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George A. Gratsos’ speech at the 2nd Annual Capital Link Forum
23/2/2011

Athens, 22 February 2011

Ladies and gentlemen,

I would like to congratulate the organizers of the 2nd annual CAPITAL LINK Greek Shipping Forum for organizing this event and wish them every success.

World shipping is the enabler of globalization, world trade and prosperity. It is more important now than ever before, in order to sustain and fuel the ever increasing growth of emerging economies, which represent, by far the largest proportion of the world’s population.

Greek beneficially controlled shipping represents about 15% of the world’s ship transport capacity. Greeks control about 18.3% of the world’s bulk carrier fleet and about 17.8% of the world’s tanker fleet making us reliable partners of the major exporting and importing nations. Greek shipping know-how is second to no one’s. In the greater Athens/Piraeus area the concentration and quality of operational and technical know-how is of a very high caliber and can probably find efficient solutions to almost any shipping problem.

Shipping is a capital intensive industry. This Forum is an important venue that helps create synergies between shipowners and investors. Shipping investments have been termed by some as erratic and high risk. This cannot be true for an industry that transports over 90% of the world’s trade. What is more probable is that the understanding of what shipping is all about is sometimes lacking.
Shipping is a self correcting cyclical industry.

The only two factors that affect shipping are tonne-mile demand fluctuations and shipping tonne mile supply capability. Understanding the underlying parameters that affect the behavior of the parties involved, is critical to the outcome of shipping investments. “Animal spirits” produce the cycles.

Landed cost of goods
Possibly the most important parameter that affects shipping, is the landed cost of the cargo. The receiver is the motive force of shipping developments. Because of him, producers produce, shippers ship, charterers charter. Shipowners serve the receiver’s transport requirements. Much like anyone in this room, the receiver is interested in getting the commodity delivered at his door at the lowest price. This directly effects the sourcing decision, therefore the tonne-mile demand of transport, which can change significantly.

Large volumes justify infrastructure developments, in order to reduce overall transport costs through the use of larger ships, faster loading capabilities etc.

They also cause prospecting for other sources which may be accessible by other means, as well as induce investments in pipelines, rail infrastructure etc. which would inevitably reduce shipping tonne-mile demand. Landed cost is the most significant driver of evolution.

Ship speed
Ships do not always trade at the same speed, they will trade at the speed at which they maximize time charter earnings for any combination of freight rate to bunker price. It is fashionable to talk of slow steaming these days but it happens all the time, ever since the price of bunkers became significant. This is so because ship consumption changes to the cube, or even more, of the ship’s speed, thus changing the mix of fixed and variable costs. In times of high markets, ships speed up and burn more fuel, since the increased fuel costs are more than compensated by the higher freight rates, which increase exponentially in periods of high fleet utilization.

Under the circumstances, ship tonne-mile supply capability is an ever changing parameter which acts as a freight rate damper both on the way up and the way down. During the recent market peaks, ship tonne-mile capability was working at its limits.

Ship prices
It is said that ship prices fluctuate wildly, and this is so. On the other hand they have a definable core value, the rest being sentiment.

We have recent historical data of newbuilding ship price lows in 1999. Such lows adjusted for the inflation for steel and engine prices, as well as for overall inflation would represent a reasonable newbuilding price floor. Whatever one pays above that is “froth” justified by discounted expectations of receivables from the freight market, if they materialize.

The scrap or residual price is dependant on the price of steel. Steel, when made by blast furnaces, uses up to 25-30% scrap as feed stock. Electric ark furnaces use 100% scrap as feed stock. Ships’ scrap, at times of high scrapping represents no more than about 1.5% of the total scrap used to produce new steel. Therefore scrap price fluctuations can be expected to relate to new steel prices, and they do. In this respect we have another known floor. These two numbers would indicate some sort of floor for ships of all types and sizes regardless of age, for valuation purposes.

That being the case I would have expected bankers and investors to have shown greater restraint during the peak market periods and to be more forthcoming in times of crisis. Shipping is a cyclical investment therefore everyone involved should understand the inevitable cycles. Ship valuations on the basis of “last done” are nothing more than tracking an index.

Controlling freight market levels
The last and most important parameter is the level of freight rates.

This is not a shipowers’ world, we only do its transport. The interest of national economies, especially those of emerging markets, is to control their input and output costs, in order for their economies to be cost competitive and grow. It is not by coincidence that England and Europe in the days of the Empires had a large shipbuilding capacity as did Japan, Korea and now China and probably India in the near future.

Shipyards are “freight market destruction mechanisms” that help keep input costs low. If one looks at it from the point of view of China, which imports about 800 million tonnes of dry bulk cargo per year by sea, the difference from the average rates of 2007 to mid 2008 to sustainable levels is about $26/tonne, and would represent about $20 billion/a year, a massive sum. This amount justifies substantial infrastructure development to reduce transport cost. Under the circumstances creating sufficient shipbuilding capacity was a priority for the economic development of China.

Similarly charterers who charter-in tonnage for periods during boom times will, in all probability, renegotiate rates when the market is low or file for protection. A difference of $10,000 a day on a period charter for 50 ships represents approximately $175 million a year, a very sizable amount for any operation. Under the circumstances, period charters do not represent much security in the inevitable freight market downturn, as has been proved time and again. They only limit shipowner earnings on the upside .

Conclusion
Concluding, the two most important players in shipping are the receiver and the shipowner. They are the long term players. The one depends on the other for his wellbeing. They must understand each other’s requirements and be able to fulfill them. Brokers and charterers not directly linked to end users, are no more than intermediates who have little influence on shipping developments.

This must be understood by both investors and financiers.
I suggest that if investors looked at shipping in this way, they would have a clearer view of the risks and the potential rewards of shipping investments, and fewer surprises.

Finally, I wish all delegates attending success and happy, profitable sailing.

Thank you

George A. Gratsos Ph.D.
President, Hellenic Chamber of Shipping


 
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