56/tonne-mile.
4.3.2 Changes in vessel speed

Shipping output can be altered by varying the speed o f the vessel, as noted in Chapter 3. Indeed,
it has been argued by some authorities that speed variations are eíĩectively the only way o f
varying short-run output in the tramp and bulk trades.

C h a p te r 4
Ships are usually designed to run at a particular speed.This speed is determined by the vessels
size, technical characteristics and engine povver.VVhen designed, vessels are often optimised for
a particular trade. So, once built, the ílexibility is reduced but there is still some room to vary
speed and output.
Making a ship go íaster does tw o things. Pirstly, it alters fuel consumption.There is a well-known
approximate relationship between speed and fuel consumption, known as the cube rule. It says
that a 1% increase in vessel speed will lead to a 3% increase in fuel consumption.This formula is
calibrated for deviations from the vessels design speed. Because the speed increase is less than
proportional to the consumption increase, fuel consumption will rise, even when the journey
time has been reduced.
But the reduction in journey time brings a second consideration into play, namely the daily
overhead, covering Capital and direct costs. A reduction in journey time means a reduction in
the allocation o f overheads to this trip, so that there are two opposing íorces at work on costs.
Modellingthese effects is bestcarried out with a simulationitaking particularvessel characteristics,

a particular voyage and, most importantly, assumptions about the price o f bunker fuel and íreight
rates available for any extra cargo carried in the time saved by speeding up the vessel.
It can be shovvn that the average cost per tonne o f cargo delivered falls, and then rises, around
the vessels design speed.The range o f vessel speeds is often limited; at the top end, by the
discomíort o f the crew due to excessive vibration, and at the bottom end, by the loss o f vessel
manoeuvrability and steerability. A 14-knot vessel may have an effective speed range o f 10 to 16
knotsithis is still a range o f -30% to + 12% relative to the design speed.
It is important to note that this relationship is derived for a given price o f bunkers. An increase
in the bunker price will shiíi; the entire relationship up and to the left, thus reducing the least
cost speed. A decrease in bunker prices will do the reverse.
6»
ĩ
0
'o
1
c Average cost
s
ọ
0
Lean cost range Vessel speed (knots)
Pigure 4.5 Average cost and vessel speed
Note, too, that when íreight rates are high.the profit rate increases, and it becomes worthwhile
to increase vessel speed.This assumes that the short-run situation exists, since an even more
proíitable response may be possibie in the long run, such as buying and operating another vessel.
There is good evidence to back up the link betvveen rates, bunker prices and speed in the
bulk trades.
There are some trades in which speed variation is only used to maintain the published
sailings timetable.The liner trades, in particular, have to meet deadlines in order to satisíy their

contractual obligations to their customers. They have far less room to respond to variations
in bunker prices. Indeed, they behave quite diíĩerently, inserting into their contracts a clause
that permits them to pass on the effects o f unexpected movements in bunker prices to the
customenThis response is needed because o f the diííerent nature o f the Service offered in these
trades. Recent developments in the vvorld economy and increasing bunker prices in the year
beíore the financial crisis showed that slow steaming in liner trades is possible as long as the
savings outweigh the cost o f adding an additional ship to the loop.
4.3.3 Changes in d is ta n c e tra v e lle d

Altering the voyage length will automatically increase the total costs incurred by a vessel o f a
given size assuming all other factors are constant.There are two obvious reasons. W ith vessel
speed held constant, longer voyage lengths mean larger fuel bills. But it also means a longer
journey time and hence the direct operating and Capital costs, vvhich accrue to that journey, aiso
increase.
Again, the relationship betvveen costs and distance can be shown as a graph, as in Pigure 4.6
below. The relationship is drawn for a given vessel size. The vertical distance o x represents
the fixed overhead that vvould be incurred if the vessel sailed no miles at all. After that, each
extra mile requires fuel and additional time costs.These will rise proportionately with distance,
assuming a fixed vessel speed.
I0
ầ
c
s
ọ
ơ
Pigure 4.6 The relationship between average cost and distance
This relationship can be developed by dravving a graph o f the relationship between cost and
voyage distance for successively larger sizes o f vessels, measured in dwt, in Pigure 4.7. Let L|, 1_2
and Lj represent three successively larger sizes o f vessel.The fixed overhead element will tend
to get larger as the vessel gets biggen because larger vessels have larger daily direct and Capital
costs. On the other hand, the increase in fuel required to travel íurther will be lovver, because
fuel consumption at a given vessel speed rises less than proportionately with vessel size.This
means that the slopes o f the lines become ílatter as vessel size increases.
Over the distance range OA, it is clear that the smallest vessel size is the most economic. Over
the range AB, it is vessel size Lj, whilst the largest vessel becomes more eíTicient as the voyage
length increases. For voyage distances around OA, vessels L| and will be in competition, whilst
around OB, it will be L between vessels o f differing sizes, and L .

C h a p te r 4
L.
L,
c
c
0
5.
V
Q
u
Pigure 4.7 Costs and distance for diííerent sized vessels
Pigure 4.7 illustrates another interesting point As the voyage distance increases, and the time
spent at sea increases relative to the time spent in port, the preíerred or optimal size o f the
vessel increases.This point will be considered in more detail below.
4.3.4 Changes in c a rg o -h a n d lin g ra te s

Changes in the rate o f cargo loading and discharge will reduce the amount o f time the
vessel spends in port. O ther íactors being equal, this will reduce the constant terms, the
vertical distances such as o x in the earlier íigures, but will not alter the slope or gradient
of the line. The reduction in the constant terms will alter the critical distances at which one
vessel size becomes more efficient than another. In general terms, higher cargo- handling
rates will reduce the distance at vvhich the larger vessel becomes more economic than
the smaller
4.3.5 T h e p ro p o r tio n o i ịo u rn e y s p e n t in b a ila s t

It should be clear that reducing the proportion o f the journey that is spent in ballast vvill iower
the average cost per tonne o f cargo delivered.This is because the vessel is carrying more cargo,
producing more output, with more or less no change in total voyage costs. Fuel consumption
will increase slightly, but not significantly.
The eíĩect is exactly the same as raising the vessels load facton
4.3.6 T im e in p o r t vs tim e a t sea

Two o f the íactors discussed above have a direct eíĩect on the relative proportions o f time
spent in port and at sea by a vessei. It should be íairly ciear that port time costs wili be affected
by a vessels size.There are tw o reasons for this. Pirstly, larger vessels will incur greater port
charges, as they are oíten based on either gt o r nt, so larger vessels will be charged more. A
related íactorto this is, o f course.the opportunity cost o f the vessel itself.The iargerthe vessel,
the greater the value o f Capital tied up in the vessel and the greater the cost o f Capital and
opportunity cost o f idle port time.
But large vessels are often able to discharge their cargoes more rapidly than smaller ones. So
that the time they need to spend in port does not need to be longer than that expected for a

S h ípp ìng c o s t a n a lysis and e c o n o m ie s o f scale
smaller vessel.The reason is simple; iarger vessels lose more revenue than smaller ones when
they do nothing. So it is often the case that they are equipped with higher capacity loading and
discharging onboard facilities. Oil tankers are a very good example.
One implication of this is that, other things being equal, the larger the proportion o f time a
vessel spends in port per yean the smaller its preíerred size.The reason is that less Capital is tied
up doing nothing. Multi-port operations also tend to reduce the optimum vessel size for similar
reasons; hence the fact that feeder ships are often o f a smaller size.
4.3.7 Changes in th e vessei’s size

There are two ways to alter vessel size:
a) Vessels can be ‘jumboised’ by the insertion o f an extra section o f the hull.The opposite
operation can also be carried out to make the vessels capacity smaller.This is clearly an
expensive process.
b) The vessels size can be altered on the drawing board.Priorto commissioning.the shipovvner
will have to considerthe most appropriateiy sized vessel íorthe intended trade.
Both o f these are long-run decisions. For the sake o f completeness, it should be noted that the
cost-distance relationship for diíĩerent sizes o f ship can be calculated, vvhich was shovvn in tìgure
4.7. It should be clear that, for greater distances, the preíerred size o f the ship increases. But the
full examination o f the relationship between average costs and vessel size leads into an analysis
of long-run costs.
4.4 L O N G -R U N VESSEL COSTS: ECO NO M IES OF SCALE

A N D O P T IM A L S H IP SIZE
A vessels capacity can be varied in tw o ways: by altering the dimensions o f an existing vessel
or by ordering a new, larger one. Iníormation from shipbuilders about the costs o f building
different sizes o f vessel, together with estimates o f their running and voyage costs, can be used
to estimate the average cost o f delivering a tonne o f cargo betvveen two ports for different
sizes o f vessel.
It is important to note that the long-run relationship between average cost and vessel size,
which is taken to measure output, is constructed with a number o f underlying assumptions.
Input prices are assumed to be constant. In the long-run context, this means the price o f Capital
o r interest rates; the price o f labour, such as crew; and the price o f fuel are assumed to take the
same values when comparing average costs at different sizes.Voyage characteristics, load íactors,
and so on vvould also need to be kept constant.
Three different relationships betvveen long-run average costs and output were identiíìed above.
The/ were:
a) economies o f scale;
b) constant returns to scale;

c) diseconomies o f scale.
Economies o f scale exist in two principal areas o f shipping, namely the ship and the port
íacilities, such as Container terminals.This section discusses the reasons íorthe presence o f scale
economies in general, and then for their existence in shipping.
Economies o f scale are essentially o f tw o broad types:

a) internal economies o f scale, as they are oniy enjoyed by a single company through that
firm ’s individual policy;

C h a p te r 4
b) external economies o f scale, vvhich result from the expansion in scale o f the whole industry
or a number o f firms vvithin the industry, and cause a decline in costs to all the íìrms in
the industry.
In the present discussion there will be a concentration on internal economies but readers
should be able to see íor themselves the effects these economies have on the wider external
economies o f the industry.
Internal economies o f scale can be classifìed under fìve convenient headings:

• managerial;
• commercial;
• financiai;
• risk-bearing;
• technical.
While much o f the remainder o f this chapter will concentrate on the latter category, beíore
proceeding, it is important to look brieíly at each o f the íormer categories,
Managerial economies
These are concerned with the control o f the organisation. This is part o f the important
process known as the division o f labour vvhere individuals increase their productivity by
specialising in a speciilc task. Management becomes increasingiy specialised in a particular
aspect o f the íunction o f a large company. Senior management can concentrate on
general policy, delegating subsidiary, oíten specialised, tasks to others, usualiy vvithin a
divisional structure.
A small shípping company with only one or tw o ships may fìnd it cheaper and more efficient
to have their ships managed by a specialist management cornpany instead o f employing its own
staíí.Thus the small shipowner will beneíìt írotn the economies o f scale aiready achieved by a
large management company.
This will apply to the point vvhere the expansion o f the fleet makes management expenses
greaterthan ío rth e company employing its own management staíĩ. As with any business, larger
shipping firms will be able to have their own specialist legal and Insurance departments, for
example, hopeíully saving fees and making more iníormed management decisions.
Such economies are also applicable to the major liner companies, which have oíĩìces all overthe
world. As part o f their company policy, they transfer staff to other piaces in the world in order
to create an all-round management structure.
C om m ercial economies
Sometimes reíerred to as marketing economies, iarge production allovvs bulk buying at a

discount. In selling, the marketing cost per unit o f output and advertising is cheaper in larger
volumes, the shipovvner or operator can achieve economies o f scale by placing regulat' orders in
respect of such things as maintenance or bunkering.
Pinancial economies
Large companies have advantages in raising íìnance for expansion either through banks or by
going to the pubiic through the saie o f shares. It is much more diffìcult for the small company to
convince potential lenders o f their íìnancial stability.

Risk-bearing economies
There are three types o f risk:
Insurable risk: often large companies can insure at low premiums simply because o f the size
and the limitation o f risk. For the same reasons, some large companies will insure themselves
internally, ratherthan give their business to Insurance businesses.
Risk-bearing: large businesses can usually beartheir own risks by introducing a new commodity
because they will have secured the coníìdence o f their customers.
Uncertainties; uncertainties are those risks vvhich cannot easily be insured against. Such
uncertainties can, and often do, cause the bankruptcy o f small companies. Larger concerns can
diversiíy their product industrial section or market and thereby compensate íorthe difRculties in
one area by the buoyancy in anotherThis is one o f the basic strengths o f the large multinational
company. Increasingly, shipping companies are diversifying their interests and investing in related
services, such as through-transport and logistics services. Larger shipping companies can more
easily svvitch vessels from one trade to another trade should the need arise. If, for example,
a certain vessel has to undergo major repairs, then the services o f that vessel can be taken
over by another vessel o f their fleet and so save the cost o f having to charter a vessel. Pooling
arrangements also offerthe opportunity to spread risk.
As can be seen in Table 4,2, there is a decrease in average construction costs as measured
by deadvveight or teu, with increases in vessel size for all three vessel types. But it should be
stressed that these are new building prices, not costs.
Newbuilding prices are market-driven as well as cost-related, so they will reílect demand
conditions as vvell as the costs o f production, In this case, 2005 represents the demand for
shipping in the boom years prior to the recession in 2008-2009 and 2 0 15 the still-recovering
shipbuilding market post-recession.
Column seven expresses the unit cost reduction as a percentage o f the cost per dwt, or teu, o f
the smallest size vessel o f a given type, and column eight gives the elasticity o f ship price with
respect to ship size.
2015 2015
D ry bulk carrier dwt US$M $/dwt US$M $/dwt Change Elasticity
Handymax 64,000 30 469 28 430
Panamax 82,000 35 427* 30 360 -16%
Capesize 180,000 61 339 54 300 -30% 0.67
Crude oil tankers dwt
Aíramax 110,000 58 527 54 486
Suezmax 150,000 70 467 65 433 -1 1%
VLCC 300,000 105 350 97 323 -34% 0,61
Container teu /teu
2,500 42 16,800 33 13,200
6,500 |I01 T5~5~38 ' 67 1 10,308 -12% M377
Table 4.2 Newbuilding prices, 2005 and 2 0 15 (source: Pearnleys VVeekly 2005 and 2 0 15)
These ĩigures all imply the presence o f signiíìcant economies to the ovvner derived from
purchasing larger ships.The smaller the elasticity value, indicating inelasticity, the greaterthe unit
cost reduction. In 2015, the largest beneíìt to owners appeared to be available in the crude
oil sector.

C h a p te r 4
Determining the appropriate size vessel fo r a given route length

Even though the cost per tonne o f the ship itselí declines with vessel size, other cost elements
involved in the operation o f a ship may not do so. Indeed, there is a trade-off in existence,
betvveen the lower unit costs brought about by operating a larger size vessel, and the extra
time ít requires to load and discharge them, assuming that cargo-ioading and handling rates are
constant. In essence, this boils down to the gains from larger ship sizes when the ship is at sea
being offset by the extra port time implicitly required to load and discharge, VVhere the voyage
length is short,the ship will spend more o f its time in port in a yean compared to if it traded on
a long-distance route.This means that there may be a point at which the potential cost savings
from using a iarger vessel when at sea are more than ofíset by the higher costs involved with the
same ship sitting idle in port.
This idea can be more formally expressed in a model o f ship costs. Basically, the model can be
reduced to three elements:
a) the daily Capital cost o f running a vessel;
b) the daily operating cost o f running a vessel;
c) the voyage-reiated cost (primarily fuel).

This model ignores cargo-loading and -discharge costs.When the ship is in port, the fìrst tw o
elements must be covered, as these costs have to be íìnanced in the long run at all times.
When the ship is at sea, the vessel also incurs the third set o f costs.The relative importance o f
the components clearly depends on the number o f days spent at sea and the number o f days
spent in port, A Calais-Dover íerry will spend a large proportion o f its vvorking year in port,
compared to a 3IO,OOOdwt very large crude carrier (VLCC) trading from the Middle East to
Japan and China.Thus short route lengths will raise the number o f port days reiative to sea days,
and wiil affect cost structures.
Second, increases in ship size lovvers average costs, but the relationship between ship size and
Capital cost is not the same as the relationship betvveen ship size and daily operating cost.The
relationship between ship size, vessel speed and fuel consumption is complex, and this affects
the third component o f the cost model.
In the past, the elasticity o f Capital cost with respect to ship size has been estimated at around
0.7, In other words, a 10% increase in ship size vvould raise the nevvbuild price o f a vessel by 7%,
thus leading to a fall in the average cost per deadweight.
Let us assume that, for direct operating costs, the elasticity was much lower; at O.S.This means
that direct operating costs only rose by 5% for a 10% increase in ship size, impiying larger savings
than from Capital. This assumption is not unrealistic as direct operating costs do not increase
relative to size. A good example o f this is crew. A ship fìve times larger does not require a fíve
times larger crew.
For voyage costs at sea, the primary determinants are assumed vessel-operating speeds, both
laden and in bailast, and fuel consumption o f main engines, vvhich is aíTected by assumed vessel
speed. !t is simplest to assume a constant vcyage speed which is the same on both !egs o f the
voyage. In the model, the assumed elasticity o f fuel consumption with vessel size is set at 0.75,
ìmplying that a 10% increase in size wili increase daily fuel consumption by 7.5%.
To construct an estimate o f costs per tonne o f cargo delivered, we make the following
assumptions íorthe calculation:
The ship is a dry bulk vessel o f 170,000dwt.The nevvbuilding cost was $97,000,000.
The economic life is 18 years.
Interest rate is 5%.
Capital cost elasticity is 0.7,

Trading life o f 350 days per yean ignoring time and cost for its fìve-year surveys. Daily
operating costs elasticity is 0.5,
Assumed operating costs for the base vessel are $2,700,000 per year
The constant speed is 15 knots and the base vessel consumes 100 tonnes a day at a price
of $720 pertonne.
The time in port is based on a load and discharge rate o f 5,000 tonnes per day. Fuel
consumed during the time in port is ignored.
The model calculates the average cost per cargo tonne, which is a long-run concept, because
Capital and direct operating costs have been included, and reveals some interesting trends:
1. For a very short route length, smaller size ships have lovver unit cargo costs per tonne than
larger ships.
2. As the route length increases, larger ships will have lovver unit cargo costs than the smallest
ship size, but the very largest ships may have marginally higher unit cargo costs per tonne. In
other words, there is a range o f ship sizes that generate lower unit costs; both smaller and
larger ship sizes will have higher unit costs.This means there is an optimum range ship size
íorthese route lengths.
3. As the route length gets longen the optimum ship size gets larger and the range of sizes
shifts to the right.
These results show that there is a range o f optimum sizes. Manipulation o f the basic elements o f
the model, such as ship prices, fuel prices, and the assumed values o f the elasticities, will all aíĩect
the precise ship sizes that are optimal.The key insight, hovvever, relates to the behaviour of costs
at sea and costs in port.
The reason why the optimal ship size range gets larger with longer route length lies in the fact
that, as the proportion o f sea time rises, íuller exploitation o f the economies o f scale are to be
gained from using larger ships, as the cost penaities from so doing, including longer time in port
with longer loading and longer discharging times, are offset by the longer-distance voyages.
Even though the model has been developed for dry bulk vessels, there is no reason to assume it
is just limited to that ship type.This helps to explain the use o f hub and spoke netvvorks on the
iinertrade. In a hub and spoke network,the liner company will have a main terminal or port in a
geographical area called the hub, to and from which the cargo is brought and distributed to the
other ports in the area, the spokes.

C h a p te r 4
16.00
8.00
4.00
2.00
1.00
12,000 10,000 8,000 6,000 4,000 2.000 1,750
Pigure 4.8 Long-run average costs per tonne o f cargo by voyage length (source; denved by author from
Evans and Marlow model)
Note: Pon load and discharge costs excluded. Bunker prices ơssumed to be ị 180 per tonne.
Large Container ships are very expensive.The rapid growth in vvorld trade in the past 15 years
has led to a big increase in the demand for Container movements from the Far East to North
America and Europe. The Emma Maersk, in 2007 the world’s largest Container ship, carried
around I I .ooơteu, although industry sources claimed its true capacity was 14,770. Engineering
studies have argued that there is no engineering obstacle to building an 18,00ơteu vessel, the
maximum size capable o f transiting the Straits o f Malacca. After that tw o main engines would
be required to maintain a Service speed o f 24 knots, with implications forfuel consumption and
voyage costs. Such iarge vesseis will have very high daily Capital charges, and their time in port
must be kept to a minimum.The Emma Mơersks main voỵage is from north-west Europe, calling,
for example, at Bremerhaven and Felixstowe, and then next calling at Singapore, before sailing
on to China and Japan. Its port time is kept as short as possible and its sea time maximised.
Some modern large Container ships will be calling at Southampton Container terminal, their
only UK port call, for 12 hours beíore sailing again.These observations are consistent with the
model above.
One other observation should be made.The assumption is made that the ship is sailing íully
laden. VVith tankers, the Standard àssumption IS o f laden one way, ballast back. Dry cargo ships
have more possibility o f back haul cargoes, but the model assumed one cargo in one direction,
fully laden. It is clear that if demand levels do not generate cargo lot sizes that are the same as
the ship, then the average cost per cargo unit will rise, as the greater Capital costs o f a larger ship
will be spread over the same cargo volume as those incurred if a smaller ship had been used.
The model thus assumed ships size and average lot size are the same.

S h ip p in g c o s t a na lysis and e c o n o m ie s o f scale
4.5 T H E EFFECT OF D IF F E R E N T PISCAL REGIMES O N

COSTS
The discussion has ignored the tax treatment o f investment in shipping. But the way that national
governments set the tax regime on ship investment plays a critical role in inAuencing the long-
run average cost o f operating vessels under the national flag. Because ships are large, expensive
and long-lived assets, the way that their purchase can be vvritten off, and the way that ship
purchases can be offset against a shipping companys liability for tax on its overall operations,
can have a highly signiíìcant effect on the overall proíìtability o f a companys shipping operations.
In the European Union, íiscal treatment o f shipping is governed by the Community Guidelines
on State Aid to MaritimeTransport 2004.The member states o f the EU cannot give unrestricted
aid to their national shipping. Although the European Commission supports EU-registered
shipping and seaíarers, it is anti-protectionist in phnciple.The guidelines are thereíore a balance
between support for EU shipping and maintaining open shipping markets.The objectives o f the
guidelines are to promote the competitiveness o f EU shipping, reduce íìscal and other burdens
on EU shipping to world norms, to encourage flagging/reflagging o f EU-owned or managed
ships to EU ship registers, and to contribute to the shore ‘maritime cluster’ o f industries. The
guidelines cover four areas; fiscai incentives for shipowners/managers; investment aid for ships;
labour-related costs, crew relieí and training; and shortsea shipping.
In the context o f this section, the key area is the fiscal treatment o f shipping. Pirstly, member
states may allow accelerated depreciation on investment in ships. Depreciation, the reduction
in the value o f an asset (ships), is normally offset against proíìts, which reduces annual taxation.
lí the depreciation rate is accelerated, then the shipovvner stands to beneĩit from a larger offset
in taxation over say, 10 years, rather than over 25 years. Secondly, if a shipovvner makes a proíìt
on the sale o f a ship, this will be tax-free so long as the money is reinvested in ships.Thirdly,
member states are allovved to replace Corporation tax (a tax on proĩits) by a tonnage tax (a
tax based on the ship’s net tonnage). Most EU member states have introduced a tonnage tax
for their shipowners, and it is for the shipowner to decide which tax method to choose. If a
shipowner made no proíìt in a particular yean he is not liable for Corporation tax. Hovvever, ịf he
elected íortonnage tax, this must be paid regardless whether he makes a profit.
The UK tonnage tax scheme was introduced in 2000. Shipping companies that wish to take
advantage o f this scheme must operate qualiíying ships, ithat is„ ships owned or chartered for
the carriage of cargo or passengers. HM Revenue and Customs (HMRC) requires the strategic
and commercial management o f these ships to be based in the UK. Strategic management
means the location o f headquarters, including senior management staff and decision-making
by the company board o f directors. Commercial management includes activities related to the
employment o f the ships, ship and technical management. When a company chooses to enter
the tonnage tax regime, it will be for a minimum period o f 10 years. Purthermore, a condition of
entering into the tonnage tax regime is that the company must enter into a training agreement,
by vvhich it trains one trainee per year for every 15 offìcers in the companys fleet (or make
payment in lieu to the UK Maritime TrainingTrust).Tonnage tax is determined by calculating a
daily 'proíìt' based on the ships net tonnage. For example, on current rates, a 30,000nt bulk
carrier tonnage tax 'proíit' for 365 days would be £36,135, and at Corporation tax o f 20%, tax
payable vvould be £7,227. It should be noted that there is no requirement for ships entered into
the UK tonnage tax scheme to register in the UK.
W hat ditĩerence has the change in tax regimes made to the relative tax burdens of the different
registries? In 2008, Marlow and Mitroussi in, EU ShippingTaxation:The Comparative Position
o f Greek Shipping, calculated the present values o f tax payments required under five different
tax regimes for fìve different speciíìc vessels, assuming the ships are new, operated for 15 years.
They compare Panama, Liberia, Greece, Netherlands and the UK ílags.They find that for four
o f the five cases, Panama and Liberia rank first and second, with the UK last. Greece is vvorst
for the 75,000dwt bulk carrier but second or third for the two Container ships and tankers (of

C h a p te r 4
difFerent sizes) that make up the five examples. All the calculations assume a discount rate o f
10% per annum.
It should be noted that the diíĩerence between the UK and Dutch figures are very small, so the
ranking is perhaps a little misleading. For example, at the 10% discount rate, the present value
o f tax payments for a new 299,700d'A^ tanker was £368,182 for the UK, £363,253 fo r the
Netherlands and £155,544 for Greece.The tax payments to Panama and Liberia were found
to be £44,91 I and £164,375 respectively.Whilst tax payments are one íactonthe magnitude of
these íìgures is relatively small when considering the overall Capital and operating costs o f such a
vessel.A flag is not always selected fo rta x reasons.
4.6 T H E EFFECT OF FLAG OF REGISTRY O N COSTS

Ship operators face very competitive conditions. One o f the post-1945 developments in
shipping has been the rise o í what are known as Open Registers or Flags o f Convenience and
the practice o f ‘ílagging out' o f ships from ‘traditional’ maritime countries to these flags.
Bergstrand deíines a flag o f convenience as“ a flag o f a State whose government sees registration
not as a procedure necessary in order to impose sovereignty and hence control over its
shipping but as Service which can be sold to íoreign shipowners wishing to escape the íìscal or
other consequence o f registration under their own flags.” (Bergstrand, s (1983) 'Buy the Flag:
Developments in the Open Registry Debate'.)
In 1950, only 4% o f world shipping was Aagged in open registers. By 1995 it had reached 50%
and in 2013,75% o f worid shipping was so registered (Pigure 4.9).
W orld shipping under íoreign flag (dw t)
Year
Pigure 4.9 Percentage o f world fleet under íoreign flag (source: UNCTAD, Review ofMantime Transport).
The original consideration for Aagging out was for tax reasons.The Liberian flag, for example,
levied no tax on profits but subscription tax based on the registered tonnage o f the vessels.
During the I980s' shipping recession, ílagging out gave shipovvners the opportunity to reduce
operating costs by employing cheaper crews, as many traditional European flags required
shipowners to employ more expensive national crews.Thus similar sizes and types o f ships may
well be operated at significantly lower costs than under national flags. Some have estimated the

cost differential at about 10%, allowing for vessel size, age, and other íactors determining costs.
There is a range o f costs for a given size, depending on the nature o f the vessels flag; this cost
range is shown in Pigure 4 .10.
ĩìc
c
s
L.
ầ.
o
ũ
«>
Pigure 4 .1OThe cost margin zone; long-run average costs for operators íacing different cost conditions.
A t vessel size ox, unit costs for the low-cost operator are OA per tonne, whereas those for an
equivalent sized high-cost operator are OB per tonne.The íìgure has been drawn to exaggerate
the difference, relative to the overall unit cost value. If it is the case that open registers permit a
higher proportion o f profits to be retained, and also permit the lowering o f daily operating costs
by the use o f crew paid at lower wage rates, then there is a strong incentive for the shipowner
or shipping company to switch registries to exploit these advantages.
The maịor open registers are Panama (21% o f world fleet), Liberia (12%) and Marshall Islands
(9%). Table 4.4 shows that traditional maritime countries' shares o f vvorld tonnage steadily
declined with the share o f the major open registers rising to over 50% o f the vvorld merchant
fleet by deadvveight.
2007 2008 2009 2010 201 1 2012 2013 2014

Developing economies 17.15 25.51 25.21 25.23 25,50 26.41 27.70 27.02
Developed economies 28.43 18.54 18.23 17.89 16,96 15.85 15.00 15.58
Economies in transition 0.13 1.15 1.06 1.00 0,93 0.82 0.73 0.72
Maịor open registries 54.26 54.35 55.1 1 55.44 56,10 56.62 56.30 56.44
Table 4.4 Shares o f vvorld deadweight tonnage (percentage) (source: UNCTAD, Review o f Mơritime
Transpon.)
Some traditional maritime nations have responded to this trend by introducing their own
version o f an open registen termed ‘second’ register.The best known o f these is the Norwegian
International Shipping Register (NIS), vvhich, among other things, permits Norwegian ovvners
to avoid national crewing regulations. It has attracted a large volume o f tonnage owned by
Norwegian shipovvners back from other open registries, since its creation in 1990. In addition, as
discussed in the previous section, many traditional maritime nations have introduced a tonnage
tax on shipping operations as an alternative to Corporation tax for companies located in their
country, with some success.

C h a p te r 4
It should be noted that the fall in the share o f traditional maritime registers does not necessarily
imply a fall in the share o f ovvnership, since the beneficial owners o f Open Registry vessels
are resident in those countries. For example, íoreign ovvners account for almost 100% o f
the tonnage in Panama, Liberia, the Marshall Islands, Bahamas, Malta, Antigua and Barbuda,
and Bermuda.
An interesting development is that as most ships fly a flag that is different from that o f the
owner’s nationality, shipovvners are increasingly iocating their companies in third countries. A
ships nationality is deíined by the nation whose flag it flies, the owner may have a different
nationality, while the owner's company that Controls the vessel may be based in a third country.
For example, a number o f Greek nationals are shipowners whose company is located in the UK.
Indeed, One o f the eíĩects o f the UK tonnage tax scheme has been to attract íoreign shipovvners
to locate to the UK.These developments will make the concept o f a 'national fleet' increasingly
difficult to define.
4.7 COSTS A N D Q U A L IT Y : T H E PRO BLEM OF S U B -

S T A N D A R D SHIPS
Economists assume that markets trade íairly. The product being offered is of merchantable
quality and is fìt íorthe purpose. Many industry stakeholders and regulatory authorities became
increasingly concerned over the decline in ship standards in the I980s and 1990s, and which
came to a head with the sinking o f the tanker Erika in 1999 off the Prench coastline.
The term 'sub-standard' ship came into use, which the OECD deíìned as "a vessel that, Ihrough
its physical condition, its operation or the activities o f its crevvs, íails to meet basic standards
o f seavvorthiness and thereby poses a threat to life and/or the environment. This would be
evidenced by the failure o f the vessel to meet regulations contained in international maritime
conventions to the extent that it would be considered uníìt to sail by a reasonable flag State o r
port State inspection."
The incentive for unscrupulous shipovvners to cheat is quite large. As long as charterers are
solely concerned with price, there are pressures placed vvhich may lead ovvners to reduce
repair and maintenance expenditures to below that necessary for the long-term quality o f
the vessel. A 1996 study by the OECD provides some estimates o f the margins available.The
estimates translate into a 13% saving on the annual running cost for the dry cargo vessel, and
15% for product carriers.These illustrative figures inTabie 4,5 indicate the very strong incentives
to cheat, if charterers pay the same rate to good and bad shipovvners alike.
One means of reducing the incentives to cheat is to raise the overall Standard o f management
in the shipping industry. The successíul introduction o f the International Saíety Management
Code by the IMO in 1998 appears to have improved the industry's períormance overall.
The appointment o f an onboard oíĩìcer; responsible for the day-to-day implementation of
the regulations appears to have led to a signiíìcant reduction in accidents and an increase in
ship quality.

20-yr-old bulk carrier: 1990 Products tanker:

30,Ó00dwt 40,00Òdwt
US$/Day US$/Day
7,500 Ceiling (1) 9,500
4,500 Good Practice (2) 4,850
3,750 Common Practice (3) 4,250
3,250 Standard (4) (6) 3,750
2,750 Ploor (5) 3,100
Table 4.5 Vessel-operating cost ‘levels’ and íinancial advantages (source: OECD ( 1996) Non-Observance
o f International Rules and Standards: Competitive Advantages, Annex, p5)
Key:
( 1) Ceiling = level o f maximum expenditure.
(2) Good Practice = high level o f expenditure adopted by minority o f shipowners.
(3) Common Prơctice = average level of expenditure adopted by maịority o[ shipowners.

(4) Standard Practice = minimum level o f expenditure to ensure owner’s compliance wìthbasic standards of
safety.
(5) Floor - level o f minimum expenditure, still keeping vessel operationơl.
(ó) Shaded area = margin o f sub-standard operation within which the sh/povvner is able to operate avessel
subịect to non-detection by regulatory authorities such as flag states and dassificơtion sodeties acting on
their behalỊ, pon states and so on.
Enforcement o f ship quality by more írequent ship inspections, carried out by port State
authorities, has also helped, In the European Union, the EQUASIS database permits national
administrations to swap iníormation on ship detentions and thus improve the targeting of
ships calling at European ports. Port State control regional co-operation, such as the Paris
Memorandum o f Understanding (Paris MOU), is very effective at targeting, detaining and
banning ships that pose a saíety and environmental risk. It is not only the ship that is identified
but also the vessels flag State, classification society and the shipovvner that are targeted in the
case of poor standards. It is clear that the maritime sector must always be vigilant in this regard if
it is to improve its public image in terms o f pollution and the treatment o f its vvorkers.
4.8 T H E EFFECT OF D E M A N D A N D IN V E N T O R Y O N
O P T IM A L S H IP SIZE
It is, in fact, the volume and characteristics o f demand and the level o f inventory costs that help
determine the preíerred size o f the vessel. Inventory cost is the cost o f time incurred by the
cargo being transported instead o f being sold and the revenue then being invested.
As noted earlier, the ability to exploit the fact that, in general, larger ships deliver the cargo at a
lower cost per tonne than smaller ships, is clearly limited by the volume o f cargo to be moved.
This can be measured in two ways. First,the average lot size, or parcel size, o f cargo, and second,
the frequency with which cargo needs to be moved in a given period o f time.
Otherthings being equal.the largerthe average lot size,the largerthe optimal size ofvessel.The
more frequent the required delivery, the smaller the optimal size o f vessel. If demand volumes,
and average parcel sizes rise, then there is scope for using a larger vessel, provided that unit
costs continue to fall.
If demand levels are not sufficient to allovv very large vessels to be used at the appropriate
Service írequency, demand acts as a constraint on the ability to exploit larger ship size.

C h a p te r 4
Two examples illustrate this point. The rapid grovvth in world trade in the past 15 years
has led to a boom in demand for liner shipping services. The most notable has been the
trade with China, prior to and after it joined the W TO in 200I.Two o f its principal trading
partners have been the European and North American economies. These are long-haul
routes. As cargo volumes grew, larger Container ships were introduced on these routes. As
even larger vessels were introduced, the previous larger vessels were cascaded down to trade
on the less busy long-haul routes, and then as economic trade volumes grow over time and
the new ships become olden they are progressed onto shorter-haul routes, where demand
volumes grow.
This process is observed in many industries. In aviation, the same thing happens to new, larger
aircraft. In the dry cargo market, China has again been instrumental in raising the demand for
coal, iron ore and Steel to record levels. Ships as large as 400,000dwt have been ordered to
serve this trade.The Brazilian mining company.Vale, ordered or underwrote the building o f 35
such vessels,the fìrst o f vvhich was delivered in 201 I.This contrasts vvith the Sharp diíTerence in
sizes observed betvveen the sectors in the I980s, when oii demand had peaked in 1981 after
rapid growth.This illustrates the fact that demand volumes also help dictate both the largest
economic ship size, and by implication, average ship size, in the different trades.
The discussion o f operating costs above íocused entirely on the costs o f operating the ship. But
in some cases, ship operators also own the cargo.This then leads to the following question:
W hat effect will incorporating inventory value have on the determination o f the optimal vessel
size for a given trade?
Inventory costs are also important as the cost o f holding the cargo in store on the vessel
increases directly with the size o f that vessel, assuming a fixed interest rate and a íìxed average
value for the cargo.VVhen inventory costs are included in estimating the overall cost o f cargo
per tonne to be delivered, it is possible to generate a U-shaped average cost curve, as shown in
Pigure 4 .1I .
Pigure 4.1 I The optimal ship size (with inventory costs).
It is clear that the higher the inventory cost, the smaller the optimum vessel size, as the slope
of the inventory cost line will increase.Thereíore, high cargo unit prices will tend to reduce the
optimal size, and vice versa.

S h ip p in g c o s t ana lysis and e c o n o m ie s o f scale
Any shipowner vvhich also operates a terminal or port, or vvhich has an interest in the cargo,
which it also ovvns, would be interested in the combined costs. For example, a maịor oil company
moving its own oil in its own vessel might consider both the inventory costs of the cargo as well
as the operating costs o f the ship when modelling overall costs.The classic case o f this would
be the traditional large multinational oil companies, at their peaks in the I970s,with large tanker
íleets and direct control o f oil from field to consumer.
It should also be pointed out that increased ship size means increased draught, beam and length.
Many parts o f the world have draught restrictions because of shallow waters. The Suez and
Panama canals also impose an upper limit on vessels designed to transit them. Many ports
do not have the ĩacilities necessary to handle the largest vessels.Thus the trading ílexibility o f
very large vessels is more limited than the smaller ones. Provided that demand conditions are
satisíactory, the vessel may survive on these restricted opportunities, but that may not alvvays be
the case.
4.9 T R E N D S IN S H IP SIZE A N D T H E C O N C E P T OF T H E
O P T IM U M SIZE OF VESSEL
Table 4.6 indicates the trend changes in the average size o f vessels o f diííerent ship types over
the past 35 years. A number o f points are worthy o f note. First, there has been a general
increase in the average size o f all ship types over the period, with the exception of general
cargo vessels. As there has also been a marked increase in trade volumes, it is not surprising that
ships' sizes have also increased. W hat is more interesting is the differences that have emerged
betvveen the ship types themselves.
The tanker category inTable 4.6 includes both crude oil and oil product tankers, vvhich are very
different in terms o f average size. From 1998 they are listed separately. The dry bulk carrier
category also includes dry bulk and bulk dry oii carhers, so-called 'combined' carriers.This type
were designed to carry both dry bulk cargoes and oil.to take advantage o f dry bulk and tanker
trades depending on the íreight rates, and to reduce ballast time.The combined carrier fleet,
which consisted o f about 400 vessels in 1980, has declined steadily such that there are only
about 70 in Service today.
The Container ship size has increased steadily year on year, passing through a number o f
‘generations’, the I st generation in the 1960s to the 7th generation, 18,000teu ships today.
In contrast, general cargo ship size has changed little. It should be noted in Table 4.6 that the
apparent step change in size in Container ships and general cargo ships in about 1992 is due to
changes in the ship types recorded in each o f these categories.
4 .9 .1 W h y th e differences?
It is clear that some ship types have been able to exploit the potential o f scale economies to
a greater extent than others. In a similar fashion, the ability to exploit the fact that, in general,
larger ships deliver the cargo at a lower cost per tonne than smaller ships, is clearly limited by
the volume o f cargo to be moved, in other vvords, by the size o f the market. Pigure 4 .12 and
Table 4.6 provide some iníormation on the trends in average ship size for a number o f major
ship types.
The increase in tanker sizes in the 1970s can be seen as exploiting the grovvth in volume demand,
the growth in average parcel sizes, and the shift tovvard longer hauls. In earlier sections, it was
noted that increases in journey distances tend to increase the optimum vessel size. In addition,
average journey lengths increased rapidly with the closure o f the Suez Canal in 1967. Larger and
larger vessels were built, culminating in a number of ultra-large crude carriers o f 500,000dwt.
The increase in average size was reversed in the early I980s. Crude oil prices had risen to their
highest ever value, thus raising inventory costs significantly. Average tanker voyage lengths have

C h a p te r 4
declined since the early 1980s; cargo volumes also stagnated.The ideal parcel size, even on the
long-haul major routes, íell.These pressures led to a decline in the average size o f tankers in the
years 19 8 1 to 1987, although the trend has again reversed.
In the I990s, the price o f crude oil had íallen to its lowest level in real terms since 1973. Since
2002, demand for crude oil has grovvn and is close to pr'ũjected inaximum refinery capacity,
creating a volatile market price vvhich is now much higher; trading well above $ 100 a barrel.This
raises inventory values again and tanker average sizes have fallen slightly in the past few years.
■Tanker (average) ^ “ Crude Oil ^ “ Oil Products ^ “ Bulk dry Container — General cargo
Year
Pigure 4. l2Trends in average ship size, 1980-2014 (source: derived íromTable 4.6).
Dry bulk cargo lot sizes have increased as coal and iron ore trades have grovvn rapidly. As
a result, dry cargo bulk vessels have also grovvn in size, with Capesize vessels going above
200,000dwt and the largest measuring 400,000dwt. The expansion ìn size again reílects the
ionger route structures and greater volumes traded in the Chinese and Asian markets, These
trends are consistent with the model outiined above. Again, larger-sized vessels need improved
cargo-handling rates in order to prevent port time increases offsetting any potential cost gains
when the larger vessels are at sea. Higher rates o f cargo handling mean less time in port, and
raise the optimal size. Larger average lot sizes also raise the optimal size o f a vessel.
Vesseis in Container trades spend a considerable amount o f time in port, despite the Container
revolution. They also need to sail at regular intervais and journey iengths may be short.They
carry a mix o f cargoes; a lot o f it with high unit value and high inventory cost. All these íactors
tend to make the optimal vessel size smaller than in the buik trades. But it is interesting to
note that cargo volumes have boomed in the past years, and there are now 18,000teu vessels
of 190,000dwt. The size o f Container ships has grown rapidly since 1995, as globaỉisation and
greatertrade volumes have led to increased viability o f very large Container ships.This process
echoes the rapid deveiopment o f tanker sizes that occurred in the i 970s.

S h ip p in g c o s t a n a lysis and e c o n o m ìe s o f scaie
Year Tankers C ru d e oil O il D ry bulk C o n ta in e r General

(average) products cargo
1980 47,51 1 38,649 15,544 4,976
1981 48,471 38,957 15,645 5,178
1982 47,605 39,057 16,864 5,094
1983 47,031 40,337 17,925 5,131
1984 48,420 40,718 18.369 5,178
1985 46.288 40,534 18,529 5,125
1986 43,263 43,146 18,967 5,132
1987 40,045 44,512 19,661 5,055
1988 39,210 44,972 19,996 4,982
1989 40,264 43,950 19,916 5,822
1990 39,226 43,283 20,198 6,244
i99l 39,788 44,228 23,894 6,301
1992 41,391 48,871 23,338 4,719
1993 41,252 49,156 24,162 4,803
1994 40,578 49,733 24,392 4,809
1995 39.314 50,179 24,617 4,744
1996 39,299 50,134 24,936 4,666
1997 39,088 50,761 25,377 4,620
1998 39,885 133,636 8.154 51,094 25,609 4,714
1999 39,994 133,838 8,256 5 1,980 25,804 4,710
2000 40,448 134,880 8,084 53,035 26,680 4,655
200 i 40,676 135,246 8,01 1 54,239 27,776 4,577
2002 40,436 135,567 7,786 55,139 28,746 4,480
2003 41,527 136,909 7,913 56,124 29,616 4,449
2004 43,524 139,476 8,353 57,077 30,637 4,527
2005 45,067 140,424 8,776 58,309 31,645 4,574
2006 46,299 141,959 9,265 59,548 32,872 4,573
2007 49,272 142,740 10,123 60,729 33,833 4,641
2008 50,523 144,292 10,680 62,323 34,889 4,730
2009 52,232 146,396 11,072 65,014 35,955 4,751
2010 52.814 149,583 1 1,506 67,669 37,556 4,934
201 1 57,182 152,971 12,057 71,01 1 39,505 5,009
2012 59,027 155,479 12,43 1 72,944 41,076 5,019
2013 57,645 157,481 11,946 74,265 43,176 5,054
2014 57,387 158,571 11,065 74,61 1 45,216 5,055
Table 4.6Trends in average ship size (source: Lloyds Register IHS/Fairplay, VVbr/d F/eet Statistics)
General cargo ships show the least increase in size. Given the amount o f time they have to
spend in port, and the low grovvth in demand ío rth e ir services, this is hardly surprising.
The above analysis and argument can be shovvn up clearly with the aid o f Pigure 4 .12 belovv. It is
assumed in the diagram that the long-run average cost (LRAC) relationship for a particular ship
type is known,This is represented by the LRAC curve in the diagram.To simpliíy matters, it is
assumed that the shipovvner is not the cargo owner; so inventory costs can be ignored.

C h a p te r 4
Two trades are represented on the diagratn. DI and D2 represent the long-run level o f demand
per time period expected on that route.The lovver demand volume represents a smaller trade
in total tonnage, assuming voyage distance, load íactors and other relevant factors are similan
This demand volume can be vievved as representing the average cargo lot size for a particular
trip; low total volumes, for a given írequency o f Service, will imply low cargo lot sizes.
If we question what size o f vessel would provide the least average cost for moving the cargo
volume, the ansvver is clean Pigure 4 .13 implies that the lowest unit cost for DI can be achieved
by using a vessel o f o x dwt capacity; for D2, it would be OY. Note the emphasis on average cost;
it should be clear that even though the average cost per tonne o f cargo is lovver in the case
o f D2, the total cost will be largen as, indeed, is the total cost o f the vessel, asTable 4,2 above
makes clean
It vvould not be efficient to use the larger vessel, which is appropriate for average lot size D2, on
the trade D I , because it would be trading at much less than full capacity, so that its average cost
pertonne would not be that read off from the LRAC at OX.This curve was dravvn assuming that
all vessels traded at the same full load íacton It is highly iikely that the unit cost per tonne actually
carried by the much larger vessel, vvhen trading at 25% load facton say, will be higher than the
average cost achieved by the smaller vessel when trading at 100% load íactor.
Pigure 4,! 3 Choice o f ieast cost vessel size
This chapter has developed some basic ideas about the determinants o f shipping costs. After a
short revievv o f basic economic cost concepts, both short- and long-run cost relationships were
explored in the shipping contextThe principa! conclusions were as follows:
I. Short-run variations in output and cost are pnmarily driven by variatíons in vessel speed,
assuming that other important íactors are held constant.
2. There is a complex relationship between long-run unit costs and vessel size; as route lengths
increase, larger vessel sizes vvill have íalling unit costs, but, if the size becomes too large on a
given route length, unit costs may rise.This leads to the concept of an optimal size range of
ships for a given route and íortrade volumes.
3. The choice of optimal vessel size is aííected by the long-run cost curve, demand conditions
and the cost o f inventory.

4. Cost levels are affected by:
a) the choice o f flag;
b) the
c)
c) the degree to which regulations are actually eníorced.

90 Institute o f C hartered Shipbrokers
Chapter 5
Competitive shipping markets:

dry bulk cargo
Iron o re is th e largest c o m m o d ity shipped in d ry bulk cargo

ships, fo llo w e d by coal.
4
Y
m
C h a p te r 5
The dry bulk trades have been transformed over the past 25 years.The average size o f the
vessel engaged in these trades has doubled in size.There is now a large range o f vessel sizes,
with ships o f 10,000dwt now being regarded as relatively small.
Dry bulk trades have in fact evoived from the tramp market.Traditional tramp markets were
served by small, general purpose vessels, essentially scouring the world's ports in search o f
business. That business was primarily undertaken on the spot market, with owners using the
global network o f shipbrokers to seek business for their vessels. A t the same time, charterers
would contact the same set o f brokers to iníorm the market o f their chartering requirements.
Brokers períòrm a íundamental íunction in providing iníormation to both sides o f the market
place to enable contracts to be agreed.
Novvadays, as vessel sizes have increased, there is a tendency for signiíìcant charterers to use
long time charters, consecutive voyage charters and contracts o f affreightment. Owners have
to be able to offer several vessels to fulfìl these types o f contracts, but if the company operates
large vessels, such contracts provide greater continuity o f employment.
Despite the growth in these types o f contracts, there is still a huge volume o f spot charters.This
market is widely regarded, by both practitioners and observers alike, as being very competitive.
In this chapten the focus is on the development o f a simple model o f the competitive process
that will then be used to analyse market behaviour in these trades. The centre o f attention,
throughout this chapter, will be the tramp ship.
5.1 D E P IN IT IO N OF T H E DRY C A R G O SECTOR

The dry cargo sector can be defined using tw o basic methods. Pirstly, it could be deíìned as
the basic unit that provides the Service: the tramp ship. Alternatively, a broader-based approach
could be adopted, defining the sector in terms o f its major market characteristics.These tw o
approaches will overiap to a considerable extent.
The tra m p ship
The first approach, used by several authors, is to define the sector in terms o f the vessel itselí.
Gripaios deíìnes the tramp ship as follows: “A deepsea tramp ship is prepared to carry any
cargo betvveen any port at any time, always providing that the venture is both legai and safe” .
This deíìnition focuses upon the nature o f the market that the vessel serves.
During the 1960s, vessel size increased, prompting a different deíìnition suggested by the late
Proíessor BN Metaxas:“Any vessel with a tonnage o f 4,000-dwt or above, vvhich in the long-run
does not have a fìxed itinerary, and vvhich carries mainly dry cargo in bulk over relatively long
distances and from one or more ports to one or more ports is an ocean or deep sea tram p” .
Notice that both deíìnitions emphasise the fact that the vessel has no fìxed pattern o f
employment. It ís this íeature that has been iabelled tramping. But Metaxas' deíìnition differs in
several respects from the earlier one. Pirstly, a minimum vessel S!ze is introduced, in crder to
exclude small vessels from the market. Secondly, attentíon is drawn to the term 'relatively long
distances’, which is a way o f focusing on the deepsea nature o f the tramping operation. Pinaliy,
Metaxas also states that the vessel trades mainly in the dry cargo secton
M arket characteristics
The problem with deíining a market in terms o f a set o f speciííc vessel characteristics should be
obvious to most people. By including a specific vessel size, Metaxas has dated his definition.The
grovving average size o f most vessel types over the past 25 years, means that 4,000dwt appears
to be a very smali vessel nowadays.

C o m p e titiv e s h ip p in g m a rk e ts : d r y b u lk cargo
In the past two decades, dry bulk vessels have increased their size range, varying from 10,000-
55,000dwt (handysize/handymax), 55,000-85,000 dwt (Panamax), up to 400,000dwt (Capesize).
These vessels are more specialised than the old tramps, as some are clearly too large to trade
from any port to any port; indeed, the very largest cannot transit the major canals of Panama
and Suez, hence the terms Panamax and Capesize.
In addition, such vessels are often employed on contracts o f aíĩreightment, which permits
the shipovvner to meet the charterers requirements by using more than One vessel, o r by
consecutive voyage charters, vvhich oblige the shipowner to commit the vessel to several
voyages in a row for a particular charterer.These longer-term commitments from both sides of
the market do not fìt neatly with either deíìnition.
A modern definition would need to include the development ofthese longer-term commitments,
which have been brought about by two major trends.
Pirstly, cargo volumes and average lot sizes have increased, thereíore creating the bulk dry trades
sector Secondly, the most effìcient way o f meeting these trends is to use larger vessels. But,
as we have seen, larger vessels require larger Capital requirements from the ovvners; they are
only prepared to risk the commitment to such large vessels if they have a better guarantee of
employment; and this is what the above contracts provide them with.
It should be clearthat íreight rates arrived at íorthese contracts are still iníluenced by the spot
market. The analysis that follows focuses on this sector o f the market noting that there are
other contract types available.
A deíìnition that was based upon market structure might be more generally applicable, as it
vvould be less affected by changes in the size o f vessels which were used to serve it.
One o f the key íeatures o f dry cargo markets is the fixing o f many contracts in an open
market situation, W hat is meant by this is the fact that most contracts between charterers
and shipowners and ship managers become well known to all the market participants through
the activities o f the essential market intermediaries, the shipbroking companies.This openness
means that all agents in the market know the prevailing levels o f íreight rates, and can make
their own decisions accordingly.
The markets publish details o f all types o f charten It is important to note a major diííerence
betvveen time charter contracts and voyage charters. Rates for the former are expressed in
terms o f dollars per day, and are effectively the hire rate for a vessel, independent o f its place of
operation. Spot voyage contracts include port and voyage expenses for the owner's account. in
time-charter instances, these are paid for by the charterer in addition to the time charter hire.
The market includes many types o f contract, from spot fixtures, to be started in a matter of
days or weeks, through consecutive voyage and contracts o f aííreightment, to time charters o f
varying durations.
Open market ĩixtures are contracts made in the spot market.The basic elements o f the spot
market are:
1. the provision o f a vessel to load cargo for a speciíìc destination at short notice;
2. to offer a vessel for hire for a single voyage or period usually four to six months or five to
seven months.There is usually an upper limit o f up to one yearThe market for long-term
and short-term íìxtures is intimately related for open market fixtures and will have an
important iníluence on other íìxtures. UNCTAD deíìned an open market as follows:
The open market embraces the aggregates at any given time o f tramp shipowners seeking
employment for their vessels and shippers requiring the services o f tramp ships for a
ỉimited period.
The keynote o f the open íreight market is the quick and easy communication o f iníormation.
The basis is an international netvvork of shipowners, shipbrokers and charterers, closely and

C h a p te r 5
continuously linked by telecommunications.Thus, any charterer needing a ship o f a certain

size and type available at a speciíìc port on or about a speciíìc date can be assured that his
needs will be made known to shipowners in all countries which possess merchant íleets.
Hence, for the purposes o f this book, the clearest definition may be found in the market
characteristics ratherthan in the particular specification o f the vessel.
5.2 M A R K E T C H A R A C T E R IS T IC S
The economic characteristics o f the dry cargo bulk freight market has led some authors to argue
that it is a very competitive one, close to the períectly competitive model used by economists.
There are a number o f important features o f this model which have to be satisíìed in real life if
the model is to be useíully applied to the analysis o f the dry cargo market.The assumptions are
listed belovv:
1. Every supplier in the industry seeks to maximise its proíìts, which are deíìned as the
difference betvveen their total revenues and total costs. Put differently, profit maximisation
requires that shipping companies sell only that output level which maximises the total profit
they make.
2. There are numerous buyers and sellers in the market.

3. The Service offered by each shipping company is exactly the same as every other company
on the market. In the dry cargo market, what is being provided is cargo space, which can be
argued to be exactly the same, no matter what ship or what company. After all, grain and
iron ore are indifFerent to their surroundings, unlike human cargoes.
4. There is easy exit from and entry to the market.
5. There is full iníormation, in the sense that all participants in the market place know
the same as everyone else; market rates are known to all, and cost iníormation is also
vvidely available.
Under these circumstances, a períectly competitive market is said to existThe dry cargo market
fulfiis all o f the above conditions. Allegedly, charterers and shipowners are both driven by the
proíìt motive.
Assumption two is clearly satisfied.There is a large number o f charterers and shipovvners in the
market, and even the very largest shipowning company owns a tiny percentage o f the total dry
cargo tonnage business; the largest charterer is responsibie for a smail percentage o f turnover.
This means that no single supplier or single user o f the market can iníluence the behaviour of
íreight rates in the market. Rates cannot be íìxed, but are driven by overall demand and supply
conditions.
Assumption three is also easily satisíied. The basic Service being provided is the safe
transportation o f cargo in a timely mannen Provided that all ships trade with the relevant
statutory and classification certifìcates, their crews are properly trained, and the vessels are
well maintained, and loading and discharging procedures are carried out correctly, it makes no
difference as to the síiip used.T he one area o f concern might lie in the presence of sub-standard
ships. if these have a greater risk o f íoundering, o f cargo damage or loss or o f unreiiability, then
the cargo space in these vessels is not quite the same quality as in those vessels that do meet
the requirements listed above.VVith that proviso, it will be assumed that the analysis is based on
ships o f an acceptable Standard.
Assumption four is also easily satisíìed. If a shipowner earns unsatisíactory protìts from the ship,
and sees no long-term prospects for recovery, then they can put the vessel up for sale.This may
take a few months, providing there are willing buyers. If it is loss making, the Capital value will
be low, but at least the owner has exited. Although, if the shipowner vvould incur a loss when
existing the market this could be a barrier to exiting.The new owner may be able to make a

proíit because o f the fact that its Capital investment is lower than the previous ovvners. If many
owners cannot make proíìts, and buyers are few, they can either lay up or scrap the vessel. Exit
occurs if the vessel is scrapped, since less tonnage is now available for supply.
Entrance is the opposite. One can enter the market by buying a secondhand vessel, or by
ordering a newbuild. It is the newbuild component that alters the supply o f tonnage in the
long term.
Entry and exit is easy in this market, because existing shipowners have no way o f preventing
such a process.This is in contrastto othertypes o f markets, vvhere existing companies may have
several difíerent ways o f preventing new íìrms from entering and competing. Note that easy
does not mean costless; it is an expensive process to set up a shipping company.What is meant,
though, is that economists do not expect the operating costs o f a new entrant to be any higher
than those of companies already in the business: they would not suffer a cost disadvantage
from entering.
Assumption fìve is best justified by two words: Baltic Exchange. Although little direct trading
is now done on the floor o f the Baltic, it symbolises the fact that there is a meeting point at
which charterers can find ships, and shipovvners can fìnd charterers, and at the same time learn
what current market rates are. Nowadays, most transactions take place on Computer screens in
shipbroking houses;the efíect is the same.The brokers act as information transmitters, ensuring
that all players are kept íully iníormed o f any event that might afFect the market.
An important characteristic o f a competitive market is that shipowners have no individual
iníluence over market rates. But since profit is made in the margin between revenues and costs,
the only element that they have control over is costs. Competitive markets tend to be driven by
cost trends, rather than by demand íeatures. In other words, continuous attention to all aspects
o f costs, keeping them as small as possible, is a hallmark o f a competitive industry.
The assumption o f a competitive industry permits the use o f a simple model o f industry
behavioun Beíore that, the structure o f the dry cargo fleet, and the use o f breakeven analysis in
tramp-operating decisions, will be explored.
5.3 DRY B U L K M A R K E T D E M A N D S T R U C TU R E A N D
TR E N D S OVER T H E PAST 20 YEARS
Table 5 .1 provides annual data on the growth o f dry bulk cargo demand over the past 20 years.
Column one reveals that the total volume o f cargo, measured in cargo tonnes, has more than
doubled in that period.This vvorks out at an annual average compound growth rate of 4.5% per
year.This rate o f grovvth is quite respectable; the UK's growth rate has been around 2% per year
for the same period, although, o f course, other economies have grovvn íaster.
The average growth rate hides tw o points worthy o f note. Pirstly, demand grovvth is much more
uneven on a year-to-year basis. Column two shows the annual growth rate over the previous
year's level o f demand.This column reveals many interesting features. It is clearthat the highest
rate of grovvth to be observed occurred in 2 0 10, at 12 .1%, about three times the long-term
average. Since 1995, the tonnage growth rate has íluctuated between -2.8% and 12.1%„ vvhich
is a large variation. Second, it should be noted that growth rates seem to go in spurts; the rate
peaks, declines, and, in some years, becomes negative, beíore recovering again. In other vvords,
demand growth tends to move in cycles o f good years, medium years, poor years, and back
again.These cycles exist around a rising trend in the total volume o f cargo moved.

C h a p te r 5
Year D ry bulk Annual D ry bulk Annual Average Bulk Annual Surplus:

cargo: growth cargo: grovvth haul: fleet: growth % of
million billion Nautical million bulk
tonnes tonne- miles dw t fleet
miles
1995 1,935 5.7% 252.2 4.3% 7.1%
1996 1,954 0.9% 261.0 3.5% 6.6%
1997 2,044 4.6% 270.1 3.5% 3.89Ố
1998 2,038 -0.3% 263.8 -2.3% 2.2%
1999 2,045 0.3% 11,263 5508 264.6 03% 3.0%
2000 2,194 73% 12,102 7.4% 5517 270.0 2.0% 1.4%
2001 2,237 2.0% 12,381 2.3% 5534 282.6 4,7% 1.0%
2002 2,310 33% 12,427 0.4% 5379 286,8 1.5% 0.8%
2003 2,452 6.1% 13,313 7.\7o 5430 293.0 2.2%' 1.2%
2004 2,649 8.1% 14,563 9.4% 5497 309.3 5.6% 0.7%
2005 2,795 5.5% 15,280 4.9% 5467 331.0 7.0% 0.6%
2006 2,987 6.9% 16,510 8.1% 5528 352.3 6.4% 1.0%
2007 3,218 7.8% 17,522 ' 6.1% 5444 374.2 6.2% 1.0%
2008 3,31 i 2.9% 17,903 2.2% 5407 399.1 6.7% 0.9%
2009 3,217 -2,8% 17,412 -1.7% 5412 437.3 9.6% 0.6%
2010 3,605 12.1% 19,702 13.1% 5465 513.3 17.4% 0.6%
201 1 3,841 6.5% 20,899 6.1% 5441 604.0 17.7% 0.5%
2012 4,098 6.7% 22,349 6.9% 5453 647.5 \72%' ~
2013 4,331 5.7% 23,350 4.5% 5391 686.3 6.0% ị
2014 4,503 4.0% 24,488 4.9% 5438 726.3 5.8% J
ỉ1'■
2015 4,668 3.7% '25381 " 3.6% 5437
1995-2014 4.5% i --5.7%. .. .. L J
1999-2015 5.2% -0.1%
Table 5 .1 D ry bulk targo: seaborne trade and dry bulk fleet, 1995-2015 (sources: D ry bulk cargo
• Clarksons Research Services: Dry bulk íleet - VVbr/d F/eeí Statistics, IHS/Fairplay; Surplus tonnage
UNCTAD, Review of Maritime Transpon.).
Notes: I . Dry bulk cargo indudes both major and minor bulks. 2. Dry bulk fleet consists o f dry bulk and bulk
dry oil ships.
The above analysis examined demand measured in tonnes o f cargo moved.This may well give
an incomplete picture if the voyage distance alters, since the basic unit o f output is the cargo
tonne-mile. Column three provides information on the volume o f tonne-miie movements
since 1999. In this period, tonne-miie demand increased bv 5.2% per year compound, whereas
cargo tonnes moved grew by 4.5% per year.The growth rate o f tonne-mile demand has varied
between -2.7% and 13.1% in the period 19 9 9 -2 0 15. Diíĩerences in the growth o f tonnage
demand and tonne-miie demand imply that journey distances have íluctuated, as column four
reveals.The average haul has declined slightly from 5,508 miles in 1999 to 5,437 in 2015.
Column six provides information about the growth o f the dry bulk fleet, vvhich has averaged
5.7% per year over the period 19 9 5 -2 0 14 in dwt terms. Note that this grovvth diíTers from that
o f tonnage demand; it would be fair to conclude that supply capacity has exceeded demand just
on the basis o f these íìgures, as supply capacity should properly be measured in terms o f tonne-
mile potential. The dry bulk íleet has expanded more or less continuously since 1999 and rose
very strongly after 2009.

The laid-up fleet has been steadily declining in tonnage terms, from 25.1 miilion tonnes dwt in
1992, and as a percentage o f the dry bulk fleet.
Case s tu d y : Elasticity of derived demand

The elasticity o f derived demand is the measure that expresses the strength o f the change
in a derived demand when there is a variation in prices.To continue the example o f the car
industry, it is known that shipping is rather price inelastic as the price o f transport, for most
goods, is a very small part o f the total cost.
Let us assume that the derived demand elasticity is -0.15.
From the example o f demand elasticity we know that, at a price o f £ 10,000, the demand
for cars is 100,000. If we assume that 8,000 cars are transported in one car carrien a
minimum o f 13 carriers are needed.
Now,asthe price increased to £1 1,000, the demand fell to 88,000 cars.A simple calculation
would reveal that only I I ships would be needed. However, following the derived demand
elasticity calculation, the demand for shipping vvould only drop by 1.5% (-0.15 X 10)
meaning that still 13 ships vvould be needed, but that overall they will carry less cargo.
5.4 A N A N A LY S IS OF T H E COST S TR U C TU R E OF T R A M P
S H IP OPERATORS
In the short run, tramp operators will have to identify their costs in terms of those items
which are aíĩected by the amount o f output that the company produces, and those that are
independent o f any variation in that output, that is, splitting their costs between íìxed and
variable. In the cost model presented in Chapter 4 it was argued that in the shipping context,
most variable costs related to those items speciíìcally related to producing output, which, of
course, implies those cost items related to undertaking a voyage, and the speed at which that
voyage is undertaken.
The other way o f viewing short-run costs is to ask a simple question. W hat costs are avoided, if
Ido not carry out a particuiar activity?The distinction betvveen avoidable and unavoidable costs
is also useíul when making operational decisions.
5.4.1 T h e ia y -u p d ecision
Here is an example.VVhat costs should be considered relevant in the decision of a tramp ship
operator to lay up their vessel, or to continue to trade?
A common sense ansvver might be to estimate the total costs incurred if the ship were to
continue to trade, undertaking another voyage that takes six weeks, say, and compare that to the
íreight revenue obtained from the trip. If the trip loses money, in the sense that íreight revenues
are less than the total costs.then the vessel could be laid up.
There are, in fact, two things wrong with this analysis. Pirstly, it assumes that lay-up is a costless
activity. Lay-up costs money; the vessel has to be maintained, it has to be provided with some
power; and it may have to be moved to a safe lay-up position. On the other hand.the vessel will
no longer have a full crew. Provisions and maintenance will be less, so that the costs associated
with owning the vessel will be reduced.
The second error is that the analysis includes costs that will be incurred by the ovvner whether
the vessel trades or not, but if these costs are common in both situations, they cannot aííect the
outcome o f the decision;they can in effect be cancelled out.

C h a p te r 5
Suppose that the owner estimates that daily operating costs are $ 10,000 for a vessel in a trading
condition, and $4,000 in lay-up. $3,000 o f this cost is assumed to be the Capital cost o f owning
the vessel; it is not avoidable, whatever one does with the vessel. It thereíore can be canceiled
out.The relevant costs become $7,000 per day when trading, and $ 1,000 per day when laid up.
Suppose the owner is now otĩered a charter vvhich takes 42 days, and will incur voyage-related
costs o f $380,000 in the period. On a total cost basis, the owner will require $800,000 in
revenues; if the vessel has a 50,000dwt carrying capacity, this implies a rate o f $ 16 per tonne o f
cargo delivered. But suppose the market rate is only $ 14. Should the owner lay up the vessei?
If the ovvner lays up the vessel, it íaces extra costs o f $42,000, say, 42 days at $ 1,000.
Ifthe ovvners takes the charter, they gain $700,000 in extra revenues.This comprises freight o f
$14 X 50,000 tonnes o f cargo. But they spend operating costs o f $7,000 X 42 + $380,000 =
$674,000.The owner thereíore gains $26,000, compared to the loss o f $42,000 resulting from
lay-up.They shouid take the charter, even though the rate is less than the full cost o f the trip.
The same conclusion would, o f course, be reached if the Capital costs o f $3,000 per day had
been included.The total costs o f lay-up would be $42,000 + (42 X $3000) = $ 168,000, vvhilst
the total loss from trading vvould be $700,000 - $420,000 - $380,000 = -$100,000. This
is o f course, a loss-making situation, but it is in fact the best that the owner can do in the
circumstances.The $ 100,000 loss is in fact smaller than the loss made by the owner if the lay-up
option were chosen. Note that the difference between the loss ($68,000), is exactly the sum
o f the cost saving from not laying up, $42,000, and the net revenue, extra revenue minus extra
costs resulting from continuing to trade is $26,000.
The hypothetical example ignored any additional costs incurred with the lay-up itselí; including
these vvould, o f course, only serve to emphasise the fact that trading vvill oíten take place at
market rates vvhich are less than the long-run costs o f providing the Service,
A t what point vvill ít become worthwhile to lay up? One way o f ansvvering this is to develop
a model o f the breakeven leve! o f íreight rates needed to maintain trading. This will be
explored below.
The analysis carried out so far has implicitly assumed that the basic unit o f analysis is the
vessel itselí; that the shipping company is a one-ship operation, VVhile this assumption may
be reasonable for many small dry cargo companies, it is not true for a large number o f dry
cargo firms who operate several vessels, maybe dozens. As the number o f ships operated by a
company increases, the role o f ship management, o f planning and Communications, ali become
more significant. It might be expected that these costs are generally unrelated to the level of
output produced by the companys vessels. But they may be related to the number o f vessels
operated and controlled and will increase as a share o f total costs, as the company size expands.
On the other hand, the discussion in Chapter 4 also indicated that larger firms may expenence
lovvet' unit costs for a number o f reasons; there are tw o íorces at play here which can work in
opposite directions.
It is vvidely argued that tramp operators tend to have a higher proportion o f their costs as
variable costs when compared to other market segments. s A Lavvrence pointed out that:“ framp
compơnies operate with smơller overheads than liners and have no commitment to maintaining a
regular Service, enjoying g rea te r (lexibility in the use o f their sh ips."
As a final point, it is worth emphasising that the distinction between short-run íìxed and variabie
costs is not clear cut. It depends on the nature o f the problem being considered, and on the
type o f vessel under anatysis, as well as the time period involved. In our discussion o f the lay-up
problem, some items o f daily operating costs could be avoided, so were treated as variable. But
if the owner was considering betvveen tw o trading options, the entire daily running cost would
become fixed, because all those elements could not be avoided. Time is also an important
íactor; the shorter the time period under consideration, the greater the proportion o f costs

C o m p e titiv e sh ìp p in g m a rk e ts : d r y b u lk cargo
that will be fixed, Once a vessel is at its loading berth, or a voyage is commenced, practically all
costs become unavoidable.
5.5 T H E USE OF B R E A K E V E N A N A LY S IS IN D E T E R M IN IN G
M IN IM U M P R E IG H T RATES
A well-known method in both economics and management is to present iníormation on
revenue and costs in the form o f a breakeven analysis.The normal procedure is to calculate the
load factor or level o f utilisation required to breakeven. If actual load íactors or utilisation levels
exceed the calculated number, it is clear that proíìts are being made. If, on the other hand, the
target load factor figure does not materialise, losses will be made.
Deíining the load íactor may well be significant in the liner trades, where vessels operate to
a timetable, whether or not they are fully loaded.This is not normally the case for dry cargo
shipping, vvhere full cargo loads are usually the rule, ratherthan the exception.
Instead o f applying the model to vvorking out the breakeven load íacton it can instead be
employed to work out the breakeven rate.That is, the íreight rate which will ensure that a full
cargo load will generate suffícient revenue to cover costs.This is a very plausible use to put this
model to, because freight rates in dry cargo trades are quite volatile; it is thereíore useíul to
w ork out the minimum rate required to breakeven.
The model is based on the following assumptions:
1. The vessel is taken as the basic unit o f analysis.
2. Costs and revenues are assumed to be linean that is, total variable costs rise in constant
proportion to output, and total revenues also rise in constant proportion to output.This
implies that the average revenue, or unit price, o f íreight rate per tonne o f cargo, is constant
overthe volume o f output being examined, and the average variable cost is also constant as
output changes.
3. The market contains many shipovvners and many charterers who cannot iníluence the
market rate on their own.
4. This means that the actual íreight rate is taken as íìxed, since no individual has any ability to
alter it. Each individuai is said to be a price taker.
Pigure 5 .1 belovv shows the Standard breakeven model, drawn for the current market rate.The
slope o f the line 0F represents the market price; since total revenues rise in line with volume
carhed.the price is constant all the way along 0F.

C h a p te r 5
Proíìt
ỘỊ
5
E
ĩ
ụ
Variable
sp costs
4i/>
0
ũ
Fixed
costs
Cargo quantity
Pigure 5 .1 Breakeven model
A t cargo quantity Q3, which represents a íull cargo load, total revenue is given by the vertical
distance Q3F. On the other hand, if no cargo is carried at all, totai revenue is zero.Total fixed
costs are R which is the same value as Q3V.Total fìxed costs are the same, no matter what
cargo quantity is loaded. Total variable costs are the diííerence between total costs and total
fixed costs; at zero cargo quantity, they are zero, so total costs equal R VVhen the maximum
cargo quantity is loaded, total costs rise to Q3T, and the distance VT represents total variable
costs at that level o f output.
It is clear írom Pigure 5 .1 that total revenue equals total cost at cargo quantity level Q2, with
associated total cost = total revenue = E.This cargo quantity is called the breakeven quantity,
because it is at this point that total revenues cover both variable and fixed costs.The figure is
oíten expressed as a percentage o f the maximum quantity that can be carried or produced, a
number vvhich is found by measuringthe ratio o f Q2/Q3,then multiplying by 100.
5.5.1 P inding th e b re a ke ve n ra te
The above analysis was outlined in Chapter 4. In a tramp-shipping context it is perhaps more
useful to use this model in a slightly different way. Instead o f discovering what cargo quantity is
required in order to break-even, the calculation might be used to discover what íreight rate is
needed to breakeven.
The assumption that is needed for this anaiysis is that the vessel will alvvays trade at or very
near its full cargo-carrying capacity for the voyage being considered. Pigure 5.2 shows the new
situation.
Two additional total revenue lines have been added to Pigure 5.2. Each represents the behaviour
o f total revenue at different íreight rates.The slope OÍTR2 represents a lovver ievel o f íreight
rate than T R I, and TR3's slope corresponds to a lower rate than TR2. In other words, the ílatter
the slope o f the total revenue line.the lovverthe íreight rate pertonne o f cargo.

C o m p e titiv e sh ip p ìn g m a rk e ts : d r y b u lk ca rg o
<Ạ
3
c
Ổ
2
ổ
yỊ
p
ũ
ễỐ
Cargo quantity
Pigure 5.2The breakeven íreight rate model.
Given the assumption thatthe vessel is always íully laden, it is clearthatthe breakeven rate must
be given by the lineTR2. If Q3 tonnes o f cargo are carried, a total revenue o f Q3T is obtained,
and total costs o f 0Q3T are incurred.
It follows that, if the íreight rate is above that implied by the lineTR2, then the tramp operator
will make a profìt. On the other hand, a rate ofTR3 will incur a loss.
Again, the quest might be to discover the lovvest rate vvhich the ovvner should accept. O r put
another way, will the ovvner ever accept a rate lower thanTR2?
The ansvver to the latter question is yes. The minimum short-run rate that is acceptable
depends on whether the losses incurred in accepting the business are smaller than the losses
incurred from being idle. As long as total variable costs are covered, it is worthwhile accepting
the business if the loss so incurred is smallerthan the loss arising from the vessel doing nothing.
In fact,TR3, which represents that rate, must also reílect the slope o f the total variable cost
curve. Underthe speciai assumptions of this model, it is the same as the marginal cost of moving
one more tonne of cargo. Put another way, the price must never be belovv the marginal cost of
producing the output, and must never be less than the average variable cost o f production.This
is in fact a general rule that always applies, no matter what the relationship is betvveen costs
and output.
It is worth recalling the discussion o f lay-up. It is clear that the lovver the proportion of variable
costs to íìxed costs in a shipowner’s company, the greater the scope for the íreight rate to
fall below the long-run total cost o f producing that output, or o f maintaining the ship.This is
an im portant point to note, because it is one o f the factors that helps to explain the Sharp
íluctuations that are observed in íreight rates in the dry cargo trades, especialiy when contrasted
vvith those set in the liner trades. Owners, in depressed markets, may vvell accept short-run trip
charters at rates well below those required to cover their long-run costs, if the proportion o f
variable costs are low.
5.6 M O D E L L IN G T H E DRY C AR G O M A R K E T
A very simple cost model o f a tramp shipowner has been discussed, in which freight rateswere
taken as given. In what follows, it is assumed that the market can be separated into speciĩic

C h a p te r 5
segments, one o f which is being modelled.The bulk dry trade is taken as an example, leaving the
segment o f smaller vessels and the markets that they serve to one side for the moment.
The analytical framework developed here can still be applied to these other segments as well,
provided that they satisty the following assumptions:
1. each shipovvner and ship management company is seeking to maximise their profits, or to
minimise their losses;
2. each charterer is seeking the cheapest rate consistent with an acceptable quality o f Service
offered by the shipovvner;
3. there are a large number o f fixtures, the details o f most o f vvhich are readily available to all
market participants;
4. the model o f períect competition is assumed to be an appropriate framework for

analysing market behaviour (the assumptions underlying this model have been discussed in
section 5.2).
5.6.1 M o d e llỉn g d em a n d
Readers may like to review their knovvledge o f demand from their studies in Chapter 2. The
individual shippers fìrm requiring transport and shipping services regards the íreight rate as a
given value vvhich they cannot alter through their own individual action. It is assumed that there
is a downward sloping relationship between the cargo volumes required to be moved and the
level o f íreight rates, other things being equal.The higher the rate, the smaller the demand for
cargo movements and vice versa.
Will market demand be responsive, or unresponsive, to a change in the íreight rate? Both
are possible and consistent vvith a downward sloping relationship betvveen rates and cargo
quantities.The discussion in Chapter 2 helps us to answerthis question.
The demand for dry cargo tonne-miles is a derived demand. Chapter 2 reviewed the basic
principles underlying the estimation o f price elasticity for derived demands.
The principal factors were:
1. the value o f the own price elasticity o f demand for the fìnal goods;
2. the existence o f close substitutes;
3. the proportion of the total final price which transport constitutes.
Take grain as an example. Grain movements are driven by production and consumption trends
in diíĩerent regions, by local weather conditions and crop yields and by changing patterns o f food
consumption. Grain is itselí an input; it is used to rnake bread or pasta, OI' is fed to animals to
produce meat. But bread, meat and pasta all have iow price elasticity o f demand. Most empiricai
evidence suggests that they are price inelastic.
Grain movements from major exporting regions such as South America or Australia have
to go by sea. A ir transport, whi!e perhaps íeasible for very small volumes, is a very
expensive alternative.
Preight rates are novv about 6% o f the fìnal price o f most traded commodities in VVestern
Europeithese details have been covered in Chapter 2.
The conclusion is that, taken as a whole, market demand is likely to be extremely inelastic with
respect to changes in íreight rates.The demand curve can be represented as an almost vertical
line, as in Pigure 5.3 belovv.
Note that this conclusion is for the market as a whole. It does not follow that demand conditions
on any one trade route are also necessarily inelastic. It could be the case that the possible
sourcing o f demand írom other countries and other routes makes the demand on each route

C o m p e titiv e s h ip p in g m a rk e ts : d r y b u lk ca rg o
much more sensitive to changes in the specitìc routes íreight rate. Indeed, ovvners will always be
seeking out trades vvhich are more proíìtable than others. But the ability to svvitch vessels from
one route to another at relatively short notice implíes that rates should not get too out o f line
with each othen although there are speciĩic additional costs attached to certain trades.
V
c
c
I
e
00
DI
Cargo quantity/tonne-miles per year
Pigure 5.3 Inelastic ĩreight demand schedules
Preight rates are measured on the vertical axis and quantity o f the commodity or cargo tonne-
miles are measured on the horizontal axis. D I , D2, and D3 show three different demand
schedules, each íurther out to the right.These represent diíĩerent volumes o f demand, generated
by higher and higher levels o f economic activity, industrial production or vvorld trade volumes. A
fall from D2 to DI would represent a decline in tonne-miles demanded, or cargo tonnes moved.
A rise, or shift, o f the demand schedule fronn D2 to D3 vvould represent long-term expansion.
Recall that there are cycles o f demand growth. In some periods the demand schedule vvill
be shilting rapidly out to the right, reílecting boom conditions. In other years, it will be hardly
shitting at all, and perhaps even declining. Over a long time period, it is generally anticipated that
the trend will be a slovv shiít out to the right.
Case s tu d y : Derived demand for shipping

The demand for shipping is a dehved demand as the product being consumed is not the
transport itself (except in passenger transport), but the goods that are being transported.
The shipping demand o f the car industry is a very good example. Cars are produced
all over the vvorld in a wide variety o f makes and models. N ot every country produces
each make or model and so cars need to be transported to satisíy customer demands.
Thereíore, when demand for cars increases, demand for transport increases. For example,
if more American íamilies decide to order cars produced in Japan, Japanese cars will need
to be transported from Japan to the United States o f America. To transport these cars,
nriore ships will have to be chartered.Therefore,the transport by ship is a derived demand
from the purchase o f the car

C h a p te r 5
5.6.2 S upply
Given the discussion o f short-run costs in Chapter 4, and the discussion o f short-run supply in
Chapter 2, ít is time to try to integrate these two. Under competitive conditions, it was pointed
out that the shipovvner should never accept a íreight rate that is less than the average variable
cost o f the ships output It has also been pointed out that diíĩerent ships have different costs,
because either they are o f different ages, or they operate under different flags, or they face
diíỉerent wage costs.
Imagine that all these costs were knovvn, and that a ranking could be organised, starting with
the dry cargo bulk vessel with the lovvest average variable cost, moving up to the next, and so
on until the last, most expensive vessel is brought in. If íreight rates were high enough and cargo
volumes large enough, all these vessels would be employed. Novv, if one imagines that the rate
is steadily reduced, one can see vvhich vessels will cease trading íirst: those with the highest
variable, or avoidable costs.
As the rate is remorselessly iovvered, more vessels are íorced into idleness, until none is trading.
Purthermore, it was earlier demonstrated that Capital costs should play no role in the lay-up
decision in the short run, since these costs have to be met vvhether or not the vessel is being
traded. Older vessels will tend to have higher operating costs than newer vessels, partly because
they will be designed with older; less effìcient equipment in place, partly because they will require
greater crew numbers than modern ships, and partly because they may have olden more fuel-
ineffìcient engines. It is not surprising then, to observe that the majority o f laid-up vessels are the
oider ones o f the fleets.
The discussion to date has ignored the fact that, in the short run, vessels' variable costs can
themselves be altered by varying the operating speed o f the ship. Lower speed means lower
output and lower costs. If íreight rates are low because demand is low, the loss o f output is
more than offset by the benefits o f slower steaming.Thus it is possible to expect the supply
o f tonne-miles, the supply curve mentioned in Chapter 3, to be directly related to the cost
considerations covered in Chapter 4.
The shape o f the supply schedule is repeated belovv from Chapter 3. It is dravvn so that it
becomes steeper in siope as maximum tonne-mile production is attained.There are tw o reasons
for this. Pirstly, the additional tonne-miles being created near full capacity are being created by
the more ineffìcient vessels in the fleet, the ones with higher variable costs.These vessels add
a lot to costs vvithout adding that much extra to output. Second, speed increases are a limited
way o f raising outputThe extra costs o f fuel consumption increase more rapidly than the extra
output, so the required supply príce increases.
The curve eventually becomes vertical, representing the notion o f full capacity utilisation. No
more output can be obtained from the existing fleet, in the short term.
In the language o f economics.the supply curve represents additionai or marginal costs o f meeting
the extra output required.This proposition is only valid if the market is itselí competitive.

Pigure 5.4 Short-run shipping supply curve
5.7 D E T E R M IN IN G T H E E Q U IL IB R IU M FR E IG H T RATE
The market is defined as the interaction o f supply and demand, vvhich both together determine
the equilibrium íreight rate and quantities sold at that rate. Pigure 5.5 below shovvs several
different possible short-run market equilibria, each determined by difFerent demand conditions.
The key íactors that make demand conditions alter relate to the volume o f vvorld trade, vvhich
is driven by overall economic activity, and changing degrees o f openness towards trade by
individual nations. Demand curves íurth e rto the right represent largertrade volumes.
II
ĩ
Ặ
I
Tonne-miles/year
Pigure 5.5 Short-run market interaction.
Demand volumes increase from DI to D4. Between DI to D3 there is a relatively small rise
in the market íreight rate and a large rise in tonne-miles produced. But betvveen D3 and D4,

C h a p te r 5
the increase in demand is translated into large increases in rates, because supply becomes very
inelastic and the scope for increases in supply becomes increasingiy limited.
The above model can be used to examine short-run íluctuations in market conditions, but not
long- run ones. This is because the supply schedule represented in Pigure 5.5 is drawn for a
given stock o f ships. But, it is a useíul framework to explore íluctuations in ữeight rates in the
short term.
Considerthe shift in demand from D3 to D4. Rates move up very sharply, and supply does not
increase much.This creates large proíìts for existing shipovvners, who will be encouraged to
order new vessels.The value o f existing vessels wiil also rise, reílecting the markets expectation
that proíìts are going to be healthy in the íuture.The increased number o f orders will translate
into a rightvvard shift in the supply curve in the long term and this will lead to a fall in rates if
demand remains at D4.
On the other hand, a fall in demand from D2 to DI will bring about a reduction in supply and
a rise in vessel lay-ups. Remember that in the short run, some vessels will be trading at rates
vvhich do not covertheir full costs.VVhile this is acceptable in the short term, it is not the case
in the longer term. Some vessels vvill be laid up or scrapped.The scrapping o f vessels leads to a
leftwards shift o f the supply curve.This process will help raise rates if the supply shifts far enough.
Extending the m odel
More detail can be incorporated into the basic modei by considering, íìrst, how the increase or
decrease in short-run supply can be implemented. A rise or fall in demand generates the rise or
fall in rates.The higher or lower rates create incentives to increase or to decrease tonne-miles
supplied through the following mechanisms:
a) higher or lower rates encourage a higher or slower speed;
b) higher or lower rates will encourage owners with high variable-cost vessels to bring them
out o f or drive them into lay-up.
In the long term, ĩluctuations in íreight rates and lay-up numbers wiil encourage owners to
embrace or reject nevvbuilds, or progress or delay scrapping.These processes will shift the supply
curve out to the right in the case o f an increase in demand, or to the left in the opposite case.
A key factor iníluencing this decision is the expectation o f shipowners. Expectations o f íuture
ievels o f ĩreight demand and íreight rates will be critical in determining how the market reacts to
short-term changes in demand and rate levels.
If ovvners are ĩundamentally optimistic about the íuture, íalling rates in the short term may not
lead to a longer-term reduction in shipping capacity. If that expectation is false, it will be revised,
and those changes will take place.
On the other hand, pessimistic expectations about the íuture will reinforce any short-term
dovvnturns, and may lead to a shortage o f capacitv if demand grovvs at an unexpected pace.
Expectations can be very volatile, and their volatility helps explain the sudden increases and
equaliy sudden íails that have been observed in rate movements, particulariy when political
events, wars or other events can have strategic impacts on dry cargo markets.
5.8 C O N P R O N T IN G T H E M O D EL W IT H T H E EVID EN C E
The above model implies:
1. that freight rates should be sensitive to short-run market conditions, reílecting both present
and expected íuture situations;
2. there will be a strong positive correlation between demand growth and new orders,
provided that the present stock o f vessels is highly utilised with low levels o f lay-up;

C o m p e titiv e s h ip p in g m a rk e ts : d r y b u lk c a rg o
Pigure 5.6 Development o f shipping íreight rates, 1947-1984

C h a p te r 5
3. there will be a strong positive correlation betvveen freight rates and new orders, with
periods o f high rates associated with higherthan average orders, lovverthan average lay-ups
and scrapping;.
4. that exceptional events will generate signiíicant increases in rates, if they occur when existing
shipping capacity is being íully stretched.These are usually anticipations or outbreaks of vvan
or strategically important changes, such as the closure o f the Suez Canai or an international
embargo on certain resource-rich countries.
Pigure 5.6 shovvs the movements in tramp voyage rates for 28 trade routes and includes tankers
engaged in the grain trade, for the period 19 4 7 -1984. It also shows the movements o f the tramp
charter index, and a tanker index. An important point to note is that these indices are based
on a notional value o f 100 for 1965-1966. It thereíore takes no account o f rates o f inflation. If
price level changes were allovved for, the later booms would look larger, and the earlier booms
look smallen
Note that there are substantial periods o f demand growth in vvhich íreight rates do not
íluctuate all that dramaticaily. In these periods, either there is plenty o f capacity available to meet
any increase in demand, or the expansion o f demand is matched by the correct expansion o f
capacity, brought about by accurate expectations generating the correct level o f ordering.The
spikes are generated by events which are not completely anticipated by the market, and as
noted earlien tend to be wars or war-related events which impact on the shipping markets.
A clear example o f such a boom is that o f the early 1970s. Growth in demand for shipping
services was very high in the late I960s and early I970s, with one peak observable in 1970.
VVorld commodity prices rose sharply in the period up to 1973, and shipovvners fell over
themselves to order new vessels. Many o f these were o f the new large designs, as this was
the period o f rapid increases in the sizes o f dry-bulkers and tankers. In September 1973 this
all came to a halt with the six-day Arab-lsraeli wan ending with the closure o f the 5uez Canal
and the Arab oil embargo on countries seen as pro-lsrael.The 400% rise in the price o f crude
oil delivered a huge shock to the VVestern economies that had been previously growing quite
rapidly. Their economic growth íaltered; the UK’s real income fell in 1974. Lovver economic
growth means lovver grovvth in the demand for shipping movements.
It is worth examiningTable A5.1 (see Appendix to this chapter) in the context o f the above
comments, and relating the data to the iníormation contained in Pigure 5.6. The rate peaks
o f 1970 and 1973 correspond to tw o o f the years o f highest annual grovvth o f tonne-mile
demand, o f 10.3% in 1970 and 15.2% in 1973. Note that demand actually fel! by 1.^% in 1975.
In 1984, demand grew at 10.2%. Note that there is no peak in the freight rates in 1984. The
difFerence in the two situations is simple. In 1970 and 1973, there was very little laid-up tonnage,
In 1985, over 20% o f the fleet was laid up.The increase in demand was easily met from existing
capacity, and no peak in íreight rates is observed.
These observations are consistent with the demand/supply model discussed above; in the
first tw o peaks, demand is at or near full capacity, so íurther increases help generate large
rate increases as supply response is very small. But in i 984 and 1985, there was plenty of
spare capacity and signiíìcant increases in dernancl were met wilh no cotresponding rise in
freight rates.

5.8.1 H is to ric a i d e v e lo p m e n ts
Pigure 5.7 shows the behaviour o f certain dry cargo rates over the period 19 8 9 -1996.
Pigure 5.7 SSY Atlantic Capesize Index, 1989-1996 (source: SSY Research Department).
Note: Base Index value = 5000.
The SSY Atlantic Index tracks the movements o f íreight rates on nine major routes on which
Capesize tramp vessels operate and reílects their behaviour in index number form. The
marked volatility o f the index reveals just how sensitive rates are to current demand and
supply conditions.The mid-l990s’ boom in the dry cargo sector is ciearly reílected in the peak
values o f the index in the 1994-1995 period. Rates are clearly very responsive to changes in
market conditions.
A more recent example o f the same dynamic behaviour can be seen in Pigure 5.8, vvhich plots
the movement o f an index o f dry cargo trip charters on a monthly basis from 2000. Note
the index is based on 1985 = 100, so the values have been kept in ‘real’ o r ‘constant’ terms. A
measure o f the volatility o f the index vvithin the year has been provided, which confirms that the
average rate has risen sharply since 2003, and with it.the volatility o f the rate. In fact,the volatility
statistic shows just how dramatic the change in the market has been since January 2003. The
intra-year volatility jumps from around 3% to figures vvhich range between 14% and 33%.

C h a p te r 5
8 8_ — —
o o o o ọ ọ ọ S o
— rNfNCS'T>fT’ <^ J J J ưì ưì
s <s rs p
8M trõ8NMr Mrõ8M õC. S õ
o
í N rr M
õ õ õ o o
í .S r S C M C M C M C
o ọ
N í M r M í S í N
o o
0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0
o o o õ õ õ õ õ õ õ õ õ õ õ õ õ õ õ
Pigure 5.8 D ry CargoTrip Charter Index, 2000-2005 (source; derived from ISL data).
Intra-year vo la tility %
2000 L3Z ______
2001 2,6
2002 .......
2003 27.4
2004 ' 14.4
2005 32.5
Table 5.2 Tnp charter volatilitỵ, 2000-2005
Note: Measured as ratio of Standard deviation of rate within year-to-year ơverage rate.
W hat has caused the dry cargo m arketto experience such a dramatic and sustained increase in
freight rates and in their volatility?
There are a number o f reasons, but they boil down to analysing demand and supply effects
on the market. As Pigure 5.8 and Table 5.1 shov^, tonne-mile demand rose at a remarkable
rate betvveen 2003 and 2008, with rates over 6% per year. If the fleet capacity does not grow
as fast, ships have to work harder and rates will rise.The increase in rates will not solve the
problem, but sends a signal to ovvners and investors that this segment o f the shipping market is
novv vvorth investing in. Just how worthwhile investment is can be judged by the report, which
provides estimates o f the daily operating costs o f various dry cargo ship sizes and the time
charter earnings they vvere negotiating in 2006. The daily operating expenses for a Capesize
were put at $6,500 per day, $5,000 for a Panamax and $4,000 for a handysize. Time charter
equivalent earnings, that is, the spot rate converted into a time charter value, on a hire-rate
basis, were estimated at $50,000 per day for a Capesize, $30,000 for a Panamax and $24,000
for a handysize in October 2006.
The time charter equivalent earnings are similarto those reported inTable 5.3.
I 10 institute of Chartered Shipbrokers

Year Capesize Panamax Handymax

172,000dwt 74,000dwt 46,000dwt
2002 I 1,918 7,725 7,978
2003 40,329 20,063 14,810
2004 69,002 35,725 28,191
2005 50,344 24,802 21,421
2006 45,139 23,778 20,940
2007 86,665 40,543 3 1,266
Table 5.3 Average spot time charter rates (source: Galbraiths weekly report,June 2007).
As the charterer pays the voyage expenses in most trip charters.the gross proíit margins in this
sector are very large, especially for the years 2003-2007.
Such large earnings during this period caused the scrapping o f dry cargo vessels to more o r less
disappear and generated a record number o f newbuilding orders. Puture rates are thereíore
being affected by the delivery o f new tonnage and prospective íuture demand growth. It also
affected the price o f secondhand tonnage, because the sellers vvould be giving up the rights to
very large proíìt flows if rates continued at those levels.This means secondhand prices become
very high. Indeed, in certain cases a secondhand ship became more expensive than its newbuild
equivalent, because the newbuild will not have been available íorthree years but the secondhand
one vvould have been earning proíìts in a few months.When rates are exceptionally high, it can
be shown that this may make the secondhand price exceed the nevvbuild price. It is sometimes
called the ready ship premium.
A number o f íactors have contributed to the demand growth and increased proíìts:
1. The rapid growth in world trade has stimulated increased manufacturing. Manuíacturing
requires industrial inputs. The demand for raw materials has risen as trade has been
liberaiised.
2. The China effect: China has become a m ajor player in international trade. Its economy has
grovvn at 10% per year compound for many years.With accession to the W TO in 2001 and
demand for Steel soaring, China is now the world's iargest Steel producenThis obviously
increases demand fo r Steel movements.
3. Steel requires iron ore and coking coal in its production.The demand for both commodities
has risen dramatically. A major driver o f this increase has been China, a country where
reserves o f high-grade domestic commodities are falling,thus encouraging a rise in imports.
4. O ther economies have grown rapidly as well, particularly India. India is another major Steel
manuíacturer and the associated need for iron ore and coal derive from the same sector
5. Shortages o f suitable ships. Anecdotal evidence in 2007 shows that cargoes were being
split into smaller lot sizes, because the largest size vessels were not available in suffìcient
quantities. This implied that demand cascaded down the Chain as cargo demand shiíted.
It also implied transportation costs would rise, as a given cargo quantity was carried in
tw o ships rather than in one. So the dry cargo market, particularly the bulk sector, was
transformed in the period 2002-2007.
5.9 D Y N A M IC C O N S ID E R A T IO N S
The model employed so far has concentrated upon demand and supply conditions.The only
additional factor which has been discussed is the role o f expectation. This helps determine
ovvners' ordering, scrapping and operational decisions, because ships are long-lived assets and
owners need to form a view about íuture market conditions as well as considering present
Economics of SeaTransport and International Trade III

C h a p te r 5
ones.To determine what shapes the expectations o f shipovvners for the future, one needs to
look at past events. Historical data and recent trends can be projected fow ard to help shape
their estimates as to íuture demand conditions.
The wave o f ship-ordering in the early I970s can be seen as a response to the widely-held
view that the market was going to continue to grow as rapidly in the second halí o f the 1970s
as it did in the fìrst three years. If one anticipates a prosperous period, one needs to order new
vessels early, as they may take 18 months to two years to build. If these expectations are fulfilled,
there will be no diffìculties encountered; especially if demand grovvs as everyone expected it
to and the capacity is there to meet it. But suppose the expectations turn out to be incorrect
and the unexpected happens. New vessels have been ordered and a large number o f them
have been delivered. Market conditions in the late I970s became a nightmare for owners but
profitable for charterers. The market was in turmoil, with large numbers o f vessels and little
growth in demand.
A similar situation occurred in the 20l0s, following the 2008 financial crisis. Pigure 5.9 shows
the Baltic Dry Index (BDI) 2000-2015.The BDI is a composite íreight market index comprising
time charter elements o f Capesize, Panamax, Supramax and handysize indices.Table 3.3 shows
that annual deliveries o f new bulk carriers continued to increase until 201 I, when 97.7 million
tonnes dwt was delivered. Scrapping o f dry bulk ships also increased, peaking in 2012 at 32.5
million tonnes dwt (Table 3.4). A key difference between the I970s and 20l0s is that laid-up
and idle tonnage remained at low levels, with shipowners opting to slow steam in order to
absorb some o f the surplus tonnage. Although the demand for transport o f major and minor
bulk cargoes has increased since 2009 (Tables 2 ,1 and 2.2), the dry íreight tnarkets continue to
be depressed as shovvn by the BDI since 2 0 12, notwithstanding seasonal and other temporary
improvements. In both cases, a contributory íactor to over-ordering o f new buildings is that
shipping íìnance was widely available during a period o f grovvth and high íreight rates. Shipping
has been a major beneficiary o f íunds as investors look for a home for their money which has a
chance o f better returns.
Pigure 5.9 Baltic Dry Index, 2000-2015 (source:The Baltic Exchange).
Trying to understand demand and suppiy conditions in the next decade vvould thereícre make
very little sense if One just examined demand and supply in the current yearThe supply available
is itself the consequence o f past decisions by ovvners. It could be argued that shipping never
really learns the iessons o f the past, in that eventually overbuilding will impact on earnings in all
markets. For the shipowner, the important íactor is to order early and not to be the last one.
Once the market starts to move, other shipowners join in and herd behaviour will eventually
result in oversupply. Orders placed during the boom period commenced delivery just as the
2008 recession took hold - a VLCC ordered for $ 150 million was soon valued at less than
$ 100 million.
I 12 Institute of Chartered Shipbrokers

This leads to the observation that the market will generate its own dynamic behaviour over
time, as it continually readịusts to new demand conditions as best it can. Poor market conditions
iníluence nevvbuilding decisions and orders became relatively scarce. But, if demand conditions
a lteríorthe betterithis lack o f new investment may itselí generate another cycle in the market.
The fact is that dry cargo markets appear to move through cycles o f boom, recession, slump,
recovery and back to boom again.These cycles are partly generated by the cyclical growth
in demand, but are also a result o f the fact that supply adjustment is a slow and often painíul
process in markets where assets are long-lived, as they are in shipping. It may be more
sensible to modííy our demand and supply model to allow for the presence o f such cycles o f
economic activity.
Some observers have suggested that there are cycles o f different periods observable in the
market, overlaying each other. For example, one might observe a seasonal pattern o f demand as
being the shortest cycle. On top o f that, vvorld demand grovvth appears to cycle over 5-7 years.
Ship supply cycles are longer, on average I 3 years. Pinally, some observers such as Kondratieff
have suggested very long cyclical patterns o f around 50 years.
It is undeniable that viewing the market as a dynamic one, as a process in vvhich demand
conditions and supply responses change over time, gives a much richer picture o f the way the
market operates. Unfortunately, it is also a more complex idea to grasp. But realising that ship
supply responds to a change in demand, often spread out over several periods (even years), is a
step in the right direction.
Pigure 5.10 is an illustration o f the potential link between íreight rates and demand and supply
conditions. Whiist the demand growth o f 2000 is similar to that o f 2003, the behaviour of prices
is not.There is clearly a link, but the link is complex. One obvious íactor is the issue of lay-ups
or low utilisation o f vessels, which vvould help to explain the difference in response in the tw o
years. Another possibility is that the structure o f demand changes, in terms o f voyage distances
and the trades afFected may be difíerent.
Karakitsos and Varnavides (2 0 14) in Maritime Economics: A Macroeconomic Approach, propose
a return to a systems approach to freight-rate determination and shipping investment,
which requires an analysis o f the interaction between the four shipping markets and formal
consideration o f the expectations of the shipowner and charteren The authors conclude that
íreight rates are the outcome o f a bargaining process, based on their expectations of future
demand and supply, rather than simply the balance o f supply and demand at a particular place
and time. Both players form expectations o f íuture íreight rates and bargain over the deviation
of íuture rates from the latest one.The final outcome is iníluenced by the relative bargaining
power o f each player. If the charterer has more powen freight rate deviation will be lower than
latest. If the owner has more powen the freight rate vvill be higher.
Economics of SeaTransport and International Trade I I3

C h a p te r 5
9.0% Tonnage-mile change year-on-year 5000
8 .0% Net fleet grovvth

Demand
Average BDI index (right)
probably higher 4000
7.0%
than estimate
6.0%
ộ 3000
ĩ . 5.0%
V
8,
<5
4.0%
Ị: 2000
u
3.0%
2 .0%
1000
1.0%
0 .0 %
1999 2000 2001 2002 2003 2004 2005 2006e 2007e 2008e
Pigure 5.10 Supply and demand growth and íreight rate indices (source: Pearnleys Research).
Note: B D IIS the Baltic Dry Index.
While many íactors can affect this relative bargaining povven economic conditions are the single
most important factor in most situations. In improving economic conditions, the ovvner has
the povver; in worsening economic conditions, the charterer has the povver Intormation is also
an important íactor in bargaining theory. Economic eíĩìciency is greatest when information is
comprehensive, accurate, timely and cheap. Asymmetric information is the situation vvhere one
party to a contract knows more than another and can confer bargaining power
The role o f the shipbroker is thereíore Central to the discussion on bargaining between charterer
and shipowner. Despite all the improvements in Communications and technology, the shipbroker
continues to have a role in assimilating iníormation for their clients. Modern Communications
have not replaced the value o f the bi'oker or the complete Service provided by the iarger
broking houses.
Recent developments include consolidation vvithin the industry, such as between Clarksons and
Platou, or Braemar and ACM. Another change has been the demise o f multi-broking; today,
the broker will be speaking to the owner and charterer in most transactions.The shipbroking
business constantly evolves, but if it was not providing a role it would not exist, vvhere businesses
are constantly trying to reduce their costs.
The broker only earns his living by concluding a deal, so the onus is heavily on him to add
suíĩicient value to justify this. It is important to note that it is the owner who actually pays the
commission, although there are times when the charterer wili want a speciĩic broker included,
by giving him a piece o f business or perhaps covering him in a direct deal for services rendered.
It is about how the principal evaluates the iníormation provided by the broker in assisting him
períbrm his role. In tanker chartering virtualiy ail spot cargoes are given by the charterer to
specific brokers to fìx, so the ow ner IS obliged to have a dialogue with such brokers in order to
be given the opportunity to fix such cargoes.
‘Last done' sets a market guide but nothing more and the broker earns his commission by
advising his principal as to whether they should foilow such a level - look at doing/taking less if
they feel the market is on the slide, or to hold out (owner)/pay more (charterer) if the market
is íìrming.The broker should be as knowledgeable as possible in his íìeld and technology has
strengthened his knowledge considerably.

C o m p e titiv e s h ip p in g m a rk e ts : d r y b u lk c a rg o
This chapter has examined the dry cargo market for tramp shipping in some detail. After
examining the changing deíìnitions o f a tramp and the changing nature o f the market, various
aspects o f the costs o f operating as a tramp were explored. It was argued that the dry cargo
market couid be vievved as a highiy competitive market structure, ciose to petfect competition.
A model o f the market was developed based on this assumption. Demand was aiways price
inelastic, but supply elasticity depended upon the present level o f fleet utilisation.The behaviour
o f market rates was examined and the data related to that provided in Table 5 .1. Pinally, the
dynamic nature o f the market was emphasised.
A P P E N D IX
The following table, published in earlier versions o f this volume, is provided for a historical
perspective on the development o f the dry cargo fleet.
Year D ry Annual D ry Annual Average O re and Annual

cargo % cargo % haul in bulk %
m iliions grovvth billions g ro w th nautical fle e t in grovvth
of o f tonne miles m illions
tonnes / miles o fg t
1968 1,066 3,425 3,103 34,9 20,0
1969 1,157 8.2 3,761 9.4 3,213 41.8 18.0
1970 1,241 7.0 4,167 10.3 3,251 46.7 1l.l
1971 1^260 1.5 4,275 2.6 3,358 53.8 14.2
1972 1,317 4.4 4,454 4.1 3,393 63.5 16,6
1973 1,544 15.9 5.187 15,2 3,382 72,6 13.4
1974 1,631 5.5 5,766 10.6 3,359 79,4 9,0
1975 1,630 -0.1 5,636 -2.3 3,535 85.4 7.3
1976 1,587 -2.7 5,874 4.1 3,458 91.7 7.1
1977 1,675 5,4 6,050 3.0 3,701 100.9 9.6
1978 1,764 5.2 6,388 5.4 3,612 106,5 5.4
1979 1,99 1 1 12.1 >,016 9.4 3,621 108.3 1,7
1980 2,010 0.9 7,372 4,9 3,524 109.6 1.2
1981 2,024 0.7 7,469 1.3 3,668 113.1 3,1
1982 1,921 -5.2 7,217 -3.4 3,690 119.3 5,3
1983 1,878 -2.3 7,022 -2.7 3,757 124.4 4.2
1984 2,065 9.5 7,778 10.2 3,739 128.3 3,1
1985 2217 7.1 7,908 1.7 3,739 134 4.4
Table A5.1 Drỵ cargo seaborne trade, fleet and grovvth, 1968- 1984 (sources: OECD, Maritime Revievv
1994: UNCTAD, Review o f Maritime Transport 1995).
Economics of SeaTransport and International Trade I 15

Competitive shipping markets:
tankers
O il a n d it s P r o d u c t s r e p r e s e n t t h e la r g e s t c a r g o v o lu m e s
in s h ip p in g .
C h a p te r 6
A tanker is deíined as a vessel that is speciíìcally designed to carry liquid cargoes.The common
types of cargo carried in such vessels are chemicais, wine, vegetable and other food oiils, refined
oil products and crude oil.This chapter will concentrate on the market for crude oil and retìned
oii tankers, as these are by far the largestThe markets for crude oil and reíìned Products are
often referred to as the tanker trades. Betvveen 2002 and 2008, the tanker markets and freight
rates have been at their strongest and íastest grovving since the early 1970s. It is this growth that
has raised the tanker industry to greater prominence within the oil sector, and also vvithin the
wider íinancial community as an area for potential equity investment. But a glut o f newbuilding
deliveries has since created downward pressure on freight rates. From the market high in 2008,
the Baltic Clean and DirtyTanker Indices had nearly halved by 2015.
Tanker trades are a subject that can be written about at great length; they are a ĩascinating
subject in their own right.The principal reasons for studying them are as follows:
1. The oil trades have grovvn enormously over the past 40 years; but they have also grovvn
very unevenly.The success o f the tanker industry over recent years cannot be understood
vvithout some knovvledge o f earlier periods.
2. The overall size of the tanker fleet has grown dramatically, especially in the 1970s and in the
last few years.
3. Specialisation in tankers has also developed in the last 20 years, with more dedicated,
specialised vessels appearing in the products trades.
4. Politics have played a special role in this sector, because o f the strategic nature of the cargo
and because o f the huge macroeconomic effects that the dramatic oil price changes have
upon the world economy,
Because o f its extreme political sensitivity, tanker íreight rates have exhibited sudden
marked increases from time to time, usually associated with vvars.VVhile it is true that most
commodity prices are sensitive to acts o f aggression, oil prices and tanker íreight rates
appearto be especially affected.The most recent boom period is probably the íìrstthat has
been triggered vvithout a conílict.
5. As in other industrial sectors, quality has become a maịor feature o f the tanker industry
following major oil spills since the 1989 Exxon Vơldei incident. Legislation has resulted in the
phase out o f single-hull tankers in 2010.
In this chapter, the reasons for the volatility o f tanker rates will be explored. The essential
explanation lies in the recognition o f the fact that the tanker market, despite some appearances
to the contrary, is a very competitive one; indeed, some sectors o f it are more competitive
now than they were 40 years ago.The competitive nature o f the market, when coupled with its
sensitivity to íundamental, strategic, and political issues, has made it an extremely volatile market
in the past.
6.1 SEABO R NE T R A D E IN CRUDE O IL A N D O IL PR O D U C TS
6 . 1.1 T h e d is tin c tio n b e tw e e n c ru d e o il and o ii P ro d u c ts

The oil market is traditionally split betvveen the analysis o f unrefined or crude oil and the
markets for refined oil or oil Products. Each barrel o f crude oil, vvhen reíìned, yields diíĩerent
quantities o f various Products, ranging from naphtha to diesel, heating oil and kerosene for the
lighter íractions, to fuel oil, bitumen and road-surfacing material for the heavier íractions. Purther
processes at the reíìnery can then produce gasoline or petrol and take some o f the heavier
products and upgrade them to more valuable lighter íractions. Some o f the lighter íractions are

C o m p e titív e s h ip p in g m a rk e ts : ta n k e rs
more volatile than the original crude oil, while the heavier ones such as bitumen have to be kept
warm to prevent them from becoming almost solid.
The oil trades, thereíore, consist o f moving either the crude oil from its country o f production
to th e international refining industry and the movement o f reíined Products from the reíìneries
to the fìnal consumen It should be clear that the location o f the refinery is crucial in determining
the relative balance o f these tw o trades. In the 1950s, many reíìneries were built near final
consumer markets, in both North America and VVestern Europe.This was for a combination o f
political and economic reasons.The political reason was to keep reíìnery capacity in countries
that were economically stab le .Th e economic reason was that transporting Products involves
smaller vessels, typically around 30-40,000 tonnes o f cargo, vvhereas crude could be moved
in larger vessels, carrying up to 300-320,000 tonnes. Moving the bulk o f the cargo in crude
form minimised the overall transportation cost to the consumenThus the crude trades evolved
more rapidly, dominating cargo movements by volume.This pattern has changed slightly with
the construction o f reíìneries in the Middle East and the grovvth o f Asian consumption, but it is
still an accurate description o f the main íorces currently shaping the movement o f crude and
oil Products. But the most recent wave o f reĩinery investment took place in 2006-2007.This
resulted in the Middle East and India becoming even bigger product exporting regions.
The development o f seaborne oil trades

Before 1914, tankers constituted some 3% o f the world fleet. By 1938 they had increased to
19% and by 1980, just over 50% o f the vvorld tonnage. See Table 6.2 for the data. In deadweight
tonnage terms, the world tanker fleet grew from I7m dwt in 1938 to 338m dwt in 1980, a
spectacular increase.VVorld oil production, which, of course, is a key driving force in the growth
o f the oil trades, rose from 258 million tonnes in 1938 to over 15 times that in 2006 and is still
grovving, reaching 4 ,132 million tonnes in 2 0 13.
Howeventhe increase in vvorld oil production has not been even. It increased fourfold between
1938 and I957;three-and-a-half times between 1957 and 1980. Grovvth then slovved abruptly.
Between 1980 and 1989 production hardly increased at all - from 3,092m tonnes to 3,l09m
tonnes. Since 1990, oil production has continued to hse and exceeded 4,000m tonnes in 201 I,
driven by Chinas continued rapid expansion, by increases in demand in the USA, the Middle
East, and other Asian countries, including India.
Oil consumption growth is the key to the trends in production, since the tw o will be very close
over the longer term, with differences being accounted for by changes in oii stocks.Table 6.1
shows the annual growth rates o f consumption over fìve-year intervals from 1965 to 2013. It
reveals signiíìcant diíĩerences in the growth pattern overthis period.
In the period 19 6 0 -1970, oil consumption grew at 7%~8% per annum compound, a tremendous
rate of growth. It slowed dovvn in the I970s and actually declined in the period 1980-1985,
when consumption fell by 1.1% per annum as a consequence o f the second oil price shock.
The lowest point o f the period was reached in 1983. Since then, consumption growth has
recovered, with a small positive grovvth rate in the iate I980s, and a return to around 2%
per year. Exceptional grovvth was seen in 2004, a 4% annual increase, due to demand grovvth
from China and the USA.The recession o f 2008-2009 is clearly shown vvith fall in consumption
of2%.
While trends in oil production and consumption are reasonable indicators o f the likely grovvth
in demand for shipping crude oil and oil Products, a much more accurate measure is that
provided in column three oĩTable 6.2, which showsthe volume o f oil shipped on an annual basis.
Betvveen 1967 and 1977 this volume doubled; 56% o f all oil produced in the world was moved
by sea in 1977. Note the change in the share - the increase in the share taken by seaborne oil
movements over the previous decade means that the demand for shipping oil rose íaster in
this period than the growth in the demand for oii itself. Conversely, between 1977 and 1987,
although oil production remained roughly static, the share o f oil shipped by sea declined to
Economics of Sea Transport and International Trade I 19

C h a p te r 6
45%. A static level o f production and consumption, combined with a falling share, means íalling
demand for shipping services in this sector; a classic example o f derived demand at work.
Indeed.oil movements declined from 1,724m tonnes in 1977 to 1,343m tonnes in 1987, beíore
beginning to recoven It was only in 1992 that the total oil cargoes moved by sea exceeded
the 1977 ievel, and continued to do so to 2000, when measured in tonnes cf cargo lifted. it is
interesting to note that, in 1994, the proportion o f oil that was traded was at the 1977 level
o f 56%.This, together with the increase in oil production, implies a signiíìcart recovery in the
demand for oil tanker services.
Period Period average Annual change

1965-1970 8 , 1% 2004 3,9%
1970-1975 3,6% 2005 1.3%
1975-1980 2 .0 % 2006 1.0 %
1980-1985 -1.1% 2007 1.5%
1985-1990 2.3% 2008 -0.5%
1990-1995 0 . 8% 2009 -1,9%
1995-2000 1.7% 2010 2.9%
2000-2005 L8% 201 1,1%
2005-2010 o’6% 2012
2010-2013 1.2% 2013 Ll%
Table 6.1 Oil consumption annual grovvth rates % per annum (source: BP Staùstical Re\fiew oị VVorld
Energy 2014)
Changes in tonne-miles and voyage length

The growth and deciine of oii tonnage movements tells only part o f the story of demand change.
Demand can be measured in terms o f tonne-miles, as well as in tonnage terms. Columns five
and six inTable 6.2 are well w orth studying. Betvveen 1967 and 1977, vvhile oil cargo shipments
doubled, the tonne-miles transported nearly trebled from 4,130 billion to I 1,467 billion.The
diíĩerence in the tw o arises from the fact that the average iength o f voyage rose from 4,775
nautical miles in 1967 to 6,651 in 1977. A large part o f the increase can be related to the
ciosure o f the Suez Canal in 1967, which did not reopen until 1975. As a consequence, the
laden distance betvveen the major exporting centre (the Middle East) and two major importing
centres (N orth America and Western Europe) increased dramatically as vesseis vvere being
routed around the Cape o f Good Hope,
This increase in the laden leg gave a dramatic impetus to the development o f large tankers,
as 100,000, 250,000 and even 500,000dwt vessels were designed and built in the period
1967-1975.
Betvveen 1977 and i 987, the average laden leg declined by nearly 50%, Note that this coincides
with a decline in the voiume o f tonnage moved as well. Essentially, demand for tanker services
collapsed dramatically during this period, creating severe problems for tanker owners and
operators. The market response to this wili be considered iaten Since 1987, average voyage
lengths have íluctuated betvveen 4,000 and 4,400 nautical miles, with changes in the balance o f
long-haul and short-haul cargoes affecting this íigure.
Changes in the regional balance o f oil consumption and production

Everyone is vvell avvare that the Middle East is the maịor source o f oil exports. What is less well
known is that its share of oil production has íluctuated in the past 35 years, but has stabilised
recently.The data for consumption and production shares are shown inTables 6.3 and 6.4.

C o m p e titiv e s h ip p in g m a rk e ts : ta n k e rs
In I9d5, North America accounted for 39% o f the world's oil consumption and 30% of
prodLCtion. It thereíore needed to meet its full consumption needs by importing. In the same
yeanWestern Europe accounted for 25% o f vvorld oil consumption and had no oil production.
It waseven more dependent on oil imports than North America.The Middle East, on the other
hand.accounted for 1% o f the world's oil consumption and produced 27% o f the world’s oil, a
smalkr share than North America.
By 2CI3, North Americas share o f oil consumption had failen to 25% while production had
íallento 19%. However,this represents a rise from a low in 2008 due to shale oil production. A t
the cirrent rate o f growth, u s oil production will soon reach the peak output achieved in 1970.
The [uropean Unions consumption share also fell, to 15% o f total, vvhile production was less
than a decline from a high o f 5% in 1999.
Meanvhile, Asia-Pacific consumption share has risen rapidly from 21% in 1990 to 34% in 2013,
whileproduction has remained static at about 10% o f world total. Asia-Pacifìc consumption has
doubad in 25 years and is in a similar position to North America and Europe in having to meet
its coisumption needs by importing oil, which was about a biilion tonnes in 2013.

C h a p te r 6
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C o m p e titív e sh ip p ín g m a rk e ts : ta n k e rs
Pigure 6 .1 Major oil trade movements, 2 0 13 (million tonnes) (source: BP Statisical Review ofWorld Energy
2014.)

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C h a p te r 6
The major trading movements for 2 0 13 are shown in Pigure 6 .1, from the 6P Review ofWorld
Energy 2014.
As the analysis o f the share data suggested, the major sources o f crude oil are the Middle East,
dominated by Saudi Arabia; the former Soviet Union countries; VVest Aírica; South and Central
America; and Canada. Although the USA is a major producer, crude oil exports are prohibited
without licence. Major inward flows o f crude oil are to Europe.the USA, China, India and Japan.
The data in Pigure 6.1 combines both crude oil and oil Products. Table 6.6 shows the same
iníormation, but separated into crude and oil Products. Major exports o f oil Products are from
the USA, the íormer Soviet Union and the Middle East, while the major importers are Europe,
Singapore and the USA.
Year 2004 2005 2006 2007 2008 2009 2010 201 1 2012 2013
!
Imports
USA 26.2% 26.4% 25.9% 24.5% 23.6% 21.9% 21.8% 20.9% 19.3% 17.6%
Europe 25.4% 25.9% 25.6% 25.1% 25.2% 23.9% 22.6% 22.5% 22.8% 22.7%
Japan 10,6% 10.2% 9,9% 9.1% 9.0% 8.1% 8.5% 8,3% 8.7% 8.1%
Rest of 37.8% 37.5% 38.6% 41.3% 42.2% 46.1% 47.0% 48,2% 49.2% 51.6%
world
Exports !
USA 2,0% 2.2% 2.5% 2.6% 3.6% 3.7% 4.0% 4.6% 4.9% 5.9%
Canada 4.4% 4.3% 4.4% 4.4% 4.6% 4.8% 4,9% 5.2% 5.6% 5.9%
Mexico 4.2% 4.0% 4.0% 3.6% 2.9% 2.8% 2,9% 2.7% ^2,5% 2,4%
South 6.6% 6.9% i 7.0% 6.4% 6.6% 7.2% 6.7% 6.9% Ị 7.0% 6.7%
and 1
Central 1 ị
America
Europe 4,0% 4J% 4.1% 3.7% 3.9% 3.5% 378%” 4.0% 4.3%
Pormer 13.1% 13.8% 13.6% 15.0% 15.0% 15.2% 16.0% 15.8% 15.1% 15.5%
Soviet
Union
Middle 39,8% 18,4% 35.4% 36.8% 35.2% 35.3% 36.3% 35.8% 34,9%
East
North 5,9% 6.0% 6.1% 6.0% 6.0% 5,6% 5.4% 3.6% 4.7% 4.0%
Aírica
West 8,2% 8.5% 8.9% 8.7% 8.4% 8.3% 8,6% 8.3% 8,0%
Aírica 1
Asia- 8,5% 8.3% 8,2% 10.8% 9.9% 10.8% 11.6% 11.2% 1 1.5% 11.6%
Paciíic
Rest of 3.3% 3.0% 2.6% 3.0% 2.5% 2.5% 1.2% 1.2% 0,6% 0.9%
world 1 L
Table 6.5 Major oil trade movements, % shares (source: BP Revievv ofWorld Energy 2 0 14).
Table 6.5 shows similar data as Pigure 6 .1, except the flows are expressed in shares for the years
2004 to 201 3. In 2013, Europe and the USA accounted for 40% o f all oil imports. China, not
shovvn, accounts for 13% o f oil imports. On the export side in 2013, the Middle East dominates
with 35%, the former Soviet Union countries accounting for 15%, Asia-Pacifìc 12% and West
Aírica 8%. It is notevvorthy that Japan, a major oil importer, has no domestic oil reserves.
Table 6.6 provides information on the total volumes o f oil traded in 201 3, split between crude
oil and products. Both the USA and Europe are major im porters and exporters o f oil Products.

C o m p e titív e sh ip p ín g m a rk e ts : ta n k e rs
Singapore is also a major importer o f oil products. In contrast, nearly all o f West Africa's
exports are crude.The reader should study these tables and link them to the flows observed in
Pigure 6.1.
C ru d e im p o rts P roduct C ru d e e xp o rts Products

im p o rts exp o rts
USA 384.4 99.2 5.6 151.1
Canada 27.6 10.8 132.2 29.7
Mexico 28,9 60.3 5.9
South and 25.1 78,0 151.3 32.0
Central America
Europe 463.8 159.0 18.9 96.6
Pormer Soviet 0,2 6.1 300,1 124.6
Union
Middle East 10.8 41.1 855.3 108.2
North Aírica 2.7 I9.i 85.2 23.7
West Aírica 13.2 214.9 6.6
East and 13.4 20.0 6.8 0.7
Southern Aírica
Australasia 28.4 22.2 11.5 3.0
China 282.6 59. í 0.9 29.3
India 190.5 12.9 59.1
Japan 178.2 45,5 0.6 14.8
Singapore 44.4 101.7 0.1 81.1
Other Asia-Pacific 226,4 142.1 34.4 92.5
Total world 1878.3 858.8 1878.3 858.8
Table 6.6 Oil imports and exports 2 0 13, million tonnes (source; 6P Revíevv ofWorld Energy 2014).
Note: Bunkers are not induded as exports. Intra-area movements (for exơmple, betvveen countries in Europe)
are excluded.
To sum up, in 2 0 13:

1. the USA accounted for 20% o f world crude oil imports and North America accounted íor
19% o f world oil production;
2. India and Japan have no indigenous oil reserves and imported 10% and 8% o f the w orld’s
traded crude oil respectively;
3. China has no signiíicant oil reserves and, in 2013, imported 15% o f the world’s traded
crude oil;
4. the Middle East is responsible for 35% o f all seaborne oil movements - but its dominance
has changed, íalling with increased oil production elsevvhere;
5. Europe is the major importer o f both crude oil and oil Products;
6. the BRIC countries are strong grovvth areas for oil consumption. China and India have
become signiíìcant consumers and are expected to become more signiíìcant in the
next decade.
6 .1.2 T h e b e h a v io u r o f th e p ric e o f c ru d e oỉl

Many o f the events that drive the tanker market are bound up with both changes in the
volume o f oil moved and with its value.The decline in oil consumption and the fall in oil sea

C h a p te r 6
transportation that occurred in the period 1975-1985 was itselí triggered by the dramatic
changes that happened in the world price o f crude oil.
Pigure 6.2 shows the behaviour o f the price o f Arabian Light Oil, one o f the reíerence markers
over the past 30 years. After averaging around $2.00 per barrel in the I960s, the OPEC
raised the world price in 1970 to $4.00. In October 1973, following on the Arab-lsraeli War,
OPEC raised the price until it reached $9,00 by the end o f that yean as well as threatening oil
embargoes on countries that were viewed as Israels allies.This fourfoid increase in the price of
a major strategic commodity generated three immediate efíects:
a) It triggered a huge economic recession in many VVestern economies, leading to lower rates
of economic growth. In some countries, such as the UK, real incomes fell in 1975 as a result.
b) It generated an international banking crisis, as many oil-exporting countries suddenly íound
themselves with large current account surpluses on their balance o f payments, vvhile many
oil-importing countries grappled with large deíìcit problems.
c) It generated a sudden and dramatic stop in the growth o f the tanker market, which had
experienced two booms in rates in 1970 and in l973.These booms vvere generated by
the huge grovvth in demand volumes at the time, vvhich had also created a very rapid
expansion in the tanker fleet.
The rest o f the I970s was characterised by a steadily rising nominal price o f oil to about $20
a barrel. In the wake o f the Iranian revolution o f 1979, the OPEC price peaked at around $40
a barrel or $ 100 at 2 0 13 prices.This was the result o f OPEC trying to maintain the price o f oil
in real terms.This in effect meant that whenever the doliar devalued against other currencies,
the dollar price o f oil was increased to compensate OPEC members ío rth e loss o f the dollars
earning powen
This policy can be seen as counterproductive since it helped create a cycle o f low growth.The
USA tried to offset its deĩicit and restore the dollar by recessionary policies, leading to low
growth, íalling demand for oil and stagnation o f oil exports.
*s of the day •s 2013
140 - p -
120 +-
Year
Pigure 6.2 Development o f oil prices 19 7 0 -2 0 13 (source: BP Review ofWorld Energy 2014).

C o m p e títiv e s h ip p in g m a rk e ts : ta n k e rs
In the míd-1980s, Saudi Arabia and other OPEC members altered their pricing policy to match
that set by Mexico, vvhich had become a signiíìcant oil producer but was not a member of
OPEC.This change in policy, coupled with rising output from non-OPEC producers, íorced a
decline in the oil phce. Saudi Arabia, for example, introduced netback pricing for its crude, which
was determined by the selling prices o f the reíined products at the point o f final consumption,
less the transport and refining costs.This policy emphasises the fact that the crude oil price
is driven by consumer demand for the products and the price obtained in the retail market.
Another price rise in 1990 was triggered by the Iraqi invasion o f Kuwait. But Middle East oil
production was no longer as dominant as it had been and the increase was short-lived.
In the period after 2002, prices rose steadily, driven by demand growth and tight supply, although
in real terms the 2008 price o f crude oil was about the same as it was in l980.The temporary
fall to $60 in 2009 reflected the eíĩects o f the recession, beíore advancing to over $100.
Continued slack global economic activity in Europe and North America, a slowdown in Chinas
economic growth rate, rising shale oil production in the USA and continued OPEC production
output, resulted in a collapse in oil price to $50 a barrel in 2 0 15.
OPEC as a cartel
The principal economic reason ío rth e dramatic rise in the price o f crude oil in the early I970s
was the ability o f OPEC to regulate the vvorld supply o f crude oil, with all members agreeing
to set common prices and, just as importantly, set production quotas to limit supply and
raise prices.
The ability to restrict phces depends heavily upon the quotas being adhered to. In the I980s,
several countries began to break ranks, undermining this powen Nigeria, for example, regularly
exceeded its quota. In addition, rising production from non-OPEC countries helped to
undermine its monopoly position.The increase in OPEC market share since 2000 may again
help to establish greater dominance, but its pricing policy is now very diíĩerent from that o f the
1970s. Consequently, this may not be such a threat to global macroeconomic stability.
6.2 C H A N G E S IN T H E T A N K E R FLEET
A t its peak in 1980, the world tanker fleet accounted for 50% o f world shipping tonnage, having
climbed steadily in the previous decade. Foilowing on from the events described above, this
trend was reversed, with the share declining steadily, reaching 27% in 2014. This was most
marked in the 1980 decade. Annual demand in tonnage and tonne-miles reached a minimum in
1984 but it was not until 1989, five years later, that the tanker íleet started growing again.
The stock o f tankertonnage has therefore broadly followed the pattern o f demand, rising rapidly
until the early I970s, stalling, and then declining in size until 1989, since when it has begun to
grow again.This long-run adjustment o f supply to the level o f demand has oíten been a painíul
process in particular periods.

C h a p te r 6
Period Tanker fle e t (d w t) O il demand O il demand

(tonnes) (tonne-m iles)
1980-1985 -3.4% -4.1% -4.3%
1985-1990 -3.7% 2.5% 2,6%
1990-1995 2.4% 4.0% 4.6% 1
1995-2000 1.3% 3.4% 3.0%
200(^2005 2.3% 2.9% 2,2%
2005-2010 4.4% 1.3% 0.9% '
ị 2010-2014 3.1% 0.3% 1,6%
1980-2014 0.8% 1.5% 1.5%
Table 6.7 Average percentage changes o f the tanker íleet and changes in demand
An indication o f the uneven development o f the tanker fleet can be seen inTable 6.7. It is clear
that even with fìve-year averages, demand growth leads to supply response.This created a huge
problem o f adjustment in the tanker market, vvhich was only resolved by 1990. This delayed
adjustment problem is well illustrated in Pigure 6.3 below.
In Pigure 6.3, index numbers are used to compare the changes in tanker fleet dwt tonnage and
oil demand in tonne-miles from 1980 to 2 0 14.This was done by dividing the 1980 value by 100
and then dividing every value from i 980 to 2 0 14 by this amount. For example, the tanker fleet
in 1980 was 337.9 million dwt, so all tanker fleet values from 1980 to 2 0 14 are divided by 3.379.
The 1980 index number becomes 100 and in 1990, for example, the index will be 70 (235.8
million dwt divided by 3.379).
•Tanker fleet supply •Demand tonne-miles
Q^HfNrO^LOVpr>OpO>Or-»<NrO^
OQỌQỌÓỌỌOO^HtH^HtHrH
p ọ p p p p o o o o p ọ o o ọ
fM(N<NfNírNfNfNrMrMrMfNrs|<NíMfM
Pigure 6.3 Growth in oil tonne-mile demand and world tanker fieet, ỉ 9 8 0 -2 0 14 (Index 1980 = 100).
The same picture emerges from inspection o f the graphs below for the period 19 6 1 to 2005.
Pigures 6.4 to 6.6 show the movement o f tanker orders, scrapping and lay-ups plotted against
the prevailing ievel o f spot rates, measured in Worldscale. W hat should be apparent is the

close correlation that exists betvveen high íreight rate levels, new ship orders, low lay-ups and
scrapping. Conversely, low freight levels, few ship orders and high lay-ups and scrapping, It must
be remembered that the stock o f vessels (supply) alters all the time, slovvly adjusting to the shifts
in demand, as shown in Pigure 6.3.
'VVorldscale' is the tanker industry convention designed to generate a uniíorm scale, or

index, for tanker rates. Each route is calibrated for an assumed vessel size and cost structure.
The calculated rate is set atWSIOO ío rth a t route.AII fixtures are then quoted relative to
this rate. Large vessels will generate a w s rate o f say. WS50, small vessels w s 120, say,
because their operating costs are so different írorn the assumed size in the model o f
75,000 dwt.
Pigures 6.4 to 6.6 also bring out the volatility o f the spot rate itselí, even on an annual basis.The
peak level is WS258 in 1973; in fact, in one particular week, it reached VVS435.
60
50
0
40 ĩ
(D
30
se
s.
20
5“
10
Pigure 6.4Tanker spot rates and orders, 19 6 1-2005
ỉ
ì
3 5’
5.
$
X
Pigure 6.5Tanker spot rates and laỵ-ups, 1961- 2005

C h a p te r 6
í
M
1
I
u ĩs
Pigure 6.6Tanker spot rates and scrapping 1961“ 2005
Note: Sources for (igures 6.4 to 6.6: 1960-1995, Pearnleys Annuơl Review: 1995 on, UNCTAD Review of
Maritime Transport.
6.3 T H E R E L A T IO N S H IP B E T W E E N T A N K E R A N D DRY
C AR G O M A R K E TS
Although most analyses o f the tanker market treat ít as an independent secton examination of
the movement o f dry cargo and tanker rates over long periods o f time reveals that they tend to
move togethen As has been pointed out, the tanker íreight rate is the more volatile o f the two,
but there is a good correspondence betvveen peaks in one sector and peaks in the othenThe
exception to this appears in the 1980s, when the dry cargo sector continued to grow while the
tankertrade suffered a decline.
There are a number o f reasons to explain the correlation related to the concept o f substitution
in economics. Separate markets are more closely related. The higher the degree o f demand
substitution betvveen the two sectors (due to the substitution between oil and coal),the higher
the level o f supply substitution betvveen them.
The tanker and dry cargo markets share the same key drivers. When vvorld trade grows, it
tends to create good conditions in both markets segments. Hence there is still a long-term link.
For example, China's economic grovvth has generated significant increases in the demand for
imported oil and gas and, at the same time. its demand for iron ore and coal has also increased.
This has led to record rates for Capesize vessels.The growth o f Chinese oil consumption and
import demand has helped to raise the demand for shipping oil.
There is one other way in which íreight rates betvveen oil and dry cargo can be theoretically
linked. High freight rates mean high proíìts, which create high secondhand prices for the assets,
the ships themselves. Shipowners rush to order more ships. But berth capacity is íìnite, so in a
boom.one way o f building more dry bulk vessels isto build fewertankers. If newtankers become
scarcer relative to demand, the nevvbuild price will rise and, implicitly, so will íuture tanker-
operating costs.This will raise freight rates in the tanker market.The limitation o f shipbuilding
capacity thus creates a potential link betvveen íreight rates. Note that this modei assumes that
shipbuilding capacity is fully utilised at all times. If not, extra dry bulk vessels can be built vvithout
reducing tanker nevvbuild capacity and the above argument carries less force.
6.4 T H E S T R U C TU R E OF T H E T A N K E R M A R K E T
In the past, the oil industry was dominated by the major multinational oil companies. Indeed, in
the 1960s,they became knovvn as the 'Seven Sisters' - seven large companies (Exxon, Gulf, Shell,

Chevron,Texaco, BP and Mobil).These companies appeared to dominate many o f the national

domestic markets for oil and oil Products, giving the impression o f a highly concentrated market
driven by a few large players.
It appeared that such a structure would dominate all markets including the tanker market. In the
I960s, the major oil companies owned one-third o f the world's tanker tonnage and chartered
another third on long-term time charter.This left only one-third o f the world’s tonnage to trade
in the rest o f the market. If the big oil companies controlled up to 70% o f the tonnage, it suggests
that the tanker market was akin to an oligopoly rather than a perfectly competitive market.
In an oligopoly, phce competition becomes less likely.There may even be periods o f collusion
between the major companies, leading to price rigging. Indeed, in the UK market for petrol.there
have been a number o f inquiries by the Competition Commission, investigating the degree of
competition that exists between UK oil and petrol companies.
Appearances can be deceptive.The general consensus amongst scholars o f the tanker market
is that it is extremely competitive. Moreoven the trends over the past 20 years have made the
market more competitive than it was, especially in the crude oil sector On the other hand, the
continuing development o f specialist vessels (such as LNG and chemicals tankers) has meant
that some o f the segments may be potentially less competitive than when the market was
less fragmented.
The tw o major contributors to the academic study o f the tanker market are Koopmans (Tơnker
Preight Rates andTankship Building, 1939) and Zannetos (TheTheory o f OilTơnkship Rates, 1966).
A number o f other studies appeared subsequently, but they have tended to accept the views
put íonAârd in the above texts. Basically, both authors have argued that the tanker market is
períectiy competitive.
The basic properties o f a competitive market are:
1. All owners seek to maximise proíìts.
2. There is a large number o f buyers o f the Service.
3. There is a large number o f sellers, but none big enough to iníluence price.
4. The product is homogeneous.
5. There is complete íreedom o f entry to, and exit írom, the market.
6. Full iníormation on market conditions and rates is available to all participants.
6.4.1 Large n u m b e rs o f b u ye rs and sellers

Even in the 1960s when the Seven Sisters were at their peak and large oil companies controlled
signiíìcant proportions o f the word’s tanker tonnage, there were still many independent oil
companies that needed to ship cargoes o f oil. Since the I970s, the economic share o f the oil
majors has declined signiíicantly for a number o f reasons. Firstly, the rise o f state-owned oil
companies in the Middle East and elsewhere, reducing the share o f the big seven. Second, the
development o f a large spot oil market in Rotterdam from the early 1970s has meant that a
ships cargo may go through many owners beíore it reaches its destination.The rise o f the oil
trader has led to an increase in the number o f independent charterers o f ships.
The rise of the Rotterdam spot market coincided with the loss o f market povver by the oíl
majors during the 1970s and 1980s as independents opened up new distribution channels in
many countries.The ramiíications spread to the tanker market, where the oil majors reduced
the amount o f tonnage held on long-term charten in response to the oversupply situation
o f the mid-1970s. They also began to reduce their direct ownership o f tonnage, partly in
response to the introduction o f the Oil Pollution Act 1990 (OPA90), which made the ovvner of
any vessel polluting the u s seaboard liable for unlimited damages.

C h a p te r 6
These changes in ovvnership have led to a substantial reduction in the relative importance o f the
oil companies’ total tonnage, as can be seen in the data displayed inTable 6.8 and Pigures 6.7 and
6.8. Independent and stock market companies accounted for 79% o f tanker tonnage in 20 i 5.
Tanker o w n e r type Tanker tonnage Per cent share

(d w t)
Independent shipping 231,665,360 47.7%
Stock market 152418.759 31.4%
^Govt shipping 29,042,377 6.0%
Govt oil company 28,424,65 1 5.9%
Oil company 12,752,843 2.6%
German KG 12,413,891 2.6%
Other 18,574,276 3.8%
Total 485,292,157 100%
Table 6.8Tanker ownership by owner category, 2015 (source: EA Gibson Shipbrokers Ltd).
The top 10 tanker-owning companies are shovvn in Pigure 6.7.The only oil company fleet in the
top 10 is the National IranianTanker Company (NITC) with 2.8% o f the vvorld fleet.The total
oii company tonnage amounts only to 9.4% o f the world fleet in 2 0 15 (Pigure 6.8).
China Shipping Dev

(CSDC), 1.6%
Maran
Tankers,
1.7%
DyitdCổm
TanỊwf^ 7— '
ỉ:
Pigure 6.7Top 10 tanker ovvners, 2 0 15 (source: EA Gibson Shipbrokers Ltd)

Pertamina, 0.3% ^Chevron, 0.2%
PDVSA, 0.4%
Petrobras, 0.4%
SONANGOL,
0.5%
Pigure 6.8Top 10 oil company tanker owners, 2015 (source: EA Gibson Shipbrokers Ltd).
Overall, there are about 2, i 00 tanker companies operating a fleet o f some 5,000 tankers, vvhich
makes for a íragmented and competitive market. About I 15 companies each have íleets in
excess o f one million deadweight tonnes.The top fìve companies have in excess o f iO million
dwt, yet this is only represents 12.5% o f the world fleet, about 2%-3% share each.
W ith the top 40 tanker operators holding 50% of vvorld tonnage, these are very low íigures
for industrial concentration, and suggest that properties tw o and three are appropriate in the
context of the tanker market.
6.4.2 Id e n tic a l Service

Although oil itselí might appear to be a homogeneous product, it does in fact vary in terms
of its sulphur content and viscosity. Some o f the trade involves the movement o f diííerent
qualities o f oil to be blended at refineries, as diíĩerent blends meet diíĩerent market needs. In
fact,the key íeature lies in the nature o f the transportation o f oil, not oil itselí. It is clearthatthe
transportation o f oil is very homogeneous, since the Service provided by one crude oil tanker is
pretty much identical to that provided by another; assuming that delivery times, vessel reliability
and so on are similanThe economic assumption thatthe product is homogeneous can thereíore
be maintained.
6.4.3 Preedom o f e n tr y and e x ít

The main íactor determining ease o f entry is access to Capital to pay for a new or secondhand
vessel. It is vvorth noting here that the purchase o f a secondhand vessel may mean the entry of
a new company, but it is usually at the expense o f an existing operator; tonnage supply has not
increased overall. Since the íìnancial crisis o f 2007-2008, obtaining the necessary funds from a
bank or other íìnancial institution can be much harder and at higher rates than before.

C h a p te r 6
Many countries provide tax relieí for investing in shipping, Many o f these investments are made
at the top o f the shipping business cycle, vvhen íreight rates and time charter íìxtures are
relatively attractive.This encourages shipowners to invest in more ships and banks to lend more
money in the expectation that rates will be high in the íuture. On the other hand, when spot
and time charter rates are low, banks are less willing to supply finance but, o f course, there are
fewer ovvners willing to risk the purchase o f a new vessel.
Exiting the market may be by scrapping the vessei or, for an individual company, selling to another
operaton although the latter does not reduce the tonnage suppiy overall. In some industries,
exiting is very diíĩìcult. For example, £8 biilion has been committed to the Channel Tunnel, yet
if the ovvners o f Eurotunnel vvanted to leave, they could not convert their Capital into cash.The
assets would have to be sold at the market value, vvhich might be well below the initial cost o f
building the tunnel. In this case, the company vvould fìnd it very diffìcult to leave the industry, in
terms oígetting out with its Capital intact. In the tanker industry, this means o f exit is much rnore
likely, since there are many buyers and sellers. Only in exceptionally bad market conditions might
there be a problem with exiting the market.
The physical mobiiity o f the vessels themselves means that the large proportion o f Capital
invested in this sector is literally mobile.This means that any regional demand imbalances can
be quickly rectiíìed by a shift in relative supply.This statement must be qualiíìed by the fact that
the development o f very large crude carriers means that some segments o f the market are less
ílexible than others.VLCCs are excluded from some trading routes by either port or draught
restrictions. For example, the very largest vessels cannot trade into the u s East Coast ports
because o f shallow waters. Purthermore, the largest vessels cannot use the Suez Canal when
laden because o f the draughtThese characteristics mean that in some trades, Suezmax tankers
are more ílexible than bigger vessels.
Despite this qualífìcation,the substitutability o f one tanker for another on most routes ortrades
means that all sectors tend to move together, Supply can be very ílexible in the short run, as
Pigure 6.9 reveais.The existence o f a fleet o f laid-up tankers meant that the increase in demand
was easily met by a Sharp fall in lay-ups. Once lay-ups had íallen to \ % , such a response would
not be available and only new capacity would increase supply in such a situation. But it is worth
noting here that the generai global tanker inspection and approvals regime does not encourage
owners to lay up their ships unless market conditions and outlook are poon
6.4.4 Fuil in fo rm a tio n

The market is extremely well served by the specialised shipbroking companies vvhich keep in
constant contact with both ovvners and charterers on a 24-hour basis all around the vvorld.
Many shipbroking companies have offices at strategic points around the globe to offer this
Service. London plays a cruciai role, because it is iocated in a time zone vvhich can trade with the
Far East on the same day as trading with NevvYork.
All this activity means that charterers and owners are continuously iníormed o f current
events and prices. Many fixtures are pubiicly reported, with all salient details available. This
rnakes the provision o f market iníormation relatively cheap and very efficient and it provides a
benchmarked market
The einergence of publicly quoted tanker companies, whose shares are traded on the worid's
stock exchanges, also means that iníormation becomes more readily available as these companies
must file accounts and provide iníormation to shareholders.
Overall then, it would appear that all the íundamental properties o f a períectly competitive
market are fulfilled when the tanker market is examined.This means that modelling its behaviour
using demand and suppỊy analysis can be justifìed.

C o m p e titiv e sh íp p in g m a rk e ts : ta n k e rs
6.5 SEG M EN TED SUPPLY

Studies have shovvn that different tanker sizes have different own-price and cross-price
elasticity o f demand with respect to íreight rates.This implies some degree of differentiation in
the market. A study o f tanker profit in the I970s showed that the gross proíìt margins varied
widely betvveen sizes and that large tankers had signiíìcantly greater variability in those margins.
lf tankers were all in the same market, the variability should have been the same. Kavussanos
(Price risk modelling o f different size vessels in the tanker industry, Logistics and Transportation
Review, vol 32, pp. 161-176), using a technique borrovved from the vvorld o f financial analysis,
also arrived at the same conclusion, by showing that the conditional volatility o f tanker íreight
rates differed across ship sizes.
The question arises: does this mean that the tanker market has become less competitive? It can
be argued that the answer is a resounding no, because although the segments vvithin the tanker
market may have become more distinct, allowing them to behave differently in the short run,
it does not follow that they are unrelated in the long run.This is because shipowners have the
choice of investing in all o f these segments, none is closed to them. Free entry and exit exists
in all parts, so that market imbalances may exist for a few years, but will be self-corrected by
different rates o f entry and exit in the sectors. If the market íorVLCCs is badly hit, this sector
wiil have very high lay-ups, higher than average scrapping rates and few new orders. Owners
will be concentrating on the sectors that are relatively more proíìtable, until the excess supply
problem is resolved.
In the long run, one would expect to see the same common íactors driving each o f these
sectors and common trends appearing.
6.6 M O D E L LIN G D E M A N D
It should be clear from the above discussions that the demand for oil transportation is likely to
be extremely price inelastic. Remember it is a derived demand and the freight rate elasticity of
derived demand depends on:
1. the ovvn-price elasticity o f demand fo rth e final product;
2. the ease with which shipping can be substituted by other modes o f oil transportation
(cross price elasticity);
3. the share o f íreight costs in the íinal delivered cost to consumers;
4. the elasticity o f supply o f tanker transport services.
The lovver the price elasticity o f demand for the íìnal product is, the harder shipping can be
substituted and the largerthe share o f the íreight costs in the final delivered cost to consumers.
In normal conditions, with spare tonnage laìd-up, one would expect the own-price elasticity o f
demand for tanker íreight services to be very inelastic.This is because:
1. the own-price elasticity o f products derived from crude oil is very low, because:
a) there is limited technical substitution, for instance, one cannot readily put methane
in a petrol engine;
b) there is limited substitution for oil as an energy source in the long run, One estimate
gave a value o f -0.1y.This is very inelastic;
2. ocean oil transportation is highly specialised. Oil pipelines act as substitutes for some trades
such as North Sea oil fìelds, but in other areas there is no practicablealternative;
3. the share o f íreight costs in the retail price o f petrol in the UK is about 2%, say, 2p on 97p.
Oil Products are often highly taxed at the retail end because o f the low price elasticity;
4. supply elasticity is usually quite high, but can fall to zero in extreme booms, assuming a
moderate value is not unreasonable.
Economics of Sea Transport and Internationai Trade 137

C h a p te r 6
All the above points lead to one conclusion.The responsiveness o f demand to changes in freight
rates can be regarded as close to zero, that is, extremely inelastic.
Although demand is very inelastic with respect to the current íreight rate, it is very sensitive
to the level o f economic activity, as seen in earlier sections. Demand might be represented as
more or less vertical when plũtting the quantity dernanded in tonne-miles or tonnes o f cargo,
against the freight rate, for a given level o f economic activity. When the rate o f economic activity
increases, the entire schedule can shitt very rapidly. It will shift to the right in booms and to the
left in recessions.
6.7 M O D E L LIN G SUPPLY

The supply schedule íorthe market as a whole is assumed to have a shape that is very similarto
that developed on the dry cargo market. It will be elastic when there are signiíìcant amounts of
tonnage laid up, as this tonnage is readily available to increase the size o f the active fleet. But one
must remember the oil company approval regime mentioned earlier.As the laid-up proportion
falls, the sources o f extra short-run supply become more limited, so that the elasticity declines.
This shape is shown in Pigure 6.9 below.
The 80:20 split is based on the analysis by Platou o f tanker rate volatility. it argues that practically
all variations that are observed in the tanker market are observed when the utilisation of the
fleet was in the last 20%.This is consistent with the shape o f the supply curve below: elastic
overthe 80% range, but becoming less and less elastic until full capacity utilisation was achieved.
It is important to remember that this is a model for the short-run supply o f shipping. The
assumption is being made that the tanker tonnage supply is unchanged, with variations in tonne-
miles produced generated by variations in lay-ups, storage, ship speed and delivery.
Pigure 6.9Tanker supply curve
6.8 T H E M A R K E T M O D EL
Putting the very inelastic demand scheduie together with the varying elasticity supply schedule
generates a model o f the equilibrium spot íreight rate for tanker services (Pigure 6.10).

C o m p e titiv e sh ip p ín g m a rk e ts : ta n k e rs
Pigure 6.10 Modelling demand and supply in the short run
DO-DI large shift in demand, but lots o f spare capacity; little efíect on rates. Preight rate moves
from Pl to P2, vvhile tonne-miles increased from Q l to Q2.
D I-D 2 smaller shift in demand and capacity is less readily available; larger increase in rates.
Preight rate rises from P2 to P3, and tonne-miles increase from Q2 to Q3.
D 2-D 3 supply nearly períectly inelastic; small shifts in demand can generate large increases
in rates. Preight rate rises rapidly from P3 to P4; tonne-miles períormed rise slightly from Q3
to Q4.
The above model is consistent with:
a) great rate volatility (at the higher demand end o f the model);
b) the possibility that rate increases do not increase the short-run supply at all, once full
utilisation o f the existing fleet is achieved.The model is very similar to the one developed
for the dry cargo sector; because both are very competitive sectors.
6.8.1 T a n k e r and d r y cargo ra te v o la t ilit y c o m p a re d

The observed higher rate volatility in tanker markets compared with dry bulk markets can be
explained by the following points:
1. The dry cargo market is, in fact, not a single market at ail. It consists o f several major bulk
trades plus large numbers o f other commodities being transported on a tramp basis.This
means that if one sector o f demand grovvs vvhile another declines, tonnage can be shiữed
from the declining sectorto the growth sector. But this process keeps rate volatility in check
in the individual markets.
2. The average size o f dry cargo vessels, even the bulk ones, is smaller than that for crude
tankers.There is a direct link betvveen rate volatility and vessel size, vvhich can be explained
in common sense terms. Large vessels generate economies o f scale, so that the average
rate is lovver than that for smaller vessels.The same size increase in rate for both sectors
will generate a larger proportional increase for the lovver initial rate, that is, for the larger
vessel.Thus rate volatility might be higher because o f the diííerences in average vessel size
betvveen the two sectors.

C h a p te r 6
3. The oil industry has a special place in Western economies. As well as being indispensable
to the transport sector, oil is an important energy source for íactory povver and for the
chemical industry.The plastics industry is based on oil-derived Products. As has been shown,
the principal export region is the Middle East.The VVests strategic control over this region
declined sharplỵ in the I960s. vvith the rise o f Arab Nationalism and the Arab-lsraeli
conílict. Practically every significant spike in tanker rates has been associated with an event
in this region.The 1956 closure o f the Suez Canal, the 1967 Six-Day War, the l973Yom
KippurVVanthe 1979-84 Iran-lraq war and the 1990 lraq-Kuwait war can all be observed
in the tanker rate data.This relationship may change in the future, but is not likely. Although
growth in the period 2002-2007 has been driven by market íundamentals, the fact that the
Middle East is likely to loom large as a supplier in the íuture means the chances o f íurther
price changes due to political instability must be quite high.
The reason íorthe early spikes is easy to see.The large multinational oil companies ordered
as much oil as possible to be extracted írom the Middle East as soon as tensions flared but
this was not associated with extra supply, hence the rates went up. It is also important to
note that rate increases, such as occurred in 1990, appear to be much more short-lived.The
Middle East was no longer quite as dominant in export shares as it had been in the early
I980s and oil companies are not so vertically integrated. In 1990, Saudi Arabias reaction
was also quite different. Pearing invasion from Iraq, it co-operated with the western military
íorces and also deliberately increased its own oil production to compensate for the loss
o f Kuvvaiti output.The price o f crude oil fell and, until the last quarter o f 1996, was trading
around $20-25 a barrel. No stock-building surge was experienced so íreight rates also
deciined after the initial scare. High prices observed for oil in recent years are related to
demand levels reaching reíìnery capacity levels, ratherthan due to political events.VVhether
VVestern economies were quite so dependent on oil in 2000 is less clear. Certainly the
UK economy appears to have absorbed the price increases with much less impact on
domestic inAation than occurred in the l970s.The Prench economy now generates 70%
o f its power from nuclear sources.The reduced share o f manuíacturing in the economies
o f the developed countries means that energy price changes have ỉess impact on domestic
inf!ation than 30 years ago.
4. The role o f expectations. It has been suggested that tanker rates were affected by what was
called price elastic expectations.That is, the higher the rate, the more sensitive the market
became to rates themselves and the market raised its expectations about future rates by
more than was warranted. But this new level o f expectations vvould cause a shift in the
current demand curve, which vvould raise prices, untii unsustainable levels were reached. It
is very like a speculative bubble occurring, where all traders know the price is not related to
economic íundamentals, but everyone is making so much money out o f the perpetual rise
in prices that no one really asks whether the process can continue !ndefinitely.
The ansvver is that it cannot. A modern version o f this idea is called rational expectations in
market behaviounThe movement o f tanker prices is driven as much by what we expect to
happen to íuture tanker rates and íuture proíìtability, as it is by anything else. If the market
is efĩìc.ient, then all knovvn iníormation about such a market is argued to be captured in its
present market price, íreight rates or secondhand tanker prices. Changes in expectations
about the future will then automatically alter current prices. A war in the Gulf will send both
oil pnces, íreight rates and secondhand tanker prices up immediately because the iikeiihood
o f greater proíitability is a consequence. Recent research has suggested that the rational
expectations modei o f tanker market behaviour is not a good explanation o f observed
events. Researchers suggested that this was because the model assumed that everyone
in the markets had identical expectations and the evidence suggested that this was not
the case.

6.9 P L U C T U A T IO N S IN M A R K E T P R E IG H T RATES
The actual behaviour o f spot tanker íreight rates was illustrated for annual average data in
Pigures 6.4-6.6.They illustrate peaks in 1967, 1970, i973 and 1979, all years associated with
wars in the Middle East. Examination o f rates over quarterly, monthly or even weekly time
periods would generate even more variation. For example, tanker rates reflect the seasonal
increases in demand generated in the West íor oil in the vvinter months or the effect o f the
USA's summer driving season on the demand for transport fuel in their summer months. Pigure
6 .1 I shows the rates íorVLCC tankers írom the Middle East Gulf to Asia, Suezmax tankers from
West Africa to UK/Continent and Aíramax tankers from North Sea to UK/Continent.
- V L C C MEG-A$ia • W A Í-U K /C (TD20) - N Sea-UK/C (TD7)
250,000
200.000
150.000
11 ỹsf I Ì I ĩ 1 1 J1 1 ẵ:l í ẳĩ 1^1 "ì ỹ1 1 I I r r l t t l 1 ĩ ẵf f ẵ

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
-50,000
Pigure 6 .1 I Crude oil tanker rates 200 0-20 15 (source: EA Gibson Shipbrokers Ltd).
The tanker fleet was fully employed up to the íinancial crisis in 2008, due to Chinese and Asian
demand.The effects o f the 2008 recession can clearly be seen in the fall in the rates post-2008.
However; íioating oil storage provided some employment to 2 0 10.Tanker owners are reluctant
to lay up in times o f oversupply in order to maintain oil company charter approval, so slovv
steaming is preíerred.The recent increase in the length o f oil product hauls has come about as a
consequence of new refineries in the Middle East and India, and closure in Europe and Australia.
Additionally, shale oil/gas production in the USA has resulted in the USA now being an exporter
o f oil products. For the same reason, crude oil shipments from West Africa to the u s Gulf have
reduced signiíìcantly, while the interruption o f supplies írom Libya to Europe has been replaced
by crude shipments from West Aírica.
6.10 E N V IR O N M E N T A L ISSUES
In the past decade, environmental issues have come to the fore and have helped raise the quality
o f the services provided by tanker operators. One might argue that some o f the improvement
has been generated by political and public reaction to major oil spills, but there also appears
to be a grovving emphasis in the industry itselí on both the quality o f the ship and o f the crew
vvhich operates it.

C h a p te r 6
The principal driver o f this change was originally the American reaction to the Exxon Valdei
pollution incident in Alaska in 1989, In the USA, the Oil Pollution A ct was passed in 1990, under
which doubled-hull tankers were to become mandatory for vessels trading to u s jurisdictions.
The USA led the way at the IMO and the phasing in o f double-hulled vessels for ali operators
by 2015 was agreed. Aíter the incidents o f the Erikơ in December 1999, and the Prestige in
November 2002, the EU proposed an accelerated phased withdrawal o f single-hull vessels by
2010, instead o f 2015. Despite the longer-term structural concerns for the integrity o f double-
hull vessels.this became the only viable solution to reducing the spill potential in the event of a
tanker accident.
The introduction o f double-hull technology provided a major spur to tanker investment;
transíorming the fleet. VVhereas in the 1990s VLCCs were largely ageing vesseis, the sector was
transíormed by the renewal programme. So to o have the other segments, creating younger,
more eíĩìcient and safer oil transportation.
There is evidence that oil pollution from tanker accidents o r operations is now signiíicantly
lower than it was in the I980s and I99ŨS. In addition, the introduction of the International
Safety Management code in 1998 has transíormed attitudes to safety in the shipping industry.
State port inspections have kept shipovvners on theirtoes in terms o f operational quality.
Pinally, the standardising o f crew certiíìcation through the Standards oíTraining, Certification
and Watchkeeping system has probably helped raise the Standard o f training o f crew. This
Standard became mandatory in 200l,These processes have all helped to raise the Standard of
shipping quality and contributed to the reduction in poilution incidents noted earlier.
After revievving the driving force o f tanker demand, changes in regional production and
consumption patterns, the principal íactors affecting the growth o f oil tonne-mile demand was
outlined.The price o f oil played a key role, not directly, but because o f its macroeconomic effects
on world economic growth rates over the period 19 7 0 -1990.
The structure o f the tanker market was examined and it was shown that it has become even
more open and competitive than in the I960s, when it was already considered by many to
be competitive. The possibility o f market segmentation was brieíly discussed and a model of
íreight rate determination was introduced. Pactors that made tanker rates more volatile were
examined in the penultimate sections.

The liner trades
Liner shipping is the m o s t efficient m ode o f tra n s p o rta tio n

o f goods.
'1 ^
C h a p te r 7
In this chapter the development o f another important sector o f the shipping markets, the liner
trade, is reviewed. In contrast to the bulk trades considered in previous chapters, there are many
significant diíĩerences.They vary both in terms o f the nature o f the Service being offered and
the consumers, and in the way the Service is provided by liner shipping companies. Essentially,
liner trades may be viewed, in economic terms, as being an oligopolistic market structure, in
contrast to the competitive markets so far considered. But it must be emphasised at the outset
that this does not mean an absence o f competition in this market. It means that the íorms o f
competition that are present are not simply observable by market price. Períect competition
implies that operators compete solely on a price basis, but once market structures alten many
other types o f competitive behaviour betvveen companies can be observed and this is true o f
the linertrade.
The second point to note is that liner trades have been revolutionised by the widespread
introduction o f containerisation. Some o f the early ciassic analyses o f liner trades, widely
reíerred to in the literature, are now very dated in terms o f the technology that they describe.
Nevertheless, the economic organisation o f these trades cannot really be understood without
some knowledge o f the historical devetopment o f the trades and an important institutional
arrangement that still exists today: the liner coníerence. Knowing the history and the effects of
containerisation on this sector helps to explain the current developments in this rapidly growing
sector o f shipping.
7.1 D E P IN IT IO N OF A L IN E R S H IP P IN G SERVICE
The liner trades differ radically from other sectors o f the industry. It cannot be deíìned on
the basis o f the individual specialised technology o f the vessel such as a tanker Rather, liners
consist o f a group o f vvideiy difFering vessel types. It is therefore more appropriate to seek a
definition in terms o f operational characteristics rather than technology used.The key feature
distinguishing liners from other sectors is that they are engaged in the provision o f scheduled
services betvveen speciíìc ports. Scheduled services are those operating at a regular írequency
on a particular trade route according to a published timetable. According to Bennathan and
VValters in The Economics o f Oceơn Preight Rates, pp 2-3:
The main operơting distinction between tramp and liner is that the latter runs on regularlỵ
scheduled services advertised in advance. whereơs the former has no schedule ơnd picks up
ưaffic w here and when it can proỊitơbly c o m p e te :A liner Service is in quite a differen t class [rom
a tram p cơrner. The value o f the Service m ơy b e re Ịle cte d in the fact that it is available at regular
intervals, whether it is used or not. The shipper, therefore, may regard the ơvơilability o f a regular
Service as being o f considerơble vơlue to him.
Two points arise, which are still relevant today.
Pirstly, the Service being provided has to be regular and scheduled. Users o f the Service know
that sailings to a certain region or set o f ports will take place on a certain day at a certain
time, week in, week out. Shippers can thereíore rely on their goods being delivered to the
destinations vvithin a very narrovv time frame.
Second, the availability o f cargo space. The port o f Hamburg claimsto be able to ioad a
containerised cargo onto a vessei with just 20 minutes’ notice. While this claim may be
exaggerated, it emphasises the fact that there must be capacity on the vessel to accept such
cargo at such a short notice, and there must be available carrying capacity on the vessel
o r vessels.
CE Fayle, in an earlier work, A Short History o f the World's Shipping Industry, provides another
definition which is stili relevant today:

T h e lin e r tra d e s
Strictly speaking, a liner Service implies todơỵ a fleet o f ships, under common ownership or
m anagem ent, which provides a fixe d Service, at regulơr intervơls, betw een n a m ed ports a n d offer
themselves as common cơrriers o f any goods or passengers requiring shipment between tíiose
ports and ready for ưansit by their sơiling dates. A fixed itinerary inclusive o f a regulơr Service
and ơn obligation to accept cargo from ơll comers and to sail, whether [ull or not, on the date
fixed by the public schedule.These, and not the size and the speed o f the ship, nor the nưmber of
vessels in the [leet, ơre what distinguish the liner (rom the tramp seeker or general trader.
This definition is worth reading several times.The following points are vvorth emphasising;
1. fleet o f ships under common ovvnership or management;
2. fixed Service at regular intervals;
3. betvveen named ports;

4. common carrier obligations;
5. vessels sail, vvhether full or not.
7 .1. i F le e t o f ships u n d e r c o m m o n o w n e rs h ip o r m a n a g e m e n t
The typical liner Service requires the use o f several vessels if it is to provide a regular írequent
Service. Normally most liner services are deíìned on a írequency o f seven days, as, for example,
in the USA’s Pederal Maritime Commission determination o f a liner operator for the purposes
o f the 1984 u s Shipping Act. Table 7.1 below shovvs a representative sample of Container
carriers providing a Service betvveen Northern Europe and the Far East, with ports o f call and
number o f vessels. A t least ten large Container vessels are used to provide a vveekly Service
calling at each p o rt
The examples in Table 7 .1 indicate that this type o f Service is operated by alliances o f liner
companies;they have pooled their shipping resources to provide a jointly-operated liner Service
from Northern Europe to the Far East and back again. Although the vessels are not under a
single ovvnen they are in effect being managed by one, namely the alliance. Note also that the
tw o services quoted overlap in two ports, but provide a speciĩic access to others. This is a
common feature in liner services.
Service o pe ra tor(s) Ports o f call Ship N o. Vessel

capacity teu
FAL 12 Xiamen, Nansha, 10 8,212-9,469
70 days.VVeekly Hong Kong.Yantian,
Cosco/Evergreen/ Singapore, Hamburg,
K-Line/CMA-CGM/ Rotterdam, Felixstowe,
Yang Ming Antwerp, Xiamen
FAL8 Qingdao, Shanghai, 11 13,906-18,982
77 days,Weekly Ningbo.Yantian, Pont
UASC/CSCL Kelang, Felixstowe,
Rotterdam, Hamburg,
Zeebrugge, Rotterdăm,
Port Kelang.Yantian,
Qingdao
Table 7 .1 Prench Asia Line (FAL) Services (source: CMA CGM Service Description Report 2015).
7 .1.2 F ixed se rvice s a t re g u la r in te rv a ls

Another key íeature o f the definition is that the Service is guaranteed to shippers.The vessels
will sail according to the timetable.This means that shippers can rely on a steady flow o f cargo

C h a p te r 7
to their vvarehouses or customers, which is increasingly important now that manuíacturers use
just-in-time (JIT) production methods to minimise inventory costs. JIT depends upon reliable
and regular delivery services at all stages o f the supply Chain.
7 .1.3 Vessels sail, fu il o r n o t

The liner vessel is obliged to sail according to the published timetable. Shippers expect their
cargoes to be delivered to the correct port at the correct time, so reliability and running-to-
time are paramount.The obligation to maintain the schedule means that vessels may often sail
with less than a full cargo load.This is especially likely to occur if trade volumes are unbaianced
between outbound and inbound legs o f a route, since the capacity required will be determined
by the volume on the busiest leg.This means that the thin leg will operate with vessels trading
at low levels o f space utilisation. It follows that one o f the prime concerns o f the liner operators
is to ensure that cargo-carrying capacity is utilised to the maximum. Many o f the distinctive
íeatures o f liner tariíĩ structures fiow from this concern.
One íìnal point to be noted is the mention o f passenger traíĩic.The decline o f passenger liners
coincided vvith the rise in international air travel, which became a cheaper and much quicker
alternative. Passenger traíĩic is still important in tw o sectors, the shortsea ferry trades and
the cruise marketVVhile there are stili vessels designed to carry some passengers and íreight,
numbers are greatly diminished and they are not a signiíìcant part o f the market. For example,
passenger/general cargo ships in 2014 account for under half a million gt, less than any liner ship
type shovvn inTable 7,2,
In general, the market has shown signs o f increased specialisation, as vessels are designed to
meet the speciíic requirements o f market niches. Pigure 7.1 belovv highlights this, by indicating
the way that the passenger and cargo liner trades have evolved into a number o f segments,
reílecting changing market conditions over time.The specialist vessels indicated in Pigure 7.1
are not comprehensive, but the diagram clearly indicates the way in vvhich the traditional all-
purpose vessel o f 60 years ago has evolved in specialised sectors.
Pigure 7 .1 Development o f modern liner services.

T h e lln e r tra d e s
7.2 S H IP TYPES SERVING IN T H E LIN E R TR AD ES

Pigure 7 .1 revealed the evolution of vessel types meeting a variety o f needs gathered under
the term general cargo.Table 7.2 shows how the maịor components o f these ship types have
evolved from 2000. The table provides data on gross tonnage, numbers and average ages of
the vessels in that secton A number o f points are worthy o f note.
1. For the period 2000-2014 the annual average growth o f Container vessels in gt was 9.0%
compound, with the average age o f vessei remaining constant at 10 years.This is well below
the average ages seen in the rest o f the table.The average size has increased from 23,243gt
to 39,657gt.This trend o f rising numbers and increasing size will continue. In 2014 vessels
o f up to 20,000teu were taken into Service. Since 2008 Container ships on order have
halved both in total dwt and numbers, although the average vessel size continues to rise.
Container vessels now became the dominant sector by dwt and gt.The increase in share
captured overthe past decade is clearly illustrated in Pigures 7.2 and 7.3.
2. General cargo vessel numbers and gt have continued to remain stable or decline slightly;
a trend that has been noted since 2000. Numbers fall from 16,755 in 2000 to 15,221 in
2014, an annual average decline o f 0.7%. Average size increased from 3,277gt to 3,535gt,
while average age rose from 22 to 23 years. Declining numbers and rising age imply a fall in
the relative importance o f the sector.This is clearly brought out in Pigure 7.3. It is clear that
as containerisation extends its reach to trades not previously large or important enough
to be unitised, the market share o f these vessels will continue to decline. It must be noted
that this does not necessarily imply that they will completely disappear, since growing total
trade volumes combined with íalling market shares may still mean that demand volumes
can increase.There will always remain trades vvhere volumes are too irregular or cargoes
too specific forthe liner services to capture the business.
3. The number o f specialist vessels has also increased. Roll-on/roll-off (ro-ro) cargo vessels
have become more popular; reaching 47.3 million gt in 2014 and growing at 4.1% per year
since 2000.These vessels serve shortsea shipping and, with greater use o f containers on
many services, integration into the logistics chain requires more o f these vessels. Some
services carry cargo only and these ships are ideal íorthis kind o f Service. Reírigerated cargo
ships ('reefer') have suffered a different fate. Reeíer numbers decreased from 1,414 in 2000
to 954 in 2014 and gt fell by 3.0% per yean Average size has hovered around 4,800 gt and
age rose from 18 to 26 years. Reeíers have íaced competition from reírigerated containers
being carried in lift-on/lift-off (lo-lo) vessels. For example, more bananas are moved by
reírigerated Container than by reeíenThis substitution process restricts the potential íor
reeíers.The globalisation o f manuíacturing trade, particuiarly the car industry, has created
a market for dedicated deepsea car carriers (PCTC) moving completed vehicles from
production country to distribution centres.
4. Another specialist sector vvhich shovvs considerable expansion is the cruise liner business,
which grew at 6.2% compound over the period 2000-2014 in gt terms, or by 2.8% per year
in number terms.There are 18.5m gt o f cruise vessels, dominating the passenger sector.The
period has seen younger age groups going on cruises and larger vessels being introduced.
The Allure o f the Seơs, and the Oos/s o f the Seas are at present the largestThese sister ships
are 225,000gt and carry around 6,296 people aboard. It is interesting to note the high
average age o f these vessels: 23 years in 2 0 14.
5. The passenger/ro-ro ships are íamiliar in the shortsea ferry sector, with steadily increasing
numbers and gt. From 2000 to 2 0 14, gt rose by 1.7% per annum and average size from
5,089gtto5,7l9gt.
Overall, the average annual compound grovvth rate for all vessels in Table 7.2 over the period
2 0 0 0 -2 0 14 was 5 .1% per yean when measured by vessels gt.

C h a p te r 7
Three trends can be identiíìed from Pigures 7.2,7.3 andTable 7.2.
1. The rise o f the Container ship as the most common form o f liner cargo transportation,
2. The separation o f passengers from cargo, as vessels specialise in one or the other o f these
now distinct market sectors o f deepsea shipping.
3. The decline in the importance o f the general cargo vessel, which is clearly being substituted
by other ship types, but will retain a niche, serving trades without Container equipment
at ports.
• Container
• General cargo
&
I • Ro-ro cargo
• fóssenger/ro-ro cargo
• Refrigerated cargo
• Passenger (cruise)
■Passenger ship
Year
Pigure 7.2 Liner cargo íleet trends, selected ship types, 200 0-20 14 (source: derived from Table 7.2).
100%
90%
80%
70% ■ Passenger ship
ã 60% ■ t^ssenger (cruise)
"5 50% ■ Reừigerated cargo
■ P«scnger/ro-ro cargo
I 40%
■ Ro-ro cargo
30%
■ General cargo
20%
■ Container
10%
0%
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Year
Pigure 7.3 Ship type percentage share o f liner trades, 2000-2014 (source: derived ĩromTable 7.2V

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C h a p te r 7
7.3 T H E N A T U R E OF D E M A N D FOR DEEPSEA LIN E R

SERVICES
Thousands o f diíĩerent cargo types are moved by liner services, with many different Products
being carried in the same vessel.This makes discussing the demand for liner services qualitatively
different from the dry bulk and wet trades, where cargoes are o f one type and carried for one
charterer in a privately chartered vessel.
The large variety o f Products are carried under the liners common carrier commitmentThis
means that the carrier is obiiged to carry anything legally offered by the shippen subject to the
usual heaith and saíety regulations.
Cargoes carried range from personal computers, electronic components, hi-fi, textiles, tea,
coffee, cement, plastics, cooled cargoes, íresh and processed íruit, wool, hides, agricultural and
industrial machinery, cars (both components and assembled), broken glass and many others.
Note that the majority o f these Products are relatively durable, especially when stored under
controlled conditions, so that shippers are interested in the regular delivery o f their shipments,
to match anticipated consumption in the destination country.
As a result o f dealing with so many cargoes, liner companies have evolved a complex structure of
pricing with tariffs for classes o f commodities. Essentially, every commodity is allocated a product
group or class and charged accordingly, although containerisation has led to simplification o f this
tariff structure.The structure o f these prices will be explored in a later section o f this chapter.
Although little can be said about the precise type o f cargo carried because o f the huge diversity,
there are some essential characteristics common to all cargoes moved by the linertrades.These
are to be found in the nature o f the Service offered to shippers by the liner companies. Alderton,
in Reeds Seo Transport: Economics and Operations, 5th edition, quotes the results o f a survey of a
number o f American shippers who vvere asked to rank the relative importance o f a number of
íeatures o f the liner Service.The results are displayed inTable 7.3,
The table highlights the importance placed upon timeliness and delivery, with phce Corning third.
Note that Ford, as a shipper o f cars, puts safety record above price and also emphasises the
financial stability o f the supplien It does not want to commit itself to suppliers who may go out
o f business and disrupt its iogistics supply Chain in the process.
This emphasis on reliability has become more and more important over the past 20 years as
shipping companies become more intermodal in their operations. Many large liner companies
now ofíer integrated door-to-door freight services to shippers, having diversiíìed into land-based
transport operations.This level o f integration requires:
1. land transport from íactory to terminal;
2. movement froín terminal to port, if cargo consolidation takes place o fĩ port limits;
3. port terminal operations, transíer to vessel;
4. vessel movement to destination port;
5. movement from destination port to shippers’ fìnal destination.
Eíĩìcient use o f these elements has led to the processes being increasingly integrated. One
signiíìcant innovation vvhich has materially helped in this process is the use o f containerised
cargo for íreight.This is briefly discussed in the next section.
ISO Institute of Chartered Shipbrokers

T h e lín e r tra d e s
VVhat shippers w a n t VVhat Ford wants

On-time delivery Saíety record
Overall responsiveness Price
Price Pinancial stability
On-time pick-up Transit períormance
Transit time Handling of damage claims
Service territory Equipment avail/suit
Billing accuracy Equipment condition
Correct equipment EDI capability
Degree of control Ease of doing business
10 Claims Processing 10 Innovative initiative
II Tracing capability
Table 7,3 Ranking of S ervice characteristics bỵ shippers (source: Alderton (2005), quoted from American
Shipper Survey, 1990).
7.4 T H E C O N T A IN E R R E V O LU T IO N
In 1966, the first deepsea Container Service was started by Sea-Land, a company set up by
Malcolm Maclean, based on his innovative development o f containerised truck íreight in the
USA. The system used 20’x8’x8' metal boxes, or containers, which were transported to and
from the port using trucks and chassis.The containers were stored on the chassis, and then
loaded onto a dedicated vessel for sea transport.The vessel was íìtted with cell guides to locate
and secure the containers, vvhich were lifted onto and from the ship using large gantry cranes.
This system o f cargo handling revolutionised the liner trades.Traditionally, general cargo vessels
spent a large proportion o f time in port, being loaded and unloaded by gangs o f stevedores.
Cargo handling was slow, prone to high rates o f pilferage and was a peculiar art, since cargo had
to be packed and secured saíely. But it also had to be stowed in the right location for retrieval
at its destination.The developm ent o f a Standard unit has transíorm ed all this.The large dock
labour component has been svvept away, replaced by large Capital investments in sophisticated
ships, strengthened quaysides for Container storage, Container storing, stacking and retrieval
systems, and container-stuffing services, vvhich are now often in the secure arena o f the shippers
own premises.Very little Container íìlling is carried out at the p o rt o r terminal.
The huge Capital investment required was repaid with a dramatic increase in productivity.
Container ships now spend little time in port - they can be loaded and discharged in a matter
o f hours, rather than weeks. A 1970 study by Lambert Brothers showed that one new Container
vessel was likely to displace up to five conventional cargo vessels in terms o f cargo moved per
yean Container movements per hour are such that the tonnes o f cargo moved per hour has
grown tremendously.
The investment efFort required to develop the system has also created fundamental changes in
the structure and organisation o f liner trades themselves. In the I970s, a new form o f shipping
organisation emerged: the consortia. A number o f UK shipping lines, which included Ocean
Steamship Company, p&o, Shaw Savill & Albion and the Cayzer Group merged to form Ocean
Containers Limited (OCL).
They needed to do this to become large enough to tìnance investment in new technology as
well as to create enough trade volume to make the investment worthwhile.This organisation
later became P&OCL, Vv'hich itselí merged with Nedlloyd in 1996 to form a nev/ joint company,
P&O/Nedlloyd.This was taken over by Maersk in 2004, reílecting the continuing evolution o f the
industry.The process o f change and concentration into larger shipping companies still continues.

C h a p te r 7
The need to manage both land and sea legs introduced logistics into the business and changed
the way companies approached pricing. As a result, ships and shipowning became sidelined,
as the core business was now through transport. For the vvorld economy, the effects vvere
revolutionary. Beíore containerisation, international transport had been slow, expensive and
unreiiable, with high-value goods prone to damage and pilíerage. Indeed.there was evidence that
maritime transport was becoming a restraint on international trade grovvth. Containerisation
made shipping fast, secure and cheap and íacilitated the relocation o f manufacturing, so as
containerisation expanded, so did globalisation (Stopíord, A^ơr/t/me Economics, 2009, p 5 12).
7.5 C O N T A IN E R LIN E R SERVICES A N D FLEET

D E P LO Y M E N T
Global Container flows and trade routes are concentrated in the ‘east-west’ trades between
North America, Europe and Asia.The ‘north-south’ trades are less densely containerised routes
betvveen these three major centres and Australasia, South Aírica and South America.The east-
vvest trades oíten link with the north-south trades via hub ports, to form the íamiliar ‘hub-
and-spoke’ network. Pinally, there is considerable volume o f interregional Container trade, fo r
example, ‘intra-Asian’ trades.
An analysis o f transatlantic Container services betvveen ports on the East Coast o f N orth
America (ECNA) and Northern Europe in 2012 showed thatthere were 29 services provided.
Twelve o f these services were ‘joint’ services, that is,. by two or more operators, including íormal
alliances such as the then New W orid Alliance (APL, HMM and MOL),The total number o f
ships employed was 153, with average sizes between 434teu and 6,765teu. Most o f the services
were weekly, provided by ío u rto seven ships (a string) depending on the number o f ports and
distance required to complete a round trip (a loop). Most o f the services were ‘end-to-end’,
ithat is, ports on either side o f the Atlantic. There were also services vvhich were part o f a
'pendulum' Service, calling at ports in Asia, ECNA via the Panama Canal and thence to Europe
and return, the ‘Panama pendulum’. Pinally, there were tw o services which vvere part o f an
eastbound round-the-world Service.
Another example o f a liner schedule is the Grimaldi EuroMed Service with five 20-knot ro-ro
ships on a vveekiy Service between Europe (seven ports) and the Mediterranean (eight ports),
saiiing to published schedule with port arrival and sailing dates.
Fleet deployment is the term used to describe the allocation o f ships to a liner Service. There
are four key variables: the number, size and speed o f the ships and the Service írequency (o r
interval).The FAL 12 Service inTable 7.1 iltustrates hovvthe four variables are linked.There are
10 ships providing a vveekly Service betvveen fìve ports in Asia and four ports in Northern
Europe.The ships’ sizes vary between 8,212teu and 9,469teu.The time for each ship to complete
the round tnp from Europe to Asia and return IS 70 days ( 10 shìps X seven day interval). If we
assume that the time spent in each port is tw o days, and that one day is taken up with each
Suez Canal transit, then the total porưcanal time is 20 days (nine port calls, tw o Suez transits). If
we deduct 20 days from the 70-day round voyage, then time at sea is 50 days.
The round voyage distance is 21,259 miles, so the minimum speed required o f each ship to
maintain this Service is 17.7 knots (21,259 miles / 50 days / 24 hours).The speed o f 17.7 knots
may appear on the low side fo r this size o f Container ships, the design speed o f which vvould be
about 25 knots. Keeping to schedule is important and there is a need to have reserve o f speed
in case o f delays at sea or in port. In addition.the recent high price o f fuel oil and oversupply of
ships has resulted in slow steaming as a strategy to reduce both fuel consumption and absorb
some excess capacity. Indeed, it is possible that this Service could operate with nine ships. In thìs
case, each ship vvould have 63 days (nine ships X seven-day interval) to com plete th e round
voyage. If we deduct 20 days for port time and Suez transits, sea time is now 43 days and the
speed required is 20.6 knots. So it is clear that there is a trade-off between ship numbers and
ship speed.

7.6 C O N T A IN E R L IN E R M A R K E T S TR U C TU R E
In 2015 there were approximately 250 Container liner operators (or operating groups). As
shovvn in table 7.2 there are 5,052 íully cellular Container ships in 20l4.Tabie 7.4 shovvs the top
20 Container liner operators ranked by teu capacity.
TO TA L OVVNED CHARTERED SHARE

Rank O p e ra to r TEU Ships TEU Ships TEU Ships %
1 APM- 2,953,441 609 1,627,082 252 1,326,359 357 16.0%
Maersk
2 MSC 2,530,51 1 498 1,094,191 193 1,436,320 305 13.7%
3 CMA CGM 1,686,938 455 544,354 82 1,142,584 373 9.2%
4 Hapag- 970,430 184 524,458 78 445,972 106 5.3%
Lloyd
5 Evergreen 965,341 203 1539,170 111 426,171 92 5.2%
6 cosco 816,316 161 470,084 89 346,232 72 4.4%
7 CSCL 722,31 1 141 485,094 70 237,217 71 3.9%
8 Hanjin 630,557 102 278,102 38 352,455 64 3.4%
9 MOL 595,872 111 191,869 30 404,003 81 3.2%
10 Hamburg 568,273 120 247,072 40 321,201 80 3.1%
Sũd
11 APL 546,100 89 386,003 50 160,097 39 3,0%
12 OOCL 528,45 1 98 331,243 47 197,208 51 2,9%
13 NYK Line 508,795 109 282,158 49 226,637 60 2.8%
14 Yang Ming 457,940 96 200,081 42 257,859 54 2.5%
15 UASC 407,894 55 243,143 29 164,75 1 26 11%
16 K Line 392,606 78 108,152 17 284,454 61 2.1%
17 Hyundai 382,812 58 153,658 20 229,154 38 2.1%
MM
18 PIL Line 363,292 156 281,610 119 81,682 37 2.0%
19 Zim 325,439 75 55,057 13 270,382 62 1.8%
20 Wan Hai 202,067 87 170,837 71 31,230 16 1.1%
Table 7.4Top 20 Container liner operators by teu and market share, March 2015 (source: Alphalinen
TOP 100)
The development o f containerisation initially resulted in rapid consolidation o f liner operators.

Table 7.5 shows the changes in market concentration for the top 20 operators since 1980.
Betvveen 1980 and 2001, market concentration actually reduced, with the top 20 share declining
from 60% to 53% and average share from 3.0% to 2.6%. Since 2001, there has been signiíìcant
consolidation, with the top 20 now accounting for 90% share, an average o f 4.5%.
This was achieved through acquisition o f other operators and the purchase o f new and
secondhand tonnage, particularly by MSC and CMA CGM, who have nearly doubled their
market share since 2005. By contrast, the tanker sector top 20 oniy account for 34% o f the
market. One measure o f an oligopoly is a five-fìrm concentration ratio o f more than 50% of
market share.Table 7.4 shows us that the top fìve share is just 50%.

C h a p te r 7
Top 20 Share Average

1980 60% 3.0%
2001 53% 2 .6 %
2005 73% 3.6%
2015 90% 4.5%
Table 7.5 Changes in market share o f the top 20 Container liner operators 19 8 0 -2 0 15 (sources:
Stopíord, Maritime Economics, 2009 p 534 and Alphaliner 2 0 15)
The second point to make about table 7.4 is that half the tonnage operated by the top 20
Container liner operators is time-chartered from independent shipovvners. These shipowners
invest in Container ships, often using German KG finance, but do not provide liner services
themselves. By this means, the liner Container operators reduce their need fo r Capital íìnancing
to expand their íleets. As a result, there are tw o markets in liner shipping: the íreight market
between operators and shippers, and the Container ship charter market between the liner
operators and independent containership owners (Stopíord, Maritime Economics, 2009),
Pigure 7,4 shows the daily time charter rates for ship sizes 2,700 teu, 3,500 teu and 4,250
teu betvveen 2010 and 2015, based on 24-month charters.The Container ShipTime Charter
Assessment Index (New ConTex) is published by the Hamburg Shipovvners'Association and is
based on assessments o f the current day charter rates for seiected ship types.
-2 ,7 0 0 te u •3 ,5 0 0 te u — 4,250teu
2011 2012 2013 2014 20IS

Date
Pigure 7,4 New ConTex C o n ta in e r ship daily time charter cates 2 0 10 -2 0 15 in us$ (source: Hamburg
Shipovvners'Association (VHSS eV) 2015)
7.7 T H E DiFFERENCES B E T W E E N B U L K A N D G E N E R A L
C A R G O TR AD ES
There are tw o key differences betvveen general and buik trades. First, transporting many small
parcels requires a larger and more expensive administrative fìxed cost because o f the many
commodities and shippers. Second.the obligation to sail to a schedule makes capacity inílexible.
Capacity expands in ship-sized increments so, when a trade is grovving, new ships must be
ordered in multiples determined by the Service írequency and with suiTicient capacity to allow
for íuture growth. In addition, as larger ships are delivered, they are put on the main east-
west trades and the ships they replace are cascaded down to trades with less cargo volumes.
If six ships are required to run a weekly Service it must operate w ith six ships, thus making

capacity management a key íeature o f the business. The development o f the Container ship
charter market and the practice o f slot chartering have helped to resolve inílexibility (Stopíord,
Maritime Economics, 2009, p 5 18).
In addition to world economic cycles, seasonal variations and trade imbalances create additional
problems. Seasonaiity occurs when cargo volume is higher at some times o f the year than
others. A íeature o f most trade routes is trade imbalance, that is, more cargo in one direction
than the othen Typically, there is more cargo out o f Asia to Europe and North America, so
utilisation in one direction might be 90% and 50% in the otherThis in turn generates the need
to reposition empty containers.While empty containers can occupy spare space on the weaker
leg, the cost o f litting them on and ofí the ship plus landside transport and handling is not
covered by revenue. As liner companies are unable to negotiate a rate for every cargo and with
so many shippers, they resort to a fixed price structure.This combination o f inílexible capacitỵ
and fixed prices results in what is reíerred to as the liner pricing problem (ibid).
7.8 T H E PR IN C IPLES OF L IN E R SERVICE EC O N O M IC S

Stopford (2009, pp 539-548) analyses the principles o f liner Service economics by the eight
building blocks on vvhich a liner Service is constructed.These are as follows:
1. Ship characteristics: ship size, speed, fuel consumption and cargo-handling eííìciency. The
design speed for ships over 6,000teu is about 25 knots, although for smaller capacity ships
it is slovver.The actual speed on a particular Service will be less, to allovv a margin fo r bad
weather and other potential delays and the need to adjust speed to meet the schedule.
The time in each port call will vary and includes pilotage and berthing/unberthingtime, plus
cargo-loading and -discharging time.
2. Service schedule: port calls, voyage distance, Service interval and number o f ships. In Pigure
7.1, in the FAL 12 Service there are nine ports with a seven-day interval and a round voyage
distance o f 21,259 miles. As noted above, there is a trade-off between ship number and
speed so the addition o f another ship, the slovverthe speed required of ali ships. However,
what might be gained in a reduction o f fuel consumption per ship is ofíset by the cost o f an
additional ship. In addition, slovver speed betvveen ports increases the transit time.
3. Capacity utilisation: the cargo liner challenge is to match the Service to the trade as closely
as possible.Too small a ship results in cargo being left behind on the quay.Too large a ship
means sailing only part full, vvhich raises the average cost perteu. In the FAL 12 Service and
based on the smallest ship size (8,2l2teu), the annual one-way capacity o f this Service is
427,024teu.This is because a vveekly Service means there are 52 voyages a year each way,
thus one-way total capacity is 52 X 8,212teu. Should the liner operator wish to change the
Service interval, then this will have an impact on the ship size. For example, a 10-day interval
generates 36 voyages a year (365 days / IO).With 36 voyages a year and the same annual
Container volume, then ships o f i 1,862teu will be required (427,024teu / 36 voyages).
Conversely, if the Service interval is reduced to five days, then the ship size required is
5,850teu because there are now 73 voyages a year.There is a trade-off betvveen Service
interval and ship size.
4. Ship costs: operating expenses, Capital costs and fuel costs. Ships’ costs were covered in
Chapter 4 to which the reader should reíer Howeven for a ship on a regular Service, the
port and bunker costs can be considered to be a íìxed for the purposes o f voyage cost
calculations.
5. Port charges and canal tolls: port charges on the ship vary from port to port and by the
method by vvhich the port authority calculates the charges.They are generally levied on
the ships tonnage, usually the net tonnage because ít is a measure o f the revenue earning
capacity o f the ship.

C h a p te r 7
6. Deployment o f containers: in any trade there are a mix o f Container type and sizes used, for
example, 30% 20-foot, 60% 40-foot and 10% reírigerated containers. Container turnaround
is also taken into account, that is, the tim e betvveen voyages, during w hich the Container is
delivered to the customen collected and repositioned íorthe next cargo fo rth e return leg.
As a result the number o f containers required is two to three times the ships Container
capacity. In addition, trade imbaiances result in an accumulation o f empty containers at one
end o f the trade route and require moving back at the cost o f loading and unloading. For
example, on a trade route with 90% utilisation one way and 50% the other way, up to 40%
o fth e containers on the weaker leg may be empty.This is an opportunity for marginal cost
pricing. If the Container is empty, any cargo which pays more than the cost of handling is
worth carrying, that is, low-value cargoes.
7. Container costs: these cover the Capital costs o f containers, maintenance and repair, terminal
handling costs (liíting on and o ff the ship), storage fo r reeíer containers, onward shipment
by sea (feeder) or land transport, repositioning empty containers and cargo claims. Liner
companies own and lease containers about 50%-50%.The daily cost, vvhether purchased
o r leased will be from $0.55 fo r a 20-foot dry Container to $4.50 fo r a 40-foot high-cube
reeíer (as o f 2 0 14).Terminal handling (THC) includes lift on and lift off the ship and moving,
stacking and storing the Container in the terminal. Onvvard shipment includes transhipment
by sea to a feeder vessel, inland intermodal transport by road or rail and repositioning to
w h e re the Container is required for loading again.
8. Administration costs: these are the costs o f running the liner Service and are charged to
each vessel to recoverthe overheads o f running the company.The overheads will include
the following activities: operations (ships, scheduling, cargo stovvage and terminals), íìnance
and administration (accounting, budgeting and human resources), global sales (booking,
documentation, pricing, advertising and agents) and IT (Communications and Computer
systems).
The costs o f administration can be measured in throughput o f teu per empioyee and the
number o f employees required per ship. Based on the average salary.the administrative cost per
ship per voyage and per day can be determined.
7.9 P R IC IN G LIN E R SERVICES

Pricing is a key issue for liner Service operators, although sea freight is onlỵ one part o f the total
cost, which includes iniand transport costs and terminal handling charges, vvhich can account for
as much as the sea freight.The large fixed overheads and the need to operate regular services
ensures that price-making is more complex than for other shipping sectors. During the cargo
liner era, a centralised system was developed for handling pricing by the liner coníerences.
A liner conference is a group o f iiner companies who agree on common íreight rates, surcharges
and conditions o f carriage, ship capacity by each member line, írequency and allocatỉon o f sailing
schedules, and arrangements for concluding joint 'Service contracts’ between the coníerence and
individual shippers.The liner coníerence era started in the 1870s on the Asia-Europe trades and
reached a peak in the 1950s vvith over 350 coníerences worldwide. Membership o f a coníerence
depended upon whether it was a closed or open coníerence.To become a member o f a cỉosed
coníerence required the unanimous agreement o f ail member lines, a consequence o f which
might reduce each members share o f cargo.Thus entry would depend upon on a number o f
íactors, inciuding the trade that the prospective member could bring, An open coníerence, on
the other hand, required to admit any liner company, subject to reasonable and equal terms,
providing that they comply with rate agreements. But,this did not extend to the number o f ships,
so that open coníerences were more vulnerable to overcapacity. Liner coníerences traditionaily
conducted price negotiations, usually with a shippers' council.They would meet periodically to
negotiate rates and agree ‘general rate increases’. Shipping companies who were not members
of a coníerence followed an independent phcing policy. The introduction o f containehsation

has weakened the coníerence organisation. Coníerences still exist today (about 100 in 2009),
but co-operation betvveen liner companies has become less structured and has been largely
superceded by a variety o f operational agreements such as trade-lane ‘discussion agreements’,
alliances and individual Service contracts.
Liner companies try to base their pricing policy on the dual principles o f price stability and price
discrimination. The need for price stability reĩlects the need to cover the high fixed costs of
providing the Service. N or is it practicable to negotiate every price with so many shippers. Once
prices are set they should only be changed for a reason.There is also a case for commodity price
discrimination. Charge higher rates for commodities which can bear the cost and discount low
value commodities to attract a wider range o f cargoes than would be economic if there was a
single Standard íreight charge. By increasing the volume o f cargo, larger ships and more regular
sailings are possible.This method o f cross-subsidisation is not universally adopted, for example,
in the Container íeeder trades. The other type o f price discrimination is betvveen customers.
Large customers can be offered special discounts through Service agreements. Customarily,
liner companies vvould set tariff classes and produce a rate book listing the tariff class. The
íreight rate was determined by the tariff class for the com m odity and amount to be shipped
(vveight or volume) and adding any additional charges. Containerisation undermined this system
by standardising unit o f carriage. As a result, simplified tarifF classes were developed, knovvn as
Commodity Box Rates or Preight All Kinds, vvhere the contents o f the Container are disregarded
(Stopíord, Maritime Economics, 2009, pp 550-55 I).
Regardless o f the basis íor the rate calculation, the íreight invoice will usually include a number
o f add-ons, such as surcharges and additional services provided. Maersk, for example, has over
100 services, surcharges and fees, in addition to the basic ocean freight, examples of vvhich are
shovvn inTable 7.6.
A d d itio n to ocean íreight A t origin/destination p orts

BAF Bunker Adjustment Pactor CCL Container Cleaning Fee
CAF Currency Adjustment íactor cus Customs Clearance Service
CON Congestion Fee OHCTerminal Handling Charge (Origin)
PSS Peak Season Surcharge OHDTerminal Handling Charge (Destn)
STT 5uez Canal Fee IHE Inland Haulage Export
PCC Panama Canal Fee IHI Inland Haulage Import
ER5 Emergency Risk Surcharge ODF Document Fee (Origin)
HWS Heavy Weight Service POS Equipment Positioning Service
OOG Out O f Gauge Service PSE Port Security Service
SER Carrier Security Service SPC Container 5tuffing/Stripping Service
Table 7.6 Example o f services, surcharges and fees (source: Maersk 2 0 14).
The price a shipper is prepared to pay may also depend on what is in the Container The
contents are different in terms o f price elasticity and Service requirements. Shippers o f high-
value commodities may be willing to pay more, vvhile for low-value goods where transport
costs are a signiíìcant part o f the delivered price, pricing is more important. Low-value goods
are subject to competition and liner companies will discount to win the business, especially
vvhere they have spare capacity on one leg o f the voyage. Shippers o f high-value goods involved
in JIT supply chains may be m ore interested in Service than price and be vvilling to pay m o re for
speed and reliability. Liner companies need to find some way o f diíĩerentiating their Service that
will support premium pricing.The Service characteristics inTable 7.3 still apply, to which may be
added the írequency o f sailings (three- or fìve-day sailings, rather than seven or 10 days) and

C h a p te r 7
guaranteed vessel space availability. Thus diíTerent shippers have different priorities (Stopíord,
Maritime Economics, 2009, p 5 19).
Pigure 7.5 shovvs the changes in íreight rates per teu in the main east-west trade lanes betvveen
1996 and 20i0.These rates are the average o f all commodities and ‘all-in’, including CAR BAF
and terminal handling charges.There are tw o observations that can be made. First,the increased
volatility after 1998, and the sudden decrease in 2009, the result o f the recession.This is not
surprising as Container shipping is most likely to be the íìrst sector to react to an economic
dovvnturn with the fall in consumer demand for íìnished goods. Second, it is clear that the rates
reílect the trade imbaiance betvveen the headhaul and backhaul, for example, higher utilisation
out o f Asia to the USA and Europe.
“ Asia- USA “ “ USA-Asia Europe-Asia ^ ^ A s ia -E u r o p e ....... 'USA-Europe ^ ^ “ Europe-USA
Year
Pigure 7.5 Container íreight rates per teu in the major east-west trades, 1996- “ 2 0 10 (source: UNCTAD,
Review oỊ Maritime Transport).
7.10 T H E PR IN C IPLES OF L IN E R P R IC IN G
Stopíord (2009, pp 552-555) identiíìes four liner pricing options, which are explained below.
Pigures 7.6 and 7.7 relate to a 4,000teu Container ship.The vertical axis is the cost or price per
teu and the horizontal axis the number o f teu carried. AC is the average cost per teu and MC
the marginal cost per teu. DI is the demand curve when supply o f shipping exceeds demand,
and D2 is the demand curve when demand exceeds supply.
Competing liner companies each operate a 4,000teu Container ship which costs $50,000 a
day to run, based on an outvvard voyage o f 40 days, This cost includes the daily Capital and
operating costs, as well as the fuel cost and port charges allocated on a daiiy basis. Thereíore
the only variable IS the Container handiing, at $400 per Container Marginal cost (MC) is the
addition to total costs o f carrying one more Container lf the ship is not full then the marginal
cost o f handling another Container is $400. Once the ship is full, the marginal cost increases to
over $2,000, the cost o f chartering another ship or hiring slots on another vessel.The average
cost (AC) is the total o f the fìxed and variable costs for a range o f cargo volumes. For example,
for 2,000teu, the fìxed cost is $2 million (40 days at $50,000 per day) and variable cost is $0.8
million (2,000teu at $400 perteu), a total o f $2.8 million.The average cost is thereíore $1,400
($2,8 million divided by 2,000teu).The more containers carried.the lo w e rth e average cost and
vice versa. A t low cargo volumes, the average cost is high because fewer containers must still
cover the total costs o f the ship.

I . O p tio n I : Marginal cost pricing

Pigure 7.6 illustrates the competitive market situation.VVhen demand is low ( D I ), liner operators
compete against one another for the available cargo and the price íalls to the marginai cost of
$400. A t this price, market demand is 3,000teu, where DI intersects the horizontal MC curve.
The average cost for 3,000teu is $ 1,067, so the carriers will make a loss o f $677 per teu, a total
o f $2 million.When demand exceeds supply as shown by demand curve D2 and the ships are
full, the price rises to over $2,000 per teu.The average cost is for 4,000teu is $900 per teu, a
surplus of $1,100 per teu, that is, $4.4 million p ro fit In the long run, the liner company must
make suíTicient profit in good times to subsidise the bad times.
-Marginal Cost (MC)
ỉ •Average Cost (AC)
•Demand D I (D<S)
•Demand D2 (D>S)
Cargo quantity
Pigure 7.6 Pricing option I : Marginal cost pricing.
2. O p tio n 2: Fixed pricing

Pigure 7.7 illustrates the íixed price situation, where liner companies co-operate to fìx prices
which give a reasonable margin over average cost and stabilises the cash flow. Assume the price
per teu is íìxed at $ 1,000 per teu. When supply exceeds demand ( D I ) demand at this price
is 2,775teu but the average price for this volume is $ 1, 120 per teu, a loss o f $ 120 per teu or
$333,000 per voyage.When demand exceeds supply (D2),the ship is full and the average cost
is $900, a proíìt o f $ 100 per teu, a total o f $400,000.The net eíĩect is to reduce losses when the
market demand is low and limit proíit when demand is high.This pricing policy will only work if
all shipowners comply with the policy. But in a recession, the price o f $1,000 is above marginal
cost o f $400 and there is strong incentive for individual carriers to reduce prices to íill their ship,
to break the cartel. On the other hand, in boom times, outside iiner companies may enter the
trade, expand supply and so eliminate profits.

C h a p te r 7
Cargo quantity
Pigure 7.7 Option 2: Fixed pricing.
3. O p tio n 3: Price discrim ination
One o f the eíĩects o f marginal cost pricing in a recession, is that demand is more when the
price is $400 (3,000teu) than $1,000 (2,775teu), vvhich attracts lovver value cargoes and helps
fill ships and generate extra revenue. Dunng boom times, under marginal cost pricing high rates
discourage cargo that vvill not bearthe high freight rates and thereíore prioritises cargo to scarce
capacity.Thereíore, ílexible pricing offers beneíìts to both shipper and liner company and reíers
to price discrimination, charging different íreight rates for different commodities, low rates for
low-value commodities and higher rate to high-value cargoes. Commoditỵ price discrimination
is widely practised by iiner companies although this is more diíĩìcult since containerisation has
standardised the physical cargo. Price discrimination can also be applied to customers, with
larger shippers being ofFered lower rates for higher volumes o f cargo. This pricing option is
called 'yield management’, a pricing strategy that maximises revenue from a íìxed 'perishable'
resource.There are three conditions for yield management to be applicable, all o f vvhich apply
to liner shipping:
• There is a fìxed amount o f resources available fo r sale, that is, ship capacity:
• The resources sold are perishable, so there is a time limit to selling the resources, aíter
which they cease to be o f value, that is, the ship saiis to a schedule vvhether full or not:
• Different customers are willing to pay a diíĩerent price for using the same amount o f
resourres, thai is, shippers with diíĩerent prioi-ities.
The principles o f price discrimination are explained in Appendix I .
4. O p tio n 4: Service contracts

The containerisation o f cargoes has reduced the opportunity for commodity price discrimination.
One way in vvhich a Service may be tailored to a shippers speciíic requirements is by the
use o f an individual Service contract between a carrier and shippen Service contracts were
normally negotiated betvveen the shipper and the coníerence as a whole. Hovveven the u s
Ocean Shipping Reíorm Act 1999 íacilitated the development o f coníidential Service contracts
betvveen a shipper and an individual coníerence line.

The te rm s o f a Service co ntract w ill include:
• duration o f the contract (usually a year);
• minimum volume o f containers;

• list o f commodities shipped;
• origin and destinations;
• Service level expectations;
• íreight rate.
These Service contracts may only apply to ocean transport, and surcharges and add-ons will
still apply.
7.1 I CASE S T U D Y : G A M E T H E O R Y A N D C O M P E T IT IO N
Game theory is a technique for analysing how firms should behave in strategic situations. In
deciding what to do, fìrms must take into account what other firms are likely to do and how
others might respond to what they do. The theory helps each fìrm to develop its optimal
strategy fo r pricing its Products and deciding how much to produce. It can help the íirm
to anticipate what its competitor will do and how best to respond if the competitor does
something unexpected. It is useful for understanding behaviour in oligopolistic competition, that
is, a market dominated by a few players.
Stopíord (2009, p 554) illustrates this using the example o f ílxed pricing in a liner trade where
coníerence members and independent lines operate.Three 4,000teu ships operate in a liner
trade, two in a coníerence and the third in a non-conference line. Container volumes in a
particular week are depressed, with only 7,500teu available, that is, 2,500 teu each ship. The
average cost o f carrying 2,500teu is $1,200 perteu. In the circumstances, the coníerence ships
agree a price o f $1,100 per Container and accept a loss o f $100 per Container However, the
outsider decides to undercut this price by $200, that is, $ 1,000 per teu and wins enough cargo
to fill his ship, that is, 4,000teu, so his average cost per teu falls to $900 and makes a proíìt of
$100 per teu.The tw o coníerence ships are now left with l,750teu each, the average cost
o f vvhich is $ 1,543. As the market rate is now $ 1,000 per teu, they stand to lose $543 per
Container. In other words,they are paying a penalty for fixing prices without securing agreement
from all the liner operators in the trade.
This illustrates why it is diííìcult to fix prices in a trade route when the coníerence does not
include all liner companies. In relation to game theory, the coníerence members must decide
what price to set and how they will respond to the non-conference line. In response to
undercutting by an independent carrien coníerences have been known to put a Tighting ship’
on the trade to sail in competition with the non-conference ship and charge the same or lower
íreight rate, with the aim to undercut the independent and to drive them out o f the trade.
The u s Shipping Act 1984 deíines the Tighting ship’ as ‘..ơ vessel used in a particular trade by an
ocean common carríer or group o f such carners for the purpose o f excluding, preventing or reducing
competition by driving another ocean common carrier out o f that trade.' Section 10 of the Act
prohibits carriers, on penalty o f a iarge fine, from using a ‘íìghting ship',
7.12 IN D E X -L IN K E D C O N T A IN E R C O N T R A C T S
The development o f Service contracts beneíìts both carriers and shippers, as the latter have as
much interest in price stability as the carriers. It requires the ca rrie rto maintain a level o f Service,
such as schedule dates and guaranteed space (with penalties for non-performance), while the
shipper is obliged to ship the agreed volume o í cargo.The alternative is íorthe shippers to rely
on informal arrangements for shipping containers, with reíerence to liner company tariíĩs and
surcharges. Pigure 7.5 shows how volatile Container rates can be. Non-contract 'spot' rates are
Economics of Sea Transport and International Trade 16 1

C h a p te r 7
more sensitive to shipping demand and supply and, at any one time, the spot rates can be above
o r belovv the agreed annual contract rate.
This can lead to tensions between the shipper and carrier in reiation to a contract.VVhen spot
rates are above the contract rate, demand for shipping space is high and ships are full. Carriers
are tempted to give preíerence to higher price spot cargoes over contract cargoes. On the
other hand, when spot rates are low, shippers will only ship the minimum contractual volume
and may pressure carriers to reduce rates during the contract period.
A solution to this is the index-linked Container contract. Index-linked contracts (ILC) allow
contract prices to adjust to an external index, which reílects spot prices.This serves to reduce
the diíTerential between spot and contract prices and hence the temptation for either party to
deíault on the contract. ILCs have been made possible by the availability o f Container íreight
indices, such as Container Preight Rate Insight (CFRI), W orld Container Index (WCI), China
(Export) Containerised Preight Index (CCFI) and Shanghai (Export) Containerised Preight
Index (SCFI). It is important that the ILC uses the index for the relevant trade in order to adjust
the contract price.
There are tw o types o f adjustment mechanism - time lag and real time. Time lag adjusts
the future contract rate based on a past change in the index, for example, Quarter I index
determines Quarter 2 contract rate. Realtime adjusts the contract rate simultaneously, usually
as a íìxed differential. Both models allow variants to reduce volatility. Dampeners reduce the
contract rate relative to the index, for example, 50%. Ploors and ceilings define the minimum,
and maximum contract rates are allovved to fali or rise.Triggers delay any adjustment to the
contract rate until such time as a predetermined threshold is reached (Drevvry, Index-Linked
Container Contracts, 2 0 12).
7 .13 L IN E R CONPERENCES A N D C O -O P E R A T IV E
AG R E EM EN TS
Liner coníerences developed in the I870s in an attempt to deal with the phóng problem,
where marginal price competition íorced íreight rates to levels that would not cover average
costs. The liner companies were able to form a coníerence in order to fìx íreight rates and
limit sailings but vvith the requirement to maintain a sailing schedule vvhether full or not.
Coníerence agreements involving íreight rates, sailings, ports, cargoes and sharing o f freight
revenues continued largely unchanged for the next century. However, market changes in the
1980s, especially containerisation and competition from independent lines weakened the ability
o f coníerences to eníorce price íixing and other restrictive practices. In the I970s there were
about 360 coníerences; bv 2002, this had reduced to 150 and, in 2009, to about 100.
In addition, the regulatory authorities progressivelv limited the market povver o f coníerences.
The u s Ocean Shipping Reíorm Act 1999 allovved coníerences antitrust exemption but
permitted shippers to negotiate confidentiai Service agreements with individual liner companies.
An OECD Liner Shipping Competition Policy Report in 2001 identiíìed three principles to
establish an equitable relationship between shippers and carriers:
• The íreedom to negotiate rates, surcharges and other terms o f carriage betvveen shippers
and carriers on an individual and coníìdential basis.
• The íreedom to protect key terms o f negotiated Service contract, including íreight rates.
• The íreedom to co-ordinate operations betvveen carriers, as long as it does not include
price fixing.
The most recent development was the repeal by the European Union o f antitrust exemption
from liner coníerences trading to and from the EU. The EU concluded that price íìxing by
coníerences was no longer necessary and that the shipping industry and shippers would
benefit from free competition. From 2008, liner shipping operating to and from the EU was no

T h e lín e r tra d e s
longer able to fix prices and capacity. As a consequence, the long-established Far East Preight
Coníerence betvveen Europe and Asia closed after 130 years in operation.These market and
regulatory changes progressively led to liner company strategies in the form o f consortia,
alliances and mergers. Alliance agreements today coverthe following:
• Service schedules:type and size o f ships, port itineraries and sailing schedules;
• support services: chartering o f ships, joint terminals, Container management, íeeder and
inland services;
• capacity management: restrictions on members' use o f third-party carriers and measures
for capacity regarding shortages and surpluses.
Alliances thereíore cannot cover sales, marketing or pricing, vvhich are left to the individual liner
companies.The evoiution o f alliances is constantly changing. Pigure 7.8 shows the alliances in the
Asia to Europe trade lane between 1972 and 2 0 14.
Carrier Alliances on the Far East-North Europe trade: 1972 to 2014

(based on date o( implementation)
Year O f M ^ ^ o o o í N ^ ự ? o ọ o r M ^ ^ 3 q p o < ; N i ^ k o q p o r s 4 ^
Ơ> Ơ> Ơ> Ơ^ Ơ>ƠSOSOSƠSƠSỠÍ Ơ^ ỠỊ Ỡ> ỠỈ OÕOOÕỌOO
TRIO '"~BÌwlJgĨBl^'uõ»Ì'^~NYICÕ C L ''''''''"

ScanDutCh EAC^MIl0V(lBroỉt^m,WilhW■lelmien«CGM(1973)4MISC(1979)
ACE fBS (uiHil 1967), K Une. NOL. ooa ♦ KSC (1977-1988) » Choyang (1980-1988)
Tricon D S R -Ìiiĩlí, Choyang ♦ Haniin (1995)
TRIO 2 HapK-LloYd. MOL. NYK
Maersk/P&OCL ___________________________ Ịjlwifcp&oci._____________
TSA C 6 M (unbl 1994), MISC, NedHoyd
G ra n d A llia n c e (l) ________________________________________________ »<apagLioYd, NOL. NYK. P&OCL
G lo b a l A l l i a n c é ______________ _________________________ I APl, MI5C, MOL, Nedlloyd, OOCL
CKY _______ __________________________ KUnẽ;jbng Ming t cosco (1997)
G ra n d A llia n c e (ll) _____________________________ Hapag-LioYd. MISC (unuỊ 2009), NVKróocCMiiẩiuntii 2004)
New VVorld Aliiance __________________________________ ÉPLÌiilii|,liĩi^~~~~'
United Alliance _________________________ DSR-Senator, đa— g. Hanịin. UASC_______
CKYH __________________________________cosco, KUne, Yai>t MlnK. Hat»»
G6 ________________________ APU Hapag-Uoyd, HMM, MOL, NYK, OOCL M B
CKYHE coscó, Kline, YangMlng,Hanjín, EvergrcetTB
P3 ___________________________________________ CMA CGM. Maersk, M scl
Independent carriers ; CSCL, UASC, Zim
Pigure 7.8 Carrier alliances on the Far East-North Europe trade, 1972-2014 (source; Alphaliner, 2 0 14)
Since 2014, the proposed 'P3' alliance between Maersk, CMA/CGM and MSC has not taken
place due to objections from the Chinese government. In its place is ‘M2', an alliance betvveen
Maersk and MSC, a 10-year vessel-sharing agreement with 185 vessels. In addition, the ‘Ocean
Three’ alliance between CMA/CGM, CSCL and UASC was announced in late 2014, involving
vessel sharing and slot exchange/chartering agreements in the east-west trades.
This chapter started by defining the characteristics o f a liner Service and identiíying the ships
and cargoes in these trades. Container liner routes and the variabies in the deployment o f ships
on a scheduied Service were discussed, including the trade-ofĩs betvveen ship numbers and
speed, and ship size and Service interval.The concentration of the Container ship sector was
noted, with liner operators relying on the independent Container time charter market for 50%
o f tonnage.The basis o f Container Service costs and pricing options was examined.The reader is

C h a p te r 7
encouraged to read Stopíord, Maritime Economics, chapter 13, for a detailed explanation o í the
economics o f liner shipping. Pinally, the decline o f liner coníerences and the rise in alliances as an
alternative form o f co-operation was highlighted.
A P P E N D IX I
The principles o f price discrim ination

In many sectors o f the economy, companies use price discrimination to increase the total
revenues they generate from the sale o f their goods or services. It is important to realise that
discrimination does not necessarily require that a monopoly exists.
A good example to illustrate this point is the fìlm and video industry. VVhen a new filnn is
released in a country, it is first shown in the cinema. Hopefully, all the development costs o f the
film will be recovered during this phase, but it is not alvvays the case. VVhen the fìlm’s popularity
declines, the rights to show it are sold.VVhen these markets are exhausted, the fìlm is released
on video, on a rental basis. Even here, video companies charge a premium rate for products that
are recently released in the format.
The company is using price discrimination over time to maximise the revenue potential o f its
product. Each fìlm can be said to be unique, but it íaces strong competition from the hundreds
o f other fìlms available, newly released or on video. By limiting its release to each segment over
different time periods and charging different prices, the company maximises its revenues and,
hence, proíits.
The ability to carry out this kind o f discrimination depends on these íactors.
1. There must be different market segments with differing own price elasticities of demand.
2. The company must be able to prevent resale.That is, to prevent one Client from reselling
the product or Service to another Client.
Diííerent elasticities have to exist to make price discrimination worthwhile. If each sector had the
same elasticity, they would respond in the same way to a price change and, from the economic
point o f view, can then be treated as the same sector.
If the company cannot prevent customers trading with each othen it is clearthat if customer A is
charged £30 and B £ 10, A could persuade B to buy two units at £10 and then resell one on, say,
at £12. A saves £18 and B gains £2.The loser is the company.
Pure price discrim ination
Suppose that the product supplied by a company could be sold, unit by unit, at a market, An
auction would be a good example.The supplier would ofĩer the íirst unit at the auction and
receive the highest bid for it, then the second, the third, and so on.The first item vvould sell at
the highest price, as it vvould be unique.The second vvould fetch slightly less.This situation is
shovvn in Pigure A I . I below.

Quantity
Pigure A M Pure price discnmination.
lf one calculates the total revenue generated by selling every possible unit in this way, it will
equal the area OAB. Purthermore, the extra revenue generated from the sale o f one more unit
must be equal to the price that the unit sells at, since it is being sold by auction. It follows that
underthese special circumstances, price or average revenue, is identical to marginal revenue.
Price discrim ination and p ro fit m axim isation

The traditional rule for maximising proíits is to set marginal revenue equal to marginal cost. In
the traditional model, this leads to a single price charged for all units sold, as shovvn in Pigure
A 1 .2 below. In contrast, Pigure A 1.3 shovvs the effect o f applying pure price discrimination to the
market. It is clear that output, total revenues and, by implication, proíits are higher than in the
usual case.
Pigure AI.2 Long-run proĩit maximisation with partial pnce discrimination.

C h a p te r 7
Pigure AI.3 Long-run proíit maximisation with perTect price discrimination.
Pigure A I . 2 shovvs the long-run proíìt maximising equilibrium for a seller with some ability to
diíiíerentiate th e ir Service from rivals. Output w ill be set at c units and a Standard price o f A is
set.The shaded area represents total proíìts.
In comparison, the profìt maximising firm would do better if they could sell each unit at a
speciíic price, because then the average and marginal revenue curves are the same and proíìt
maximising output IS F in Pigure AI.3.There is no such thing as an average price here, because
each unit is sold at the maximum it could íetch on the market.Total revenue is then area ODEF,
much larger than OABC, assuming identical demand conditions. It is clear that proíìts are larger
in the second case, as total costs vvould be given by the height o f the average cost curve
multiplied by the number o f units sold.
Cross-subsidisation and price discrim ination
In the particular conditions o f the liner trades, it was noted that average incremental cost or
short-run marginal cost was very low,much lovverthan long-run average cost. Pigure A I ,4 shows
the short-run proíìt maximising equilibrium achieved under these conditions. Note that certain
units are being sold at less than their long-run average and marginal cost o f production, even if
they still cover their short-run attributable or direct costs.This is called cross-subsidisation, as it
implies that certain services (units Q I Q2) are being sold to the inarket at iess than the long-
run opportunity cost o f production.This is regarded as ineíTicient, since it implies a misallocation
of resources; those resources would generate better returns if they were applied elsewhere in
the ecoriomy.

T h e iín e r tra d e s
Pigure A I .4 Short-run profit maximisation and cross-subsidisation

Chapter 8
Ports, sea canals and waterways
The longest canal in the vvorid is the Grand Canal o f China,

completed in 609AD at 1,115 miles long.
C h a p te r 8
Unlike other modes o f transport, ocean and Coastal shipping have no need for an inírastructure
o f tracks, bridges and roads. But ships do need elaborate, and usually extremely expensive,
terminai íacilities in the shape o f harbours and ports.This is probably one of the most diffìcult
tasks o f maritime economics: the allocation o f fesources in an optimum way to create an
economically eíĩìcient port.The problem is highlighted in two ways: íìrst, where a massive and
very expensive port investment has been undertaken to construct a port that few vessels
visit. Second, vvhere a port lacks necessary investment, long and costly delays are imposed on
vessels avvaiting a berth. Some o f the basic elements o f the problem will be examined in this
chapter Ideally, ports and the íacilities they provide should be designed as part o f an integrated
transport system. Account should be taken o f the ships that vvill use them, the port facilities at
the other end o f the major routes, the role o f ship canals and waterways vvhere applicable as
well as the interaction with land transport.
Port-ownership structures are now quite complex, ranging from public ovvnership and operation
through to private ownership and operation.There is now a wide variation in the arrangements
betvveen port owners and ship operators, ranging from complete integration where the same
company owns the landside and vvaterside assets to complete separation vvhere the ovvnership
o f the ship and the ovvnership o f the port assets are independent o f each othen
8.1 D E P IN IT IO N OF PORTS A N D H A R B O U R S
The following deíìnitions apply:
A harbour is a haven for the protection o f ships; a place where vessels can shelter from
inclement weather and, if required, undergo repairs or revictualling and undertake their normal
business. Harbours are o f tw o distinct types, either natural or artiíìcial. Natural harbours are
those sufficiently protected by their situation not to require any artiíìcial add-ons. They are
phỵsically protected or enclosed by the coastline. Prime examples o f this type are Sydney
harbour.the bay at Rio de Janeiro and Milíord Haven.
Artificial harbours are those vvhich require the natural coníìguration o f the coast to be
supplemented to a greater or lesser extent by breakvvaters and the like. A harbour is íormed by
the natural structure but requires man-made breakvvaters, piers or jetties to compiete the task.
Prime examples o f this are Dover harbour in the United Kingdom, which is almost purely
artiíìcial, possessing a length o f breakwater o f over 3km, andTema in Ghana.
The majority o f harbours are a combination o f the tw o types. The latten artiíìcial harbout; is
the most important from an economic cost point o f view as it will generaliy be the most
expensive, using a large amount o f íactors o f production particularly Capital in its construction
and maintenance.
A port is sometimes reíerred to as a commercial harbour since ports are primarily designed
and organised for commercial use.They are often called gatevvays betvveen iand and sea or
vvater, as ports can refer to seaports, river ports o r ports on canals or waterways.
The centrai function o f a port is to be a point o f transíer o f commodities and peopie from land
to water and vice versa. It is a place vvhere land and vvater transport modes come into contact
and the services are provided ío rth e purpose of the interchange o f cargoes and passengers as
an essential íeature o f the whole national and international transport netvvork.
8.2 T H E P U N C T IO N OF PORTS
There are four general categories o f a ports íunctions.These íunctions are:
a) traditional íunctions;

P o rts , sea canals a nd w a te rw a y s
b) transport or transit íunctions;

c) industrial íunction;
d) netvvork íunctions:
e) supply chain íunction.
It is necessary in any analysis to make clearthe close interrelationship between these íunctions.
a) Traditional íunctions of ports These can be looked at from a broad perspective. Pirst, the
seaport períorms an important link in the total Chain o f transport. Second, seaports usually
provide areas or íacilities íorthe storage o f goods until transported to their destination.The
storage íunction can range from a simple parking area for road haulage vehicles to massive
tanks hoiding miliions o f barrels o f crude oil.Third, seaports are oíten alternative locations
for industry, particuiarly heavy industry and those associated with shipping.
b) Transport íunctions of ports N ot only do ports provide the essential link in the transport
network, a íurther distinction has to be made in the area o f transhipment o f goods.
Transhipments can be from seagoing vessel to barges using canals and watenA/ays, railway
trucks, road haulage, aircraít or any other modes o f transport. Increasingly, it is between
seagoing vessel and another seagoing vessel. The transport íunction is characterised
essentially by the transport mode used, which in turn is a function o f the type o f goods
carried and the length of journey to be made as well as the geographic and other
conditions.The storage íunction of a seaport is directly related to its transport íunction.
Seagoing vessels are several times larger than units o f inland transport, so for transport
overland the total cargo carried in one trip by a seagoing vessel has to be split up into
smaller consignments. These are consignments vvhich are going to be conveyed aiong a
route determined by íactors other than those that iníluence the need to dispose o f a
ships total cargo as quickly as possible.The provision o f storage space provides an obvious
ansvver for perishable and non-perishable goods which do not depend on onvvard shipping
by sea transport.
c) The industrial íunction of a p ort This is the logicai offspring o f the two previous íunctions.
The consideration that transhipment always involves handling costs as well as onward
shipping in smaller; generally more expensive, transport has induced many industries,
notably those o f Processing raw materials to locate in seaports. For a port to fulfill these
various íunctions, íacilities are needed for ships, vvaterâys, harbour bases, berths for inland
transport, canals, roads, railways and storage and industrial land and buildings as well as the
services they require. All these facilities call for a large investment with a very long liíespan
vvhich will impact upon the physical and economic environment o f the region.
d) N e tw o rk íunctions: hub-and-spoke ports o r the load centre concept The increased use
of containerisation methods in shipping has led to a change in the way that ports are
vievved. Because o f the need to exploit scale economies, vvhich require large cargo volumes,
ports serving the liner trades have become increasingly specialised into one o f tw o types;
hub ports and feeder ports.
A hub port, or load centre, as it is sometimes called, acts as an important íocus o f Container
trading activities. It is served by many ships calling to load and discharge cargo on many
different routes. It has become a centre o f cargo distribution which is olten o f great regional
geographic importance, rather than merely a national or local one. Singapore and Hong
Kong both serve this íunction in the Far East. Rotterdam does the same in Europe.
A íeeder port, as its name implies, is o f lesser signiíìcance, as cargo volumes are smaller
Economies of scale are not so easily exploited, so the routes it serves will be less busy, with
smaller vessels engaged on them. A hub port will be at the centre o f a local network of
these smaller ports, a system which has been called hub-and-spoke operations, because of
the fact that cargo is íìrst moved to a hub port, and then radiated out along the spokes.

C h a p te r 8
This arrangement is also to be observed in the vvorld o f air transport, where it is used for
the same reason: to exploit scale economies by using large aircrati; to serve the hubs and
smaller ones on the íeeder routes.
The development o f the hub port concept means that ports in the íuture may not
necessarily need to have large industriai hinteriands close to thern. An exarnple is the
important Container port o f Algeciras, which has little or no industrial development close
by, but it is ideally located to act as a transhipment terminal, vvhere containers can be
shiíted from one vessel to another in order to minimise the liner companies' overall costs
o f providing shipping services. According to this vievvpoint, port development will be
closely tied in with its location, since this will determine its strategic importance to the liner
companies' route netvvorks.
e) Supply chain íunction The port is viewed as a crucial element in the operation o f a
modern logistical supply Chain.The previous four íunctions have all tended to view the port
as a discrete element, to be evaluated independently o f its relationship with the rest o f the
economy, although industrial íunction and netvvork íunctions do imply some external links.
In modern cargo transport, great weight has been placed on the concept o f the logistics
supply Chain. W ith increased trade liberalisation and globalisation.the supply Chain can now
extend from Chinese íactories to New York retail shops, from Australian coal and iron ore
mines to Chinese Steel mills, and from Japanese car plants to European garages.
Seeing the íunctions o f a modern port in the context o f supply Chain analysis may help to
explain competition between ports, vvhich can be seen as competition between different
supply chains, of vvhich ports are a part.
8.3 PO RT COSTS A N D SHIPS’ T IM E
8 .3 .1 P o rt in fra s tr u c tu r e and in v e s tm e n t
One o f the basic elements o f which all students o f transport or shipping economics must be
aware is the íunctional difference between mobile plant and fixed plant from an economic point
o f view because it has a major impact on the industry.The economic characteristics o f mobile
plant or equipment, for example, m otor vehicles, planes or ships, are that they are cheap relative
to the investment expenditure involved in setting up a large inírastructure item, such as a port
or an airport. Aircraít or ships aiso have a short economic life relative to ports and airports.
Eurotunnel, for instance, has an assumed economic life o f 50 years.
Economists have pointed out that fixed plant or inírastructure has four important characteristics:
• the extremely high cost o f investment;
• once constructed it is exceptionally long-lasting; ancient ports and roads are still in
commercial use;
• little or no alternative uses, as they are unwanted in any other íunction than the original use;
• often possess considerabie potential for economies of scale.
To summarise, transport inírastructure, like ports, canals and watenA/ays, is typically expensive,
single purpose and offers economies o f scale if it can be designed and built from the start for a
high volume o f traffìc or cargo.
C rite ria fo r investm ent appraisal
A number o f methods have been developed to enable the systematic evaluation o f investment
in large Capital items, such as port íacilities.They can be split into tw o broad categories: those
that do not involve discounted cash flow techniques and those that do. A brief outline o f these
techniques is given here:

P o rts , sea canals and w a te rw a y s
a) N on-discounting m ethods
The simplest form o f this is the payback method. Essentially, an investment project is evaluated
by estimating the cash outflows associated with the proịect over the initial period o f its
construction, the expected cash outflows generated by operating the facility once it is in use,
and the cash inflows arising from the charges levied on users o f the íacility.This is to be done for
every year of the assets economic life, which may be a considerable period, lasting many years,
in the case of port investments. Pinally, estimates are made o f any inflow arising from the sale of
the asset at the end o f its life or additional costs involved with its disposal.
This method builds up a cash flow proíìle o f revenues and costs associated with the asset. In
fact, all systematic appraisal techniques use this as the basis.
The payback method simply fìnds the ansvverto the following questions:
1. How much has been expended on setting up the asset. In other words, what is the value of
the investment?
2. How many years will it take before the surplus from revenues less the operating costs of
the asset accumulates to a sum equal to the value o f the investment?
The answer to question two is the payback period. Companies repeat this exercise for all
proịects they are evaluating, and then rank them by the payback period. They then select a
criteria. For instance, Shell UK may require all investments to have a payback o f three years.
If the proposed project meets this criterion, it will be approved for íunding. If the íunds are
available.the project can be undertaken.
The United Nations UNCTAD Secretariat, in its handbook entitled Porĩ Development, examines
a number o f evaluations o f the nature and magnitude o f port investment. In particulan it looks at
the payback period method which is illustrated in the figure below.
The payback method must be taken literally: it means that there is a considerable time gap,
a period o f years, required to recover or pay back the initial investment. Section One is the
installation period: the time it takes to construct the íacility. During this period, there are only
costs and no revenue or income. Income begins in section two when the íacilities are beginning
to operate and thereíore gaining revenue from tariffs. Section three shovvs a period where
income is in excess o f operating costs.The payback period in this example is clearly a long time,
as the accumulation o f Capital from section one and the losses incurred in the start-up period
in section two, will have to be recouped from the surpluses o f revenue over operating costs
expected in section three.

C h a p te r 8
Pigure 8 .1 Accumulated costs, revenues and payback.
The payback period has many advantages. It is simple to understand and is easy to apply, once
the cash flow projections have been made. Unfortunately, it is logicaliy vvrong and deeply flawed
as a technique.
One reason for its logical íailure is simple to see. In the introductory section, it was suggested
that certain projects might require expense at the end o f their lives. For example, Shell ran into
great diíTiculty over the disposal o f an old oil rig, which it planned to sink at sea.This vvould cost
it very little. But public pressure forced them to abandon the idea after Greenpeace occupied it.
They had to spend millions o f pounds on the safe disposal o f the rig.This additional expenditure
appears at the end o f the assets life, and is not included in a payback calculation.
A second and more íundamental flaw is somewhat more diíTicult to convey. The fact is that
cash earned by a company in one year is not pertiaps worth the same as cash generated in the
following year, vvhich itself is not worth the same as cash in two years’ time, and so on. In fact, the
íurther fonA/ard one goes, the less is the current or present value o f that cash.The implication
o f this is simple.VVithout adjustment, one cannot simply add up this years and next years cash,
because they do not have the same value.
b) Discounted cash flow methods

Discounted cash flow analysis has been developed to deal with this problem. There are two
phncipal investment appraisal techniques which use discounted cash flow analysis. They are
knovvn as net pf'esent value and internai rate o f return.
N e t PresentValue (NPV)
The computation o f the net present value o f a project vvould start in the same fashion as the
payback procedure.The íìrst step would be to set out the cash flow profile that the project
is expected to generate.The second step is to multiply net cash inflows or outflows by the
appropriate discount íactor íorthe year o f the project.The third step is to add up the discounted
cash flows, taking due account o f the sign o f the cash flow itselí; positive for inflow, negative
for outflow. Pinally, the net present value ruie is applied.This states that it is worthwhile for a
company to invest in any Capital project at the assumed discount rate, if the net present value
is positive.

In other words, if the result o f adding up the discounted negative and positive cash flows, over
the entire life o f the project, yields a number greater than zero.
This appraach is clearly much more complicated than payback, but it has the merit that it
incorporates all the cash flow iníormation into the final result and correctly adjusts for differences
in the value o f money overtime.
Internal Rate o f Return (IRR)

This technique is very similar to that o f the NPV. Indeed, it can be shown to rely on the same
basic equation linking the value o f the investment to the cash flows it generates. However, it asks
a slightly different question, which is:
W hat rate o f interest, oryield.generates a net present value ofzero íorthe cash flow projections
o f a given project?
In other words, what rate o f interest makes the present value o f the Capital investment going
into the proịect exactly match the present vaiue o f the excess o f revenues over operating costs
which are generated by the project? Since these are negative and positive respectively.their sum
will equal zero when this condition is met.
The rate o f interest vvhich achieves this is called the internal rate o f return, o r IRR.
The IRR rule, stated simply, is: invest in any project in which the IRR exceeds the opportunity
cost o f Capital to the firm.The latter may be measured by the borrovving rate, if the fìrm finances
the proịect by 100% loans or the fìrm’s own required rate o f return.
NPV and IRR are general investment techniques and can be applied equally well to ships as to
p o rt investment. Indeed, NPV and IRR are Standard procedures in marine banks, w hen evaluating
any proposal for a loan for ship finance.
A more detailed explanation o f these techniques is beyond the scope o f this text.
8.3.2 Ships and p o r t tim e

Turning to the consumer; or customer o f ports, it must be emphasised that the size of the ship
in terms o f deadvveight tonnes vvill be very closely related to the time it spends in a particular
port.The following rules hold in virtually all cases.The less time the ship stays or lies in a port
the larger will be the size o f the vessel employed.
Staying in port means that the ship is not earning income; it has an opportunity cost in terms of
income foregone. Large ships íorego more lost income than small ships, hence decreasing port
time means that larger ships can be employed, as the higher íoregone income per day is offset
by the fewer days spent in port.
lf port time or port turnround in certain trades is slow, then the smaller the size o f the ship will
be. If the cargo in a certain trade is difficult and time-consuming to handle in port (for example,
loose dressed timber) the optimum size o f the ship will be less than for carrying other easily
handled cargoes. If, on the other hand.the cargo is easily loaded or unloaded (for example, oil or
ore),the vessel’s size will be considerably greater
Obviously, steaming distance will be o f importance. Shortsea or Coastal vessels will be in port
very oíten, thereíore port time must be seen in its vvider sense.Thus the preíerred vessel size
tends to be inversely related to the proportion of time that it has to spend in port.

C h a p te r 8
Pigure 8.2 The correlation between port time and ship size.
Ali other things being equal, one sees that, as port time increases, ship size dimension in
economic terms decreases. As port time reduces, ships' size increases.Thereíore larger vessels
become more economic as illustrated in table 8 .1.
Passenger Cargo Deepsea C o n ta in e r Tankers

Percentage 63 140 !57 72 81
ị
time at sea i
Percentage 37 Ì 60 i 43 i28 19
time in port 1
Table 8 .1 Average % o f ship time at sea and in p ort (early 1980s) (source: Drewry, Shipping Statistics and
Economics)
This table illustrates the fact that vessel size will relate very closely to port time.Tankers and
bulk carriers (not included in the table) have become larger in size for a number o f reasons.
One factor vvhich encourages the grovvth in size has been that load and discharge times have
decreased, thus reducing the proportion o f time spent in port. On the other hand, general cargo
ships spend 60% o f their time in port. One o f the principal gains arising from containerisation
has been a dramatic reduction in the proportion o f time spent in p o rt by Container vessels
compared to general cargo ships.This has permitted thern to become significantly larget:
Anecdotal evidence suggests that the proportion o f time that a modern Container ship spends
at sea has increased to 80%, a reílection o f their increased size and the greater opportunity cost
o f their p o rt tim e. Indeed, the v e ry largest Container ships, operated on the long-haul routes,
could have sea-time levels higherthan this.

8.3.3 P o rt e ffic ie n c y o r in e ffic ie n c y w ith re g a rd t o ship

tu rn r o u n d tìm e
Port time is time required for any ship to carry out the essential íunctions in port and can be
divided íorthe purposes o f analysis into three parts:
1. Time spent at anchonThis is perhaps the greatest vahable due largely to congestion. It is
the first point about which managers must be particulariy concerned as it can be the time-
consuming proportion which is subject to the greatest variable and hence the greatest
opportunity for reduction in port time. A vital consideration in shippers’, íreighters' and
ships’ costs is the aim to remove congestion.
2. Time spent in internal manoeuvres. Some of the time spent in motion in the channel
waiting for tugs and pilots, shipping towards berths and time lost before and after cargo
handling can be subject to improvement only vvithin strict limits. For example, moving a ship
too quickly within a port might cause damage or accident.
3. Cargo-handling time.The truly productive time at a berth is from the commencement of
cargo handling until its completion.This encompasses a large number o f subsystems, each of
vvhich will have different handling times vvhich may, o f course, inciude periods o f storage.
8.4 PORT COST S T R U C TU R E

The purpose o f a port is as previously defined, to make a smooth transíer o f íreight between
sea and land transport. This is a productive process for port and other management. The
following subsections provide an analysis o f the production and particularly the all-important
cost íunctions.
8.4. i P o rt costs:
The port costs (strictly the shore costs) are made up o f tw o parts:
a) The fixed cost component (FC) that is independent o f the tonnage throughput, which
involves the Capital costs o f quays, sheds, cranes and so forth. As the tonnage handled at
the berth increases, such fixed costs or fixed components, expressed as costs per tonne,
decrease. Curve A shows the average fixed cost declining with traffic volume, as the same
total íìxed cost is divided by larger and larger units.
Pigure 8.3 Average p ort costs and traffìc volume.

C h a p te r 8
b) The variable component or variable cost vvhich depends on throughput, includes laboun
staff costs, fuel, Container costs and suchlike. This variable cost, when expressed as an
average cost per tonne, will remain íairly stable untii the port berth comes under pressure
to achieve highertonnage throughputThe average variable cost pertonne will tend to rise
at this point, ovving to the need to use more costly methods o f handling cargo (curve B).
The model illustrates the relationship betvveen port costs per tonne and throughput or
traffic volume.The average total cost curve (C) is the sum o f the average fixed (A) and
vahable cost (B) components, reaching a minimum at point RTratĩìc volume at this point is
Q.This is the most efficient level o f traffic volume, because average total costs vvhich are
incurred by the port are now minimised. In other vvords, the lowest cost pertonne possible
is achieved with a cargo throughput o f Q. It vvould thereíore be in the port managements
interest to try to ensure that cargoes actually handled were close to this target figure.
8.4.2 Ships* costs

The above model vvould be appropriate from a purely commercial or private perspective.The
port authorities would be primarily concerned with their own costs and their own revenues.
But economists sometimes take a broader view, examining the total resource costs involved
in the operation o f a large entity like a port, which is often publicly ovvned and controlled.The
eííìcient working o f a port affects the way that ships can be used, so the value o f their time
can also be included as a port-related cost from this broad perspective. If both shipovvner and
port are from the same country, the analysis is being conducted in terms o f the social costs and
beneíits that effìcient port operation may bring, rather than íocusing on the ports own direct
commercial interests.
A ships time spent in port is made up o ftw o parts. Firstly,the time the ship spends at the berth,
which is berth utilisation, when the ships are actually loading or unloading. Secondly, the time the
ship spends vvaiting for a berth to become vacant. As traíĩìc increases, the time spent waiting to
get alongside or onto a berth increases at high berth occupation.
Traffìc volume
Pigure 8.4 Ships time costs in p ort and traffic volume

In the above model, curve A represents the time on berth, while curve B shows the extent to
which the costs will increase quite rapidly vvith waiting time.This rapid increase occurs when
the port is operating close to full capacity.The VVorld Bank report o f 1996 has highlighted the
growing threat to íurther economic development in the Far East created by a íailure to expand
po rt capacities and related transport inírastructure in line with recent strong economic growth.
The result is that many ports in the region are operating ineffìciently, imposing congestion costs
on ship operators in the region.
The cost of a ships time in p o r t is shovvn as curve c, a summation o f curve A, (ship's time) and
curve B, (berth and vvaiting time). Note that ali o f these curves are measured on an average
cost or pertonne basis.
8.4.3 T o ta l p o r t costs
The average total costs incurred by both ships when in port and the port operations themselves,
are found by adding together actual port costs and the costs o f the ship, that is, Pigure 8.3 and
Pigure 8.4 will equal Pigure 8.5.
Pigure 8.5 Combined average costs o f port operations and ships time.
The average total cost pertonne curve is at minimum point at point B.This means that from the
broader point o f view (ithat is, taking into account both ship’s time and port operating costs)
the lowest level o f average total cost occurs atTraiTic volume Q.
It is important to note that this is not the volume that minimises the average total cost o f the
port itselí. Minimising o f the average total cost o f the port (C Q I) occurs at traííìc volume Q I ,
which is greater than Q. In other words, port managers have a cost incentive to run a port at a
greater traffìc volume level than might be deemed efficient from a broader vievvpoint. Indeed,
the consumer may well be very concerned, as minimising port costs on their own will generally
result in an unsatisíactory level o f Service ío rth e consumer (in this case.the shipowner o r ship
operator) whose costs o f ship time in port increase rapidly beyond BQ.This can lead to conílict
and is commercially and economically unacceptable.
Indeed.this model may well explain why so many large ship operators either lease or build their
own dedicated ternninal íacilities. Large oil companies build private terminals linked directly to
their refineries; íerry companies own or lease íacilities to speed up their own íerry turnaround
times; liner companies lease o r jointly own large Container terminals as part o f an investment
in through transport. In every case, the shipovvner has vertically integrated the ship operation
and port operation sides o f the business in o rd e rto minimise the overall costs o f delivering the
product. By this means, they are in eíĩect including the cost o f ships time as well as the costs of
ports themselves.

C h a p te r 8
An example illustrates the potential conílict that can arise between users and operators. In
1983, the Ports Corporation o f Queensland, Australia, a state-owned Corporation, built the
Dalrymple Bay CoalTerminal as a common user íacility. In 2001,the asset was privatised under a
long lease.The íacility was still owned by the Queensland government, but leased to Babcock &
Brovvn Inírastructure (BBI).The behaviour o f the operator o f the terminal was monitored by the
Queensland Competition Authority, a body created to regulate such companies given that they
had potential monopoly power overtheir customers.The Q C A had to declare that the terminal
was a natural monopoly and that declaration meant that obligations and responsibilities were
imposed on both users and ovvners o f the terminal.
The terminal had originally been designed with an annual capacity o f 15 miliion tonnes. By 2003,
that capacity had been increased to 44 million and to 54 million in 2005. Purther expansion
plans were designed to eliminate the congestion that occurred in 2005, íollovving the boom in
demand from China and elsewhere. In April and May 2005, ship queues and demurrage cost
were estimated at $2m per day. The Australian Competition and Consumer Commission had
given interim authorisation to the terminal operatorto implement a queue management system
to reduce ship congestion. New user rates were to be negotiated and the terminal operator
proposed increasing the loading charge from $2.08/tonne to $2.77/tonne.Terminal users offered
$1.00/tonne.This can be cited as evidence o f the impiicit cost o f congestion, as users were only
willing to oíĩer $ 1,00/tonne because o f the other costs they had suffered.
This particular dispute was resolved by the Q C A arbitratíng and determining that the rate
should be $1,56/tonne.This draft value was met with the terminal operator stating that íurther
expansion plans would not go ahead, as the rate set was too low to make their plans viable.
The queue management system was, in fact, a stopgap designed to improve the use o f existing
íacilities, given that the expansion programme had been halted. Ultimately, a revised rate o f
$1,72/tonne was agreed and the expansion plan was restarted.This case illustrates the potential
for conílict when the terminal operator and terminal users have differing objectives. It also
illustrates issues o f reguiatory effìciency when monopoly assets are operated privately.
8.5 T H E A IM S OR PR IN C IPLES OF PO RT TAR IFFS

Port tariíĩs will be the main instrument by which port authorities cover their costs or earn some
surplus or proíìt. But such tariffs for port services are not merely Instruments to ensure the
accounts are balanced.The port tariíĩs have an important effect in encouraging or discouraging
the use o f port services. Because o f the importance o f ports to national, and particularlỵ
international trade and industry, it can be argued that general port poiicy is motivated by the
desire to promote a country's interest. This concept has not been thoroughly vvorked out
because it is often diffìcult to identiíy speciíically national interests in the way particular port
policies ortariíĩs are created. All ports will ciaim that one o f their main concerns is to promote
the national interest.
In order to understand the extent to vvhich this idea underlies management pricing and
investment in ports, it is necessary to examine the tw o main principles or doctrines on which
port deveỉopment generally tends to be based.These are known as:
i) Anglo-Saxon or Peninsuiar doctrine;
ii) the European doctrine.
The Anglo-Saxon doctrine states, notvvithstanding the benefits to the hinterland, that the port
should stand on its own feet, not incur losses and aim to make a reasonable profìt. This is a
principle on which many ports in the United Kingdom operate.This view has been sharpened
by the privatisation o f Associated British Ports (ABP), which runs many o f the UK's ports and
terminals. Now, in the private sector, ports are driven by the proíit motive and commercial
considerations to a greater extent than they were beíore. ABP has since been purchased

by a private equity Capital venture, headed by Goldman Sachs, but it still operates using the
ABP name.
The European doctrine views the port as part of the social structure o f the vvhole region.The
value o f the port should be assessed not solely on the accounts o f the port but in terms o f the
progress o f the industry.transport and trade o f the port in the port region or hinterland. As the
name suggests, this view lies behind the development o f many European ports and is often the
basis on vvhich subsidies for port development are justifìed.
While implicit in both these principles is the requirement to cover costs and be eíĩìcient, the
extent to vvhich this will be the main aim will depend on the context within which pricing and
investment decisions have to be made.
For management,therefore,the aim will either be:
a) to run an effìcient port whose assets assist regional development; or
b) have a policy fortarifís and investment geared to making money.
8.6 PO R T P R IV A T IS A T IO N : O W N E R S H IP A N D EFFIC IE N C Y
Port management structures, like most other inírastructures, have been radically transformed in
the last 25 years. For example, in the UK with the íloating o f the nationally-ovvned trust ports
and their privatisation. ABP was first set up as a private company, running many o f the UK’s well-
known ports on a commercial basis. As mentioned earlier, it is now part o f a venture Capital
operation led by Goldman Sachs. Port privatisation is a policy that has spread to other countries
w h e r e State o w n e rsh ip w a s previously th e norm .
There are many conflicting arguments about the beneíits and costs of such an approach, In
the UK, privatisation has been accompanied by the abolition o f the National Dock Labour
scheme, making labour relations more ílexible than they were. Ports can seek Capital from
private sources and have to operate in a commercial íashion.The privatisation and deregulation
is sharply reiníorced with these developments. UK ports have shed signiíicant numbers in the
labour force following these developments and, it is ciaimed, have become more eíĩìcient and
more ílexible.
The rising popularity o f privatisation has led many observers to raise the question of the link
between ownership and economic efficiency.There are those who argue that ports should be
run as part o f a nationally integrated plan and the best w ay o f achieving this is through State
ownership.There are others who argue that privately owned and run ports are more efficient,
because they respond more ílexibly to market needs.
The evidence on this question is m ixed. It is best summed up by Proíessor Gosss analysis of
the relative merits o f the ports o f Singapore and Hong Kong.They are both regarded as being
very effìcient; but Singapores is State owned, vvhile Hong Kongs is private. Goss concluded that
ownership was not the key issue; management competence, investment and cultural íactors
were o f far greater significance.
There is now a wide variety o f port operating arrangements. For example, the fully integrated
terminal owned by shipping lines, for example, AP Moller Ports, or Southampton Container
Terminal, used by the Container ship operators in the Grand Alliance, which inciuded p & o
Nedlloyd at the time. It was ịointly ovvned by ABP (51%) and p & o Ports (49%), Dubai Ports
W orld (DPW) has bought out p & o Ports so the joint ovvners are ABP and DPVV. The 5 1%
share gives ABP the controlling interest.

C h a p te r 8
The following table gives some idea o f the possible combinations that now exist.
Table 8 .1 Port authority typologies (source: Alderton, Port Management and Operations. 2005,
2nd edn, p 94)
Reading across the rows gives the different mixes o f responsibility o f the port authority. The
landlord port just provides the quay, the deepvvater approaches, but nothing else; the tenant
provides the rest. In the tool port, the inĩrastructure and superstructure are both provided,
such as cranes and cargo-handling equipment, as well as the infrastructure.Where the authority
provides all services, it is called, n ot surprisingly, a Service p ort.
8.7 PO RT C O M P E T IT IO N
Ports are oílen in an uneasy relationship with one another lf they share the same hinterland.they
may try to compete by ofíering better íacilities for cargo handling, storage and distribution or
through simple price competition. For example, there is considerable rivalry betvveen Antwerp
and Rotterdam. Both o f these ports are subsidised by their respective local and national
governments, as both believe that they have a major impact on their domestic economies. By
contrast, the decline o f London as a major port was not accompanied by any subsidies from the
UK government.
From an economic vievvpoint, it can be argued that competitive subsidies offered by Antvverp
and Rotterdam are ineíĩicient. Both ports serve the larger European market. Both should
thereíore compete on equai terms. The fact that many ports are still in national hands vvill
alvvays create a riskthat poiiticai considerations will lead to interTerence in the way the p o rt sets
its tariffs and runs its affairs.
8.8 PORTS IN T H E LO G ISTICS SUPPLY C H A IN

The analysis o f ports presented so far has implicitiy taken them to be an independent entity.The
issue o f conílicting interest between user and provider has been touched upon, but it still has an
individualistic element in the analysis.The supply Chain approach alters that perspective because
it treats the entire process o f producing, distributing and delivering the consumer product as
part o f a continuous supply Chain. Clearly, if the supply Chain can be shortened in som e way,
the stock levels held by producers will fall, lowering operating costs. If other aspects o f product
quality can be improved as well (such as the reduction o f stock losses and increased accuracy o f
iníormation flows), everyone wins.
Ports are indeed becoming more integrated into supply processes.The electronic transmission
o f ca rg o d o cu m e n ts m ean s tru ck s can e n t e r t h e Container term inai to d eliver o r pick up b o x e s
vvith a minimum o f delay. A ships ioading pians can be transmitted to the port authority to
boxes are stacked in th e correct areas fo r faster cargo loading. These are
e n su re Container
some o f the ways that the Chain can be shortened. Another way is to integrate the services.
NYK Lines has started its own land-based logistics Service. While the Capital requirements for
entering the Container shipping business are large, the Capital requirements for setting up a
trucking operation are not. Greater integration can also occur within the port itself.
Robinson has suggested the following diagram captures the changes taking place in the port
value chains. In his view, ports will compete with other ports as part o f an embedded supply

P o rts , sea canais and w a te rw a y s
Chain; that is, competition is not betvveen ports per se but betvveen competing supply chains. In
his vievv, the role o f the port would b e ‘defined by its íunction as an element in the value-driven
Chain system’.
Blue water segment Land-based íreight handling system
Shipping
>c
> c
^ c
Level of íunctional integration
Pigure 8.6 Port-oriented value-dnven chain systems (souixe: Robinson, 2002, p 249),
8.9 SEA C A N A L S , IN L A N D W A T E R W A Y S A N D
L A N D B R ID G E S
The economic importance and effects o f sea canals and waterways can be summarised
as reducing nautical distance, due charges, economics o f ship size, and hinterland and port
development.
There are a number o f reasons for constructing major vvatenâys; economic, political, strategic
o r miiitary.There are two important categories o f watenA/ays. Pirstl sea canals like Suez, Panama,
Kiel and the Corinth vvhich join two seas or oceans. Second.those providing internai access to
ports, for example, the St Lavvrence Seavvay.

C h a p te r 8
A t its simplest, these vvatenAâys reduce nautical mileage as the following table illustrates:
From the p o rt of Via Suez Via Cape o f Good Via Panama

Rotterdam to Hope
Kuwait 16,500 11,300 -
Auckland 1IZ670 13,480 11.380

Melbourne ; 11,060 11.900 12,950
Yokohama 1 11,150 14,470 ' 12,520
Table 8.2 Different nautical distances.
Such shortening o f distance appears to present shipowners or operators with extremely simple
choices, but these choices are far more complicated than at íìrst sight. This is best seen by
constructing a number o f simple voyage estimates.
Examplel: Panamax voyage betvveen Newcastle, Australia and Rotterdam with a cargo o f coal.
Nautical distance Miles Knots Distance per day

vía
Cape of Good Hope 12,765 14 336
Suez 11,464 14 336
Distance Saved 1,301
Suez route nautical miles saved:

1,301 miles 336 Distance per day = 3.87 Days
Cost per day $

Running 7,500
Bunkers $350 tonne, average 40tpd 14,000
Total 21,500
Reduction in expenses if Suez Canal used ($):
3.87 days X $21,500 daily cost 83,205

Cost of using Suez Canal dues 216,850
Cost o f using Suez rather than Cape o f Good Hope = Cost o f canal dues minus the saving that
the shorter journey makes to expenses when compared to the Cape.
Canal dues minus cost saving = $ 2 16,850 - $83,205 = ($ 133,645).
It foilows from the example that, under normal conditions, the Suez routes would be the more
expensive, adding $133,645 to costs. Such a simple example does not take into consideration a
number o f íactors, the most obvious being the vveather conditions rounding the Cape of Good
Hope and the level o f íreight rates vvhich could make time saving an important criteria.
It should also be pointed out that both the Panama and Suez Canal operating authorities
consider the costs o f alternative routes when setting their toll charges. ỉn this case, a toll o f only
$80,000 would have reversed the conclusion o f the example. Canal authorities will monitor
rates and bunker costs when setting their chargesithey wili not be determined just by costs.

Example 2: Container routeing betvveen Shanghai and NewYork/New Jersey.

Container liner services betvveen Asia and USA offerthree routes:
Asia cross-Pacific to Los Angeles, then mini-landbridge to NevvYork by railroad;
i. Asia cross-Paciíìc to the Panama Canal.then direct to NevvYork;

ii. Asia westbound to the Suez Canal, the Mediterranean and cross-Atlantic to NewYork.
The majority o f Container shipping is through the u s West Coast ports. In addition to the time
differences, the routes provide other advantages and restrictions, for example:
• Although the Los Angeles route is the shortest, the mini-landbridge is estimated to take a
íurther five to seven days.The cost o f land transport, whether road or rail, is likely to be the
major component o f the through transport cost.
• The largest ship able to transit the Panama Canal is currently 5,200teu.When the new locks
are complete in 2016, ships up to I2,500teu will be able to transit.This will have major
implications for the u s Atlantic coast ports.
• The Suez Canal route has been recently gaining market share.This is due in part to large
Container ships entering Service on this route.The Suez route is better able to absorb the
larger ships by also serving the Asia-Mediterranean trade and hubs.
• The distance and time differences will change depending on the origin o f Asian cargo. For
example, if the Asia ports o f departure move tovvards South China, Vietnam and India, this
will produce a shiíl in íavour o f the Suez Canal route.
The intermodal nature o f containers and double-stack raiiroads has resulted in major land-
bridge plans, such as betvveen the Adriatic Sea and the Baltic Sea, and from Jeddah (Red Sea)
to Damman (Arabian Gulf). Canals and landbridges have major implications for Container line
schedules and fleet deployment. Assuming a weekly Service betvveen Shanghai and New York,
an estimate o f the number o f ships and speed required for a round voyage can be determined:
Assumptions:
• an end-to-end Service with one port call at each end;
• round voyage time is the number o f ships times the S e rvice interval (seven days);
• estimate o f port time based on ship utilisation, mix o f Container sizes, number o f cranes and
lifts per houn and port working time;
• canal transits are assumed to add one day to port time for each transit.
It has been argued here that the aim o f any canal or landbridge is to reduce distance, decrease
transit time and lower costs. VVhile the examples above serve to highlight these aims, for
example, by the reduction o f maritime distance, they do not necessarily satisíy the economic
efficiency chteria o f minimising costs.

C h a p tc r 8
The aitn o f this chapter has been to analyse p o rt sea canals and landbridges and their interaction
with the shipping industry. These combine to make up what is reíerred to as the maritime
industry o r maritime transport. The chapter defined ports by their Central íunction, ports as
an essential link in the transport netvvork, and sea canals and vvatenâys as shortening the
transport gap. Much o f the discussion was around their importance in relation to ships’ costs
and the problems this creates. Emphasis was also given to the relationship betvveen the mobile
transport unit (the ship), vvhich is relatively inexpensive, and its inírastructure.This inírastructure,
it was pointed out, is exceedingly expensive, has a very long economic life and was built to
períbrm a single íunction vvhich means it had no alternative use; íactors which are o f vital
importance in any operational or economic analysis.
In the ICS examination, a student may well be required to apply this theoretical analysis to
examples o f different ports throughout the world. It is important,therefore,that as part o f your
understanding o f this chapter you can assess the extent to vvhich it applies to ports and trade
routes with which you are íamiliar as well as the major ports in the world.

Shipping and international trade
In 2014 m o re than 14 m illion co nta in ers w e re moved by sea.

C h a p te r 9
This chapter discusses the relationship between international trading activity and shipping
demand. It then presents the principal explanations o f those trade flows used by economists as
an aid to understanding their development.The arguments for and against free trade are brieíly
discussed, as is the role and signifìcance o f transport costs as a barrier to trade.The chapter
concludes with a brief outline o f the role the VVorldTrade Organization.
9 .1 T H E G R O W T H A N D P A TTE R N OF W O R L D T R A D E
W orld trade has increased dramatically over the past half century. Pigure 9 .1 shows that real
GDP has grovvn nearly thirty-one-fold overthe period 1970-2005, but exports in value grew
even íaster, by fiftyfold. This growth has generated a corresponding growth o f demand for
transportation services, both in shipping and elsevvhere. Some parts o f the world have grovvn
much more rapidly than others over this period. VVestern Europe and the USA dominated in
the I950s and I960s, Japan and the Far East in the I970s and I980s, and the AsianTigers in
the period 1990-1997. Since Chinas preparation for entry into the WTO, stimulation to vvorld
trade has come from its 10% per year economic growth since 1995, as well as from lndia’s
switch from protectionist to liberalised trading policies.Together with the recovery o f Japanese
economic growth, world trade has maintained a good momentum in the past few years, leading
to buoyant market conditions in many shipping markets. Since 2008, the growth o f vvorld trade
has slovved dovvn due to the economic crisis gripping the us and Europe.The continued overall
growth is carried by the emerging economies o f China, India and Brazil.
Pigure 9.1Trends in world exports and GDR volume terms, 2000 = 100 (source: derived by author from
WTO data).
Purther inspection o f Pigure 9 .1 also shows that export grovvth has not been constant over the
period. By comparing the slopes o f the tw o series, it is clear that export volume growth has
exceeded growth in vvorld real GDP since 2003, but has been slower than income growth in
other periods, particularly the late 1970s and early 1980s.

S h íp p in g a nd in te r n a tio n a l tr a d e
$20 trillion
m Imports
Exports
$15 trillion
$10 trillion
$5 trillion
llllll
1970 1975 1980 1985 1990 1995 2000 2005 2010
Pigure 9.2 Growth in vvorld merchandise trade by value, 1970 -2010 (source: derived from WTO Trade
Statistics Database. at www.wto.org).
Pigure 9.2 shows that world merchandise trade or the trade in goods, in dollar terms, tripled
between 1995 and 2008, reaching an estimated $15.23 trillion, increasing from $5.16 triliion.
Trade in commercial services or invisibles also rose from $1.17 trillion to $3.69 trillion. It is
important to note that these are value figures and are affected by changes in the prices o f the
traded goods and services. For example, íluctuations in the price o f crude oil will affect the value
o f trade in oil and especially affect the export earnings o f countries that are dependent on oil
as th e ir primary e xport.T he períod 2002 to 2005 saw Sharp increases in commodity prices,
such as in oil, coal and iron ore, and the increases have raised the value o f trade íasterthan the
volume o f trade.
How is this trade shared betvveen countries? There are a number o f ways o f considering the
data. One is to aggregate export and import data for each country into broad geographical
groups. Table 9 .1 presents data which shovvs seven W T O groups, the total value o f exports
and imports in 2003 and 2013 and the percentage shares of each geographical group. Exports
are valued at transaction value plus the cost o f transport and Insurance to the írontier o f the
exporting countrỵthat is, FOB valuation, Imports are valued at transaction value plus the cost o f
transport and Insurance to the írontier o f the importing country, that is, C1F valuation.The value
of merchandise exports and imports increased approximately 250% during the decade.This
increase reílects both changes in the volume o f trade and also commodity prices.
International trade can also be aggregated into economic groups according to a countrys
level o f development: Developed economies, Developing economies and Least-developed
countries (LDCs). Developed economies include the USA, Canada, the EU (28), EFTA (Iceland,
Liechtenstein, NotM/ay and Switzerland), Australia, Japan and New Zealand. A particular group
of developing economies are the BRIC countries o f Brazil, Russia, India and China. In addition
to the EU, there are other regional integration agreements by which country trade data can
be aggregated, such as the Economic Community o f West Aírican States and the Asia-Pacific
Economic Cooperation.
A new perspective on trade patterns is global value chains (GVCs). A GVC exists where
diíĩerent stages o f production process are located across different countries. Asian economies
have increased their participation in GVCs as measured by domestic intermediate Products
exported to their production partners. For example, Chinese Taipei plays a dominant role in
the export o f manuíactured intermediate goods to China and partners in the Association o f
Southeast Asian Nations. W TO now records exports and imports in intermediate goods for
each country.

C h a p te r 9
VVorld trade shares and values, 2003 and 2013 ($ billion)

Exports Imports
Year 2003 2013 2003 2013
WTO value $7,380 $18,301 $7,696 $ i 8,409
Share (Percentage)
North America 15,8% 13.2% 22.4% 17.4%
(USA, Canada
and Mexico)
South and 3.0% 4.0% 2.5% 4.2%
Central America
Europe, of vvhich: 45.9% 36.3% 45,0% 35.8%
EU (25) in 2003 42.4% 33.2% 41.3% 32.6%
and EU (28) in
2013
Commonvvealth 2,6% 4.3% 1.7% 3.1%
of Independent
States
Aírica 2.4% 3.3% 22% 3.4%
Middle East 4.1% 7.4% 2.8% 4,2%
Asia (incl. 26.1% 31.5% 23.5% 31.8%
Australia and
New Zealand)
Total 100.0% 100.0% 100.0% 100.0%
Table 9.1 Developments in shares of world trade, 2003- 2013 (source:WTO, International Trade Statislics
20/4,Table 1.5, p 24)
In Table 9 .1 it can be observed that, although North America and Europe both experienced a
relative decline in their share o f international trade betvveen 2003 and 2013, the value o f their
trade increased about 200% in this period.This apparent anomaly is explained by the fact that
other economies grew at a íaster rate, Asia in particular.
Table 9.2 provides a list o f the major exporters and importers in 2013.There are a lot o f useíui
points to be made from the iníormation in this table. First, the rise o f China is dramatically
indicated through its rise to íìrst place in export and second place in im port ranking.This is an
understatement o f the position, because if Hong Kongs trade is included, a large part o f it is re-
exported at $ 5 16bn. A large part o f Hong Kong’s re-exports originate from China.
Second, you will note that the countries inTable 9.2 fall into one o f three geographical groups:
Asia, Europe and North America. It is no coincidence therefore that Container shipping is
concentrated on these 'east-west' trades.The lesser Container flow s on the ‘north-south’ trades
to Australasia, South America and Africa appear íurther down the ranks, for example, Australia
(21), Brazil (22), Nigeria (29) and South Africa (30).
The third point to note is the dơminant position o f the United States o f America and China,
together responsible for 20% o f the world’s exports and imports.The USA has lost its number
one position in exports partly because the doliar has íallen in value against other major
currencies in the past few years and this increases the value o f other countries exports in
dollar terms. Some o f the changes that occur on a year-to-year basis are due to exchange rate
volatility, rather than changes in volume.
Pinally, it should be pointed out that the rankings inTable 9.2 are very different if the European
Union o f 28 nations is taken as a singie trading entity.The four European countries in the top
10 vvould thereíore be subsumed into Extra-EU (28) and Canada, Singapore and Mexico woulG
now appear in 8th, 9th and I Oth positions, respectively.The reader is encouraged to explore the
inĩormation available at the W TO vvebsite, which is excellent.

S h íp p in g and in te r n a tio n a l tra d e
Rank Exporters Value Share Rank Im porters Value Share

China 2,209 I 1.7% United States 2,329 12.3%
United States 1,580 8.4% China 1,950 10.3%
Germany 1,453 1J%_ Germany 1,189 6.3%
Japan 715 " 3.8% Japan 833 4.4%
Netherlands 672 3.6% Prance 681 3,6%
Prance 580 3.1% United 655 3,5%
Kingdom
Korea, 560 3.0%^ Hong Kong, 622 3.3%
Republic of China
United 542 2.9% Netherlands 590 3.1%
Kingdom
Hong Kong, 536 2 . 8% Korea, 516 2.7%
China Republic of
10 Russian 523 2 . 8% 10 Italy 477 2.5%
Pederation
W orld 18,816 100.0% VVorld 18,890 100.0%
Table 9.2 Leading merchandise traders, 2013 ($ billion) (source:WTO, International Trade Statistics 2014,
Table 1.7, p 26)
Note; World Trade total includes signiỊicant re-exports or imports for export.
Another important aspect to consider is the trade patterns. The commonly held view of
trade is a rich, developed country with a large industrial base exporting íìnished and semi-
finished goods and services to less developed countries, which provide a market for the íìnished
goods and supply the developed country with raw materials for the production process.
Whilst this may be partially correct, its accuracy is very limited. The view implies that trade
predominantly takes place betvveen developed and developing countries and is reíerred to as
'inter-industry' trade.
Modern trade is much more complex and sophisticated than implied by the above crude model.
Modern multinational car companies regularly generate trade flows that do not fit the above
stereotype. For example, Ford's engine plant in Bridgend, South Wales, regularly exports large
numbers of car engines to other Ford car assembly plants in Belgium, Spain, and Germany.The
engines become part o f new Piestas in Spain or Mondeos in Belgium and Germany.The nevvly
assembled cars are then exported to the UK.
VVhat was exported by the UK (the engines) becomes part o f an imported íìnished product.
This trade in Products that belong to the same industry is called 'intra-industry' trade and is
attributable to the íragmentation o f production by outsourcing and off-shoring as a result of
globalisation in recent decades.
These facts must be borne in mind when discussing economic explanations o f trade flows, as
some o f the early and most vvidely known theories are not designed to explain examples such
as that given above.The point is reiníorced by examination of the iníormation provided inTable
9.3, which shows the pattern o f inter-regional merchandise exports in 2013.
Take North America as a trading region, that is, the USA, Canada and Mexico. In 2 0 13,49.2% of
its trade was with itself, that is, vvithin region. For Europe, the íìgure is 68.6%, for Asia, 53.3%. In
terms of vvorld trade, the regional trade in N orth America, Europe and Asia adds up to 48.2%
o f total world exports in 2013. It is not surprising thereíore that the shortsea and intra-regional
Container íeeder trades are so busy.

C h a p te r 9
In 2012, 65% o f UK exports o f merchandise trade went to the EU (27), Switzerland and the
USA.The íìgure for imports from the same countries was 60%. In contrast, only 2\% o f its
exports went to developing countries and only 29% was imported from such countries in 2005.
In 2013, over half o f merchandise exports from developing economies (52%) went to other
developing economies.
These kinds o f proportions are not new. It appears that leveis o f economic development
determine your trading partners and that the most iikely trading partner is another country
with a similar level o f economic development.
From í )estinatio n
N orth South Europe CIS Aírica Middle Asia VVorld
America and East
Central
America
VVorld 3082 782 6669 566 618 760 5423 18301
North 1189 216 368 19 40 78 501 2418
America
South 178 195 121 9 20 18 178 736
and
Central
America
Europe 506 129 4560 253 222 220 667 6646
CIS 33 9 407 149 13 19 139 779
Aírica 54 30 216 2 97 18 160 602
Middle 110 11 143 6 38 135 703.... ' 1347
East 1
Asia 1012 191 855 i28 188 270 3076 15773
Share of regional trade fiows in each regions total merchandise exports
VVorld 16.8 4.3 36.4 3.1 3.4 4.2 29.6 100.0
North 49.2 8.9 15.2 0.8 1.7 3.2 20.7 100.0
America
South 24.2 26.6 16.4 1.2 2.7 2.5 24,1 100.0
and
ị
Central ii 1
America L.............. ỉ
Europe 7,6 1.9 68,6 3.8 3,3 3.3 10.0 !00.0
CIS 4.2 1.2 52.2 19.1 1,7 2.5 17.8 100.0
Africa 8.9 4.9 35.8 0.3 16.2 1
3.0 26.6 100.0
Middle 8.2 0.8 10.6 0.5 2.8 lO.I 5 2 .2 '" ~ 100.0
East
Asia 17.5 3.3 14.8 2.2 3.3 4,7 53.3 100.0
Share of regional tracie fiows in world rnerchandise ex|ports
World 16.8 4.3 36.4 3.1 3.4 4.2 29.6 100.0
North 6.5 1.2 2.0 o.i ^ ,2 0.4 2.7 13.2
America
South 1.0 l.l 0,7 0.0 0,1 0.1 1.0 4.0
and
Central i
America
Europe 2.8 0.7 24.9 1.4 1.2 1.2 3,6 36.3
CIS 0.2 0.1 2,2 0.8 0.1 0,1 0,8 4.3

S h ip p ìn g and in te r n a tio n a l tra d e
Aírica 0,3 0.2 1,2 0.0 ! as 0.1 0,9 3,3

Middle 0.6 0.1 0,8 0.0 0.2 0.7 3.8 7.4
East
Asia 5.5 1.0 4.7 0.7 1.0 1.5 16.8 31.5
Table 9.3 Intra- and inter-regionai merchandise trade (billion dollars and percentage), 201 3 (source:
WTO, International Trade Statistics 20 13,Table 1.4, p 2 1)
9.2 T R A D E A N D E C O N O M IC G R O W T H
The above section has highlighted the grovvth o f world trade and noted the broad pattern of
trade that has evolved in the past i5 years or so.The link between vvorld GDP and trade was
illustrated in Pigure 9.I.Table 9.4 presents more detailed iníormation o f the difíering pace of
growth over the period.
Exports
Year VVorld G D P (US$) Value (US$) Volume index Volume
1960 1,358,387,167,557.41 130,000,000,000.00
1961 1,410,608,233,685.96 136,000,000,000,00
1962 1,51 3,404,695,377.64 143,000,000,000.00
1963 1,628,388,004,738.53 157,000,000,000.00
1964 1,784,360,982,526.69 176,000,000,000.00
1965 1,942,254,025,641.97 190,000,000,000.00
1966 2.107,207,965,227,99 208,000,000,000.00
1967 2,241,542,227,890.60 218,000,000,000.00
1968 2,416,450,291,754.34 242,000,000,000.00
1969 2,659,1 10,000.252.50 277,000,000,000,00
1970 2,891,362,474,231.58 317,000.000,000.00
1971 3,194,568,442,049.53 354,000,000,000.00
1972 3.689,964,015,142,10 419,000,000,000.00
1973 4,506,166,017,259.41 580,000,000,000,00
1974 5,200,206,052,521,42 840,000,000,000.00
1975 5,801,135,254,578.26 877,000,000,000.00
1976 6,316,371,676,484.16 992,000,000,000,00
1977 7,149,062,801,386.29 1,128,000,000,000,00
1978 8,415,669,042,995.36 1,307,000,000,000,00
1979 9,774,093,034,233.56 1,659,000,000,000.00
1980 10,999,665,872,673,80 2,034,000,000,000.00 100.00 0.00
1981 11,283,752,102,526.80 2,010,000,000,000.00 98.80 -1,20
1982 11,174,973,288,455.30 1,883,000,000,000,00 93,60 -6,40
1983 11,416,604,244,429.60 1,846,000,000,000.00 98.00 -2.00
1984 11,850,927,683,167.60 1,956,000,000,000.00 105.90 5.90
1985 12,445,405,016,965.60 1,954,000,000,000.00 99.70 -0.30
1986 14,720,588,914,103.90 2,138,000,000,000.00 109.40 9.40
1987 16,718,094,850,408.20 2,516,000,000,000,00 117.50 17.50
1988 18,698,481,21 1,395,10 2,869,000,000,000.00 113.70 13.70
1989 19,624,364,867,905.00 3,098,000,000,000.00 107.80 7.80

C h a p te r 9
1990 21,920,792,256,960,00 3,449,000,000,000.00 112.90 12.90

1991 22,995,566,641,243,60 3,515,000.000.000.00 101,50 1.50
1992 24,546,395,695,297,80 3,766,000,000,000.00 106.70 6.70
1993 24,915,078,827,178.50 3,782,000,000,000.00 99.80 -0,20
1994 26,752,109,865,946.30 4,326,000,000,000.00 113,60 13.60
1995 29,692,894,750,906.30 5,164,000,000,000.00 119.30 19.30
1996 30,303,289,996,658.90 5,403,000,000,000,00 104.60 4.60
1997 30,222,356,622,95 1,40 5,591,000,000,000,00 103.40 3.40
1998 30,1 15,107,530,226,90 5,501,000,000,000.00 98.70 -1.30
1999 31,231,321,824,407.90 5,712,000,000,000.00 103.90 3.90
2000 32,240,383,199,090.10 6,456,000,000,000.00 112,90 12.90
2001 32,046,348,810,620.30 6,191,000,000,000,00 95.90 -4,10
2002 33,304,640,616,151.20 6,492,000,000,000.00 104.80 4,80
2003 37,465,967.921,629.80 7,586,000,000,000,00 116.90 16.90
2004 42,228,984,476,590.60 9,218,000,000,000.00 121.60 21.60
2005 45,658,316,886,272.40 10,489,000,000,000.00 113.90 13.90
2006 49.506,293,314,880.40 12,1 13,000,000,000,00 115.60 15.60
2007 55,848,896,227,304.20 14,003,000,000,000.00 115.70 15.70
2008 61,304,541,579,435.60 16,120,000,000,000.00 115.30 15.30
2009 58,088,277,293,607.50 12,5 16,000,000,000.00 77.40 -22.60
2010 63,123,887,517,709.30 15,237,000,000,000.00 121,70 21.70
Table 9.4 Growth rates o f world GDR exports and production, 1960 2005 (source: denved from
AppendixTable A. I , InternationơlTrade Sĩơtistics 2006).
The table is o f interest because it reveals that the highest rates o f trade grovvth (in value ternns)
were experienced in the 25-year period after the end o f the Second VVorld WanTrade growth
slovved down aíter 1973 and then recovered, for reasons you should be aware o f from Chapter
6.The period 1990-1999 saw a higher level o f grovvth in export value than the period in the
1980s, but a slovver grovvth in GDP growth.
Hovvever; recent rates oígrovvth in value terms are much higher than those experienced in the
1980s and 1990s because commodity prices fell in the 1980s but have risen since 2000, It is also
worth noting that there was only one period in which vvorld trade volume grovvlh was lovver
than the rate o f growth o f GDP in the period, namely, 1980-“ 1989. In every other period, trade
has grovvn íaster than vvorld economic activity, implying that economies have become more
integrated, and more open than they were beíore.
The VVorld Bank has researched the link between trading períormance and economic grovvth
over many years and in many countries and has concluded that two key íeatures appear to be
vital ingredients for an eíĩìcient, dynatnic economy.The tw o rnajor íeatures are:
a) the development o f increasingly open economies; and
b) the iiberalisation o f markets.
An ‘open’ economy is deíìned by the degree o f openness, the extent to which the national
economy is exposed to international trade. One way o f measuring this is to express the value
o f a countrys exports as a percentage o f the GDP o f that country. Since exports are a part
o f the total output generated by an economy, the higher this percentage, the more dependent
the economy is on world trade grovvth and the more competitive that economy has to be in
world markets.

S h íp p in g and in te r n a tio n a l tr a d e
Alternatively, the ratio of imports to GDP can also be measured. A third way is to add the
value o f exports and imports and express this as a percentage o f national GDRThese ratios
can be calculated for both merchandise goods and commercial services. Another measure of
a countrys trade with the rest o f the vvorld is the ‘balance o f trade’, the difference between
the values o f exports and imports. In addition,'exports per capita’ is measured by the value o f
exports divided by the population o f a country.
Table 9.5 presents iníormation on the population, GDP and value o f merchandise exports and
imports for a selection o f countries for 2 0 12. Using these íigures, the balance o f trade, export
ratios and exports per capita have been determined.
The first point to note is that tw o o f the largest economies in the vvorld in GDP terms, the USA
and Japan, are low in terms o f openness, at 10% and I 3% respectively, based on merchandise
exports only.The USA economy is so large that exports account for about one dollar in 10 in
the us national income and one dollar in seven for imports.Yetthe USA is ranked numbertvvo
in terms o f it exports and number one in terms o f imports. So it is important to appreciate that
this implies the USA can affect the world trading environment without its own economy being
as afíected, as it is relatively independent o f vvorld trade. Albania has been included to emphasise
this point.This least-developed country has a higher export ratio ( 15%) than either the USA or
Japan. Nevertheless, both the USA and Japan have high exports per capita, about $50,000,
On the other hand, Hong Kong, part o f China, has an export ratio o f more than IOO%.This is
possible because most o f its trade is re-exports and most o f these are sourced írorn China itselí.
The same situation explains the position of Belgium, as the port of Antwerp and Zeebrugge
are big exporting ports.The same can be said ío rth e Netherlands and Rotterdam.The Dutch
and Belgian trade íigures are distorted by this fact. Another very good example is the position
o f Singapore.
Country Population GDP Merchandise Merchandise Balance Export Exports

(000) (2012 us$ exports imports of trade ratio / capita
million) (US$m) (US$m) (US$m) {%) (US$)
Albania 3,162 13,1 19 1,968 4,882 -$2,914 15% $4,149
Argentina 41,087 470,533 80,927 68,508 $12,419 17% $1 1,452
Australia 22,684 1,520,608 256,680 260,942 -$4.262 17% $67,034
Belgium 11,142 483,709 446,529 437,246 $9,283 92% $43,413
Brazil 198,656 2,252,664 242,580 233,372 $9,208 1\% $ 11,340
Canada 34,880 1,821,424 454,794 474,920 -$20,126 15% $52,220
China 1,350,695 8,358,363 2,048,714 1,818,405 $230,309 25% $6,188
Germany 81,890 3,399,589 1,407,082 1,167,236 $239,846 41% $41.514
Hong Kong, 7,155 263,259 492,907 553,486 -$60,579 187% $36,794
China
India 1,236,687 1,841,717 294,158 489,668 -$195,510 16% $ 1,489
Japan 127,561 5,959,718 798,568 885,843 -$87,275 13% $46,721
Korea 50,004 1,129,598 547,870 519,584 $28,286 49% $22,590
Netherlands 16,768 772,227 655,700 591,198 $64,502 85% $46,054
Nigeria 168,834 262,606 116,000 51,000 $65,000 44% $1,555
Russian 143,533 2,014,776 529,255 335,446 $193,809 26% $14,037
Pederation
Singapore 5,312 274,701 408,393 379.723 $28,670 149% $51,713
South Aírica 51,189 384,3 13 87,256 124,245 -$36,989 23% $7,508
United Kingdom 63,228 2,435,174 474,476 689,927 -$215,451 19% $38,514
United States 313,914 15,684,800 1,545,709 2,335,537 -$789,828 10% $49,965
Table 9.5 The openness o f selected economies, 2 0 12 (source: derived from W rO , Trade Proples 2013)

C h a p te r 9
9.3 TYPES OF T R A D E FLO W S: IN T R A -IN D U S T R Y T R A D E

A N D IN T E R -IN D U S T R Y T R A D E
W TO classitìes merchandise trade into three main groups: manuíactures, fuels and mining
products, and agricultural products. In terms o f the export value in 2012, manuíactures were
valued at $1 1,848 billion (64%),fuels and mining products $3,997 billion (23%) and agricultural
products $1,745 billion (9%). Manuíactures are worth more because the process o f making
something adds value to the more materials from which they are made.
Here are some facts about manuíactured trade in 2012. Albania's exports were 55%
manuíactured and imports were 59% manuíactured.The UK exports were 71% manuíactured
and imports vvere 63% manuíactured. The USA exported 71% manuíactured and imported
69% manuíactured. O f Chinas exports, 94% were manufactured, and 58% o f its imports were
manuíactured.
These statistics tell us that the dominant element in trade by value is the manuíacturing sector
But they also tell us that trade does not fìt with the common-sense view mentioned above.
Many countries trade large volumes o f similar Products with each othen
An important distinction is now made between inter-industry and intra-industry trade, When
Saudi Arabia exports crude oil to Japan, and in exchange imports manuíactured goods such as
cars, electrical equipment or ships, the trade so generated is knovvn as inter-industry trade. It fìts
in with the concept o f trade discussed earlier
But novvadays, only 50% or so o f vvorld trade is o f this type.The other 50% is what is known
as intra-industry trade. VVhen Jaguar Land Rover, a UK-based manuíacturer (owned by Tata,
an Indian company), exports luxury cars to Germany, and BMW, a German company, exports
luxury cars to the UK, it is not clear why such trade takes place, as both countries are capable o f
producing luxury cars and only one country can have a cost advantage over anothen not both
at the same time.
It is clear that this type o f trade flow has to be explained in a different way from the oil/cars
trade between Saudi Arabia and Japan.
One important íactor underlying some o f the trade flows mentioned above involves the rise o f
multinational corporations as important players in vvorld trade. It has been estimated that one
third o f w o rld tra d e is b e tw e e n t w o subsidiaries o f th e same multinational C orp oration (MNC),
Such trade flows may be dictated by íactors that have little to do with relative costs in the
countries concerned but reílect transíer pricing and differential tax regimes.Transíer pricing is
th e d e vice used by large multinational corporations to m axim ise the value-added P ro cessin g ot'
its subsidiaries in the countries o f low taxation. For example, a subsidiary in a high tax country
can sell its product at a low price to a country with a low tax regime, so that the greater
mark up is made in the country with the lowest tax. Since the MNC owns both subsidiaries,
where the accounting proíìt is made is largely immaterial.Tax minimisation becomes a íactor in
determining the value o f trade flows since export prices are affected by these considerations.
This type o f trade is reíerred to as intra-firm trade.
The above points highlight the fact that in todays global markets it is no longer possible to
expiain all trade flows with just one economic model or theory o f trade.
9.4 T R A D E G R O W T H A N D T H E D E M A N D FOR S H IP P IN G
SERVICES
The spectacular growth in world trade has generated a corresponding growth in the demand
for transportation services, particularly shipping.The volume o f cargoes moved, both in tonne-
miles and tonnes o f cargo generated per yean has grovvn in line with the grovvth in world trade
volumes. It is a good idea to revievv the data provided in Chapter 2, which demonstrated the

S h ip p in g and in te r n a tio n a l tra d e
grovvth in voiume of cargo moved.there being a strong link between the growth in world trade,
industhal production and seaborne trade.
This point is worth re-emphasising. All industry analyses o f the shipping markets begin with an
analysis o f the key elements generating the demand for those services, vvhich are to be found in
the volume and pattern o f world trade.The changing demand for oil tankers is linked to changes
in trade patterns for crude oil.The grovvth o f the containerised liner trades is most marked in
the Far East, which is the region with the highest rates o f economic growth and industrialisation
in recent years. No self-respecting shipping analyst examines the demand for any shipping sector
vvithout fìrst examining and analysing trends in the markets that generate the demand, namely
the flows o f current and expected vvorld trade.
9.5 E C O N O M IC MODELS OF T R A D E FLOW S

There are two traditional explanations o f trade flows, both concentrating on the supply side
o f the economy.They essentially argue that trade flows are driven by relative costs only.The
models try to explain why one country exports certain commodities and imports other,
different commodities in exchange. It implies that one country has a cost advantage relative to
the other country for one industry.Thus Saudi Arabia is abundant in oil, which can be extracted
cheaply because its fields are on land and can be moved to the coast for export. It has a cost
advantage in oil production. On the other hand,Japan has a cost advantage in car production, so
both can trade. Note that this is inter-industry trade, not intra-industry trade.
9.5.1 A b s o lu te a dva n ta g e
The íirst economist to develop the theory o f absolute advantage was Adam Smith.The theory
basically argues that a country will export those commodities which it produces more cheaply
than any other country, and in exchange, import those products which it produces less cheaply
than elsevvhere. The obvious examples o f absolute advantage vvould be a countrys natural
endovvment of raw materials and natural resources. In Saudi Arabias case, as mentioned above,
an absolute advantage exists in oii production, as it does in other Middle Eastern economies
vvhich are similarly blessed. Brazil and Australia are endovved with iron ore, vvhile Japan has none.
A natural trade is for Japan to import these essential manuíacturing raw materials as it has no
such materials itselí.
Hovvever, one question arises with this theory. Suppose economy A was absolutely more
efficient in production in all goods, compared to another economy, B. If the doctrine is correct,
it vvould appear that economy A should never trade with B, since it is capable o f producing all
products more cheaply than B, Since, in reai life, it is often argued that Japan or the us is capable
o f producing all goods more cheaply than the UK,then why should these two economies trade?
9.5.2 C o m p a ra tiv e a dva ntag e

The doctrine o f comparative advantage is the most vvidely known theory o f trade flows.The
idea is best understood with the aid o f an example. Suppose that you are a Com puter whiz and
also good at decorating and painting. In fact, you are better at these two activities than your
neighbour, Fred. Fred is not too good at computing, but very good at decorating and painting,
though not as good as you.
Initially, both you and Fred spend equal amounts o f time in both activities. But, if you trade,
both can gain. This is because Fred is comparatively good at painting and decorating; if he
concentrates on that activity, while you concentrate on computing, you can trade the Service
to each other and both would be better oíĩ.This gain arises from the fact that resources have
been reallocated towards their most eíTicient uses. As a result, more total output o f Computer
services and painting/decorating is produced, to be reallocated between the tw o people.

C h a p te r 9
In reality, comparative advantage is nothing more than the extension o f Adam Smiths principle
o f the division o f labour to trade between countries. Each country will tend to specialise in
producing those products vvhich it is relatively good at producing and trade some o f the
increased output from the expanded sector for imports which replace the output lost from the
shrinking, less productive secton
9.5.3 P o rm a l m o d e ls o f c o m p a ra tiv e a d va n ta g e
A formal model o f the principle o f comparative advantage is presented below:
Model I - Assum ptions
1. There are two countries, country Home (HC) and Poreign (FC).
2. Both have one íactor o f production, laboun which is used in producing the outputs.
3. Labour productivity, average and marginal, is constant in all sectors.
4. Total person hours available are 12,000 per year in both HC and PC.This implies that both
economies are of a similar size.
5. Technology is identical in both countries.
6. There are two products, cars and rice, produced in both countries.
7. There is no trade between the two countries to begin with.

8. Initially, each country allocates 50% o f its resources to each product.This implies demand
conditions are identical in each country.
9. Labour is aiways fully employed in both countries.
10. Competitive conditions prevail, leading to prices equalling opportunity costs.
Tabie 9.6 shows the labour input requirements in each country per unit o f output.
Labour in p ut requirem ents p er u nit o f o u tp u t (person hours)

[ Home country (HC) Poreign country (FC)
Cars Ị 60
Rice : 60 ' 2Õ .. . ...............
Table 9.6
Given the iníormation in the assumptions above, Table 9.7 shovvs the maximum output
achievable if ail the available labour is employed in that secton
Maximum o u tp u t achievablí2 in t h e t w o c o u n t r i e s ( a s s u m in g r e s o u r c e s a l lo c a t e d t o
only one industry)
HC LFC i
Cars 600 200
Rice Ị 200 600
Table 9,7
lf country HC puts all its resources into car production, it can produce 12,000/20 = 600 cars
per period. FC, on the other hand, can produce 200 (12,000/60).The/ are less eíĩìcient in car
production than HC. Country FC can produce 12,000/20 = 600 units o f rice per period if
labour is solely devoted to rice production, vvhilst HC can produce a maximum o f 200
(12,000/60). Given the assumption that resources are split 50:50 between cars and rice in the

S h ip p in g and in te r n a tio n a l tr a d e
pre-trade situation, or autarky as it is called in economics texts, the actual output and self-
sufficient consumption is given inTable 9.8.
Initial p ro du ctio n and consum ption in the tw o non-trading economies

_H_C rc VVorld
Cars 100 400
Rice 100 300 400
Table 9.8
It is very important that you note the assumption being made in this model is that labour
productivity is constant, no matter how many units o f labour are being employed in car o r rice
production.This assumption means that the trade-off betvveen the two outputs is always the
same. If one less car is produced in country HC, it follows that 20 labour hours are released. If
moved into rice production, the 20 extra hours will generate one-third o f a unit o f rice, since
one unit o f rice requires 60 hours. In country FC, the loss o f one unit o f car production frees
up 60 labour hours, by assumption, but rice production requires only 20 hours per unit. So the
shift in resources would generate three extra units o f rice.These trade-offs are assumed to be
the same, vvhether we are talking about the loss o f the 600th unit o f car production in country
HC such as the very last unit or the very first unit.This assumption implies that the opportunity
cost o f output is a constant in both countries, although the value o f that constant differs
betvveen them.
O p p o rtu n ity cost

How do these two countries gain from trade? Recall the earlier example. If one country is
better at making one good relative to the other country, then an opportunity for trade may
exist. In order to measure relative effìciencies, economists use the concept o f opportunity
cost. Opportunity cost is defined as the output íoregone as a consequence o f producing one
more unit of output. In country HC, one extra unit o f car costs one-third o f a unit o f rice,
since producing one more car takes up 20 hours. So for releasing one-third o f a unit o f rice,
the equation is 1/3 X (60) = 20 hours. Alternatively, the production o f one more unit o f rice
requires 60 extra person hours in HC, o rthree cars íoregone.
The opportunity costs íorthe two countries are shovvn inTable 9.9.
O p p o rtu n ity costs o f e xtra o u tp u t

HC FC
One extra car One-third rice Three rice
One extra rice Three cars One-third car
Table 9.9
It is clear that the tw o countries have diíĩerences in the pre-trade opportunity cost ratios.
Country HC can produce cars at the least opportunity cost (1/3 < 3), vvhile country FC can
produce rice at the least opportunity cost ( I /3 < 3). It is clear that there is a potential for a
global increase in production and consumption, if specialisation and trade are introduced.
In the pre-trade position, both countries are limited to consuming exactly what they produce.
Table 9.8 above thereíore can be read as a table o f consumption levels in both countries as
well as production. But, once trade is permitted, consumption and production can diíTer by the
amount o f exports and imports generated. An assumption has to be made about the rate at
vvhich the two commodities exchange with each other.

C h a p te r 9
The opportunity cost ratios which exist in the pre-trade position provide limits on the
opportunity cost ratio that will be agreed. Assumption 10 stated that opportunity cost ratios
can be viewed as price ratios.The equilibrium trade ratio must thereíore lie betvveen the tw o
ratios that already exist.
Opportunity cost cars: l/3 R ic e (H C )< x < 3 R ic e (F C ) (I)
Opportunity cost rice; 3 Cars (HC) > y > 1/3 Cars (FC) (2)
Note that the reiationships above are closely related: the second relationship is simply the same
as the first, but inverted. Once one is satisíled, the other must be.
in o rd e rto determine the fìnai position, an agreed rate o f exchange must be determined.The
rate o f IR = I c has been selected, but note that it falls between the extremes given in one and
two. A t this rate, it is rnore proíìtable for country HC to specialise in car production and im port
rice from FC. Each extra unit o f car costs it one-third o f a unit o f rice domestically speaking,
but exchanges for one unit o f rice when traded with PC.Thus, by switching more resources
to car production and trading with FC, an extra two-thirds o f a unit o f rice is created.The
creation occurs because labour is moved to the sector in which it is relativeiy most efficient, in
both countries.
If FC reduces car production by one unit, resource capable o f producing three extra units o f
rice is released. So, rice production goes up by three in FC. If we want to keep the world car
production equal, HC has to increase production by one.This is at the cost o f one-third rice, By
this reallocation o f resources, two and two-thirds extra units o f rice have been generated, vvhich
can be split between the tw o countries. As world car producLion was unchanged, it follows that
vvorld consumption and production is greater than in the no-trade situation. Free trade has
created larger output and greater consumption.
As there is no change in the relative opportunity costs described in the above paragraph, the
incentive to raise production o f cars in HC and production o f rice in FC exists all the time.The
process must stop only when it no longer becomes possible for resources to be switched into
the expanding sector; vvhich only occurs in this example, when all o f HCs labour resources
are employed in car production. A t this point, the production íìgures are shown in table 9 .10.
Based on the assumption o f equal-sized economies, in this example both economies will end
up specialising completely in the sector in vvhich they have a comparative advantage. W here
economies are unequal in size, specialisation vvould be incomplete as the beneíìts o f íurther
trade are limited when the smaller economy becomes fully specialised in its export secton
Final p ro d u ctio n levels w ith free trade

! HC FC VVorid
Cars 600~ to 600
Rice 0 160cT 600
Table 9.10
Comparing Table 9.8 vvith Table 9.10, it is clear that trade has increased production. in this
example, both car and rice production are increased. (Other examples can be constructed
where only one commodity is increased in the process.) From a global vievvpoint, ít is clear
that both countries can be materially better ofí, since there are more cars and more rice to
go round.
The example can now be completed by assuming fìnal consumption points for HC and FC.
The model developed above does not explain the fìnal consumption points and models that
do are beyond the scope o f this textThe consumption points chosen are thereíore somewhat
arbitrary, but they illustrate the point that both countries can gain from trade. It will be assumed
that country HC exchanges 300 units o f cars for 300 units o f rice, vvhich is the agreed rate of

exchange íortrade. Using HCs domestic opportunity cost ratio, HC’s gain o f one car unit costs
it one-third of a rice unit in lost production. But if FC vvere to increase its rice production by
one-third o f a rice unit, it would cost one-ninth (1/3 X 1/3) o f a unit of a car.This reallocation of
resources, exploiting the greater productivities in each o f the efficient sectors o f each economy,
creates the gains from trade.Table 9.1 I provides one possible equilibrium position for both
countries and the implied trade flows.
Final consum ption Assuming 50:50 in both countries

HC I fc World
Cars 300 : 300 600
Rice 300 300 600
Pinal trade position

HC FC
Cars 300 Exports 300 Imports
Rice 300 Imports 300 Exports
Table 9.1I
Note that the rate o f exchange o f rice to cars is I : I and both HC and FC completely specialise.
HC specialises in cars, FC in rice.Trade is balanced in the sense that, at the going rate o f exchange,
each countr/s value o f imports equals the value o f their exports. In the world o f comparative
advantage there are never any crises generated by trade imbalances.
Both countries’ consumption levels are higherthan they were in the pre-trade position. Country
HC has 200 more units o f rice and the same level o f consumption o f cars; country FC has 200
more units o f cars and the same level of consumption o f rice. Both countries are better off from
obtaining higher levels o f consumption from the same given set o f resources through free trade.
Gains fro m tra de and the term s o f trade

The example above generated gains to both parties. This arose because the agreed rate of
exchange or the terms o f trade diíĩered from the pre-trade price ratios that existed in both
countries. VVhen a large country trades with a small one, it is likely that the price ratio in the
large country will not be affected by the trade volume itselí. in this case, all the gains from
trade would accrue to the small country, since the difference betvveen the pre-trade price
ratio and the agreed terms o f trade determines the degree to which a country can reach a
consumption point vvhich was not previously open to that country. For example, if the relative
price o f computers and apples is unchanged in the USA following its opening up o f trade with
New Zealand, but New Zealanders fìnd that the relative price o f apples to computers has
increased, New Zealand will benefìt from increased apple production and trade with the USA
at these higher prices.The gains will go to New Zealand, since the resource reallocation that
occurs in the USA is at exactly the same rate as would have occurred in the absence o f trade.
The distribution o f trading advantages can be affected by movements in the relative prices of
imported and exported goods.When, in 1973, world oil prices increased by 400%, the terms
of trade for oil exporters moved sharply in their íavour, whilst oil importers experienced the
opposite effect. An improvement in the terms o f trade for oil exporters means that for a given
volume of oil sold abroad, a larger physical quantity o f imports can be ílnanced.The oil-exporting
countries found themselves much better ofí, and the oil-importing countries much vvorse off,
as a result o f this change.The decline in oil prices between 1980 and the mid-l990s had the
opposite effect, vvhich was noted in earlier sections, when the decline o f OPECs share o f world
trade was highlighted.

C h a p te r 9
M odel 2 - C om parative advantage w ith variable o p p o rtu n ity cost
The above model, although complicated, is not complex enough for a complete analysis o f
comparative advantage. Two key assumptions have to be moditìed to improve the analysis.
Pirstly, the assumption o f constant opportunity cost has to be dropped. Secondly, production
is undertaken with several íactors o f production (such as land, labour and Capital) which are
combined to produce either cars or rice. if the assumption is made that rice requires a relatively
large amount o f land, and car production requires a relatively large amount o f Capital, it no
longer becomes possible to assume that the opportunity cost o f cars or rice remains constant
as resources are reallocated.
The reason for this is not too difRcult to understand. Suppose that HC has a relatively large
amount o f Capital and FC a large amount o f land, Now suppose all HCs resources are
concentrated on car production.Then it moves some o f those resources into rice production.
Efficient reallocation would mean moving the íactors vvhich are most productive in generating
rice (such as the wettest lands) and the most suitable labour IS diverted from car production to
rice production.This process is repeated. But each time it is repeated.the land that is shifted and
the labour that is moved is slightly less appropriate for rice production and more appropriate
for car production.This means that in terms o f opportunity costs, early movements o f resources
do not reduce the production o f cars by much but they increase the output of rice a great deal.
In economic jargon, the marginal product o f íactors empioyed in car production is low, since
ail resources have been pushed that vvay.The extra rice produced, from an initial value o f zero,
will be very large and the marginal product o f íactor inputs in rice production will be high.This
relative situation vvill alter as resources shiit into rice production.The marginal product o f the
last land was used for rice long ago, so that expensive methods o f irrigating dry land need to be
employed.The resources being switched are in fact much better used in car production and are
less effìcient in terms o f output when employed in the rice sector,
The p ro d u ctio n possibility íro n tie r

In order to understand how the variation in opportunity cost can be modelled.the concept o f
the production possibility írontier (PPF) has to be deíìned. Pigures 9.3 and 9.4 show tw o such
írontiers for countries HC and FC respectively.
Pigure 9.3 Country HCs production Pigure 9.4 Country FL's production
possibility írontier possibility írontier
Note: Pigures are not drawn to scale.
The PPF for HC shows that, if all its resources are íully employed in car production, 100 cars per
year will be produced. If all o f HC’s resources are employed in rice production, only 65 units of
rice will be produced.This is consistent with the idea that HCs resources are best suited to car

S h íp p in g and in te r n a tio n a i tr a d e
p ro d u c tio n because it has m o re Capital and less suitable land th a n PC.The c u rv e FG show s all
the possible combinations o f cars and rice that can be produced vvith the full employment of
resources in country HC. Considerthe process o f moving from point G to point F.When there
is a large level o f rice output, no cars are being produced; reieasing Capital and labour from rice
production will reduce rice output and increase car output.
U nderthe models assumptions.there will be a large increase in car output at the cost o f a small
reduction in rice production.The reason íorthis is thatthe resources being released atthis stage
are the ones most suited to car production and least suited to rice production.The marginal
product o f íactors employed in cars will be large at this stage, but the marginal product o f the
inputs in rice will be low. So, in terms o f íoregone rice production, extra car production does
not cost much. By the time resources have been shiíted to point F, this is no longer true.The
resources being released from rice production will now be the most productive ones:the best
lands and the best íarmers.They will help increase car production, but not by much. A t point F,
the marginal product o f those few íactors remaining in rice production has become very high.
The opportunity cost o f one extra car now becomes very much greater and much larger losses
o f rice production occur.
These changes are the reason for the changing slope o f the line FG. In fact, the slope o f FG
measures the opportunity cost, the price paid for an extra unit o f cars as measured by the lost
output o f rice.This opportunity cost is very high when car production is high and low vvhen rice
production is high. It varies as the relative mix o f cars and rice is varied.
The same arguments apply to country FC. Pigure 9.4 is dravvn to reílect FC's greater íacility in
producing rice relative to cars. Initial production is assumed to be as shown in the fìgures.World
production o f cars is 30 in HC, 30 in FC, totalling 60. Rice production is 100: 50 in HC, and 50
in FC.
Trade equilibrium
Pigures 9.3 and 9.4 show that the opportunity cost ratios are quite different in countries HC
and PC.The slope o f the straight line drawn tangent at HCs pre-trade equilibrium is ílatter or
greater than the equivalent line for PC.This means that the opportunity cost o f rice relative
to cars in HC is greater than the opportunity cost o f rice relative to cars in FC. Under the
assumption o f competitive conditions in all sectors.this also implies thatthe relative price o f rice
relative to cars is greater in HC than in FC. Rice is thereíore relatively expensive in HC: relatively
cheap in FC.
If trade is permitted and there are no transport costs, these two relative prices must converge
to a common, equilibhum one. But this means that the relative phce of rice will fall in country
HC and rise in country FC, vvhile the relative price o f cars will fall in country PC.The differences
in the pre-trade relative prices and the common post-trade prices will create incentives for
producers in both countries. In country HC, car producers will find it attractive to make more
cars and sell them to country FC. Production of cars will expand and rice production vvill
contractThis is seen more clearly in Pigure 9.5. A similar process will occur in country FC, but in
this case the expanding sector vvill be the rice sectonThe changes are shown in Pigures 9.5 and
9,6 respectively.

C h a p te r 9
Pigure 9.5 Post-trade equilibrium in HC Pigure 9.6 Post-trade equilibrium in FC
Country HC will end up producing 60 cars and 40 rice units, while country FC produces 20
cars and 80 rice units. Both countries have shiíted resources into the sector in which they
have a comparative advantage, but note that neither completely specialises in that sector.This
is because o f the fact that the relative prices alter as resources are shiíted betvveen the sectors.
A second point to note is that both countries end up at consumption points which would not
be possible in the absence o f trade; both have gained. Country HC now consumes 40 cars and
60 rice units while pre-trade it was 30C, 50R. And country FC consumes 40 cars and 60 rice
units when pre-trade it was 30C, 50R. Country HC exports 20 cars and imports 20 units of
rice: country FC exports 20 units o f rice and imports 20 cars.The im p lie d post-trade rate of
exchange is one car = one unit o f nce.that is, the relative price ratio, and equals unity.
It is important to note that the lines NP and JK have the satne slope o f unity.This must be the
case, because the slopes o f these lines measure the agreed common rate o f exchange betvveen
cars and rice íorthe tw o trading partners. One can also see how production has shifted tovvards
the goods in vvhich each country has the comparative advantage.
VVorld production and consumption have increased as a result o f trade. VVorld production,
before trade was 60C and IOOR. After trade, it changes to 80C and 120R. The gain o f 20C
and 20R, has been evenly distributed in this example, with country HC gaining lOC and lOR in
terms o f consumption. It was 30C, 50R, but now is 40C, 60R.
Simiiar numbers are found for country FC when the relevant íìgures are examined. The
numerical example has been simplified, but the principle that at least one party gains in overall
consumption is a result vvhich is not conditioned on the precise examples used.
It is quite a diíTicult model to grasp because o f the number o f assumptions used and the
hidden nature o f the economics on vvhich it draws.The followíng paragraphs provide a succinct
summary o f the basic conclusions derivable from the analysis o f this model.
1. HC country is endowed with a number o f resources, some o f vvhich are more abundant
than others. Saudi Arabia has an abundance o f oil, Australia an abundance o f minerals and
the USA an abundance o f Capital. In each case, abundance is deíined in relative terms, that
is, oil relative to Capital, minerals relative to Capital and so on.
2. If competitive conditions prevail in every secton and if technology is the same in these
countries, each country will produce certain goods relatively more cheaply than other
countries.The goods that they can produce cheaply wiil be those that use large amounts of
the abundant íactonThus the USA will export goods vvhich involve large amounts o f Capital
relative to labour, because these will be the goods it can make relatively cheaply. India has

a large amount o f labour relative to Capital. Thereíore, it should export labour-intensive

products such as textiles and garments. Natural resource-abundant countries, such as Saudi
Arabia and Brazil, should export natural resources according to this theory.
Im plications and lim itations o f the theories o f com parative advantage

A very important implication that arises from the model discussed above is that trade will be
unidirectional. If Saudi Arabia has a comparative advantage in oil, it exports oil. It will import
cars, luxury goods and so on in exchange. lf the USA has a comparative advantage in Computer
equipment, it will export such equipment and import labour-intensive goods such as textiles.This
type of trade has been defined as inter-industry trade. But a signiíìcant proportion o f the world's
trade is now intra-industry trade.The theory o f comparative advantage does not explain this
type o f trade flow at all. For example, if the USA imports computers and exports computers at
the same time, say, from Japan or Singapore, which country then has the comparative advantage?
The model does not allow for both countries to have the comparative advantage. Economists
have developed additional theories to help analyse this type o f trade.
The predictions o f the comparative advantage models were also based upon a number of
crucial assumptions, the most important o f which are listed below:
1. full employment o f resources exists in both economies;

2. model only explains balanced trade, value o f exports = value o f imports;
3. the model is o f a barter economy where money does not exist;
4. the model is static - there is no explanation o f grovvth;
5. economies o f scale are not allovved for;

6. each sector is competitive with no allowance for monopolies.
These assumptions should make it clearthatthe model is notterribly realistic.Yet it has provided
the basis ío rth e liberal intellectual argument in support o f free trade, because o f the gains that
have been demonstrated in the models discussed above.
9.5.4 M u ltin a tio n a l C o rp o ra tio n tra d e : th e in te rn a tio n a l

p ro d u c t life cycle
One key statistic noted is that multinational corporations are now responsible for a significant
proportion of trade flows.There are tw o points vvorth noting here:
1. That the trade between subsidiaries o f the same MNC may help to explainthe observed
trade in computers, say, betvveen the USA and Japan. Nippon IBM and IBM (US) may well
be trading w ith each othen each specialising in a certain Computer type and then trading.
Such processes may help to explain intra-industry trade;
2. That multinational corporations can shiíi; the protìts that they earn to the country with
the lowest rate o f Corporation tax by the use o f transfer pricing. Since all subsidiaries are
usually vvholly owned by the parent multinational, the prices charged by one subsidiary to
another are largely immaterial. It does not really matter if accounting profits are struck in
Brazil or in the USA. But if tax rates are lower in Brazil, it would be better to ensure that
the trading profìt vvhich arises is located, as far as possible, in the Brazilian subsidiary.This
may sometimes be done by charging the u s subsidiary artiíicially high rates for services
provided, thus shifting proíits to Brazil. Transíer pricing is difficult to prove since many
o f these transactions are internal to the MNC and are never made public. MNCs can
thereíore locate production in the cheapest place and serve global markets.
A good example is to follow the history o f the trade in pocket calculators. First designed
and launched in the USA by Texas Instruments (TI) in the mid-l960s, they were priced at

C h a p te r 9
around $500 and replaced mechanical adding machines that were then still widely used.The
production íacilities were located in the USA, with North America the íìrst target market.
After a few months, the same product was launched in Europe.This early market was met
by exports from the USA. As the market expanded in Europe, it became íeasible to source
the market from European íactories, as the production costs fell enough to make EC tariff
barriers and the transport cost írom the USA a more expensive option. Rapid technical
change and increased competition drove down caiculator prices. Texas lnstrument’s
response was to relocate production to Malaysia and Singapore, taking advantage o f the
global mobility o f Capital and low transport costs. Now the product is imported into both
the USA and Europe from this source.
Note that this example generates three diíTerent trade flows. Pirst, calculators are exported
from the USA, as technology leading Products. Second.they are made in Europe and other
markets, so that u s exports decline. Finally,the same product is exported from the Far East
(by TI) back into the USA and into Europe. Such trade flows cannot be explained by
comparative advantage.
9.5.5 E conom ies o f scale and p ro d u c t d iffe r e n tia tio n as sources

o f tra d e a d va n ta g e
The newer economic theories of trade shift attention from cost differences and allovv for the
fact that P ro d u cts are often generated by companies, not by Industries. BMW cars are regarded
as being superiorto Ford cars by many consumers in Europe; Coca-Cola is different from Pepsi
and so on.The traditional comparative advantage model assumes that every company within
an industry is identical, thus ignoring these differences. New theories o f trade have shown
how trade in similar goods can flow in both directions at once, if consumers show p re íe re n ce s
fo r particular types o f P ro d u cts and if e co n o m ie s o f scale exist. Under Standard co m p etitive
assumptions, a trade equilibrium can be found vvhich explains why the UK sells luxury cars to
Germany and Germany selis luxury cars to the UK.
The explanation is simple.The individual markets in Germany and the UK are not suffìciently
large to create efficient production levels for this type o f car and there are not enough
consumers to create suíĩicient demand. In order to exploit economies o f scale, each company
has to seli abroad as well. If consumers vievv BMW cars as slightly different from Rolls-Royces
or Mercedes, this means that both BMW and Rolls-Royce can sell in each others home market
and not take too much business away from each other Consumers view the product as being
diíĩerentiated. Under this assumption about demand, it is possible to arrive at an equilibrium
position in which the combined UK and German market for luxury cars is served by several
luxury car manuíacturers. Each manuíacturer will sell some o f its products in its home market
and some abroad.This gives rise to the trade in luxury cars going in both directions at once
because no one country has a comparative advantage. The advantage is better understood
in terms o f each company creating a niche for itself in both its home and export markets by
producing a simitar, yet slightly difíerent product.
9.6 T H E BENEPITS A N D COSTS OF FREE T R A D E

The above models o f trade have also been used to provide the basis for the debate over
the benefits and costs o f moving tovvards íreer trade.The theory o f comparative advantage
illustrated that, in principie, everyone in society vvould be on balance be better o ff than without
trade. This conclusion is arrived at by assuming that every person in society has the same
economic weight and importance as everyone else.The loss to one member o f society such as
a producer who has to cut output because o f import penetration is regarded as being offset
by the gains to consumers, who pay lovver prices because o f the extra competition. It can be
shown that under certain special assumptions the net gains to consumers more than offsets
the losses to domestic producers.The principal gains arise because consumers pay lovver prices

S h íp p in g and in te r n a tio n a l tr a d e
and because domestic resources are redeployed to more efficient and productive uses, thus
generating production effìciency gains.
Thereíore, it should appearthat free trade is an unalloyed blessing. But, in reality, many countries
have deliberately created barriers to trade, to protect their domestic economy from external
competition.Why the diíĩerence betvveen theory and practice?
There are a number o f reasons íorthis:

1. The model o f free trade assumes that resources displaced by the opening up of markets
are redeployed in other sectors. In the real vvorld, import penetration often leads to job
losses and unemployment, so there are economic and political pressures generated by
those who stand to lose in this process.
2. One very signiíìcant group vvhich stands to lose from free trade are the producers who
currently survíve behind relatively high domestic prices for their goods or services. Unlike
the model, if they are few in number and large employers, they may well be able to exert
significant political pressure on the government to resist free trade pressures.
3. The major beneficiaries o f free trade are domestic consumers. But there are many millions
o f them and each will perhaps gain only a very small individual amount from lower prices.
Thus consumers tend to have less political iníluence on the decision-making process.
4. There are some economically justifìed arguments vvhich can be put forward by a country
in support o f a policy o f limiting free trade, such as a policy o f protecting the domestic
economy from import pressures.
9.7 FREE T R A D E VERSUS P R O T E C T IO N IS M

There are fìve main economic arguments which can be empioyed in the support o f government
regulation o f free trade.They are:
9 .7 .1 T h e in fa n t in d u s try a rg u m e n t
The iníant industry argument is very simple. It basically states that a country may protect a
young, grovving industry from the full rigours o f global competition in order to permit the
industry to develop in both size and technical knowledge. When mature, the industry vvould
be capable o f competing against íoreign companies with no government support, either via
subsidy, by tariff barrier or by quota.The argument rests on the implicit assumption that small
Industries are unable to exploit scale economies open to large íirms in other countries, and
thereíore operate at a competitive disadvantage.The playing field is thereíore being levelled by
government support.
The obịection to this argument is simple. When does an iníant industry become a teenage
industry? A t what point, precisely, should a subsidy or a quota be withdrawn? Once created, the
industry may come to rely on the subsidy rather than become more effìcient and competitive.
9.7.2 S m o o th in g th e re a llo c a tio n o f resources a rg u m e n t

A second argument, less popular now that many countries have industrialised, is that protection
is required in certain sectors o f the economy so that the transition o f resources may be more
smoothly carried out.The argument has been applied in support o f protecting the agricultural
sectors o f many countries. In the past, because o f its low productivity, rural íarming supported
many workers. Governments íeared that opening up their markets to open competition vvould
generate large levels o f rural unemployment and would exacerbate population drift to the
towns.This argument has less force for countries vvhich have industrialised as the proportion of
their workforce engaged in agriculture declines steadily. But it is still employed as a justifìcation
for support The European Union has a social fund which subsidises certain activities in the

C h a p te r 9
poorer parts o f the community for just this reason.
9.7.3 T h e s tra te g ic a lly im p o r ta n t in d u s try a rg u m e n t

The third argument employed in support o f protecting an industry is that it is strategically
vital for domestic production capability to be maintained. The obvious reason for this is to
provide that capability for vvartime conditions, when reliance on imported goods becomes a
weakness. Many countries have justifìed support for domestic agriculture for this reason. Some
also support their domestic shipbuilders for the same reason. It used to be hard to imagine the
UK, Germany or the USA ever allowing their domestic ship repair and shipbuilding íacilities to
disappean no matter how eíĩicient the world's competitors become.
9.7.4 To c o u n te r d u m p in g b e h a v io u r by fo re ig n g o v e rn m e n ts
o r co m p an ies
The íourth argument put fow ard for protectingthe economy from íoreign competition is based
on th e o b serv atio n that so m etim e s co m p an ies m ay sell P ro d u cts in o v e rs e a s m arkets at a price
that is less than the real costs o f making and transporting it.This undercuts even the effìcient
home producer and can occur if the exporter deliberately cross-subsidises the exported goods
from excess profits made in their protected home marketThe fear is that, once the imported
goods have captured the home market, the producer can use their monopoly position to drive
prices up afterwards.The u s government has accused Japanese manuĩacturers o f memory chips
of doing just this to its domestic market. It threatened to retaliate by imposing a 100% tariff
on the offending products. The problem was resolved by the appreciation o f the yen, which
increased the dollar price o f the chips concerned.The u s also accused British Steel o f dumping
Steel on the us market in the early I990s, Such disputes can be potentially damaging to all
parties if retaliation actually takes place.
9.7.5 To c o rre c t a te m p o ra ry balance o f p a y m e n ts

d is e q u ilib riu m
Protection for this reason is only justified if the dìsequilibrium is temporary, since a permanent
disequilibrium represents a more deep-seated problem in the economy itselí. The increasing
openness o f vvorld trade, together with the formation o f regional trading blocs such as the
EU (which prohibits its members from using such tactics against other members), has meant
that adopting protectionist measures to cure a temporary problem is less and less common.
In the I960s, the UK government imposed a 15% import surcharge on goods but at the time
it was only a member o f the European PreeTrade Association, EFTA. Such an action would be
illegal under EU rules if levied on other EU member countries' exports to the UK. A number of
other arguments are often put íonAârd in support o f protection, but they do not carry much
economic justification.
a) Retaliation
A government may be tempted to retaliate if a trading partner imposes a restriction on its

exports.The threat o f retaliation may be employed as a means o f persuading the trading partner
to iift the proposed restriction. When, in 1996 the other EU countries announced a ban on all
UK exports o f beef, follow ing the discovery that BSE (bovine spongiform encephalopathy or
mad cow disease) can be transmitted to calves.the UK government tried to find non-retaliatory
solutions to the problem. It argued that British health standards had been improved enough to
ensure that the disease vvould not be transmitted to Europe via the export o f cattie. It was only
in 2006 that Prance finally lifted the ban on UK-beef imports.

S h íp p in g and in te r n a tio n a l tra d e
Retaiiation was widespread in the I930s, when world trade volumes collapsed. Retaliation
leaves both countries vvorse off than they were beíore.The W orld Trade Organization now
has a forum designed to allovv the resolution o f trade disputes beíore they reach this stage. It
should be noted that the USA has oílen used the threat in negotiations to reduce the huge
trade deficit it has with Japan.As noted earlienthe USA vvould be less affected by such disputes
than European countries, which have a higher proportion o f trade to national income than has
the USA.
b) The cheap íoreign labour argument
Often, national businessmen complain about unfair competition from companies located in low-
cost labour economies.There is an important distinction to be made betvveen low vvages and
low labour costs. A low-wage economy can in fact be a high labour-cost economy, if labour
productivity is also very low. Unit labour costs are determined by the unit cost o f labour, divided
by the unit productivity o f labour. Low labour productivity and low wages often offset each
othen lf low labour unit costs do exist in one country rather than anothen this may well reílect
on the relative abundance o f the íactors o f production.
It is interesting to note that Japan’s labour íorce earns higher real wages than the UK’s. This
has been achieved alter 30 years o f íantastic grovvth, both in economic output and in labour
productivity.Japanese íirms may well still have lower unit labour costs than a rival UK fìrm, if the
grovvth in labour productivity has outpaced the grovvth in their wages.The argument that once
was applied to Japan is now being appiied to China’s development, with many citing low wages
as the reason for its rapid growth over the period 1995-2005. Economists expect that rising
real incomes in China will lead to rising real wages and a convergence o f growth, although this
process may take many years given the size and level o f development o f Chinas economy even
in 201 I.
O f course, we cannot forget that industries and companies will oiten lobby with governments
for protection.Very different arguments can be used from time to time, pointing out differences
in regulation between countries. For example, a company can also point out its strategic
importance for the country, such as the íìnancial sector in the City o f London.
The above arguments notvvithstanding, many economists are convinced that freer trade is a
more desirable goal ío rth e world community to aim forthan regulated or restricted trade.The
principal reason for this has already been highlighted in that free trade encourages innovation
and competition, rewards the efFicient and involves less government intervention.The invisible
hand of the market directs resources.
9.8 M E TH O D S OF P R O T E C T IO N
There are six main ways o f creating barriers to trade:
• trade tariffs;
• quotas;
• voluntary export restraints;
• exchange Controls;
• production subsidies.
All have effects which can be observed in the market place, via their effects on price. In addition,
governments can iníiuence trading patterns via a number o f more subtle vvays.These include
public procurement policies, product quality standards, and health and hygiene regulations.
Economists put these into tw o categories: tariff and non-tariff barriers to trade.

C h a p te r 9
9.8.1 T a riffs
A tariíĩ is a tax imposed on a commodity import. it may be levied in two basic ways: on an ad
valorem basis or as a specific duty. More complex schemes exist, combining these two, but the
basic blocks are ad valorem or specitìc duty.
Ad valorem
This is a tariff vvhich is levied as a percentage o f the import price. For example, if computers
from the USA are imported into the UK, an EU common external tariff of 5% might be levied.
A £1,000 Computer costs the im porter £1,050, plus carriage, Insurance and íreight. If the price
were to rise to £2,000, the duty to be levied would rise to £100.The UK price thus varies in
proportion with the vvorld price if an ad valorem tarifí is used.
Specific duty
The amount o f the tax to be paid is alvvays fixed no matter what the price o f the imported
commodity. It might be I Op per kilo o f tomatoes. If the world price o f tomatoes was 20p a kilo,
the price in the UK would become 30p. If the vvorld price doubled to 40p, the UK price rises
to 50p, which is less than double.This is because the tariff is íìxed in absolute terms, rather than
being determined as a proportion o f the import price.
Tariffs as a source o f revenue

It should be noted that tariffs can generate signiíìcant revenues to the government that levies
them.This assumes, o f course, that any tariff that is imposed is not set at such a high level that
imports are completely eliminated. It would be pointless from the revenue point o f view to
set a tariff so high that the domestic market was served only by domestic suppliers.This would
mean no imports and no imports means no tariff revenues.
The effect of a ta riff

The simple model o f demand and supply can be used to illustrate the economic effects o f a
tariff. By imposing what is in eíĩect an import tax.the government raises the domestic price level
o f a product, stimulates domestic production, reduces or eliminates imports and raises revenues
for the exchequer All o f these effects are measured relative to the ffee trade position, The
model is drawn under the following assumptions in Pigure 9.7;
• Ccompetition exists in the domestic market for the product
• The world supply o f the product is períectly elastic.This means that the domestic economy
can obtain as much or as iittle as it likes o f the product at the prevailing world price, which
is constantVariations in demand from the home economy have no effect on that price as it
is too smail an economy in the vvorld market to have any impact.
• Underthese assumptions.the vvorld supply curve is given by w s,th e domestic supply curve
ST and the domestic demand curve DD. In the absence o f anỵ government interíerence,
and in the presence o f free trade, the domestic market price must be the same as the
world price, 0W,
2 10 Institute of Chartered Shipbrokers

S h ip p ín g and in te r n a tío n a l tr a d e
Pigure 9.7 Free trade versus protection,
Given the market price is w , market demand at that price is Q4.This is met by producing Q I
from domestic companies, as ST shovvs the amounts that domestic íìrms are willing to supply at
any market price.The quantity Q IQ 4 will be supplied by imports, as the world supply schedule
implies that overseas companies can supply any amount at that price. Note the small domestic
sector. Now a tariff is imposed. It is reílected in the vertical difference between the line w s and
the line RZ, vvhich represents the new price o f imported goods aữerthe tariíĩ has been levied.
This raises market price, vvhich generates three principal eíĩects. Pirst, market demand declines
slightly, so total sales fall from Q4 to Q3.The precise size o f this fall will depend on the slope
o f the demand curve or the own price elasticity o f demand.The second efíect is that domestic
supply is increased, as domestic producers are willing to supply more at a higher market price.
Thirdly.the importers suffer a decline in business, as import volumes fall to Q2Q3.
This does not mean that the economy would be better offbeing protected.Tvvo principal eíĩects
can be observed in the diagram. Pirstly, consumers are vvorse off than they were in the free trade
position.They have to pay higher prices and, as a consequence, they buy less o f the product
which is being protected.They are clearly worse oíí.Their precise loss is in fact measured by the
triangle N, vvhich measures their loss o f consumer surplus.To see this, note that at the old price
consumers bought Q3.They also bought Q3 when the price rose to P2 from Pl. In a sense,
they were willing to pay P2 even when the price was at Pl This vvillingness to pay is measured
by the vertical distance between the price actually paid and the demand curve for each unit o f
output.The output range Q 3Q 4 generates the area shovvn by the triangle N as a result.
It appears that producers are better off as they have expanded. In a sense they are, but this is a
false impression, Remember that the comparative advantage model assumes full employment.
This means that the resources that have been redeployed in the protected sector have been
moved from elsewhere. It follows that output in another part o fth e economy must have íallen
as a resultThese tw o eíĩects can be shown to lead to the economy being vvorse off overall.
Look careíully at the triangle marked M.This shovvs the difference between what it cost the
economy to import the quantity Q IQ 2 , and what it now costs to produce the same amount in
the domestic economy (for example.the Q2th unit used to cost p I as it was imported but now
after the tariff is imposed, it costs P2, a difference o f p IP2). Repeating the same process for all
units between Q I and Q2 generates a total resource cost o f M.
Overall, there is a loss to consumers and also an effìciency loss on the production side, as
resources are redeployed in an inefficient manner.These tw o aspects lead to the argument that
free trade is superior to protected trade.
Economics of SeaTransport and International Trade 21 I

C h a p te r 9
9.8.2 Q u otas
These are quantity limits imposed on the amount o f imports that can be landed in the country
in a particular time period, usually a yearThey operate by the simple device o f the issuing o f
licences which are needed by any importer to bring their goods through customs.The most
common form o f quota is to determine the number o f units to be permitted to enter the
economy under licence although the quota limit might be set in value terms as an alternative.
This second type might be used if the primary obịective is to save a given quantity o f íoreign
exchange, since the amount is predetermined.
The USA has quotas limiting the amount o f sugar imported into the country. In Europe, the EU
has sugar quotas for sugar produced by the West Indian economies, primarily to protect its own
internal sugar beet industry, but these are set to expire in 2 0 15.
The economic effect o f a quota is identical to that generated by tariffs. Domestic market price
and production are increased. Instead o f raising revenue from tariíĩs, the government can
generate it from the sale o f import licences. Since the domestic market has been restricted,
the higher price means that importers are willing to pay a premium to obtain the licence. If
the licences are given away for nothing, the beneíiciaries will be the importers who receive the
entire excess proíit because they pay the world price and receive the full domestic price.
It is easy to see how corruption can creep in when governments determine who should receive
the licences.
Quotas are, in some sense, easier to monitor than a tariíĩ as they can be easiiy measured.The
effect o f a tariff on market price depends on demand conditions, which may be less easy to
determine. On the other hand, quotas may lead to severe shortages if the product cannot be
easily supplied by the home market It may also be diffìcult to adjust the required quota amount
to changes in demand conditions. W hat is appropriate this year may be inadequate next year if
demand grows rapidly.
9.8.3 V o lu n ta ry e x p o r t re s tra in ts
In the I980s, the grovving openness o f the world economy meant that individual countries
found it increasingly difficult to use tariíTs and quotas to protect their own economies as these
were regulated by the various trading rounds o f general agreements on tariíĩ and trade (GATT).
W hat emerged in this period was the growth o f vvhat has become known as voluntary export
restraints (VERs) as a substitute. In the UK, for example, the practice was first introduced in
1975, as a means o f limiting the share that Japanese car manuíacturers vvere taking off the
domestic car market.The UK government and the Japanese car makers' association entered an
agreement whereby Japanese car manufacturers agreed to limit their exports to the UK to be
no more than 15% o f the total car market in any one year.This practice spread.The EC íound
that Italy had a limit o f I I %; Prance i 0% on the same productThe arrangement, being voluntary,
was not illegal under the existing GATT rules, which explains its rise.The USA negotiated a
similar agreement with Japanese car manuíacturers when its domestic market sufFered the sarne
fate. In 2006, a VER was agreed betvveen the EU and China over China's exports o f textiles.This
arrangement is compatible with the W Ĩ O ruies, because China agreed to be subject to such
restraints during the transition phase to full W TO membership in 2010. A fter that date, such
restraÌRts are incompatible with the VVTO trade rules.
9.8.4 Exchange c o n tro l

Exchange control reíers to measures implennented by the government to ensure that there is
a limited supply o f the domestic currency onto the íoreign exchange markets. By limiting the
amount available to be exchanged for íoreign currencies, its value in terms o f those currencies is
also controlled. Many countries used to limit the amount o f their domestic currency that could
be taken abroad by tourists.
2 12 Institute of Chartered Shipbrokers

S h ip p in g a nd in te r n a tio n a l tra d e
This device is increasingly uncommon, as the trend towards greater liberalisation o f the world’s
economies continues. For example, the UK government abolished all limitations on currency
movements in 19 8 1. Any UK citizen can enter any UK bank and open an account denominated
in any currency they wish.This would not have been possible beíore 1981,The EU insists that
any new m em ber coun try abolishes its exchange Controls vis-à-vis o ther m em bers over a
period o f time to permit the free movement o f Capital. For example, Greece liberalised its
currency Controls in 1996. Even Japan is moving in this direction. Many developing countries
have íound that support from the W orld Bank has been conditional on a similar liberalising of
their exchange Controls.
9.8.5 Em bargoes
Embargoes or trade sanctions prevent the export o f all goods (or a range o f selected goods)
to a particular economy. It is normally the result o f politicai events rather than economic ones
and can be very eữective. For example, no country permits the import o f cocaine or other
hard drugs.They are illegal substances so, unless they are required for medical purposes, they
are not legally available. More spectacular cases have arisen in which trade with a particular
economy is prohibited by one or more countries.The USA has embargoed all trade with Cuba
since Castros takeover o f that country. As many o f you will be avvare, the Cuban economy is
now in some disarray, especially following the loss o f trade with Soviet Bloc economies who had
ignored the American sanctions.Trade with South Aírica was embargoed by the UN. Nelson
Mandela actively encouraged the boycott o f South Aírican exports prior to the ending of
the apartheid regime. Since January 2012, the EU has imposed an embargo on the import of
Iranian oiỊ.
9.8.6 Subsidies
A subsidy is a payment by the government agency to the domestic producers o f goods which
permits them to charge lower prices for their products. There are two types o f subsidy: an
export subsidy and a general subsidy.
As its name implies, an export subsidy is received by producers selling Products into overseas
markets. A very good example is the use o f cheap finance which was oíĩered by Japanese
shipbuilders to overseas shipowners who decided to place an order for a new ship in a Japanese
yard. Beíore the OECD Standard term s w e re agreed, which outlavved such practices, each
shipyard vvould offer more and more attractive íìnance deals to overseas ovvners, as a means of
competing.The Japanese government met the cost difference betvveen the loan terms offered
to the ovvner and the cost o f the íìnance to the shipyard, in effect, a subsidy. Under OECD rules,
all such íìnance is now offered under Standard terms.
Subsidies can also be offered in the form o f location grants, tax relieí on proíìts and subsidised
raw materials. All these devices have the eíĩect o f lovvering production costs and prices.
A general subsidy is any support vvhich is granted to domestic producers irrespective of their
export perTormance. Such subsidies drive dovvn the domestic price o f the products, thereíore
limiting the market share taken by imports.The subsidy is íunded by higher general taxation, so
the consumer fìnds lower phces but highertaxes.
9.8.7 C ritíc is m s o f th e fre e tra d e a rg u m e n t

Many economists have pointed out the limitations o f the arguments underlying free trade.The
main ones are listed belovv.
I. The strong gain: there is a general íailure to analyse the way that gains from trade are
distributed between the trading partners. Some have argued that only strong economies
have gained, with weak ones losing outThe rise o f the AsianTigers may perhaps be seen as

C h a p te r 9
a counterto this position.These economies have demonstrated an ability to exploit trading

opportunities to a greater extent than Europe or North America has in the past 15 years.
2. Infant Industries: it is argued that certain Industries will alvvays need to be protected or
supported before they can become large enough to become competitive on a global basis.
A good example is the rise o f Airbus Industrie, a European consortium vvhich, by i 996, had
obtained a 50% share o f the world’s large commercial aircraít market, íormerly dominated
by Boeing. It has achieved this with the aid o f subsidies from the EC. Boeing and Airbus
have accused each other for a number o f years o f both receiving subsidies.The W TO ruled
in August 2010 and May 201 I that Airbus Industrie had received improper government
subsidies from several EU countries in the form o f loans with belovv market interest rates.
In Pebruary 201 I, in a separate ruling, W TO íound that Boeing had received local and
íederal subsidies in violation o fth e W rO rules.
3. Unemployed resources: the basic model o f comparative advantage assumes that resources
are íully employed. No economic tnodel has been developed to ascertain the net efíect if
increased trade leads to permanently higher unemployment. But it should be noted that,
while the historically high levels o f unemployment observed in the 1930s in Europe (and
the rest o f the vvorld) were associated with íalling trade volumes, the general consensus is
that trade stimulates jobs rather than destroying them.
4. Monopoly elements: it used to be argued that the free trade argument was flawed because
the comparative advantage model is based on the assumption that all sectors o f the
economy are competitive. It is well known that many sectors o f real economies contain
monopoly or oligopoly elements.Their existence was used to argue that free trade vvas
vveaker as a result. But some o f the modern theories o f trade are based explicitly on the
presence o f oiigopoly and economies o f scale.These theories have stiil demonstrated that
more trade is betterthan iess trade.
9.9 T R A N S P O R T COSTS A N D IN T E R N A T IO N A L T R A D E
The discussion o f the benefits from trade has so far been conducted on the assumption
that goods can be moved without cost. W hat happens to the model if transport costs are
introduced? The ansvver is that the presence o f transport costs means that there is another
potential barrier to trade: the size o f the transport cost element itseif, lf transport costs are high,
they act just as if the price o f the import has been increased. Aíter all, the consumer has to pay
both the import price and the costs o f delivery. If transport costs can be reduced.then it follows
that trade can be stimuiated.The size of, and trends in, transport costs can thus iníluence the
way the market develops.
Transport costs are deíìned here as any costs vvhich are incurred in the act o f transíerring the
commodity from its origin in one country to its íìnal destination in another.This ciearly includes
seaborne transport costs, port loading and discharge costs, transfer costs and land transport
costs as well as Insurance premiums and interest costs arising from inventory o r bank credit
The presence o f such costs explains why some goods are not traded in signiíìcant amounts. A
good example is brevving.There is very little exporting o f beer, relative to domestic production
and market size.The reason is simpie: 95% o f the product is waten Beer is a bulky and heavy
product, vvhich generates very high transport costs for road distribution. It is cheaper to build
breweries near major consumption centres and serve markets this way than it is to develop a
large international trade in beenVVhen major brewing companies achieve export success, they
license a domestic brewer to make the product. Many successíui European lagers are actually
made by UK brevvers to meet UK consumption ratherthan being exported.
Pigure 9.8 belovv shovvs the effect that the incorporation o f a constant transport unit cost
has on prices and outputTransport costs have the efíect of raising the price o f the imported
goods from w to R, an increase in price o fW R per unit.The inclusion o f transport costs thus
has exactly the same effect as a tariff: it raises the domestic price and helps protect domestic

S h íp p in g and in te r n a tío n a l tr a d e
suppliers. It follows that íalling transport costs actually help to stimulate world trade, as they
make it easier for imported goods to compete with domestically produced ones. Shipping has
played a role in this process over the past 30 years with the use o f larger ships and the spread
o f containerisation.These tw o technical changes have helped to lower transport costs and thus
assist the development o f world trade.
Another model o f the effect o f transport costs on trade is shown in Pigure 9.9.This shows the
effect in a slightly different way. It íocuses on the market for imported goods.The demand curve,
DDI in the íigure, shovvs the demand for the imported goods only, in contrast to the demand
curve in the previous íigure. If there were zero transport costs, equilibrium imports would be
given by Q, at price Pvv.The addition o f transport costs raises the domestic price o f the im port
and demand íalls. Sales now run at Q I . In this model the supply curve is upward sloping, so that
a fall in price discourages suppliers.The new equilibrium price is Pw+t, but suppliers only receive
RThe difference, PPw+t, represents the transport cost elementThe model shovvs that this is
divided between suppliers and consumers, as suppliers previously received Pw per unit, so they
have lost PPw per unit to transport.
u
Q.
Pigure 9.8 The efĩect o f transport costs on trade.
o
u
"O
c
V
u
Pigure 9.9 The ePíect o f transport costs on the market for imported goods.
Economics of SeaTransport and International Trade 2 IS

C h a p te r 9
Similariy, consumers now pay the extra amount PwPw+t compared to the no-transport-cost
case.The distribution o f the burden o f transport costs depends on the relative slopes of demand
and supply. If you were to imagine that the demand curve was almost vertical (technically
speaking, períectly price inelastic), there vvould be little or no change in the output sold and the
full amount o f the transport cost element is passed on to consumers. If the demand curve vvas
horizontal or períectly elastic, the market price would not change and suppliers would have to
absorb the transport cost element.This vvould entail the suppliers reducing output sufficiently
and lowering production costs to create the necessary margin to fund the transport element.
If shipping companies are able to reduce the size o f transport costs relative to market demand,
the effect is to stimulate output and lower prices.
9 .10 D E V E LO P IN G FREE IN T E R N A T IO N A L T R A D E : T H E
ROLE OF T H E W O R L D T R A D E O R G A N IZ A T IO N
The W orld Trade Organization (W TO ) came into being in 1995, replacing the General
Agreement on Tariffs and Trade (GATT), which had been set up after the Second VVorld W ar
with the express purpose o f reducing the size and extent o f barriers to trade vvhich had existed
in 1939. It did this by meeting every few years to conduct a round of negotiations between
member countries, the aim o f vvhich was the lovvering o f external tariff barriers.The famous
Kennedy round made a signiíìcant contribution tovvards the iowering of taritĩs on manuíactured
goods, vvhich averaged 40% in 1947. By 1995, the Uruguay round had seen this tìgure drop to
less than 5%. As manufacturing tariffs dropped, tariffs in the agricultural sectors and barriers to
trade in services became the centre o f attention.
The W TO policy objectives, in both the short and long run, have been seriously questioned
by demonstrations and protests in the examples o f Seattle and Genoa.Those serve to cast a
shadovv over its activities, particularly in areas like the environment and the developing countries
trading potential. Based in Geneva, the W Ĩ O has as its own objective the íurther liberaiising
o f trade, and its focus has shiíted towards the resoiution o f such problems as the non-
recognition o f American and European Copyright and patent rights in some Far East countries'
and the reduction o f im port restrictions imposed on textile manuíacturers by the Multi-Fibre
Agreement. In addition, trade conílicts, the determination o f internationally accepted standards
in, for exampie, food hygiene, are all current issues on the V /ĨO 's agenda.
Since l995,W TO membership has grovvn vvith hardly any country outside its orbit. Some 160
countries are full members and most others have observer status, vvhich usually ends with
accession. Becoming a member implies responsibilities as well as rights o f access to vvorld
markets at agreed rates.
The present multilateral round at the WTO, the Doha round, started in 2 00 1 and is not yet
agreed.As membership has grown,the need for unanimous consent means reaching agreement
has become more diATicult.This is reiníorced by the fact that manuíacturing tariffs are now at a
very low level and the main potential fo r ĩurther trade liberalisation lies in agriculture.The Doha
round is still stalled because the EU and the USA cannot agree on cutting the iarge subsidies
they both provide to their agricultural sectors. If they manage to reduce the subsidy. present
distortions in vvorld agricuiturai prices and greater trade flows in these goods can be expected.
The íuture grovvth o f shipping markets will be shaped by the success o f this organisation in
íurther stimulating trade.
This chapter has provided iníormation about the growth and pattern o f worid trade, which, of
course, is the key driving force for shipping demand.Types o f trade fiows have been examined
and economic theories o f trade have been brieíly outlined.The arguments for and against free
trade policies were revievved, as well as discussing the main forms o f protection.The concepts
employed in this chapter have been introduced in earlier chapters.

In 2001, one U.S. dollar was w o rth 1.65 m illionTurkish Lira.
■l-:
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ĩ- ỉì
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C h a p te r 10
This chapter is concerned with certain aspects o f international trade: the balance o f payments,
exchange rates and the way that shipping activities are recorded in internationai transactions.
Balance o f payment accounting is complex because o f the numerous and diíĩerent items that
appear in International trade. There is one simple principle underlying the accounts: that all
transactions that involve resources, such as the export o f iron ore, oil, coal and so on, involves
a credit to the exporting country. Most transactions that appear in the balance o f payments
accounts also involve a corresponding ílnancial adjustment, which is entered in a separate part of
those accounts.This procedure is caíled double-entry bookkeeping, and explains why the overall
balance o f payments account is expected to sum to zero.The reason is that the íìnancial entry
is entered with an opposite sign from the resource entry, so if all transactions vvere períectly
matched, they vvould sum to zero.
A simple example is given belovv, to make this íundamental point clear
Suppose there was only one trade between the UK and Germany in the year.The UK exports
£ lm worth o f cars to Germany and Germany exports nothing to the UK. Two transactions
would appear in the balance o f payments accounts.The flows that relate to resources vvould
appear on the current account and are shovvn inTable 10.1 below.
In the case being considered at present, the payment for the cars would create a need for the
German importer to buy sterling to settle the account.The UK has, by selling goods abroad,
created an increase in the UK's holdings o f overseas assets.There wili be a demand for sterling
from Germany in order to settle this debt, which will be funded by a suppiy o f Germanys
currency, the euro, onto the íoreign exchange market. Every resource transaction creates a
matching change in the assets and liabilities position of the economy and these changes are
recorded in the second part o f the balance o f payments accounts, now called the Capital and
financial accounts o f the UK balance o f payments.
Note that changes that increase a countrys assets are, by convention, avvarded a negative sign:
those that increase a countrys external liabilities are given a positive sign.This is very important
to remember when studying the accounts.
C u rre n t account (m easuring resource flow s) £ m illions

Exports of goods 1
Imports of goods 0
Current account balance
Transactions in UK assets and liabilities
UK’s overseas assets "-i.... (2)
Balancing item 0 (3)
Balance(l) + (2) + (3) 0
Table 10 ,1 Hypothetical example o f UK balance o f payments account.
The simple example in Table 10 .1 highlights another important point. Credit items on the
current account create a demand for a country’s currency, while debit items create a supply
o f the countrys currency seeking to purchase other currencies. Hence a deficit in the balance
o f payments means a country is losing reserve assets and a surplus means they are increasing
these assets.There is a link betvveen the balance o f payments’ position and movements in the
exchange rate: countries that experience weak growth and persistent deíicits fìnd that their
currencies depreciate over time. It should be noted that a defìcit in the current account need
not create, for a number o f reasons, an immediate change in the value o f the currency. One
significant factor is the growth in the volume and values o f financial transactions that are not
related to the trading o f physical goods. In many countries, such as the UK, these flows are

T h e b a la n c e o f p a y m e n ts and exchange ra te s
several times larger than the flows of Capital that would be required to finance trade. This
means that trade imbalances are no longer the sole determinant o f currency movements and
other explanations forthe behaviour o f currency values have to be sought. Capital mobility and
the liberalisation o f international Capital movements are often a key part o f IMF reíorms when
considering giving support to deveioping economies. Shipping can play an important factor in
the baiance of payments calculations at a number o f levels vvhich will be discussed below.
10.1 D E P IN IT IO N OF T H E B A L A N C E OF PAYM EN TS
International trade will give rise to indebtedness between countries. Such indebtedness is the
be deíined as a system atic reco rd o f all
Central e le m e n t o f th e balance o f paym ents. It m a y
economic transactions between the residents o f the reporting country and the residents o f all
íoreign countries over a given period o f time.The term resident covers both individuals being
permanently in a country and corporate bodies located therein, but not their overseas branches
and subsidiaries. It also includes government agencies and military forces located abroad.The
term economic transactions includes exchange o f currency for goods and services, but also the
transíerring o f currencies and valuable assets abroad and exchange o f goods for other goods
involved. Care also must be taken o f the word 'balance'. It is to be understood in the sense of a
relationship rather than as an exact equality, since it is unlikely that goods and services bought
by residents o f a country from abroad will be exactly balanced by those sales and services to
íoreign countries.
To deíìne the balance o f payments from a siightly different point of view, rather than simply
stating what it is, look at what it is fon From an economic point o f view its obịect is to identiíy
and record transactions between residents o f the domestic economy and all other economies.
It uses a method that is suitable for analysing the economic relationships betvveen the
domestic economy and the rest o f the world. Such transactions may involve the movement
o f real resources, goods, services or property incomes, betvveen the domestic economy and
íoreign economies, as well as the change in the domestic economys íoreign assets, liabilities or
transíer payments.
It is usual to set out the economic transactions o f the domestic economy with all other íoreign
economies as a series o f credit and debits.These transactions are divided into three broad areas:
I. Accounts relating to the flows o f goods and services currently being produced by the
domestic economy or ovvned by residents o f the domestic economy. Ail these transactions
appear in the current account.
1. Accounts relating to changes in the stock o f assets or liabilities o f permanent residents of
that country.This part o f the account records changes in the net vvealth o f the country and
is recorded in the Capital and financial accounts.
3. An account o f the total Holdings by residents o f assets abroad and of holdings by overseas
res'dents o f assets in the country is called the international investment position.
10.2 T H E S T R U C TU R E OF T H E B A L A N C E OF PAYM EN TS
The account headings listed above can be examined in greater detail:
i) current account: covers transactions o f trade in goods, the visibles, trade in services,
investment incomes and transíers, the invisibles;
ii) Capital and íìnancial accounts cover several important sections o f the balance o f payments
accounts.They record changes in the flows o f direct investment, changes in the flows of
portíolio investment, transactions by banks and the general government account.The latter
records changes in oíĩicial reserves, borrovving and lending o f currencies and the take-up or
repayment o f loans from Ihe International Monetary Fund (IMF);

C h a p te r 10
iii) net errors and omissions represent the net total o f errors and omissions arising throughout
the accountThese arise mainly through timing errors in recording transactions and on
recording Capital flows. As in the hypothetical example inTable 10.1, the sum o f all flows
in i) and ii) above should equal zero.The net errors and omissions item ensures that this
convention is met;
iv) international investment covers the levels o f identiíied external assets and liabilities.
Note that the íourth item mentioned above is not shovvn in these accounts. The overall
international investment position is shown elsewhere.
C u rre n t account
l.l Trade in goods
Exports (+) Imports
Net position = Visible trade balance
1.2 Trade in services
Exports (+) ! Services imports (-)
i
Net position
. - i Services trade balance
1.3 Investment income
i
Interest payments (+) Interest payments (-)
Proíìts (+) Proíìts ^)
Dividends (+) Dividends ^)
Net position = investment income balance
1.4 Secondary income
Govt. receipts from abroad (+) Govt. payments abroad (-)
r
Private receipts from abroad (+) Private payments abroad (-)
Net position Transíers balance
Current account balance = sum of balances from 1.1, 1.2, 1.3, and 1.4.
Note: Services and investment income trades are sometimes cơlled invisible trades.
2. Capital account
2.1 Capital account
Capital transíers
Acquisition/disposal of non-produced, non-financial assets
3. Pinancial account
3.1 Direct investment
UK companies investing abroad (-) Poreign companies investing in UK
Net position 1
i— ....
3.2 Porưolio investment
UK residents' purchase of UK (-) Poreign residents' purchase of (+)
stocks and shares overseas stocks and shares
Net position
3.3 Pinancial derivatives
' 3.4 Other investments
3.5 Reserve assets
N e t e rro rs and omissions
Balance on current account = balance on Capital account + net errors and omissions
Table 10.2 Outline o f the balance o f payments.

T h e bala n ce o f p a y m e n ts and exchange ra te s
Pigure 10.1 is derived from the basic structure o f the UK balance o f payments accounts as
presented by the Office for National Statistics (ONS) in the Pink Book for 2006.There have
been a number o f changes in nomenclature and individual items over the years, but the basic
structure remains unchanged. Details may vary from country to country but, in each case, it
should b e possible to identiíy th e cu rre n t accoun t, s o m e kind o f Capital a c c o u n t reco rd in g
private sector transactions and government Capital transactions, a balancing item and a record of
the present stocks o f a countrys overseas assets and liabilities.
It is w orth outlining the conventions in a little more detail.Table 10 .1 provides a detailed outline
o f how certain entries are recorded in the balance o f payments accounts. Comparison o f the
outline vvithTable 10.2 should help in your understanding o f the basic structure o f the accounts.
For example.Table 10.3 shows that the UK has run a persistent trade deíìcit in its visible trade
balance. It is negative in all the years shovvn. Put simply, UK residents import a larger value of
traded goods than they export. VVhilst a deficit o f £1 10 billion might appear to be large, the
UK’s GDP for 2 0 13 was £ 1,713,122 billion, vvhich means the visible trade deficit was 6.43% of
GDRThe overall current account trade deficit was 4.23% o f GDP: well within the targets set for
good management o f a modern economy.
The UK has run a consistent surplus on the trade balance in services.This reached £78,096
million in 2013, representing a diíĩerence in exports o f £204 billion and imports o f £126 billion.
The períormance o f the City o f London as a major financial centre and with a still significant
role as a global centre for maritime services, such as marine banking, Insurance, legal services
and arbitration, helps generate this surplus.
There is also a large deíìcit on the secondary income account. One signiíìcant item here is the
fiows o f payments to and from the European Union, as well as government expenditures on
activities abroad, ranging from support o f embassies to financing war.
The net balance o f current account trading will generate counterparts on the Capital account, as
has been shown above. But there are extremely large flows that enter the Capital and fìnancial
accounts independently o f the trade in goods and services. For example, in 2013, overseas
residents purchased £ 158 billion worth o f direct investment, creating additional liabilities for the
UK, so treated in the Capital account as a credit. On the o th er hand, UK residents purchased
£171 billion o f overseas direct investment, creating additional potential assets for UK residents.
This is entered as a debit on the financial account, with the net position on this one item being
£ 158,204 million - L 170,542 million = £ -12,337 million net debit. In other words, in 2 0 13 more
investment went out o f the UK in this category than came in.
The size o f the flows o f the íinancial account is very large, largerthan the current account flows.
In 2 0 13, the value o f exported goods was $307 billion, with a íurther flow o f £204 billion of
Service exports. Imported goods ran at £417 billion, imported services, £126 billion.The value
o f direct investment in the UK was £1,261.7 billion, that o f portíolio investment in the UK,
£2,490.3 billion, and other investment, such as loans and currency deposits, £3,846.1 billion.
The corresponding debit flows such as purchases by UK residents abroad, in the financial
accounts ío rth e UK in 2013 were £1,228.2 billion direct investment, £2,506.8 billion portfolio
investment and £3,478.4 billion o f other investment. Some o f these flows are largerthan those
created by trade and help to emphasise that understanding modern currency movements is as
much about understanding the determinants o f íinancial flows as it is about understanding the
link betvveen trade deficits and currency values.

C h a p te r 10
Table 10.3 provides summary data íorthe UK’s accounts on this basis.
2007 2008 2009 2010 201 1 2012 2013

Current account £ millions
Trade in goods -93,296 -96,415 -83,591 -97,410 -96,5 15 -108,972 -100,196
Trade in services 52,602 51.514 55,476 60,352 72,690 74,503 78,096
Investment income 14,258 2,874 2,030 17,444 18,671 -4,841 -12,337
Secondary income -13,996 14,1 12 15,826 -20,696 -21,937 -22,195 -27,1 62
Current balance -40.625 -56,437 -41,403 -40,584 -27,033 -61,925 -72,395
Capital and financial account balance £ millions
Capital account Ị 310 785 915 910 837 835 530
Pinancial account -35,592 -45,865 -31,435 -28,735 -14,697 -49,129 -62,592 '
Net errors and 4,723 9,787 9,053 10,939 11,499 11,961 9,273
omissions
Table 10.3 Summary account o f the UK's balance o f payments 2007 2 0 13 (source:Table I , I , UK Balance
o f Payments 2 0 14, Offìce for National Statistics)
Note: Increases in assets are shown with a negơtive sign.
To recap on the basic structure o f the balance o f payments.

VVhatever the exact form the íìgures take in any particular country, they wiil include payments
arising from:
• vis ib le trade, that is, the sale and purchase o f goods;

• invisible trade, that is, payments for interest; proíìts and dividends; and services, o f vvhich
shipping would be an example;
• the transfer o f Capital from one country to another.
In addition, there vvill be a category known as net errors and omissions vvhich covers mistakes
made and items omitted or items undeclared, vvhich ensures that the double-entry balance o f
payments alvvays does balance overall.
In this chapten in order to highlight the íactors iníluencing the balance o f payments, the
experience o f the UK is used as a general example.The points made will all, to a lesser or
greater degree, apply to the balance o f payments o f other countries.
Throughout the chapten the reader should attempt to evaluate the extent to vvhich the íactors
discussed apply to their own country.The basic headings o f the UK balance o f payments are:
1. current account;
2. Capital and íìnanciai accounts;
3. net errors and omissions;
4. the international asset position;.

Table 10.3 presents the net position for these fiows, except for item 4.
10 .2 .1T h e c u rr e n t a c c o u n t
Trade in visible goods
The current account is the account o f which the general public is usually made most aware, since
it is concerned in part with actual goods exported and imported by a countrỵ.This includes raw

T h e b a la n ce o f p a y m e n ts and exchange ra te s
materials, íuel, foodstuffs, semi-processed and íinished manufactures.AH items are important to
the industrial base o f a co u n try and its Standard o f living.The oíĩicial definition is transactions in
goods vvhich are íreighted into and out o f a country.This section o f the balance o f payments,
the visibles in the current account, is known as the balance o f trade or trade íìgures and oiten
íeatures in the national news.
When íìgures are prepared for the balance o f payments they are based on the overseas trade
statistics compiled from HM Revenue and Customs records to which adjustments have been
made. But it should be noted that trade flows inside the European Union cannot be collected
this way, because with the creation o f the single market in 1992, all internal customs monitoring
of trade flows vvithin the EU was stopped.The most important valuation adjustment made is
the deduction o f the íreight and Insurance elements from the CIF or cost, Insurance and íreight,
valuation declared for imports to arrive at the required FOB or free-on-board valuation for the
balance o f payments. Preight and Insurance are services and thereíore included in the services
section o f the current account.
Tables 10.4 and 10.5 show an analysis o f UK trade, by commodity and by geographical area.
Year 2007 2008 2009 2010 2011 2012 2013

EXPORTS {€ million)
Food, beverages i 2,160 14,1 12 14,835 17,573 21,104 19,038 19,804
and tobacco
Basic materiais 5,493 6,607 5,170 7,336 8,991 8,464 7,670
Oil 22,397 31,857 24,568 31,288 37,966 39,516 39,314
Coal, gas and 1,972 3,571 2,402 3,827 4,747 4,198 3,607
electricity
Semi-manufactured 68,060 76,085 71.379 79,961 87,832 85,226 81,108
goods
Pinished 108,830 117,155 106,855' 123660 136,640 139,923 147,065
manuíactured
goods
Commodities and 3,550 5,578 5,537 7,171 11,904 8,777 8,242
transactions not
classifìed
Total 222,462 254,965 230,746 270,816 309,184 305,142 306,810
IMPORTS {€ miHion)
Food, beverages 26,665 3i,IOO 32,281 33,443 35,920 36,589 38,192
and tobacco
Basic rmaterials 9,527 10,980 7,594 10,247 11,900 10,674 12,491
Oil 27,120 38,390 28,020 36,010 49,461 53,896 49,327
Coal, gas and 5,174 10,600 7,446 8,872 12,376 11,391 12,413
electricity
Semi-tnanufactured 76,450 82,293 77,547 90,701 101,418 103,174 98,056
goods
Pinished 165,332 171,774 157,286 183,787 ~I87^82"~ 190,905 201,625
manuĩactured
goods
Commodities and 5,490 6,243 4,181 5,166 7,242 7,485 4,902
transactions not
classified
Total 315,758 351,380 314,337 368,226 405,699 414,1 14 417,006
BAƯ\NCES (£ million)
Food, beverages -14,505 -16,988 -17,446 -15,870 -14,816 -17,551 -18,388
and tobacco

C h a p te r 10
Basic materials -4,034 -4,373 -2,424 -2,9 11 -2,909 -2,210 -4,821

Oil -4,723 -6,533 -3,452 -4,722 -1 1,495 -14,380 -10,013
Coal, gas and -3,202 -7,029 -5,044 -5,045 -7,629 -7,193 -8,806
electricity
Semi-manufactured -8,390 -6,208 -6,168 -10,740 -13,586 -17,948 -1 6,948
goods
Pinished -56,502 -54,619 -50,413 -60,127 -50,742 -50,982 -54,560
Ị
manuíactured
goods
Commodities and -1,940 -665 1,356 2,005 4,662 1,292 3,340
transactions not
classified
Total -93,296 -96,4 Ị 5 -83.591 -97,410 Ị -96,515 -108,972 -1 10,196
Table 10.4 UK trade in goods in the balance of payments accounts by commodity group, 2007-2013
(source;Table 2,1, UK Balance of Payments 2014, Offìce for National Statistics)
Year 2007 2008 2009 2010 201 1 2012 2013

EXPORTS (£ million)
European Union 193,566 21 1,353 193,860 215,890 240,864 230,401 227,699
EFTA 15,874 16,162 17,91 6 19,662 20,090 21,785 22,226
Other Europe 5*645” 6,530 5,494 5,261 5,205 5,524 9,103
Americas 82,530 87,670 86,457 94,341 105,606 109,244 114,841
of which USA : 64,849 68,423 66,967 71,902 80,565 83,540 "9 ã Ĩ23
Asia 53,108 63,753 '"62,562” ’ 72,105 81,468 86,404 i"ỹ42l8
Australasia and 6,961 8,300 8,180 9,609 11,550 12,134 1 11,325
Oceania
Aírica 12,928 16,204 [16796 I9J74 20,901 '2 ^4 5 7 '^ 17,800
Total 379,768 420,900 '400,260 ’ 447,057 499,452 1 500,735 51 1,275
IMPORTS (£ million)
European Union 227,005 242,691 220,366 244,370 262,548 269,912 283,871
EFTA 24,605 32,127 26,033 33,624 37,245 36,073 30,764
Other Europe 2,310 2,375 "2Ĩ428 2,855 3,227 J 3,651 7,928
Americas 59,502' 63,093 61,816 66,5 10 68,533 167,747 66,574
of which USA 42,852 43,889 44,672 47,335 49,151 49,651 48,731
Asia 74,901 87,707 84,5 17 100,837 110,980 112,098 108,758
Australasia and 5,195 5,520 5,340 5,895 6,065 6,136 6,1 14
Oceania
Aírica 13,745 16,998 15,272 16,422 18,448 22,454 22,810
Total 420,462 405,801 428,375 484,1 i 5 523,277 535,204 543,375
BALANCE (£ miiiion)
European Union -33,439 -31,338 -26,506 -28,840 -21,684 -39,51 1 -56,172
EFTA -8,731 -15,965 -8,117 -13,962 -I7 ,i55 -14,288 -8,538
Other Europe 3,335 14,155 3,066 2,406 1,978 1,873 1,175
Americas 23,028 24,577 24,641 27,83 1 37,073 41,497 48,087
ofwhich USA 21,997 24,535 22,295 24,567 31,414 33,889 41,392
Asia -21.793 -23,594 -21,975 -28,732 -29,5 12 -25,694 -14,540

T h e b a la n c e o f p a y m e n ts and excha nge ra te s
Australasia and 1,766 2,780 2,840 3,714 5,485 5,998 5,21 1

Oceania
Aírica -817 -794 1,524 2,752 2,453 -1,003 -5,010
Total -40,694 -44,901 -28,115 ị -37,058 -23,825 -34,469 -32,100
Table 10.5 UKTrade in goods and services: geographical analysis, 2007“ 201 3 (source:Table 9.3, UK
Balance o f Payments 2 0 14. Offìce fo r National Statistics)
£FĨA = Europeơn Free Trade Association: Iceland, Liechtenstein. Norway ơnd Switzerland
Trade in services
The transactions that are concerned with the im port and export of services are recorded in
this section.These are, o f course, a vital part o f international trade and have played an important
role in the UK balance o f payments.Traditionally, the UK has had a deíìcit on the visible trade
part o f its current account, that is, it has imported more goods than it has exported, but this has
often been compensated for by a surplus earned in services.This changed in the I980s, as oil
exports expanded, and the oil price peaked.The visible trade balance was in surplus between
1980 and 1982, after which it moved into deíìcit again.The traditional surplus on services, vvhich
reached £78 billion in 201 3, has not proved large enough to prevent a persistent deíìcit on the
overall trade in goods and services since 1997. Some o f the principal components o f the trade
in services account are:
a) transport, including sea transport;
b) Insurance services;
c) financial services.
Relevant components o f these items are discussed below.
The sea tra n s p o rt accou n t

This now íorms part o f the transport account in the UK's balance o f payments. It is important
to note that it does not measure the total value o f shipping to the balance o f payments, for
three main reasons.
The transactions are recorded on an expenditure basis, and not adjusted to measure the value
added o f each sector.
The transactions associated with shipping, and the provision o f shipping services, such as marine
insurance, cargo Insurance and shipbroking services are recorded elsewhere in the accounts.
The figures do not allow for any knock-on effects that the earnings might create for employment
and additional domestic jobs related to the shipping industry.They must be regarded as very
rough and ready measures o f the role o f shipping in the UK economy.
Appendix 10.1 reproduces part o f the transportation account from the 2014 UK Balance of
Payments, published by the ONS. The íìgures available for sea transport are subdivided into
passengen dry cargo and wet cargo. Receipts include earnings from the countrys merchant
fleet, either owned by o r chartered to residents o f the home country; íreight on UK exports;
passenger revenue collected írorn abroad; time charter hire from abroad and disbursements
by foreign ships in the ports o f the home country. These are all credits to the home or
recording country.
The payments on the debit side o f the sea transport figures incỉude home operators' payments
abroad.The chartering o f íoreign vessels, íreights and passenger payments to overseas operators
and various disbursements such as canal dues, p o rt charges and payments for fuel and other
services to vessels. Only the baiances part o f the table is provided in Appendix A. i .

C h a p te r 10
In the case o f the UK, tankers ovvned by oil companies are considered to be UK-operated.
Table 10.6 shows that the UK’s sea transport account has run at a surplus since 2003. The
shipping market boom has raised rates in the years 2005 and 2008, raising credits signiíicantly
and increasing the surplus.The introduction o f the tonnage tax in 2000 led to a recovery in the
UK-registered fleet, which also helps generate greater flows through the account. In 2 0 13, £8.8
billion o f credit was generated and £7.0 billion paid out as debits.These flows are relatively small
compared with those generated by the íìnancial services secton but nevertheiess, they are still
signiíicant. Howeven in 2 0 13, 66 ships left the UK flag while only 19 joined, with such countries
as China and Singapore being among the key beneficiaries. It remains to be seen how this will
affect the UK sea transport account balance.
What were the reasons for the UK's long-term relative decline and imbalances in its sea
transport account over the last tw o decades?
it has been suggested that the following elements heip in understanding the past decline:
1. The heavy commitment historically to sterling area trade and its cross trade which has
grovvn at a slovver rate than international trade.
2. The significant reorientation o f UK trade and movement away from the more distant
markets tovvards the closer industrial regions, in particular Europe, has run counter to
UK shipping which had traditionally concentrated on the long-distance trades. 50% o f UK
merchandise trade is now with its European Union partners.
3. Shipping íreights are usually related to cargo weight rather than value. British export
tonnage has been declining since 1914 with a movement away from the heavy staple
Industries, developed in th e i 9th cen tu ry exporting coal, iron, Steel and textiles, tovvards
more technologically sophisticated exports o f high value and low vveights.
4. The Virtual disappearance o f the re-export trade has been a depressive iníluence on the
UK shippings net contribution to the balance o f payments, as most o f this trade is novv
through Rotterdam or Antvverp.
Trade in financial services - th e c o n trib u tio n o f the C ity o f London financial centre
This category includes a wide range o f íìnancial and other services which generate íoreign
exchange earnings.This may be a very important item in the economies o f certain countries, for
example, Hong Kong and Singapore and, o f course.the UKThe financial sector inciudes receipts
fro m and p aym ents fo r Insurance, banking, c o m m o d ity tra d in g , m erch a n ting , brokerages, th e
earnings o f investmenttrusts and pension íunds. Some oíthese earnings are shovvn inTable iO.7.
The Insurance sections will incorporate the earnÌRgs o f Lloyds o f London.The Lioyds Annual
Report for 2 0 13 reports total gross premiums o f £26 billion in 2 0 13. Only 18% o f Lioyds total
business was in the UK in 2 0 13, so much o f this Insurance flow will be a credit, contributing
to the net balances shown inTable 3.4 o f the UK balance o f payments 2014. The credits from
m arine and o th e r ty p e s o f Insurance, w h ich are also shipping related, are n o t se p a ra te ly re co rd e d
in these accounts.
In a study carried out by O xford Economics in 20 i 3, it vvas estimated that the UK maritirne
business services sector employed 10,100 people, largely in London, and generated £1.5 billion
in gross value added to the UK GDP in 2 0 1I , in addition to the contribution o í UK shipping and
ports. Gross premiums o f marine Insurance were £2 , 195 million in 2 0 13.
It should also be noted that the government account in the trade in services section is the
location for debits arising from the maintenance o f embassies and military bases abroad.The
UK government has had a persistent net deíicit on this account because o f its expenditures on
military bases overseas.

T h e b a la n c e o f p a y m e n ts and excha nge ra te s
Year 2007 2008 2009 2010 2011 2012 2013

Credit 7,390 9,595 17,745 8,105 9,155 9,515 8,761
Debit 6,097 6,891 6,601 ! 6,788 7,036 7,091 7,01 1
Balance Ĩ293 2,704 1,144 1,317 2,1 19 2,424 1,750
Table 10.6 Sea transport in UK trade in services (£ million), 2007-201 3 (source:Table 3.2, UK Balance of
Payments 2 0 14, Office for National Statistics)
Years 2007 2008 2009 2010 2011 2012 2013

Direct Insurance, ' 8,696 8,41 I 10,747 1,151 16,675 17,407 Ị 16,325
incl, íreight
Insurance
Reinsurance -599 1,498 -824 -81 -927 -302 1,860
Baltic Exchange 769 948 714 746 840 228___
Monetary financial 15,539 17,422 I 8,25 I 15 ,174 17,941 i 17,320 16,350
institutions
Table 10.7 Contribution o f selected financial services (balances) 2007-2013 (source:Tables 3.4 and 3.5.
UK Balance o f Payments 2014, Office for National Statistics)
Investment income
The third component o f the current account, items which are recorded here, have generated
significant surpluses until 201 I. In 201 I, this baiance had reached £18 billion, reílecting the
UK's success in becoming one o f the leading íìnancial centres o f the world, rivalling the USA
in particular for leadership.The growth in these Tigures reflects the increased globalisation of
services that has occurred in the past decade.The principal items on this account are direct
investment, portíolio investment and 'other’ investment, in the íorm o f earnings fronn proĩits,
dividends and interest payments arising from the ownership o f assets in the rest o f the world
and the payment o f similar items to overseas residents who own assets in the UK. Hovvever, in
2012 and 2013, the balances were in deíicit by £4,8 billion and £12.3 billion respectively.This
was primarily due to lower earnings and íalling international interest rates.
Transíers
These items differ from all others on the current account because they do not correspond to
an underlying resource transaction.They relate to the transíer o f funds from One country to
another. Government transíers include contributions and subscriptions to the EU and bilateral
aid to developing countries. Private debits would include the repatriation o f salaries by Indian
workers in the UK to relatives in India.Transíers are not included in the calculation o f either
G D P orG N R
Calculating the four net balances o f the trade in visibles, trade in services, investment income,
and transíers yields the current account balance.
10.2.2 T h e Capital and tinancial accounts

The Capital and íìnancial accounts o f the balance o f payments contain the flows concerned with
investment and other Capital transactions, and will include the accounts measuring changes in
the governments reserves, vvhich may be used from time to time if exchange rate movements
become excessive, or if there is a run on the currency in the íoreign exchange markets. In a
íreely global Capital m arket, such direct intervention is v e ry rare.

C h a p te r 10
The two principal types o f Capital investments are recorded in this section o f the accounts, direct
investment and portíolio investment. Direct investment is the act o f buying physical plant and
equipment located in a different country, For exatnple.the large investment by Nissan in setting
up a car plant on Teesside in the UK vvould be direct inwards investment. GlaxoSmithKlines
setting up o f a íactory in Singapore to manuíacture its drugs vvould be an outvvard direct
investment. Portíolio investment reíers to the purchase or sale o f financial assets, such as stocks,
bonds and shares. If a UK citizen decides to buy Microsoít shares, a Capital outflow is created,
as sterling is sold to pay for dollars to purchase the shares, but assets will increase. O ther
Capital transactions cover the main borrovving and lending o f banks and som e o th e r financial
institutions in respect o f non-residents.
An important distinction should be drawn between the current account and the investment
sections o f th e Capital account.
The current account reíers to flows o f expenditure which directly cause flows o f goods and
services and vvhich are likely to be iníluenced by the level o f income at home and abroad,
and by relative prices at home and abroad (imports, exports and home-produced goods and
services).
Transactions in the Capital and financiai accounts relate to changes in the national stock o f assets
and are likely to be iníluenced by relative rates o f return and rates o f interest in particulan
For example, a UK company looking for development opportunities may choose to invest in
íactories abroad if the proíìts it is likely to earn (its rate o f return) will be higher than could be
earned in the UK. Increases in the rate o f interest in the home country may result in íoreigners
investing in that country ratherthan in their own because they will earn more interestThis may
have important implications íorthe rate o f exchange, vvhich will be discussed belovv.
The recordings o f movements in the Capital account may give some diííìculty to readers o f this
publication. It may seem strange, fo r exam ple, that a Capital o utflow is recorded as a debit when
it actually makes the country a creditor.
But it must be remembered that:
• an inflow o f Capital, such as íoreign direct o r portíolio investment, is an immediate credit to
the balance o f payments.This would have the same effect as an infiow of funds paying for
exports;
• an outflow of Capital, such as direct or portfolio investment overseas is an immediate debit

to the balance o f payments.This would have the same eíĩect as an outflow o f funds paying
for exports.
A net infiow o f direct or portfolio investment might well be advantageous as it could result in a
surplus on the balance o f payments. It is important to remember this may only be a short-run
advantage, fon in the long run, the proíits, interest and so on resulting from this investment will be
a debit on the investment income section o f the current account.This latter disadvantage would,
howeven also have to be vveighed against the extent to which íoreign investment significantly
affects job opportunities for the home countrys vvorkers.
A net outílovv o f direct or portíoiio investment may result in an initial deíìcit for the home
country, but in the long run this vviil be compensated for by credits to the invisibles o f the
current marketThis has historically been an important íactor in the UK balance o f payments.
On the other hand, if the direct investment abroad takes jobs away from home country workers
then it may have serious implications for the national economy.
Since the liberalisation o f Capital Controls in 1981, the UK has steadily accumulated a large
portíolio o f overseas assets. In the early I980s, the outflow o f funds was ĩinanced by the
surpluses on the current account.Atthe same time, overseas companies have built up ownership
of UK íactories or equity. For example, Maersk’s takeover o f p & o Nedlloyd in 2005 is a form of
purchase o f UK equity, as was the 2006 sale o f British Airports Authority to a Spanish company.

T h e ba la n ce o f p a y m e n ts and excha nge ra te s
The purchase by Vodaíone o f an Indian telecommunications company in 2007 would be an

example o f a flow in the opposite direction.
10.2.3 A c c o u n tin g f o r g o v e rn m e n t in te r v e n tio n in ío re ig n

exchange m a rk e ts
An important section o f the trading account in UK assets and liabilities measures the degree of
intervention used by the domestic monetary authorities, such as Central banks, in stabilising the
exchange rate o f their currency. In the case of the UK, the Bank o f England monitors the par
value o f the pound and, from time to time, may intervene to try to stabilise it.The movements
of funds required to Tinance these transactions are recorded in several accounts, vvhich will be
discussed in more detail in the section on exchange rates.The principal means o f intervention is
the use o f offìcial reserves.The officialTreasury deíìnition o f offìcial reserves states thatthis item:
consists o f the sterling equivalent, at current rates o f exchơnge, o f drơwings on and ơdditlons
to, the gold, convertible currencies and special Drawing Rights (SDR's) held in the Exchange
Equalisation Account and, from Julỵ 1972, changes in UK reserves in the IMF. From July 1979 it
ơlso included reserves o f European Currency Units.
It should be pointed out that one o f Gordon Brown's fìrst acts on becoming Chancellor of
the Exchequer was to sell the last remaining stocks o f gold - the UK no longer uses it as a
reserve asset.
The Bank o f England sells these reserves on the foreign exchange market when it vvants to
increase the demand for sterling and buys íoreign currencies to add to its reserves when there
is upward pressure on the pound. Intervention o f this type is much less common than it used to
be, because for most of the past 18 years, the pounds value has been driven by market forces.
This IS discussed in more detail below.
The absence o f any persistent intervention, by the UK government, and its repayment of loans
taken out in the I97ŨS from the IMF mean that many o f the account entries are zero, as can
be seen in Appendix 10 ,1. Transactions involving the Exchange Equalisation Account (EEA),
allocations of SDR and IMF gold subscription account have all been non-existent.When the UK
government has intervened, its intervention has shovvn up in borrowings from other European
Central banks and its use o f official reserves. All o f the action revolved around the UK's
relationship with the exchange rate mechanism o f the European Community, which became
the single European currency, the euro, in 1999.The UK exercised its option to remain outside
the Eurozone and retained sterling.This allovvs the UK currency to adịust to changes in world
market conditions, rather than just using the single monetary instrument o f the interest rate.
l0 .2 .4 T h e In te rn a tio n a l M o n e ta ry Fund (IM F )

The IMF was one outcome o f the Bretton Woods Agreement, which came into operation
in 1947. The agreement was intended to encourage international co-operation in respect of
the stabilisation o f íoreign exchange rates in the post-war period.VVhen a country becomes a
member o f the IMF, it is given a quota that is based on the members national income, its stock
o f íoreign exchange reserves and other signs o f its economic importance.The quota is directly
reílected in terms o f the voting and drawing rights o f that country. A subscription is paid by each
member, 25% in gold and the remainder in the countrys own currency.The IMF has a reserve
o f currencies from its members vvhich it may later lend to countries with balance o f payment
deficits. A country may b o rro w up to 75% o f its quota, and any loan, plus Service charges, has
to be repaid usually vvithin three to five years. Purther drawings above the 75% may be made,
but these normally result in the IMF imposing increasingly severe conditions on the country
concerned in terms of the economic policies it should pursue.These additional drawings are not
normally included in the balance o f payments in terms o f currency reserves because they are
only lent under certain conditions.

C h a p te r 10
Special D raw ing Rights (SDRs)

These were agreed by the IMF in 1967 and came into operation in l970.These are additional
reserve assets, inconvertible paper money vvhich is issued to members in proportion to their
quota.Any member has free access to SDRs, but it must maintain 30% o f its initial allocation over
a fìve-year period. Dravvings may be used to purchase foreign exchange from other members.
SDRs are charged at a rate o f 5% interest and, since they are never repaid, they make a net
addition to vvorld reserves and so differ from ordinary drawing rights which have to be repaid.
10.3 E X C H A N G E RATES A N D T H E B A L A N C E OF P A YM EN TS
A glance at any o f the íìnancial press reveals that there are very vvide íluctuations in currency
values; a situation that has developed from the early 1970s. A lter discussing some different
measures o f exchange rates, this section gives a brieí outline o f the post-war changes that have
occurred in the way that the international monetary system has evoived since 1945. A simple
model o f exchange rate determination is then d e v e lo p e d and its limitations discussed.
There are a number o f diíĩerent ways o f deíìning the rate o f exchange.The spot rate is the
rate for immediate delivery o f a currency, which is usually two or three days.The fow ard rate
is the name given to a contract vvhich promises to deliver a fixed amount o f íoreign exchange
a certain period o f time in advance, usually one or tw o months. Both o f these rates are for
specific currencies. Measuring the relative value o f a currency against another is easily done
with the spot rate, but countries trade with hundreds o f partners. Economists now use a trade-
weighted indexto measure Lhe overall períormance o f one currency against itstrading partners,
the weights being given by the relative shares o f trade. For the UK, the relevant index is the
Sterling Exchange Rate Index, set at 100 for January 2005. A t December 2 0 14 it stood at 88.25,
this means that the pounds value fell by about 12% against all its trading partners currencies,
reflecting an overall devaluation o f the currency.This is sometimes called the effective exchange
rate, because it reAects the currencys value against all o f its trading partners.
Between 1945 and 19 7 1 most world economies operated a fìxed exchange rate system. Under
these arrangements, each countrys currency was given a par value, vvhich was guaranteed by
the Central bank within a band o f 2.5% either side.The Central bank thus needed to intervene
to maintain this rate. Suppose there is a greater supply o f sterling onto the íoreign exchange
m arket than th e re is d em an d fo r it at its cu rre n t p a r v a lu e .T h e Central bank, in this case , the
Bank o f England, would intervene by buying its own currency from traders, which it vvould
íìnance by running down reserves o f gold and íoreign currencies held for that purpose. If there
was an excess demand for sterling, it vvould sell its own currency and purchase dollars, yen and
so on to be placed back into its reserves.
Providing that there was, over time, a broad balance o f demand and supply, this kind of
arrangement vvorked quite well. But if there is a persistent excess suppịy o f sterling.there vvould
be a persistent drain on reserves.This cannot be sustained indeíìnitely, so the government vvould
have to intervene to try to eliminate the cause o f the problem.There is thereíore scope for
government policy action.
One major disadvantage o f the above system was that par values were not changed to reílect
diíĩerences in the underlying economic performance o f the majortrading economies.The rise of
Japan and the decline o f the UK as economic powers were not reílected in the relative values
o f the two currencies.The UK, in particulan found it had persistent problems on its balance of
payments at the par value o f £ I = $2.40; a rate vvhich lasted from 1949 until 1967.
One way o f understanding the arise o f such problems is to follow the model below. Assume
that all currency flows are driven by trade. Portíolio and direct investment are set to zero.There
are two trading countries.the UK and the USA.The UK exports goods and services to the USA
and the USA does the same to the UK. Consider three different exchange rates: L\ = $1, £1

T h e ba la n ce o f p a y m e n ts and exch a n g e ra te s
= $0.667 and £ I = $0.50.This is equivalent t o $ l = £ l , $ l = £1.50, and $ I = £2.00.Thus the

dollar is appreciating against sterling or sterling is depreciating against the dollar,
A UK car costing £5,000 will sell at $5,000, $3,333, and $2,500 respectively. A t the lower dollar
pnce, more cars will be sold to the USA. As a result, there is a greater demand for sterling
from u s exporters.This is shovvn as schedule DD in Pigure 10. i. Now consider the efíect of
these exchange rates on the sterling price o f a u s export priced at $5,000. This translates
into sterling prices o f £5,000, £7,500 and £10,000 respectively. As the pound depreciates against
the dollar; the sterling price o f u s dollar exports rises and demand will fall.This means that the
supply o f sterling onto the íoreign exchange market wili rise as the value o f the pound rises.This
relationship is drawn as s in Pigure 10 .1.
If the market is allovved to find its own level, an equilibrium rate o f exchange is determined. In
this example, it is £ I = $ 1.50. A t this rate, the demand for sterling from u s exporters equals the
supply of sterling írorn UK importers. Since they are both using the same rate, it follows that the
value o f exports to the u s must equal the value o f imports at that rate o f exchange. In other
vvords, equilibrium in the íoreign exchange market coincides with equilibrium in the value of
international merchandise trade.
Now suppose the u s manages to sell far more goods to the UK as the result o f launching a new
productThere will be a Sharp rise in the sales o f u s exports at every possible rate o f exchange.
This is shovvn by a rightward shift in the ss curve as UK importers supply more sterling at every
possible exchange rate. In a free market, the value o f the pound would fall against the dollan to
£ 1.00 = $ i .00 in this example. A t this new rate o f exchange, UK exports are cheaper in dollar
terms and imports from the u s become more expensive in sterling terms.This will reduce us
im port volumes and increase UK export volumes, with a new equilibrium at point B,
lf, on the other hand, the government is unwilling to permit the pound to fall in value, it vvould
have to step in. It does this by providing an additional source o f demand, suffìcient to maintain
the rate at £1 = $1.50. It vvould have to run down its reserves to fund this process. Note that
if the problem persisted next year, it would again have to run down its reserves.This solution is
only temporary in nature:there are limits to the degree o f support.
Pigure 10 .1 Free market equilibrium in the íoreign exchange market
Aíter i 9 7 1, this kind o f intervention became less necessary. Exchange rates have now been
left to find their own levels, that is, they have been permitted to íloatThe government can still
iníluence the free market rate, but the intervention is usually achieved via the manipulation of
Economics of Sea Transport and International Trade 23 I

C h a p te r 10
interest rates. The reason for this is that a very large proportion o f currency movements are
now driven by portíolio investments, which are not directly related to trade. Indeed, a large part
o f modern financial derivatives trading has evolved as a means o f profiting from risk in various
forms, including currency riskThese currency flows are affected by the rates of return earned,
vvhich themselves are driven by levels o f interest rates. In the context o f the above example, the
UK government can raise the rate o f interest, which has the effect o f increasing the demand for
sterling írom abroad. Such rate rises also reduce domestic demand, so governments have to use
them with care.
An example may help to illustrate the ideas mentioned above. In the late I980s, the UK was
shadovving the German currency, the Deutsche Mark (DM), with a target rate of £1 = DM2.95,
as part o f its anti-inflation strategy. During 1991 and 1992, u s interest rates feli and German
rates rose, as reuniíìcation was financed. As a result, a large amount o f portíolio funds and
banking assets, were moved to Germany.This caused a wave o f selling o f the pound, which the
UK authorities met by raising domestic interest rates. A wave o f speculative selling then triggered
several currency realignments in Europe.The UK borrovved £7.25 billion in íoreign currency to
assist its deíence o f sterling. By 16 Septemberthe currency was trading at its íloor level. On that
day, two successive rises in interest rates were announced, from 10 to 12, and then from 12 to
15%. Neither had any effect on the sellin g vvave o f sterling, so the pound was allowed to float, it
fell from 2.95 to 2.36DM in one month, a devaluation o f about 20%, against that currency.
In this case, neither interest rate increases nor government announcements were suffìcient to
prevent a change in the value o f the currency against the German mark.
Pigure 10.2 shovvs the development o f the spot exchange rate betvveen sterling and the us
dollar over the period 1995 to 2 0 10, together with the associated trade balance, in £bn, over
the same period. It is clear that there is some association between the rising value o f sterling in
the period 2001 to 2005 and the rising UKtrade surplus in that period.The relationship is not
very strong, because other íactors drive the currency as well, as has been discussed.
1995 2000 2005 2010
Pigure 10.2 UK-US trade balance and the spot exchange rate, 19 9 5 -2 0 10 (source: denved by the
authorírom IMF Direction oíTrade Statistics, MIMAS, 2007)

T h e balance o f p a y m e n ts and excha nge ra te s
iO.4 D E A L IN G W IT H A B A L A N C E OF PAYM EN TS D EPIC IT:

F IX E D E X C H A N G E RATES
The way in vvhich a balance o f payments deíicit is dealt with by a government will depend to a
large extent on the cause o f the deíìcit and whether it is a long- or short-term trend.
A detìcit may arise on the part o f the private transactions recorded in either the current or
Capital account ofthe balance o f payments. In effect,this creates an excess supply ofthe domestic
currency on the íoreign exchange markets, since the demand fon say, sterling, generated by its
credits, is less than the supply o f sterling generated by private sector debits. If a government is
committed to maintaining the present rate o f exchange, it will have to find a means of supplying
the difference between these two amounts, in o rd e rto maintain the target exchange rate.
It may do this by running dovvn its stock of reserves o f íoreign exchange. In effect, it enters
the íoreign exchange market and buys back its own currency, creating an additional source
o f demand. But it can only do this as long as there is a positive stock o f reserve currencies.
Persistent deíìcits will drain these reserves and so their use can only be a temporary device.
Alternatively, the government may try to reduce the deíicit by the use o f domestic monetary
policy, namely, raising domestic rates o f interest.This has two effects: it encourages an increase
in holdings o f portíolio investments o f UK assets from abroad and it reduces domestic demand,
thus slowing the growth o f imports. Both these effects will reduce the size o f the private sector
deficit.
In extreme circumstances, additional íìnancial support may be obtained from the IMF or other
international banks, primarily to back up the offìcial reserves.The price o f such arrangements
often means that national governments have to run their economic policies in line vvith IMF
recommendations and these may not be very comíortable.
In addition to intervening in the íoreign currency markets or using interest rate policy,
governments may use the following policy instruments to try to reduce the defìcit:
• raise tariff barriers;

• grant export subsidies;
• im pose exchange Controls;
• impose quotas on imports.

Many o f these alternative strategies are now more diffícult to apply on a unilateral basis under
W TO rules. For example, in 2001 the USA created an international row by unilaterally raising
tariíĩs on Steel im ports, ostensibiy because its traditionai Steel producers were íacing unfair
competition from Japanese, European and Indian producers. Atter a number o f years, the issue
was resolved, with the W TO íìnding that the USA had breached the agreed trade rules.
Note that many countries now recognise that these devices do not cure the underlying
reason for exchange rate realignments, which are driven by changes in the relative economic
competitiveness o f the world’s economies. The only way o f ensuring a strong currency is to
have a strong economy. In the long run, policies designed to ensure that the economy remains
competitive are far more likely to be successíul than those designed to deal with what is a
symptom, not a cause, o f a problem. But political expediency, as in the 2001 case o f President
Bush and u s Steel imports, is often a very strong driven
The vast trade surplus generated by China has to be reinvested abroad in the form o f overseas
investments to help prevent an accumulation o f large amounts o f foreign currency in its reserves.
Under a fixed rate scheme, the trade surplus currency will be in excess demand, and íoreign
currency can be purchased in exchange for Chinese currency needed to fund the trade. But
accumulating reserves does not help the economy to grow.The Chinese economy has grown
rapidly. In which case, the revaluation, by making Chinese exports slightly more expensive in
dollar terms, might help slow down Chinese export growth slightly. It vvould also lower the

C h a p te r iO
domestic price o f imported goods in China, thus marginally encouraging more imports and
helping to reduce the trade imbalance.
In March 2 0 12, the Chinese government announced that it would allow the yuan to float more
íreely. This is in line with previous appreciations o f the yuan against the dollan In the penod
2 0 1I - 2 0 12 the yuan rose by 8% in value compared to the dollan
10.5 D E A L IN G W IT H A B A L A N C E OF P A YM EN TS D E P IC IT:
P LO A TIN G E X C H A N G E RATES
Under a regime o f íloating exchange rates, government intervention should not be required, at
least in theory.This is because any private sector deíìcit will generate economic íorces that will
help to restore equilibrium to the account.Two examples are given here.
Pirst, suppose there is a deíìcit in trade in goods and services on the current account and a
balance on the private transactions o f the Capital account. There will be an excess supply of
sterling at the present rate o f exchange as a result. If sterlings value is determined by supply
and demand, its price will fall against other countries' currencies.This will make exports become
cheaper in overseas markets and imports dearer in the UK. Provided that certain conditions
are satisíìed, exports will rise, generating an increase in demand for sterling and imports will
fall, reducing its supply. Both o f these processes will lead to a reduction in the excess supply of
sterling.Thereíore, the rate íalls until it íìnds its equilibrium level, at which point exports and
imports are also rebalanced.
Alternatively, the deficit may be on the Capital account. But this means the same process will
evolve.The diíĩerence being that lower currency values raise rates o f return to outside holders
o f currency and start to make sterling look more attractive as a home for portíolio investment.
10.6 E X C H A N G E RATES A N D S H IP P IN G
One o f the most obvious exampies o f the potential iníluence o f exchange rates in shipping
is that o f brokers who earn their commission in u s dollars.This is the currency in which their
business is done, but their expenses must be met in their home currency, so as the exchange
rate alters so does their income. For example, sometime in mid-2007 the £ was worth u s$ 1.97,
whereas at the start o f 2 0 15 it was vvorth us$ 1.54.Therefore, an income o f us$ 100,000 was
vvorth only £50,761 in 2007, but £64,935 in 201 S.The fall in the value o f the dollar generates a
sterling Capital loss in this case.
As you may imagine, this couid create problems as all the UK brokers' own expenses will
normally have to be met in sterling and not u s dollars. For this reason, brokers may very well
opt for a u s dollar rather than a sterling mortgage when buying a house.They also hire staff to
manage their risk exposure to currency Auctuations.
We can look very simply at the business side for a moment and consider the cost o f bunkering
a vessel.This is a dollar cost. Let us say that in late 2014 the price in Rotterdam o f 1,000 tons
of bunkers would be us$600,000 ($600 per ton) giving a totai o f £387,000, using the current
exchange rate.Three months previously the exchange rate was such that the cost would have
been £379,075 (assuming the dollar cost was the same).
This volatility in exchange rates can be dealt with in a number o f ways: measure all transactions
in dollars, vvhere possible; hedge some o f the currency risk by using the forward exchange
market.This works by entering into a contract to buy dollars, at a rate íìxed today, for three
months fow ard delivery, lf a UK importer had a contract to settle with a us trader three
months íotârd, they could hedge against currency risk in this íashion.There is, of course, a cost
to the hedge.

T h e ba la n ce o f p a y m e n ts and excha nge ra te s
The increased volatility o f exchange rates has led to the development of sophisticated financial
products that are designed to permit shipowners and ship charterers to limit their degree
o f currency risk exposure.These are called financial derivatives or options. An analysis o f this
market is beyond the scope o f this chapter
The rate o f exchange evidently has a strong iníluence on the balance o f payments and is vital in
considering prices in international trade.
The individual and the company in international trade and related services must understand
what is happening on the exchange market and the balance of payments o íth e ir country.


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i

TÀI LIỆU THƯVIỆN

First published 2015

Institute of Chartered Shipbrokers 2015

Printed by Cambrian Printers

ii Institute of Chartered Shipbrokers

Economics of SeaTransport and International Trade iii

iv Institute of Chartered Shipbrokers

Economics of SeaTransport and International Trade

3.3 TRENDS IN THE WORLD MERCHANT FLEET 1970-2014 41

3.6 SURPLUSTONNAGE A N D TH E CONCEPT OFTHE ACTIVE FLEET 53

3.8 REƯ\TINGTHEORYTO EMPIRICALEVIDENCE 56

vi Institute of Chartered Shipbrokers

4 S h ipp ing c o s t analysis and e con om ies o f scale 61

4.7 COSTS A N D QUALITYiTHE PROBLEM OF SUB-

5.9 DYNAMIC CONSIDERATIONS 1I I

6.1 SEABORNETRADE IN CRUDE OIL A N D OIL PRODUCTS I 18

Economics of SeaTransport and International Trade v ii

6.4 THE STRUCTURE OPTHETANKER MARKET 132

6.5 SEGMENTED SUPPLY 137

6.7 MODELUNG SUPPLY 138

6.9 PLUCTUATIONS IN MARKET PREIGHT RATES 14 1

7 T h e lin e r tra d e s 143

7.1 DEPINITION O F A LINERSHIPPING SERVICE 144

7.9 PRICING LINER SERVICES 156

8 PortSy sea canals and w a te rw a y s 169

8.3 PORTCOSTSAND SHIPSTIME 172

8.4 PORT COST STRUCTURE 177

v lii Institute of Chartered Shipbrokers

8.9 SEA CANALS, IN Ư \N D WATERWAYS A N D LANDBRIDGES 183

9 S h ip p ín g a n d in te rn a tio n a l tra d e 187

9.3 TYPES OPTRADE FLOWS: INTRA-INDUSTRYTRADE A N D

9.5 ECONOMIC MODELS OPTRADE FLOWS 197

9.11 CONCLUSION 216

10.4 DEALING W ITH A BAƯ\NCE OF PAYMENTS DEPICIT:

Economics of SeaTransport and International Trade ix

Institute of Chartered Shipbrokers

The basic tool kit

I Shipping m arkets are highly co m p e titiv e . T h ey satisíy m o st

Institute of Chartered Shipbrokers

Economics of SeaTransport and International Trade

1.3.1 Real and n o m in a l prices

Pigure I . I Nominal and real value coal trade.

Institute of Chartered Shipbrokers

Year Price per Index N om inal value Real value

Economics of SeaTransport and International Trade

Case s tu d y : Pactors of production

Institute of Chartered Shipbrokers

Price o f cruise ($) Q u a n tity N e w higher level o f N e w lo w e r level o f

Table 1.2 Market demand schedule for cruises

9 10 12 15 20 25 Passenger numbers (OOOs)

Pigure 1.2 Market demand curve for cruises

Economics of SeaTransport and International Trade

1.5.1.1 Prices o f o th e r co m m o d itie s

The price o f substitutes: an item o f goods is a substitute if consumers purchase it instead of

9 10 12 15 20 25 Passenger numbers (OOOs)

Pigure 1.3 Shifts in the conditions o f demand.

8 Institute of Chartered Shipbrokers

There are two distinct movements in demand.