Introduction
The paper explains how shipping markets are organised and investigates the volatility of Efficient Market Hypothesis alongside Rational Expectations in the formation of dry bulk ship prices over a given period of time. Multiplicity of plausible explanations demonstrates how prices are estimated based on market cycles, how they service depression and what influenced ship design. It also employs market efficiencies such as the orthogonality and unpredictability of excess returns on investments and performs tests based on Autoregressive models, a methodology applicable to real assets with limited economic life.
Results obtained in this research indicate that prices for newbuilding and second hand vessels are not determined by their efficiency but rather triangulated on various factors. Itâs also evident that failure of the Efficient Markets Hypothesis in determination of ship prices are triggered by the existence of time-varying risk premia, which links excess returns to investors. All these variations are modelled through General Autoregressive Conditional Heteroscedasticity (GARCH) models linked to both newbuilding and second hand market of shipping investments.
Secondly, the paper investigates the existence nature of seasonality in terms of shipping cycles in freight markets and compare and measure them across different sectors under different market conditions for an extended period of time. The existences of different seasonalities indicate helps to record increases or decreases in shipping rates at a certain period which vary across different markets depending on vessel size and market condition.
To arrive of conclusive results on seasonal analysis, we use Stopfordâs theory to reveal the seasonal rate movements which brought brings us to the conclusion that seasonal movement rates are more pronounced in a recovering market compared to small changes when the markets are falling. In terms of dry bulk freight markets, seasonality depends on vessel size and duration of the contract. Itâs therefore important to note that shipping markets are greatly determined by seasonal variations and different in vessel sizes are eliminated as the contract duration increases. Shipping operations are also affected by timing of dry-docking, chartering strategies, freight rates hedging activities and switching between sectors.
Still on seasonality change, dry bulk rates are measured and compared across different freight rates of different vessels like the Panamax, contract duration and market conditions such as the peaks and the troughs. The average freights rates were reported to have been varying from 18.2% to 15.3% within individual months of a given year. Itâs also realised that seasonality declines as the contract duration rises and larger vessels are bound to reveal larger higher seasonal variations compared to smaller ones.
The paper also examines the dynamics of conditional volatilities in dry markets for second hand ships. Models were used to compare volatility estimates between different size vessels in a given month, and for this case, Autoregressive Conditional Heteroskedasticity (ARCH) was used. We therefore find that vessels of larger ships are more volatile than smaller ones and to this we conclude that the nature of volatilities varies across sizes. The already mentioned Panamax volatilities are used by old vessels while new shocks are driven by Handysize and Capesize volatilities. Itâs also important to note that conditional volatilities such as the Panamax and Handysize are positively related to the interest rates and time charters.
Market efficiency tests in developing shipping markets display mixed evidences hedging effectiveness of future contracts whose underlying assets are indexes hence the backbone of the economy. To mention just a few indexes, the research examines BIFFEX, BPI, BDI briefly in freight futures contracts to determine how seaborne trade flows. The investigations entailed the composition of underlying asset, the Baltic Freight Index (BFI), which has been revised numerous times to improve the hedging performance and ARCH models to allow for explicit comparison of time-varying risks. Baltic Panamax Index (BPI) for this instance is used is calculated from the weighted, average rates on time chart routes and voyages as assessed by a panel of brokers.
The indexes changes according to demand for the raw materials that are to be shipped. The paper is concluded by critically reviewing the maritime economic theory for its inability to meet the expectations of the bulk shipping freight markets. The theory stipulates that risk premium must be time varying and must be symmetric fashion depended on freights markets and the duration of a period time charter. The piece of the risk premium depends upon various risk factors.
The paper investigates the existence and the nature of seasonality present in the shipping rates. For the period examined, we conclude that the deterministic seasonality depends on a). dry bulk sector which increases in peak season of March and April and drops in June and July and b). the tanker sector increases in November and December and drops in January and February. This brings us to the conclusion that ship owners diversify and extend their operation in shipping sector to maintain stable aggregate revenue during the year.
Literature Review
The introduction of new vessels has greatly contributed to the chronic oversupply in the shipping markets, forcing line operators to provide synthetic products in conjunction with the normal sea-leg transport of containers alone. These variations have exerted intense pressure on container companies to search for more customised solutions for their customers. Service differentiation has therefore become the central battle point for market shares.
Due to this competitive pressure, shippers have gone global to correspond to the changes on the demand side. The recent wave of mergers such as the joint ventures and joint services in shipping industry pushed the advantage of size and synergies to the extreme making operators to seek cost minimising solutions. Freight and vessel markets are often associated with demand and supply mechanism, a role liked to ship brokers although the advent of technology has directly increased transactions between buyers and sellers and operational activities in vessel chartering. The competitive advantage of national fleets is connected to the policy issues of a country (Stopford 114).
In business, many transactions are triangulated, and in this case, the shipping markets triangles include charterers, brokers and ship owners. The three business associates are also connected in contractual agreements that include voyage charters, affreightment contract, time charter and bare boat charter. The business relationship commences when ship owners contract a cargo at an agreed price per ton and the market charters are involved in hiring the ships daily, an event known as the time charter.
The contractual activities associated with seaborne trade flows are legally agreed by charter parties and displays the terms of the service the parties are expected to abide by. Freight rates statistics display price movement over a period of time, often recorded in dollars a ton on the time charter or the world scale. And finally, the Baltic International Freight Futures Exchange (BIFFEX) is enacted to enable charterers and ship owners to hedge their freight risks (Stopford 114).
Second hand ships are sold in sale and purchase markets where buyers and sellers are the ship owners. Ship prices are very volatile, and the prices for second hand ships depend on freight rates, age, inflation and ownerâs expectations. New building is somehow different since participants are ship owners and ship builders. Here, ship prices depend on the specification, delivery date, finances and stage payments. In demolition markets, old and obsolete ships are sold for scrap with speculators acting as middle men between ship owners and demolition merchants. All the four mentioned markets work together and are linked by cash flows and market sentiments. Itâs often perceived that what happens tomorrow depends on what people do today hence resembling the activities of a country market.
Each market cycleâs twists bring either new opportunities or threats to seaborne trade flows and in case of markets fluctuate, ship owners are advised to buy low and sell high. The economic cycle of each ship is unique, which helps us understand how fright market cycles are generated (Stopford 114).
Influences of supply and demand
Seaborne trade activities are affected by theories of demand and supply relationships. In theoretical perspective, we determine factors influencing demand and supply in shipping markets in attempt to answer some practical questions on how they work. First of all, demand functions for sea markets depend upon five variables such as the world economy, seaborne commodity trades, average haul, transports costs and political events while the supply function is identified with variable such as fleet productivity, world fleet, ship building deliveries, scrapping and freight rates.
All these variables fit together into a simple model of shipping markets of demand, supply and shipping modules which core-relate in regulating cash flows from one sector of the market to the other. On the demand side, the world economy incorporates industry activities in various parts of the world to generate goods which require sea transport. Developments in various industrial sectors such as oil price, changes in distance in which the cargo is transported and the final demand for shipping services which is measured in ton miles may modify the general growth trend. On the supply side, merchant fleet represents the stock of shipping capacity and the fleet can only trade at one given time. In some instances, ships may be laid up or used for storage and the fleet can be expanded by new building or reduced by scrapping.
The amount of fleet transport depends on efficiency of the ship in terms of speed and waiting time. The efficiency variable is known as the fleet productivity and is often expressed in ton miles dwt per annum. Supply side of the market is also affected by policies, banks and regulators (Stopford 118).
The world economy generates most its income from sea transport through the importation of raw materials for manufacturing or trade of manufactured goods. Business cycles very important factor in analysing shipping market models since they determine price estimates and rank risks between markets. Sea trade is triangulated into three vicious cycles known as the business cycle, trade elasticity and trade development cycle.
Business cycle for instance relates to the freight cycles and any fluctuation in the world of economic growth is directly linked to the seaborne trade thereby creating a cyclical pattern of demand for ships. There is also evidence that suggests that there exist close relationship between growth rate of seaborne trade and industrial production. Economists argue that economic cycles of sea trade are beginning to be influenced by both external and internal factors. External influences here include factors such as change in crude oil and wars while internal factors include dynamic structure of the world economy. Business cycle can also be affected by multiplier and accelerator, time lags, stock building, mass psychology and random shocks (Stopford 118).
Technological change in freight rates
Freight rates are driven by technical change which steadily reduces the shipping costs. For example, the voyage across the Atlantic is completed today in half the time it took 40 years ago. Technical change as first applied in voyages to and from India, China and other countries have saved incredible motive power and labour. The shipping industry has also introduced steel ship building which grew rapidly from 1868 to 1912 hence increasing seaborne trade flows. The technology enabled ship builders to build ships that were bigger and efficient hence the birth of the largest transatlantic liner âOceanicâ which comprised of 3800 vessels with 3000 hp engine capacity of 14.75 knots, and later followed by Aquitania with even bigger vessels (Stopford 118).
Bulk Shipping Market Cycles
Bulk shipping markets developed during the Second World War and major shippers took the initiative of developing integrated transport operations hence reducing transport costs. It was also reported that during this period seven dry cargo freight market cycles were shorter and by 1945, merchant fleets started including passenger ships, liners, tankers and tramps. By 1975, shipping industry had grown tremendously and taken over major trade markets.
Dry bulks for this case only carries fleet of bulk carriers, cargos, crude tanker oils, forest products and chemicals in parcel tankers, increasing specialisations which lead to the increase in ship size. Rapid growth of ship size faced major disruptions during that period such as the political developments that took place in Korean war in the 1950s, Suez Canal closure in 1956, Yom Kippur War in 1973, oil crisis in 1979, Gulf war in 1990 and the latest Iraq invasion in 2003 (Stopford 120: Kavussanos & Alizadeh 1.7.13.).
There were major falls in sea trade between the early 1980s due to the lost momentum and fleet that made the markets grow old and sluggish. During this period, the transport requirements became complicated which gave way to risk takers. However, sea trading did not stop, bulk carriers continued to increase their cargo size and materials such as iron ore and coal and later car carrier were built with vessel able to carry 6,000 vehicles. In the mid 1902, shipping technology improved with satellite navigation, anti-fouling paint finishes, efficient diesel engines, improved hatch covers and unmanned engine rooms (Stopford 120).
Short-term cycles between 1945 -2007
From 1945 to 2007, there were eight dry cycle periods with peaks of an average of 2.4 years and the troughs 3.2 years making it an average cycle of 5.6 years. The markets cycles varied with shape and intensity. Peak seasons lasted for only 2 years while the long drawn off peak lasted 9 years from 1988 to 1997 which extended to 2003 to 2008. The recessions that took place from 1958 to 1964 and from 1982 to 1987 also intensified sea trade activities (Stopford 120).
Cycle 15: 1945-1951
The post war market took off successfully at the beginning of 1945 which increased the need of transportation. The markets remained firm in 1946 and began going down in 1949. In cycle 16; The Korean war that took place in 1951 sparked seaborne trade growth by 16% which only lasted one year and dropped by the following year by 70%.and by 1953, tonnage began to pile up due to the increased import restriction leading to increased ship prices. Freights markets continued to deteriorate through 1954 and improved again in 1954 by 30% (Stopford 121).
The obvious fact here is that sea borne cycles are so irregular and research continues to demonstrate how seasonal variations however small they may seem can have great impacts of seaborne trade flows and the undercurrent fundamentals of demand and supply as determined by the market tone at a given time. Most market cycles were driven by prosperity and competitiveness contrary to what is happening today.
Prosperity perspective, periods between 1950s and 1998 to 2007 reported growth in demand and ship building capacity while in competitiveness, only three periods with busy activities experienced growth in trade and ship building capacity that expanded fast to keep up with demand. Its evident from the mentioned 12 cycles that cyclical peaks and troughs appear again and again which is very normal to any business condition. Trade growth characterised by ordering and scrapping of ship are the fundamental variables which will be analysed and extrapolated in my dissertation to determine how the two variables co-relate.
It is also evidenced that variables remove some uncertainty and reduce risks but wild cards such as political influence trigger the speculators booms and slumps. For example, the closure of Suez Canal, the 1900 South African War, stock building and strikes in the shipyard played important part in triggering slumps. It therefore makes it difficult to analyse this factors due to the complexity of the world economy and the years economists have to wait to obtain statistics to obtain accurate results (Kavussanos & Alizadeh 3).
Evidence obtained from Stopford (131), time-varying hedge ratios reduce spot market risks in different commodity and financial futures markets. The dissertation continues with the empirical evidence by investigating service markets in terms of Baltic dry index (bdi) and Baltic Panamax index (bpi). We also extent to look at the Baltic International Freight Future Exchange (BIFFEX) as a contract that determines cash settlements against the Baltic Freight Index (BFI), which is a weighted dry cargo freight index obtained from compiling actual freight rates on 11 different shipping routes, and different in vessel size and commodities transported. In determining hedging effectiveness, GARCH models are introduced to measure future contract across different shipping routes. It is for this reason we conclude that time-varying hedge ratios effectively reduce market risks in four shipping routes although they fail to effectively eliminate the riskiness of spot position.
It is evidenced that freight futures contracts are used as cross-hedge in comparing fluctuations of individual ships routes with the underlying index. Therefore routes that are prone to fluctuations may not be accurately tracked by future prices.
Latest monthly poll reports organised by Hellenic Shipping News Worldwide revealed that second hand vessels have increased shipping investments compared to newbuildings. Most of the readers who favoured second hand vessels included ship brokers, owning companies and charterers. The poll participants linked the improvement of market segments of second hand vessels to the belief that âbuy nowâ to take advantage of the rise of Baltic Dry Index (BDI). This strategy provides the owner with a modern vessel of a shorter time period of 2.5 years, which is the normal time taken to complete an order.
Another option considered by Hellas is to invest in new building orders, although this depends on individual ownerâs perception his strategic approach to the market. The argument here has always been that shipping companies are more likely to go for second hand vessels or even a resale contract since itâs often hard to persuade companies to invest large amounts of capital in a new vessel that would not yield the anticipated income in less period of time (Roussanoglu 2010).
Conclusion
Markets are still overwhelmed by oversupply hence the need of market drivers to devise long term solutions to stimulate the growth of transporting commodities to the world market and absorb the number of vessels in the next years. Hellenic Shipping News World invites members to take part in monthly pools to help assess shipping market trends and provide viable solutions where necessary. Dry bulk market cycles are important factors in the entire shipping industry but it is characterized by high risk due to the vagueness caused by factors such as the degree of world trade, the global economy as well as the government policies. This unpredictable market has brought both risks and opportunities to its investors therefore it is wise to identify the market correctly to take the ultimate decision possible
Works Cited
Kavussanos, Martin.G. & Alden, Alizadeh, âSeasonality patterns in tanker shipping freight marketsâ. Economic Modelling 35 (2002): pp.1-50.
Kavussanos, Martin.G. & Alden, Alizadeh, âSeasonality comparisons by types of contracts and sectors in dry bulk shipping freight marketsâ. NAV2000 International Conference Proceedings on Ship and Shipping Research, Volume I (2000): pp. 1.7.1 â 1.7.13.
Stopford, Martin. (3rd Ed.) Maritime Economics. New York: Routledge , 2009.
Roussanoglu, Nikos. 2010. âHellenic Shipping News Poll: Ship owners should go for second hand dry bulk carriersâ. Web.