March/April 1992
Although most exporters rely on their ship brokers to negotiate the best rates for them, a basic knowledge of how this segment of the market operates can help scrap shippers in their journeys.
BY BARRY D. PARKER
Barry D. Parker, a former shipping broker, is a Bayville, N.Y.-based consultant.
The voyage of scrap from a U.S. recycler's plant to an overseas mill can be a long and complex journey, encompassing a multitude of details. While much of the process is similar —if not identical —to that of moving scrap domestically, chartering ocean-going vessels presents additional intricacies.
Despite the added details presented by the sometimes-secretive business of ocean freight, the amount of scrap transported in this way is significant. In fact, worldwide, between 15 and 20 million tons of ferrous scrap alone is annually exported in seaborne trade, with major quantities shipped from the United States (12.1 million tons exported in 1990), the United Kingdom (approximately 3.5 million tons exported), and the Port of Rotterdam, Netherlands (exporting approximately 1.5 million tons of scrap annually). Leading importers—those taking 500,000 tons or more annually include Japan, Korea, Taiwan, Pakistan, India, Turkey, and Spain.
Although it's possible to trade scrap on an international level with little knowledge of how ocean freight works, understanding the fundamentals of this vital link in the export chain can help to increase a shipper's chances of making the best deal possible.
Brokering Basics
Chartering vessels is an over-the-counter market, with deals negotiated through a worldwide network of brokers who typically earn a 2 1/2-percent commission of the freight paid. Although there are only a handful of U.S. cargo brokers that specialize in arranging ocean freighting of scrap materials, these brokers are plugged into international networks that advertise potential cargoes and secure vessels.
Brokers are constantly proposing cargoes, via telephone and telefax, to shipowners. While some ships are locked into particular trade routes, and transport only certain materials, vessels from the "tramp" sector of the freight market will generally haul whatever cargo generates the most revenue, as measured in dollars per day.
If a shipping company is interested in transporting an offered cargo, it makes a "firm" offer, specifying the freight rate, quantity to be transported, loading and discharge time allowed, dates for the cargo to be loaded, and other matters related to the shipment. Because shipowners are constantly evaluating all types of potential cargo, aiming for the highest rate possible, offers always include some time limit. For example, an owner might make an offer that is "firm" for one hour. When that offer expires, the shipping company may then propose the vessel to other cargo shippers.
The vessel is finally "fixed" when both sides have agreed on a freight rate and a variety of other logistical matters. The legal contract that results, known as a "fixture" or "charter party," includes the following details:
- the name and description of the vessel,
- the weight of the cargo in tons, with a tolerance for variances,
- the freight rate in dollars per ton,
- acceptable payment methods,
- loading and discharge rates (expressed in tons per day),
- method of counting time,
- earliest commencement and cancellation dates,
- demurrage and despatch rates, which account for time gained or lost relative to the agreed-upon schedule,
- the arbitration venue, and
- brokerage commissions.
Although regional and individual scheduling factors can affect the rates on a particular cargo, the level of freight rates around the world is principally a function of overall supply and demand. Thus, obtaining the lowest freight rate and the most advantageous terms comes down to how many cargoes need to be moved and how many suitable vessels are available within given time constraints. Charter brokers, therefore, maintain computerized data bases of vessel availability, which can be invaluable in determining an appropriate negotiating posture.
The Art of Negotiation
Negotiations between a shipowner and a charterer can take weeks, if both sides are not pressed for time; when one or both sides are in particular need, the process might take only a few hours.
Avi Eilon, vice president of Maritime Brokers and Consultants, a ship and cargo broker based in Northbrook, Ill., describes the process of marrying a particular vessel to a cargo of scrap as "an art, rather than a science." Consider, for example, that some shipowners prefer not to transport scrap, and those that will move it may do so only in specially equipped vessels, such as ships with carbon dioxide fittings to limit fire dangers on a cargo of steel turnings or those with heavy material-handling gear for cargo that will be discharged into barges at an anchorage.
Adding to this is the volatility of freight rates. For example, rates for one major scrap trade route, from northeastern U.S. ports to the Far East via the Panama Canal, have been around $35 per ton in recent months, while the same cargo could be charted for $25 per ton in mid-1990, when the freight market slumped substantially.
The ups and downs in the ocean freight markets can determine where scrap supplies are marketed. When rates on a particular route are relatively low, for instance, more scrap than usual may be exported to an area. High freight rates, on the other hand, can shrink potential export markets and can have a profound impact on the domestic pattern of scrap movement.
There is also a strong interrelationship between freight rates and scrap prices around the world. Successful scrap exporters, therefore, often spend time listening to the freight market —with their freight broker as antennae —and create business opportunities when there is a shift in the freight market or in material prices. Some scrap merchants have been able to speculate in the prices of freight, which can further enhance profits if their timing and direction are right.
In the short term, a competitive process keeps freight rates in line with material prices. For example, if a certain cargo of scrap iron is priced at $100 per ton, fob (a price at a loading port, with title passing when the cargo is loaded into a vessel), and the cif price (a "delivered" price, on the dock at the receiving facility) is $140 per ton, this leaves $40 to pay freight and profit. If the expected freight rate is $35 per ton, a $5-per-ton profit remains. What if the price at the export destination softens, say to $137? The scrap shipper would have to negotiate a freight rate of $32 per ton in order to maintain the same $5 profit margin. Conversely, if the scrap prices are bid up at the destination, say by $2 per ton, then the shipper might be willing to pay $37 for freight.
In any case, it's usually up to the ship charter broker to provide guidance on the amount of room that exists for negotiating price. In the first example above, it is easy for the charterer to say, "I will only pay $32"; in reality, considerable thrashing —and some luck —may be required to drive the price down to this level. If the broker is aware that there are few vessels available but many cargoes available to move, such a posture may not be possible.
The negotiating process is rarely smooth; shipowners are keen to minimize the time they're not earning revenue and may be working several different potential cargo deals simultaneously to improve their odds of landing a favorable contract. Some chartering negotiations include " midnight madness"—all-night negotiations—especially if the vessel is operating in the Far East .
The Big Picture
One mistake that scrap exporters commonly make is to assume that if the scrap trades are quiet, the freight market is quiet. The amount of scrap moved by ocean-going vessels is but a small fraction of the 1.2 billion tons of cargo moved annually by the bulk carriers. Developments in other markets, therefore, especially the volatile grain trades, can have a strong impact on spot shipping rates. A Soviet grain chartering spree, for example, might draw ships away from various other trades, including scrap shipping, and force shippers of all cargoes to pay higher freight rates.
There may also be times when the state of the freight market simply makes it impossible to get any fresh export business on the books at all. While overall freight market levels are determined by aggregate supply and demand, some trades are seasonal and regional. Maritime Brokers's Eilon describes the market for cargo out of Great Lakesports, for example, as "a market on its own." At times, he explains, "the Great Lakes offer a charterer freight rates that have no correlation to the other areas of the shipping market."
These factors provide a hint of what the scrap shipper is sometimes up against. Clearly, the guidance of the ship broker on vessels and competing cargo requirements can be invaluable.
Determining Rates
An important part of negotiating rates is understanding a shipowner's cost structure and how this determines the minimum freight rates the owner will accept. (See table an outline of vessel economics.) Although some shipping companies took on voyages in the mid-1980s at rock-bottom freight rates —basically, the floor of the vessel's pricing structure —at certain cost levels, it may be cheaper for an owner not to operate a vessel. (When low freight levels in the mid-1980s caused even the cost of mothballing such vessels to become prohibitive, large numbers of ships were scrapped. Since 1987, as freight earnings have picked up, it's been more economical to operate vessels and the number of vessel being scrapped has plummeted.)
Table 1 also provides a simple example of how a shipping company might convert its "time charter" (the daily value, in dollars per day, of a vessel in the worldwide marketplace) into the dollars-per-ton "voyage rate," which is more familiar to scrap shippers. In the computation, fuel and port costs are added to the vessel value over the entire voyage (daily vessel value multiplied by total time of the voyage, in days). This total is then divided by the total number of tons to be shipped, to arrive at the voyage rate.
Shipowners sometimes reverse this calculation, starting with the dollars-per-ton figure to determine the daily vessel value (dollars per day) after netting out fuel and port costs.
Substantial knowledge of a shipowners' business can be very helpful in negotiating the best charter rates, especially in seeing when an owner's costs are dropping. For example, if fuel prices drop, the shipowner could earn the same daily return on a lower freight rate, and the ship charterer that realizes this is in a better bargaining position.
One way to lock in freight rates, if the charterer has regular movements of cargo, is to agree to a contract with a reputable shipowner in which one rate, agreed upon at the inception of the contract, applies to several voyages.
Some scrap merchants have taken this one step further, actually leasing a vessel for period of time (perhaps a year) and operating the ship in the tramp freight market as a hedge against unpredictable freight rates. In such cases, the scrap merchant might haul not only its scrap, but also different bulk cargoes. In theory, if the freight market rises, this allows gains on vessel earnings to offset increases in the freight rates the charterer must pay to move its own cargo. The danger of this approach, however, is that if the scrap shipper's cargo book dries up during the charter period, it is at the mercy of the shipping market to provide other cargoes.
This is, therefore, a strategy that's not for the uninitiated charterer. Still, those with a good knowledge of the ocean freight business gained through experience and an understanding of the basics will likely develop other tactics geared toward making the best international shipping deal possible. •
Table 1
Owner's Freight Rate Calculation
Assume:
- vessel value: $10,000 per day*
- 70-day voyage (18 days in port, 2 in canal, 50 at sea)
- fuel consumption: 30 tons per day
- fuel cost: $80 per ton
- load port cost: $30,000
- discharge port cost: $45,000
- canal cost: $20,000
- vessel capacity: 30,000 tons cargo
Break-even freight rate:
Vessel cost (70 days @ $10,000 per day) $700,000
Fuel at sea (50 days @ 30 tons per day @ $80 per ton) 120,000
Port and canal charges ($30,000 + $45,000 + $20,000) 95,000
Total cost $915,000
Cost per ton (total/30,000 tons) $30.50
* includes capital costs, insurance on vessel, crew costs, and vessel maintenance
Although most exporters rely on their ship brokers to negotiate the best rates for them, a basic knowledge of how this segment of the market operates can help scrap shippers in their journeys.