Maritime & Trade Blog

Lifting the fog on shipping costs

The increasing use of Big Data analytics to forecast shipping costs signals a sea change in the way the industry—and its customers—plan for the future.

Shipping has always been a game of chance, with profits too often riding at the mercy of geopolitical forces, powerful boom-and-bust cycles, and the best guesses and gut instincts of the established families and entrepreneurs who created and drove the maritime industry, generation after generation.

In such a complex, zero-sum environment, one key to success has been moderating risk through accurate forecasting. But the variables have proven so numerous and complex—everything from stiffening credit restrictions in China to small bands of sea pirates terrorizing shipping routes—that the forecasts produced from them are extremely brittle.

This was never more evident than when world powers considered lifting an oil export embargo on Iran, a reward for agreeing to nuclear treaty terms. Shippers and their customers suddenly had a new set of complex factors to forecast, and the variables to plug into the equations were daunting.

Sure, shippers were likely making the calculation that increased oil supply on world markets would lower oil prices, and that tanker demand, especially to China, would rise, leading to an increase in shipping rates. This would also affect the businesses of shipping customers, who ultimately underwrite the industry. But the variables that would determine the magnitude of the Iranian situation were complex. When would Iran be able to export oil? July? October? The later in the year it occurred, the less impact on 2015 freight rates it would have. Would Iranian oil be exported to many countries, with each casting its own influence on shipping; or would exports be confined just to the major Asian economies? How much oil does Iran actually have in floating storage as well as on-shore storage? Some believe there are 20-30 million barrels in floating storage; yet this would not have an impact on freight rates initially, as they are already out of the market. The impact on freight rates would be when non-Iranian ships can export crude.

The real problem for the industry is that much maritime forecasting is stuck in technologies or processes from the past—some even relying on back-of-the-envelope calculations or, more likely, some combination of instinct and technology to give shippers and their clients a better view into future demand.

Yes, technology is increasingly making shippers smarter, with such things as on-board sensors monitoring engine performance, fuel usage, and tracking cargo container by container. But technology has frustratingly not been as influential in the home office, where forecasts that drive a company’s prosperity are made.

Enter the arrival of big-data analysis, which promises to improve the fortunes of the industry and its customers just as it has revolutionized every other industry it has touched. IHS believes that the equation of Big Data, plus analysis, plus hypothesis, equals a significant competitive edge that few in the industry are yet taking advantage of.

Companies able to analyze data and gain critical insight can enhance, as never before, their balance sheet, take control of their business, and improve the likelihood of survival in a fragmented and volatile industry. Better forecasting might also mean more investment in the industry, as investors and bankers gain more transparency into companies and how they operate.

The picture today

First, let’s take a snapshot of the industry today, using some of the new data tools available to us. IHS research reveals two distinct sides to the shipping market in mid-2015, driven largely by events in the energy sector and, in particular, the crude oil business.

On one side, some players are taking advantage of geopolitical developments to improve their bottom lines. Larger tankers have seen earnings rise rapidly since the fourth quarter of 2014. Underwriting their success has been a low oil price that has increased demand, with China and OECD countries taking advantage of the situation to top up their strategic reserves, together with the stockpiling of crude oil on shore. Tanker revenue has also been helped by a slowdown on the supply side: newbuilding orders have been slow since 2012. (The picture for these tankers could change soon, however; there are concerns that improved freight rates have encouraged shipowners to return to the shipyards. Will the increased level of vessel deliveries in 2016 force the tanker market down into another cycle? What can OPEC be expected to do next on production?)

Other fleets are not faring as well. China, which drives so much commerce, also takes it away. The unrestrained growth that underwrote an increase in shipping capacity over the past two decades may be running out of steam with increased restrictions on credit lending.  This is of significant concern for the maritime community, since China’s growth had been the prime guarantor of investment in shipping. Imports of steelmaking raw materials (iron ore and metallurgical coal) and energy resources (thermal coal, crude oil, and liquefied gas), together with exports of electronic and consumer goods, have driven demand for dry bulk vessels, tankers, and gas carriers, as well as for container shipping. This is also a headache for Asia-Pacific raw material exporters, which have built up their own extractive economies on Chinese demand.

Profitability depends not only on how many ships are available, but also on how much cargo is demanded by the industries and countries being served. These are complicated end markets, inextricably linked to one another and to the wider global economy. With 3.5% growth forecast for 2015, global trade growth as tracked by IHS has been slowly improving.

While this is a good sign, more interesting for shipping is where this trade is happening and where it is expected to go in the future. For accurate forecasts, a deep understanding of market drivers is needed.

Too much supply

The link between supply of, and demand for, cargo capacity lies at the heart of the fundamental challenge the shipping industry has confronted in recent years: increasing uncertainty at a time of greater volatility. Few economists predicted the global financial crisis, and no one appears to have anticipated last year’s plunge in the price of crude oil. The shortfall in demand left by China’s slowdown has not been filled by increased demand in the United States or the European Union, and the result has been surplus shipping capacity across the world.

One consequence: this surplus has depressed freight rates for dry bulk and container shipping, and there is little sign of improvement. According to IHS Maritime and Trade, the current order book for dry bulk ships stands at 18% of the existing fleet. Ships are, therefore, accepting contracts at less than operating cost just to remain employed. That makes sense in the short term but digs deep into financial reserves over the medium and long term. When will this end?

In contrast, tanker shipping has seen freight-rate growth for the past six months, as the low price of crude oil has encouraged emerging economies to burn oil rather than use dirty coal, expensive gas, or unproven renewable energy. Companies operating the largest tankers (VLCCs – Very Large Crude Carriers) have posted stellar earnings for the first half of 2015, and excellent revenue is anticipated throughout the year or until oil prices rise again. VLCCs on the Middle East Gulf–Far East route were earning $60,000 per day in April 2015 versus $10,000 in April 2014 and breakeven rates in April 2013.Crude rate forecast for two major trade routes (US$ per metric ton)

Understanding these market developments will inform the decisions by charterers as to whether they should persevere with high spot rates, or if they should look to secure a period charter covering the medium term. The current disconnect between the expectations of owners and charterers for three- to five-year spot rates and stable newbuilding prices suggests that freight rates are not expected to maintain their current high level.

From an owner’s perspective, lucrative earnings could be made from chartering a ship at the right rate at the right time. Conversely, the aim for the charterer is to achieve a rate that is less than that of their competitors at the time of fixing, which is not necessarily the actual freight rate figure.

So, that’s great news if you own a fleet of tankers. But it’s not so rosy if you own a fleet of bulk carriers, which is why several shipowners have switched their newbuilding orders from bulkers to tankers. Whether this is the right decision depends on what the market will be like in two or three years’ time. Today’s healthy or unhealthy shipping market is rarely a good indicator of profitability in five years.

A challenging environment for decision-making

That’s a quick look at the current state—and it’s a messy environment, as always. And unforgiving. For one, there is less time to make quality decisions. Market volatility has traditionally been masked by the familiar rise and fall of business cycles, but times are changing as forward freight agreements (FFAs) and trading models reduce the window within which informed, strategic decisions have to be taken. Moreover, decision-making is made more onerous by the addition of governance and regulation gripping the industry, along with the complexities and requirements imposed by banks and private equity as they become more involved in shipping management.

The environment is transforming in another, fundamental way. Maritime leadership is changing. The new realities of global interconnectedness, advancing technology, and speeded-up business conditions have spurred a shift away from the romantic notion of shipowners fulfilling dreams toward more hard-nosed business entrepreneurs. This new breed possesses a deep understanding of the heightened importance of return on investment, residual value risk, and cost of debt and capital. The necessity to understand a company’s net asset value and the health of its balance sheet has made vessel owners and investors more sophisticated. Moreover, business is seeking to share responsibility with investors concerning regulations that have eaten away at profitability.

Despite these changes, the industry appears not to have learned from its mistakes, as history repeats itself with overcapacity and overexposure to risk, presenting a new group of questions. How should shipowners mitigate prices and rates? On the shipping side, is it better to lock in the good returns for a three-year timecharter or take the risk on the spot market?

The answers to these questions lie in understanding where in the cycle the business finds itself, helping to manage risk and maximize financial leverage. And in this environment, uncovering those answers requires data. Lots of data.

Reactive to proactive

Big Data and advanced analytics are especially valuable because they provide an ability to move beyond what is known and what is predicted, enabling, for example, business strategists to understand how a target market can be penetrated with flexibility to minimize risk of illiquidity and liability.

Here’s one example of how data reported by remote sensors—a basic ingredient feeding the data revolution—can advance maritime forecasting capabilities.

From a shipping point of view, shore support has a major influence on a ship’s behavior. Automated Identification System (AIS) is a good big-data point to start with: it tells us where ships are operating, and where they are loading and discharging. Connecting this to ports and bill of lading data gives insight into what commodities ships are carrying and how trade routes are developing. Decision-makers can also use AIS data to optimize trading routes, taking into account weather, piracy, and ice as well as fuel consumption, linked to slow steaming. Other key issues on which big-data analysis can help companies sharpen forecasting models include:

  • Ability to watch all aspects of business
  • Maximizing earnings potential and cost management
  • Fleet utilization
  • Maintenance schedules
  • Trade pattern changes

Clearly, technology is providing the industry with views of its world never available before, with the promise of providing better visibility into the future—whether that is weeks, months, or even a few years ahead.

For example, by applying pattern-recognition technology to examine fleet-wide behavior, new data sets can be created. These tell us in much sharper detail than previously available which carriers spend more or less time than their competitors in certain ports; it means we can monitor delay up until real time at a port and nearby alternative ports.

More to the point, proper use of this technology is dramatically improving forecast accuracy. IHS has used these techniques to improve its matching of AIS records to ship records, bringing the number of verified bulk carriers from 69% to over 90%. This means more port calls are being captured, which improves understanding of trading activity.

Risk vs. reward

The shipping industry and its customers should be offered a better grasp of the underlying elements of the market so that investment decisions can be built on top of the very best data available and the clearest insight that data reveals. What counts, after all, is not the existence of Big Data but what can be done with it.

Let’s look at an example. By using data to build crude freight-rate forecasts, customers can develop actionable insights into two of the most critical questions in shipping: whether to charter ships, and whether to merge companies.

Rates have been comparatively strong in recent years, impacted by the low oil price as well as the increase in metric ton miles. Last year’s annual average cost for the VLCC Middle-East-Gulf-to-Japan route was in the region of $30,000 per day; this year IHS forecasts that this could be nearer $57,000 per day. Having the capability to utilize a forecasting tool to inform trade route selection for the years ahead should enable companies to compare how they have performed against the actual earnings for those routes and whether they could have increased earnings by using different routes.

Another major issue faces the industry: market consolidation. Shipping businesses are seeking advice on whether to follow the latest public company merger (Navig8 with General Maritime) or the lead of privately listed companies. Consolidation often appears reasonable at a superficial level, but would potential earnings be increased from the owner perspective, or return on investment enhanced from a private equity point of view? At this time there is no definitive answer. However, understanding how a fleet operates within the crude market (today and over the next five years) and whether additional regulations will impact potential earnings will guide strategic decisions for reacting to unforeseen scenarios faster and more accurately than competitors.

Understanding data from technology

When looking at data, we need to treat history with respect, as a guide. Finding reasons and explanations provides the indicators and insight, and it is the indicators we can take into our assessment of the future. This knowledge is hard to find unless you have the expertise and time within internal teams or external advisors to distinguish between the predictable and unpredictable; filtering out the background noise frees you to focus and refine the useful data.

The speed of information flow and the amount of external data available is probably far too much for most companies to take in, process, and utilize intelligently on their own. Yet without the ability to anticipate market developments, businesses are doomed to react to events instead of being proactive—a ship’s captain waiting for the storm to hit rather than navigating around it.

Who are partners in this work of finding, filtering, analyzing, and predicting?

Shipbrokers are a significant part of this information equation—but only up to a point. They are the workhorse of the current market, passing information among various parties to aid their decisions. They use proprietary models to understand what they see and what it will mean going forward, with varying degrees of accuracy. But the outcome is just one view or analysis of the situation, and could be dangerous to follow if taken in isolation. That being said, if enough of these individual opinions build into a consensus, additional weight can be fed into a company’s model

A second opinion based on independent analysis and insight can come from outside consulting advisers, a viewpoint especially important given the extra governance demands being placed on companies. However, these end markets are complex, often opaque. One question to ask: Does the adviser provide rigorous and advanced analysis that draws on multidisciplinary data and expertise to reflect our interconnected world? In short, the more telescopes and microscopes you have trained on the problem, the more likely the data is going to be verifiable, suited to your specific company and market, and with insights gathered from many points of view.

Sea change ahead

The arrival and acceleration of Big Data in shipping is starting to signal a sea change in how the industry and its customers plan for the future.

As forecasts become more accurate, shippers can run more productively (choosing ideal routes), operate more efficiently (using best-price fuel), and become more competitive (understanding what competitors are up to). For shipping customers, the information revolution helps them move product or raw materials from Point A to Point B in the quickest time possible, at the most cost-effective prices. And for maritime investors, Big Data reduces risk exposure and extends visibility into business operations, encouraging further investment.

And for the industry in general, data-driven insights into cycles and where the industry sits in them allow players to pursue their strategies with more confidence—whether it’s building or reducing capacity, turning to the spot market, or delaying or rerouting a shipment.

Big Data won’t end the industry’s cyclical nature or remove all the uncertainty that comes with geopolitical forces, such as oil embargoes. But it will allow players to look with more confidence into future events and act proactively to turn challenges into opportunities.

Richard Clayton is chief maritime analyst, and Andrew Scorer is principal trade analyst, IHS Maritime & Trade