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«Price Formation of Dry Bulk Carriers in the Chinese Shipbuilding Industry Liping Jiang December 2010 © University of Southern Denmark, Esbjerg and ...»

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Price Formation of Dry Bulk Carriers in the Chinese

Shipbuilding Industry

Liping Jiang

December 2010

© University of Southern Denmark, Esbjerg and the author, 2010

Editor: Finn Olesen

Department of Environmental and Business Economics


ISSN 1399-3224

All rights reserved. No part of this WORKING PAPER may be used or reproduced in any manner whatsoever without the written permission of IME except

in the case of brief quotations embodied in critical articles and reviews.

Liping Jiang Centre for Maritime Research and Innovation Department of Environmental and Business Economics University of Southern Denmark Niels Bohrs Vej 9-10 DK-6700 Esbjerg Tel.: +45 6550 1593 Fax: +45 6550 1091 E-mail: lji@sam.sdu.dk Abstract In this paper we present, for the first time, the price formation of China’s dry bulk carrier using vessel prices quoted by major Chinese shipyards in actual shipbuilding orders. This allows us to investigate the relationship of price and determinants in the Chinese shipbuilding industry by including generic market factors as well as Chinese elements. The analysis, employing Principal Component Regression (PCR) approach, indicates that the time charter rate has the most significantly positive impact. While increases in other four factors, namely shipbuilding cost, price cost margin, shipbuilding capacity utilization and credit rate, have descending order of positive influences. Different from traditional perception, we assert that the most important role of time charter rate plays mainly attributes to the ‘China Factor’ in bulk carrier sector. In addition, simulations are performed to investigate what would happen to the Chinese dry bulk carrier prices under changes of time charter rate and shipbuilding cost. This paper has implications for the Chinese shipyards, shipbuilding industry customers and industry policy makers.

Keywords: Price Formation, Dry Bulk Carrier, Chinese Shipbuilding Industry Acknowledgment: This research is partly funded by the Chinese Scholarship Council and TORM Foundation.

1. Introduction Shipbuilding is an important cog in the shipping industry and provides the supply of marine transportation system. It is a market that major yards compete internationally for orders at their quoted prices. Shipbuilding price plays an important role for shipyards in winning orders and for ship owners in making investment decisions. The price is very much related to the world economy and other shipping sectors. When there is a strong economy and high demand for the world’s seaborne trade, freight rates will firstly be driven up by the limited transport capacity. This stimulates ship owners’ desire for expanding current fleet and gaining substantial profit. It usually takes years to deliver the ship after placing an order (Stopford 2009). For this reason, whethership owners are prepared to take ship building contracts and at which price levels they are willing to pay depend on their expectations of the future shipping market. If a long term of thriving market is expected, investors are more likely to place an order.

This is because the availability of shipyard berths may be scarce and shipbuilding prices may be even higher in the future if the market keeps going up. With market confidence growing and orderbook rising, shipbuilding prices will be pushed up and shipyards would expand their capacity to meet the berth shortage. But when the market turns down, ship owners will with more discretion and conservative mood face the market. Struggling with faltering demand, shipyards will lie in a weak position. On the one hand, it is usually quite slow and difficult for shipyards to reduce the capacity which was expanded in the time of prosperity or by the government subsidies. On the other hand, the overcapacity will lead to lower shipbuilding prices and acute competition. In addition to these generic factors driving shipbuilding prices up and down, there are several country, yard and ship specific factors that will influence the actual price of a new ship. These mainly include the national industrial policy, production capacity, shipyard cost of production, currency fluctuation, ship design and payment options. In essence, there is no single driving force behind the determination of shipbuilding price and above factors are having effect integrated.

As world’s shipbuilding center shifts from high cost capacity in Western Europe to low cost shipbuilders in East Asia, China has taken a giant leap in the shipbuilding industry and developed into a world shipbuilding base of dry bulk carrier during the past years. There are several reasons for this great achievement. First, the industry experiences considerable expansion in parallel with China’s accelerated economic growth and rising demand for the seaborne trade of dry bulk. China adopted a policy of building up the domestic fleet to meet the local growing demands of international trade, and this greatly increased the domestic output of dry bulk carriers (OECD 2008). Second, the production focus of top shipbuilders in Japan and South Korea are gradually moved from dry bulk carrier to high value-added vessel types. This provides the opportunity for the Chinese shipyards to face less competition and to develop progressively in the dry bulk carrier sector. Third, the low labour cost plays a fundamental role for the Chinese shipbuilders to compete in the dry bulk carrier sector which contains relatively low-technical content and competitive focus is the price.

Understanding the tanker prices, therefore, is important to the Chinese shipyards and industry policy makers, and it also has the implication for the Chinese shipyards moving into more advanced shipbuilding segments. Especially in recent years, the industry is confronting with new situations which may challenge China’s price competitiveness. We see continuous increasing of raw material costs, labour costs and steel prices. High level of governmental investment has unfortunately led to excess shipbuilding capacity. The RMB appreciation against US dollar has also caught great attention within Chinese shipbuilding community. Which factors actually determine the Chinese dry bulk carrier prices? How would dry bulk carrier price in China react to the new circumstances? How would Beijing promote the dry bulk carrier sector by introducing new policy? Academic investigation is required to build a comprehensive view of the Chinese dry bulk carrier price and to answer above questions.

Extensive research has investigated the dynamic behavior of world shipbuilding prices. Traditional approaches for price modeling are mainly based on supply and demand equilibrium model (see Koopmans 1939; Hawdon 1978; Jin 1993;

Haralambides 2005, among others). More recent studies apply portfolio theory proposed first by Beenstock (1998a,b; 1992; 1993) and he develop this idea further in following papers. By contrast, limited scholarly attention has been paid to the formation of Chinese shipbuilding price. This is due partly to the short development period of shipbuilding industry in China compared to traditional shipbuilding powers. Furthermore, the data of Chinese prices is not as detailed as world prices, since most of the shipping consultants only elaborate on the world shipbuilding prices. There is no systematic research on the Chinese shipbuilding prices across different vessel types. Also the existing evidence does not appear to bear out the impact of low costs and governmental support on Chinese shipbuilding prices. To fill the gap in the current literature, we select top 200 Chinese shipyards according to the rank of shipbuilding capacity in Compensated Gross Tonnage (CGT). Then actual shipbuilding orders from these shipyards are collected since the development of modern Chinese shipbuilding industry in 1995. Historical orders without the contract prices are excluded from the dataset and the remaining is classified according to vessel types. This unique data set is used to make the first economic analysis of Chinese shipbuilding prices in different vessel types.

The paper contributes to the literature in a number of ways. First, this article enriches the growing but still the small amount of research on the Chinese shipbuilding industry especially on the Chinese ship price. Instead of using the time series of world shipbuilding prices, this paper, to the best of our knowledge, is the first academic work based on vessel price quoted by major Chinese shipyards in actual shipbuilding orders. Second, the price formation model in this paper can account for generic market factors as well as the Chinese shipbuilding characteristics, for instance, Chinese shipbuilding cost and governmental financial support. The overall effect of cost is established through the construction of a Chinese shipbuilding cost index. The use of comprehensive cost index is superior to the use of single cost proxy as it puts into better perspective the Chinese shipbuilding industry’s cost. A competition indicator is also constructed to measure the competition extent that Chinese shipyard faced in the world dry bulk carrier market. In doing so, this model enables us not only to reveal the most important determinants of the Chinese dry bulk carrier price, but also draw a dynamic picture of the price movement under world and national factor changes. In addition, we provide a Principal Component Regression (PCR) approach which is new to maritime economics field and it is proved to be an effective way especially in solving the problem of multicollinearity. Finally, the findings of this paper have implications for Chinese shipyards, shipbuilding industry customers and Chinese policy makers, and may also shed some light on the emerging shipbuilding nations who start development from dry bulk carrier sector.

The remaining sections are organized as follows: Section 2 reviews the extant literature on shipbuilding prices; Section 3 explains the econometric model and price determinants; Section 4 describes the data; The Principal Component Regression model is introduced in Section 5; Section 6 analyzes the result and discusses scenarios based on price model; finally, Section 7 addresses the conclusion.

2. Literature Review The topic of shipbuilding price has received considerable attention in maritime field. The earlier studies can be classified into two groups. One influential group is supply and demand theory and Koopmans (1939) is among the earliest researchers who employ the theory to model the shipbuilding market. Koopmans argues that the time lag between the demand for shipping capacity and actual availability of this capacity triggers expectation of the future market. Then Hawdon (1978) uses current and lagged freight rate to represent different market conditions during the time lag. Besides, he also takes labour costs, costs of steel, and ship size into consideration. Hawdon finds that current freight rate has a significant coefficient, while lagged freight rate is insignificant. Jin (1993) enriches the literature by not only utilizing previous theory but also integrating it with cost-base approach. More specifically, he models the relationship of tanker market factors regarding endogenous and exogenous variables, such as shipbuilding cost, shipyard capacity and technology changes. Major factors affecting the tanker new building market are identified, but his way of using average number of employees in the Japanese shipbuilding industry as a proxy for shipbuilding capacity is under controversy, not to mention his small number of observations. One of most recent researches on shipbuilding prices is from Haralambides (2005) which utilizes new econometric method of SEM (Structural Equation Model) and both short and long term impacts of variables are included in the price model.

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