Chapter 2The Tanker Shipping Market

2.1 Introduction

Oil tanker is designed for the bulk transport of oil. Basic types of tankers includecrude tanker and product tanker. Crude tanker transports unrefined crude oil fromextraction locations to refineries while product tanker ships refined products topoints close to consuming markets. Tankers are generally categorized by size, e.g.,Panamax, Aframax, Suezmax, VLCC, and ULCC. Tanker shipping provides aneconomical and convenient way to transport liquid bulk for international seabornetrade. Many maritime economists believe that the supply of tanker shippingoperates under perfect competition is characterized by several conditions. The firstfeature is number of shipping service providers. There are a number of ship ownersthat own tankers that provide identical shipping services. The second characteristicis the availability of information. In the tanker market, information on freight ratecan be searched via such means as the Baltic Index. Hence, shipping serviceproviders are unable to manipulate the price. Obstacles to entry to and exit fromthe industry exist but these challenges can be managed. Entry barriers, such asgovernment regulations, economic factors, and marketing condition, are notpresent in the tank shipping industry. On the one hand, huge capital investment isneeded to acquire ships (new ships from the new building market or second-handships from the sales and purchase market) to enter the industry. On the other hand,shipping firms may withdraw from the market by selling their assets (i.e., ships) inthe second-hand vessel sale and purchase market.

In 2010, the tanker trade volume reached to 2,767 million tons due to growth indemand for energy commodities. The increased cargo volume in the tanker marketleads shipping firms to adjust their supply by building new ships in the newbuilding market, and acquiring second-hand vessels in the sale and purchasemarket. In tanker shipping, price level (i.e., freight rate) is influenced by themarket (i.e., demand for shipping service and supply of shipping service). In thecontext of research in tanker shipping, the demand for shipping is seaborne trade inenergy products because demand for tanker shipping occurs as a result of demand

Y. H. V. Lun et al., Oil Transport Management, Shipping and Transport Logistics,DOI: 10.1007/978-1-4471-2921-9_2, � Springer-Verlag London 2013

13

for seaborne tanker shipping service (i.e., derived demand). On the other hand, thesupply of shipping service is fleet size in the tanker shipping market. From theperspective of the industrial organization paradigm, the interaction betweenthe demand for and the supply of tanker shipping service affects the marketstructure, which in turn plays a significant role in determining the investment andoperation decisions in the marketplace (Tirole 2003).

The tanker shipping market brings shippers and carriers together to determinethe supply of shipping capacity (i.e., fleet size) and demand for shipping services.Hence, demand for shipping service plays a significant role in the shippingindustry. Although oil prices have experienced a sharp increase, there is a sig-nificant growth in the demand. The volume of seaborne trade has doubled over thepast two decades. The increase in quantity demand for shipping services due togrowth in seaborne trade volume leads to rise in freight rate. Freight rate motivatesshipping firms to adjust their fleet sizes by placing orders for new vessels orscrapping their serving vessels. It also affects vessel prices.

The topic of tanker shipping is important to explore from the perspectives ofboth academic researchers (Glen and Martin 2002; Lyridis et al. 2004; Alizadehand Nomikos 2006; Goulielmos and Psifia 2007) and industrial practitioners(Ocean Shipping Consultants Ltd 2004; UNCTAD 2009; Clarkson ResearchStudies 2010). Studies dedicated to developing an empirical model to forecast fleetsize is desirable to facilitate industrial practitioners to make key decisions such ascapacity management and investment strategy. This chapter aims to provideempirical evidence to illustrate the linkages between the different market segmentsin tanker shipping industry. Another aim of this chapter is to provide an overviewof the linkage among different segments in the shipping market for researchers andpractitioners to better understand the shipping industry.

2.2 Tanker Shipping

The tanker shipping industry comprises four different but closely associatedmarkets. Sea transport services are dealt in the freight market, new ships areordered and built in the new building market, used ships are traded in the sale andpurchase market, and old or obsolete ships are scrapped in the demolition market.Prices of these four shipping markets are determined by the interactions of buyersand sellers of the markets (Dikos and Marcus 2003). These four shipping marketscan be categorized into real market and auxiliary markets (Strandenes 2002;Adland et al. 2006a, b; Lun and Quaddus 2009). Shipping firms order new ships inthe new building market and scrap unused ships in the demolition market. Newbuilding and scrapping markets are real market as their activities affect the overallshipping activities. On the other hand, shipping firms provide sea transport ser-vices to shippers in the freight markets and shipper owners trade their used ships inthe sale and purchase market. The auxiliary market consists of the freight market

14 2 The Tanker Shipping Market

trades sea transport services and the sale and purchase market trades second-handvessels. These two markets are categorized as auxiliary market as their transac-tions do not change existing shipping capacity. Shipping firms provide seatransport services to shippers in the freight markets and shipper owners trade theirused ships in the sale and purchase market.

2.2.1 Seaborne Trade

Shipping firms provide global shipping services transporting cargoes to meet thedemand for sea transport services (Kendall and Buckley 2001). Generally speak-ing, carriage of goods does not take place unless there is a need for cargoes to bedelivered from production to consumption areas. Demand for tanker shippingservices is derived from the trade between buyers and sellers in the energy trademarket. As demand for tanker shipping service is a derived demand, seaborne tradeis a crucial variable in tanker shipping market. Previous studies (e.g., Metaxas1971; Lun and Quaddus 2009; Stopford 2009) have suggested the positive asso-ciation between seaborne trade and freight rate. Change in freight rate is influencedby seaborne trade volume (Lun et al. 2010). In the tanker shipping market, freightrate is an important indicator for shipping firms to conduct their business. Whenthe volume of seaborne trade goes up, demand for sea transport services will rise.The excessive demand for shipping services will lead to the upward trend of freightrate. Freight rate also affects the decision of tanker shipping firms to adjust theirfleet size and hence increase their supply in the tanker market. High freight ratestimulates growth in world fleet.

Tanker shipping can be seen as a capital intensive industry as huge investmentin ships are required (Chen and Wang 2004). The return on investment in shipsrelies on seaborne trade volume (Stopford 2009). Cargoes cannot be delivered todestination without adequate investment in shipping capacity. If ships are investedbut demand for shipping services is insufficient, lay up of ship is costly. The needfor sea transport is derived from seaborne trade and shipping firms are not able tocontrol the change of demand for shipping service (McConville 1999). To tacklewith an increase in sea cargo volume, tanker operators tend to enlarge the capacityof sea transport. Hence, seaborne trade influences the key decision in shippingindustry with regard to adjustment of shipping capacity.

2.2.2 Freight Rate

The freight market is a place where buyers and sellers are brought together to tradesea transport services. The demand for and supply of tanker shipping servicesinteract with each other to determine freight rate. Due to the nature of derived

2.2 Tanker Shipping 15

demand, demand for sea tanker shipping services depends on the seaborne tradevolume (Lun and Quaddus 2009). On the other hand, supply of shipping service isinelastic in the short run. Excessive supply of shipping capacity not only causesreduction in freight rate but also extra operational cost to lay up ships. On the otherhand, shortage in ships leads to an increase in freight rate to motivate shippingfirms for adjusting their shipping capacity. Although trade volume grows in thepast decades, shipping firms may make their investment decision only when theyexpect that future freight rate will increase. However, it may take a few years forshipping firms to take delivery of new ships if they decide to increase theirshipping capacity.

2.2.3 New Building Vessel

The new building market and the freight market are positively associated. Ship-ping firms order new ships to expand their fleet sizes during freight boom. In thetanker shipping industry, demand for new vessels reflects the need for shippingcapacity. It may take one to 3 years from placing an order of a new vessel till thedelivery of ship to carry cargo in the freight market. The order of new ships fromtanker shipping firms indicates that they have positive expectation of the growth ofseaborne trade and increase in future freight rates.

From the perspective of business operations, prices of new building ships havea stabilizing effect in the tanker shipping (Dikos 2004). When the demand forshipping services increase, shipping firms make the decision to increase theirshipping capacity by ordering new ships. At the same time, freight rate increasesdue to the high demand for shipping services. High freight rate indicates thatshipping firms can earn higher than normal profit. When the demand for seabornerises, high freight rate and profit level affect shipping firms to place orders for newships. With the increase in demand for new ships, prices in the shipping buildingmarket also increase. Hence, capital cost of shipping firms increases. Such rise inthe prices of new ships could be seen as a ‘‘stabilizer’’ to set a ‘‘barrier’’ forshipping firms for excessive profit.

2.2.4 Second-Hand Vessel

In the shipping market, the freight market is the main source of cash for the tankershipping operations. The revenue earned in the freight market provides financialsupport to tanker shipping firms for acquiring new ships and second-hand vesselsto serve the demand for shipping services. Beenstock (1985) proposed that the newbuilding and second-hand vessels are substitutes to each other as they are samekind of assets. New building ships and used ships are positively associated as bothof them can be deployed to carry cargoes. While the deployment of new building

16 2 The Tanker Shipping Market

ships may require waiting for a few years after placing the new order, the lead timeto deploy second-hand ships to freight market are much shorter. At the time offreight booms, the second-hand vessel market is a good option for shipping firmsto adjust their shipping capacity to satisfy the demand for tanker shipping services(Goulielmos 2009).

The second-hand vessel market can be categorized as an auxiliary market andthe buying and selling of used ships are unlikely to alter the existing number ofships and the carrying capability in the tanker shipping market (Strandenes 2002).The sales and purchase market facilitates the entry of shipping firms to the ship-ping market as shipping firms may acquire ships in the sales and purchase marketwith lower capital requirements. Another key function of the second-hand vesselmarket is the allocation of ships among ship operators. With the sales and purchaseof used ships, the ship owners are able to exit the market or restructure theirexisting fleets in response to the changing demand (Strandenes 2002). As thedemand for second-hand ships increase during the freight booms, the second-handvessel market is also closely linked with the freight market. At the time of highfreight rate, demand for second-hand ships are high as shipping firms can deploythese ships to earn higher than normal profit. Hence, the price of second-hand shipsincreases during the time of freight boom and decreases during the time of freightdepression (Lun and Quaddus 2009). On the other hand, low vessel prices usuallycorrespond with low freight rates.

2.2.5 Scrapping Vessel

Ships are bought and sold in different tanker markets. The new building marketdeals with new vessels while old or obsolete vessels are scrapped in demolitionmarket. Activities of these two markets determine tanker shipping capacity toserve the seaborne trade (Strandenes 2002). With the exception of old ships thatare unable to meet the safety requirements and regulations, the scrapping decisionmade by ship owners depends on expected financial return from scrapping the shipand the future freight rate. Knapp et al. (2008) suggested that an increase in scrapprice leads to a higher chance of vessels being scrapped. In the last decade, 2006,the worldwide consumption of steel grew significantly. The increase in demand forsteel induces higher price of steel and subsequently boost scrapping price ofdemolished vessels (Knapp et al. 2008). On the other hand, the activity inscrapping market is associated with the second-hand market. At the time forfreight boom, ship owners may keep the used ships to carry cargoes or sell theseships to other ship owners. On the contrary, ship owners are willing to send theirships to demolition market when they expect the profitability for vessels arenegative in the foreseeable future and the demand for second-hand ships in the saleand purchase market is weak.

2.2 Tanker Shipping 17

2.3 Research Design

To study the tanker market, we used data from Suazmax Tankers, between 1987 and2010, extracted from the Clarkson Research Studies. Clarkson Research Studies isone of the world’s leading providers of offering statistical and research services toship brokers and the maritime industry throughout the past decades. The professionalcompilers of Clarkson Research Studies gather general cargo fleets database of over30,000 vessels on a daily basis and a wide variety of cargo pertaining to dry cargo, oiland raw materials, specialty chemicals, liquefied natural gas, and containers (source:www.clarksons.com). This published data provides relevant objective data to mea-sure our study variables comprising seaborne trade, freight rate, fleet size, newbuilding vessel price, second-hand vessel price, and scrapping vessel price in thetanker shipping industry. Descriptions of the data are shown in Table 2.1.

2.4 Tests and Results

2.4.1 The Four Shipping Markets

There are four inter-linked market in the tanker shipping industry. Sea transportservices are dealt in the freight market, new ships are ordered and built in the newbuilding market, used ships are traded in the sale and purchase market, and old orobsolete ships are scrapped in the demolition market. Correlation analysis isconducted to illustrate the linkage among these four interrelated shipping markets.The study variables involved are: (1) freight rate, i.e., the value that carriers arewilling to accept and shippers are willing to pay for sea transport services, (2) newbuilding vessel price, i.e., the value that ship builders are willing to accept and shipowners are willing to pay to buy new ships, (3) second-hand vessel price, i.e., thevalue that ship owners are willing to pay and accept to trade used ships in the salesand purchase market, and (4) scrapping vessel price, i.e., the value that scrappersare willing to pay and ship owners are willing to accept to scrap old ships.Table 2.2 shows the correlation matrix reporting the relationship of the studyvariables. The results suggest that these four markets, namely freight market, newbuilding vessel market, second-hand vessel market, and scrapping vessel market,are positively associated.

2.4.2 Trade Volume and Fleet Size

Tanker shipping service provided by shipping firms aims to meet the demand forsea transport services. Carriage of goods takes place only when there is a demandfor transport. Tanker shipping services derived demand from the seaborne energy

18 2 The Tanker Shipping Market

trade. When there is an increase in the demand for tanker shipping service, freightrate will go up. High freight rate attracts ship owners to provide more shippingcapacity to increase the supply of shipping services. Hence, seaborne trade is acrucial variable in tanker shipping market.

To illustrate these relationships, we develop several regression models. Theresults are shown in Table 2.3. The findings suggest that the following relation-ships: (1) freight rate is positively associated with fleet size with b value of 0.408,(2) freight rate is positively associated with seaborne trade with b value of 0.654,and (3) seaborne rate is positively associated with fleet size with b value of 0.902.Their relationships are illustrated in Fig. 2.1.

To examine the mediating effect of seaborne trade, we use path analysis tocompare the direct and indirect effect of the relationship among the study

Table 2.1 Data for the study variables

Year Seabornetradea

Freightrateb

Fleetsizec

New buildingvessel priced

Second-handvessel pricee

Scrappingvessel pricef

1987 1343.00 54.33 31.90 36.00 25.00 4.921988 1488.00 62.37 32.11 45.00 35.00 6.241989 1661.00 82.04 32.62 54.00 42.00 5.761990 1587.00 87.88 34.34 66.00 39.00 4.561991 1551.00 89.73 35.33 68.00 40.00 4.081992 1641.00 59.95 37.29 62.50 32.50 3.361993 1783.00 72.98 40.13 62.00 33.00 3.721994 1802.00 73.27 40.49 51.00 34.00 4.321995 1844.00 82.47 40.08 54.00 38.00 4.801996 1942.00 92.69 39.63 51.00 42.50 4.081997 2041.00 96.83 38.89 52.00 44.00 3.941998 2070.00 85.28 40.42 44.00 36.50 2.901999 2108.00 75.91 41.70 42.50 35.00 3.462000 2180.00 160.96 40.79 52.50 49.00 4.392001 2237.00 110.53 41.51 46.50 39.00 3.222002 2223.00 80.50 39.39 43.75 38.00 4.322003 2356.00 135.00 41.30 51.50 47.00 6.602004 2486.00 196.99 42.71 71.00 75.00 9.362005 2576.00 159.52 44.62 71.00 75.00 7.922006 2686.00 151.68 48.21 80.50 82.00 9.842007 2764.00 118.75 51.83 90.00 92.00 12.602008 2760.00 180.34 54.08 91.00 78.00 6.842009 2659.00 65.53 54.82 62.50 56.50 8.162010 2767.00g 98.78 59.50 66.75 59.00 11.88a Seaborne tanker trade in million tonsb Worldscale rate is a weighted average of spot prices from different routesc Fleet size in million deadweight tonsd New building vessel price in million USDe Second-hand five-year vessel price in million USDf Scrapping vessel price in million USDg Estimated figure

2.4 Tests and Results 19

variables. Direct effect refers to the relationship linking two constructs, whereasindirect effect refers to the relationship characterizing a sequence of relationshipswith a mediator variable involved. Table 2.4 shows the results of path analysis toexamine the linkages between freight rate and fleet size. The results suggest thatthe path coefficient of the direct effect of freight rate on fleet size (i.e., freightrate ? fleet size) is 0.408, while the path coefficient of the indirect effect (i.e.,freight rate ? seaborne rate ? fleet size) is 0.590. Hence, the indirect effect isstronger than the direct effect. The results suggest that seaborne trade is a mediatorinfluencing the relationship between freight rate and fleet size.

In the regression model, seaborne trade is an indicator of fleet size in thetanker shipping market with b value of 0.902. Figure 2.2 is a scatter plot ofregression line and observed values fleet size expectancy. The observed valuesare evenly distributed above and below the regression line. The results indicatethat seaborne trade is a significant factor influencing fleet size in the tankershipping market.

Table 2.2 Correlation matrix

Freight rate New buildingvessel price

Second-handvessel price

Scrappingvessel price

Freight rate 1sig. (2-tailed)N 24New building vessel price 0.578a 1sig. (2-tailed) 0.003N 24 24Second-hand vessel price 0.760a 0.843a 1sig. (2-tailed) 0.000 0.000N 24 24 24

Scrapping vessel price 0.443b 0.665a 0.826a 1sig. (2-tailed) 0.030 0.000 0.000N 24 24 24 24

a Correlation is significant at the 0.01 level (2-tailed)b Correlation is significant at the 0.05 level (2-tailed)

Table 2.3 Results of the regression analysis to examine the linkage between freight rate and fleetsize

Independent variable Dependent variable b p

Freight rate Fleet Size 0.408 0.048a

Freight rate Seaborne Trade 0.654 0.001b

Seaborne trade Fleet Size 0.902 0.000b

a p \ 0.05b p \ 0.01

20 2 The Tanker Shipping Market

2.4.3 Vessel Prices

As seaborne volume grows, ship owners need to adjust their fleet size to meet themarket demand. Freight rate plays an important role in the tanker shipping market ashigh freight rate affects ship owners’ decision on their shipping capacity. Whenfreight rate increases, ship owners places more order to build new ships and the vesselprice will increase. At the same time, the price of second-hand ships also increases assecond-hand ships are substitutes of new building vessels and can be deployed toshipping market in a relatively short period of time. To illustrate the relationships, wedevelop several regression models. The results are shown in Table 2.5.

To illustrate the relationships, we develop several regression models. Theresults are shown in Table 2.5. The findings suggest that the following relation-ships: (1) freight rate is positively associated with new building vessel price with bvalue of 0.578, (2) freight rate is positively associated with second-hand vesselprice with b value of 0.760, and (3) second-hand vessel price is positively asso-ciated with new building vessel price b value of 0.843. The relationships amongthese three variables are illustrated in Fig. 2.3.

To examine the mediating effect of second-hand vessel price, we use path analysisto compare the direct and indirect effect of the relationship among the study vari-ables. Table 2.6 shows the results of path analysis to examine the linkages betweenfreight rate and new building vessel price. The results suggest that the path coefficientof the direct effect of freight rate on new building vessel price (i.e., freight

Seaborne

Trade

Fleet

Size

Freight

Rate

0.654 0.902

0.408

Fig. 2.1 Mediating role ofseaborne trade

Table 2.4 Indirect effect of seaborne trade

Path Direct effect Indirect effect

Freight rate ? Fleet size 0.408 –Freight rate ? Seaborne trade ? Fleet size – 0.654 9 0.902 = 0.590

2.4 Tests and Results 21

rate ? new building vessel price) is 0.578, while the path coefficient of the indirecteffect (i.e., freight rate ? second-hand vessel price ? new building vessel price) is0.641. Hence, the indirect effect is stronger than the direct effect. The results suggestthat second-hand vessel price is a mediator influencing the relationship betweenfreight rate and new building vessel price.

2.5 Discussions and Conclusions

There are separate but closely correlated markets in tanker shipping operations. Inparticular, the new building and second-hand vessel markets can be categorized asthe factor market in which vessels can be bought and sold. The freight market can

Fig. 2.2 Relationship between seaborne trade and fleet size

Table 2.5 Results of the regression analysis to examine the linkage between freight rate andvessel prices

Independent variable Dependent variable b p

Freight rate New building vessel (NB) price 0.578 0.003a

Freight rate Second-hand vessel (SH) price 0.760 0.000a

SH price NB price 0.843 0.000a

a p \ 0.01

22 2 The Tanker Shipping Market

be classified as the product market where sea transport services are traded in amarket place. Hence, shipping firms are involved in two exchange functions. Onthe one hand, they sell product (i.e., shipping services) in the product market.Freight rate is the value that ship operators are willing to accept and shippers arewilling to pay for the shipping service. On other hand, ship owners obtain pro-duction factors (i.e., ships) in the new building market or sale and purchase market.

In the product market, seaborne commodities trade determines the demand fortanker shipping services. In this chapter, the volume of seaborne trade is identifiedas a mediator affecting the relationship between freight rate and fleet size in tankershipping. The result shows that seaborne trade has a stronger impact on influencingfleet size. In a period of trade boom, tanker shipping firms tend to adjust theircapacity when demand for tanker shipping increases. The findings suggest thatboth freight rate and seaborne have significant impacts on fleet size. In comparingthe magnitudes of the effect on fleet size, the coefficient of seaborne trade(b = 0.902) is stronger than that of freight rate (b = 0.408). The results indicatethat the key factor affecting the decision of ship owners to adjust their fleet size iscapacity utilization. Return on investment in vessels relies on cargoes to fill theships. Seaborne trade increases continuously in a growing market lead to ashortage of ships. Ship owners decide to adjust their fleet sizes when they areconfident that additional shipping capacity can be utilized to earn revenue fromfreight market as lay up of ships are costly.

In tanker shipping, the order of new ships in the new building market and thepurchase and sale of vessels in the second-hand market are activities in the factor

Second-hand

Vessel Price

New Building

Vessel Price

Freight

Rate

0.760 0.843

0.578

Fig. 2.3 Mediating role ofsecond-hand vessel price

Table 2.6 Indirect effect of second-hand vessel price

Path Direct effect Indirect effect

Freight rate ? New building vessel price 0.578 –Freight rate ? SH Price ? NB price – 0.760 9 0.843 = 0.641

2.5 Discussions and Conclusions 23

market while trading in sea transport services in the freight market belongs to theproduct market. Our study shows the result that the prices of both new buildingand second-hand vessels are affected by freight rate. New building vessel price isthe value that ship builders are willing to accept and ship owners are willing to payto buy new ships, whereas second-hand vessel price is the value that ship ownersare willing to pay and accept to trade used ships in the sales and purchase market.Our study results show that the prices of both new building and second-handvessels are affected by freight rate. The results indicate that freight rate positivelyinfluences both the product market and the factor market.

The findings of this study also suggest that second-hand vessel price is a mediatorin influencing the relationship between freight rate and new building vessel price.New building market and the freight market are associated with the sale and purchasemarket in tanker shipping. The findings of this study also suggest that second-handvessel price is a mediator in influencing the relationship between freight rate and newbuilding vessel price. High level of freight rate leads ship owners to acquire extrashipping capacity by ordering new ships from new building market or buying usedships in sale and purchase market. New building vessels and second-hand vesselssubstitute each other, and the only difference is their age. Ship owners look for shipsin the sale and purchase market when freight rate increase because acquired ships canbe deployed to carry cargoes in a short period of time. High vessel prices and shortageof ships in the sale and purchase market may divert ship owners to acquire shippingcapacity in the new building market.

The implications of this study are two fold. From a research perspective, thisstudy illustrates the role of freight rate in both the product market and factormarket. In addition, the factors influencing fleet size and the mediator of seabornetrade have been identified in the product market. In addition, the mediating role ofsecond-hand vessel price has been examined. From a management perspective,this study examines how the four key markets in tanker shipping are interrelated. Itprovides a useful reference for shipping firms to anticipate opportunities andthreats in the tanker shipping business. On the other hand, we should take accountof the limitations and pitfalls in this study. Methodologically, this study usessecondary data to conduct the data analysis. Although we have gathered dataspanning 24 years (i.e., between 1987 and 2010), it is difficult to validate the dataaccuracy. Additionally, this study is confined to tanker shipping operations.Therefore, further research could be extended to other shipping sectors, includingthe container shipping market and the bulk shipping market.

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