Tuesday, March 12, 2013

Why not a derivatives market in vessel asset values?

Shipping investment projects have always been mostly asset plays rather than new business models to serve customers more efficiently in the transport of cargo. The Greek shipping industry craves for investment in physical assets as opposed to the Norwegian asset-light cargo operator model with chartered-in tonnage often on purchase options. Profits are generated from moving in and out of assets in the shipping cycle. Cargo transport operations remains secondary in the process mainly to keep holding costs down. Lately investment firms have also gotten into the game, teaming up with operating companies to acquire shipping assets.

Would not it be easier and more efficient to develop a derivatives market for this process rather than taking on all the headaches of physical asset ownership?

The latest version of this asset play concept is the Oceanbulk Carriers partnership between Petros Pappas and Oaktree Capital with the purpose of picking up distressed dry cargo shipping assets and eventually making profits on market recovery. Petros Pappas has an excellent record as one of the most successful asset players in the Greek shipping community, having sold off most of his dry cargo fleet in the heady boom years of the late 2000’s to the point of even moving out of basic ship management and operations.

There is no doubt that the dry cargo business is currently under severe stress. The sector has been plagued for years with a historically high vessel order book on expectations of infinite Chinese growth with their insatiable appetite for commodities imports and incessant speculation in commodities resources. The Chinese themselves have become major shipbuilders with huge expansion of yard capacity, mainly for dry cargo vessels. It did not take much of a drop in Chinese growth rates in 2012 and some inventory destocking to send dry cargo freight rates tumbling.

As this point, several high profile listed dry cargo companies like Genco (GNK) and Excel Maritime (EXM) are on the verge of bankruptcy, plagued by asset prices falling below loan outstandings and cash flow problems to service the debt payments. Unlike Asian competitors like Pacific Basin with large cargo books, these companies themselves started as asset speculations. They leveraged up with debt to expand their fleets in large block purchase deals, playing the market cycle.

Excel Maritime went to the extreme of merging very unwisely with another asset play, Quintana (QMAR) shortly before the 2008 global financial crisis and reportedly taking on US$ 1 billion additional debt to finance this transaction. The motive to merge for the Quintana stakeholders backed in part by First Reserve private equity was to realize their asset position for profit because their operating profits were restricted by long term time charters and this kept their stock price from appreciating as much as they would have liked to see. Just the announcement that they were planning this move caused a bounce in their share price.

Contrary to their mission statement to focus on distressed assets, the Oceanbulk-Oaktree venture recently decided to place new orders rather than to wait for opportunities in existing tonnage. At the same time, their new business development director and former investment banker, Hamish Norton, recently gave a dry bulk presentation at an industry forum in Athens where he sagely noted that the continued drybulk order book risks putting off any market recovery for another year yet in the sector. So ordering additional dry cargo vessels would at least appear to be contributing to more industry distress and counter-productive in hastening any market upturn in rates.

Perhaps a vessel asset futures market – if feasible – would be a more efficient tool for these cyclical asset plays. The ship derivatives could be based on standard type bulk commodities vessels, just as the Baltic Freight index is based on standard voyage routes. Banks could use the derivatives in order to hedge their loan exposure, reducing their credit risks to shipping companies. Shipping companies could hedge their asset purchases against fall in value and impairment charges. Hedge funds and institutional investors could take speculative positions on rising and even falling asset prices.

The beauty of a derivatives market for ship values is that it would not entail any ship ordering. Shipping companies could go back to the fundamental business of transporting cargoes for their customers. Because the derivatives market would allow for both long and short positions on vessel values, it might even assist in providing a reduction of vessel asset price volatility. Positions could be taken and unwound very quickly.

All this would relieve investors from the trouble for these cumbersome partnerships to buy physical assets, the need for bank finance, the travails of ship management and needs to charter the vessels with risks of charterer default, etc., only to lead to a game of musical chairs on market recovery to sell the assets or the shares in the company to the next guy with a mark-up.

Of course, the last guy in the chain like Excel Maritime in the Quintana merger or Berlian Laju (acquiring Chembulk from AMA at a sizeable mark-up), is invariably left holding the candle, facing bankruptcy as the market sours.

The shipping industry would become more of a logistics business, but is it not what it was supposed to be in the first place?


  1. Thanks for great information you write it very clean. I am very lucky to get this tips from you

    shipping companies

  2. Totally agree! A derivatives market could mitigate the overall counter-party exposure to shipping, which would in turn attract more risk-averse capital sources to the shipping terrain.. Implicitly, it would make the sector that is, by definition, rigid, more liquid with positive consequences at all financial aspects. Thanks for this insightful view!

  3. There does exist financial tools like Clarkson's SPFA or FOSVA
    Forward Ship Value Agreement which are FFA based product designed specifically for the sale and purchase market.