At a recent shipping event a panel of highly experienced executives took to the stage, microphones in hand, to air their views on a number of topics that are considered prescient to the market today.
The fact that it was a panel of financiers and advisors made it all the more interesting as none of the questions related directly to the shipping finance market. Outsiders looking in can be very instructive. Among the many subjects covered was one particular statement that stuck on my mind. ‘Shipping is about as close to perfect competition as a market can get’ we were told. Admittedly I am taking this quote a little out of context, but nevertheless it is not the first time that this opinion has ever been raised, including no doubt by myself at various points in my shipping career. It is also not beyond the realms that I will use it again and although fact checking is turning into more art than science these days, this one is pretty fundamental to how all business models within shipping shape themselves. It is even more critical if the leading investors and financiers believe it to be so that it is really so. Up into the attic then for my ‘An Introduction To Positive Economics’ by Richard G. Lipsey, the Bible for budding economics students, but also a classic reference point for those that might have forgotten or corrupted the basics.
The basic tenets of perfect competition are as follows:
- many companies participate in the market
- freedom/low barriers to entry or exit – basically low sunk costs
- a homogenous/identical product or service is sold
- all firms are price takers, so the demand curve is perfectly elastic
- there is perfect information and knowledge
Shipping does display quite a few of the characteristics, but generally with some caveats (from minor to major). There are undoubtedly lots of companies in the market (more on this point shortly). The second point is a bit more tenuous though. Some types of company can come and go as they please. The operator does need some cash, the more the better, but not a vast fortune. However, owners have very large sunk costs and exits are not exactly liquid. You can almost always eventually find a buyer of your assets, or indeed a seller if you want to start playing, but certainly costs are restrictive.
If you were so inclined to tell a ship owner that all ships are basically the same you would be unlikely to come away from that conversation unscathed. In fact, some may argue that no two ships are ‘exactly’ the same and you don’t really find out the true specs of a ship until you have run it for a while. Ships are all different sizes of course (let’s assume we all know this part), but there wouldn’t be such an art form in doing voyage estimates if they were all same and at times it appears that it would take an infinite number of monkeys with an infinite number of voyage calculators to come up with figures that everybody could agree on (again, more on this shortly).
In theory all shipping companies are price takers. You get what a charterer will pay. However, logic does sort of suggest that at the point where doing business is going to lose money companies would choose not to take the price. The current market shows this not to be the case at all in shipping, and there are many examples. Maybe one could argue that operators would choose not to do fix as they have that option, but owners might rather just keep the ship moving, even at a loss. Operators regularly take on loss-making voyages for reasons such as ‘customer relationships’, so that starts to undermine two other definitions of the ‘perfect competition’ model. Firstly, that all sellers are selling for the same reasons (homogenous product in the marketplace). And secondly, what is a loss for one is not necessarily a loss for another, so pricing is not transparent or perfect. When the price hits X, not all companies are making a profit or loss. This is starting to feel a long way from the perfect marketplace.
The last point is probably the most troublesome for shipping to be considered perfect competition. If we assume that all of the individuals who fix ships have fairly equal abilities (let's not even start to discuss this one), one would assume that every chartering manager would make the same decision if given identical circumstances and information. Let’s lean up at the bar after the conference for a moment. I am confident that if you run out of things to say that if you mention that shipping is fundamentally a ‘people’ business, you would not show yourself up to be a charlatan. But it’s hard to be a people business that is so full of contrasting opinions and characters, coupled with appreciation and appetite for risk, as well as techniques to analyse the market, along with accompanying trading strategies and yet at the same time assume that the protagonists will make the same decisions with the same information.
On the subject of information, a quick look at the Infospectrum database will tell you that there are thousands of companies that charter ships each year. A typical charterer is in the 0.5-2.0m tonne per year range rather than grain house size. 5bn tonnes of dry bulk cargo per year, more or less, and it’s not hard to imagine that information is very far from perfect. The database also reveals that there are charterers in almost every country that has a coastline, not forgetting Geneva-based traders and Bolivian copper miners. As a ‘people’ business, not surprisingly we are all tempted to deal with people we know and trust, and failing that we ask those that we know if they know anything about the people we don’t. Geography, time zone, language, nationality, culture are all factors that contribute far more strongly that AIS data in deciding who sees what and fixes with who.
One may wonder that the offshore nature of both shipping and commodities contributes heavily to this fractured phenomenon. In markets like FFAs, where trades are cleared so due diligence is done on companies in order to allow them access to the market, but once completed they are able to trade with any other participant, might discourage the (quite reasonable) practice of only dealing with those you know. But it would appear to blow a large hole in the idea that information and knowledge is perfect. It seems a very bizarre concept to argue that dry bulk shipping, which could cover as many as 70-75,000 fixtures per year (not counting time charters and relets), could suffer from a liquidity problem. After all, every cargo does seem to get fixed. But it does seem to suffer from a chronic information problem, particularly on matters of performance, counterparty risk and credit.
I met with the head of coal trading for a major exporting region at one of the world’s largest coal traders about a year ago. He confidently informed me that his shipping team spoke with every Capesize owner and operator in the world. He then checked how many different shipping companies he fixed ships with for the previous year. Answer? Just 13. I’d say we were both pretty shocked at that number.
So in summary, shipping does have some minor elements of perfect competition, but when examined in detail, as per a good old-fashioned undergraduate economics text book, we are very far from perfect. How to improve? I think the more pressing question for the industry is ‘why bother to improve?’ If you are happy with how things are right now and believe that the business model is working for you then just sit tight and fix!
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