THE FOUR LNG SHIPPING MARKETS By Georgios H. Dretakis SUPERVISORS: Dr Michael Tamvakis Mr Hadi Hallouche The Dissertation is submitted as part of the requirements for the award of the MSc in Energy, Trade and Finance CASS BUSINESS SCHOOL FACULTY OF FINANCE CENTRE FOR SHIPPING, TRADE AND FINANCE Academic Year 2004-2005 Date: 31 August 2005
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THE FOUR LNG SHIPPING MARKETS
By Georgios H. Dretakis
SUPERVISORS: Dr Michael Tamvakis
Mr Hadi Hallouche
The Dissertation is submitted as part of the requirements for the award of the
Ηέροι και νεφέλη κεκαλυµµέναι: ουδέ ποτέ σφίν. Ούτε τι πηµανθήναι έπι δέος
ούτθ’ απωλέσθαι.
Οµήρου Οδύσσεια, θ, 555-566.
Tell me also your country, nation, and city that our ships may shape their
purpose accordingly and take you there. For the Phaeacians have no pilots;
their vessels have no rudders as those of other nations have, but the ships
themselves understand what it is that we are thinking about and want; they
know all the cities and countries in the whole world, and can transverse the
sea just as well even when it is covered with mist and cloud, so that there is no
danger of being wrecked or coming to any harm.
Homer, Odyssey, VIII, 555-566.
i
ACKNOWLEDGEMENT
I wish to express my sincere gratitude to Dr. Michael Tamvakis and Mr. Hadi
Hallouche for their mentorship and generous support they provided me at all
levels. Without their encouragement and guidance, this project would have not
been completed successfully
ii
ABSTRACT
This project aims to investigate the structure of the four LNG shipping
markets; freight rate, new building, second hand and demolition market.
Each market is discussed separately to identify their special characteristics and
the main factors that influence their activity and the way that interrelate to
each other.
The methodological approach deals with the identification of objectives and
constraints of the market participants, the supply and demand of each market
and the long and short-term response of the shipping market given the changes
of various external and internal factors.
The number of ships available, the LNG transaction type and the liquefaction
and regasification capacity, affect freight rates. Changes in those factors do
not influence substantially the freights under long term shipping agreements,
however their effect will be important in the spot trading.
LNG new building and second hand market are connected with freight rates in
short-term agreements and this is reflected by the increased activity
encountered over the last couple of years in those markets. New market
participants are likely to use new and second hand ships to take advantage of
the imbalances between supply and demand, however long term agreements
will dominate the LNG market, unless a globalised LNG market is established.
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EXECUTIVE SUMMARY
This project deals with the identification of the triggers and constraints in the
LNG shipping market given the rapid expansion in the LNG trade. The
analysis focuses on the four main shipping markets; the freight rate, new
building, second hand, and demolition market.
LNG shipping markets are not as liquid as the wet or dry bulk ones since
participants are limited; the current fleet is equally distributed to a small
number of LNG producers/importers and independent owners. LNG fleet is
relatively young and expanding very aggressively. Bigger ships are built
indicating the market prospects for further LNG trade development. Most of
ships in the current fleet are trading in the Pacific basin, but the majority of
new orders have contracts to trade in the Atlantic basin.
Freights in long-term agreements are related with Sales & Purchase
Agreements (SPA) and will not be influenced significantly. Freights in short-
term agreements depend on the LNG ships available for short-term trading,
spare capacity of the committed ships under long-term charters, and
availability of uncommitted ships. Oversupply will cause freight rates to drop
but increase of LNG demand for spot trading will increase freights.
The key issue of traditional LNG (Take or Pay) contracts was reliability and
security of supply but proved inflexible. Deregulation of the gas market
introduced the new style contracts which emphasize on flexibility, price and
cost competitiveness, reduced duration and most important, no destination
clause.
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Changes in the LNG industry including shorter and more flexible SPA,
increased demand for LNG, and the surplus capacity of production plants
introduced the spot or short-term trade.
Shipping costs affect the price of LNG delivered. Under CIF type of LNG
procurement, the seller bears the cost of shipping. It is a mean to maintain
security of supply but that introduces a risk premium, which increases the
freight rates. Producer selling CIF have the ability to minimise price risk by
diverting cargoes when a contract expires. Under FOB sales, the buyer bears
the cost of shipping which allows the re-routeing cargoes to its own alternative
terminals. That reduces shipping costs but the buyer is exposed to volatility of
the market in case of surplus capacity.
Freight rates are also affected by liquefaction and regasification capacity.
Lower liquefaction costs reduce the price of LNG delivered. Added
liquefaction capacity uncommitted to long term trading will create demand for
ships available for spot trading. Freight rates will rise if ships are not available
for spot trading and will fall if there is oversupply of ships.
Despite the emerging short-term market, long-term contracts dominate 62% of
the orderbook. However, all time record orders for LNG ships is likely to
introduce some speculation in new building re-sales.
Asian shipyards control the LNG ship building market. Competition between
shipyards has decreased prices for LNG ships. New building prices are related
to the demand for new tonnage. High demand raises the price and low demand
push prices down.
Worldwide LNG shipbuilding capacity is limited while increased ship
building activity for other ship types might cause undersupply for LNG ships
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when orders carry on in the same rate. In this case, second hand prices will
rise accordingly.
However, if LNG shipping capacity grows faster than liquefaction capacity, it
would address oversupply of tonnage, driving freights rates down and
increasing scrapped tonnage.
LNG second hand market is very weak. Limitation in the liquidity of second
hand markets arises from the limitations of LNG ships to participate in several
trades. The emergence of spot trade will probably introduce a more flexible
second hand fleet, which will trade uncommitted surplus capacity in the
Atlantic region. Independent shipowners can speculate in the second hand
market while producers/importers are likely to benefit by being more flexible.
LNG scrapping is historically weak. Ships are usually laid up instead of
scrapped. Scrapping records involve ships built in speculative grounds, which
could not secure a contract. With the introduction of a more flexible second
hand LNG fleet, scrapping and laying up activity will be increased.
Liquidity in LNG shipping market will be introduced with the emergence of a
globalised gas market.
vi
TABLE OF CONTENTS
LIST OF FIGURES ......................................................................ix
LIST OF TABLES........................................................................ix
1 THEORY BACKROUND.......................................................................1 1.1 INTRODUCTION ...................................................................................1 1.2 GENERAL INFORMATION ABOUT LNG ................................................1 1.3 SUPPLY. ..............................................................................................3
2 METHODOLOGY AND LITERATURE REVIEW............................6 2.1 INTRODUCTION ...................................................................................6 2.2 “ECONOMETRIC MODELLING OF WORLD SHIPPING”...........................6
2.2.1 Model Description and some theory aspects. ............................6 2.2.2 Summary of Model Structure .....................................................7
2.3 RELATED LITERATURE........................................................................9 2.3.1 Future Trends...........................................................................10
4.3.1 LNG Fleet by trading routes ....................................................19 4.3.2 LNG Fleet by age .....................................................................20 4.3.3 LNG fleet by size ......................................................................21
4.4 THE EFFECT OF LNG FLEET TO FREIGHT RATES ................................23 4.4.1 Long term contracts .................................................................24 4.4.2 Medium and short term contracts. ...........................................24
4.6.1 Long term contracts .................................................................27 4.6.2 Short term Contracts................................................................28 4.6.3 The Effect of LNG Contracts to Freight rates. ........................29
4.7 LIQUEFACTION CAPACITY AND ITS EFFECT TO FREIGHT RATES .........31
5 NEW BUILDING MARKET................................................................35
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5.1 INTRODUCTION .................................................................................35 5.2 FLEET EXPANSION.............................................................................35 5.3 SHIP BUILDING INDUSTRY .................................................................36 5.4 PRICE OF NEW BUILDING ..................................................................37 5.5 SHIPBUILDING CAPACITY AND IT’S EFFECT TO FREIGHT RATES .........41
6 SECOND HAND MARKET .................................................................44 6.1 INTRODUCTION .................................................................................44 6.2 LNG SECOND HAND PRICE...............................................................44 6.3 CHARACTERISTICS OF LNG SECOND HAND MARKET.........................45 6.4 FUTURE TRENDS................................................................................47
7 DEMOLITION MARKET....................................................................52 7.1 INTRODUCTION .................................................................................52 7.2 CHARACTERISTICS OF LNG DEMOLITION MARKET. ..........................52 7.3 LAY UP AND SCRAP PRICES...............................................................54
LIST OF FIGURES FIGURE 1: WORLD GAS CONSUMPTION.............................................................12 FIGURE 2: GAS AND LNG MAJOR TRADE MOVEMENTS......................................13 FIGURE 3: LNG IMPORTS 2003-1004................................................................14 FIGURE 4: LNG EXPORTS 2003-1004 ...............................................................15 FIGURE 5: MAJOR LNG SHIPOWNERS (CURRENT FLEET AND ORDERBOOK)......18 FIGURE 6: EXISTING AND ORDERBOOK FLEET BY TRADING ROUTE ...................20 FIGURE 7: AGE OF LNG FLEET IN 2009 .............................................................21 FIGURE 8: LNG FLEET 1996-2009....................................................................22 FIGURE 9: EXISTING AND ORDERBOOK LNG FLEET BY SIZE..............................23 FIGURE 10: OPERATION COSTS BREAKDOWN. ..................................................26 FIGURE 11: CURRENT AND FUTURE CONTRACTS PER REGION............................30 FIGURE 12: EXISTING AND UNDER CONSTRICTION LIQUEFACTION PLANTS........32 FIGURE 13: IEA’S ESTIMATED IMPORT GROWTH AND INCREMENTAL
LIQUEFACTION CAPACITY 2002-2010........................................................33 FIGURE 14 :ORDERBOOK...................................................................................36 FIGURE 15: ORDERBOOK BY SHIPYARDS AND CAPACITY...................................37 FIGURE 16*: LNG SHIPS DELIVERIES AND NEW BUILDING PRICES.....................38 FIGURE 17: GLOBAL TONNAGE COMPLETED 1974-2004 AND FORECAST UP TO
2020..........................................................................................................42 FIGURE 18: LNG DELIVERIES AND S&P RECORDS............................................46 FIGURE 19: UNCOMMITTED SHIPPING CAPACITY UP TO 2020. ..........................48 FIGURE 20: EVOLUTION OF SHIPPING, LIQUEFACTION AND REGASIFICATION
TABLE 1: LNG TRANSPORTATION COSTS ON SELECTED ROUTES LOADING FROM QATAR. .....................................................................................................27
TABLE 2: COMPARISON OF THE CHANGE IN ADDED VALUE OF VLCCS AND LNG TANKERS...................................................................................................39
Figure 9: Existing and orderbook LNG fleet by size
Source: Combined data from Clarksons SIN and Maritime Business Strategies
Note that there are no ships ordered in the range of 100,000-130,000 cubic
metres, and ships greater than 145,000 cubic metres are not present in the
current LNG fleet. There are even larger ships ordered, with capacity 210,000
- 215,000 cubic metres, but terminal issues such as limitations on LNG storage
capacity, restrictions on vessel displacement, length and draft, and
modifications of terminal loading arms, mooring systems and gangways,
should be taken in consideration.[36]
4.4 The effect of LNG fleet to freight rates
According to Beenstock and Vergottis (1993) model, supply of freight
services is proportional to the amount of ships trading multiplied by the
average speed. The total freight rate supply is directly proportional to the size
of the fleet and is positively related to freight rates but negatively related to
bunker prices. In order to investigate the applications of this model to the LNG
shipping freight market it is necessary to distinguish between long term and
short or medium term shipping agreements. This distinction is useful because
23
the unique feature of LNG supply chain has been affected over the last years
by the changes in LNG shipping contracts. The structure of LNG contracts is
discussed in detail in paragraph 4.6.
4.4.1 Long term contracts
LNG freight rates structure consists of two elements, the capital and the
operating element. The capital element depends on the cost of building a new
ship and the financing cost of the ship[25], while the operation element depends
on transportation costs (see paragraph 4.5).
LNG ships employed under long-term contracts reflect agreements of LNG
projects between buyers and suppliers. Destination, fuel consumption and
speed is specified in the time charter contract which the shipowner is obliged
to maintain in order to be treated as constant. The main factor affecting freight
rates is the amount of ships trading. But this depends solely on the LNG
projects, which are closely related to the state of the world economy in
general, and the individual LNG projects undertaken.
New ships will be ordered to serve respective LNG trade agreements to meet
shipping demand for long-term contracts. Shipping contracts will extend along
with the extension of GSPA. If this assumption stands right, freight rates for
long-term contracts should not be affected since supply of ships is determined
and controlled solely by the LNG projects available. Freight rates should rise
only in a case where the growth of LNG trade is so big that can cause a
demand for shipping capacity surpassing the shipbuilding capacity of
shipyards.
4.4.2 Medium and short term contracts.
Under a perfect competitive environment, when freight rates rise, freight
market supply utilises more efficiently ships for trading. Beenstock and
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Vergottis (1993) model assumes that the total fleet trading consists of ships
not laid up, and treats the time charter contract as a special feature where the
charterer pays a rent to the shipowner for assuming control of the ship over an
agreed period.
Freight rates in short-term contracts are far more complex than in long-term.
Freight rates are determined by the supply and demand for shipping, which
depends on the quantity of LNG available for short-term trading. Ships supply
for short-term contracts depends on the spare capacity of the existing ships
under long-term charters and the capacity of ships that are uncommitted while
their competitiveness depends on their age and technical characteristics.
The structure of long-term contract shipping agreements makes difficult to
utilise ships trading in alternative destinations, however if there is spare
capacity, these ships can be chartered under short-term basis. This implies that
the LNG tanker business would become similar to oil tanker business. But this
suggests an established LNG market where freight rates will balance the
supply of demand of LNG. This market already exists but unlike the dry bulk
and wet market, its capacity is limited because the size of the entire LNG
market is limited. Furthermore, LNG ships are more capital intensive than oil
tankers and as the long-term trade ebbs, speculative LNG tanker ownership
would be riskier than oil tanker ownership. Shipowners with spare capacity to
deliver spot trade would benefit if prices are high, but those would be the large
companies with multiple resources and multiple terminal outlets that have the
ability to maintain spare capacity and divert, in case of a weak market. Unlike
oil tanker business where speculative owners can enter the market and be
competitive offering lower prices, LNG speculative owners have to deal with
enormous financial pressures and uncertainty since the risk and costs
associated would be greater.
25
If the number of uncommitted ships is large, and there is also spare capacity
for short term hired ships, then there would be oversupply of shipping capacity
relative to the quantity of spot traded LNG and the freight rates will tend to
fall.
Similarly, if the fleet is fully utilised, an unanticipated increase in demand
should lead to an immediate increase in the freight rates.
4.5 Transportation Costs
LNG transportation costs are divided into operation and voyage costs.
Operation costs are non-trading costs incurring irrespectively of the trading
commitments of the ship. These costs include manning costs, insurance,
repairs and maintenance (spares, store, lubricants etc, dry docking) and can be
considered fixed. Manning cost is the largest among operation costs as shown
in Figure 10.
Figure 10: Operation Costs breakdown. Source: LNG One World[38]
26
Voyage costs include bunker costs, port costs and canal fees. They are
associated with certain trade routes where loading and discharging ports are
specified. Bunkers being the major cost including boil off rate.[26] Boil off rate
is the amount of boil – off gas, which is produced due to some heat inleaks.
This gas is used as a fuel for propulsion systems. Its value varies between 0.1-
0.15% of the full content per day.[41]
Some indicative transportation costs from Qatar to selected routes are given in
the Table 1.
Route Transportation cost
($/MMBtu)
Abu Dhabi-Japan $0.98
Algeria-Cove Point $0.60
Egypt-Lake Charles $0.90
Qatar-Lake Charles $1.50
Qatar-Japan $0.94
Nigeria-USG $0.94
Table 1: LNG Transportation Costs on selected routes loading from Qatar.
Source: Poten and Partners[25]
4.6 Contracts
4.6.1 Long term contracts
Traditional LNG trade is based on long term take or pay (TOP) Gas and Sales
and Purchase Agreements (GASP). The duration of the contracts is over 20
years with pricing formulas fixed for the entire life of the contract and
provisions to ensure minimum revenues. Take or pay clauses shift the volume
risk to the buyer, and seller bears the price risk, since prices are indexed to oil
prices. LNG ships employed under long-term charter, delivered ex ship (DES)
or freight on board (FOB) and dedicated to transport LNG sold under GSPA
27
agreements. Furthermore, destination clauses are included to prevent buyers
from reselling the cargo to third parties.[9]
The key issue of traditional LNG contracts is reliability and security of supply.
The uniqueness of LNG contracts is that buyer and supplier are negotiating
directly with one another and the transportation elements – liquefaction for
supplier and regasification for the buyer- remain under the control of the
contracting parties.[16]
Deregulation of the gas market followed by the concept of market competition
and the assumption that governmental monopoly of electricity and gas is
inefficient, lead to restructures in traditional contracts. Besides, long-term
GSPA proved limited and inflexible. During the financial crisis in Asia in
1998, the energy consumption dropped significantly and the traditional LNG
consumers (Japan, Korea and Taiwan) committed to GSPA with fixed prices,
forced to contravene their contractual terms.[30]
The new style contracts emphasize flexibility and price and cost
competitiveness. Duration is between 10-15 years and prices are indexed to
gas prices, since oil linked prices indexation proved a poor indicator. In
addition, frequent price adjustments provision have been added to ensure
competition. Destination clause is now removed and some sellers try to keep
their destination option open by integrating downstream through “self
contracting” with their own market affiliates.[15]. Take or pay clause still exists
but less frequently.
4.6.2 Short term Contracts
The main difference in short-term contracts is that they obey the logic of
spatial arbitrage, enhancing the integration of existing regional gas markets.
Another difference is that short-term trading introduces temporal arbitrage
28
opportunities, which implies the development of storage facilities and the
development of an organised market.[19]
The short-term market has grown substantially, from 0% in 1990 to 8% in
2002. Forecasts expect short-term trade to rise up to 15% - 20% by 2010.
Korea, a traditional importer under long-term agreement, has gone into short-
term market to deal with the increased demand during seasonal peaks.[29]
But switching from TOP to short-term contracts requires fundamental changes
in the principles of the international gas trade, with great uncertainty and
various risks involved.[19] For example, terminals have to add sufficient capacity
to receive and process additional short-term shipments, on top of the
scheduled shipments.
Gas market infrastructure is also an important issue. In countries like USA
with advanced pipeline network, gas pricing is fully deregulated and LNG
represents only a fraction of natural gas supply. However, in Asia, LNG is
heavily indexed to oil prices since there is no any indigenous pipeline gas, and
natural gas is treated as a substitute to oil. Security of supply with long-term
contracts with rigid TOP contracts, dominate the Asian market. Suppliers in
the Asian market impose a security premium that buyers agree to pay,
resulting to higher LNG prices in the Pacific basin.[29]
4.6.3 The Effect of LNG Contracts to Freight rates.
Figure 11 below presents the current type of LNG contracts in the three major
regions. Data is based on the information available from LNG One World[38].
There are 183 GASPs LNG agreements worldwide, but for only 95 of them
information is provided about the type of the contract. FOB contracts
dominate the market in the Atlantic basin (FOB: 7.1%, CIF: 1.64 %) whereas
in Middle East (FOB: 2.73%, CIF: 5.46%) and in the Pacific basin (FOB:
29
8.7%, CIF: 19.7%), CIF is the most preferable type of shipping agreement.
DES agreements represent only a very small percentage in all regions,
according to data available.
0
5
10
15
20
25
30
35
40
No
of C
ontr
acts
.
A tlantic P acific M iddle E ast
C urrent and Future C ontracts
C urrent C IF C urrent FO B C urren t D E S
Figure 11: Current and future contracts per region Source: LNG One World[38]
The transaction type of LNG procurement affects the shipping costs and the
cost of LNG delivered. In CIF transactions the supplier bears the cost of
shipping and insurance on behalf of the buyer for transporting LNG to the
specified delivery point. The supplier will charge a premium in the case of CIF
supply and this will result in higher cost of shipping and consequently in
higher cost of LNG delivered. The premium reflects the risk for events such as
non-ships availability and unforeseen costs in shipping and insurance. In
addition, when the supplier controls the shipping, the risk of demand is
minimised. For example, in case of excess production, or in case of a dispute
with a buyer, the supplier having the control of shipping can divert cargoes to
alternative buyers and minimise the price risk. Control of shipping will also
put suppliers in advantageous position at the end of a contract, as they can find
other customers without having to invest in new shipping therefore minimising
their shipping costs and increasing their competitiveness.
30
The CIF procurement therefore is a mean to maintain security of supply.
Countries like Japan and Korea, with no indigenous pipeline network, are
heavily dependent on LNG and security of supply is more important than the
price. This is the main reason why CIF contracts dominates Pacific region.
However, now many buyers prefer to buy FOB and this is reflected to the
large number of uncommitted ships under construction, which represents a
15.18% of orderbook capacity (Figure 6 above). Where the buyer is able to
take delivery of LNG on an FOB basis, the flexibility associated with ship
scheduling will pass to the buyer; this will manage the potential exchange or
resale of LNG cargoes and will allow re-routeing cargoes to its own
alternative terminals. In this way importers can reduce LNG cost by managing
LNG transportation themselves[43]. But the latter implies that buyers will have
to bear shipbuilding or ship purchasing costs, fleet management costs plus the
risk of ships laid up in case of shortage of supply or a significant decrease in
shipping freights.
4.7 Liquefaction Capacity and its effect to freight rates
Liquefaction plant is the largest cost component in the LNG value chain. Over
the last years, the economies of scale achieved, increased the capacity of
liquefaction trains, which in turn contributed, to a substantial decrease of
liquefaction costs by 30-50%.
Pacific basin is the strongest in terms of liquefaction capacity, with Indonesia
and Malaysia being the major producers, counting for 47.7% of worlds total.
In the Atlantic basin the major producers are Algeria, Nigeria and Trinidad
and liquefaction capacity counts for 30% of worlds total. In Middle East
Qatar is the largest producer, and the total liquefaction counts for 22.2%
respectively. When plants under construction will be delivered, Pacific will
31
count for 37.9% of worlds total, Atlantic 34.5% and Middle East 27.6%, as
shown in Figure 12 below.
E x i s t i n g a n d U n d e r c o n s t r u c t i o n L i q u e f a c t i o n P l a n t s
0 1 0 2 0 3 0 4 0 5 0 6 0 7 0 8 0 9 0
A l g e r i a
E g y p t
E q u a t o r i a l G u i n e a
L i b y a
N i g e r i a
N o r w a y
T r i n i d a d a n d T o b a g o
A t l a n t i c B a s i n T o t a l
A u s t r a l i a
B r u n e i
I n d o n e s i a
M a l a y s i a
R u s s i a
U S A
P a c i f i c B a s i n T o t a l
O m a n
Q a t a r
U A E
M i d d l e E a s t T o t a l
C u r r e n t ( M m t p a )U n d e r c o n s t r u c t i o n ( M m t p a )
Figure 12: Existing and under constriction liquefaction plants.
Source: LNG One World[38] (Combined data)
According to IEA’s estimates (Figure 13 below), Atlantic basin market
appears to be undersupplied. Future LNG demand in the Atlantic basin will
create demand for shipping services and this is verified by the large orders of
new ships committed to trade in the Atlantic (Figure 6 above).
In the Pacific basin, the potential new projects supply is greater than the
demand of the nearby markets and this is reflected in the reduced planned and
under construction projects. Pacific market appears to have reached its
capacity and most probably will be less important in the future.
32
Figure 13: IEA’s estimated import growth and incremental liquefaction capacity
2002-2010. Source: Jensen (2005) [15]
Freight rates are linked to the liquefaction capacity through the concept of
supply and demand. However, it is necessary again to distinguish between
short-term and long-term trading. In the long-term, decrease in liquefaction
cost and oversupply of LNG is not an important variable since freights,
quantity, destination and time is agreed.
On the other hand, in spot trading, LNG supplies, liquefaction costs, and
destination would affect freight rates. Lower liquefaction costs reduce the
price of LNG delivered and shipowners would like to cease the opportunity to
be competitive. Added capacity of liquefaction trains with some capacity
uncommitted to long term trading will create demand for ships available for
spot trading. Depending to the market status, freight rates will balance supply
and demand. If there is oversupply of ships available for spot trading, freight
rates will drop. If there are not too many ships available, and the cargoes have
to be delivered to the designated points due to lack of storage capacity or due
to contractual agreements, then freight should rise. Geographical location of
the loading and discharging port will be a key issue, since long hauls are more
costly, and depending to the delivery point a premium would be added. Middle
33
East location in this respect is favourable since it can be the link between
Atlantic and Pacific basin.
Added liquefaction capacity for short term trading will create a market in
which freight market supply will be determined in line with the surplus
capacity of exporters, availability of ships for spot trading and import needs
others than the long term TOP agreements. Short term traded LNG is more
likely to take the advantage in the imbalances of demand and supply and
introduce a secondary LNG shipping market with rather great volatility in
freight rates in which potential for great profits or losses will be evident.
34
5 NEW BUILDING MARKET
5.1 Introduction
The uniqueness of the new building market is that it trades vessels that have
not yet been built. The contract negotiations can last from 6 months to one
year and usually focus on the price, the vessel specification, the terms and
conditions of the contract and the finance scheme offered by the shipbuilder.
The ships will be delivered after 1-3 years depending on the type.
The price of new building from the supply viewpoint is determined by the
shipyards capacity. When new building supply rise, then prices will rise
accordingly. Moreover, the increase in costs of raw material (e.g. steel) will
increase the price of new building. But increased demand in new building will
extend the delivery time, which will further increase the lagged response of
the shipbuilding to the increased demand for shipping services. On the demand
side, the prices are affected by the freight rates the price of second hand ships,
credit availability, expectations and liquidity of the buyers.[22]
Orderbook represents the ships to be delivered in the future. The number of
ships ordered depends on the new building prices in relation to shipbuilding
costs. Long-term changes in the freight rates will affect shipbuilding
production and prices since new orders reflect markets expectation, especially
with regards to the second hand prices.[2]
5.2 Fleet expansion.
Figure 14 below shows the orderbook for LNG ships (31/05/04). There are
112 ships ordered with capacity 16.3 million cu.m to be delivered up to 2009.
35
O rd e rb o o k
0
10
20
30
40
50
60
2005 2006 2007 2008 2009
Tota l No s h ips orderedCapac ity ( ,00000 c u.m.)
Figure 14 :Orderbook
Source: Maritime Business Strategies[35]
However, it is more likely that the majority of shipowners will not opt for the
short-term market. The average committed contracts’ length for the 62% of
orderbook fleet is 23 years. The rest of the ships will either be involved in
long-term agreements in the near future while a quite substantial percentage
will be available for short/medium-term trading.
5.3 Ship building Industry
The primary method of increasing the number and tonnage of ships and their
quality in terms of economic and commercial performance is through
shipbuilding. The delivery rate of new ships is determined by the capacity of
the shipyards and the lagged distribution of past orders.
Shipyards use compensated gross tonnage (cgt) as an indicator of the capacity
and the work content of shipbuilding. It is based to the gross tonnage and
reflects the complexity of the building process by measuring the comparative
work content inherent in building the ship.
From 1990 and onwards, shipbuilding industry has recovered from the
recession that started in 1975 following the oil crisis of 1973. The upturn in
the industry is not solely due to the need for replacement of the obsolete ships,
36
but also due to the expansion of world trade which generated a need for
additional shipping capacity. The latest developments in the containerisation,
the expansion in cruise market and the use of LNG as a fuel source, and the
introduction of stricter regulations against pollution made shipbuilding again a
high growth industry.[7]
The standards of construction of LNG carriers are higher than any other type
of ship. Construction is limited to 15 licensed shipyards worldwide and the
entry cost into this sector is significant.
As shown in Figure 15 below, South Korea has the largest share of the market
with Daewoo and Samsung holding the 28.6% and 28.5% of total capacity
ordered. Current LNG fleet capacity is 20.9 million cu.m and the orderbook at
end of May 2005 stands at 16.6 million cu.m, which represents almost 80% of
the current fleet capacity.
Ships orde re d by s hipya rd
0 5 10 15 20 25 30 35 40 45 50
Hudong
Kaw as aki Sakaide
Koy o Doc k
Mits ubis hi Nagas aki
Mits ui Chiba
Univ ers al Ts u
Daew oo
Hy undai
Hy undai Samho
Sams ung
A tlantique
IZ A R Ses tao
Capac ity ( ,00000 c u.m.) Ships
Figure 15: Orderbook by shipyards and capacity
Source: Maritime Business Strategies[35]
5.4 Price of New Building
Prices of new buildings are determined quite simply and are depending on the
spare capacity of the shipyards and the amount the shipowner is prepared to
37
pay. The traditional view of shipbuilding prices was that they behaved much
like a commodity, with prices rising and falling along with demand.
Depending on the state of the market, the negotiating power may lie with
either side. If the market is rising, the shipowners will hustle to order new
ships and yards will take the advantage to raise the price; if the market is bad
and freight rates are low, yards will lower the price in order to lure shipowners
to order new ships.
But in reality this relationship is sensitive to developments in shipbuilding
capacity and it’s influenced by a number of parameters; that is, the balance of
demand and supply, the shipyard costs, currency fluctuation, shipping market
condition brokers aspiration and national policies.
LNG Deliveries #
0
5
10
15
20
25
30
35
40
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
Ship
s N
umbe
r
.
0
500
1000
1500
2000
2500
3000
$/cu
b.m
.
Deliveries (left)New building prices (right)
Figure 16*: LNG ships deliveries and new building prices
Source: Maritime Business Strategies[35] (Combined data)
# Color changes in series indicate orderbook * For the period 1985-88 and in 2009, prices assumed equal to previous years since no data or deliveries available
Balance between supply and demand Capacity: Prices for LNG ships are
coupled with LNG delivered volume and changes are moving in line, as
shown in Figure 16 above, with a time lag of 2 years. This is due to the fact
that prices are negotiated and agreed when the building contract is signed, and
not when the ship is delivered. However after 2000 there is an all time record
in new ships delivery, which is not followed by a respective increment in
38
prices, as someone would expect. Prices although still tracking the changes in
volume, have decreased dramatically. The lowest level reached in 2000 where
Exmar ordered a ship from Daewoo Shipbuilding for $143 million. The same
ship in 1990 would have cost $260 million.[25] The main reason for low prices
and the de-coupling of price from volume delivered is competition against the
shipyards to gain a share to the high valued sector of LNG ships.
Shipyard costs and revenue: The price of a ship depends on its type and size. It
is far more complex to built an LNG ship than a bulk carrier and that implies
that higher complexity commands a higher price. But higher work content
does not necessary equate to higher value of work. Shipyards use the concept
of added value to describe the portion of revenue from the construction of a
ship covering labour costs, overhead interest and depreciation. Added value is
the profit of the shipyards when material, contract and other direct costs have
been deducted from the agreed price of the ship.
Table 2 below is shown the comparison in the change of a VLCC and an LNG
ship. It is clear that whilst both type of ships have seen a reduction in price, the
reduction in LNG has been far higher. As a result, shipyards are competing
with each other to capture the largest share in this market.
Estimated added Value
(US$/CGT) Ship Type
1997 2003
VLCC 760 480
LNG Tanker 1,570 680
Relative value of LNG tanker compared to VLCC 206% 142%
Table 2: Comparison of the change in added value of VLCCs and LNG tankers
Source: CESA [10]
39
Currency Fluctuation: The Asian financial crisis in the late 1990’s had a
major influence on the LNG shipbuilding industry. The Korean won declined
almost 50% compared with the US dollar and that gave a strong advantage to
Korean shipbuilders against Japanese, since their labour costs in US dollars
declined significantly. Koreans lowered the price and introduced high
competitiveness in the LNG market. But when the won recovered, without
price increases profitability South Korean shipbuilding started to deteriorate
and a number of shipyards got into financial difficulties (e.g. Daewoo). In the
meantime low prices resulted to full orderbook in 1999 and 2000 and then
prices rose again but in 2002 orderbook was no longer full and prices fall
again.
Shipping market condition: Price negotiation between seller and buyer
depends on the orderbook of the yard and the buyer’s view about the market.
Obviously a fully booked shipyard makes price negotiations much harder for
the owner. The nature of the buyer will have an effect to the negotiation as
well. If the buyer is a major shipping company for example; a regular buyer
will wield a greater level of influence than a speculative buyer. The majority
of LNG owners are well-established operators with long experience, however
with the development of LNG trade, shipowners traditionally involved with
the dry and bulk, entered the LNG market. A great number of ships ordered
with no committed contacts, which is rather unusual for the LNG shipping
sector. Shipowners make a great amount of profits by buying or building ships
when the market is weak and prices are low, and sell when the market has
peaked. It would be interesting to see whether these shipowners would enter
the LNG market as operators, or they would take advantage of the low prices
to speculate and sell the ship later, when prices will rise again.[10]
40
5.5 Shipbuilding Capacity and it’s effect to freight rates
The ill effect of overcapacity is a known concern in the shipyard industry and
the control of capacity was a major issue during 1980’s in Japan and Europe.
Following the oil crisis in 1973, the shipbuilding industry in 1975 went into a
long-lived recession and governments did not permit further development in
shipbuilding capacity while granting subsidies to the shipyards in order to
contribute to competitiveness. By that time Korea entered the industry
exacerbating the existing massive overcapacity and many started referring to
shipbuilding as a “sunset industry”.[34]
LNG shipbuilding capacity from 15 shipyards worldwide is 57 ships per year
Decision for scrapping is based on the appraisal of the long run market
condition and to the shipowners’ expectation about the future prospects. Weak
market with low freight rates and negative owners expectations will increase
scrapping activity.
7.3 Lay up and Scrap Prices
Scrapping markets balances scrapping volume and prices. In a depressed
market the tonnage offered for demolition increases and scrap prices fall.
However demand for scrap steel is affecting scrap prices, although the
influence is not significant. This process is reversed in a strong market with
positive expectations for future revenues. Shipowners will be reluctant to
scrap, and scrap prices will rise.[21]
Scrapyards’ interest focus on the amount of steel and other non-ferrous metal
obtained from a ship and the scrap value is determined by the light
displacement tonnage; this is the weight of the hull plus machinery, equipment
and spares. Scrap prices are quoted in $/lightweight tone and obviously
depend on the type of ship. LNG cargo tanks are made of stainless steel, which
is more expensive than steel and this should be reflected in the scrap price.
54
Furthermore, the fact that high standard machinery and equipment used in
LNG ships is resalable should also contribute to higher scrap prices. Although
the evident is strong to support this statement, unfortunately no scrap prices
data is available at this stage to prove its validity.
Lay up is the temporal withdrawal of tonnage during a weak market. The
difference from scrapping is that lay up is temporal and tonnage can be
returned to active trading operations when market will recover. Therefore the
decision to lay up relates to freight rates and market expectations but the
withdrawal is not permanent and the owner has the option to reactivate the
vessel when favourable economic opportunities arise.
But it should be noted that even in laid up conditions fixed and maintenance
cost still incur and shipowners take those in account when a laying up decision
is considered.
With the introduction of a more flexible second hand LNG fleet, scrapping
and laying up activity should increase. However unless a globalised LNG
trade is established, the structure of the LNG shipping tends to present
oligopolistic characteristics. The recent developments in LNG contracts add
some degree of freedom to the market structure enabling a number of
participants to enter, but there is still long way to go for a liberalised LNG
shipping market.
55
8 CONCLUSION
LNG shipping markets are not as liquid as the wet or dry bulk markets.
However the emergence of LNG trade coupled with the changes in the
traditional GSPA structure has caused rapid expansion in the size and capacity
of the LNG fleet. The preceding analysis identified the main parameters that
affect freight rates and how LNG shipping markets are interrelated to each
other.
The main factor affecting freight rates is the amount of ships trading, the
transaction type and structure of LNG procurement and the liquefaction
capacity and regasification. In the long-term agreements, if shipping contracts
will extend jointly with the extension of GSPA, freight rates should not be
affected unless LNG demand overtake shipbuilding supply. In the short-term
agreements excess of ships available will push freight rates down. Similarly, if
the fleet is fully utilised, an unanticipated increase in demand should lead to an
immediate increase in the freight rates.
Added liquefaction and regasification capacity will create a short term trade
market in which freight market supply will be determined in line with the
surplus capacity of exporters, availability of ships for spot trading and import
needs others than the long term TOP agreements. In case such market emerges
it is expected to be volatile, however the regional gas market structure implies
limitation in terms of liquidity, high price risk and uncertainty.
Activity and prices in the new building market are affected by the long-term
changes in freight rates and market expectations, which also influence second
hand prices. Orders for LNG new building have reached all time records and
this might create overcapacity that will drive freights downwards and might
56
introduce speculation in new building re-sale market. However limited
shipbuilding capacity for LNG ships coupled with increased production of
other ship types might cause undersupply, causing a peak to freights, new
building and second hand prices.
Surplus in liquefaction and regasification capacity and development in LNG
trade are connected with the emergence of spot trade. The traditionally weak
LNG second hand market is likely to take advantage of the imbalances
between demand and supply that would arise. Market participants will use
second hand ships for spot trade since new buildings would be engaged in
long-term contracts.
With the introduction of a more flexible second hand LNG fleet, scrapping
and laying up activity will be increased.
However, LNG shipping markets are not likely to be as liquid as oil markets,
since LNG ships cannot still operate in several trades. Unless a global gas
market is established with enough participants that will ensure
competitiveness, long-term agreements will dominate LNG market.
57
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