How Does a Ship Owner Make Money?
Ship owner either charts out their ships in the spot markets or signs a time charter with a charterer (refinery, iron ore importer, grain importer etc),under time charter a customer pays a fixed daily or monthly rate for a fixed period of time for use of the vessel.Ship owner pays the entire vessel operating expense such as wages, repairs, insurance premiums, lubricants, dry docking charges and special survey charges. These expenses are fixed in nature, unlike road logistics where the fleet operator (truck owner)has to pay for the fuel expense which is the biggest expense in the income statement of a truck logistic company; here the ship owner does not pay the fuel expense and the port charges which can be related to the toll charges in case of road logistics.Fuel and port charges fall on the head of the charterer (refinery) and these are called voyage expenses.
A ship owner optimizes to maximize the TCE (time charter equivalent) measured in USD which is calculated after we subtract the voyage expenses (fuel and port charges) from the freight revenue.the shipping business in general is a high margin business.
A seller of a ship in the market has two alternatives –
Scrapping- The decision to either scrap the ship or sell it in a transaction depends upon the price differential between second hand ship and prevailing scrap price. We are currently in an environment where steel prices have rebounded and alongwith it scrap prices have also rebounded.
Second hand sale- Second hand sale will not bring staggering money because the services these ships provide (transportation) is not able to command higher prices (higher freight rates), therefore the ship seller can send the ship in the scrap yard.These ships are dismantled and then their scrap is burnt in an EAF or IF of a steel plant.
Why is Crude Tanker Fleet Seeing Higher Scrapping?
Crude tankers such VLCC’s, Aframax, Suexmax are seeing higher scrapping because of lower freight rates because of the age. Older vessels tend to underperform newer vessels in operations and newer vessels command higher freight rates resulting into higher TCE and older vessels also require frequent repairs and maintenance work (higher vessel operating expenses).With age, the dry docking cost and special survey cost also rises which further supports scrapping of the vessels in a low freight environment constraining the supply.
Rising compliance cost: Impact of ballast water treatment and IMO-2020 regulations will materialize over the next two years. These regulatory changes will actually increase hurdle rates required to run a tanker business profitably,
thus increasing scrapping of older vessels.
Dynamics of IMO-2020 Regulation
According to IMO-2020 regulation, ships have to burn low sulphur fuel starting 2020; ship owners have two options either procure low sulphur fuel
from refineries or install scrubbers on the ships which will convert high sulphur fuel burnt today into low sulphur fuel.
Refineries currently do not have enough capacity of the low sulphur fuel, hence there will be supply constraint of this new fuel starting 2020
which will raise prices and thus voyage expenses for the charterers, which would mean freight rates should trend upward and thus we should
hope an improvement in TCE for the ship.