Finally . . . some research!

So this week I put on my white lab coat and fired up the Commodore 64 to do a bit of number crunching. By now you have probably got the idea that I’m none too fond of shipping ‘cliches’. Some of this stuff is so full of dead wood that it could be an extra from a Ron Jeremy movie. ‘Buy low and sell high when rates are values go up’. Genius alert.

Be careful who you ask when wanting to experience ‘the Greek way’. Now I don’t want to be unfair to Greek owners, investors or anybody at all of Greek extraction, not every Greek thinks that you can only make money in shipping if you come from GMT+2 time zone. There are many many Greeks who have made their fortunes in shipping and many of the very smartest brains in the business hail from there, but you wouldn’t take guitar lessons from somebody just because he told you ‘Well me and Keith Richards are both British’ now would you? I am pretty certain a little more work goes into the planning than ‘it looks cheap’. Who knows.

Ready for research in Prospector Towers.
Ready for research in Prospector Towers.

However, clearly advising people to buy low, sell high would need to done by those whose faculties are being closed down faster that the University of Telex. I once got a tip from a stranger while playing a particularly abysmal round of golf. As I completed the ‘jumbo’ on my card (7-4-7) he came over and told me that ‘If you want to really improve your score you need to cut out those 3-putts’. If only I’d thought about it when I was standing over that second putt which I missed?

So, let’s have a look at what Rafa Benitez would describe as ‘facts’. The fact is that vessel values have cratered. Here’s another fact, vessel earnings have cratered. Last facts (I think these are less contentious than Rafa’s), that the values and earnings are interlinked, somehow. What is kind of interesting is that this ratio between asset values and earnings varies greatly. Going back to ‘buy low/sell high’ one might want to ask ‘what is low? what is high?’ and how do I know when low is at its lowest and high is at its highest?

We only want to deal in facts, right Rafa?
We only want to deal in facts, right Rafa?

Now history, for once, teaches you a little bit on this subject. It teaches you the average value over time of a vessel for example. But that is life in the bell jar and ultimately doesn’t help you to answer when is ‘low’ and when is ‘low’ not ‘low’? So let’s have a look at earnings against vessel values. I think we all agree that they are linked, but how exactly?

Well I fiddled up an earnings to values normal distribution curve for a 5 year old capesize. You’ve seen it, sort of, in a previous post ‘Mr Prospector thinks about buying capes’, but not in a normal distribution representation. Then I did the same for panamaxes and supramaxes. Now what do you use to forecast earnings going forward? Well, again you will know that I think forecasts of any kind, but especially earnings forecasts are just the devil’s work. So what is real and traceable? FFA forward curves fit the bill nicely, primarily because you can actually execute the trade rather than theorise it.

So here’s the basics. We’ve got 5 year old vessels. We’ve got the time charter index FFA curve going out for 5 years. You take the price of the ship and the combined earnings if you traded the mid-point of the FFA curve and you have a ratio of values to earnings. You can then back calculate through time what that ratio has been using two ways, first what real earnings were for the next 5 years; second what the FFA curve was on the day that each vessel was valued. Then you need to do a bit of Mr.Prospector jiggery-pokery and hey presto! I have an index for this and presented in the most boring table ever.

Capesize Panamax Supramax
22/04/15 507 533 889
08/04/16 626 920 1107
22/04/16 753 992 1140

When the index is at 0-750 it would imply that selling a particular ship and buying FFA 5 year strip would likely be the best policy i.e. it’s a market where earnings are more interesting than assets. 750-900 and it’s starting to get interesting to accumulate assets and sell earnings. An index of 900 or higher (it will literally never get to 2,000) and without doubt you are in territory where you would buy an asset and sell the earnings, i.e. it is now an asset player’s market.

Capes rallied prolifically over the past two weeks. One would imagine that buying a second hand cape would be where the magic lies. not necessarily!

Capes appear to still be in the territory where historically more often than not you have made money from selling the ship and buying the asset. And you think about it. Had you been a seller of a cape over the past couple of months you might well feel a bit sore because earnings are much higher and the price for that asset is a little higher too. However, if you had looked at the price/earnings index that I’m showing you then you would have sold your ship all the same, but bought the FFAs so that you capture the arbitrage in your favour. Net result? You would be a couple of million dollars better off, even when you consider that the ship you sold is now worth a bit more. It’s like entering a triathlon without ever training for the swimming bit. You might well feel like you’ve nailed the cycle, but then at some point you realise that you didn’t do something that you really should have.

This triathlon just got a lot harder.
This triathlon just got a lot harder.

Noteably, panamaxes are at a level where asset accumulation looks interesting and as for supras; if you catch hold of a supra seller either buy his ship off him fast or (if you actually like him) tell him that he is just about to hand somebody free money.

What is most appealing to me about this is not the ‘absolutes’, but the relatives. You can change the age of the ships to whatever you want. You can change the duration of the return. You can change any part of it and come up with what you feel is the most meaningful exercise. There’s no need to ‘watch for a bit’ – you have years of history to analyse. You can use it for spot trading, FFA trading, asset trading, bunker trading. Just roll your sleeves up and have a go.

One thing that I have to own up to is that this is not intended to be definitive. What I mean is that OK, you want to buy or sell a ship, but is your timing historically good against the value of the ship in terms of earnings potential? One cannot separate the two, and when viewed next to each other they do start to show a different picture to the usual clarion call of the ‘it’s cheap’ – a method that so many people have ruthlessly exposed by going bankrupt. So one must finish the trade off by creating a ratio against something that is very very far from its standard deviation. And it is surprising to find out that actually it may just be the earnings.

Trotter, stone heads and the candle factory

It was an absolute pleasure to get a call from Otto last week. Otto is one of life’s serial entrepreneurs, who is always headed for the newest best thing in the world, although seemingly never quite gets there. That’s probably why his nickname is ‘Trotter’, after the great Del Boy, who we all know and love. This time next year we’ll be . . . oh, you know the drill. Otto called me up while I was ironing my socks, which led to a trip to the accident ward with a burned ear, but once the swelling had gone down I called him back to see what was up.

‘Hey man!’ (he’s from Kettering, but talks like he’s just jumped off a surf board), ‘What’s up man?’ he asked. Other than the throbbing red lug hole I told him I was fine and dandy. What did he want? ‘Well, I’m in New York and headed for a bunch of roadshow meetings. I’m trying to get some cash together to get this new business idea of mine going,’ he informed me. He had a lot of new business ideas that didn’t always take off. Like his collection of Rolf Harris artwork for example.

He told me to be in New York on Friday and that he’d send me the business plan beforehand (something he never did). ‘Mr. P. I need a guy there with a beard. Beards are cool at the moment. I’ll tell them that you’re my advisor. You won’t have to say anything, I’ll do the talking.  Just wear a suit please, don’t wear your work boots and have a wash for God’s sake,’ he shouted. So it came to Friday and I was suited and de-booted standing outside Yellow Snow Asset Management waiting for Trotter.

'And I'm like sat there, and he's like just sat there, and like I called him the other day and . . . '
‘And I’m like sat there, and he’s like just sat there, and like I called him the other day and . . . ‘

We sat waiting for the obligatory 25 minutes while listening to the trials and tribulations of the receptionist’s love life until ushered into a meeting room looking out over Park Avenue. No drinks, no biscuits, no clue that it was even the office we were supposed to be in. Finally three 15-year olds and a balding thirty-something walk in. Golf shirts from a broker’s golf day? Check. Badly fitting enormous beige chinos? Check. Metal-rimmed specs? Check. Tan tassled loafers? Check. We’re in the right office alright.

Barely a smile, the youngest opens a leather-bound jotter and writes the date at the top of an empty page. They mutter to each other and laugh quietly like they’ve just heard the punchline to a joke that we on the other side of the table will never even get to hear. Then they turn gravely and seriously to Trotter and me. Not a word, not a gesture, but we’re on!

Trotter then begins to explain his business. He says he wants to buy a bunch of factories. He’s going to fill these factories with regular equipment to make candles. He is then going to rent the factory and equipment out to somebody who wants to run a candle-making operation. He then describes the business to them to make sure they ‘get it in one sentence’.

Welcome to Yellow Snow Asset Management.
Welcome to Yellow Snow Asset Management.

He looks up at the stone heads across the table, takes a deep breath and says ‘OK. So here it is in a nutshell. We buy the factory and rent it out. In order to create economies of scale we’ll buy lots of factories in fact. Don’t know how many are required, we’ll just buy as many as we can afford. We’ll fill every one with candle-making equipment. Then we’ll hire the staff and create the candle-making business for ‘persons unknown’ who we’ll find later to rent the factory off us. Then all they have to do is buy the wax and the wicks and produce the candles. Or is it ‘sell the candles? It’s easy to lose track.

‘Now, here’s the interesting part. We’ll collect rent from them only based on what they can sell the candles for. If they sell them for lots we’ll get more money. If they sell them for less then we’ll get less. What is important here is that we have no control over the price of candles and no guarantees on our income or utilisation of our equipment, we will just receive what they receive, less a bit – even though we’re staffing and running the factory for them.

‘The price of the real estate for candle factories also moves. It is based on whether people want to buy candle factories or not. When the revenue for candles is at its lowest, the market for candle factories is at its lowest. That can happen at any time. Over time the factory will only be worth salvage when it gets knocked down, but let’s not dwell on that.

‘What’s our competitive edge I’m sure you’re thinking? Well, there is no licensing required to build a candle factory or make candles. So there are zero barriers to entry. And in fact, lots and lots of people have come up with this exact same business plan and gone bankrupt with it. We don’t have a brand and customers are not really that bothered anyway as anything that burns wax and lights the dark is considered a candle. They’ll buy the cheapest possible. All of the candle sellers compete like crazy and drop their prices without a second glance, so the lowest price is usually the price for all. Oh, and I almost forgot. If you get a good contract to supply at a nice margin, if they find that they can buy them cheaper elsewhere then the buyer will probably walk away and give you the candles back to sell (or make, I’m confused now) at a price where you’re  losing money doing so.

No, I meant handles for forks . . .
No, I meant handles for forks . . .

‘If we decide to make long white candles then the equipment cannot be recalibrated to make say, birthday cake candles. What we make on day one we’re going to be making until the factory falls down. When candle-making businesses like ours go bust then the factories are not necessarily knocked down and the machinery isn’t changed. A new business, just like ours, comes in and starts making candles on behalf of somebody else to sell them at any price to pay for the mortgage on the factory and equipment that they just bought.

‘It is impossible to forecast the future price of candles or candle factories by the way. But I know what you’re thinking right? Are we a real estate company that buys factories specifically in the candle-making sector? Are we in fact an equipment leasing business for aspiring candle makers? Are we candle makers or sellers? Well, we’re a bit of all of it. What we’ll do is buy the factories, so we’re in the real estate business. Then we’ll fill it with equipment and workers – or maybe hire a company to fill it with workers for us, to whom we’ll pay a fee. So we’re candle makers. But we will tell investors that we are in the ‘candle business’ generally, not which specific bit and it seems that they just hear the word ‘candle’ and forget to ask about the rest.

‘Then when the investors want to know what we’ve been doing with their money we can talk about the prices people are paying for candles, how many candles are being made globally and forecast the Chinese candle demand and the likelihood of power cuts to boost candle sales. So we’ll describe the business of the guys who are using our factory and workers to justify our results, but not explain what we are doing. Oh I nearly forgot. There’s only one way to make a candle so technical innovation isn’t likely to ever be a factor.’

Finally he pauses and looks into the eyes of the astonished chuckle brothers sat opposite him. He stares at each one slowly, as I shift from buttock to buttock in a state of massive unease. ‘You fellas got any questions? You’re looking a tad confused’ says Trotter. In fact angry would be my description.

‘Mr Otto’ says baldy, who seems to be the boss on account of being the only one old enough to be able to drive, ‘That has got to be the single dumbest pitch I’ve ever heard. No facts, no figures, the most horrific business plan. What in the hell made you think that we would be interested in having our time wasted by you for this?’ He sits back, folding his arms and smirking at Trotter. The boy with the jotter slams it shut dramatically and to a man, they all push their chairs back from the table, lean back and stare mockingly at my friend.

‘Well’ says Trotter confidently, ‘You boys have a lot of money invested in shipping. I thought if I tried something that sounded a bit more plausible then it just couldn’t fail.’

PS: By the way, next week I’m actually going to do some serious stuff (sort of), so please read it as for once it will actually take some time to write.

 

 

Dirty Digger, Agent Orange and bad advice

Sometimes, just sometimes the best intended and most well meaning advice can turn out to be some of the worst. Take my mate Dirty Digger as an example. Like me, he cut his teeth diggin’ in the dirt way out west hoping to find his fortune. It’s a tough, lonely existence out there, always working on the promise that tomorrow you’re gonna get rich. As a result, men tend to be real men, and that leaves very little time for a love life.

Digger was lonely. Digger wanted a wife. Digger wanted little Diggers running around the yard. Digger got himself a date. On the evening before his big date we sat by the light of a mechanical crusher unit, drying our underpants on the engine cowl. Digger turned to me whistfully and asked if I had any advice for his date. As I turned over my toasty undercrackers to dry the gusset I looked up at the moonlit sky and sighed.

‘Well Digger, I could tell you to do this, do that, say this and that, but at the end of it you know what? The best thing to do is just to be yourself’, I said. ‘That’s mighty fine piece of advice’ he said while peeing on the dying embers of a pile of burning plastic sacks. I went to bed feeling like I had done a good thing.

When Digger returned to work on the following Monday the first thing I asked him was how his date went. ‘Well I took your advice Prospector’ he said, staring into the distance. ‘And at the end of the date she told me that I was the biggest asshole she’d ever met in her life.’ With that, he swung into the cab of his JCB, turned the key and chugged off over to the far side of the mine. I guess I just plain forgot that Digger is in fact an asshole.

copper-ore-crusher
A great place to dry your under-crackers

Here’s another piece of useless advice that I have heard recently. An investor told my ship owner pal Private Ryan that shipping companies should be getting closer and more involved with the commodity markets of the piles of stuff that they’re transporting. With a name like Mr Prospector you might well expect me to know a bit about digging up stuff and selling it. So not surprisingly Private Ryan told me he called Agent Orange, a trader friend or ours to see what I thought.

There’s some pretty sharp pratices in the dry bulk business. That we all know. Slick Eddy told me about a guy who was known to his enemies as Superman. His favourite trick was to book a long term contract to ship some stuff each mid-December, then put the address commission straight into his PnL. He’d trouser the bonus due for his great work then try to cancel the contract come the first day of January. There’s a lot of people right now lauding ‘the Greek way’ of doing things. I asked Les Miserable about what he thought that meant. He told me that if he chartered a ship from a Greek owner these days one ‘Greek way’ is to steam so slow that to the naked eye the ship is going backwards. Under-performance? Well, the way to deal with that is just to delete the word ‘under’ and blame it on the weather.

It seems that fiddling the bunkers has become a legitimate form of poker, whereby what you get and what you paid for might not be exactly the same. And assessing the balance is like assessing an Alsatian’s favourite poet. Luckily it has been legitimised for you to try it as the worst that can happen is that you pay back the difference for what you say happened and what really happened. Why would you not try it?

He looks like a W.B. Yeats sort of dog.
He looks like a W.B. Yeats sort of dog.

But these, along with every other ‘sharp’ trick in the freight market would give you the impression it is full of scoundrels. That might be true, but while shipping has a collection of naughty boys, the commodity trading world is where Ted Bundy trades with The Boston Strangler. Agent Orange, a commodity trader at the nether regions of the business told Private Ryan to approach the commodity trading business like running through a field of nettles in a pair of Speedos. Incidently he’s called Agent Orange because his head is exactly the same shape as an orange. He was asked to tell me a few war stories and replied ‘Would a top 100 would do?’ Hmmmmm, let’s just stick to the basics.

‘Let’s take a typical easy trade’ he said. ‘We were selling RB1 coal to India. I bought a panamax cargo off a very regular supplier. Now RB1 is RB1 right? Terms for that are 100% load port test. Standard. I take it, ship it, buyer unloads it and calls me and says ‘this ain’t RB1 buddy. It’s too late for me to do too much about it with the seller as he’s been paid. My buyer is hopping mad. I end up having to trim the price to get it accepted by the buyer. I’m out of pocket. So what happened?’

Me and Ryan were listening to him silently, thinking ‘Say nothing and I won’t look stupid’. He fires up ‘I’ll tell you what happened. They took some RB1, got it tested and its all OK. Then like a miracle some other coal got in there and got mixed up with my nice RB1 that I paid for!’ he howls. is this standard? ‘Well yes, but today it’s worse’ he said. Give me some examples?

‘Now I’ve seen a stockpile of grey iron ore on Monday turn into nice orange iron ore on Tuesday. I went to a coal trader’s office and he showed me a cupboard full of blank test reports from a very well known testing company. All ready to print when required. The stamps were there as well.’ I was starting to get a bad impression here so asked him to describe a really bad one. Surely it can’t be that bad?

080413-N-7643B-009 A U.S. Navy search and rescue swimmer jumps out of an MH-60S Knight Hawk helicopter assigned to Helicopter Sea Combat Squadron 21 during a search and rescue exercise in the Persian Gulf on April 13, 2008. The Knight Hawk crew is deployed on amphibious assault ship USS Tarawa (LHA 1), which is conducting exercises in the U.S. 5th Fleet area of operations. DoD photo by Seaman David A. Brandenburg, U.S. Navy. (Released)
He missed the inspection of the cargo at the port.

‘I know a guy who didn’t check an iron ore cargo before it was loaded and didn’t attend the inspection by the testing company. He got told by his boss that he better get a helicopter out to the ship, which had sailed with no certificate from a testing company in hand. He couldn’t do that of course. The testing company strangely failed to produce the certificate so the LC couldn’t be cashed until the ship arrived off China 30 days later. Then it showed that the cargo was 7% down on the FE content. That was rejected, no LC paid, the ship couldn’t go back. Stuck paying demurrage. To make matters worse, this guy decided to try to fake the test certificate. That’s possible of course by paying a bribe, but not helpful. The idiot then went and paid a $10,000 bribe to the wrong testing company! A nice lady there had a great Christmas courtesy of the strange man from the East.’ By now my man was boiling.

‘It got worse. The cargo got rejected, but the ship was on demurrage, so they paid off the owner to discharge it into a bonded yard for a premium. It was discharged and they all flew to China to sell it on the ground. It turns out when they got there it was not in a bonded yard. The original buyer had paid the port handlers to move it into into their own yard. Now it has been rejected, the ship was gone, it was in somebody else’s yard which they had no access to and funnily enough they got a bid from the yard owner at shall we say ‘distressed seller’ prices. That little lot cost them $3m, their entire reputation in the Chinese market and when they complained to the miner they found out that he’d already been murdered by a previously disgruntled buyer. And I’m not joking. Dead.’

But surely at least it is all done by LCs? ‘Bah! Big companies use small banks. The LC process is a massive tune up in terms of fees. So the banks are fighting for a big importer’s business. You present your documents as a seller per LC terms then nothing happens. You pretty much always get the first payment as you’ve got the bills of lading (in theory – provided you’re paying the ship owner), but everyone knows that’s fiction so it’s factored in. When it comes to balance payment, firstly the testing agency at the importing port seemingly never get around to it. When they do you can expect at least 1% off the quality that the load port report said. That depends on who bribes them the most. Incidently I don’t think it even gets tested most of the time. I went to a testing facility once and saw about 10,000 unopened bags of coal. They just clip off a standard amount based on the origin, then have the biggest summer barbecue ever. Then the bank just sits on the payment until the buyer gets round to saying ‘OK pay them’. And that is an irrevocable LC!’ he raged.

It sounded like a pretty rough sort of business. ‘Rough? I had a fist fight on a bulk carrier at anchorage two miles out to sea when the testing guys, all eleven of them, spent the whole day asleep. I woke ’em up to ask if they were going to test and ended up going at it with half a dozen of ’em until the crew intervened. I genuinely thought I’d have to stay on the ship until it got to Singapore as the trip on the lauch back to shore with the locals looked, to put it mildly, a bit dangerous.’

‘So what would you say to a ship owner thinking of getting a bit closer to the cargo?’ I asked, while bracing myself for the onslaught. ‘Well, this is literally skimming the surface of the top 100 scams and rucks. If you work in an office in a reasonable city then get your kicks by being welcomed onboard a vessel you’ve chartered like Prince Charles. Take some pictures of you in a boiler suit with a load of smiling crew members, have a beer with the captain and then head straight back to where you came from. Leave the rest of it to the poor hapless idiot who actually owns the cargo. You’ll recognise him because he’s the one who’ll look like Christopher Walken at the end of the Deer Hunter.’

Cargo owner talks to sampling agents on board the ship.
Cargo owner talks to sampling agents on board the ship.

This week I decided to stay indoors. I am not going to moan about shipping, or anything else for that matter, but I’ll leave you with a joke. An old ship owner dies. Not surprisingly he goes to hell. When he gets there the devil tells him that he needs to pick a room to stay in for eternity. He looks into the first one and sees a group of men covered in blood all fighting eachother. ‘Ship brokers’ the devil says. The next room is full of people being repeatedly slapped around the head with large planks of wood until they are black and blue and bleeding. ‘Ship owners’ says the devil. The third room is full of men standing up to their knees in human waste sipping cups of tea. ‘Commodity traders’ says the devil. The dead ship owner says ‘This doesn’t look so bad. I’ll choose this one.’ And in he goes. He is given a cup of tea, but before he can take a sip a bell rings. Out comes a huge ogre with a huge wooden club over his shoulder who bellows ‘Alright lads, tea break’s over for this year, back on your heads.’

Poncherello, private equity & the men’s room

I got invited to a posh lunch at a private equity company last week. I flew up to Manitowoc, Wisconsin, the home of Pine Coffin Capital Partners LLC after receiving an invite from Frank ‘Ponch’ Poncherello, the chief investment officer and former colleague of mine when I worked for the California Highway Patrol back in the 1980s. Ponch hadn’t changed much. He was still the same macho rambunctious guy that he was back then, with me his straight laced partner on our Harleys. Today he had retired from unpicking huge highway pile-ups and had the easier more relaxed lifestyle of running a private equity business.

On the flight up there I read the website. They are patient investors who like to partner with blah blah. Yep, the usual nonsense that all PE companies put on their ‘About Us’ page. No mention of Ponch trying to impress a good looking lady with his disco moves once a week, or us racing against time to defuse a battery about to explode on an intelligent experimental police robot.

He now runs a private equity investment business.
He now runs a private equity investment business.

After a good solid lunch of boiled moose buttock and french beans cooked by the ‘in house’ chef, coupled with a cold beer or two and some chat about shipping I had to excuse myself from the table to de-ballast. I noticed stuffed behind the cistern was what looked like a brochure. I fished it out and read the cover ‘A Guide To Shipping For Private Equity Investors’ – dated 1992. Other than a couple of pages ripped out towards the back (It was the chapter ‘High Yield Bonds’ – I’m guessing they couldn’t find the spare toilet tissues) it was pretty much intact. The final chapter was entitled ‘Terminology – Translation of Shipping Terms’. I quickly flicked to it and got comfortable. Here’s some extracts:

Pre-Investment phase

Volatility – if said before you invest it is ‘how we make money’

Volatility – if said after you have invested it is ‘why we lost money’

Opportunity – tall tale

Third Party Management Fees – how the owner gets rich

Experienced professional – check High Court records

Cyclical business – you will lose eventually

Cyclical low – we’re broke

Play the cycle – buy high/sell low

Ship owner – Bond villain

Operator – chancer

Commodity trader – robber

Commodity trading house – robber in a house

Long term customer – people we let screw us over

Private equity – mugs

Hedge fund – unicorn rancher

Capital markets – Willy Wonka’s factory

Entry point – best guess

Exit point – bankruptcy

Access to market information – plays golf with a broker

Business model – Powerpoint presentation

Research – Excel spreadsheet

Under-valued – obsolete

Niche sector – dead man’s shoes

A man died wearing these. Try them on for size . . .
A man died wearing these. Try them on for size . . .

Tax efficient – dodgy

High quality tonnage – over-priced crap we want to unload on you

Forward looking statement – guess

Good reputation – always pays brokers

Today’s asset values – the price at which you are about to buy our liabilities

Diversified group – we won’t share the profitable stuff

Family interests – all the good stuff you’ll never get your hands on

Focused strategy – no strategy

End of Year One

Current market – market of six months ago

Core business – bit that we can explain

Business unit – unmanageable employees (often in overseas location)

Peer group – other chancers

EBITDA – Brazilian pole dancer who did the christmas party last year

Discount to NAV – you now own our over-valued assets

End of Year Two

Restructure – no idea what we’re doing

Cash requirement – preparing to run for it

Equity injection – management are updating their CVs

Challenging markets – give it a month and we’re bust

Financial accounts – Disney classic

Profitable – break even

Break even – loss

Small loss – massive loss

Loss – bankrupt

Balance sheet – game of Jenga

Mark to market – see ‘Financial accounts’

Hedge – loss

Profitable hedge – hedge we didn’t understand

Cost cutting – stuff we can’t get away with anymore

Long runway – we’re past V1, but no hope of getting over the airfield fence

Optimistic outlook – we’re doomed

Positive outlook on China – run out of ideas

Chapter XI – longest chapter in any book about shipping

If only this hadn’t been hidden in the men’s room in a tiny office in northern Wisconsin since 1992. It would have been nice for all the ‘patient’ guys who are now stuck up to the wazoolahs with problems to get a better read on ‘shipping speak’. To add insult to considerable financial injury, they are actually getting the blame for today’s woes from some folk for ordering ships. How many private equity funds got into shipping totally out of the blue, receiving no advice from an ‘experienced shipping professional’?

Stepping out for a quick coffee from a private equity shipping meeting
Stepping out for a quick coffee from a private equity shipping meeting

After our most convivial catch-up lunch, Ponch drove me back to the airport. He said that he was thinking of getting back into shipping again. I smiled, looked him in those twinkling eyes and said ‘Then you better look down the back of the toilet in the men’s room. I think you’ll find all that you need to know back there.’ We said our farewells in the manly way (hug is fine, but pat the back, do not rub it) and I slipped my Walkman headphones on and pressed play on ‘Crocodile Shoes’ – the Jimmy Nail cassette single that I liked to play to calm my nerves before flying. If it’s patience people in shipping wanted, they’d be better off hiring Dr Kildare.

New York, Pound Shop and discount charter parties

‘New York! Just how I pictured it’. These are, of course, the words of Stevie Wonder from his hit tune ‘Just Enough For The City’. And so, with the vision of Stevie to fall back on, to New York, and the manicured lawns of southern Connecticut, went the maritime conference circuit last week. It always amazes me that New Yorkers use the word ‘like’ so often, particularly as they are usually explaining something that they actually don’t like.

To the Capital Link shindig my thoughts wandered. I’m not sure if there is a collective noun for people who lose money (whether theirs or somebody else’s), so I’ve invented one. Here you found ‘a bulker’ of losers. Examples of companies that went bankrupt when the market was far higher, and yet they are still strumming the same three chords from the same Status Quo song. If you went bust when the market was three times higher and haven’t changed the tune, then, well, ummm, maybe . . . . Some shipping companies must have unbelievably good boardroom biscuits considering how often their bankers keep turning up for pointless meetings about rescue plans that are less plausible than the plot of Con Air.

The only reason that bankers show up to meetings at shipping companies.
The only reason that bankers show up to meetings at shipping companies.

I must confess that I didn’t go. I must confess further that I would rather stay in Airdrie and empty my dog’s anal glands than sit through another panel of ‘bulkers’ tipping us on when the Chinese economy will rescue their hopelessly antiquated business models. But me being me (unless when booking a table at the Harvester in Luton, where I pretend to be someone else after my lifetime ban for crashing the salad cart through the glass doors and running down the high street with it) I knew people who were there. By the way, just revisiting the Harvester for a moment, how come I was apprehended and charged with theft and criminal damage when the waitress clearly said ‘Help yourself to the salad cart’?

So back to New York and also the many cocktail parties at CMA. My spy there was a trader friend who goes by the name of Stavros McTavish. His Dad went to watch Scotland play in the 1978 World Cup in Argentina, got on the wrong flight home and ended up settling in Piraeus. Stav may be a bit slick when it comes to some of his trading manoeuvres, but he knows the difference between fillet steak and horse meat. In my eyes his opinions count. So I was delighted to hear that he ran into a mutual acquaintance of ours, a man we call ‘The Pound Shop Onassis’.

Pound Shop likes to talk about Pound Shop. Usually he does it loudly, but always he picks his audience like OJ’s lawyers pick a jury. In an ideal world he will hold court with people he pays (brokers mostly), people who know absolutely zero about shipping (private equity bods mostly) and those who haven’t realised that if you haven’t realised who is the dumbest in the room, if Pound Shop is there then it’s him (journalists mostly). But never, ever will he open the floor to questions as it would become clear that he has no practical answers.

From humble beginnings come humble intellects.
From humble beginnings come humble intellects.

Stav told me that Pound Shop had found such an audience in the corner of a drinks reception hosted by the Maritime Sanitary Towel Providers Association of America. He was braying at the assembled onlookers who wore expressions of people who were trying their mother in law’s cooking for the first time. Stav sidled up so that he could eavesdrop.

‘I tell you pal. Even by Pound Shop’s standards it was stunning. He told them that he was the only man in shipping who could correctly price risk. That’s why he was making so much money trading FFAs’ laughed an incredulous Stavros. Now I might not be totally on the pulse when it comes to who trades what, but I am very certain in the case of Pound Shop that he doesn’t trade FFAs. He’s had the opportunity at every company he’s ever worked for (and left smouldering like a tyre mountain once finally kicked out), but never pulled the trigger. I remember having dinner with a broker pal when we bumped into Pound Shop. Sweating, drunk and loud, he bellowed at his fellow diners ‘This guy is my FFA broker. What a guy!’ My mate reliably informed me when out of earshot that Pound Shop would call him at odd hours, ask some stupid questions, give him an impossible spread to trade then disappear again with nothing done. ‘Just a lonely bloke’ he concluded mournfully.

Interestingly Stav told me that while parting his fellow drinkers’ slicked hair in Connecticut, he regaled them with his best trades of the year. ‘I wrote them down just to make sure I didn’t get it wrong. When I got back to the office I confirmed what I suspected all along. Every trade was a loser,’ he laughed. Luckily for his employers, Pound Shop no more did those trades than I can get my dream date with Samantha Fox. However, there was something that did require closer inspection in those ill-chosen words of his.

There is more than a nagging suspicion that risk could be priced more efficiently on a structural level. Take a typical trade in the dry bulk sector. The cargo seller is a grain house for example. The ship itself is owned by somebody with a fleet of 20 vessels. The cargo buyer is also a grain house. The ship is on time charter to an operator. Now one of these participants in the chain has no assets and is very much in the cash flow management business on a limited credit line for which it pays good interest. The rest have large balance sheets, access to deep pools of cheap trade finance and assets to back it all up with. The operator is really ‘back to back’ trading between ship and cargo owner, with a time lag in payment terms.

So on which of these entities should the risk be most efficiently priced? There are only two parties to this whole shipping transaction who have to play the cash flow game. The first is the operator, who is paying up front for the time charter hire and port costs, and secondly the bunker supplier who will give payment terms to the operator based on risk profile. So it is pretty clear that the credit risk is actually placed on the riskiest part of the deal. The typical operator can find themselves sat on a pile of invoices ready to be sent out to companies with investment grade ratings. Yet the operator, the weakest link in the chain is the one being leaned on.

Spot the operator in the credit chain.
Spot the operator in the credit chain.

I called Les Miserable to see what he had to say about this. ‘Yep, it’s true. I spend more of my time here juggling cash flow than actually thinking about what’s best to trade. I know we’ll get paid, but it’s like being a hamster in a wheel’ he explained. Has he thought about other ways around this. ‘Yep. I came up with a really good way to deal with this. There must be a market for something here,’ he pondered.

He was recently in exactly the position where he was owed millions by good credits for outstanding charter parties while additionally owing millions to various bunker suppliers and owners. So he approached one of the bunker suppliers and explained the issue. He had a supramax which he’d bunkered in Europe on its way to the Plate to pick up a cargo of grain. He was then going onto Japan to deliver to a major Japanese grain house.

The bunker supplier reviewed his charter party and, having been the supplier of the bunkers for the vessel going from the Plate to Japan, he knew it was a real fixture. He agreed to lend Les 90% of the total value of the fixture (at the time probably close to $3m), keeping back the outstanding amount that was to be paid for the original bunkers. Les got the grain house who had bought the cargo to assign the earnings to the bunker supplier and the rest is history. ‘We paid off a couple of outstanding bunker payments and it allowed us to quote and get another trade with a long ballast leg which, without the up front payment, we wouldn’t have been able to do,’ he concluded. ‘You know, the longer the ballast the worse it is. Sometimes we have to leave paying business just to be prudent,’ he moaned.

A pound of tomatoes and two front haul Vale's please luv!
A pound of tomatoes and two front haul Vale’s please luv!

Thinking about this, there is the possibility to take it a step further. For example, would a charterer offer an advance payment to a well trusted operator in exchange for a discount? Would a bank or fund offer a trade discounting service for charter parties with companies who’s credits are better than the operating company that is borrowing? Could there be a pool from which operators could commit capital then use it to cash in charter parties early? Like a clearing house for charter parties in essence.

A step even further would be to create a marketplace for people to offer charter parties for discounting, on which participants could offer terms and interest rates, the best terms winning the deal. This would essentially create a ‘crowd funding’ style of platform for freight which would ease the cash flow burden of operators considerably. After all when a company with no assets and a $10m unsecured credit line is the reference point for pricing risk in a chain where they are not responsible for the main financial risks seems odd, if not just plain wrong. Will a Rio Tinto or Vale pay you? If you think ‘no’ then you are in the wrong business. So knowing that ultimately the cash to pay to transport goods comes from these entities, why are the terms based on the asset-less service provider in the middle?

Fat Zeke, the budget and egg and chips for one

A drink with the boys these days isn’t half as much fun as it used to be. After the recent UK budget the new sugar tax is going to bite pretty hard in these here parts of Scotland, particularly for my buddy Zeke, who’s favourite tipple is moonshine mixed with ginger beer. Who knew that if he’d been adding Lilt to his hooch all these years then he may have kept his teeth from falling out and his weight under 320lbs? Admittedly he wouldn’t have been able to claim all that lovely disability benefit as he can barely walk, but then again the double whammy of paying more for his mixers while getting less for his medical worries seems a bit harsh to him. Still, as he brews his own liquor in his boiler cupboard, he’s skipped paying all those dues to The Man in the end. It was a win for the little guy, although in Zeke’s case he ain’t so little.

As we got to talking in the snug at the the Drumgelloch Bar (rated no.51 out of 51 in Airdrie on TripAdvisor) one of the boys told me that a packet of smokes now costs more than £10 after the Conservative government’s latest budget. ‘Even more in London I reckon’ puffed Zeke. Now I remember times in the dry bulk markets when things were rough. I also remember getting a helicopter to pick me and a buddy up from the office to take us to a casino. Shipping has its good times too you know, but let’s briefly focus on the bad again.

‘So how bad is it down there?’ I asked Slick Ricky Pratt, the best ship broker in London that I know. ‘Oh mate’ he said, ‘It’s more than a tenner for a packet of cigs now. I tell you what, with the commission I earned on a Capesize fixture I did today, by the time I’d parked the motor at the station, bought a copy of the current bun and got a coffee I’d spent all the bro I’d earned. So once I’d paid for the train into the office I was losing money by showing up. The boss wants us to work in the dark to save on the electric bill.’ Knowing his boss I don’t doubt that to be true.

He told me that one of his mates across town at another London brokers got an email from the CEO last week asking all of the dry desk to attend a meeting. When he went the CEO asked if any of them would volunteer to work from home for the foreseeable future. When one brave soul asked why, he was told that they wanted the desks so that they could get more tanker brokers in. This is the same brokers who’s chairman once strutted along the streets of London wearing a cape while wafting an ivory tipped antique cane like a slightly camp Jack The Ripper.

A dry cargo broker in the olden days of 2008.
A dry cargo broker in the olden days of 2008.

Such tales from the City are now rife. Smart Eddy told me that he went for dinner with his biggest broker last week. It turned out to be egg and chips at a Wetherspoons for him, while his broker had a tap water with ice. Eddy ordered a pint of Stella and was told by his embarrassed broker that ‘brand beers are not allowed on expenses until the 4tcs are back over $8,000/day. Now can you still reverse the charges on pay phones? I need to call a client and I’m out of 20ps’.

All of these tales, while titillating, are not really why I am bending your ear today. It actually goes back to the UK budget: it turns out that the UK government is rubbish at forecasting its own economy. Please don’t take this as a political statement because this government is no different from any other in this respect. While it is going well they think it is because of them, but the circumstances cannot be replicated it seems, so each review seems like an exercise in pointing out how little they actually know about what happens and why.

The UK economic think tank doing the final edit of its forecast.
The UK economic think tank doing the final edit of its forecast.

I called up a very earnest young analyst who is a head global chief of worldwide research strategy (or similar) at a maritime data provider and asked him a straight forward question. ‘Do you make forecasts?’. ‘Oh yes,’ he trumpeted. ‘We have developed a model that can track and forecast freight rates in real granular detail. For instance I can give you a month by month forecast for the next five years on any single dry bulk route’. ‘How so?’ you may ask. ‘We take the bottom up approach, using all of the base case economic data available and building it into our forecasts. Then from there we take the relevant demand data to build a picture of what is happening to cargo and in what regions, helping to see a tonne mile as well as actual volume outlook’ he explained enthusiastically. ‘It’s all built by algorhythms’ he said proudly (because algorhythms are notoriously unshakably reliable right?).

The approximate number of variables in a freight forecast.
The approximate number of variables in a freight forecast.

Now I don’t know what you think, but we are now in a situation where his model in theory must be more capable of predicting the economic outlooks for individual countries themselves. He claims his output is accurate, so the components must be accurate. So he gets the economic forecasting for the UK right, right? One would assume that in his ‘bottom up’ model he pays close attention to the fortunes of the world’s fifth largest economy. So if he is so confident that one of the key foundations of his model is correct he should let the Chancellor of the Exchequer know his thoughts.

Alternatively, one might cynically put his efforts (which when back-tested look very convincing) into the category of ‘exponential guess work’. This means that by using thousands of guesses of thousands of different factors, while not realistically being able to forecast their changing relationships (even if you could truly understand their current ones), you can come up with one single figure for one single route by month for the next five years. The path to this number is so complex and circuitus that questioning any single input into it becomes entirely meaningless.  That can be deflected by the phrase ‘It was built using algorhythmns’ one assumes.

What does the future hold then? Let’s be frank here, whether you are George Osbourne, fat Zeke, Slick Ricky Pratt or Nostradamus, your guess is as good as mine. Smart Eddy put it more bluntly; ‘If oil is $38 for the balance of this year, iron ore is $50 and the meaning of life is 42, does that tell me when I can order brand lager again when my broker takes me to Wetherspoons on a jolly?’

 

 

 

 

 

Wikiships, Vim and Old Meg

My mate Les Miserable recently described me as the Julian Assange of dry bulk shipping. I assumed because of my tireless pursuit of the truth. He said no, it was because I have a personality which would be more likeable if I was locked away from the public view. That was not far from the truth this week (the locked away bit, not the personality bit) as Julian sits trapped in the Ecuadorian Embassy in London waiting to see if he can avoid a trip to America, while I sit trapped in the Premier Inn on the Forfar ring road, waiting for some UPVC windows to be fitted in my penthouse bedsit over Frank’s Chip Shop in Airdrie high street.

It gave me time to read a lot this week, passing the time between repeats of Homes Under The Hammer. While skimming the increasingly disappointing Linkedin pages I read with keen interest a post suggesting that now was the time to buy a ship. Now my Ford Capri isn’t the only thing I’ve brought with me from the 80’s. My recollection of ships making a one way voyage from the launch to the scrap beach always makes me think that when you see light at the end of the tunnel it could actually be somebody with a torch bringing you more bad news.

franks
The new windows at Prospector Towers, Airdrie.

So it seemed like a good time to go see Vim Van Vinky, a particularly smooth old friend who suns himself down in the Mediterranean. Vim picked me up from airport in cheery mood. He smiled to himself as he tapped his finger on the steering wheel of his 4×4 while Boys Boys Boys by Sabrina played on Tax Dodge FM. Life was clearly pretty good for Vim. As we swerved along the coast road I asked him what his secret to happiness was, because everybody else is about as cheery as the attendees of the ‘coffin building for pensioners’ course at Airdrie Tech.

‘In 30 years in this business I’ve never lost a buck in shipping’ he said. Well I suppose that’s true. His investors might have lost billions in that time, but he was right. He personally had got stinking rich. As we sat in a bar by the harbour looking at the yachts, him in his Ray Bans sipping a Bellini, me in my England away strip (vintage circa 1994) eating my Duty Free Toblerone for lunch, I popped the question. ‘Should I think about buying ships now?’

Vim sat back, took a deep breath and fixed me with an intense stare. ‘Well, what you need is somebody with real experience to advise you. Somebody with a track record.’ Like you Vim? ‘You could do worse! Hahahaha!’ Some have suggested that the only way to make money with Vim is to actually be Vim. But much like what Vim used to say when he sold second hand carpets in a previous life, never mind the quality, just feel the width.

He talked about supply, demand, Greek asset players, Chinese economics, interest rates, leverage, iron ore demand, the list of things that make people nod along when talking about shipping. ‘This guy really knows his stuff’ you often hear. Some 25 minutes later he had made a case using all of his experience and weighing it all up. ‘So what’s your conclusion then Vim?’ I pleaded. He held the last dregs of his bellini up to the Mediterrean sunshine, rolled the glass between finger and thumb, then slowly slid the bill across the table towards me. Without looking away from the endless blue sky he simply said ‘It looks cheap. Why not?’

Time to call Smart Eddie – the biggest frontal lobes in shipping and the mother of all sceptics. ‘Well for a start I don’t want to speak to technical managers, spend huge amounts of time and money on surveys and reports that, to put it mildly, I wouldn’t trust. I don’t want to worry about P&I Clubs, have meetings with 1001 different service providers from armed guards to caterers. So on that basis, buying a ship may very well be cheap, but the amount of management time in running the thing eats into your opportunity cost enormously. It feels like it would be better to pay all of the service providers half the money to not do it,’ he told me from a ski lift somewhere near Zermatt.

‘Put it like this. Sponsors of asset buying vehicles always tell you about the high level of experience the various technical and commercial managers have, about how they can charter out to the best in the market, get the best deals and so on. But you’ve got to remember that the only people who are guaranteed a return on the venture are the service providers and often the sponsor owns the service providers too.’ Heads I win, tails you lose.

Call this guy before you pick up the phone to somebody selling a shipping fund.
Call this guy if you want to invest.

‘So how can I avoid the traps set for me by the conventional investment vehicles?’ I asked him. ‘I’d consult a shaved chimp before any of these advisors and sponsors,’ he snapped back. ‘What if I could do all of this without ever having to listen to anybody tell me that ‘shipping is different, or a ‘people business’? The smartest brains on Wall Street have fallen for many snake oil sellers that pop up out of the woodwork with a tale of vast riches and long track records. They miss out the bit that the industry is currently bankrupt as a result of people using exactly the methodology that they themselves are peddling. Now I’ve got to go as me and a bankrupt ship owner are heliskiing and I think that the chopper is landing in a minute’ were his parting words before I heard a muffled cry over a background of whirring blades.

60% of the time it works every time.
60% of the time it works every time.

It does appeal to have a way to invest in dry bulk either through my belief in rising asset prices or rising earnings, but never have to get my hands dirty running the darned things. What if Old Meg, my trusty calculator, was telling me that today I should own an asset and sell the earnings as an arbitrage. Then tomorrow the earnings move and Old Meg tells me that I should be long the earnings and short the asset value? All you need to know is the asset value, the break even and the FFA forward curve and you have a really interesting way to get away from much of the cold stew that is currently served.

Once on a trip to New York, Vim and I were leaning up against the bar of an expensive hotel with some investor folk in tassled loafers, way past midnight, and he says ‘Well, shipping equities always trade at a discount to asset value’ They all nodded along and asked why? ‘People who invest in shipping know nothing about it,’ he declared. I thought that maybe actually they might know something and that perhaps (and I’ll whisper this) it’s the asset values that are wrong and not the investors.

Before Vim dropped me back at the airport I did have a chance to ask him ‘What about the idea of a derivative I can trade based on ship values? Then I can choose if I think capes are cheap. I can choose to buy vessel values and sell earnings.’ ‘But who’s going to do all the shipping?’ he said. ‘And how on earth am I going to make money from it if everyone knows the secrets?’ he added with a wink and a swagger before disappearing through the crowd of sunburned Glaswegians in sombreros and Rangers shirts who, like me, were headed back to Scotland in a state of befuddled confusion.

Bunkers, Bob and The Bandit

I was stuck into a particularly fiendish Sudoku puzzle on a flight back to London from Singapore recently when I happened to notice Boring Bob, an old neighbor from my time living in Climax, Georgia. He had his seat reclined as he roared out loud while watching a rerun of ‘Just For Laughs’ on the AVOD. I slipped though the curtain from my bulkhead seat, stepping over my colleague Fat Andy who was snoring loudly with his shoes and socks in the aisle and approached old Bob. After a few minutes of catching up I noticed a tanker report on his table.

So over an airline-style Bloody Mary (warm tomato juice, a splash of Worcester sauce, a pint of vodka and an ice cube) we got talking about what he was up to in tankers these days. It turned out that he was now a tanker FFA trader for an owner, having previously worked at a couple of very big swingers in the tanker market. One was an oil major, the other a Wall Street bank. Bob had the second biggest house in our street in Climax, Georgia until he moved to New York, the biggest being mine.

Population 228 when Boring Bob left for Singapore to trade FFAs.
Population 228 when Boring Bob left for New York to trade FFAs.

I really know less about the tanker market than I do about where to go for fun in Pyongyang, so I thought it was a good chance to ask him a few little teasers to see if it would help me run my dry bulk business. One thing that has always bothered me is the question of bunkers. People in proper companies seem to always call it fuel oil, but it pretty much amounts to the same thing, the stuff you put in a ship’s engine to make it go.

Many years back Bob got poached to go work for this mega-tonne white shoe bank on Wall Street, with a sign on that could have bought the whole of Climax had he so desired. So he was paid well to trade tanker FFAs. Nothing else mind you, just tanker FFAs. His main market was TD3, which I am told is Arabian Gulf/Japan in VLCCs. It trades in Worldscale, which apparently is not measured in feet and inches. I cannot be bothered to explain Worldscale to you here, I suggest a well known search engine can do that for you. What I do know is that it does contain two elements; freight rate and fuel oil cost. So if you trade TD3 then by definition you will be taking on fuel oil exposure.

So I asked Bob what did he do about hedging it? Well he told me that one day at the bank he put on a small trade and decided to hedge the fuel oil exposure. He had to walk across the trading floor, which was the size of a football pitch to find the fuel oil trader to make him a market. Firstly, it was a long walk. Secondly, Bob didn’t know the fuel oil trader. Thirdly, inevitably the fuel oil guy would laugh at the tiny cover Bob needed, tune him up on the bid/offer as Bob couldn’t see his screen and also, most crucially he would now see a small part of Bob’s PnL.

Old Bob did hedge one trade and all of the above happened. The fuel oil trader was known around the desks as ‘The Bandit’, and The Bandit had no problem telling everyone what a horrid trade Bob had done. Cue shame, embarrassment, humiliation and the whiff of violence. So Bob told me that he made a plan. He worked out that in fact the fuel oil risk wasn’t so bad as to make him want to cross the floor and deal with The Bandit. Instead he did what all quality traders would do in the circumstances and decided to hope for the best and leave it unhedged.

Just your regular Fuel Oil Trader.
Just your regular Fuel Oil Trader.

Now Bob is a very straight guy. He vacuums in straight lines. He makes lists of lists that he needs to make. So what he told me really was pretty revealing. Sure enough Bob told me that he decided that some time later, after picking at the edge of the scabs of the market, he needed to make a VaR-busting name for himself at the bank. He put on a trade on the same TD3, which he described to me as chunkier than a Georgian McDonalds worker. He also did it unhedged.

It was a Friday and only the sad, desperate and the criminally insane trade freight swaps after midday on a Friday. Everybody else is drunk by 1pm so no need to worry. Bob took the afternoon off and left early for a weekend fishing trip in Scotland. After the hour-long flight he casually flicked on the Blackberry to glance at his PnL. Now nobody trades freight on a Friday afternoon, but they do trade crude. And crude had tanked. So had the fuel oil, going down with it. The freight element, for which he was paid to trade, was unchanged. The fuel oil had gone down the crapper and to his horror he’d booked in a marked to market loss of $250,000 over that one hour flight!

How could this happen? If Bob had taken some of his VaR cash and bought a consignment of hover boards and lost 250 grand I think it quite likely he would have been fired. Putting it simply he lost $250,000 because he had taken on exposure in a market that somebody else was paid to trade and simply didn’t know what he was doing. His words here, not mine! This is actually a more common theme than one might imagine.

Bob’s dislike of The Bandit was issue one. It is worth, as a manager, investing some time in working out if every person who has to interact as part of the trading and risk management process can walk past each other without thinking about drowning the other one’s kittens. Issue two was that Bob was not allowed to have a live fuel oil price screen on his desktop. Effectively he had no access to control the risk for a large part of his trade. That was The Bandit’s job, and he knew Bob’s predicament so would tune him up on the bid/offer and serve up general abuse as a free gift for loyalty card holders to boot.

The ‘solution’ Bob elected to use was that he was allowed the ICE Brent screen on his desktop. Brent is a decent proxy of fuel oil, but hardly perfect. Recently the Rotterdam and Singapore bunker prices have fallen far faster than the crude price. This relationship I am informed is called the crack spread (even I’m too proud to be making jokes about that one by the way). This is not constant and displays volatility. The east/west spread on bunkers is also variable, and all of these elements can and often are traded as part of sensible arbitrage strategies.

I did think that there were some lessons for my dry bulk business though. Clearly unforeseen internal dynamics can actually cause the business to take on risk that it did not intend to, and also might well be failing to capture, manage or price it correctly. Also, even the simple bunker hedge has many aspects; Brent vs WTI, East vs West, crack spreads, forward curves and so on. When dry bulk businesses operate on margins thinner than Yoda’s hair, it is a crime not to sweat the small stuff. This is in my control, unlike the general market direction. The last part is that it seems imperative that each trader can dissect his product into all of its moving parts and manage them properly.

Should Bob have had access to the fuel oil market? What if Bob was long, then The Bandit went short? The market roofs and Bob is a hero while The Bandit puts down ‘What Porsche’ magazine and starts thumbing the used Ford pages of ‘Auto Trader’. Bob lands a big bonus, The Bandit gets nothing and the company is left with a PnL which took no real market risk while using up VaR, made no net return and yet paid Bob a bonus for his troubles. Bad work all round.

Amazing what you can learn over a strong Bloody Mary.
Amazing what you can learn over a strong Bloody Mary.

So what was the conclusion one might draw overall from this tale? Bob says that he hedged the fuel oil using his Brent on his ICE screen (which for some reason he was allowed) for a while, basically making him hedged a bit in the right general direction. However, in no way could he say for certain that the calls he made on freight would be reflected perfectly in his PnL. After a while he told me that he started to think that actually the oil was the only interesting part of most of his trades, so he just gave up hedging altogether. None of his bosses even noticed.

I asked him what his one take away from this whole tale would be? He finished the last drop of his Bloody Mary, the ice cube that was stuck to the bottom of the cup fell painfully onto the bridge of his nose as he upturned the plastic glass. With tomato juice gently dribbling down his chin he fixed me with a cold brown-eyed stare and said: ‘That’s easy. The Bandit is an asshole’.

Mr.Prospector thinks Capesize purchases

The other day I was sitting in the economy class lounge at East Midlands airport, sipping a non-vintage Cava from a plastic flute while humming the theme tune to ‘Bonanza’ when who should I see across the way, but my old buddy Pippy. Pippy is a high flyin’ dry bulk trader who’s worked for the best of the best out there. I siddled up to him and said ‘Howdy’ and we shot the breeze for an hour or so waiting for our flights.

I asked him why he thought all these rich dudes are buying up Capesize ships at the moment. I told him about my plan to create a floating health club using a Capesize (tennis courts on deck, squash in holds 1 and 9, a weights room in 2 and 8, with spa and sauna plus a bar and changing rooms in the rest). He didn’t take to it well, but he did point out a few interesting facts and figures for me regarding buying a ship right now.

A modern capesize vessel was sold from a listed company into private ‘old money’ of shipping for $19.2m not so long ago. Basically that ship will need to earn about $11,400 per day over its life to break even. One argument is well, that’s darned cheap right? Historically yeah, I guess it does look cheap. But hang on there partner. It’s only cheap if it makes you money, and this one looks like it might not be a money spinner.

Granted, a lot of the buyers of these capesizes are also tanker owners who are choosing to take their chips off the table there while the cards are still running hot in order to place them somewhere where the luck must surely eventually change. Pippy showed me a little graph which I thought I would share with you, which puts prices vs earnings into some kind of historic format.

What Pippy was telling me was that if you take the value of a ship, then divide it by its earnings over the next five years then you come up with a ratio. When a ship costs $20m and it earns $20m then the ratio is 1.0. The higher this ratio gets frankly the better it is to sell a ship rather than buy it. Pippy took the FFA forward curve to model earnings over the next five years, in effect creating an arbitrage window for owners of tonnage or those wishing to buy.

On my way to Airdrie, pondering to buy or not to buy.
On my way to Airdrie, pondering to buy or not to buy.

This graph shows that buying a ship right now isn’t the best deal, but is far from the worst. The ratio for the $19.2m ship comes in at 1.25, kind of better than most ratios, but not at the end of the normal distribution curve either. Now let’s talk bucks here. The average earnings over the next five years of the FFA curve when we were chatting was $8,481 (average of the 4t/c’s, not the 5 t/c’s).

graph1

So the buyer is committing to funding a loss of $5.43m if he bought the ship and hedged the earnings. What Pippy said was that it looks a decent trade if you take the other side of it. The guy who sold his ship could now take some of that cash (once he’s let his bankers off the hook) and buy the long dated FFA curve. It looks a bit like an options trade right? Like a slightly odd shaped covered call, but using the earnings as cover.

What Pippy had to say certainly got my head thinking. My weekly stats round-up will have to give this more context, detail, different ship types and granularity. Pippy jetted off in his flat bed seat, destination Monaco, cursing the penny pinching that dry bulk traders are having to do to survive these days. I headed off into the night, watching the bright lights of Newark twinkle below me while tucking into a bag of Wotsits and a mini Mars Bar that I had unfortunately sat on, looking forward to getting home to my one bed flat in Airdrie.