Page 42: of Maritime Reporter Magazine (June 2005)

42 Maritime Reporter & Engineering News

By Sydney P. Levine, President

Shipping Intelligence Inc.

The ocean shipping business has been cyclical for as long as anyone can remember. Some cycles are longer, some shorter, some deeper and some shallower. But regardless of the status at any time, those markets do fluctuate.

And the fluctuations are between easily recognized limits. Oversimplifying grossly, when charter rates fall too far, ships will be scrapped until demand and supply return to an equilibrium that allows for at least marginally profitable operation. On the up side, if charter rates rise too high, more ships will be built and eventually rates will fall.

Be that as it may, when a cycle is at its hottest, some individuals decide that "this time it's different"; they believe that the present state of the market will continue on into the indefinite future.

They hold this belief in spite of all logic and past history.

Consider the following indicators of the heat of the tanker and dry bulker markets.

In May of 2003 a capesize bulker was chartered for 2 years at the daily rate of $19,250. The very next day, the ship was relet for 1 (option 2) years at the rate of $21,500 per day. Six days later the ship was relet once again for 6 to 8 months at the daily rate of $27,500. And finally, at the conclusion of the 6 to 8 month charter the ship was relet one more time for 15 to 17 months at the extraordinary rate of $55,800 per day.

In only 6 to 8 months, the earning power of this vessel had increased by an aston- ishing 290%.

The ship sale and purchase market, clearly influenced by the booming char- ter market performed similarly.

In June of 2003 a 10 year old capesize bulker was sold for $13 million. In

January 2005 the same ship, now 12 years old, changed hands for $40 mil- lion. Just one year earlier, 40 million dollars would have bought a 4 year old capesize bulker. And, perhaps even more extraordinary, there have been recent sales of 20 year old capesize bulkers for almost 40 million dollars.

In addition, the depreciation curve relating the values of similar ships of different ages has been all but repealed, validating the shipbroker's adage that "strong markets make old ships new". In the first quarter of 2004, a 12 year old

VLCC sold for less than 40% of the price of a 2 year old VLCC, a price con- sistent with past sales history. In the first quarter of 2005, a 12 year old

VLCC sold for more than 60% of the price of a 2 year old VLCC. This com- pression of the price spectrum accompa- nied a large absolute increase in ship prices. The 2 year old VLCC price increased about 60% from the first quar- ter of 2004 to the first quarter of 2005.

These buyers and sellers of ships have been placing bets on future freight rates and ship values. But since they clearly hold contradictory views of the develop- ing ship markets they can't both be right.

Buyers of ships, often old ships at ele- vated prices, believe that the current very high freight rates will continue into the indefinite future, at least until the ship purchases have been amortized, and hopefullly far beyond. They expect to make their money by operating their ships in a very strong and sustained charter market.

Conversely, the sellers of those ships believe that those freight rates are a tem- porary aberration. They expect to make their money by selling ships for more than their real worth, or as it is known in the business by exercising "the asset play".

Dedicated cycle watchers believe that eventually the sellers will be proved right; ships being built and on order will exert increasing downward pressure on freight rates and cause the speculative bubble to burst. Perceptive buyers will have liquidated or locked in their prof- itable positions prior to this downturn, but not all buyers will have the disci- pline and foresight to do that. At that point, our buyer and seller will face rad- ically different situations.

With shipyard space becoming avail- able again, our seller will be able to order a new ship, paid for in large part

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A Bubble in Bulk: Spreading the Risk

In June of 2003, a 10 year old Capesize bulker was sold for $13 million. In January 2005 the same ship, now 12 years old, changed hands for $40 million 2005

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