Special Report: The mystery of shipping’s vanishing opex
Greg Miller, Senior Editor | 3 November 2016
Some owners are spending considerably less cash on vessel operations. Photo: PA
During the 2003–08 shipping boom, vessel operating expenses (opex) surged, sometimes by double digits per year. In 2012–16, it has been a mirror image: amid a weak freight rate environment, opex has fallen.
Why should this correlation between rates and opex persist, given regulatory pressure to maintain quality and the fact that the overall number of ships – and thus global demand for ship services – is higher today than it was during the boom era?
Is the industry’s cost-slashing acumen in the face of weak rates a positive, pointing to creative problem-solving and a more efficient way of doing business? Or is it a negative, evidence of corners being cut to the detriment of asset values and customer service, or worse, to an extent that puts crew and the environment at risk?
The answer is: it depends on the owner. In addition, there are other factors in play beyond these purely positive and negative interpretations.
Opex includes the cost of crew, stores, lube oil, insurance, and repair and maintenance, and excludes fuel (which is not paid for by the owner under a timecharter). According to the recently released ‘OpCost 2016’ benchmarking survey by UK-based accounting and consulting firm Moore Stephens, annual vessel operating costs fell 2.4% in 2015, marking the fourth consecutive year of decline. Costs fell across the board last year: for crewing by 1.2%, for stores by 4.3%, for repairs and maintenance by 4.3%, and for insurance by 3.2%.
According to Moore Stephens shipping and transport partner Richard Greiner, the latest annual cost reduction was triple the previous year’s pullback and “had not been widely anticipated”.
A new IHS Fairplay data analysis of securities filings by US-listed shipping companies confirms the trend and implies that it is accelerating in 2016. The analysis covered 13 public companies with an aggregate fleet capacity of 39.3 million dwt. It found that these companies lowered their operating costs per ownership day by an average (weighted by dwt) of 4.7% in 2015 and 6.8% in 2016 year to date.
There is significant pressure on public companies, not just shipping companies, to cut costs. Cost-saving initiatives are perceived positively by analysts and are believed to be helpful to stock pricing, which can be an important component of management compensation. In 2016, public shipping companies have increasingly highlighted their opex reductions in quarterly reports, while simultaneously insisting that product quality is unaffected.
Seaspan Corp – which has just reported a 7.8% year on year (y/y) reduction in daily opex for January–September – hailed its cost savings as “remarkable”, while affirming that its “reputation for excellence” remains central. Scorpio Bulkers cited the need to balance “a high priority on safety and environmental compliance, customer service, and better standard of maintenance” with the need “to do that efficiently”. Star Bulk, which reported a 12% y/y reduction in daily opex in its second quarter, maintained that “this is not at the expense of the quality of maintenance, as evidenced by our vessels’ Rightship ratings and port state control inspection records”.
“When you look at some of these opex numbers, you have to scratch your head,” said industry veteran Randee Day, who runs the maritime restructuring practice of Goldin Associates. “With everybody bragging about having the lowest opex, how are they getting there?
“Clearly in a bear market, people do cut corners. Let’s hope they’re not impairing the safety of the vessels,” Day told IHS Fairplay. “If you’re a small dry bulk owner and you know you’re not going to make it and you’re going to hand the ships back to the bank in a few months, you’ll cut whatever costs you can.”
An anonymous respondent in a recently released Moore Stephens survey raised concerns about third-party managers. “Operating budgets have been pushed further and further south, with numerous managers willing to ‘low ball’ operating budgets to catch the eye of new and existing owners. This can cause severe risk to the operating condition of vessels, but it appears that owners are willing or have no choice but to accept operating budgets that include unattainable assumptions and to fund additional cash-call requirements where they become necessary.”
According to Deutsche Bank analyst Amit Mehrotra, public owners’ recently reported opex levels are “ridiculously low”. “Everyone has the lowest operating expense. Everyone’s in the top quartile. How is that possible?”
Mehrotra told IHS Fairplay that the key factor is “how much of your operating expenses are discretionary and how much are not”. According to his industry channels, the discretionary portion is only around USD1,000/ship/day. “So it does make me concerned when I see USD2,000–3,000/day declines in some cases. I think these companies are finding every single way they can to save money, and rightfully so, but I definitely think there’s deferred maintenance going on. Whether that is catastrophic or not, I have no idea.”
“There are some operating cost areas you can’t avoid and others you can,” Moore Stephens’ Greiner told IHS Fairplay. “You can choose to defer the timing of some of your repair and maintenance expenditures. There is an element of discretion, although in order to maintain the same quality, you’ll have to spend the same money within the five-year special survey cycle. The logical conclusion is that if there’s a permanent reduction in spending, there could potentially be an increase in hull and machinery failure.”
Whether owners are cutting costs during special survey drydockings was debated at the Norwegian/Hellenic Chambers of Commerce (NACC/HACC) conference in New York in February, at the height of the dry bulk crisis. During that event, Blue Wall Shipping CEO George Gourdomichalis said, “There are special surveys and there are special surveys. There’s the kind you go through when the market is USD30,000/day and you spend a million-and-a-half, and there’s the kind you go through these days, when you spend USD150,000.”
That prompted a rebuttal from the audience. DNV-GL vice-president Blaine Collins asserted, “Speaking for class, there are special surveys. Period.” Another audience member, a representative of Philadelphia Coatings, a company that does drydocking paint work, countered, “I can corroborate George’s point. Projects on the paint side that should be worth USD80,000–90,000 are being done for USD40,000, which is not an intelligent decision for the operation of the ship in the medium term.”
Despite concerns that corners are being cut, there has been no increase in casualties, at least not yet. According to data compiled by IHS Sea-Web, the number of maritime casualties (including minor incidents) involving vessels 5,000 dwt or larger was unchanged in January-October 2016 vs January-October 2015. Furthermore, the number of casualties in these two periods was 10% below the number of incidents recorded in January-October 2014.
This lends credence to the more positive interpretation of shipping’s vanishing opex. According to this perspective, ‘necessity is the mother of invention’, weak freight rates are compelling management to develop more cost-effective processes and shipping is evolving into a better business.
Greiner’s view is that falling opex is due to “continuing good husbandry in a difficult operating environment” and the decline in costs is “good news for shipping”. “I think the capacity for innovation is not exhausted and I think that as people look to increasingly harness ‘big data’, efficiency could move forward again,” he said.
He also pointed to an important market-based reason for the correlation between freight rates and opex. During the shipping super-cycle in 2002–8, when opex rose dramatically, the main driver was the cost of crew. “Everybody wanted to trade their ships every single day possible and they were literally going around and saying ‘we’ll pay you 10% more than the guy down the road if you come and work for us’,” said Greiner.
In addition to crew wage inflation during the super-cycle, there was less pushback from owners on other opex costs. “In a better-rate environment, you could absorb it,” said Greiner. As Mehrotra put it, “Good markets in shipping are few and far between. When they’re good, owners are going to be focused on making the most money possible”, not on cutting costs. “It’s just human nature,” he added.
As the current down-cycle drags on, there is much less crew wage inflation because “there are reduced levels of trading, so it’s an ‘owner’s market’ [for labour]”, said Greiner. At the same time, owners are intently focused on reining in other opex drivers.
The correlation between freight rates and opex that has been apparent since the turn of the century begs the question: What will happen during the next shipping up-cycle? Will opex shoot right back up again? Greiner believes it could. “You never know whether things will repeat, but if freight markets came back, it wouldn’t be a surprise. The strength of the freight market trumps the opex. It’s as simple as that.”
OTHER FACTORS IN PLAY
There could be several reasons that reported opex/day is declining even if the quality of vessel operations is not.
The first is currency. If opex is reported in US dollars, and a portion of the opex is paid in another currency, a rise in the value of the US dollar against that currency would lower the opex number reported in dollars. In fact, the US dollar index (which measures the dollar’s value versus a basket of currencies) fell during the 2002–8 period when the Moore Stephens OpCost index rose, and rose in 2012–15, just as the OpCost index declined.
According to Greiner, “Shipping remains a predominantly dollar-denominated business and because owners generate revenue in dollars, buy ships in dollars, and borrow in dollars, they report opex in dollars. I don’t have a clear answer [on whether currency is affecting reported opex] because that data isn’t captured by the owners. But I do think that a lot of operating expenses are actually dollar-driven.”
Another variable involves economies of scale. As an owner’s fleet gets bigger, the owner can negotiate better prices for insurance, stores and other sources of opex. This would lower opex/day while keeping quality constant.
Yet another possible factor relates to whether owners account for opex on a cash or accrual (spread over time) basis. “Sometimes, when these companies talk about opex of USD3,000–4,000/day, it’s not on a cash basis, it’s on an accrual basis,” said Mehrotra. “Over time, those two should be the same, but you don’t buy lubricants on a per day basis, you amortise that cost over a period of time and come up with a daily number. So they may be amortising it differently, stretching it over a longer period,” a process that would lower the reported cost/day in a particular quarter.
Finally, there could be an issue in the public sector stemming from related-party technical management. It is possible that the private manager (owned by the public company founder) had previously paid higher than market rate for opex items and/or charged higher fees, but as the public entity came under heightened pressure, prices were normalised, reducing reported opex.
Gourdomichalis told the NACC/HACC forum in February, “If you put the opex and management fees of a private company like ours side-by-side with an equivalent public dry bulk company, you’ll see that our costs are 25–50% cheaper. I don’t know where that money [reported by the public company] is going.”