Insight: SAL Heavy Lift Day
A big “thank you” to SAL Heavy Lift for inviting me to speak in Hamburg before an engaged group of roughly 70 maritime professionals! At a lovely venue with, of course, a view of the water, we were also given an opportunity to listen to other great speakers who shared their thoughts on shipping.
For those of you just tuning in, SAL (formerly: Schiffahrtskontor Altes Land/SAL) Heavy Lift is a major north German heavylift operator owned by shipping conglomerate Harren & Partner. They operate a fleet of specialized vessels that are able to perform a variety of lifting and transportation project roles. The SAL Heavy Lift Day is hosted by SAL Heavy Lift to celebrate its customers and clients but also to bring in a variety of industry professionals to share their thoughts with the attendees.
A Market Overview
The first duo was from Töpfer Transportation, a Hamburg-based shipbroker. As a “close to the market” agency, it was all about what’s going on in the multi-purpose vessel chartering market. Fleet, market share, cargo and charter rate analysis was capped off by an introduction to the Töpfer’s Index, which was developed in-house on the basis of information relating to ca. 11 multi-purpose F-type vessels (thanks to Christian Hoffmann of SAL Heavy Lift for this additional detail). These were held to be reflective of the multi-purpose vessel market in general.
“Cautiously optimistic,” was the message. The orderbooks are slimming while most of the recent construction originated in China, the presenters argued, meaning that those Chinese built vessels would probably be retiring roughly five years earlier than other builds, so in perhaps 15-20 years at most. This would winnow out the currently existing overcapacity in the heavylift market. Also, orderbooks for Chinese yards are down 73 percent year over year in Q1 2019 – it’s a good time to be a buyer!
An analysis of relative company shares in the heavylift market follows. The “Top Four” heavylift operators control 72 percent of the deadweight tonnage; these tend to be “P-Type” lifters which are somewhat less flexible and versatile and sometimes cannot perform offshore operations. Indeed, for the most demanding work, equipment like dynamic positioning systems is required. This can be expensive and high-skilled, and not every operator wishes to make the requisite investments.
In terms of cargo volumes, Töpfer’s representatives argued that the cargo mix is critical. Crude steel, they noted, is a good base cargo to fill up most of a ship, while leaving enough capacity for higher paying items. Crude steel volumes are largely stable (“neutral”) however. The same was true of oil.
Perhaps most interestingly, market exits were almost impossible pre-2017. This was due to a lack of buyers. The market segment has only become liquid again from Q2 2017 onward. It’s difficult to make a definitive statement on this aspect, however, due to the players largely being closely held companies.
The market, though, is changing: especially as it relates to finance, Germany isn’t ready to face the global markets. This is both in terms of the flexibility of the institutions as well as the contracting. Further, the stakeholders aren’t in a position to make a compelling case. To illustrate, an anecdote was provided of a shipowner saying he would “never invest his own money in shipping.” Of course, advice was provided to this gentleman to keep that thought private; if he doesn’t believe in the business, why would a bank?
And Now… CO2 and the Great 2020 Equalizer?
Following this great opening act, Wilhelm Borchert’s two representatives stood up to discuss the upcoming IMO 2020 emissions regulations. Tongue in cheek, the topic was: “To scrub or not to scrub?”
As emissions control areas expand, encompassing Chinese ports in 2018 and all Chinese domestic waters in 2019, followed by a global 0.5 percent global sulfur cap in 2020, the proverbial noose is tightening for heavy fuel oil, heavy sulfur burning vessels. A MARPOL amendment will even make it illegal to carry non-compliant fuel, absent certain carve-outs. Of course, the U.S., Caribbean and California have been emissions control areas for some time now, so new developments are chiefly of interest to international operators, rather than shipping companies chiefly focused on European, Chinese and American markets.
As alternatives to old-style fuels, marine distillates, LNG and low sulfur fuel oil were mentioned, but each of these have issues vis-à-vis “tried and true” (and cheap!) high-sulfur heavy fuel oil.
Wilhelm Borchert, a strategic consulting firm based in Hamburg, Germany, is projecting a rise in scrubbers being installed and in switches over to LNG fuel. Even so, relative to the global merchant fleet, such LNG refits/installs and scrubber installs are going to represent a tiny fraction. The firm projects that distillates, blended distillates and low sulfur fuel oil will fill the gap before LNG.
However, even in the best-case scenario, energy demand in the transport sector, globally, will only peak by 2040 (vs. roughly 2020 for the OECD, developed economies). In other words, overall demand for fuel in shipping will continue to grow powerfully in the decades to come, reflecting more trade. Noteworthy is that even as the OECD economies cut their energy use in transportation, the growth in Asia, Africa, India and China will more than make up for – and even exceed – that savings.
According to Wilhelm Borchert’s analysis, bunker prices in the early 2020s may have a spread of $450-$550 per metric ton (thanks to Justin Archard of SAL Heavy Lift for this additional detail). Bunker would cost two or even three times more than now. Note that such a price shock would be a problem for the industry inasmuch as the cost increase isn’t possible to pass along to charterers or cargo interests, as it typically the case today via bunker price clauses.
The picture of massively increasing fuel demand coupled with the political desire to cut CO2 emissions leads to only one solution: much better efficiency. But none of the fuels deployed will be efficient enough to generate the CO2 reductions desired. Instead, even the “low impact/low demand” projection shows CO2 generation above the levels of today and certainly above the political CO2 target.
From the perspective of this author, the major error is expecting CO2 generation to decline without a corresponding financial incentive. This could be either provided by the public sector (subsidies or tax breaks) or by the private sector, e.g. via the development of a cheap, easy alternative fuel which would reward shipowners who switch to it with an improved business scenario for their company.
Failing that, implementation will only be on an “as required” basis and will not progress swiftly. As shown by the anticipated spikes in bunker prices, certainly there is no financial incentive at this time. In fact, using the “compliant fuel option” (i.e. marine distillates, low sulfur fuel oil) is the most expensive. The scrubber is cheapest. In between is using LNG, though this propulsion type is still relatively tricky.
Greed And Bad Contracts
Following all this, I got a chance to speak about counterparty risks and how the myopic focus on getting the absolute lowest price on the part of cargo interests leads to irrational allocation of risks. The idea is that a contract should allocate risks to each party as it can best bear them. This way, the value is maximized, since inefficiencies due to poor risk allocation are eliminated. But when price is all that matters and risks are one-sidedly placed on one party without regard to whether or not that party is best able to bear said risk, the overall net value generated by a transaction is severely reduced.
The talk largely followed the lines of my article in The Maritime Executive earlier this year, reproduced here:
Counterparty Risk and the Rabbit Hole
A contract can be a clear reproduction of the intent of the signatories, with straightforward, well-written, properly spelled clauses framed by nicely appointed formatting and infused with adroit legal reasoning. Or, more often, it can be a chopped salad of expectations and misunderstandings.
I’m convinced that every time a bad contract is drafted, unfortunately, a new lawyer joke is born.
So far, apart from the one noteworthy exception of Arrested Development, the number of jokes about maritime lawyers has been under control. Not only has maritime law had a reputation as one of the most “elite” fields of practice, it had pride of place within an ancient, well-manicured, secret garden of shipowners, brokers, agencies, yards and managers – a community virtually invisible to the world of consumers served by it who would, without it, either freeze or starve. The barriers to entry were high for anyone seeking to start a business in shipping, both in terms of getting the financing and capital and making personal and professional connections.
All this, of course, changed roughly ten years ago now with the so called “shipping crisis”.
Now, insolvencies are eroding the deep networks of the past; and, due to this, cargo interests have filled some of the emerging fissures to take over roles previously held by middle-men. To get the same profit, the remaining traditional actors have needed to take on more risk.
And one of the least anticipated, most underestimated risks is counterparty risk. With that, I don’t mean the traditional definition of default or breach of contract; what I mean is that it is surprisingly hazardous to deal with customers who lack background and know-how in shipping. We also have within the industry both increasing specialization as well as economic conditions that are driving companies to try to diversify and expand into new specialties, and both motivations can lead to insufficient background within a particular niche, even given solid overall knowledge.
To circle back, a contract is only as good as the parties who are behind it, in the same way that a product can ultimately only be as good as the raw materials that went into its making. Ludwig Wittgenstein said, “The limits of my language mean the limits of my world.” A customer entering the maritime sector or into a new niche within their industry retains his old language; his world is still limited to his previous world. But what the customer does not know is that the maritime sector is its own world and, to function and thrive, it needs its own language: from esoteric terms like laytime and deadfreight to workaday phrases like tow line and bow thruster, without command of the language, the world will remain obscured. Or you have lifelong players in the maritime industry who are, for the first time potentially in decades, faced with being a novice in a new (or new to them) field. It can be difficult to branch out, difficult to reinvent, but there is no alternative.
And yet, it is not so simple: the structural change in the industry is evident and when two worlds collide, there will be collateral damage. An example: a construction company has taken on responsibility for work on a navigational channel and orders a cargo of Norwegian scouring material for delivery on an old non-geared bulker. The arrival of the ship is delayed a couple of days due to rough weather, causing losses to the construction company. The shipowner, not liable for such delays both under his contract and under the applicable law, is surprised when the general manager of the construction company makes an angry demand for tens of thousands of euros of damages. Both sides think they are in the right, making the situation even more maddening.
While “just in time” delivery is a daily fact of life in land-based work, anyone acquainted with working at sea knows that all plans stand or fall with the waves, wind and tide. It was not so much the intentions of the parties going into this contract that caused it to ultimately become bad, but rather that neither of the parties spoke the other’s language. Their worlds, limited as they therefore were, channeled their expectations about how the respective other party would behave.
Taking time in advance of closing the deal to discuss and explain the unique nature of seagoing voyages is often rewarding, but it’s also a lot of ground to cover. Experts in the maritime industry - no matter the niche - are not made overnight, so addressing this specific counterparty risk can feel like going down the rabbit hole – a waste of time, with an uncertain return, requiring immense effort and patience. Sometimes, after weighing all the options, the best action may be reaction. But don’t tell anyone I said to surrender the initiative when there is so much at stake.
At the management level, the challenge begins in dealing with executives who were born and bred on land, e.g. energy utilities now getting involved in offshore wind power or manufacturing companies who fabricate high and heavy cargoes and want to now use barges instead of roads. The goals are typically clear enough: deliver cargo “A” at destination “B” by time “C”. But the methods involved to make that simple wish a reality are totally alien and unfamiliar. To convey that each project poses not only a logistical challenge, but also a unique seamanship challenge is the first step to communicating the difference between moving goods by road and by water.
And yet we all take to the water for a reason: whether for profits, to find adventure, to exploit new opportunities or because, ever more frequently, the old, land-based solutions are no longer working for the next generation infrastructure and logistics projects that lie ahead. It doesn’t ultimately matter whether you are part of the salty old guard or part of the new makers and shakers jumping in, as it were, at the deep end; we must adapt to the sea to succeed. “The sea never changes,” noted Joseph Conrad, “and its works, for all the talk of men, are wrapped in mystery.”
That mystery used to be mediated by a coterie of professionals and advisors, but that bench is thinning out as well, as time passes by; in Hamburg, one of Germany’s oldest (small) maritime law firms recently merged with a (bigger) general commercial law firm based in Frankfurt am Main which is known for its work in banking, real estate and e-commerce. Despite excited press statements that the maritime law division would be strengthened by the new affiliation, in shipping industry circles, the mood was less positive, akin to bidding adieu to a close, trusted friend. But times are tough, and there is little time left to mourn lost friends. It can be hard to make a living from the sea, nowadays; perhaps especially for this reason, many shipowners resented this act of self-preservation, seeing it as a lack of loyalty when, in hard times, loyalty is needed most.
This “brain drain” in a sector already suffering through restructuring adds yet another day to day frustration for shipowners; namely, that the high-level professionals whose jobs are to facilitate transactions, i.e. to make deals happen, are bleeding away. Roger Ebert, the American film critic, noted in one of his columns: “Employees of corporations are like free-ranging scavenger cells. When the corporation inhales in good times, they find themselves in a place with good nurture. When it exhales in bad times, they go spinning into the vast, indifferent world.” And so it is, here, as well.
Demand for the shipping industry’s services is higher than ever – just not at a life-sustaining price point. That’s due to relentless cost pressure from customers and intense competition. And yet, the expertise and knowledge that commerce by sea deserves is only sustainable in an environment where stakeholders can earn enough to support themselves and reinvest. This applies to shipping lawyers in Europe, who would in the past have assisted green customers in navigating their way into a good relationship with a shipowner who would be able to cater to their specific needs, but it also explains some of the big name exits in recent years, like Hamburg Süd. They are the result of capital goods being depreciated beyond the point of no return. Ultimately, owners see that it would go beyond their capacity to give their company the new assets it would need to thrive. Those who remain are either straight bitter enders – or they are brilliant survivalists.
Part of survival is moving beyond the traditional maritime comfort zone, reaching out to find and acquire unlikely customers and to offer the sea as a service to those who had never considered it before. It’s in these encounters that going down the rabbit hole is the only way to get the carrot.
In the past, competition was hard, but arguably fair and on the same level – or it seemed that way. It was based on price, but also ships, sailors and service to the customer. Even companies whose horns were locked in battle for certain ports, cargoes or lines had a grudging respect for each other and were at least on speaking terms. Now, amidst the shifting ice floes left by a few years of restructuring, it’s hard to even tell who should be speaking with whom. The old way might have been preferable: better to at least speak the same language, to know the strengths and the weaknesses of your competition, to fight and know that one battle won’t determine the outcome of the war. The new way is one of alienation, persuasion, patience and perseverance, working with customers who see a trade with an ancient history as being only a vendor who must be, above all, cheap.
On board, some days are smooth sea, sunshine and blue sky and other days are chop, storm and dark clouds. But we all know the only way to reach port and to touch land again is to keep going. When it’s time to win over a new customer, when it comes to taming expectations, when it comes to framing a project in a way that will work on the water, it’s important to remember: it’s been done before, it’ll be done again and the one who does it best is the one who will set sail once more.
The opinions expressed herein are the author's and not necessarily those of The Maritime Executive.