What is a ton mile?
It is what you get when you multiply the number of tons by the distance you ship them. For example, if you ship 10,000mt of sludge a distance of 300 miles, then the ton miles involved would be 3,000,000. Ton miles (more commonly known as tonne miles) are a measure of true demand for ships. While the 10,000mt mentioned above measures the demand for sludge at point B, it doesn't adequately measure the demand for the tonnage (ships) to move it. The distance is factored in order to account for how long the vessel will not be available for other shipping employment. Ton miles on a given shipment are not that relevant - but aggregate tone miles are very important - as they help determine if a shipping market is over or undersupplied. Specific to bulk shipping - it takes fewer ships to move 5,000,000mt of ore from Australia to China than from Brazil to China. Since either scenario involves the same quantity, 5,000,000mt, the way to determine the effect on demand for tonnage is to factor in the distance travels. In layman terms, you just need to know you need fewer pizza delivery guys to deliver pizzas within a 5 mile radius than within a 30 mile radius.
What are the basics of dry bulk shipping?
Lacking desire to re-invent the wheel, the Genco website provides a very efficient explanation of the dry bulksector: http://www.gencoshipping.com/industry.html
What are the basics of tanker shipping?
Tankers are simpler than dry bulk in some ways, and much more complicated in others. The more difficult issues I will address below, but for sake of simplicity, I will again point you a outside website – this time, the “sister” company of Genco, General Maritime: http://www.generalmaritimecorp.com/newgencor5.html
What is TCE?
TCE stands for time charter equivalent. It is calculated by subtracting all voyages costs from all voyage revenue, and then dividing by the number of days in the voyage. You could call it “daily net income”, although from this “net income” the Owner still needs to pay financing costs, insurance, overhead and other costs. What TCE allows for is comparison of returns for different voyages done by the same ship, or the same voyage done by different ships – as the only numbers being compared relate to the given voyage – and not to items like how the ship was financed.
What is a time-charter?
Let’s start with the concept of a voyage charter. A voyage charter is where someone needs to move cargo from point A to point B. They pay the going rate, and once the cargo is delivered, then – barring some form of legal claim, the voyage ends and both parties move on. Similar to you booking a hotel for a few days. Time-charters take this idea a step further. Under this arrangement, the person looking to move cargo might know that he has a lot of cargo to move – and will therefore need the vessel for more than voyage. Instead of booking the vessel every few weeks, he instead agrees to charter (i.e. rent or lease) the vessel for, let’s say one year. The rate he agrees to take the ship is known as the time-charter rate. In addition to paying this rate, known as “hire”, the person now chartering the vessel must pay all voyage costs, which include bunkers, port costs, canal fees – or generally speaking – any costs incurred due to the fact that the vessel in not sitting idle at anchor.
What is Worldscale?
Worldscale is a standardized rate system in the tanker industry. It allows for rough apples-to-apples comparisons for similar sized ships on different voyages. It was created during and after WW II, when the US and British governments had to charter out vessels that they had requisitioned during the war. They needed to establish a system that allowed for equality of returns, in terms of daily net revenue (TCE), to all the Owners whose vessels they controlled. You could say it is comparable to a pitchers ERA or an NFL quarterback’s rating – as it tries to provide a way to compare things that aren’t quickly comparable. The Worldscale concept works in two parts. The first is the "flat rate" – which is a rate published by Worldscale – and represents a base rate for a voyage from point A to point B that allows for comparable returns for similar ship sizes performing near-similar voyages. Worldscale publishes these flat rates for thousands of possible voyages. The flat rate, for the most part, only changes once per year. But since the tanker market moves up and down on a daily basis – the flat rate, on its own, won’t allow Owners and Charterers to agree on a rate that reflects the state of current market. This is where the Worldscale “multiplier” comes in. When you see a rate quoted in a market report, let’s say, WS 175 – this means the rate per ton that the Owner will get paid is 175% of the flat rate – or, 1.75 times the flat rate. When the market gets hot, the Worldscale multiplier increase. When the market goes cold, the multiplier decreases. All the while the flat rate never moves. The link to the Worldscale site is here: http://www.worldscale.co.uk/
Why not just fix cargos on a per-ton basis?
Even though you eventually end up with a number that gives you a per-ton rate, the purpose of Worldscale is to allow for simplicity. When most cargos are fixed, the Charterer isn’t 100% sure where the cargo will load – and rarely knows with any sense of certainty where the cargo will discharge. In the meantime, the Charterer needs a lot of load and discharge options. So instead of agreeing to a rate for all the permutations involved with 3 load ports and 12 discharge ports – they agree on one Worldscale rate (which reflects the state of the current spot market). Once the load and discharge port(s) have been finalized, then the flat rate can be looked up in the Worldscale tables and multiplied by the “multiplier” – which gets you to the per-ton rate. This provides for a much more efficient market.
What is the difference between TCE and earnings?
Not much - and what little difference there is all depends on the context in which you are using these terms. TCE and earnings can be used interchangeably in general conversation - as all you are doing is subtracting voyage revenues from voyage costs, and dividing by the number of days. That leaves you with net daily earnings - ie TCE, ie "earnings". The thing to keep in mind when using these terms is that the generic concept of "earnings" is just that - generic. The calculation involves numerous assumptions, many of which will apply disequally to individual ships or voyages. Further, the generic terms earnings and TCE do not take waiting time and off-hire into account. Therefore, taken at face value, they are likely slightly higher than a ship may actually achieve. Although the general formulae are the same - some people include commissions, some don't. Some assume that a VLCC makes the same speed in ballast and laden, some don't. All told, earnings estimates are usually within reason once all the variables between formulae cancel out.
So how do I apply the generic concept of earnings to my expectations for what I think Frontline will earn next quarter?
Very carefully. First of all, just because the average vessel on a given route might earn $70,000/day for a month, it doesn't mean that FRO vessels fixed any of those voyages. Market spikes don't always last long. So if you are the Owner that fixed a voyage just before the market spiked - by the time you complete your round trip voyage, the market might be right back where it was when you fixed your last voyage. There isn't much you can do about that. Some Owners will sense where the market is headed - and try to capture the higher rate trends - but - this can go awry awfully fast. It is hard to do. But back to the main point - in addition to FRO possibly not earning what other ships are earning on a given route, you have to consider that earnings and TCE are calculated on a round trip basis - and not all ships perform the full round trip. Now, the bigger point: when FRO announces their results, the "earnings" they reference are the actual amounts that the ships earned - when ALL factors and costs have been considered. This means that off-hire, waiting time and other similar costs have been thrown in, as the goal here is to provide specific insight into how their vessels actually performed.
And from this number they still have to subtract finance, overhead, insurance etc?
Correct. With the above example, you will often see companies advise what their break even TCE level is. This break even level tells you what the Owner pays in crew costs, financing etc - and represents the level at which earnings covers these costs - and nothing more. For example, the break even level for FRO's Suezmax fleet is about $23,000/day, while NAT claims to have a break even of about $10,000/day. Big difference - and tells alot about how the ships were financed as well how the companies are able to miminimze certain costs.
Why doesn't FRO just get their break even level down to $10,000/day. Wouldn't they make more this way?
If it were that easy, they would do it. Now you are getting into leverage, debt and other financial machinations that reflect how a company chooses to do business.
But if the ship doesn't perform the full round trip, where does it go? Does the Owner still receive full payment?
The mindset involved with Worldscale, earnings and TCE is based on what the vessel will earn if it goes A to B and then back to A. Since most vessels, especially crude carriers, have limited backhaul opportunities - they run their numbers on the assumption that they will ballast back to the load port - point "A". But - this doesn't always have to be the case. For example - if an Owner has a choice between a voyage from the MEG to Japan and MEG to the USG, he has to asssume that the first voyage will likely require the vessel to ballast directly back to the MEG, while the voyage to USG will offer the possibility of loading out of WAFR next - or maybe even a fuel oil cargo from UKC or Caribs to the Far East. The Owner must therefore know the state of all markets and make decisions as to which voyage will provide the best returns, keeping in mind what the next voyage might look like. In terms of receiving full payment - the Owner gets paid the full agreed-to rate, and once the cargo is discharged, he is free to send the vessel wherever he chooses.
But these backhaul voyages are not pure backhual. Sounds like a lot of deviation involved.
Correct - and that's what makes some Owners more succesful than others. This is part art and part science. Since everyone has a calculator, spreadsheet and high-priced software - the "science", or math, aspect of shipping isn't necessarily where the better money is made. The "art" portion of this is where the magnates stand apart. Do you take the MEG/Japan or MEG/USG voyage. Do you accept the lowball counter from the Charterer, or do you sit the ship until the market improves? Do you sell your ships when asset prices are high? Do you put your ships out on long term charter if you fell the market might soften? The high seas are littered with companies who were unable to excel at these concepts. It's not easy.
What is MEG? What is USG?
Below I will list some of the more common acronyms for tanker shipping. But in terms of MEG - is stands for Middle East Gulf, which is called the Persian Gulf (PG) by some, and Arabian Gulf (AG) by others. It's somewhat of a political issue, which is why MEG represents a neutral approach to who actually "owns" this body of water where about 17 million bpd of crude oil is exported from(about 20% of world production).
MEG Middle East Gulf
AG Arabian Gulf
PG Persian Gulf
UKC United Kingdom to Continent Range
Cont Continent, meaning the land mass of North West Europe
Med Mediterranean Sea
WAFR West Africa
SAFR South Africa
USG US ports within the Gulf of Mexico, ie Houston, New Orleans
USAC United States Atlantic Coast, same as USEC
USWC United States West Coast, Vancouver is sometimes iincluded
t/a trans-Atlantic, usually specific to Cont/USAC voyages with mogas (motor gasoline)
Straits Strait of Malacca
SKAW Northern point of Denmark, somewhat of a separation between point the North Sea and the Baltic
Are there similar acronyms for dry bulk?
Yes. The above acronyms also apply to dry bulk, for the most part, but dry bulk has some that are specific to that sector.
NOPAC Northern Pacific, implies USWC-Vancouver region
PASS Passero, southern tip of Sicily
RV Round Voyage
SKAW Northern point of Denmark, somewhat separates North Sea and Baltic
SK South Korea
What is off-hire?
Just what it sounds like - time that the vessel is not earning money. Specifically, it refers to time that the vessel is not able to perform (ie earn money), whether due to engine trouble, simple repairs, voyage deviations required by the Owner and not the Charterer etc. It applies to both voyage charters and time charters. For long term time charters, it also applies to shipyard and drydocking time. During periods of off-hire - whether a few hours, or a few months, the Charterer is not paying the Owner the daily hire - so the Owner is not making any money on their asset.
What is the best book to read about shipping?
It depends on whether you are looking for literature or info. There are many books that have some element of shipping tied into their central theme, e.g. Conrad's "Lord Jim". But in terms of how the shipping world works, Stopford's "Maritime Economics" is an incredible source. Though it is largely a text book in format, it is so well written that you can read large portions at a time without getting bored. Anyone who invests in, or want to better understand shipping in any capacity needs to have this book. Manolis Kavusssanos also has a book covering risk and return in shipping, though I haven't yet read it. A simple search on either Google or Amazon will point you in the right direction, but I would start with Stopford's book.
What are the best sources for shipping info on the web?
There are plenty, although their really isn't one source that can get you all the "relevant" data. The reason I created this blog was to add the dimension of spot market data - as well as FFA information. Most reports are just numbers, which are how the business works, but some reports are written with a decent level of humor - or at least provide some information above and beyond what rates are being done. Per Mansson at Nor Ocean Sweden writes a very colorful report - that contains recent rates, a sense of the market - and of course Per's opinion on worldly matters. With that said, the links I have put up on the links page are the ones I feel are the most relevant. From there, you can link your way wherever you want to go. I even find some of the Yahoo! message boards useful. You have to have a strong stomach to troll for info there, but despite the high jackass factor, you can still pick up info, or sources, that you might not already have.
What about reports from the Wall St analysts?
Yes - these are very valuable sources of info. Although the info in these reports will mostly be priced into a given stock, you can learn alot about which Owners prefer the spot market and which prefer contract coverage. You can get some ballpark estimates for how share price will change for a given change in VLCC earnings. You can also get some insight into how the companies are viewed by the investing public. OSG, for example, trades at about 65% of its net asset value. Investors and analysts alike are frustrated by this. OSG a lot of moving parts, and is therefore difficult to value - but these reports will always provide some insight. You can never have access to too much information.
But the chat rooms are filled with jackasses?
No, not at all, but some message boards contain a disproportionate share of them. There is a lot you can learn here. Sometimes a stock you own will plummet - and you can't figure out why. Occasionally someone in the chat room will have already pointed out the reason. Since shipping is a very peculiar industry, there are many occasions where you wouldn't reasonably expected to have all the info all the time. The message boards can help fill gaps. That said - yes - the jackass factor can be quite high, and its usually just one or two people that can spoil it for everyone. But, these things are free - so the price you pay, technically, is having to wallow through the sludge.
If I want to put on a directional trade against the dry bulk market, should I just short DRYS?
That would be one way to do it. Since DRYS, and TBSI, have the highest spot exposure - they would likely fall the most if the physical market crashed. But, the market doesn't always behave as it should. Mid summer last year, I had thought the tanker market was due for a fall. So I shorted FRO. Big mistake - as I had to cover at $53/share. That's alot of pain and thats what you get when you play in volatile markets like shipping. Further - going up against these shipping magnates (ie John Fredriksen) is also a dangerous game. They are not only smarter than you are, but they access to infinite amount of information that you just don't have.
Why are these markets so volatile?
The short answer is that the supply and demand curves are both vertical when the market gets tight. What this means is that very tiny changes in either supply or demand can result in very large changes in freight rates. The reason for this is that when markets are tight, there is no short term solution to provide more ships. Ships take about 3 years from the you order one until the day it is delivered to you. So in tight markets, when you have two Charterers bidding on the same ship, Owners can raise their rates significantly - and Charterers have to pay the going rate.
In the graph below, you see the demand curves are just about vertical at all stages. The supply curve, however, is flat at first, before turning near vertical about halfway through. Assuming constant supply of ships, watch what happens when the demand curves shift, first to D1, then the D2. The increase in demand is about the same, but look at where the curves intersect once you get onto the vertical section of the supply curve. Look how much further rates moved up at D2. Thats why markets are volatile. Since the suppy of vessels cannot not be increased in the short turn, the curve turns up - and leads to massive changes in rates even when the fundamental supply/demand function has only changed slightly. You can also see that if the supply curve shifts out, then the curves will intersect on the lower portion, the "non-volatile" portion, of the supply curve. I will repeat the bottom line: in the short run, there are a finite number of ships - and with inelastic demand - rates can undergo voilent spikes.
Why don't they just refuse to pay the high rates?
Because then they won't have a ship. As Rodney Dangerfield said in the movie Back to School, "These guys aren't the Boy Scouts we're dealing with!" Shipowners have invested a lot of money in their ships, and they have every intention of earning as much as they can on a given voyage. Of course there are always longer term considerations that Owners must take into account when raising their rates very high - but, tomorrow rates could collapse. Therefore, they get what they can when they can. It's pretty simple. This applies to both dry bulk and tankers - but, an issue specific to tankers is that the cost of transporting oil is only about 5% of the total delivered cost. This is very small, meaning even if rates were to double overnight, which can happen - the delivered cost of the oil still doesn't change drastically.
So Owners always have the upper hand?
No. In tight markets they do, but when the supply of vessels begins to overwhelm demand, then the reverse is true. Rates can drop 100 Worlscale points in one fixture. Charterers can play the same game in reverse. When the market is falling and the Charterer receives multiple offers for his cargo, then he is going to try force rates down as low as possible. It's all part of taking the good with the bad.
So shorting shipping stocks is a bad idea?
It can be, due to both the inherent volatility - and the fact that some of these shipping companies will pay out massive dividends when times are good, including some crazy special dividends. This is one reason , of many, why shorting FRO can be a bad idea. The special dividend can really hurt the shorts as well. Last year, Genmar paid a special dividen of $15/share while the stock was trading in the low/mid $30s. If you were short, you got killed. Shipping can provides such high returns when the market is strong, that people like Fredrisken and Peter Georgiopoulos are well known for taking care of their shareholders - and have no qualms about returning cash to them when they don't see a better investment in front of them.
So how else can I invest, long or short, in shipping?
Other than buying and selling of the equities - you are likely limited. The bigger players can obviously buy and sell ships, but it you are reading this site, I doubt you are a bigger player. Another way is to buy and sell FFAs, forward freight agreements. But this too is only geared to sophisticated investors. There are minimal capital requirements and other regulations that pretty much rule out small investors from playing in this market. We are not talking about buying a few hundred shares of Navios or Teekay. FFAs are for this big boys.
How can learm more about FFAs?
The Imarex website is a good place to start. They have a well written FAQ that can provide some fundamental info. http://www.imarex.com
So FFAs work like other futures markets?
For the most part yes, but there are also some aspects that make them quite different from other derivatives markets.
In terms of equities, since the correlations between some of the stocks is so high - do people pairs trade them?
Yes. I have found that pairs trading the tanker equities can provide decent returns, although it's not as easy as it was four years ago. When I started day trading in 2004, the market still had a fair amount of relative mispricings. Anytime two of the names diverged by more than 1.5% or more, pairs trading provided some very good returns. Not always, but more often than not.
Why doesn't this strategy work today?
I think it does, but not as well. First, the market is more efficient, thus creating fewer relative mispricings. Second, and more importantly, many of the shipping companies have changed their purpose. OSG, as mentioned above, has a lot of moving parts. Do you really want to pairs trade OSG against FRO, even with a 4% spread or so? Well, it's not the worst idea, but - the correlation between these two names isn't what is it used to be. GMR, highly contracted - versus NAT, almost 100% spot? IS that a good trade? Maybe - the structure of all these companies have become so different the past few years, that profits from this approach are harder to come by.
What about dy bulk?
Dry bulk is another story. I am sure someone has found a way to pairs trade this sector - but I sure haven't. A few months ago when the market got wild and the EXM/QMAR deal was thought to be canceled, the daily spread between QMAR and NM reached 25% intraday. So let's say you got in at 10%, and made plans to buy a new car with your soon-to-be-had eye popping profits. Well, when the spread hits 15% - you add to your position, which is now more tenous - but this trade is quite promising. So the question becomes - how many times do you add to this losing position before you cover at 25% spread and realize you just lost 20-30% of your funds? Like I said, I am sure it can be done, but if you try this get crushed - don't say you weren't warned by Ton Mile Trader.
How are dry bulk FFAs settled?
They are settled in $ / day - the same way they are quoted and priced. In terms of the math - it is quite easy. Let's say you bought Calendar 2009 at $50,000, and that you bought 365 days of that contract. If at the end of 2009, the average daily index price averaged $51,000 for the entire year - then you lost $1,000 x 365, or $365,000. The party that you sold the contract to, gains this same amount. Remember, this is a zero sum game.
But what if I don't want to buy the full contract for a whole year? Can I buy half a contract?
Sure. You can buy any portion, or percentage, of the contract that you want, although dealing in round numbers tends to allow for more counterparties (in other words, if you constantly come into the market looking to trade 43.75 days - you would not be able to trade that as easily as maybe 30, 45, 90, 180 days or so). But - if you buy 182.5 days of a Calendar contract, then you own 50% (182.5/365) of the contract. You then would lose only $500 per day, for the whole year, for a loss of $182,500. You could also do the math this way - where you lost $1,000/day for 182.5 days, ie $182,500. The math is simple once you get the concept down.