We have all heard about the shipping industry, how freight rates are dropping, and ships are waiting without cargo. Having been in the navy, I have actually seen those ships anchored out in open waters (so that they don't have to pay charges for being in harbour) as they await instructions on where to go.
There really is a lot of excess cargo space.
Simple demand and supply tells us this: if supply is constant, and demand goes up, price increases. If demand goes down, price decreases. And in the shipping market, where it takes a while for supply to change (you can't build a ship overnight), we can safely assume that supply in the short term is a constant. Which means prices will and do fluctuate based on demand, which changes a lot more quickly based on the market needs in different countries.
But that doesn't mean supply doesn't change. It does. When prices go up, shipping companies will want to reap themselves more profits, and so they try to increase their supply of cargo space. Simple math: if I have 200 tons of cargo space being sold at $1000 per ton, and I see that demand is rising, I will want to increase my cargo space, maybe to 300 tons, so that I can earn $300,000 instead of $200,000.
But the problem is, building ships is a long term investment, and there is a life cycle cost to it. So shipping companies usually rely not just on their own ships to meet the market's demands, but also lease additional ships when necessary to meet high demand periods. The good thing about leasing is that the shipping companies do not have to bear the life cycle cost. I mean, it is the same thing as leasing office equipment. You just pay for what you need.
However, things like ships don't disappear just because they are not being leased. They hang around, and for the case of ships, they hang around for quite a while (like 10 to 15 years, if not more). So when global demand for sea freight is high, and shipping companies build ships, and others build ships to lease to shipping companies, the overall supply of cargo space in the world goes up. Which is necessary since that much cargo space is needed to move goods around at that point in time. But global demand does not always remain high. And when demand drops, we are left with ships lying around.
This is not a problem if demand doesn't fluctuate that much. Which is usually the case, since no one doubles or triples their demand for food or oil overnight. Right? Actually, no. There was actually a sudden and huge increase for sea freight demand in the mid 2000s. This drove up prices so high, it attracted many many many people into the shipping market. People started to build a lot more ships, thinking that the demand will continue and hoping to reap profits out of it.
And so when demand suddenly dropped, we were left with many ships (and lots of cargo space) on hand, and many more ships being built in the shipyards (and these ships, when completed, will further add to the cargo space supply, more than those ships being retired and scrapped). And when there is excess supply, with demand more or less the same, prices drop. Simple microeconomics.
And prices may drop so low it goes below operating cost, which means shipping companies are operating at a loss. Those without huge reserves or other forms of income will soon go bankrupt, like what actually happened to some already.
It is not an easy problem to solve. Simple thinking tells us that we have excess supply, which drives down prices. So why can't we just artificially limit the supply? Push down the supply to a level such that it drives prices up to an acceptable level to break even with the operating cost. Simple, right?
Wrong.
One is the practical part. Unlike a cup at home, where you can keep in storage when not in use, ships can't just be stored like that. They need to be regularly maintained even if not in use, else they will rust away (literally). And even finding space to store them is an issue. If you keep them in harbour, you incur wharfage. If you keep them out at sea, you need to put people on them (so that the ship doesn't drift to unknown waters, or worse, drift into something and then you end up having to pay for damages). So there is a cost to keep them lying around.
And no one wants to drastically reduce the number of ships they have. After all, if demand does go up again, they want to have the capacity to meet that demand, and it takes time to build a ship.
Even if one company artificially tries to limit its supply, there is no stopping its competitors from doing otherwise. I mean, let's say a group of shipping companies sat down, and decided, "Okay, let's all sell at $1000." There is nothing stopping one of them (or all of them) from selling at $900 (or less) just so that they can secure more orders. And they can all do this because they have the excess cargo space to take on those additional orders.
So this is what we end up with. We have many ships, no one wants to get rid of them, and no one trusts each other enough to try and sell at a higher price. So until the supply starts to reduce (over time, as ships get scrapped), prices are going to depend mostly (if not fully) on the demand, and with demand as it is now and in the foreseeable future, I think the current situation of low shipping rates will continue for quite a while more. Analysts, especially those in the shipping industry, try to see things in a more complicated, and optimistic, way, but the simple truth is there are too many ships, and no one wants or dares to do anything about them. And since no one likes to bring bad news to the boss, there will always be people trying to give optimistic predictions. But as an outsider, my take is that it will be a long while before prices go up, and good luck to all ship owners until then.
(Why we ended up with so many ships is another issue altogether, brought about by non-traditional players entering the shipping market when prices soared. But it will take another article to fully talk about that issue.)
There really is a lot of excess cargo space.
Simple demand and supply tells us this: if supply is constant, and demand goes up, price increases. If demand goes down, price decreases. And in the shipping market, where it takes a while for supply to change (you can't build a ship overnight), we can safely assume that supply in the short term is a constant. Which means prices will and do fluctuate based on demand, which changes a lot more quickly based on the market needs in different countries.
But that doesn't mean supply doesn't change. It does. When prices go up, shipping companies will want to reap themselves more profits, and so they try to increase their supply of cargo space. Simple math: if I have 200 tons of cargo space being sold at $1000 per ton, and I see that demand is rising, I will want to increase my cargo space, maybe to 300 tons, so that I can earn $300,000 instead of $200,000.
But the problem is, building ships is a long term investment, and there is a life cycle cost to it. So shipping companies usually rely not just on their own ships to meet the market's demands, but also lease additional ships when necessary to meet high demand periods. The good thing about leasing is that the shipping companies do not have to bear the life cycle cost. I mean, it is the same thing as leasing office equipment. You just pay for what you need.
However, things like ships don't disappear just because they are not being leased. They hang around, and for the case of ships, they hang around for quite a while (like 10 to 15 years, if not more). So when global demand for sea freight is high, and shipping companies build ships, and others build ships to lease to shipping companies, the overall supply of cargo space in the world goes up. Which is necessary since that much cargo space is needed to move goods around at that point in time. But global demand does not always remain high. And when demand drops, we are left with ships lying around.
This is not a problem if demand doesn't fluctuate that much. Which is usually the case, since no one doubles or triples their demand for food or oil overnight. Right? Actually, no. There was actually a sudden and huge increase for sea freight demand in the mid 2000s. This drove up prices so high, it attracted many many many people into the shipping market. People started to build a lot more ships, thinking that the demand will continue and hoping to reap profits out of it.
And so when demand suddenly dropped, we were left with many ships (and lots of cargo space) on hand, and many more ships being built in the shipyards (and these ships, when completed, will further add to the cargo space supply, more than those ships being retired and scrapped). And when there is excess supply, with demand more or less the same, prices drop. Simple microeconomics.
And prices may drop so low it goes below operating cost, which means shipping companies are operating at a loss. Those without huge reserves or other forms of income will soon go bankrupt, like what actually happened to some already.
It is not an easy problem to solve. Simple thinking tells us that we have excess supply, which drives down prices. So why can't we just artificially limit the supply? Push down the supply to a level such that it drives prices up to an acceptable level to break even with the operating cost. Simple, right?
Wrong.
One is the practical part. Unlike a cup at home, where you can keep in storage when not in use, ships can't just be stored like that. They need to be regularly maintained even if not in use, else they will rust away (literally). And even finding space to store them is an issue. If you keep them in harbour, you incur wharfage. If you keep them out at sea, you need to put people on them (so that the ship doesn't drift to unknown waters, or worse, drift into something and then you end up having to pay for damages). So there is a cost to keep them lying around.
And no one wants to drastically reduce the number of ships they have. After all, if demand does go up again, they want to have the capacity to meet that demand, and it takes time to build a ship.
Even if one company artificially tries to limit its supply, there is no stopping its competitors from doing otherwise. I mean, let's say a group of shipping companies sat down, and decided, "Okay, let's all sell at $1000." There is nothing stopping one of them (or all of them) from selling at $900 (or less) just so that they can secure more orders. And they can all do this because they have the excess cargo space to take on those additional orders.
So this is what we end up with. We have many ships, no one wants to get rid of them, and no one trusts each other enough to try and sell at a higher price. So until the supply starts to reduce (over time, as ships get scrapped), prices are going to depend mostly (if not fully) on the demand, and with demand as it is now and in the foreseeable future, I think the current situation of low shipping rates will continue for quite a while more. Analysts, especially those in the shipping industry, try to see things in a more complicated, and optimistic, way, but the simple truth is there are too many ships, and no one wants or dares to do anything about them. And since no one likes to bring bad news to the boss, there will always be people trying to give optimistic predictions. But as an outsider, my take is that it will be a long while before prices go up, and good luck to all ship owners until then.
(Why we ended up with so many ships is another issue altogether, brought about by non-traditional players entering the shipping market when prices soared. But it will take another article to fully talk about that issue.)
