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There are four separate but interrelated markets in shipping, namely, the freight market, which trades sea transport, the second-hand market, which trades used ships, the new building market, which trades new ships, and the demolition market, which deals with scrap ships. These four shipping markets are closely interrelated. This section aims to provide insights into the four shipping markets and explain how these separate markets interact to affect one another. We discuss an empirical study which shows that seaborne trade significantly affects fleet size and the freight rate. On the other hand, fleet size is affected by the freight rate, and the latter has a significant impact on vessel prices. 1. Introduction Bulk shipping transport is a practicable and cost-effective means for transporting large volumes of cargo to serve international trade. Bulk ships carry dry cargo in bulk from one port to another. Bulk shipping usually operates without a fixed route and schedule. In the freight market, cargoes are carried at freight rates, whereby the terms and conditions are negotiated between shippers and carriers through shipbrokers. There are numerous factors affecting the operation of the bulk shipping market. The performance of the bulk shipping market depends on the demand for and supply of bulk shipping services, as well as the characteristics of the market structure, such as the number of shipping firms, the sizes of their operations, and the degree of homogeneity of their services. Bulk shipping researchers have suggested that the bulk shipping industry operates under a market structure similar to that of perfect competition (Harlaftis and Theotokas 2002; Clarkson Research Studies 2004). The market structure of bulk shipping is characterized by several conditions: • First, large numbers of firms that own bulk ships are able to provide similar bulk shipping services. • In addition, entrants to the bulk shipping market can easily gain access to in formation and customers such as freight rates from the Baltic Dry Index and customers from shipbrokers. • Although the large capital investment required to purchase ships can deter new entrants to the bulk shipping market, assistance and support from shipping commercial banks are available to finance shipping investors. • The entry barriers to the bulk shipping market are weak other than the large capital investment requirements. • There are fewer regulatory or economic obstacles for bulk shipping firms to with draw from the market. Their exit is unlikely to result in a corresponding decrease in the supply of tonnage as the exiting bulk shipping firms may have sold their tonnage to other shipping firms in the second-hand sale and purchase market. • Product development and promotion activities are not necessary for bulk ship ping firms to operate, and information about freight rates and other business mat ters can be easily obtained through various sources such as the Baltic Dry Index. • To a large extent, price (i.e., freight rate) and fleet size in the bulk shipping market are determined by the market. From the industrial organization perspective, the demand and supply conditions in the bulk shipping market can influence the market structure. The market structure affects the operations and investment decisions of firms in the marketplace. In the bulk shipping market, buyers and sellers trade transport services to set the freight rate (i.e., price) and determine the fleet size (i.e., quantity). In the bulk shipping market, the freight rate is affected by seaborne trade, which is key to the demand for bulk shipping services. On the other hand, the freight rate can influence carriers' decisions on adjusting the fleet size to meet the market demand. The bulk shipping market consists of four separate but interrelated markets, namely: 1. the freight market, where sea transport services are traded; 2. the new building market, where new ships are ordered and built; 3. the sale and purchase market, where second-hand ships are sold and brought; 4. the demolition market, where old ships are scrapped. FIG. 1 illustrates the composition of these four shipping market segments. These four shipping markets can further be divided into a real market and an auxiliary market: • The real market represents the new building and demolition markets, where an increase in new building leads to an increase in total capacity, whereas an in crease in ship scrapping means a decrease in total capacity in the bulk shipping market. • The auxiliary market corresponds to the freight market, which trades sea transport, as well as the sale and purchase market for second-hand ships. These are auxiliary markets because the transactions in sea transport between shippers and shipping firms, as well as buying and selling of second-hand ships between shipowners, have no influence on the total capacity in the bulk shipping market. 2. The Shipping Market ----------
Shipping Market Shipping market Real Market Real market Auxiliary Market Auxiliary market New Building Market New building market Demolition Market Demolition market Freight Market Freight market Sale & Purchase Market Sale and purchase market -----------
Sale and Purchase Market Demolition Market New Building Market Freight Market Shipping Cash Flow Sale and purchase market Demolition market New building market Freight market Shipping cash flow -----------
Trade volume -- Investment in new ships -- Freight rate -- Price of new ships -- Firm's profit ---------- These four shipping markets can be linked by cash flows among them. As shown in Fig. 2, the cash flow movement can be described as follows: • The main cash inflow is the revenue generated from the freight market, where the ups and downs of freight rates are the primary mechanism driving investors to adjust their fleet sizes. • In the demolition market, old ships sold to scrap dealers provide another source of cash inflow. In general, more old ships are delivered to scrapyards during a recession period. Demand for shipping services decreases during economic downturns. Scrapping of old ships in the demolition market reduces the total capacity in the bulk shipping market. • Both cash inflow and cash outflow can be generated from the sale and purchase market, where shipowners buy and sell used ships. However, the transactions involving second-hand ships would not change the shipping capacity available in the shipping industry. • Finally, the new building market is an outflow of cash as shipowners pay cash to shipyards for new ships. 2.1 New Buildings Demand for new vessels reflects the need for sea transport capacity. It usually takes a few years from ordering a new ship before the ship is ready to serve the freight market. A decision to order a ship should reflect a shipping investor's expectation of future freight rates. The price of building a new vessel can serve as a stabilization mechanism for the shipping industry. FIG. 3 shows how the new vessel price can function to stabilize the shipping market: • When sea transport demand goes up, the freight rate will increase and investment in new vessels is accelerated subsequently. • As a result, the new building price will rise, stabilizing the shipping market with a "barrier" to excessive profits. • To increase the supply of sea transport at periods of high freight rates, ship owners increase their fleet sizes by purchasing new ships. • Following the rise in the freight rate, shipbuilders will respond to the increased demand for new vessels by setting a higher price for new buildings. Thus, the freight rate can be considered as a determinant of the price of new buildings. Building new ships is the primary method of increasing the supply of tonnage in the bulk shipping market. The demand for new ships by shipping firms is de rived from the need for new tonnage to meet their increased sea transport requirements. Because it requires a large capital investment to purchase a new ship, the cost of building a new ship therefore becomes crucial in terms of return on in vestment. Shipowners tend to favor a low new building price. Investors opt for new ships when they perceive the price is low, with the expectation of selling the vessel later at a higher price. There fore, investors may order new ships when the price of building new ships is low. The price mechanism of the new building industry has implications for the demand for new vessels. 2.2 Second-hand Vessels The main cash inflow of the bulk shipping business is the revenue generated from the freight market. Such inflow of cash from the freight market provides capital for shipowners to acquire new vessels, as well as second-hand ships to satisfy the market demand for sea transport (Clarkson Research Studies 2004). Because it takes a few years to build a new vessel, the second-hand ship market becomes an alternative source of ships during freight booms. Indeed, Beenstock (1985) suggested that second-hand and new ships are substitutes as they are the same assets only differing in age. The second-hand ship market can be considered as an auxiliary market because the buying and selling of second-hand ships is less likely to change the number of vessels or carrying capacity in the shipping market. On the other hand, the second hand market is closely integrated with the freight market. The price of a second-hand vessel rises at the time of a freight boom and drops at the time of a freight depression. A key function of the second-hand ship market is to reallocate vessels among ship operators. Besides, the second-hand ship market improves the efficiency of the shipping market by reducing the market exit cost, where shipowners can sell their used ships when they leave the industry. It also facilitates market entry by allowing potential investors to buy used ships and enter the shipping market. A ship could have been bought for about USD 32 million in late 2001. In 2004, a few years later, a used ship of similar size could be sold for USD 62 million (Xinhua Financial Network News 2004). To maximize their profits, investors acquire ships when ships are cheap and sell ships when the peak is reached. Owing to fluctuations in the price of second-hand ships, considerable profit opportunities may arise through "buy low and sell high" strategies. However, low freight rates usually coincide with low vessel prices, which are not desirable for shipowners with excessive tonnage, but they do provide a good opportunity for investors to buy ships at low prices. 2.3 Demolition Vessels The second-hand vessel sale and purchase market is highly competitive and cyclical, and the price movement is usually limited by the price of a new ship and the price of a scrap vessel. The price of a new ship imposes a constraint on the upper limits of second-hand ship prices. However, there are exceptions during periods of a freight boom when shipowners pay in excess of new building prices to secure timely tonnage to serve the freight market (Ocean Shipping Consultants Ltd 2004). On the other hand, the vessel scrapping price denotes the minimum price of a second-hand vessel. Similar to the second-hand vessel price, the scrap vessel price tends to follow the movement of the freight market. During the period of a freight boom, when expectation of future revenue is high, the second-hand vessel price is high and shipowners are reluctant to sell their tonnage for scrap. As such, there will be reduced scrap supply during the period of a freight boom, exerting pressure on the scrap dealers to increase the vessel scrapping price. Old vessels sold to scrap dealers provide a cash source from the perspective of shipowners . The decision to scrap a ship is based on a carrier's expectation of the future operating profitability of its ships and its own financial position. Usually, the supply of old ships to the scrap market depends on the scrapping value. The decision to scrap is related to shipowners' expectations about the future prospects of international trading activities. Ships will be scrapped when profitability for ships is negative. A high scrap price motivates carriers to send more ships to the demolition market, which in turn reduces their fleet sizes. Scrap ping can also be a tool for ship operators to adjust their capacity. In sum, vessels in the bulk shipping market include new buildings and second-hand and scrap vessels. Fleet size can be influenced by the prices of these vessels. 2.4 Freight Rate The freight market trades shipping services for transporting cargoes. The demand for freight transport is a function of the freight rate and shipping demand per time period. The freight market creates a situation where the freight rate moves to a level at which the shipping demand is equal to the shipping supply in the market. Seaborne trade growth would lead to an increase in the freight rate. When the growth of seaborne trade triggers a shortage of ships, the shipping industry adjusts by increasing the fleet size. Alternatively, the fleet size in the bulk shipping market will fall if there is a drop in the freight rate, reflecting the pessimistic view of carriers to generate profits from their existing fleet sizes. 2.5 Seaborne Trade Bulk shipping allows flexibility in sea transport to satisfy the timely shipping requirements of seaborne trade by providing transport services worldwide. Carriage of cargo generally does not take place unless there is a need for cargo to be shipped. Shipping demand depends on the needs of shippers to transport their cargoes. Hence, seaborne trade is a major determinant of shipping services. An increase or a decrease in seaborne trade volume would change the demand for sea transport, which in turn influences the freight rate. In other words, the freight rate is determined by the demand for and supply of ship ping services. The freight rate can serve as a signal for carriers and shippers to transact shipping services. If the seaborne trade volume increases, shippers demand more shipping services. When shipping demand exceeds shipping supply, the freight rate will go up. The freight rate coordinates the decision of carriers and shippers to transact shipping services in the bulk shipping market. A high freight rate tends to encourage growth in the world's fleet. Such an association between the freight rate and fleet size can be regarded as the existence of an invisible hand that regulates the bulk shipping market (Smith 1776). Whereas acquiring ships requires a high level of capital investment, the return on investment in ships depends on the volume of trade. If ships are invested in, but seaborne trade does not grow as expected, expensive ships could be laid up (Metaxas 1971). Demand for ships is derived from seaborne trade (Jansson and Shneerson 1987), and a change in seaborne trade can lead to a change in demand for ships. Demand for ships reflects the need for shipping capacity, whereas demand for sea transport is determined by the demand of consumers for goods. Such customer demands will subsequently lead to demand for bulk shipping. This suggests that shipping service providers have little control of shipping demand. To cope with an increase in seaborne trade volume, carriers increase the supply of sea transport. In other words, shipping managers adjust their fleet sizes on the basis of changes in seaborne trade. 3. The Empirical Model In this section we discuss an empirical bulk shipping model, which provides an overview of a number of key factors that affect the bulk shipping market, and how these factors are related to one another. Lun and Quaddus (2009) used 16 years of data extracted from the bulk shipping industry to develop this empirical model. The data source is presented in the Appendix. Key findings are summarized below: • Vessel prices and fleet size: The results show that both new building price and second-hand vessel price do not have a significant impact on fleet size. The findings indicate that a low new building price has no significant impact on the decision of shipping firms to increase their fleet sizes with new ships. On the other hand, a high vessel price does not have a significant impact on restraining shipping firms from ordering new ships. Similarly, the price of second hand vessels does not have a significant impact on the decision of ship operators to adjust their fleet sizes. • Four shipping market segments: The results suggest that there is a positive correlation between new building price and second-hand vessel price. The results also suggest a positive correlation between new building price and scrap vessel price. On the other hand, the results indicate that the relationship be tween new building price and the freight rate is weakly significant (with the p value between 0.050 and 0.100). In addition, second-hand vessel price is positively correlated with scrap vessel price. The findings also show that both second-hand vessel price and scrap vessel price are positively correlated with the freight rate. Hence, the results indicate that the four markets in shipping (i.e., freight market, new building market, second-hand vessel market, and demolition market) are interrelated, as demonstrated in Table 1. • Freight rate, seaborne trade, and fleet size: The findings show that fleet size is affected by the freight rate, and the latter is influenced by seaborne trade. The study also found that fleet size is affected by seaborne trade. The findings can be deployed to develop an empirical model of bulk shipping (as shown in Fig. 4). In the bulk shipping market, there are numerous shipping firms providing homogenous ships and services to compete for the revenue generated from freight rates. In the freight market, the shipping demand is composed of many shippers who need ships to transport their goods by sea. The findings generally support the view that seaborne trade cargo volume positively affects the freight rate. More demand for shipping services leads to a higher freight rate. The capacity of the bulk shipping market is influenced by shipping firms' responses to changes in the freight rate. The findings suggest that there is a positive relationship between the freight rate and fleet size. A trade boom that leads to increased freight rates would motivate shipping firms to increase their fleet sizes. The dynamics of the bulk shipping market determines the freight rate and fleet size. A market can be defined as "an arrangement whereby buyers and sellers interact to determine the prices and quantities of a commodity". In the bulk shipping market, higher seaborne trade volume leads to more demand for shipping services, resulting in a higher freight rate. The relationship between the freight rate and fleet size indicates that suppliers of shipping services tend to increase their capacity when they experience a high market price for shipping services. --------------- Seaborne trade Seaborne trade Fleet size Fleet size Freight rate Freight rate Vessel price Vessel price ---------------- There are different but interrelated markets in bulk shipping. Specifically, the new building and second-hand vessel markets where ships are bought and sold can be considered as the factor market. On the other hand, the product market is the freight market where sea transport services are traded. In general, shipping firms engage in two exchange functions: they buy factors of production in the factor market, and they sell sea transport services in the product market. In bulk shipping, the factor market is the new building and second-hand vessel markets, where ships are bought and sold, whereas the product market is the freight market, where sea transport services are traded. The empirical model of bulk ship ping indicates that vessel prices are not determinants of shipowners' decisions to adjust their fleet sizes. This means that shipping firms do not buy ships in the factor market owing to low vessel prices. Instead, the freight rate is found to influence the decisions of shipping firms to adjust their fleet sizes. These results indicate that the product market (i.e., the freight market) is crucial in determining fleet size. 4. Determinant of Fleet Size of Bulk Shipping In bulk shipping, fleet size has been experiencing continued growth in recent years. According to the empirical model of bulk shipping, both seaborne trade and the freight rate are determinants of fleet size. To understand how these determinants affect fleet size, Lun and Quaddus (2009) developed a regression equation to predict fleet size: • The first step in developing the regression equation involves selection of a complete set of potential predictor variables. Any variable that might add to the ac curacy of the prediction should be included. According to the empirical model, seaborne trade and the freight rate should be used to predict fleet size. • The second step is to screen out the independent variables that are not appropriate for inclusion in the analysis. Multicollinearity, which refers to the correlation among the independent variables, can reduce the independent variable's predictive power by the extent to which it is associated with other independent variables (Tabachnick et al. 2007). Therefore, it is desirable to select variables that have low multicollinearity with the independent variables but have high correlations with the dependent variables. Table 2 shows the correlation relationships among the independent variables (i.e., seaborne trade and the freight rate) that affect fleet size. The results suggest that these independent variables are highly correlated. • The next step is to refine the list of predictor(s) to determine the "best" regression equation. To select the best independent variable among the predictors, the value of the ß coefficient of the independent variables was computed. The ß coefficient indicates how much the value of the dependent variable changes when the value of that independent variable increases by 1.0 and the values of the other independent variables do not change. A positive ß means that the predicted fleet size increases when the values of the independent variables increase. The ß coefficient allows for a direct comparison between coefficients as to their relative explanatory power for the dependent variable. According to Table 3, ß of the independent variable of seaborne trade is the highest (i.e., 0.984) when compared with the others. The findings indicate that the independent variable of seaborne trade is the best predictor among the three independent variables to predict fleet size. To show how much fleet size is affected by seaborne trade, a scatter plot is shown in Fig. 5. The pattern of dots slopes in the scatter plot from the lower left to the upper right, suggesting that fleet size and seaborne trade are positively correlated.
df degrees of freedom When firms operate in an atmosphere of uncertainty, forecasting is necessary for them to make decisions that affect their future. In the bulk shipping industry, quantitative forecasting of fleet size can be the starting point for effective decision making on fleet adjustment. The regression analysis technique is an excellent tool to predict fleet size in the bulk shipping market. In a regression model, the fitted regression equation is formulated in the following form 011, YbbX =+ where b0 is the intercept and b1X1 is the linear effect of X1. The coefficient of the independent variable affecting fleet size is listed in the final column in Table 4. On the basis of the regression results, the following regression equation to predict fleet size can be obtained: FS 32.291 0.048ST, =- + where FS is fleet size and ST is seaborne trade. In the regression equation, seaborne trade is the indicator of fleet size in the bulk shipping market. ß (i.e., 0.048) in the equation has a positive value, meaning that the predicted value of the fleet size increases when the value of seaborne trade increases. The regression equation indicates that shipping capacity will increase by 1 ton with a growth of 20.83 tons of seaborne trade in the bulk shipping market. Hence, the ratio of the increase in shipping capacity (in terms of tons) to the growth in annual seaborne trade (in terms of tons) is approximately 1:20. 3.5 Discussion and Conclusions In the study of Lun and Quaddas (2009), both the freight rate and seaborne trade were found to have a significant effect on fleet size. The coefficient of seaborne trade (ß = 0.984) was higher than that of the freight rate (ß = 0.556). This indicates that shipowners tend to increase fleet size when cargoes are available to fill their ships. Return on investment in ships depends on the volume of trade. If the fleet size does not increase while trade grows, sea transport will be overburdened owing to a shortage of ships. On the other hand, if fleet size increases but trade does not grow, the expensive ships will be laid up. Shipping firms adjust the fleet size when they are optimistic about a growth in cargo volume that will demand more ship ping services. The empirical model suggests that the price for new buildings is positively correlated with the freight rate and the relationship is weakly significant as the p value was between 0.050 and 0.100. As its p value was higher than 0.050, the price of new vessels seems to be suboptimal (i.e., a satisfactory but not optimal price). The suboptimal price can be explained by government subsidies in the shipbuilding industry, causing lack of incentives for shipyards to respond to the market for additional shipping capacity. On the other hand, the correlation results of the study shows that new building price affects second-hand vessel price, and the freight rate also affects second-hand vessel price. The results indicate that both the new building market and the freight market are related to the second-hand market in bulk shipping. In the second-hand ship market, timing of investment is critical because of the cyclical nature of the shipping market. Ship value varies directly with the expected return on ships. A higher freight rate can lead to higher profitability and higher second-hand vessel price. The study found that new building price and second-hand ship price are correlated. The result is consistent with the view of Beenstock (1985) that the prices of new and second hand ships are correlated. Second-hand and newly built ships are substitutes as they are similar assets serving the same purpose for sea transport; the only difference is their age. The empirical model found that both seaborne trade and the freight rate are important factors affecting the decisions of shipping firms to adjust their fleet sizes. A regression equation was formulated to predict fleet size. The equation indicates that fleet size is positively related to seaborne trade. Seaborne trade positively affects fleet size and such a relationship suggests that change in demand for sea transport can influence the decisions of shipping firms to adjust their fleet sizes. In the study, the regression equation contributed to predicting fleet size, and explained seaborne trade volume as a key determinant that affects fleet size in the bulk shipping market. Appendix In this study we used 16 years of data from Panamax Bulkers, from 1990 to 2005, collected from Clarkson Research Studies, to develop an empirical model of bulk shipping market. These secondary data included seaborne trade, the freight rate, fleet size, new building price, second-hand vessel price, and scrap vessel price (Table 5).
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