OCEAN CARRIERS

6 Pages   |   1,424 Words

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

Spot charter rates, are basically tariffs that are charged to a single shipment to be carried from place to another, in the immediate future, within the next six weeks. Spot rates comprise of all expenses of operating the vessel, from fuel to the crew, but exclude costs related to the cargo.
The spot market rates tend to fluctuate more than the time charter rate, when the rate is high it is very high, and when the rate is small it is unusually low. In case of high market demand, the charterers select spot market, as they have to pay extremely low as compared to time charter. According to the forecast, in the long run, Australian production in iron ore, as expected is going to be strong and Indian iron ore exports are going to increase. However, since 63 new vessels were scheduled for delivery and imports of iron and ore are going to be stagnant over the next two years, the spot rate would drop. Exhibit 5, shows the average spot price, which is extremely high in 2000. At the same time if the fleet area is going to increase, thus the sport rate would fall.
 

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2. What factors drive average daily hire rates?

 
The demand for larger dry bulk vessels is affected by the volume and pattern of trade in a relatively small number of commodities, therefore; charter hire rates of larger ships tend to be more volatile than those for smaller vessels. In the time charter market, rates vary depending on the length of the charter period and vessel specific factors such as age, speed and fuel consumption. Short-term time charter hire rates are generally higher than long-term charter hire rates.
The average daily hire rate is determined by the supply and demand. In case of high market demand for the shipping capacity, the owners would keep a vessel in operation as long as they can. Apart from this, when market demand was low, they started scrapping or sinking. Similarly, supply was also affected by the increase in size and efficiency of the newer ships. As ships got bigger, faster, and became more fuel efficient, lesser ships were needed to carry the same cargo. Apart from this, there had been extremely few scrapings in recent years, and most of the capacity of the worldwide fleet of capsizes was fairly young.
Furthermore, the worldwide iron ore vessel shipments and charter rates are strongly related. If the market for the iron ore vessel shipments is going to increase, the average daily charter rates are also going to increase. Exhibit 6 shows the forecast of the daily high rates, showing and annual 2% growth in the worldwide iron ore shipments from 2002 to 2005 and then dropping to 1.5%; at the same time the average daily rates also fell.

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

 
The international dry bulk shipping industry is highly fragmented and is divided among state controlled and independent dry bulk vessel owners. As a general principle, the smaller the cargo-carrying capacity of a dry bulk vessel, the more fragmented is its market, both with regard to charterers and vessel owners/operators.
The future of the dry bulk capsizes is determined by the world economy. The three largest commodity drivers of the dry bulk industry, iron ore, and steam coal and grains, are all affected by seasonal demand fluctuations. In 2000, approximately 521 million tons of iron ore was exported worldwide. The capesizes carry 85% of the iron ore and coal. The production and demand for these products increased in the developed economy. Changes in trade patterns also affected the demand for capsizes. Generally, growth in gross domestic product and industrial production correlates with peaks in demand for dry bulk carriers. Certain economies will act from time to time as the "primary driver" of the dry bulk carrier market. Like in future, Australian and Indian ore exports are expected to start, and thus these new supplies would increase the trading volumes. If a country decides to get supply of iron ore from Australia rather than United States, more capesizes would be demanded, as the distance between Europe and Australia is larger than the distance between Europe and the United States.

4. Should Ms Linn purchase the $39M capesize? Make 2 different assumptions. First, assume that Ocean Carriers is a U.S. firm subject to 35% taxation. Second, assume that Ocean Carriers is located in Hong Kong, where owners of Hong Kong ships are not required to pay any tax on profits made overseas and are also exempted from paying any tax on profit made on cargo uplifted from Hong Kong.

 
Ocean carriers in the past had been operating on small capesize and since Finn predicted that the demand would increase they needed a large capesize. There weren’t any available in the second hand market so the company had the option of purchasing a new fleet, which had a cost of 39 million. Finn was now in dilemma whether to buy the vessel or not.  In the appendix, table 1 and table 2 shows the calculation of cash flows and NPV to find out the feasibility of the investment project. In the table 1, the assumption is taken that a 35% tax is charged in accordance with US government. The NPV comes out to be positive i.e. $14,287,864.68. In the table 2, it is assumed that Ocean Carriers is located in Hong Kong, where owners of Hong Kong ships are not required to pay any tax on profits made overseas and are also exempted from paying any tax on profit made on cargo uplifted from Hong Kong. The NPV comes out to be higher than in the figure 1 i.e. $21,981,330.28
In both the assumptions, Oceans carrier is earning a positive and very high NPV. In other words the value of a dollar today to the value of that same dollar in the future, is high. Therefore, they should purchase the new capesize. This will be a good opportunity for them to earn higher returns, and since Linn has already predicted a boost in the market there would be an increase in demand for the vessels in the future. They can operate in US as well, however, if they want high returns they can shift their business to Hong Kong. Furthermore, the vessels of Ocean carriers cannot commit to a time charter. This is mainly because the ships were too small or leased during the period, to meet the customer’s needs. Also, there was no large capesize fleet available in the second hand market, so they should go for the investment.
 

ASSUMPITON 1 with 35%tax
    0 year 1st year 2nd year 3rd year
FIXED ASSET          
Cash paid for the fleet -3900000 -3900000    
           
WORKING CAPITAL        
cash flow invested in working capital 500000 515000 530450
           
OPERATIONS        
Net income     7140000 7211400 7282800
depreciation     1560000 1560000 1560000
           
           
Total project Cash flow -3900000 5300000 9286400 9373250
Tax paid     1855000 3250240 3280637.5
Cash flow after tax -3900000 3445000 6036160 6092612.5
           
NPV   $14,287,864.68      
 
 
ASSUMPTION 2 without tax
    0 year 1st year 2nd year 3rd year
FIXED ASSET          
Cash paid for the fleet   -3900000 -3900000    
           
WORKING CAPITAL          
cash flow invested in working capital   500000 515000 530450
           
OPERATIONS          
Net income     7140000 7211400 7282800
depreciation     1560000 1560000 1560000
           
           
Total project Cash flow   -3900000 5300000 9286400 9373250
           
NPV   $21,981,330.28      
5. What do you think of the company’s policy of not operating ships over 15 years old?
The number of ships removed from the fleet in any period is dependent upon prevailing market conditions, scrap prices in relation to current and prospective charter market conditions as well as the age profile of the existing fleet. Generally, as a vessel increases in age its operational efficiency declines due to rising maintenance requirements, to the point where it becomes unprofitable to keep the ship in operation.
Ocean carriers have a strong policy of not operating ships over 15years old. This is because, after every five years, they have to mandate a special survey to determine the seaworthiness, as per the international regulations, after the fifteenth year the maintenance charges for the special survey becomes very costly. The exhibit 5 shows the capital expenditure done in the preparation of the special surveys, which have immensely increased over the years. The company plans to sell the vessel in the second hand market or scrap it just before the third party survey in order to avoid large expenditures.

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