Part 5 The Market II

September 2019



The bulk shipping industry’s economic environment is much different from the liner industry. Bulk shipping is much less structured and not organized along schedules but it is, in its own way, very disciplined. The bulk trades, mainly oil, chemicals, and dry raw materials, are structured to follow the cargoes. This means that an operator does not have a fixed schedule of sailings for his vessel and will employ it where and when he can get a cargo. Bulk service is generally not provided on a regularly scheduled basis, but rather as needed, on specialized ships transporting a specific commodity. Cargoes are shipped unpackaged either dry, such as grain and ore, or liquid, such as petroleum products.

The rate structure is not set in deliberations by a group of operators as they are in a liner conference framework. Rather, the rates are set by the dictates of market forces of supply and demand for the commodity and for tonnage availability. Brokers are the key to making contracts and many contracts are executed over the telephone and by email strictly on the verbal agreement of businessmen. Hence the importance of the Baltic Exchange brokers motto: “Our Word is Our Bond”. In the bulk trades, bulk operators are contract carriers, either time or voyage chartered by the shipper.

Charterers are those that hire a ship’s transportation services. There two main types of chartering method:

  • time charter where the charterer pays for time usage of a ship and
  • voyage charter where the charterer pays only on per ton of cargo carried

Under the time charter category there is also what is known as bare boat charter. This is in effect a time charter but the charterer assumes the role of owner/manager and takes responsibility for all of the vessel’s operating expenses including of course insurance, crew and maintenance costs.

Time charters can apply over a specific voyage only, in which case they are time charter trip agreements, the duration of which is the duration of one voyage laden perhaps including also the ballast (empty) leg. These time charter trips are found in the “spot” market and some like to call this, erroneously, spot chartering. Spot refers to how long prior to a ship coming off its going employment is that ship chartered (fixed) again for its next employment. If it is left until the last minute, then that ship is “spot” as opposed to fixing well in advance for forward delivery. In tanker bulk trades however spot chartering tends to signify voyage chartering, where owners get paid in accordance with tons of cargo carried.

Photo by Kinsey on Unsplash

Back to time charters, where owners are paid a hire rate per day to in effect rent their ship to a charterer and aside from time charter trips, we have short and long period time charters. Short can be for as little as a 2-4 month period and long can go up to 20 or more years.

The main differences between time chartering and voyage chartering are as follows:

  • On time charters the owners are paid hire basis a daily hire amount every 15 days in advance. On voyage charters owners are paid freight ($/ton) usually a little after completion of loading with a small balance due after completion of discharge. If the ship, through no fault of owners, takes longer to load/discharge than agreed in the charter party (time allowed) then charterers pay a specified daily “penalty” to owners called demurrage extra to freight($/ton) paid. If the opposite happens and the ship completes loading/discharging sooner than agreed (time allowed) then the owners will pay back to charterers a daily “penalty”, called dispatch.
  • On time charters it is the charterers who have the right to control commercially the ship in accordance with the terms agreed in the charter party and for this they are also called “disponent owners”. They may use the ship they hired to transport a cargo or, if the market conditions are right, they may even sublet the ship to other charterers and secure a profit by the difference. There can be several time and voyage charterers down the line on just one ship.
  • On voyage charters the owners agree under detailed and very specific terms to execute a transportation job. Owners are called to cover all voyage related costs and be left with a “time-charter equivalent” net daily earning commensurate with the market. Owners run their calculations and having taken all eventualities into account through a detailed “voyage estimate” they ask for a sum of money which translates to $/ton of cargo to be carried and the freight rate ($/ton) is agreed.
  • On time charters it is charterers that pay for voyage related expenses including: bunker fuel, port expenses, canal costs, pilot costs and loading/discharging costs. On voyage charters, where charterers pay in US$/ton of cargo carried, all voyage related expenses except for loading/discharging costs (typically arranged by cargo shippers/receivers) are for owners account.
  • Voyage charters are primarily prevalent amongst tanker trades and on dry bulk trades usually when the charter market is low. The reason is that time chartering carries more risk for the charterer than voyage, but when the market is strong (an “owners market”) the charterer’s options diminish to time chartering.
  • A charter party can be quite a complicated and long contract consisting of tens of pages. Usually a competitive broker sits in the middle between a charterer’s in-house broker and an owner’s in-house broker and tries to put the two together. If he succeeds he will be paid typically 1.25% commission of the gross hire (if time charter fixture) or off the gross freight payable (if voyage fixture). Charterers typically also charge a commission called address commission, typically around 3.75% of gross hire, “allegedly” to cover their in-house chartering costs. On voyage chartering the charterers address commission is typically less than on time chartering as their in-house brokers have less of a job to do since they don’t (rent) control the ship. Owner’s brokers typically get paid a salary without commission in order not to prejudice their duty. An owner’s in-house broker’s duty is to look after the ship and the owner’s interests and not just to achieve the biggest income. Hence there no commission incentive applicable for owner’s brokers. The same applies more or less to a charterer’s in-house brokers, even though a hefty commission is paid by owners to charterers in the form of the 3.75% address commission as mentioned above. So, if an owner fixes out his ship on time charter for $10,000/day, upon delivery of his ship to charterers he will receive: cost of bunkers already on board his ship plus 15 days x US$10,000 i.e. $150,000 less 5% total commission (3.75% retained by charterers and 1.25% paid to brokers).
Image by Gordon Johnson from Pixabay

This is different to dry chartering in that it uses a pre-agreed system that defines the actual US$/ton of oil carried to be paid by charterers to owners. This system is called World Scale Rate and the World Scale Association produces two times annually standard flat rates that at 100% are supposed to cover all relative costs to every conceivable tanker trade in the world and leave owners with a small profit. This scenario is called WS100. The market then fluctuates purely around that World Scale and any agreement reached between owners and charterers is expressed in points on that scale. So a WS50 fixture for instance will not even cover (theoretically) the vessel’s running & voyage costs (bunkers & port/canal/pilots costs). A fixture done at WS200 should theoretically cover all costs and provide a small profit (WS100) with the remaining 100 WS points producing a nice extra pure profit over and above average profits.

Time charter trips rarely (almost never) exist in tanker trades. Time charters when seen in the tanker market are usually for when a tanker charterer hires a ship for a long period of time, typically in excess of one year.

The tanker market is dominated by Oil Majors such as EXXON, BP, SHELL, TOTAL, CHEVRON. It is these companies that have shaped the market, and compliance with tough regulations are usually enforced through commercial means and the standards set by Oil Majors. Typically when markets are poor the standards go up and charterers selection criteria become tougher. When the markets are strong (an owner’s market) then criteria tend to relax so that charterers can have access to a larger pool of ships and hence resist rate hikes.

Liner or berth service is defined as a scheduled operation by common carriers whose ships operate on a predetermined and fixed itinerary over a given route, at relatively regular intervals, and are advertised considerably before sailing in order to solicit cargo from the public. These common carriers provide transportation on fixed schedules and at rates (tariffs) often made electronically available to the public. The liner fleet includes full containerships, partial containerships, roll on/roll off (Ro/Ros), and barge-carrying vessels. Vessels in the liner trades carry high-value cargo as to its worth and multi-faceted cargo as to its physical description, including packaged goods and refrigerated fruit and vegetables.

Photo by Vidar Nordli-Mathisen on Unsplash

Because of the predictability of the trading patterns of liner ships, it is easier to apply operational measures for consumption reductions such as virtual port arrival, optimized routing and long term planning in general. However the portion of the transport work done by such trades by comparison to tramp shipping trades is very small, almost insignificant. Ships engaged in liner trades tend to be chartered on time charter basis for lengthy periods of time and not voyage.

In some cases a ship owner will choose to take a contract with a shipper to transport the shipper’s cargoes over a period of time with a specific voyage rate agreed ($/ton) but without any specific ship declared. So an owner may assume the responsibility to transport 50,000 tons of coal twice a month from Australia to China for 12 months against US$20/ton loaded. This is a COA of 1,200,000 tons of coal for a year. Usually owners abstain from COAs. Instead Charterers/Operators tend to take on such COAs on the back of which they go out and charter ships either on voyage or time charter to cover the COAs.

Important for COAs and other such voyage-type agreements is the escalation of certain costs such as port, bunkers and other costs. Typically there are provisions that help the executors of the COAs be covered against sudden bunker fuel cost rises etc. so as to ensure their original profit calculations are unaffected.

Now in chartering, the allocation of liability for certain costs lies almost exclusively within the terms agreed in the charter party. However there are certain rules and provisions that apply generally and are irrespective of the negotiations. For instance under time charters, Charterers are responsible for the trading pattern of the ship. It is under their direction and control. So if due to their trading direction the ship goes into an area where extra costs apply, then these are to be for those responsible for ordering the ship there: i.e. the Charterer. Typically owners will insert protective clauses such as that “all expenses resulting from charterer’s trading to be for charterer’s account”. Under this principal for example, if emissions costs result from regional regulations, then normally time charterers will cover these extra costs, even if they strictly speaking weigh on the manager. Prudent owners are constructing clauses and inserting them in charter parties for when needed, making charterers clearly responsible for any emissions taxes/levies/carbon allowances etc required.

Forward Freight Agreements (FFAs) are derivatives that provide a means of hedging exposure to freight market risk through the trading of specified time charter and voyage rates for forward positions. Settlement is effected against a relevant route assessment, usually one published by the Baltic Exchange. Commissions are agreed between principal and broker. The broker, acting as intermediary only, is not responsible for the performance of the contract.

FFAs are primarily transacted on a cleared basis and will normally be based on the terms and conditions of the FFABA standard contracts as adapted by the various clearing houses.

The main terms of an agreement cover:

  1. the agreed route,
  2. the day, month and year of settlement,
  3. contract size and
  4. the contract rate at which differences will be settled.

International trade is a dynamic business and its customs and practices change with the advent of new modes of transport, improved communication, changes in demand and supply, banking arrangements, national and international laws and many other factors. As a result, the terms on which traders do business evolve to suit changing times. To cope with this, the International Chamber of Commerce regularly reviews and revises the terms included in its template contracts after consultation with trade bodies and other organizations.

The most important terms are the Maritime Incoterms which describe the duties and responsibilities of each party of a trading agreement that is related to its transport by means of a merchant ship. The two most important and widely used international sales contracts are CIF and FOB.

CIF – Cost, Insurance and Freight

This is the most widely used form of International Sales Contract. It involves the seller in the arrangement of the carriage and the insurance as well as the provision of the goods. The price of goods sold CIF will be considerably higher than the same goods sold FOB (see below). The contract is based on the discharge port rather than the load port. If anything happens to the goods during the voyage, the buyer will be protected.

FOB – Free on Board

The seller has responsibility for bringing the goods to the named port and loading them over the ship’s rail. They then become the buyer’s responsibility. Freight and insurance, being concerned with matters after loading, are the responsibility of the buyer. The buyer is under a duty to name an effective ship and select a port.

Many variations of sales contracts also exist: CFR – Cost and Freight, DEQ – Delivered Ex Quay, FAS – Free Alongside, etc. The purpose of the following infographic is to provide a visual overview of the various Incoterms that are used in international trade. Prior to entering into any contract you should consult an expert in such matters, for example, an experienced freight forwarder, chartering broker, etc.

Incoterms 2020 infographic

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