THE FOUR LNG SHIPPING MARKETS

By Georgios H. Dretakis

SUPERVISORS: Dr Michael Tamvakis

Mr Hadi Hallouche

The Dissertation is submitted as part of the requirements for the award of the

MSc in Energy, Trade and Finance

CASS BUSINESS SCHOOL

FACULTY OF FINANCE

CENTRE FOR SHIPPING, TRADE AND FINANCE

Academic Year 2004-2005

Date: 31 August 2005

Είπε δέ µη γαίαν τε τεήν δήµον τε πόλιν τε, όφρα σε τή πέµπωσιν

τιτουσκώµεναι φρεσί νήες. Ού γάρ φαιήκεσσι κυβερνητήρες έασιν. Ουδέ τι

πηδάλι’ εστί, τά τ’άλλε νήες έχουσιν: Άλ’ αυταί ίσασι νοήµατα καί φρένας

ανδρών. Καί πάντων ίσασι πόλιας και πήονας αγρούς ανθρώπων, καί λαίτµα

τάχυσθ’ αλλώς εκπεροώσιν.

Ηέροι και νεφέλη κεκαλυµµέναι: ουδέ ποτέ σφίν. Ούτε τι πηµανθήναι έπι δέος

ούτθ’ απωλέσθαι.

Οµήρου Οδύσσεια, θ, 555-566.

Tell me also your country, nation, and city that our ships may shape their

purpose accordingly and take you there. For the Phaeacians have no pilots;

their vessels have no rudders as those of other nations have, but the ships

themselves understand what it is that we are thinking about and want; they

know all the cities and countries in the whole world, and can transverse the

sea just as well even when it is covered with mist and cloud, so that there is no

danger of being wrecked or coming to any harm.

Homer, Odyssey, VIII, 555-566.

i

ACKNOWLEDGEMENT

I wish to express my sincere gratitude to Dr. Michael Tamvakis and Mr. Hadi

Hallouche for their mentorship and generous support they provided me at all

levels. Without their encouragement and guidance, this project would have not

been completed successfully

ii

ABSTRACT

This project aims to investigate the structure of the four LNG shipping

markets; freight rate, new building, second hand and demolition market.

Each market is discussed separately to identify their special characteristics and

the main factors that influence their activity and the way that interrelate to

each other.

The methodological approach deals with the identification of objectives and

constraints of the market participants, the supply and demand of each market

and the long and short-term response of the shipping market given the changes

of various external and internal factors.

The number of ships available, the LNG transaction type and the liquefaction

and regasification capacity, affect freight rates. Changes in those factors do

not influence substantially the freights under long term shipping agreements,

however their effect will be important in the spot trading.

LNG new building and second hand market are connected with freight rates in

short-term agreements and this is reflected by the increased activity

encountered over the last couple of years in those markets. New market

participants are likely to use new and second hand ships to take advantage of

the imbalances between supply and demand, however long term agreements

will dominate the LNG market, unless a globalised LNG market is established.

iii

EXECUTIVE SUMMARY

This project deals with the identification of the triggers and constraints in the

LNG shipping market given the rapid expansion in the LNG trade. The

analysis focuses on the four main shipping markets; the freight rate, new

building, second hand, and demolition market.

LNG shipping markets are not as liquid as the wet or dry bulk ones since

participants are limited; the current fleet is equally distributed to a small

number of LNG producers/importers and independent owners. LNG fleet is

relatively young and expanding very aggressively. Bigger ships are built

indicating the market prospects for further LNG trade development. Most of

ships in the current fleet are trading in the Pacific basin, but the majority of

new orders have contracts to trade in the Atlantic basin.

Freights in long-term agreements are related with Sales & Purchase

Agreements (SPA) and will not be influenced significantly. Freights in short-

term agreements depend on the LNG ships available for short-term trading,

spare capacity of the committed ships under long-term charters, and

availability of uncommitted ships. Oversupply will cause freight rates to drop

but increase of LNG demand for spot trading will increase freights.

The key issue of traditional LNG (Take or Pay) contracts was reliability and

security of supply but proved inflexible. Deregulation of the gas market

introduced the new style contracts which emphasize on flexibility, price and

cost competitiveness, reduced duration and most important, no destination

clause.

iv

Changes in the LNG industry including shorter and more flexible SPA,

increased demand for LNG, and the surplus capacity of production plants

introduced the spot or short-term trade.

Shipping costs affect the price of LNG delivered. Under CIF type of LNG

procurement, the seller bears the cost of shipping. It is a mean to maintain

security of supply but that introduces a risk premium, which increases the

freight rates. Producer selling CIF have the ability to minimise price risk by

diverting cargoes when a contract expires. Under FOB sales, the buyer bears

the cost of shipping which allows the re-routeing cargoes to its own alternative

terminals. That reduces shipping costs but the buyer is exposed to volatility of

the market in case of surplus capacity.

Freight rates are also affected by liquefaction and regasification capacity.

Lower liquefaction costs reduce the price of LNG delivered. Added

liquefaction capacity uncommitted to long term trading will create demand for

ships available for spot trading. Freight rates will rise if ships are not available

for spot trading and will fall if there is oversupply of ships.

Despite the emerging short-term market, long-term contracts dominate 62% of

the orderbook. However, all time record orders for LNG ships is likely to

introduce some speculation in new building re-sales.

Asian shipyards control the LNG ship building market. Competition between

shipyards has decreased prices for LNG ships. New building prices are related

to the demand for new tonnage. High demand raises the price and low demand

push prices down.

Worldwide LNG shipbuilding capacity is limited while increased ship

building activity for other ship types might cause undersupply for LNG ships

v

when orders carry on in the same rate. In this case, second hand prices will

rise accordingly.

However, if LNG shipping capacity grows faster than liquefaction capacity, it

would address oversupply of tonnage, driving freights rates down and

increasing scrapped tonnage.

LNG second hand market is very weak. Limitation in the liquidity of second

hand markets arises from the limitations of LNG ships to participate in several

trades. The emergence of spot trade will probably introduce a more flexible

second hand fleet, which will trade uncommitted surplus capacity in the

Atlantic region. Independent shipowners can speculate in the second hand

market while producers/importers are likely to benefit by being more flexible.

LNG scrapping is historically weak. Ships are usually laid up instead of

scrapped. Scrapping records involve ships built in speculative grounds, which

could not secure a contract. With the introduction of a more flexible second

hand LNG fleet, scrapping and laying up activity will be increased.

Liquidity in LNG shipping market will be introduced with the emergence of a

globalised gas market.

vi

TABLE OF CONTENTS

LIST OF FIGURES ......................................................................ix

LIST OF TABLES........................................................................ix

1 THEORY BACKROUND.......................................................................1 1.1 INTRODUCTION ...................................................................................1 1.2 GENERAL INFORMATION ABOUT LNG ................................................1 1.3 SUPPLY. ..............................................................................................3

1.3.1 Shipping Market Cycle...............................................................4 1.4 DEMAND .............................................................................................5

2 METHODOLOGY AND LITERATURE REVIEW............................6 2.1 INTRODUCTION ...................................................................................6 2.2 “ECONOMETRIC MODELLING OF WORLD SHIPPING”...........................6

2.2.1 Model Description and some theory aspects. ............................6 2.2.2 Summary of Model Structure .....................................................7

2.3 RELATED LITERATURE........................................................................9 2.3.1 Future Trends...........................................................................10

3 MARKET OVERVIEW........................................................................12 3.1 INTRODUCTION .................................................................................12 3.2 LNG CONSUMERS.............................................................................13 3.3 LNG SUPPLIERS................................................................................15

4 FREIGHT MARKET ............................................................................17 4.1 INTRODUCTION .................................................................................17 4.2 SHIP OWNERS ....................................................................................17 4.3 LNG FLEET.......................................................................................19

4.3.1 LNG Fleet by trading routes ....................................................19 4.3.2 LNG Fleet by age .....................................................................20 4.3.3 LNG fleet by size ......................................................................21

4.4 THE EFFECT OF LNG FLEET TO FREIGHT RATES ................................23 4.4.1 Long term contracts .................................................................24 4.4.2 Medium and short term contracts. ...........................................24

4.5 TRANSPORTATION COSTS .................................................................26 4.6 CONTRACTS ......................................................................................27

4.6.1 Long term contracts .................................................................27 4.6.2 Short term Contracts................................................................28 4.6.3 The Effect of LNG Contracts to Freight rates. ........................29

4.7 LIQUEFACTION CAPACITY AND ITS EFFECT TO FREIGHT RATES .........31

5 NEW BUILDING MARKET................................................................35

vii

5.1 INTRODUCTION .................................................................................35 5.2 FLEET EXPANSION.............................................................................35 5.3 SHIP BUILDING INDUSTRY .................................................................36 5.4 PRICE OF NEW BUILDING ..................................................................37 5.5 SHIPBUILDING CAPACITY AND IT’S EFFECT TO FREIGHT RATES .........41

6 SECOND HAND MARKET .................................................................44 6.1 INTRODUCTION .................................................................................44 6.2 LNG SECOND HAND PRICE...............................................................44 6.3 CHARACTERISTICS OF LNG SECOND HAND MARKET.........................45 6.4 FUTURE TRENDS................................................................................47

7 DEMOLITION MARKET....................................................................52 7.1 INTRODUCTION .................................................................................52 7.2 CHARACTERISTICS OF LNG DEMOLITION MARKET. ..........................52 7.3 LAY UP AND SCRAP PRICES...............................................................54

8 CONCLUSION ......................................................................................56 BIBLIOGRAPHY-REFERENCES .................................................................58

viii

LIST OF FIGURES FIGURE 1: WORLD GAS CONSUMPTION.............................................................12 FIGURE 2: GAS AND LNG MAJOR TRADE MOVEMENTS......................................13 FIGURE 3: LNG IMPORTS 2003-1004................................................................14 FIGURE 4: LNG EXPORTS 2003-1004 ...............................................................15 FIGURE 5: MAJOR LNG SHIPOWNERS (CURRENT FLEET AND ORDERBOOK)......18 FIGURE 6: EXISTING AND ORDERBOOK FLEET BY TRADING ROUTE ...................20 FIGURE 7: AGE OF LNG FLEET IN 2009 .............................................................21 FIGURE 8: LNG FLEET 1996-2009....................................................................22 FIGURE 9: EXISTING AND ORDERBOOK LNG FLEET BY SIZE..............................23 FIGURE 10: OPERATION COSTS BREAKDOWN. ..................................................26 FIGURE 11: CURRENT AND FUTURE CONTRACTS PER REGION............................30 FIGURE 12: EXISTING AND UNDER CONSTRICTION LIQUEFACTION PLANTS........32 FIGURE 13: IEA’S ESTIMATED IMPORT GROWTH AND INCREMENTAL

LIQUEFACTION CAPACITY 2002-2010........................................................33 FIGURE 14 :ORDERBOOK...................................................................................36 FIGURE 15: ORDERBOOK BY SHIPYARDS AND CAPACITY...................................37 FIGURE 16*: LNG SHIPS DELIVERIES AND NEW BUILDING PRICES.....................38 FIGURE 17: GLOBAL TONNAGE COMPLETED 1974-2004 AND FORECAST UP TO

2020..........................................................................................................42 FIGURE 18: LNG DELIVERIES AND S&P RECORDS............................................46 FIGURE 19: UNCOMMITTED SHIPPING CAPACITY UP TO 2020. ..........................48 FIGURE 20: EVOLUTION OF SHIPPING, LIQUEFACTION AND REGASIFICATION

CAPACITY..................................................................................................50

LIST OF TABLES

TABLE 1: LNG TRANSPORTATION COSTS ON SELECTED ROUTES LOADING FROM QATAR. .....................................................................................................27

TABLE 2: COMPARISON OF THE CHANGE IN ADDED VALUE OF VLCCS AND LNG TANKERS...................................................................................................39

TABLE 3: LNG SHIPYARDS CAPACITY. ..............................................................41 TABLE 4: SCRAPPED LNG SHIPS .......................................................................54

ix

1 THEORY BACKROUND

1.1 Introduction

This project focuses mainly on the four LNG shipping markets: freight market,

second hand, new building and scrapping markets.

The methodological approach deals with the identification of objectives and

constraints of the market participants, the supply and demand of each market

and the long and short-term response of the shipping market in the context of

the changes of various external and internal factors.

Before proceeding with the main analysis, it is useful to provide some basic

information about LNG; this can be found in the ‘general information’ section.

A review of previous analyses of the shipping market is provided in the

‘literature review’. The model developed by Beenstock and Vergottis (1993)

on dry and wet shipping market mechanism will be the main reference point

for the analysis.

It then follows a detailed description of each market with a consideration of

the constraints and structure of each market and the differences between them.

1.2 General Information about LNG

Liquefied Natural Gas (LNG) is called the liquid form of natural gas.

Liquefaction procedure involves the cooling of natural gas to a temperature of

1

-1610 C, at atmospheric pressure. LNG is odourless, non-corrosive, smokeless

and non-toxic.

The reason of liquefying natural gas is mainly for transportation and storage

purposes, since one volume unit of LNG is 600 times smaller than a volume

unit of natural gas. It is therefore more economical to transport LNG between

continents instead of using traditional pipelines systems which are

uneconomical for distances more than 8000 km, due to technical and political

constraints. On the other hand, even though liquefaction cost has been

decreased over the last years, it still remains expensive making LNG

transportation for short distances.[13]

The major stages of the LNG value chain consist of exploration and

production of natural gas from dry gas fields or associated gas fields. Gas is

transported via pipelines to liquefaction plants in which natural gas is cooled

down to cryogenic temperatures (-1610 C) and converted to a liquid known as

LNG. The liquefaction plants consist of processing units called “trains”. The

size of each train depends on the capacity of compressors and varies between

2 million tonnes to 4 million tonnes.

Another stage is shipping of LNG in special designed tanker ships, the LNG

carriers. These ships are very expensive to build because of the low

temperature of the cargo and the need for special design and insulation.

The final stage is storage and regasification, in which LNG is stored in

specially made storage tanks and converted to gaseous form, and distributed to

end consumers.[8]

Each link in this chain is extremely capital intensive and investment structure

does not allow cash inflow unless the project is complete.

2

1.3 Supply.

The supply of any commodity or service is the amount that producers are able

and willing to offer for a sale, in a given price at a certain time. Supply can be

defined as a two dimensional relationship between quantity of goods or

services the suppliers will sell for a range of prices in a given time, keeping all

other parameters constant.[21]

In this respect, shipping supply can be defined as the quantity of shipping

services offered in the market at a given freight rate over a certain period of

time. The freight rate and the time frame are important because freight rates

are directly proportional and positively linked with the amount of services

offered (tonnage or ships available in the market). Normally, the higher the

freight rates, the quantity of tonnage supplied will go larger.[21]

There are three shipping markets in which different commodities are traded:

the sale and purchase market, the new building market, and the demolition or

scrap market. The sale and purchase market trades second hand ships, the new

building market trades new ships and the demolition market trades ships to be

scrapped. There is also the freight market where sea transportation is traded

and in which supply and demand come into equilibrium through freight rates.

The players in the shipping markets are usually the ship-owners, who provide

the ships, the charterers who provide the cargoes to be transported, the

shipyards who provide the new ships, the scrapyards who buy ships for

scrapping and the brokers that bring shipowners and charterers together.

Shipowners depend on bank loans; therefore bankers can influence

investments, and during recession can put financial pressure to shipowners

that can result in scrapping.

3

The shipowners are the most active players, since they are participating to all

markets. Shipping markets are interrelated and changes in one market are

usually reflected to the others. For example, when the freight rates rise due to

an increased demand and/or lack of supply, the prices of new building ships

are going high and consequently the prices of the second hand vessels are

rising.

1.3.1 Shipping Market Cycle

Changes in the shipping markets cause fluctuation in the cash flows moving

from one market to the other creating, what is called, the shipping market

cycle. Cash flow between markets controls and coordinates the whole

commercial process.[27]

The shipping market cycle usually begins when freight rates prices rise. The

prices of the second hand ships then also rise, as more shipowners try to

benefit from the high freight rates. At the same time shipowners place orders

for new ships aiming to take full advantage of the rising market. When, in a

couple of years time, the new ships will be available for trading there will be a

surplus of supply and freight rates will decline in order to balance supply and

demand. Low freight rates put financial pressure to shipowners who try to sell

their ships in order to meet their financial commitments; as a consequence, the

price of second hand vessels drops. Weak shipowners will be forced to sell or

scrap the older ships because new ships are available in the market in

competitive prices, and it becomes difficult for the old ships to get a cargo.

The scrap prices are also dropping. However, as more ships are scrapped,

supply again falls driving the freight rates to rise and the whole process starts

over again.[27]

4

It is important to note that the mechanism described above characterises the

dry bulk cargoes and the oil tanker sector, however it does not apply directly

to the LNG market, because the trade structure is based in long-term contracts

where the ships are time chartered for 10-20 years. This implies however, that

scrap market is not very active; moreover the long-term contract commitments

do not allow the second hand market to be also active. These issues will be

dealt with in detail in the following chapters.

1.4 Demand

Demand for shipping services results from the demand for commodities that

required to be transported by sea. LNG demand derives from the demand of

natural gas as an alternative substitute to oil, which is mainly used in the

power sector unlike the demand for oil, the products of which are used for

transportation. The level of seaborne trade determines the number and the

capacity of ships required.[21]

Demand for shipping is positively linked with economic growth, seaborne

trade, average haul and political events. When economic growth is rapid,

industrial demand for raw material increases and shipping trade expands,

resulting in a tonnage extension. The relation ship between seaborne trade and

world economy is described by trade elasticity of world economy; that is, the

percentage growth of sea trade divided by the percentage growth in industry.

Seaborne commodity trades are divided into long and short term. Short term

commodity trading is related to the seasonality characterising some trades and

is usually dealt with in the spot market. Long term trading is related to the

characteristics of the industries that produce and consume traded commodities.

5

2 METHODOLOGY AND LITERATURE REVIEW

2.1 Introduction

The objective in this chapter is to review previous attempts to describe the

mechanism of the four shipping markets. There are several analyses of the

behaviour of shipping markets and the shipping market cycle; however there

not many could be found in the literature focusing on the LNG shipping

markets.

It was decided to base the analysis on the model constructed by Beenstock and

Vergottis, in their “Econometric Modelling of World Shipping”.[2] The reason

for doing so, is because the authors have created a general model that attempts

to forecast the world-shipping markets in which freight rates, shipbuilding,

scrapping and lay up are the central variables. Their model will be the

reference point of this project, which attempts to investigate its application to

the LNG market.

The papers of Mazighi [20], [19], Banks[1] and Jensen[17] are considered along with

LNG tanker market reports and Status and Outlook of the Global LNG market.

Finally, the report of Poten and Partner “LNG Tanker market report”[25] is used

for presenting the structure of LNG shipping market as it stands today.

2.2 “Econometric Modelling of World Shipping”

2.2.1 Model Description and some theory aspects.

Beenstock & Vergottis[2] have developed an econometric model of the world

shipping market in which freight rates (including spot and time charter), vessel

6

prices (new building and second hand), shipbuilding, scrapping and lay up are

the endogenous variables. It is a mathematical representation of the demand

and supply relationship and equilibrium conditions in the shipping markets.

The main aim of Beenstock and Vergottis model is to explain how freight

rates, time charter rates, lay up, optimum speed, new and second hand prices,

and shipbuilding and scrapping are determined in terms of various external

factors that can be directly linked to freight rates or the markets for the ships.

These factors include the demand for freight, fuel prices, operating costs,

laying up costs, shipbuilding costs, scrap prices etc.

The model is based in a hypothetical shipping industry explicitly derived from

assumptions of optimising economic behaviour. Ships are treated as capital

assets, of which the demand varies according to expected return on other

assets. The methodological approach considers the objectives and constraints

that market participants face and analyses their responses to changes in their

environment.

The model also studies the response of the shipping markets to both

anticipated and unanticipated changes in external factors. For example, it

shows that freight rates, prices, shipbuilding and scraping tend to overshoot

their long term equilibrium values in response to demand or bunker prices

shocks. It shows also that the market response to the anticipated and

unanticipated shocks in the long term has similar affects, however the short-

term response is different.

2.2.2 Summary of Model Structure

For simplicity, the theoretical analysis involves only one ship type, however

the model distinguishes between the tanker and dry sector. The hypothetical

7

industry consists of freight, second hand, shipbuilding and scrapping markets.

Inessential details are omitted in order to focus on the key interactions among

these markets which gives rise to the observed fluctuations and co-movements

in ships rates, prices, fleet growth etc, during the cycle.

Freight market: The supply of freight services is proportional to the amount of

ships trading multiplied by the average speed and the optimum speed varies

directly with fuel consumption. The total freight rate supply is directly

proportional to the size of the fleet and is positively related to freight rates, but

negatively related to bunker prices.

The demand of freight services is treated as exogenous. Freight market

balances itself through freight rates by making demand always equal to

supply.

Second hand market: It is considered that portfolio demand for ships varies

directly to the expected return of ships compared with the return of other

assets. Small changes in demand affect expected return and investors are

prepared to hold ships only if the return on ships is equal or greater to other

assets with similar risk.

New building Market: The supply of new ships depends on the ratio of the

new building prices to the prices of the variable factors used in the production

process. New building prices will depend on the steel prices since steel is a

major input in the production process. New ships are ships that are traded

before they even exist therefore, it follows that new building prices are

determined in the same pattern as prices in future markets.

Scrap market: A scrap value is determined by the steel price at the time of

scrapping multiplied by the given amount of steel (lightweight) of the ship.

8

Again scrap prices change in line with second hand prices. The supply of ships

for scrap depends on the age profile, the freight market and the ratio of ship

prices to scrap prices.

The model can reproduce the real world cycle, the mechanism of which is

described earlier (see paragraph 1.3.1.).

2.3 Related Literature.

J. Jensen (2004)[17] identifies the conditions for the existence of a Global LNG

market, and the time that is likely to occur. He considers potential similarities

between the oil market and the natural gas market, however, the way a global

LNG market will set up and function is found to be different.

According to Jensen (2004)[17], the high cost of LNG transportation is one of

the main reasons preventing the LNG market to be as flexible as the oil market

where considerable oil quantities are moving across long distances. LNG can

be competitive only if there is surplus in liquefaction capacity and in LNG

tankers. We will see however, that LNG transportation costs are decreasing

since liquefaction costs have dramatically fallen over the last years.

Jensen also claims that LNG could to be as competitive as gas markets in

South America and UK after market deregulation, mainly due to the long-term

commitment infrastructure of LNG trade in these countries. North America

will emerge as the largest LNG importer, followed by Europe. Middle East

and Africa are and will probably remain the major suppliers while Egypt and

Bolivia aspire to join them. The author predicts that the Northeast Asian

market and Pacific Basin trade will be less important in the near future since

growth seems to shift to the Atlantic basin.

9

Mazighi (2003)[20] claims the globalisation of LNG markets requires four

conditions to be met; the natural, the economic, the technical and the

institutional conditions. Natural conditions involve the existence of surplus

and deficits in gas supply. Economic conditions refer to the cost decrement of

liquefaction cost. Technical conditions involve the improvement and

innovation in LNG tankers design. Institutional condition is related to the

willingness of gas producers to sell in a non-contracted basis. The presence of

these conditions is expected to create an organised market with high liquidity

and to contribute to the separation between the physical and financial side of

LNG trade (however this process will take at least 10 years).

According to Mazighi (2003), a main difference between oil and gas trade is

that the share of the oil in inter-area trade is almost 45%, while it is only 6% in

an LNG. This implies that there is a 45% chance for an oil tanker to load in

one region and discharge to another region. This probability is only 6% for the

LNG (BP statistical review data[3]). The main reason for this difference is the

differences in the structure of oil and gas markets. Trade for LNG is controlled

by long-term contracts, while trade for oil is controlled by organised markets,

such IPE and NYMEX. Moreover, LNG trade aims to ensure security of

supply while oil trade follows the logic of arbitrage and speculation.

2.3.1 Future Trends

A report for LNG market released by the Energy Information Administration

(2003)[9] states that liquefaction costs have decreased by 35%-50% over the

last ten years from $500 per ton to $200 per ton annual liquefaction capacity.

LNG new building tanker prices have been decreased from $280 million in

late eighties, to $155 million in 2003 and approximately $160 in 2004.

Regasification terminal costs have been also decreased significantly.

10

Considering that liquefaction costs and shipping costs represent 30%-45% and

10% - 30% of total LNG project cost, it is not difficult to realise the level of

improvement and growth these reductions in cost represent and the potential

contribution of the LNG shipping markets to the globalisation of LNG trade.

Poten and Partners (2004b)[25] highlight the growth in the size of LNG tankers.

This capacity increment reflects the rapid expansion of LNG trade over the

last years. They forecast that even larger LNG tankers are about to come in the

near future having a size over 200,000 cu.m. Bigger ships will result in

reduced transportation costs by 15%, reduced shipping costs by 5.5% reduced

operational costs by 25% and reduced boil-off rates, port charges and canal

fees. However there are draft limitations, since not too many terminals can

accommodate such large ships.

11

3 MARKET OVERVIEW

3.1 Introduction

Global gas consumption is steadily increasing. This increase does not follow

the same patterns in every region, but in general there is an upward trend in

the use of gas (Figure 1). The main reason for that is the distance separating

the gas-reserve areas from the gas consuming areas. Another reason is that

natural gas is a substitute fuel to coal or oil. Furthermore inclining oil prices

and security of supply for energy substitute fuels have contributed to the

increased use of gas, mainly for power generation. An additional factor relates

to environmental issues enforcing a shift to cleaner fuels following the Kyoto

protocol, a United Nation framework on climate change, which was ratified by

141 countries with the notable exception of USA and Australia. The World

NG consumption grew 3.3% in 2004 compared with a ten year average of 2.3

%. International trade in NG increased also by 9% last year.[3]

Figure 1: World Gas Consumption

Source: BP Statistical review of World Energy 2005[3]

12

Major LNG consumers are usually located in coastal areas without an

integrated pipeline network, which favours the delivery of LNG. In countries

like USA and Europe with established pipeline network, the introduction of

LNG can bring alterations to the “basis differential”, the pricing relationship

between the different delivering points of the pipeline system within a region.

Basis risk – the non-convergence of physical and paper prices- is the main

factor to determine the quantity of LNG a regional market can absorb before it

start affecting the market pricing structure. For example, in China LNG has to

regasified and transported via pipeline to the interior of the country. The cost

of regasification and transportation determines the competitiveness of LNG

compared to other fuels.[17]

3.2 LNG Consumers

In 2004 LNG trade rose by 5.3%[3]. LNG is an expensive fuel to transport

because of the huge investment required and it is not as flexible as resource as

oil. However, approximately 26% of the internationally traded gas was in the

form of LNG as shown in Figure 2.

Figure 2: Gas and LNG major trade movements Source: BP Statistical review of World Energy 2005[3]

13

Figure 3 presents the LNG imports by country for the last two years. In the

Atlantic basin, USA LNG total imports in 2004 rose by 22.3%. Considering

the fact that gas consumption in USA stagnated over the last year due to high

gas prices, this figure could increase more in the future as the resumption of

LNG imports appears the most favourite solution.[3] Algeria has been

traditionally the major LNG supplier to USA but this changed after 2000 when

Trinidad and Tobago became the leading supplier.

LNG im ports by country 2003-04

0102030405060708090

USA

S. and

centr

al Ameri

ca

Belgium

France

Greece Ita

ly

Portug

al

Spain

Turkey

India

Japa

n

S.Kore

a

Taiwan

Bill

ion

cubi

c m

etre

s

imports 2004

imports 2003

Figure 3: LNG Imports 2003-1004 Source: BP Statistical review of World Energy 2005(Combined data) [3]

Europe is a traditional LNG importer with Belgium, France and Spain being

the leading LNG importing countries. LNG imports rose only by 0.12%

because gas supplies in Europe are presently in surplus, but it is expected to

rise in the future as North Sea production is declining.[17]. In the UK

approximately 30% of the total power generation is gas powered. Declining

British indigenous production will make UK net importer of gas in the

following decade.[1].

In the Pacific basin, Japan, Taiwan and Korea are the larger LNG importers.

LNG imports rose in 2004 by 4.32%. In Japan 70% of LNG imported is used

14

in the power sector, however, LNG imports in Japan have declined by 3.5% in

2004 as nuclear plants returned to operation following a shutdown in 2003.[5]

India and China represent the emerging Asian market, but their future rate of

development is not clear as yet.

3.3 LNG Suppliers

Figure 4 below presents the leading exporting countries. In the Atlantic Basin,

Middle East suppliers are the fastest growing. Qatar has the largest gas field in

the world and LNG exports rose by 20.2% in 2004. Oman and UAE (Abu

Dhabi) are also major suppliers, but Iran is the potential leading power in

Middle East with gas reserves representing 15.3% of total world proven gas

reserves. Yemen has proposed an LNG project ten years ago without any

significant progress.[24]

LNG exports by country 2003-04

0.005.00

10.0015.0020.0025.0030.0035.0040.00

USA

S. and

centr

al Ameri

ca

OmanQata

rUAE

Algeria

Libya

Nigeria

Austra

lia

Brunei

Indon

esia

Malays

ia

Bill

ion

cubi

c m

etre

s

.

exports 2004exports 2003

Figure 4: LNG Exports 2003-1004

Source: BP Statistical review of World Energy 2005(Combined data) [3]

The major LNG exporters in Africa are Algeria and Nigeria. In Algeria the

LNG exports declined by 8% following a fire accident in Skikda last year,

which destroyed 3 out of 6 liquefaction trains that comprise the GL-1K

complex.[40] Nigeria exports in 2004 increased by 6.3%. Libya and Egypt are

emerging exporters but still not very strong.

15

In the Pacific basin, the major suppliers are Indonesia, Malaysia, Australia and

Brunei. Indonesia and Brunei production in 2004 declined by 6.48% and

1.79% respectively whereas production in Malaysia and Australia increased by

15.5% and 13.56 % respectively. Other potential exporters include Peru and

Bolivia.

16

4 FREIGHT MARKET

4.1 Introduction

In the bulk shipping, the level of supply and demand determines the freight

level at any given time. If there are not enough ships available in the market,

rates tend to go high; if there are more ships than cargoes then rates tend to be

low.[12]

The Freight market is the market where sea transport is traded. Freight is the

amount of money that the charterers have to pay to the shipowners for the

transportation services they provide.

Under the time charter agreement the ship is hired for a specified period of

time and the charterer is obliged to pay voyage costs.[8] LNG carriers are

usually time chartered for long terms contracts of 10 to 20 years or more. The

ship owner is not exposed to the volatility of freight rates in spot markets since

freights are agreed.

Charterers are companies or individuals that hire a ship to transport a cargo

from one place to another. The brokers are intermediates that provide

information about the cargoes and the ships being available and the prices that

owners and charterers are willing accept.

4.2 Ship owners

Ship owners can be classified into the following five categories:[25]

1. LNG suppliers, which own the ships and transport their own LNG for

sales based on delivered ex ship (DES) terms. Under DES method of

delivery the seller provides and order the vessel to the discharged port

17

as specified by the buyer. Property and risk pass from seller to buyer at

ship’s flange at discharging port.[8]

2. LNG buyers that own the ships to transport LNG purchased on Free on

Board (FOB) terms. FOB means that buyer provides the vessel and

property and risk passes from seller to buyer at the loading port.[8]

3. Independent ship owners with secured long-term contracts from LNG

suppliers or buyers transport committed LNG volumes.

4. LNG project participants that either have access to LNG supplies

through shareholding or participation or have access to LNG market

through control or sharing terminal capacity.

5. Independent shipowners with no committed long-term employment but

offer their ships to LNG buyers or sellers when opportunities arise.

Current Ships (5 or more)

Australia LNG 6% Bergesen

5%Golar LNG

9%

Hyundai MM 5%

M.I.S.C. 15%

Mitsui OSK Line9%

MOL/LNG Japan 7%

National Gas Shipping

7%

Nigeria LNG Ltd. 9%

NYK Line 8%

Shell Group 11%

SK Shipping 4%

Sonatrach 5%

Orderbook (3 or more)

A. P. Mol l er

6% Ber gesen

9%

BP Shipping

5%

Br i ti sh Ga

9%

Dyna Gas

4%Gol ar LNG

4%K Line

6%Kr isten Navigati on

5%M.I.S.C.

14%

Mi tsui OSK Line

5%

Niger ia LNG Ltd.

4%

NYK Line

6%

Oman Gas/ MOL

5%

Over seas

Shi pholding

5%

Pr oNav Ship

Management

5%

Sovcomf l ot/ NYK

Li ne

5%

Teekay Shipping

4%

Figure 5: Major LNG shipowners (Current fleet and Orderbook)

Source: Maritime Business Strategies (Combined data)[35]

Figure 5 above presents the percentage of owners in the current fleet owning 5

or more ships and the percentage of owners ordered 3 or more ships.

Current LNG fleet consists of 177 ships owned by 45 owners with capacity of

21 billion cubic metres. Thirteen major owners (29%) own more than five

18

ships and control 68% of total fleet capacity. Out of those twelve major

owners, producers or importers own 33% of total fleet capacity and

shipowners control 35% of total fleet capacity.

It is obvious that only a small number of owners control the majority of the

LNG fleet highlighting the limited market structure contrary to the highly

competitive structure of oil tankers market.

In the orderbook however shipowners appear determined to capture the

potential opportunities in the LNG market. Orderbook consists of 112 ships

ordered by 39 owners. Seventeen owners (71%) who ordered more than three

ships control 75% of the total orderbook capacity. From those seventeen

owners, producers/importers orders count only for 16% whereas ship owner’s

share of the orderbook capacity is 57%.

4.3 LNG Fleet

4.3.1 LNG Fleet by trading routes

Most LNG ships are engaged with long term contracts and committed to trade

on certain routes, therefore we characterise LNG fleet by the trade in which

ships are employed. Figure 6 below presents the distribution of both LNG

existing ships and orderbook according to their major trading routes.

Existing fleet in Pacific basin dominates the LNG markets with 104 ships

engaged in this route representing 60.54% of total fleet capacity.

However, in the orderbook market prospects shift to the Atlantic basin with 56

ships committed to trade in the area counting for 51.21% of orderbook

capacity. Moreover, there would be 24 ships with uncommitted trading

contracts (15.18% of orderbook capacity).

19

0

20

40

60

80

100

120

140

160

Altantic Pacific Uncommitted

Existing ships (No of ships)Existing Capacity (,00000 cum)Orderbook Ships (No of Ships)Orderbook Capacity (,00000 cum)

Figure 6: Existing and orderbook Fleet by trading route Source: Maritime Business Strategies (Combined data)[35]

The large number of ships ordered to trade in the Atlantic basin indicates that

Pacific market will be less important in the future and addresses potential

arbitrage opportunities in the Atlantic basin

4.3.2 LNG Fleet by age

LNG fleet will be relatively young in 2009 since 57% of the fleet will not be

more than 15 years old as shown in Figure 7 below.

Ships in the range of 25-35 years represent 26% of total capacity; range of 35-

40 years old represent 7.34% of fleet capacity and 2.26% of capacity would

have to be scrapped. Given the current rate of growth in the LNG market, and

the new LNG projects under way or under considerations it is likely that more

orders will come for new LNG ships in the future.

20

Age o f F leet in 2009

0

10

20

30

40

50

60

70

80

90

<10 10-15 15-20 20-25 25-30 30-35 35-40 >=40

Years

No

of s

hips

/Cap

acity

.

0%

5%

10%

15%

20%

25%

30%

35%

40%

% o

f Tot

al C

apac

ity

.

N o of shipscapac ity ('00000 cum )% of T otal C apac ity

Figure 7: Age of LNG fleet in 2009 Source: Maritime Business Strategies (Combined data)[35]

4.3.3 LNG fleet by size

Figure 8 below presents the LNG fleet development from 1996 to date. The

numbers of ships available are calculated according to their age considering

that LNG ships economical life is usually 40 years.

The growth of LNG fleet is following a steady growth until 2001.Therefter the

fleet is presenting a rapid expansion. There were 176 ships available in March

2005, a change of 192% since 1996. In the orderbook there are 112 ships to be

delivered up to 2009, raising the total number of ships to 2851, a 308% change

since 1996.

1 Four ships were not taken in account since they would be more than 40 years old in the period 2005-2009.

21

LNG Fleet 1996-2009

0

50

100

150

200

250

300

350

400

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Ship

s nu

mbe

r

.

0%

50%

100%

150%

200%

250%

300%

350%LNG shipscapacity in '00000 cub mtrsgrowth in capacity (%)growth in fleet (%)

Figure 8: LNG Fleet 1996-2009

Source: Combined data from Clarksons SIN and Maritime Business Strategies

Fleet capacity is also increasing. Ship sizes increased as shipping distances

and plant capacities grew. Loading and unloading facilities with storage tanks

were built in order to accommodate the larger ships.[25] From 1996 to 2001

capacity growth follows the fleet expansion rate, however from 2003 onwards,

fleet capacity presents an aggressive growth reaching an expansion of 289% in

2009. The development in the ships’ capacity indicates the prospective needs

of larger LNG cargoes resulting from the increasing demand for LNG.

Figure 9 below presents the size distribution of existing and under

construction LNG ships. There are 53 ships in the range of 100,000-130,000

cubic metres counting for the 32.15% of total capacity, and 91 ships in the

range of 130,000-145,000 cubic metres representing the 59.8% of total

carrying capacity. In the orderbook, ships size is considerably higher. Forty-

one ships in the range 130,000-145,000 cubic metres are under construction,

counting for 35.33% of the total orderbook capacity and 56 ships in the range

of 145,000-155,000 cubic metres, a 50.55% of orderbook capacity.

22

Size of LNG Fleet

0

10

20

30

40

50

60

70

80

90

100

<50k 50k-100k 100k-130k 130k-145k 145k-155k >155k

Ships size ('000 cum) .

No

of S

hips

.

0%

10%

20%

30%

40%

50%

60%

Ship

s C

apac

ity (%

)

.

Existing shipsOrderbookExisting ships Capacity (%)Orderbook ships Capacity (%)

Figure 9: Existing and orderbook LNG fleet by size

Source: Combined data from Clarksons SIN and Maritime Business Strategies

Note that there are no ships ordered in the range of 100,000-130,000 cubic

metres, and ships greater than 145,000 cubic metres are not present in the

current LNG fleet. There are even larger ships ordered, with capacity 210,000

- 215,000 cubic metres, but terminal issues such as limitations on LNG storage

capacity, restrictions on vessel displacement, length and draft, and

modifications of terminal loading arms, mooring systems and gangways,

should be taken in consideration.[36]

4.4 The effect of LNG fleet to freight rates

According to Beenstock and Vergottis (1993) model, supply of freight

services is proportional to the amount of ships trading multiplied by the

average speed. The total freight rate supply is directly proportional to the size

of the fleet and is positively related to freight rates but negatively related to

bunker prices. In order to investigate the applications of this model to the LNG

shipping freight market it is necessary to distinguish between long term and

short or medium term shipping agreements. This distinction is useful because

23

the unique feature of LNG supply chain has been affected over the last years

by the changes in LNG shipping contracts. The structure of LNG contracts is

discussed in detail in paragraph 4.6.

4.4.1 Long term contracts

LNG freight rates structure consists of two elements, the capital and the

operating element. The capital element depends on the cost of building a new

ship and the financing cost of the ship[25], while the operation element depends

on transportation costs (see paragraph 4.5).

LNG ships employed under long-term contracts reflect agreements of LNG

projects between buyers and suppliers. Destination, fuel consumption and

speed is specified in the time charter contract which the shipowner is obliged

to maintain in order to be treated as constant. The main factor affecting freight

rates is the amount of ships trading. But this depends solely on the LNG

projects, which are closely related to the state of the world economy in

general, and the individual LNG projects undertaken.

New ships will be ordered to serve respective LNG trade agreements to meet

shipping demand for long-term contracts. Shipping contracts will extend along

with the extension of GSPA. If this assumption stands right, freight rates for

long-term contracts should not be affected since supply of ships is determined

and controlled solely by the LNG projects available. Freight rates should rise

only in a case where the growth of LNG trade is so big that can cause a

demand for shipping capacity surpassing the shipbuilding capacity of

shipyards.

4.4.2 Medium and short term contracts.

Under a perfect competitive environment, when freight rates rise, freight

market supply utilises more efficiently ships for trading. Beenstock and

24

Vergottis (1993) model assumes that the total fleet trading consists of ships

not laid up, and treats the time charter contract as a special feature where the

charterer pays a rent to the shipowner for assuming control of the ship over an

agreed period.

Freight rates in short-term contracts are far more complex than in long-term.

Freight rates are determined by the supply and demand for shipping, which

depends on the quantity of LNG available for short-term trading. Ships supply

for short-term contracts depends on the spare capacity of the existing ships

under long-term charters and the capacity of ships that are uncommitted while

their competitiveness depends on their age and technical characteristics.

The structure of long-term contract shipping agreements makes difficult to

utilise ships trading in alternative destinations, however if there is spare

capacity, these ships can be chartered under short-term basis. This implies that

the LNG tanker business would become similar to oil tanker business. But this

suggests an established LNG market where freight rates will balance the

supply of demand of LNG. This market already exists but unlike the dry bulk

and wet market, its capacity is limited because the size of the entire LNG

market is limited. Furthermore, LNG ships are more capital intensive than oil

tankers and as the long-term trade ebbs, speculative LNG tanker ownership

would be riskier than oil tanker ownership. Shipowners with spare capacity to

deliver spot trade would benefit if prices are high, but those would be the large

companies with multiple resources and multiple terminal outlets that have the

ability to maintain spare capacity and divert, in case of a weak market. Unlike

oil tanker business where speculative owners can enter the market and be

competitive offering lower prices, LNG speculative owners have to deal with

enormous financial pressures and uncertainty since the risk and costs

associated would be greater.

25

If the number of uncommitted ships is large, and there is also spare capacity

for short term hired ships, then there would be oversupply of shipping capacity

relative to the quantity of spot traded LNG and the freight rates will tend to

fall.

Similarly, if the fleet is fully utilised, an unanticipated increase in demand

should lead to an immediate increase in the freight rates.

4.5 Transportation Costs

LNG transportation costs are divided into operation and voyage costs.

Operation costs are non-trading costs incurring irrespectively of the trading

commitments of the ship. These costs include manning costs, insurance,

repairs and maintenance (spares, store, lubricants etc, dry docking) and can be

considered fixed. Manning cost is the largest among operation costs as shown

in Figure 10.

Figure 10: Operation Costs breakdown. Source: LNG One World[38]

26

Voyage costs include bunker costs, port costs and canal fees. They are

associated with certain trade routes where loading and discharging ports are

specified. Bunkers being the major cost including boil off rate.[26] Boil off rate

is the amount of boil – off gas, which is produced due to some heat inleaks.

This gas is used as a fuel for propulsion systems. Its value varies between 0.1-

0.15% of the full content per day.[41]

Some indicative transportation costs from Qatar to selected routes are given in

the Table 1.

Route Transportation cost

($/MMBtu)

Abu Dhabi-Japan $0.98

Algeria-Cove Point $0.60

Egypt-Lake Charles $0.90

Qatar-Lake Charles $1.50

Qatar-Japan $0.94

Nigeria-USG $0.94

Table 1: LNG Transportation Costs on selected routes loading from Qatar.

Source: Poten and Partners[25]

4.6 Contracts

4.6.1 Long term contracts

Traditional LNG trade is based on long term take or pay (TOP) Gas and Sales

and Purchase Agreements (GASP). The duration of the contracts is over 20

years with pricing formulas fixed for the entire life of the contract and

provisions to ensure minimum revenues. Take or pay clauses shift the volume

risk to the buyer, and seller bears the price risk, since prices are indexed to oil

prices. LNG ships employed under long-term charter, delivered ex ship (DES)

or freight on board (FOB) and dedicated to transport LNG sold under GSPA

27

agreements. Furthermore, destination clauses are included to prevent buyers

from reselling the cargo to third parties.[9]

The key issue of traditional LNG contracts is reliability and security of supply.

The uniqueness of LNG contracts is that buyer and supplier are negotiating

directly with one another and the transportation elements – liquefaction for

supplier and regasification for the buyer- remain under the control of the

contracting parties.[16]

Deregulation of the gas market followed by the concept of market competition

and the assumption that governmental monopoly of electricity and gas is

inefficient, lead to restructures in traditional contracts. Besides, long-term

GSPA proved limited and inflexible. During the financial crisis in Asia in

1998, the energy consumption dropped significantly and the traditional LNG

consumers (Japan, Korea and Taiwan) committed to GSPA with fixed prices,

forced to contravene their contractual terms.[30]

The new style contracts emphasize flexibility and price and cost

competitiveness. Duration is between 10-15 years and prices are indexed to

gas prices, since oil linked prices indexation proved a poor indicator. In

addition, frequent price adjustments provision have been added to ensure

competition. Destination clause is now removed and some sellers try to keep

their destination option open by integrating downstream through “self

contracting” with their own market affiliates.[15]. Take or pay clause still exists

but less frequently.

4.6.2 Short term Contracts

The main difference in short-term contracts is that they obey the logic of

spatial arbitrage, enhancing the integration of existing regional gas markets.

Another difference is that short-term trading introduces temporal arbitrage

28

opportunities, which implies the development of storage facilities and the

development of an organised market.[19]

The short-term market has grown substantially, from 0% in 1990 to 8% in

2002. Forecasts expect short-term trade to rise up to 15% - 20% by 2010.

Korea, a traditional importer under long-term agreement, has gone into short-

term market to deal with the increased demand during seasonal peaks.[29]

But switching from TOP to short-term contracts requires fundamental changes

in the principles of the international gas trade, with great uncertainty and

various risks involved.[19] For example, terminals have to add sufficient capacity

to receive and process additional short-term shipments, on top of the

scheduled shipments.

Gas market infrastructure is also an important issue. In countries like USA

with advanced pipeline network, gas pricing is fully deregulated and LNG

represents only a fraction of natural gas supply. However, in Asia, LNG is

heavily indexed to oil prices since there is no any indigenous pipeline gas, and

natural gas is treated as a substitute to oil. Security of supply with long-term

contracts with rigid TOP contracts, dominate the Asian market. Suppliers in

the Asian market impose a security premium that buyers agree to pay,

resulting to higher LNG prices in the Pacific basin.[29]

4.6.3 The Effect of LNG Contracts to Freight rates.

Figure 11 below presents the current type of LNG contracts in the three major

regions. Data is based on the information available from LNG One World[38].

There are 183 GASPs LNG agreements worldwide, but for only 95 of them

information is provided about the type of the contract. FOB contracts

dominate the market in the Atlantic basin (FOB: 7.1%, CIF: 1.64 %) whereas

in Middle East (FOB: 2.73%, CIF: 5.46%) and in the Pacific basin (FOB:

29

8.7%, CIF: 19.7%), CIF is the most preferable type of shipping agreement.

DES agreements represent only a very small percentage in all regions,

according to data available.

0

5

10

15

20

25

30

35

40

No

of C

ontr

acts

.

A tlantic P acific M iddle E ast

C urrent and Future C ontracts

C urrent C IF C urrent FO B C urren t D E S

Figure 11: Current and future contracts per region Source: LNG One World[38]

The transaction type of LNG procurement affects the shipping costs and the

cost of LNG delivered. In CIF transactions the supplier bears the cost of

shipping and insurance on behalf of the buyer for transporting LNG to the

specified delivery point. The supplier will charge a premium in the case of CIF

supply and this will result in higher cost of shipping and consequently in

higher cost of LNG delivered. The premium reflects the risk for events such as

non-ships availability and unforeseen costs in shipping and insurance. In

addition, when the supplier controls the shipping, the risk of demand is

minimised. For example, in case of excess production, or in case of a dispute

with a buyer, the supplier having the control of shipping can divert cargoes to

alternative buyers and minimise the price risk. Control of shipping will also

put suppliers in advantageous position at the end of a contract, as they can find

other customers without having to invest in new shipping therefore minimising

their shipping costs and increasing their competitiveness.

30

The CIF procurement therefore is a mean to maintain security of supply.

Countries like Japan and Korea, with no indigenous pipeline network, are

heavily dependent on LNG and security of supply is more important than the

price. This is the main reason why CIF contracts dominates Pacific region.

However, now many buyers prefer to buy FOB and this is reflected to the

large number of uncommitted ships under construction, which represents a

15.18% of orderbook capacity (Figure 6 above). Where the buyer is able to

take delivery of LNG on an FOB basis, the flexibility associated with ship

scheduling will pass to the buyer; this will manage the potential exchange or

resale of LNG cargoes and will allow re-routeing cargoes to its own

alternative terminals. In this way importers can reduce LNG cost by managing

LNG transportation themselves[43]. But the latter implies that buyers will have

to bear shipbuilding or ship purchasing costs, fleet management costs plus the

risk of ships laid up in case of shortage of supply or a significant decrease in

shipping freights.

4.7 Liquefaction Capacity and its effect to freight rates

Liquefaction plant is the largest cost component in the LNG value chain. Over

the last years, the economies of scale achieved, increased the capacity of

liquefaction trains, which in turn contributed, to a substantial decrease of

liquefaction costs by 30-50%.

Pacific basin is the strongest in terms of liquefaction capacity, with Indonesia

and Malaysia being the major producers, counting for 47.7% of worlds total.

In the Atlantic basin the major producers are Algeria, Nigeria and Trinidad

and liquefaction capacity counts for 30% of worlds total. In Middle East

Qatar is the largest producer, and the total liquefaction counts for 22.2%

respectively. When plants under construction will be delivered, Pacific will

31

count for 37.9% of worlds total, Atlantic 34.5% and Middle East 27.6%, as

shown in Figure 12 below.

E x i s t i n g a n d U n d e r c o n s t r u c t i o n L i q u e f a c t i o n P l a n t s

0 1 0 2 0 3 0 4 0 5 0 6 0 7 0 8 0 9 0

A l g e r i a

E g y p t

E q u a t o r i a l G u i n e a

L i b y a

N i g e r i a

N o r w a y

T r i n i d a d a n d T o b a g o

A t l a n t i c B a s i n T o t a l

A u s t r a l i a

B r u n e i

I n d o n e s i a

M a l a y s i a

R u s s i a

U S A

P a c i f i c B a s i n T o t a l

O m a n

Q a t a r

U A E

M i d d l e E a s t T o t a l

C u r r e n t ( M m t p a )U n d e r c o n s t r u c t i o n ( M m t p a )

Figure 12: Existing and under constriction liquefaction plants.

Source: LNG One World[38] (Combined data)

According to IEA’s estimates (Figure 13 below), Atlantic basin market

appears to be undersupplied. Future LNG demand in the Atlantic basin will

create demand for shipping services and this is verified by the large orders of

new ships committed to trade in the Atlantic (Figure 6 above).

In the Pacific basin, the potential new projects supply is greater than the

demand of the nearby markets and this is reflected in the reduced planned and

under construction projects. Pacific market appears to have reached its

capacity and most probably will be less important in the future.

32

Figure 13: IEA’s estimated import growth and incremental liquefaction capacity

2002-2010. Source: Jensen (2005) [15]

Freight rates are linked to the liquefaction capacity through the concept of

supply and demand. However, it is necessary again to distinguish between

short-term and long-term trading. In the long-term, decrease in liquefaction

cost and oversupply of LNG is not an important variable since freights,

quantity, destination and time is agreed.

On the other hand, in spot trading, LNG supplies, liquefaction costs, and

destination would affect freight rates. Lower liquefaction costs reduce the

price of LNG delivered and shipowners would like to cease the opportunity to

be competitive. Added capacity of liquefaction trains with some capacity

uncommitted to long term trading will create demand for ships available for

spot trading. Depending to the market status, freight rates will balance supply

and demand. If there is oversupply of ships available for spot trading, freight

rates will drop. If there are not too many ships available, and the cargoes have

to be delivered to the designated points due to lack of storage capacity or due

to contractual agreements, then freight should rise. Geographical location of

the loading and discharging port will be a key issue, since long hauls are more

costly, and depending to the delivery point a premium would be added. Middle

33

East location in this respect is favourable since it can be the link between

Atlantic and Pacific basin.

Added liquefaction capacity for short term trading will create a market in

which freight market supply will be determined in line with the surplus

capacity of exporters, availability of ships for spot trading and import needs

others than the long term TOP agreements. Short term traded LNG is more

likely to take the advantage in the imbalances of demand and supply and

introduce a secondary LNG shipping market with rather great volatility in

freight rates in which potential for great profits or losses will be evident.

34

5 NEW BUILDING MARKET

5.1 Introduction

The uniqueness of the new building market is that it trades vessels that have

not yet been built. The contract negotiations can last from 6 months to one

year and usually focus on the price, the vessel specification, the terms and

conditions of the contract and the finance scheme offered by the shipbuilder.

The ships will be delivered after 1-3 years depending on the type.

The price of new building from the supply viewpoint is determined by the

shipyards capacity. When new building supply rise, then prices will rise

accordingly. Moreover, the increase in costs of raw material (e.g. steel) will

increase the price of new building. But increased demand in new building will

extend the delivery time, which will further increase the lagged response of

the shipbuilding to the increased demand for shipping services. On the demand

side, the prices are affected by the freight rates the price of second hand ships,

credit availability, expectations and liquidity of the buyers.[22]

Orderbook represents the ships to be delivered in the future. The number of

ships ordered depends on the new building prices in relation to shipbuilding

costs. Long-term changes in the freight rates will affect shipbuilding

production and prices since new orders reflect markets expectation, especially

with regards to the second hand prices.[2]

5.2 Fleet expansion.

Figure 14 below shows the orderbook for LNG ships (31/05/04). There are

112 ships ordered with capacity 16.3 million cu.m to be delivered up to 2009.

35

O rd e rb o o k

0

10

20

30

40

50

60

2005 2006 2007 2008 2009

Tota l No s h ips orderedCapac ity ( ,00000 c u.m.)

Figure 14 :Orderbook

Source: Maritime Business Strategies[35]

However, it is more likely that the majority of shipowners will not opt for the

short-term market. The average committed contracts’ length for the 62% of

orderbook fleet is 23 years. The rest of the ships will either be involved in

long-term agreements in the near future while a quite substantial percentage

will be available for short/medium-term trading.

5.3 Ship building Industry

The primary method of increasing the number and tonnage of ships and their

quality in terms of economic and commercial performance is through

shipbuilding. The delivery rate of new ships is determined by the capacity of

the shipyards and the lagged distribution of past orders.

Shipyards use compensated gross tonnage (cgt) as an indicator of the capacity

and the work content of shipbuilding. It is based to the gross tonnage and

reflects the complexity of the building process by measuring the comparative

work content inherent in building the ship.

From 1990 and onwards, shipbuilding industry has recovered from the

recession that started in 1975 following the oil crisis of 1973. The upturn in

the industry is not solely due to the need for replacement of the obsolete ships,

36

but also due to the expansion of world trade which generated a need for

additional shipping capacity. The latest developments in the containerisation,

the expansion in cruise market and the use of LNG as a fuel source, and the

introduction of stricter regulations against pollution made shipbuilding again a

high growth industry.[7]

The standards of construction of LNG carriers are higher than any other type

of ship. Construction is limited to 15 licensed shipyards worldwide and the

entry cost into this sector is significant.

As shown in Figure 15 below, South Korea has the largest share of the market

with Daewoo and Samsung holding the 28.6% and 28.5% of total capacity

ordered. Current LNG fleet capacity is 20.9 million cu.m and the orderbook at

end of May 2005 stands at 16.6 million cu.m, which represents almost 80% of

the current fleet capacity.

Ships orde re d by s hipya rd

0 5 10 15 20 25 30 35 40 45 50

Hudong

Kaw as aki Sakaide

Koy o Doc k

Mits ubis hi Nagas aki

Mits ui Chiba

Univ ers al Ts u

Daew oo

Hy undai

Hy undai Samho

Sams ung

A tlantique

IZ A R Ses tao

Capac ity ( ,00000 c u.m.) Ships

Figure 15: Orderbook by shipyards and capacity

Source: Maritime Business Strategies[35]

5.4 Price of New Building

Prices of new buildings are determined quite simply and are depending on the

spare capacity of the shipyards and the amount the shipowner is prepared to

37

pay. The traditional view of shipbuilding prices was that they behaved much

like a commodity, with prices rising and falling along with demand.

Depending on the state of the market, the negotiating power may lie with

either side. If the market is rising, the shipowners will hustle to order new

ships and yards will take the advantage to raise the price; if the market is bad

and freight rates are low, yards will lower the price in order to lure shipowners

to order new ships.

But in reality this relationship is sensitive to developments in shipbuilding

capacity and it’s influenced by a number of parameters; that is, the balance of

demand and supply, the shipyard costs, currency fluctuation, shipping market

condition brokers aspiration and national policies.

LNG Deliveries #

0

5

10

15

20

25

30

35

40

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

Ship

s N

umbe

r

.

0

500

1000

1500

2000

2500

3000

$/cu

b.m

.

Deliveries (left)New building prices (right)

Figure 16*: LNG ships deliveries and new building prices

Source: Maritime Business Strategies[35] (Combined data)

# Color changes in series indicate orderbook * For the period 1985-88 and in 2009, prices assumed equal to previous years since no data or deliveries available

Balance between supply and demand Capacity: Prices for LNG ships are

coupled with LNG delivered volume and changes are moving in line, as

shown in Figure 16 above, with a time lag of 2 years. This is due to the fact

that prices are negotiated and agreed when the building contract is signed, and

not when the ship is delivered. However after 2000 there is an all time record

in new ships delivery, which is not followed by a respective increment in

38

prices, as someone would expect. Prices although still tracking the changes in

volume, have decreased dramatically. The lowest level reached in 2000 where

Exmar ordered a ship from Daewoo Shipbuilding for $143 million. The same

ship in 1990 would have cost $260 million.[25] The main reason for low prices

and the de-coupling of price from volume delivered is competition against the

shipyards to gain a share to the high valued sector of LNG ships.

Shipyard costs and revenue: The price of a ship depends on its type and size. It

is far more complex to built an LNG ship than a bulk carrier and that implies

that higher complexity commands a higher price. But higher work content

does not necessary equate to higher value of work. Shipyards use the concept

of added value to describe the portion of revenue from the construction of a

ship covering labour costs, overhead interest and depreciation. Added value is

the profit of the shipyards when material, contract and other direct costs have

been deducted from the agreed price of the ship.

Table 2 below is shown the comparison in the change of a VLCC and an LNG

ship. It is clear that whilst both type of ships have seen a reduction in price, the

reduction in LNG has been far higher. As a result, shipyards are competing

with each other to capture the largest share in this market.

Estimated added Value

(US$/CGT) Ship Type

1997 2003

VLCC 760 480

LNG Tanker 1,570 680

Relative value of LNG tanker compared to VLCC 206% 142%

Table 2: Comparison of the change in added value of VLCCs and LNG tankers

Source: CESA [10]

39

Currency Fluctuation: The Asian financial crisis in the late 1990’s had a

major influence on the LNG shipbuilding industry. The Korean won declined

almost 50% compared with the US dollar and that gave a strong advantage to

Korean shipbuilders against Japanese, since their labour costs in US dollars

declined significantly. Koreans lowered the price and introduced high

competitiveness in the LNG market. But when the won recovered, without

price increases profitability South Korean shipbuilding started to deteriorate

and a number of shipyards got into financial difficulties (e.g. Daewoo). In the

meantime low prices resulted to full orderbook in 1999 and 2000 and then

prices rose again but in 2002 orderbook was no longer full and prices fall

again.

Shipping market condition: Price negotiation between seller and buyer

depends on the orderbook of the yard and the buyer’s view about the market.

Obviously a fully booked shipyard makes price negotiations much harder for

the owner. The nature of the buyer will have an effect to the negotiation as

well. If the buyer is a major shipping company for example; a regular buyer

will wield a greater level of influence than a speculative buyer. The majority

of LNG owners are well-established operators with long experience, however

with the development of LNG trade, shipowners traditionally involved with

the dry and bulk, entered the LNG market. A great number of ships ordered

with no committed contacts, which is rather unusual for the LNG shipping

sector. Shipowners make a great amount of profits by buying or building ships

when the market is weak and prices are low, and sell when the market has

peaked. It would be interesting to see whether these shipowners would enter

the LNG market as operators, or they would take advantage of the low prices

to speculate and sell the ship later, when prices will rise again.[10]

40

5.5 Shipbuilding Capacity and it’s effect to freight rates

The ill effect of overcapacity is a known concern in the shipyard industry and

the control of capacity was a major issue during 1980’s in Japan and Europe.

Following the oil crisis in 1973, the shipbuilding industry in 1975 went into a

long-lived recession and governments did not permit further development in

shipbuilding capacity while granting subsidies to the shipyards in order to

contribute to competitiveness. By that time Korea entered the industry

exacerbating the existing massive overcapacity and many started referring to

shipbuilding as a “sunset industry”.[34]

LNG shipbuilding capacity from 15 shipyards worldwide is 57 ships per year

as shown in Table 3 below.

Yard 2005 2006 2007 2008 2009 Slots AvailableCapacity

Daewoo 6 7 10 7 0 10 10 El Atlantique 2 1 0 0 0 2 2 Hanjin H.I. 0 0 0 0 0 2 2 Hudong 0 0 1 1 0 2 2 Hyundai 2 1 8 4 0 9 9 Hyundai Samho 0 0 0 1 0 3 3 Imabari 0 0 0 0 0 1 1 IZAR Sestao 0 0 0 1 0 4 4 I.H.I. 1 1 Kawasaki Sakaide 2 3 1 3 3 0 3 Kvaerner Masa 0 0 1 1 0 3 3 Mitsubishi Nagasaki 1 3 4 3 1 5 6 Mitsui Chiba 2 0 0 1 0 2 2 Samsung 4 7 9 8 1 7 8 Universal Tsu 0 0 2 0 0 1 1

Total 19 22 36 30 5 50 57

Table 3: LNG shipyards capacity. Source: LNG One World[38]

There would be 50 “slots” available in 2009 while 61% of world’s LNG ship

building capacity is booked in 2007. If orders for LNG ships continue with the

current rate, it is likely the demand for ships override the shipbuilding

41

capacity. Under this worst-case scenario, the shipyards will increase the prices

since there will be increased demand but limited supply and prices might peak

again in previous level. Such increment in new building prices should cause

freight rates to increase as well.

The second hand market in LNG is historically weak, since ships are

committed to trade under long-term agreements. Recent changes in the SPA

contracts might introduce a more liquid second hand market; if there is

shortage of ships, second hand prices will peak too and profits from this

market would be substantial.

The world shipbuilding industry is experiencing a great boom with shipyards

operating in full capacity. Yards in Asia are expanding their capacity or plan

to expand within the next years.[6]

Figure 17: Global Tonnage completed 1974-2004 and forecast up to 2020.

Source: CESA (2004)[10]

Figure 17 above presents the global tonnage completed and the forecasted

shipyard capacity up to 2020. The shipbuilding capacity is steadily increasing

42

and in the future will be much larger than shipbuilding activity. CESA

(2004)[6] evaluates a substantial oversupply of shipbuilding capacity is likely to

develop within a few years. The current growth in shipbuilding activity is

massive but according to CESA (2004) these records are not seen as

sustainable. However the massive orderbook of bulk carriers, tankers and

containers has increased the competition for shipyard capacity resulting in a

shortage in LNG shipbuilding capacity.[39]

43

6 SECOND HAND MARKET

.

6.1 Introduction

In the sale and purchase market ships are bought and sold. The purpose of the

second hand market is to increase the efficiency of operators in providing

shipping services by re-allocating ownership of vessels and does not affect the

tonnage capacity offered in the market. The main participants are the

shipowners, which they come to the market to sell and buy ships.[28]

Prices in second hand vessels are determined in accordance to the position of

the market cycle. Obviously at the bottom of the market, a ship worth less and

a shipowner will sell at such at time only if the need for financing is pressing.

The main factors that influence the price of a ship in a given period of time are

the freight rates, the age of the ship, the inflation and the shipowners’

expectation for the future and the price of new buildings. Among these factors

the most significant is the freight rates. Freight are also strongly influenced

and determined by the behaviour of buyer and sellers.[27]

6.2 LNG Second Hand Price

Beenstock and Vergottis (1993) assume that second hand ships can be treated

as risky assets in which profits will be a function of the rate of return on ships

relative to the return on other assets plus a risk premium. The risk premium

changes in accordance with the size of the fleet shipowners will hold ships if

the return by owning ships equals the return had they owned other assets given

the market expectation about prices and profits. If market expectation about

other assets is positive, this will result in increased expectation in shipping

returns and will create a demand for shipping which will drive current ships’

44

prices up. Increased prices will tend to increase the size of fleet, but at the

same time the risk premium associated will also increase.

In order to maintain equilibrium with the expected future profits and returns

on other assets, current ships prices should then fall. This implies that market

activities and price variation is quite attractive to shipowners and other

investors who focus on potential rise in ships prices and that they will enter the

market to exploit such variations in ships’ values.[28]

It should be noted that the higher the age of a ship the lower its value. An old

ship incurs higher maintenance costs, reduced performance, and is subject to

more frequent damages. Inflation affects the ship’s price as well as the

expectations of buyers and sellers. Unfortunately there are not enough data to

illustrate the fluctuation of LNG second hand prices. It is quoted for reference

only that two LNG ships with capacity 122,225-cu.m, aged 12 and 11 years

sold for $22 million in 1988. The same ships sold again for $13 million in

1992, almost 60% reduction in value within 4 years.[38]

6.3 Characteristics of LNG second hand market.

Second hand market activity in LNG ships is very weak as can be seen in

Figure 18 below. The reason is the limited number of participants in the LNG

market and structure of the new building market in which the ships were

ordered after a GSPA has been secured. Ships were dedicated to trade in

certain routes under long-term contracts in agreed rates and operators

exposition to volatility of freight rates was limited with given amount of

profits.

In traditional GSPA contracts, it was a common practise to use new buildings

for servicing new LNG projects, which resulted in an inflexible tanker fleet.

Ships with surplus capacity therefore could not be sold or diverted and

45

remained in lay up. That was the case during 1970’s when a number of ships

ordered to serve trades from Algeria and Indonesia to USA but when the

projects abandoned fifteen ships –representing one quarter of the fleet at that

time-remained laid up for more 15 years. Another important issue in the early

days of LNG shipping was that LNG tankers would have a limited life and

often assumed that would not outlast the terms of the original contracts,

therefore new ships would have to be ordered should the contract was about to

be renewed.[17]

De live r ie s and S&P

0

5

10

15

20

25

1965

1969

1970

1971

1972

1973

1974

1975

1976

1977

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

Num

ber o

f shi

ps

T otal deliveriesT otal S& PT otal Scrapped

Figure 18: LNG Deliveries and S&P records

Source: Combined data Clarksons Maritime Business Strategies

There are only 21 LNG tanker sales and purchase transactions recorded since

1965. For comparison purposes it is worth to note that in the tanker market

during 2004, four hundred and ten ships were sold representing sales of

$11,800 million[34]. The majority of LNG transactions at mid and late 80’s

involved the purchase of laid up ships, rather than active ships. For example,

during the mid eighties when the Bonny project was under development, 9 laid

up ships were purchased in order to reduce capital costs and demonstrate the

economical feasibility of the project.

46

A second hand fleet started to appear after 90’s, which is mainly connected to

the development of the short term LNG trade resulted by LNG surpluses in

Pacific and uncommitted terminal capacity, mainly in USA. The industry also

realised that the economical life of an LNG ship can be up to 40 years and

older ships employed. If a renewal of a contract is followed by an expansion in

the quantity to be transported, additional shipping tonnage is required. Larger

ships will be used and the smaller ones have to be laid up. The laid up ships

are then being purchased to serve similar requirements for other projects. This

trend is illustrated in Figure 18 above where the most of the transaction

recorded after 1990.

6.4 Future trends

The changes in the LNG trade traditional patterns resulted in the re-structuring

of the LNG shipping industry. Although the majority of new building orders

involve ships committed with long or medium term shipping contracts, a

number of uncommitted ships will be available in the market. Second hand

market for specialised ship types like LNG cannot be as liquid as for standard

type of ships because they cannot operate in several trades. However the

emergence of spot or short term trading will probably introduce a more

flexible second hand LNG fleet.

47

Uncommitted S hipping Capacity 2020

0

5

10

15

20

25

30

35

40

45

50

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

mill

ion

cu.m

.

T otal CapacityPacific Uncommit tedAtlant ic Uncommited

Figure 19: Uncommitted Shipping Capacity up to 2020.

Source: Maritime Business Strategies[35]

In Figure 19 above is shown the uncommitted shipping capacity up to 2020.

Capacity includes those ships with economic remaining life more than a year

old after their contract would be expired as well as the uncommitted capacity

of the orderbook. It is assumed that contracts would not be renewed after their

expiration and this introduces an optimistic view of future uncommitted

capacity. However the purpose is not to estimate the exact figures of

uncommitted capacity but only to highlight potential trends in the second hand

market.

In case that a contract expires and the ship has 5 years economic life

remaining, it would be difficult to secure another long-term contract. If spot

market is strong and the owner’s expectations are positive, it is likely this ship

to enter the spot trade. The capital cost would have been written off and the

owner’s exposure will be limited to the volatility of the current freight rates.

The shipping market for spot trading will most probably focus in the Atlantic

basin and especially in the USA where the majority of spot trade has been

recorded. Gas market in the US is fully deregulated and there is a gas index in

place, which will favour spot trade. Nevertheless, gas prices is by far more

48

volatile than oil prices and the freight rates are expected to follow the same

pattern, but that might contribute to a more flexible and liquid second hand

LNG fleet. However in Pacific basin there is a need for spot traded cargoes,

even though most LNG imports are based in long-term contracts. But since

LNG transportation costs are increasing in line with distance, cross trade

cargoes are not likely to occur with the current market structure. The

transportation cost from Egypt to Lake Charles amounts to 0.9 $/MMBtu but

from Qatar to same destination this figure rises to 1.5 $/MMBtu. The price

differentials among regions might offset high transportation costs, but this is

related to gas pricing, which is beyond the scope of this dissertation.

The players involved in the second hand market could be either the market

participants (importers/producers LNG) or independent owners (LNG

shipping companies or operators). It was shown earlier that independent

owners are entering the LNG market by ordering new ships. An LNG ship is

extremely capital intensive and it is rather unlikely independent owners to use

new buildings in the spot market due to uncertainty and the economical

pressure. Market participants can be more flexible and utilise or divert their

fleet according to market position and deal effectively with the uncertainty of

spot market. Moreover, they could be more competitive in a strong market by

offering newer ships.

A more interesting feature of the uncommitted contracts market is “self-

contracting”. Some major LNG producers have integrated downstream with

their own market organisation; hence being sellers can sell to their own

affiliates. On the other hand, importers acquire an upstream position and thus

effectively integrating upstream.[17] If this trend proves successful, then market

participants will hold an important link in the LNG chain and will be able to

utilise their own fleet with greater flexibility. In case of surplus in tanker

capacity they will have the advantage on the independent owners by diverting

49

their fleet accordingly. But in the case of surplus in liquefaction capacity and

increased demand for LNG, should there be shortage of tonnage, independent

shipowners will benefit by entering the spot market and freight rates should

raise.

But there is also another scenario that can lead to unexpected developments in

LNG shipping market. Figure 20 below presents the evolution of shipping,

liquefaction and regasification capacity by considering all three to start off

from the same level. The liquefaction growth rate is moving in line with the

shipping capacity growth rate up to 2004-2005 by thereafter shipping capacity

growth is by far surpassing the liquefaction growth. This introduces a surplus

shipping capacity, which means that shipping markets will be very sensitive to

minor changes in LNG demand. If there are plenty of ships available, market

will balance itself by lowering the freight rates and prices. It would be difficult

for the older ships to get any cargoes because better ships will be available in

competitive prices and then shipowners will have to lay up or even scrap them.

0

5

1 0

1 5

2 0

2 5

3 0

3 5

4 0

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

2012

2014

2016

2018

2020

L ique f a c t io nR e ga sif ic a t io nSh ip p in g

Figure 20: Evolution of shipping, liquefaction and regasification capacity

Source: GasStrategiesOnline[37]

The effect of overcapacity is well known to dry and wet market but it would

be quite interesting to observe possible similarities in the LNG market in the

near future.

50

It appears that liquidity of second hand fleet will emerge in the LNG market

and independent shipowners will try to capture this area, but market

participants will have the upper hand by being more flexible. Independent

shipowners can speculate in the second hand market since they can diversify

their risk by engaging their new ships under long-term agreements and

introduce liquidity in the market. Nevertheless, it is not expected LNG

shipping market to be as liquid as oil market, unless a global gas market will

be established with enough participants that will ensure competitiveness.

51

7 DEMOLITION MARKET

7.1 Introduction

Old and obsolete ships are bought by scrapyards for demolition. Brokers who

keep a track of the market usually handle sales. The ships available for scrap

and the need of scrap steel determine prices. Scrapping depends on the long-

term fluctuations of the freight market, since freight level indicates the

expected income of a ship over its technical life. [27]

Scrapping capacity is quite flexible since there are no special qualifications

required, however scrapping is labour intensive and different methods are used

for different ship types. Recently environmental concerns and health issues

faced by workers have set focus on scrapping activity The flexibility in

scrapping capacity is crucial since scrapping capacity varies directly with

freight rates. [28]

7.2 Characteristics of LNG demolition market.

The activity of the scrapping market is related to the activity in the ship

building market and they are conversely synchronised as shown in Figure 18

above. When there is an absence of, or even limited shipbuilding capacity, the

scrapping activity increases.

Quality assessment and quality requirements are affecting the functioning of

the activity of second hand and scrap markets. A recent example is the

implementation of the IMO regulation to phase out single hull tankers ships

reflecting stricter requirements in terms of environmental and safety issues.

This increased the activity of scrap market since a significant tonnage did not

52

meet new requirements. However, there is no similar example in the LNG

scrap market because construction of ships is subject to very high and strict

standards and the limited number of incidents justifies this. There are 17

incidents recorded (status March 205) which include minor fires, engine

breakdowns, damages from typhoon in shipyards, one grounding, two

collisions, and a struck with a nuclear powered submarine.[34]

Seven LNG ships with capacity over 50000 cu.m and another 4 ships below

50000 cu.m have been scrapped since 1965 as shown in Table 4 below. There

are also three LNG large ships that never traded but converted to another ship

type.[35]

Scrapping activity is related to second hands prices, but that depends on the

type of the ship. Standard ships with multiple trade options in a competitive

market can be sold in the second hand market or in the scrap market.

Shipowners are speculating by taking advantage of the fluctuation in the

freight market to buy cheap and sell at high prices. Vessels are scrapped when

operating costs are more than the revenue in the long run, or the scrapping

value is greater than the respective trading value.

But in LNG era with a weak second hand market, ships are rather laid up

instead of being sold. Laying-up depends on the contract in which the ship is

engaged. As stated in paragraph 6.3 when some contracts were abandoned,

nine out of fifteen ships dedicated to these contracts were laid up for more

than 15 years and the remaining six were subsequently scrapped. This can be

attributed to the fact that the charterers were obliged to hire the ship for a

period of time and in case of a breach of the contract terms, they would have

been liable to pay at least the capital element of the time charter rate.

Therefore the owner was not exposed to financial pressure and could put the

ship in lay up until a new contract could be found.

53

Operator Year Built or Rebuilt # of Voyages Year With-

drawn

Cargo Capacity (cu.m.)

Disposition Age

SNTM-Hyproc 1975 5 1980 120,000 1980 5 SNAM 1971 335 1984 40,000 1984 13 El Paso Tankers 1976 12 1980 129,500 1985 9 El Paso Tankers 1977 26 1980 129,500 1985 8 El Paso Tankers 1977 15 1980 129,500 1987 10 British Gas 1964 467 1992 27,400 1992 28 British Gas 1964 500+ 1998 27,400 1998 34

Table 4: Scrapped LNG ships Source: GasStrategiesOnline[37]

Decision for scrapping is based on the appraisal of the long run market

condition and to the shipowners’ expectation about the future prospects. Weak

market with low freight rates and negative owners expectations will increase

scrapping activity.

7.3 Lay up and Scrap Prices

Scrapping markets balances scrapping volume and prices. In a depressed

market the tonnage offered for demolition increases and scrap prices fall.

However demand for scrap steel is affecting scrap prices, although the

influence is not significant. This process is reversed in a strong market with

positive expectations for future revenues. Shipowners will be reluctant to

scrap, and scrap prices will rise.[21]

Scrapyards’ interest focus on the amount of steel and other non-ferrous metal

obtained from a ship and the scrap value is determined by the light

displacement tonnage; this is the weight of the hull plus machinery, equipment

and spares. Scrap prices are quoted in $/lightweight tone and obviously

depend on the type of ship. LNG cargo tanks are made of stainless steel, which

is more expensive than steel and this should be reflected in the scrap price.

54

Furthermore, the fact that high standard machinery and equipment used in

LNG ships is resalable should also contribute to higher scrap prices. Although

the evident is strong to support this statement, unfortunately no scrap prices

data is available at this stage to prove its validity.

Lay up is the temporal withdrawal of tonnage during a weak market. The

difference from scrapping is that lay up is temporal and tonnage can be

returned to active trading operations when market will recover. Therefore the

decision to lay up relates to freight rates and market expectations but the

withdrawal is not permanent and the owner has the option to reactivate the

vessel when favourable economic opportunities arise.

But it should be noted that even in laid up conditions fixed and maintenance

cost still incur and shipowners take those in account when a laying up decision

is considered.

With the introduction of a more flexible second hand LNG fleet, scrapping

and laying up activity should increase. However unless a globalised LNG

trade is established, the structure of the LNG shipping tends to present

oligopolistic characteristics. The recent developments in LNG contracts add

some degree of freedom to the market structure enabling a number of

participants to enter, but there is still long way to go for a liberalised LNG

shipping market.

55

8 CONCLUSION

LNG shipping markets are not as liquid as the wet or dry bulk markets.

However the emergence of LNG trade coupled with the changes in the

traditional GSPA structure has caused rapid expansion in the size and capacity

of the LNG fleet. The preceding analysis identified the main parameters that

affect freight rates and how LNG shipping markets are interrelated to each

other.

The main factor affecting freight rates is the amount of ships trading, the

transaction type and structure of LNG procurement and the liquefaction

capacity and regasification. In the long-term agreements, if shipping contracts

will extend jointly with the extension of GSPA, freight rates should not be

affected unless LNG demand overtake shipbuilding supply. In the short-term

agreements excess of ships available will push freight rates down. Similarly, if

the fleet is fully utilised, an unanticipated increase in demand should lead to an

immediate increase in the freight rates.

Added liquefaction and regasification capacity will create a short term trade

market in which freight market supply will be determined in line with the

surplus capacity of exporters, availability of ships for spot trading and import

needs others than the long term TOP agreements. In case such market emerges

it is expected to be volatile, however the regional gas market structure implies

limitation in terms of liquidity, high price risk and uncertainty.

Activity and prices in the new building market are affected by the long-term

changes in freight rates and market expectations, which also influence second

hand prices. Orders for LNG new building have reached all time records and

this might create overcapacity that will drive freights downwards and might

56

introduce speculation in new building re-sale market. However limited

shipbuilding capacity for LNG ships coupled with increased production of

other ship types might cause undersupply, causing a peak to freights, new

building and second hand prices.

Surplus in liquefaction and regasification capacity and development in LNG

trade are connected with the emergence of spot trade. The traditionally weak

LNG second hand market is likely to take advantage of the imbalances

between demand and supply that would arise. Market participants will use

second hand ships for spot trade since new buildings would be engaged in

long-term contracts.

With the introduction of a more flexible second hand LNG fleet, scrapping

and laying up activity will be increased.

However, LNG shipping markets are not likely to be as liquid as oil markets,

since LNG ships cannot still operate in several trades. Unless a global gas

market is established with enough participants that will ensure

competitiveness, long-term agreements will dominate LNG market.

57

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Review, 27(1): 25-63 [2]. Beenstock M. & Vergottis A. (1993), “Econometric modelling of world

shipping”, (London, Chapman and Hall) [3]. BP Statistical Review of world Energy, (2004), (2005). http://www.bp.com/ [4]. Brito L.D & Hartley P.R, (2002) “ Evolution of the International LNG

Market”, Rice University MS#22, June. [5]. Chabrelie M-F. (2003) “A New Trading Model for the Fast-Changing LNG

industry” CEDIGAZ, 1st Asia Gas Buyers Summit, Mumbai March 24th-25th. [6]. Community of European Shipyard’s Association (CESA) (2004), “Global

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