The Chittagong ship breaking yard in Bangladesh is the largest of its kind in the world, and in the past few months even its abundant shores have become inundated with pleasure cruises and industrial cargo ships alike that all could have otherwise sailed the oceans for many more decades. These are all very troubling signs for the unsung heroes of our modern global economy, the merchant marine fleet. Every year trillions of dollars worth of cargo is transported on ships like these and losing this fleet could turn into a huge barrier to global trade. But what is really going on here? Why would profit-motivated companies destroy billions of dollars worth of productive assets? Sure times are tough, tourism and trade have declined massively but this hardly looks like a reasonable response right?
Well as always it has to do with economics, and to understand this bizarre behavior we need to understand a few key areas. What are the economics behind the merchant marine fleet? How do these factors make it financially viable to destroy ships? what does this mean for the future of international trade? And what does this all have to do with Chinese bridge building?
Most ships have a service life of around 40 years, at the end of the day they are a depreciating asset like a car, truck or piece of industrial equipment. After a certain point they cost more to maintain than they bring in from profit. What’s more, is that older ships are naturally less efficient. They burn more fuel and require larger crews. With the average crewmember costing around $75,000 per year, this is a major consideration. This whole industry runs on razor-thin margins and the difference between a crew of 10 and a crew of 30 could be the difference between a profitable journey, or a journey that ended up costing money.
This type of numbers game extends to other areas as well. An increasingly common trend amongst shipping companies is something called slow steaming, which is sailing the ships far slower than they are capable of in order to save on fuel costs. The trade-off is of course that items get delivered days later than they would have otherwise but shipping companies have determined that a net reduction in speed offsets the cost of requiring slightly slower global supply chains. This also suits major shipping companies because of their push to operate larger and larger vessels. A large industry-standard vessel is usually around 275 meters long, and in fact, this is an extremely popular size because it’s the longest ship that can make it through the Panama canal. In fact, they even have a class designation, these ships are known as panamax’s. These kinds of ships can normally carry around 100,000 tons of cargo or raw materials, which sounds very impressive but compare that to the largest ships roaming the ocean. The valemax class of bulk carriers which are “only” 40% longer than these Panama crossers at 360 meters in length. These ships have a capacity of 380,000 tons, meaning they have 4 times the cargo of their smaller Panama crossing peers. This is thanks to the square cube law.
Basically shipping companies only care about how much stuff they can fit into their ships, the cargo, that’s what they make money on, the ships themselves are basically containers to be filled. Now if you make a container twice as long, twice as thick, and twice as high you might think.. I can fit twice as much stuff in it, but in reality, you can actually fit 8 times as much stuff in it, while only using 4 times as much material. This is one of the key benefits of shipping over all other mediums of transport, ships can get really big.
The meticulous obsession over numbers and scale is what makes the merchant navy the Pack mule of globalization. Many nations are landlocked and it is considered as a massive disadvantage for them. The reason is that it cut them off from international trade via shipping. However, there are plenty of other ways to move stuff around, trains, planes, trucks, carrier pigeons 🙂 and none of these alternatives require an ocean or port infrastructure. And that’s perfectly fair, but none of these alternatives are nearly as cheap as using a ship for all of the reasons we saw above.
Trains are the efficiency runners-up because there steel on steel locomotion offers very little friction so once they get going they keep on going, but these still lose out to cargo ships and require much more infrastructure to facilitate. This also becomes much more difficult to implement if this train line needs to span across multiple nations that may or may not even be benefiting from this trade. The benefits of shipping show some really incredible results that you may not expect. If you wanted to get just 1 standard 40-foot shipping container from the United Kingdom to Australia, you would pay a retail shipping rate of 2,200 pounds, which sounds expensive but these containers are very large. On the other hand, if you wanted to ship that same container from the UK to Switzerland, it would cost 3,100 pounds. This is despite Switzerland being 20 times closer. A ship can sail straight from the UK to Sydney, or work across popular shipping routes, the container destined for Switzerland would either have to fly, or be transported on the back of a truck. Of course, these are retail rates and major exporters would have deals in place with shipping companies. But the margins are actually likely to wider in these wholesale deals rather than this one of example of a single shipping container.
This has implications beyond moving houses. It can determin the economy of nations. If a landlocked country wanted to compete on price for manufactured goods it would not only need to produce items cheaper than their competitors, they would need to produce items cheaper than their competitors after the expenses of trucking components in and finished products out are considered. What this means is that low-cost manufacturing is just not really an option for these countries which is a major bummer, because low-cost manufacturing has been the driver of nations to make the leap from underdeveloped to developed, bringing millions of their residents out of absolute poverty all across the world in recent decades.
Of course for nations like Switzerland, it doesn’t really matter, because most of their economy is based around advanced financial services which don’t need to be loaded into shipping containers, and what few products they do manufacture are so valuable that shipping costs are an irrelevant rounding error. But for a country like Mongolia, this is just an unfortunate reality. However, this status quo has been majorly challenged by the fallout of the coronavirus. International trade has fallen drastically as nations move to close borders, and consumer demand dries up across the world.
There have also been major hits to companies that operate a fleet of both cargo and passenger ships because absolutely nobody is getting on a cruise these days. This shrunk demand has meant that fewer containers are been moved which requires a fleet of fewer and smaller ships to move. Remember smaller ships are far from ideal for shipping companies. Now one reprieve has been that oil costs during this period have also been extraordinarily low. This has been a major win for shipping companies in two ways. For starters, it has offset a good portion of the costs of having to run smaller less efficient ships with smaller cargo loads, but it has also provided a very odd revenue source. You might remember that earlier the year 2020 oil prices went into the negatives. But the breakdown was basically that the world had too much oil and nowhere to keep it before an arbitrary due date determined by derivates that drive the oil market. Or even more basically the world needed somewhere to keep it’s oil and well oil tankers are great at that.
Cunning speculators actually ordered space on these tankers, got paid to take on oil, sailed the ships around in circles for a month, and then sold the oil back to the market that paid them to have it in the first place. This was obviously a very profitable, albeit risky strategy for the commodities speculator, but it was a loverly risk-free payday for the shipping companies. They got paid to effectively do what they were doing anyway with their ships which was pretty much nothing. Now, this little win was great and all but it was short-lived. Oil prices stabilized at more reasonable levels but the demand for ships did not do the same. This has led these companies to start making some Tough decisions. During times of economic uncertainty, responsible governments will roll out fiscal stimulus that aims to fill the shortfall in consumer spending with government spending. The hope of these projects is that they can maintain employment, incomes and quality of life during times of turbulence. These stimulus bills can also achieve some nice healthy side effects. For example, the USA used this stimulus to prop up corporations that might be useful to them once the economy recovers. Australia used its fiscal spending to keep on propping up a housing market that definitely won’t end badly, and there are similar stories for most developed countries around the world. However, amidst the headlines of trillion-dollar bailouts, and quantitative easing concerns people have overlooked that China is doing something very similar albeit with a little bit more forward planning.
The Chinese government is spending hundreds of billions of dollars on stimulus just the same as everybody else, but that stimulus is coming in the form of infrastructure spending. Which a quick side note, is a real big brain move. Infrastructure stimulus is just fantastic, it employs people like laborers, engineers, tradesmen in the short term, it gets money out to local suppliers all while having the benefit of actually producing a bridge, or railroad or shipping port which will continue to provide industrial capacity into the future. Okay but despite being a very clever piece of policy, spending on all of those loverly infrastructure projects requires a lot of materials, specifically iron. The demand from China to facilitate these infrastructure developments has been so strong that it has increased the price of iron or by over 300% from where it was just 5 years ago. This spike in iron ore prices has also been accelerated by reduced supply from nations like Australia which has been battling with state to state lockdowns which means a lot of their miners can’t actually get to work.
This is all well and good commodity prices go brrr, but what does that have to do with ships? Well, ships are made of steel and the money that shipping companies will receive for scrapping their ships is at the highest point it has been in almost a decade. So shipping companies have a choice, hold out and continue to pay millions of dollars a year in crew costs, insurance, docking fees, maintenance, and fuel for ships that may or may not go back to work in full capacity within the next few years or scrap them for a payday right now. Unfortunately for all the reasons listed above the market for second-hand ships is weaker than the market for scrap metal so it’s starting to look like a pretty compelling option and one that more and more companies will need to exercise.
What they are doing is thinning out their fleets starting with the oldest ships first in the hopes that it will lower their overheads while giving them an injection of cash that can use to ride out the global pandemic or maybe even be used to invest into the next generation of more efficient ships. It is obviously a gamble, if the world went back to normal tomorrow it would have been a terrible move to sell a perfectly operational ship for the price of its scrap metal, but unfortunately for many companies, it is becoming a decision that is getting made for them. But with less and less ships around to carry the weight what does this mean for the future of global trade?! A smaller merchant marine fleet may very well be an accelerating factor in the push for nations to become more and more self-sufficient. If 2020 has shown anything it’s that if things go wrong it’s every man for themselves for better or for worse. Now the trade-off to this self-sufficiency will be that global trade allows countries to leverage their comparative advantage, that advantage could be oil production, the UAE, luxury cars from Germany, or low-cost manufacturing in China. If any of these countries were forced to dabble in the industries of their peers they would either do a very terrible job of it or produce goods that are prohibitively expensive.
Global trade has allowed nations to focus on what they are good at the expense of being a little bit less self-sufficient. Over time the shift from self-sufficiency to co-operation has always been a positive one. I mean imagine if you had to produce everything you ever needed by yourself. But will the process be slowed or even reversed by these factors? Well yeah probably, it looks like that’s the way the big money is betting, but it really just is too hard to tell for now. If nothing else the wrecking of ships is a great case study into how nothing in the global economy happens in isolation. Lost demand in the united states means fewer cargo containers from Japan, which is making greek ships useless outside of providing raw materials to China for infrastructure projects that are trying to prop up the same demand shortfall that caused this whole issue in the first place.
Source: Economics Explained