Shipping Market Cycles Essay
Shipping Market Cycles
Comments of this sort appear time and again in shipping market commentaries and they make shipping investors sound short-sighted and incompetent as they scramble to over-order ships, triggering yet another recession. But appearances can be deceptive. Despite the industry’s apparent inability to learn from history, its performance in providing transport has been excellent (see Chapter 2). If we set aside the volatility, over the last century there has been an impressive reduction in shipping costs. In 1871 it cost $11.40 to ship a ton of coal from Wales in the United Kingdom to Singapore.
4 In the 1990s the average freight cost to ship a ton of coal from Brazil to Japan, a roughly similar distance, was still $9.30, both figures reported in market prices. As far as shipowners are concerned the cycles are like the dealer in a poker game, dangling the prospect of riches on the turn of each card. This keeps them struggling through the dismal recessions which have occupied so much of the last century and upping the stakes as the cash rolls in during booms. Investors with a taste for risk and with access to finance need only an office, a telex, and a small number of buy, sell or charter decisions to make or lose a fortune.
5 They become players in the world’s biggest poker game, in which the chips are valued in tens of millions of dollars, betting on ships which may or may not be needed. If trade is to be carried, somebody has to take this risk, and the analogy with poker is appropriate because both activities involve a blend of skill, luck
and psychology. Players must know the rules, but success also depends on their skill in playing the shipping cycle, a game shipowners have been playing for hundreds of years. This is the model we will explore in this chapter.
3.2 CHARACTERISTICS OF SHIPPING MARKET CYCLES
The components of economic cycles Cycles are not unique to shipping, they occur in many industries. Sir William Petty, writing in the 1660s, noticed a 7-year cycle in corn prices and commented that ‘the medium of seven years, or rather of so many years as make up the Cycle, within which Derths and Plenties make their revolution, doth give the ordinary Rent of the Land in Corn’.
6 Later economists analysed these cycles more deeply, and found that they often had several components which could be separated statistically using a technique known as ‘decomposition’.7 For example Cournot, the French economist, thought that ‘it is necessary to recognise the secular variations which are independent of the periodic variations’.8 In other words, we should distinguish the long-term trend from the shortterm cycle. This approach is illustrated in Figure 3.1, which identifies three components of a typical cyclical time series.
The first is the long-term cycle (referred to by Cournot as the ‘secular trend’), shown by the dashed line. The long-term trend is of importance if it is changing, and the big issue here is whether, for example, the underlying cycle is moving upwards, which is good for business, or moving downwards, which is bad. The example in Figure 3.1 shows a long-term trend with upswings and downswings lasting 60 years. The second component is the short-term cycle, sometimes referred to as the ‘business cycle’. It is the one that corresponds more closely to most people’s notion of 94
Long shipping cycles (the ‘secular trend’)
At the heart of the cyclical mechanism is the long-term cycle which ‘ferries along with it other cycles which have neither its longevity, serenity nor unobtrusiveness’.9 These long-term cycles are driven by technical, economic or regional change. This makes them of great importance, even if they are more difficult to detect. The long-cycle theory of the world economy was developed by the Russian economist, Nikolai Kondratieff. He argued that in the major Western countries, between 1790 and 1916, there were three periods of slow expansion and contraction of economic activity, averaging about fifty years in length. After studying 25 statistical series, of which ten concerned the French economy, eight the British, four the US, one (coal) the German and two (pig iron and coal production) the world economy as a whole, he identified the three cycles with the initial upswings starting in 1790, 1844 and 1895.
The peak-to-trough length of the cycles was 20–30 years, with an overall troughto-trough length of approximately 50 years. Writing shortly after Kondratieff, the economist J.A. Schumpeter argued that the explanation of the long-wave cycles could be found in technological innovation.10 He suggested that the upturn of the first Kondratieff cycle (1790–1813) was largely due to the dissemination of steam power, the second (1844–74) to the railway boom and the third (1895–1914/16) to the joint effects of the motor car and electricity. The upswing which started in the 1950s may be attributed to a combination of major innovations in the chemical industries, aircraft and 95
SHIPPING MARKET CYCLES
the electrical/electronic industries. Unfortunately these Kondratieff cycles do not fit well with the long-term freight cycles we will review in Figure 3.5. For example, 1790 was a peak in the long shipping cycle, not the beginning of an upswing, and in general the shipping cycle looks much longer, with a downswing that lasted for the whole of the nineteenth century.
The French historian, Fernand Braudel, identified much longer cycles lasting a century or more, with peaks in the European economy occurring in 1315, 1650, 1817 and 1973. This analysis matches the cycles in Figure 3.5 more closely. Whatever the exact timing, the history of the shipping industry in Chapter 1 made it clear that the long-term technical, social and political changes we observed are precisely the sort of developments that might well drive long-term shipping cycles.11 For example, the period from 1869 to 1914 saw a downward spiral in freight rates which was driven by the increasing efficiency of steamships and the phasing out of the much less efficient sailing ships. Similarly, from 1945 to 1995 the mechanization of the bulk and liner shipping businesses using bigger ships and more efficient cargo-handling technology produced a fall in real freight rates. So these long cycles deserve a place in our analysis, even if we cannot define them precisely.
The study of short economic cycles started in the early nineteenth century after a series of severe ‘crises’ in the UK economy in 1815, 1825, 1836–9, 1847–8, 1857 and 1866. Observers came to the conclusion that these ‘crises’ formed part of a wavelike mechanism in the economy and they started to refer to them as cycles.12 These short cycles ‘shoot up and down, and are easy, indeed conspicuous to see. Everyday life, today as in the past, is punctuated by the short-lived movements which must be added to the trend in order to estimate them as a whole’.
However, they also spoke of the ‘periodicity’ of cycles, by which they meant that they consisted of a sequence of phases, irrespective of duration. For example, the nineteenth-century banker, Lord Overstone, observed that ‘the state of trade revolves apparently in an established cycle of quiescence, improvement, prosperity, excitement, overtrading, convulsion, pressure, stagnation and distress’.14 This periodicity theory does not require cycles to be of equal length.
It is easy to identify Overstone’s phases with the different stages in modern shipping cycles, an example of which is shown in Figure 3.2. The short cycle
has four main stages (see Box 3.1): a market trough (stage 1) is followed by a recovery (stage 2), leading to a market peak (stage 3), followed by a collapse (stage 4). In this example the trough lasts 4 years, reaching a peak 7 years after the first market peak, then falling sharply. However, during the trough in year 8 the market starts to recover, but fails and slowly subsides back to recession levels in year 10. Abortive recoveries of this sort are quite common, and in shipping are often the result of counter-cyclical ordering. Investors anticipate the recovery and order large volumes of cheap ships, so that supply dampens off the recovery. A dashed line superimposed on the chart illustrates what might have happened if investors had been less aggressive. In that case the 96
Stages in a typical dry cargo shipping market cycle
Source: Martin Stopford
shipping cycle lasts 4 years, not 7. In fact there is a strong case for supposing that the longer cycles of the sort shown in Figure 3.2 are often produced by a build-up of supply capacity during a succession of very profitable market spikes as a result of which the market ‘jumps’ a cyclical upswing, due to the pure weight of supply. Obviously the opposite effect can occur during these long recessions. These are important points we will come
back to when we discuss past shipping cycles in Section 3.4. For example, does that abortive recovery in year 8 of Figure 3.2 count as a peak? And what about the ‘dead cat bounce’ in year 15? Frankly it is not easy to decide, but the cycles in Table 3.1 were compiled on the basis that neither counts.
Seasonal cycles occur quite widely in shipping, and are the fluctuations in freight rates which occur within the year, usually at specific seasons, in response to seasonal patterns of demand for sea transport. There are numerous examples, some of which are far more prominent than others. In the agricultural trades, there is a noticeable cycle in freight rates for ships carrying grain, caused by the timing of harvests. Typically there is a surge in grain movements during late September and October as the North American harvest reaches the sea for shipment. Then there is a quieter period during the early summer as shipment of the previous season’s stock runs down. Similarly, there is a strong seasonal cycle in the reefer trade, associated with the movement of fresh fruit during the harvest in the Northern Hemisphere. Another example is the stocking up of oil for periods of peak demand in the winter.