Ocean Carriers Analysis Report

1. Do you expect daily spot hire rates to increase or decrease next year?

Ocean Carriers is a shipping company with offices in New York and Hong Kong.  In January 2001, Marry Linn, the Vice President was now evaluating a project of leasing a ship for three-year period starting in early 2003. The customer had offered to pay a rate of $20,000 per day with annual escalation of $200 per day. Currently, no vessel in Ocean Carrier’s current fleet meets the customer’s requirement because they are either too small or were already leased out. Furthermore, ships with required size were not available in the second hand market. Commissioning a new ship would cost Ocean Carriers $39 million, using 10% purchase payable in the first year and another 10% in the following year and the rest of it on delivery. Since the customer’s proposed lease of ship only last for three years, which was a quite short period of time. Thus, in order to decide whether or not to accept this project, Marry Linn needed to analyze whether this project proven to be profitable or not. This report is going to assist Marry Linn to make a decision by calculating the project’s NPV under different scenarios as well as taking different factor in to account, such as long-term prospect of the capsize dry bulk industry, future hire rate and company policy.

The daily spot hire rate determines the company’s revenue of each year, thus affecting the company’s free cash flow for each year as well as the project NPV. To predict the trend in the daily sot hire rate, we considered two aspects: supply and demand. When considering supply, we think about the quantity and the age of the capesizes. From the information provided, we found that the number of capesizes that over 24 years and between 20 years and 24 years only accounted for a very small percentage, while the number of capesizes that were ordered and that were projected to commission to the market was much higher than the former one. Moreover, most of the capesizes in the market currently were very young, thus, we could expect that there would not have a large number of capesizes to be scraped. Even though we assumed all the capesizes that over 24 years and between 20 years and 24 years would be scraped, the supply of the capesizes would increase in short term. And based on the fleet size and average spot rate, we assumed that the expected number of Iron ore vessel shipments and fleet size in 2001 were both correct and the expected number of Iron ore vessel shipments in 2002 (See Exhibit 6 )was also correct,  so we could calculate the expected number of capesizes in 2002. In order to calculate that, we also assumed that the number growth rate of capesizes in 2001 and 2002 were the same, and the current order book number in 2001 and 2002 were 63 and 33 respectively. From the growth rate and the number of booked vessels, we calculated the expected fleet size as follow equation:

612 + (612-552) * (33/63) = 643

We could see that the expected fleet size had an increase in 2002. From this perspective, we expected the spot daily hire rates would reduce in a short-term period. On the other hand when considering demand, since over 85% of the cargo carried by capesizes was iron ore and coal, we could mainly focus on the demand in the iron ore and coal market. With Australian production in iron ore expected to be strong and Indian iron ore exports expected to take off in the nest few years, it makes sense to conclude that the Australian market and the Indian market were expected to be strong in the next few years. So we expected that the demand of capesizes would not change much in short period, but would rise dramatically in the long run.

Therefore, after considering all the information provided above together, we could get the growth rates of both expected Iron ore vessel shipments and expected fleet size: 2.06% and 5.14% respectively. After that, because of the data and figures, we could then reach to the result of the daily hire rates projection. Since expected Iron ore vessel shipments represented the demand in 2002 and expected fleet size represented the supply in 2002, basing on our assumption that demand and supply would mostly be effected by these two factors respectively, the figures could let us to conclude that the daily hire rates would decrease in short term, but would increase in long term. And for 2002, the spot daily hire rates would reduce.

2.What factors drive daily hire rates?

The spot daily hire rates prediction led us to one question: What factors drive daily hire rates? We also considered this question from both supply and demand aspect. We first think about supply, the factors that could be included in supply aspect were number of capesizes, capesizes efficiency and age and size of capesizes. As for the number of capesizes, if there were more capesizes in the market, the daily hire rates would decrease, otherwise, the the daily hire rates would increase. For the capesizes efficiency, we could set an example. If two market A and B had the same amount of capesizes, and the demand were also same in the two markets. The capesizes efficiency in market A was higher than market B, so market A would not need as many capesizes as market B needs, and the daily hire rates in market A would be lower than that of market B. Finally, we looked at the age and size of the capesizes, the newer and the larger the capesizes there were in the market, the fewer capesizes would be needed to carry the same amount of the cargo, for Ocean Carriers, the newer their vessels was, the more premium they could earn.

As for another aspect demand, demand of shipping, economic conditions and trade pattern should all be take into consideration. First, if the demand of shipping was high, the daily hire rates would rise, otherwise, the daily hire rates would reduce. Second, the influence magnitude of another factor economic conditions would differ from production, for Ocean Carriers, the main production they carried were iron ore and coal that demand raised when economic condition was good. And the demand of the production would indirectly effect the demand of the capesizes. Lastly, the trade pattern. As we known that in the shipping industry, spot charter rates were more flexible than the time charter rate, so the daily hire rates would not easy to be changed in time pattern.

3.How would you characterize the long-term prospects of the capsize dry bulk industry?

 Since Australian and Indian ore exports would begin, these new supplies would significantly increase trading volumes. As a result, the demand for capesizes would possibly increase with these higher trading volumes, which would boost up prices.

 So we further process data in Exhibit 5 to see the growth rate of iron ore vessel shipments and average 3-year charter rate. Although the amount of iron ore vessel shipments fluctuated from 1994 to 2000, due to the strong supply and demand in the future, the trend was still growing in the long run. We could see from the exhibit that the iron ore vessel shipments were 375 millions of tons in 1994 and 440 millions of tons in 2000, there was a 17.3% increase. However, the average 3-year charter rate was $18,250 in 1994 and $15,344 in 2000, there was a 15.6% decrease in the long run.