LNG Shipping Markets

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 φρεσί   νήες. Ού γάρ φαιήκεσσι  κυβερνητήρες έασιν. Ουδέ τι  πηδάλι ’ εστί , τά τ’άλλε  νήες έχουσιν: Άλ ’ αυταί  ίσασι  νοή ίσασι  νοήµατα καί  φρένας ανδρών. Καί  πάντων ίσασι  πόλιας και  πήονας αγρούς ανθρώπων, καί  λαίτµα τάχυσθ’ αλλώς εκπεροώσιν. Ηέροι και  Ηέροι  και  νεφέλη  νεφέλη κεκαλυµµέναι : ουδέ ποτέ σφίν. Ούτε τι πη τι  πηµανθήναι έπι  ανθήναι  έπι δέος δέος ούτθ’ απωλέσθαι . Ο µήρου 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.

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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

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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.

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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 shortterm 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.

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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

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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.

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TABLE OF CONTENTS

LIST OF FIGURES ................................................ ......................................................................ix ......................ix LIST OF TABLES...................... TABLES .............................................. ................................................ ..........................ix ..ix 1

THEORY BACKROUND .............................................. ..................................................................... ......................... ..1 1

1.1 I NTRODUCTION ...................................................................................1 1.2 GENERAL I NFORMATION ABOUT LNG .............................................. ................................................ ..1 1 1.3 SUPPLY. .............................................. ..................................................................... .............................................. ......................... ..3 3 1.3.1 Shipping Market Cycle.......................................... Cycle...............................................................4 .....................4 1.4 DEMAND ............................................. .................................................................... .............................................. ......................... ..5 5 2

METHODOLOGY AND LITERATURE REVIEW............................6

2.1 I NTRODUCTION ...................................................................................6 2.2 “ECONOMETRIC MODELLING OF WORLD SHIPPING”...........................6 2.2.1 Model Description Description and some theory aspects. aspects. ............................6  ............................6  2.2.2 Summary of Model Structure Structure ........................................... .....................................................7  ..........7  2.3 R ELATED ELATED LITERATURE ........................................................................9 2.3.1  Future Trends................................. Trends........................................................ ..........................................10 ...................10 3

MARKET OVERVIEW..................................... OVERVIEW............................................................ ...................................12 ............12

3.1 3.2 3.3 4

I NTRODUCTION .................................................................................12 LNG CONSUMERS .............................................................................13 LNG SUPPLIERS ................................................................................15

FREIGHT MARKET ............................................. .................................................................... ...............................17 ........17

4.1 I NTRODUCTION .................................................................................17 4.2 SHIP OWNERS ....................................................................................17 4.3 LNG FLEET............................................. .................................................................... ..........................................19 ...................19 4.3.1  LNG Fleet by trading routes ............................................ ....................................................19 ........19 4.3.2  LNG Fleet by age....................... age .............................................. ..............................................20 .......................20 4.3.3  LNG fleet by size ........................................... .................................................................. ...........................21 ....21 4.4 THE EFFECT OF LNG FLEET TO FREIGHT RATES ................................23 4.4.1  Long term contracts .............................................. .................................................................24 ...................24 4.4.2 Medium and short term contracts..................... contracts. ...........................................24 .......................24 4.5 TRANSPORTATION COSTS .................................................................26 4.6 CONTRACTS ............................................ ................................................................... ..........................................27 ...................27 4.6.1  Long term contracts .............................................. .................................................................27  ...................27  4.6.2 Short term Contracts...................... Contracts............................................. ..........................................28 ...................28 4.6.3 The Effect of LNG Contracts Contracts to Freight Freight rates. ........................29 ........................29 4.7 LIQUEFACTION CAPACITY AND ITS EFFECT TO FREIGHT RATES .........31 5

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

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5.1 5.2 5.3 5.4 5.5 6

SECOND HAND MARKET .............................................. .................................................................44 ...................44

6.1 6.2 6.3 6.4 7

I NTRODUCTION .................................................................................44 LNG SECOND HAND PRICE ...............................................................44 CHARACTERISTICS OF LNG SECOND HAND MARKET .........................45 FUTURE TRENDS ................................................................................47

DEMOLITION MARKET.......................... MARKET................................................. ..........................................52 ...................52

7.1 7.2 7.3 8

I NTRODUCTION .................................................................................35 FLEET EXPANSION EXPANSION.............................................................................35 SHIP BUILDING I NDUSTRY .................................................................36 PRICE OF NEW BUILDING ..................................................................37 SHIPBUILDING CAPACITY AND IT ’S EFFECT TO FREIGHT RATES .........41

I NTRODUCTION .................................................................................52 CHARACTERISTICS OF LNG DEMOLITION MARKET. .......... .............. ......... .......... .......52 ..52 LAY UP AND SCRAP PRICES ...............................................................54

CONCLUSION ............................................ ................................................................... ..........................................56 ...................56

BIBLIOGRAPHY-REFERENCES BIBLIOGRAPHY-REFEREN CES .............................................. .................................................................58 ...................58

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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 ...................15 FIGURE 5: MAJOR LNG SHIPOWNERS (CURRENT FLEET AND ORDERBOOK )......18 )......18 FIGURE 6: EXISTING AND ORDERBOOK  FLEET BY TRADING ROUTE ...................20 FIGURE 7: AGE OF LNG FLEET IN 2009 .............................................. .............................................................21 ...............21 FIGURE 8: LNG FLEET 1996-2009....................................................................22 FIGURE 9: EXISTING AND ORDERBOOK  LNG FLEET BY SIZE..............................23 FIGURE 10: OPERATION COSTS BREAKDOWN . .............................................. ..................................................2 ....26 6 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 ...................................................................................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.................................................... 2020........................................................................... .............................................. ...............................42 ........42 FIGURE 18: LNG DELIVERIES AND S&P RECORDS ............................................46 FIGURE 19: U NCOMMITTED SHIPPING CAPACITY UP TO 2020. .......... .............. ......... .......... .......48 ..48 FIGURE 20: EVOLUTION OF SHIPPING , LIQUEFACTION AND REGASIFICATION ................................................................... .............................................. ...............................50 ........50 CAPACITY ............................................

LIST OF TABLES

TABLE 1: LNG TRANSPORTATION COSTS ON SELECTED ROUTES LOADING FROM QATAR . ........................................... .................................................................. .............................................. ...................................27 ............27 TABLE 2: COMPARISON OF THE CHANGE IN ADDED VALUE OF VLCCS AND LNG .................................................................... .............................................. ...............................39 ........39 TANKERS ............................................. TABLE 3: LNG SHIPYARDS CAPACITY ...............................................................41 TABLE 4: SCRAPPED LNG SHIPS .......................................................................54

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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 

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-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.

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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.

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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]

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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.

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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

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 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 shortterm 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

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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.

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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.). 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.

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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.

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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.

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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 (Figure 1). 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]

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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

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[3]

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 por ts by countr y 200 2003-04 3-04

90   s 80   e   r 70    t   e   m 60   c 50    i    b 40   u   c 30   n 20   o    i    l 10    l    i    B 0

   i    l    i  n   m   c  e   c  e   A  m  e  r    l  y   g   a    i  a   a  n   r  e  a   a  n   e  y   d   u    i   a   a   S    k   e   n    t   u   g    r  o    i  w    t   p   n    I    l   e    U   l  A    I   J  a  p    K   e    F  r  a   G  r   S    T  u  o  r  .    T  a    B   a    P   S   r    t   e  n   c imports 2004   n  d   a imports 2003   S .  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 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]

 .   s   e   r    t   e   m   c    i    b   u   c   n   o    i    l    l    i    B

LNG exp orts by country 2003-04

40.00 35.00 30.00 25.00 20.00 15.00 10.00 5.00 0.00

  A    i  c  a    U  S   m  e  r    l  A   r  a    t   n   c  e   d   a  n   S .

  a  n   O  m

   t  a  r   a   Q

   E    U  A

   i  a   e  r   g     l   A

   i    i  a    i  a    i  a    l   y  a   r   s   i  a   s   n  e   a    b   e   y   e    i   r   u    t   g    r   a   n    L    l   s    B   a    N   i   d o    M   A  u    I  n exports 2004 exports 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.

Orderbook (3 or more)

Current Ships (5 or more)

SKShipping 4%

Sonatrach 5%

Shell Group 11%

AustraliaLNG Bergesen 6% 5%

Sovcomfl ot/ NYK

GolarLNG 9%

ProNav Ship

Line

Management

5%

Overseas

Teekay Shipping

A. P. Moller

4%

6%

Bergesen 9%

5%

Shipholding

BP Shipping

5%

HyundaiMM 5%

NYKLi KLine ne 8%

5%

OmanGas/ MOL 5%

Briti sh Ga Ga 9%

NYK Line 6%

NigeriaLNGLtd. 9%

M.I.S.C. 15% NationalGas Shipping 7%

MOL/LNGJapan 7%

Dyna Gas

Nigeri a LNGLtd.

4% Golar LNG

4% Mitsui OSK Line

4%

5%

Mitsui OSKLi KLine ne 9%

K Line Kristen Navigation 6%

M.I.S.C.

5%

14%

 Figure 5: Major LNG shipowners (Current fleet and Orderbook) [35]

Source: Maritime Business Strategies (Combined data)

Figure 5 above presents 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

16 0

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

14 0

Orderbook Capacity (,00000 cum)

12 0 10 0 80 60 40 20 0 A lta n ti c

P a c ifi c

U n c o m m i tte d

 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 3540 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 of Fleet in 2009

90

No of ships capacity ('00000 ('00000 c um) % of Total Capacity

80

 .

70

40 % 35 %

 .

30 %

60   y    t    i   c 50   a   p   a    C    / 40   s   p    i    h   s 30    f   o   o    N 20

25 % 20 % 15 % 10 %

  y    t    i   c   a   p   a    C    l   a    t   o    T    f   o    %

5%

10 0

0% <10

1 0 -1 5

1 5 -2 0

2 0 -2 5

2 5 -3 0

3 0 -3 5

3 5 -4 0

>=40

Years

 Figure 7 : Age of LNG fleet in 2009

[35]

Source: Maritime Business Strategies (Combined data)

 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 285 1, 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 20052009 .

21

LNG Fleet 1996-2009 400 350

350%

LNG ships capacity in '00000 cub mtrs growth in capacity (%) growth in fleet (%)

300%

300  .

250%

250

  r   e    b   m200   u   n   s   p    i    h150    S

200% 150% 100%

100

50%

50 0

0% 1 99 6 1 997 1 998 19 99 200 0 20 01 20 02 200 3 2004 20 05 20 06 2 007 2 008 2 009

 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. Fortyone 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 100 90

 .

80

60%

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

50%

70

40%

   )    %    (   y    t 30%    i   c   a   p   a 20%    C   s   p    i 10%    h    S

60

  s   p    i    h    S    f   o   o    N

 .

50 40 30 20 10 0

0% <50k

50k-100k

100k-130k

130k-145k

Ships size ('000 cum)

145k-155k

>155k

.

 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 t o 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 0.10.15% of the full content per day.[41]

Some indicative transportation costs from Qatar to selected routes are given in the Table 1.

Transportation cost

 Route

($/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. [25]

Source: Poten and Partners

 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 shortterm 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 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.

Current and Future Contracts

40 35  .   s    t   c   a   r    t   n   o    C    f   o   o    N

30 25 20 15 10 5 0

A tla n tic

P a c if ic C ur u r r e n t C IF IF

C ur u r r e n t F OB OB

M id d l e E a s t C ur u r r e n t D ES ES

 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 (Figure 6 above). 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 in 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 io io n P l a n t s 0

1 0

20

30

4 0

50

60

70

80

90

A l g e r ia 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 ti ti o n ( M m t p a )

E g y p t E q u a t o r ia ia l G u i n e a Libya N i g e r ia N o r w a y T r in i d a d a n d T o b a g o A t la la n t i c B a s i n T o t a l A u s t r a li a Brunei Indonesia M a l a y s ia R u s s ia U S A P a c i fi c B a s i n T o t a l O m a n Q a ta r U A E M i d d le E a s t T o t a l

 Figure 12: Existing and under constriction liquefaction plants. Source: LNG One World [38] (Combined data)

According to IEA’s estimates (Figure ( Figure 13  below),  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). 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

60

Orderbook Total No ships ord ered C a p a c i ty ty ( , 0 0 0 0 0 c u . m ..))

50

40

30

20

10

0 2005

2006

2007

2008

2009

 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 ordere d by shipyard IZA R Sestao Atlantique Samsung Hyundai Samho Hyundai D ae ae w o o Univers Univers al Tsu Mitsu Mitsu i Chiba Mitsubishi Mitsubishi Nagasaki Koyo Dock Kaw asaki Sakaide

Capacity (,00000 cu .m.) .m.) Ships

Hudong 0

5

10

15

20

25

30

35

40

45

50

 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

#

40  .

3000 Deliveries (left) New building prices (right)

35

2500

30   r   e    b   m   u    N   s   p    i    h    S

2000

25

 .

1500   m  .

20

   b   u   c 1000    /    $

15 10

500

5 0

0

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

 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 Ship Type

(US$/CGT) 1997

2003

VLCC

760

480

LNG Tanker

1,570

680

206%

142%

 Relative value of LNG tanker compared to VLC C  C 

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

39

[10]

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.

Daewoo El Atlantique Hanjin H.I. Hudong Hyundai Hyundai Samho Imabari IZAR Sestao I.H.I. Kawasaki Sakaide Kvaerner Masa Mitsub Mitsubish ishii Nagasa Nagasaki ki Mitsui Chiba Samsung Universal Tsu

6 2 0 0 2 0 0 0

7 1 0 0 1 0 0 0

10 0 0 1 8 0 0 0

7 0 0 1 4 1 0 1

2 0 1 2 4 0

3 0 3 0 7 0

1 1 4 0 9 2

3 1 3 1 8 0

Slots Capacity Available 0 10 10 0 2 2 0 2 2 0 2 2 0 9 9 0 3 3 0 1 1 0 4 4 1 1 3 0 3 0 3 3 1 5 6 0 2 2 1 7 8 0 1 1

Total tal

19

22

36

30

5

Yard

2005 2006 2007 2008 2009

50 50

57 

Table 3: LNG shipyards capacity. [38]

Source: LNG One World 

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]

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

Deliveries and S&P 25 To tal deliveries deliveries Total S&P Total Scrapped 20   s   p    i    h 15   s    f   o   r   e    b 10   m   u    N

5

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

 Figure 18: LNG Deliveries and S&P records Source: Combined data Clarksons Clarksons Maritime Business 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 Shi pping pping C apacity apacity 2020

50 45

Tot al Capacity Capacity Pacific Uncommitted Atlantic Uncommited

40 35 30

  m  .   u   c 25   n   o    i    l    l 20    i   m

15 10 5 0 20 0 5

20 06

2 00 7

20 0 8

20 09

2 01 0

20 1 1

20 12

2 01 3

20 1 4

20 15

2 01 6

20 1 7

20 18

2 01 9

20 2 0

 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 “selfcontracting”. 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.

40 Liquefaction Regasification Shipping

35 30 25 20 15 10 5 0    0    9    9    1

   2    9    9    1

   9  4    9    1

   9  6    9    1

   8    9    9    1

   0    0    0    2

   2    0    0    2

   0  4    0    2

   0  6    0    2

   8    0    0    2

   0    1    0    2

   2    1    0    2

   1  4    0    2

   1  6    0    2

   8    1    0    2

   0    2    0    2

 Figure 20: Evolution of shipping, liquefaction and regasification capacity [37]

Source: GasStrategiesOnline

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.

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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 longterm 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

1975 1971 1976 1977 1977 1964 1964

5 335 12 26 15 467 500+

1980 1984 1980 1980 1980 1992 1998

SNTM-Hyproc SNAM El Paso Tankers El Paso Tankers El Paso Tankers British Gas British Gas

Cargo Capacity  Dispositio  Disposition n Age (cu.m.) 120,000 40,000 129,500 129,500 129,500 27,400 27,400

1980 1984 1985 1985 1987 1992 1998

5 13 9 8 10 28 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

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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

competitiveness, long-term agreements will dominate LNG market.

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ensure

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[11].

[12]. [13]. [14]. [15].

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[22]. MSR-Consult Aps, (2004), “New building Market Survey”, (Prepared exclusively for the Danish Export Association) September. http://www.msrconsult.com/ [23]. Ocean Shipping Consultants, (2004) “LNG fleet needs to tremble by 2020”, (Summary), April. http://www.osclimited.com/ [24]. Poten and Partners, Inc, (2004a), “LNG in world Markets”, vol 16, number 9 October. http://www.poten.com/ [25]. Poten and Partners, Inc, (2004b), “LNG tanker Market Report”, Ref: 23123_8, March. [26]. Saleem Alavi, “LNG Tanker Market Report” (2003), DVB Research and Strategic Planning, June. [27]. Stopford M., (1997) “Maritime Economics”, (London: 2 nd edition, Routledge). [28]. Strandenes S.P (2002), “Economics of the market ships” In The handbook of  Maritime Economics and Business, edited by Grammenos C.T (London: LLP). [29]. Terry A and others, (2004) “Pacific Basin LNG”, FW Oil gas & Energy Review, http://www.financierworldwide.com/ [30]. Terry A. and others, (2002),  Flexible Friends”, Project Finance, Global Oil and Gas report, December 2002/January 2003. http://www.taylor-dejongh.com/news/downloadFiles/articles/PFGLOB-1.PDF

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