Missing the Wave in Ship Transport
Despite a repeating boom-bust cycle in the shipping industry, owners seem to make the same investment mistakes over time. Can other cyclical industries learn the lessons of the high seas? Research by Robin Greenwood and Samuel G. Hanson.
Like investing in a mansion when the real-estate market is at its peak, buying a dry bulk ship in a boom time is a terrible long-term investment, according to new research that predicts cycles in the shipping industry.
The contrarian research results out of Harvard Business School could help investors succeed in volatile, cyclical markets as far ranging as real estate, high technology, and truck transport.
In Waves in Ship Prices and Investment, a National Bureau of Economic Research working paper, Professor Robin Greenwood and Assistant Professor Samuel G. Hanson studied trends in the bulk shipping industry, constructing patterns of return for investors.
"We were shocked at how predictable the returns are in this industry."
The research results—that heavy investment in a boom depresses future earnings—were unexpected, says Greenwood, the George Gund Professor of Finance and Banking. "We were shocked at how predictable the returns are in this industry."
Over the course of a year, Greenwood and Hanson interviewed a variety of people, including dry bulk shipping industry leaders, private equity investors, and two shipping scholars.
Battles at sea
Three types of ships dominate the industry: dry bulk carriers, which primarily carry iron ore, coal, and grains; cargo ships, run by companies like Maersk that rent container space; and fuel tankers.
In 2011, Dry bulk ships made up about 40 percent of the shipping industry, with tankers and cargo ships comprising the rest. Worldwide, there were about 9,000 bulk carriers, which varied in dimensions from small to supersized. The bulk shipping market was valued at roughly $180 billion.
Owners in this highly competitive industry make money either by transporting cargo for hire or by chartering for a specific period, typically 12-month contracts, where the lessor pays for fuel and insurance and the owner pays for the crew (about $6,000 a day), along with maintenance and depreciation expenses.
Owners charter their ships for an average of 357 days a year, docking for maintenance for eight days. New ships, which have a life cycle of about 25 years before being scrapped, are ordered through shipyards and take two or three years to build. About 10 percent of the fleet is bought and sold on the secondary market.
For the study, Greenwood and Hanson focused on the earnings and secondhand prices of a sample number of midsized dry bulk carriers called the 76,000 DWT (deadweight tonnes) Panamax. Using earnings and secondhand prices between 1976 and 2011, they computed the ships' return on investment.
Swells and troughs
The researchers found that earnings were quite volatile but followed a predictable boom-bust cycle. Several factors influenced the cycles: a rush to build too many ships when market demand rose, coupled with a lack of attention owners paid to increasing worldwide competition.
In the paper, Greenwood and Hanson point to Nicholas Kaldor's "cobweb" model of industry cycles, in which firms choose the quantity to produce based on the naive assumption that there will be "zero supply response, so that earnings will always be the same" as they were in a particular time period.
This assumption is wrong. Owners, perhaps for psychological reasons and the fact that there's a lag time between ordering and building a ship, scrambled to build new ones. That led to a glut of ships competing in the market a few years later, accompanied by a decline in fees going into the hands of owners and, at the end, the scrapping of ships.
When the study begins in 1976, the shipping market was at a low point. By 1979, oil price increases drove an industry uptick as the market shifted from oil to coal.
Demand for ships outstripped supply until 1981, when a global recession and the US coal miners' strike led to a collapse in ship-hire rates. By 1983, anticipating a recovery, many owners ordered new vessels. Greenwood notes the folly of that strategy, quoting marine historian Martin Stopford, author of Maritime Economics, a leading treatise on shipping: "If so many owners had not had the same idea, this would have been a successful strategy."
The heavy delivery of bulk carriers worldwide by 1984, Stopford said, "ensured that the increase in [shipping] rates was very limited."
"When everyone is ordering ships is the time you should be selling."
The industry's largest boom, however, began early in 2003, driven by demand for iron ore to fuel China's infrastructure development—a shipbuilding boom followed. By 2007, ports were overcrowded and suffering from delays and ship shortages, which led to high rates that stimulated the over-ordering of ships. The owners greatly underestimated the magnitude of their losses this time.
"You see this absolutely crazy period in 2007-2008, where ships that historically leased for $30,000 a day were being leased for $120,000 to $200,000 a day." At peak, buyers may have overpaid for a ship by 100 percent. By early 2009, the market imploded, "the biggest drop in prices the industry has ever seen," Greenwood says.
The bust cycle in the dry bulk shipping industry continues today. Prices are extremely low, ships are being scrapped, and private equity firms are moving in to invest.
Against the wind
The bulk shipping boom-bust trend offers sound advice to investors.
"When rates are low and when everyone else is destroying ships, you want to order them," Greenwood says. "It's a contrarian strategy. When everyone is ordering ships is the time you should be selling."
The shipping and real-estate industries are, unlike the stock market, quite similar in their long-term predictability, he says. High investment typically will create a low return. "If you buy a ship in a boom it's a terrible investment. The magnitudes are stunning."
A group of Harvard Business School students discovered similar boom-bust trends when researching the truck industry, Greenwood says. They found that when trucking companies were expanding their supply, overall returns to the industry were poor.
"People mistake a shock to demand with an ability to generate profits. They overinvest because they don't understand."
The growing body of research is causing Greenwood to think about business cycles more broadly, he says, noting that the tech boom similarly caused a rush of companies to compete but few made money.
"It's not just in shipping," he says. But in shipping and real estate, where feedback is delayed, he concludes, "learning is slow."
Greenwood and Hanson were drawn to maritime studies after teaching cases on the shipping industry. "We noticed the tremendous bubble in shipping prices—and subsequent collapse—in the late 2000s," Greenwood recalls. "As researchers in asset pricing and behavioral finance, and interested in bubbles more broadly, we simply wanted to understand what was going on."