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CANCELLED
WORKING PAPER
ALFRED
P.
Time-Charter Rates
by
Zenon S. Zannetos
Sloan School of Management
Massachusetts Institute of Technology
MASSACHUSETTS
INSTITUTE OF TECHNOLOGY
50 MEMORIAL DRIVE
CAMBRIDGE, MASSACHUSETTS
02139
Time-Charter Rates
by
Zenon S. Zannetos
Sloan School of Management
Massachusetts Institute of Technology
i<
This was prepared for the 25th anniversary issue of Sun Oil Company
Analysis of World Tank Ship Fleet.
Time-Charter Rate^
by
Zenon S. Zannetos"
The purpose of this paper is to analyze the factors which affect the
level and structure of time-charter rates.
charter rates for the period 19U9 through 1959 were mainly affected by the:
it
Management and the MIT Computation Center are also gratefully acknowledged,
^Zannetos, Zenon S., The Theory of Oil Tankship Rates:
Analysis of Tankship Operations, MIT Press, April, 1955.
An Economic
1,
2,
3,
U,
The conclusion was also reached at the time that, in general, normal
costs,
charter rates.
rates was found to be stronger the longer the duration of the charter
agreement.
the size composition of the operating fleet that we are witnessing, these
of rates during the period of 1959 to 1966 should exhibit greater variation
Another conclusion that emerged out of the 1949-1959 analysis was that
the spot rate affects the level of time-charter rates as well as the duration
of the agreement and the lead-time between the point of transaction and de-
about the future, when spot rates were high so were the time-charter rates and
the longer were the duration of the agreements and lead times.
The combined
impact of normal costs and spot rates caused the level of time-charter rates to
converge asymptotically to the normal rate (normal cost) from both above (when
^We define as normal cost the time-charter rate (normal rate) which will,
over the life of the vessel, return to the owner 8% on his investment after
taxes (using discounted cash-flow analysis).
3-
the spot rate was greater than the normal rate) and below (when the spot
rate was lower than the normal rate) as the duration of the contract increased.
analysis.
X.
X- =
DV.'T
Xj^
100
Intascale points
X. =
o
Intascale points
op . cit .
For more on this see The Theory of Oil Tankship Rates , "^
Chapter 9.
The size (X
of time, influences expectations about the present and the future market
Realizing that
in the spot market we have a whole structure of rates due to the various
ducing the correlation between the particular level in spot rates and the
spot rate of vessels reflecting economies of size,*^ so that we can better
and X
sam.e
manner.
V.'hen
market conditions
v;ere
duration of the contract and lead time the lower was the time-charter rate.
Under depressed market conditions the opposite was observed.
Extensive tests were conducted during which the marginal vessels were
chosen such that the spot-rate deviations from these marginal spot rates
for all vessels chartered in the spot market were almost completely uncorrelated with the level of marginal spot rates.
5-
The latter
Xj.)
under conditions of normal employment for tv/enty years, 50 per cent tax
rate, use of the sum-of-the-years
'
per
The purpose of
variable X
fa
rates.
a lo;;-
for
with stratified data (by level of spot rates and size of vessels chartered)
and the results are shown in Tables 6, 7 and 8.
Certain characteristics of the data used for the analyses and which are
-6-
viously asymmetric.
(b) The mean marginal spot rate and the mean spot-rate equivalent
charter rate.
between the mean marginal spot rate and the mean time-charter
rate (for a mean size of 50,000
DV.'T)
us to
leads /conclude that market
(c) The mean differential (X )(i,e. the differences between the actual
G
This also reflects the fact that some large vessels are chartered on
private terms.
-7-
deviation of
X^
The standard
(d) The average time-charter duration was 69.5 months but the vari-
These hypotheses we
and
we notice that:
size the lower the rate as some of the economies of size are
very insignificant.
>
anti
X_
(the ipot
(extending over
rates is negligible.
relatively calm.
v/as
It did not exhibit the v;iia fluctuations in spot rates v;hich oc-
This we
It must be
v'lUe
the contribution of
-9-
variables X^, X
and X
X,
is rather insignificant.
v/e
vessels earn more than 8% return while the smaller vessels earn
The subsequent stratification of the data by size of vessels
less.
the vessel the lower the charter rate because some of the economies
of size are passed on to the charterer.
V.'hat
proportion of these
savings remains with the owner, however, depends upon how efficient
his vessel is as compared to the average.
Tables
and
provide em-
pirical evidence that the larger vessels earn a higher rate of reSo in effect size affects the general level of time-charter
turn.
(negative) and
-^
16'^
X,
and X^ (positive),
-10-
complete agreement with theoretical formulations advanced previously^ and which will also be used for our discussion under
Part II.
(which
X^ and X5) the signs of all the correlation and the regression
ment and the charter rate are negatively related (although not
Also the
X,-
showing
We
fidence level.
-11-
and Xj-.and X^ indicate that the larger the chartered vessels the
results of Tables
and
gression coefficients of
Ail
).
Because X
5.
(the difference between the actual and the break-even time-charter rate)
ranges over negative values it was dropped from the logarithmic r.odel and two
plus 35 Inta-
is X
8
X^
and
we ob-
(the other three variables only adding 1.4 per cent to the total variance ex-
plained) and ^7 per cent of the variation in X (the rest adding less than
The regression equation for X^ shows that the coefficient of X^ (spotrate level) is not important but all the other coefficients are statistically
-12-
In the case of X
is
in the strong intercorrelation between lead time and the other variables (es-
ferent levels of spot rates and also with different sizes of vessels, we stratified our data.
57''.-.
32-o
DV/T
over Intascale less 32% (the break-even time-charter rate of the smallest of
the marginal vessels) as
liip.h
rates.
In terms of size
DV/T
v;e
divided the
o.ata
into
and
show that:
1,
increase
shov;in,g
tlie
short run.
and
-13-
2.
tirr.e.
As Table
shows for vessels under UO.OOO DWT the mean duration was 42.1
For vessels of
40,000 DWT and over, however, the comparable figures are 97.5
and 13.3 respectively.
We
also note (Table 5) that as the level of spot rates rises the
No matter what the level of spot rates, size and spot equivalent
of time-charter rates are negatively correlated and size versus
X, positively correlated.
strengthened as the level of spot rates increases revealing possible heterogeneities in the size composition of the vessels
11
-14-
We also
This is
DV^T.
spectively.
50-o
re-
under 40,000 DWT 43% of the contracts were for five or more
years and 4.6% for tv;elve or more years, whereas the comparable figures for vessels of 40,000 DUT and over are
57.5% and 29%.
It
t?iis
effect.
-15-
U,
(mostly over
goes beyond Inta-18 the large vessels of 30,000 nWT and over
show a negative correlation.
are shouldering.
Section II.
25.
X
2
markets
5.
This is in complete
-16-
12
agreement with the theory that is fully developed elsewhere,
7,
This is
predictability of the models and points out once again the significance of the economies of size in determining time-charter
rates,
9,
develops its own notion as to what the marginal and normal vessels
are over the average duration of the contracts.
the differences between X2 and X
An analysis of
-17-
is expected
II
We will now use our knowledge of the time-charter market to develop and
test a model for determining time-charter rates for the long run.
The model
Factors Affecting the Long-Term Charter Rates for Tankers in the Long Run and
himself from certain vagaries of the spot market, and shifts certain risks to the cy.arterer.
Adjustments, therefore,
m.ust be
made
"""This is rhe rate which will provide an 8% return after taxes to the
owner of the fictitious vessel which is continuously marginal during the
time-charter agreement.
-18-
coordinative
systerr.
of their size.
market conditiona.
Once
The charter
If the owner
industry
in some cases,
-19-
listed in Table
equity financing.
To the ex-
tent that certain costs fall upon the charterer under a time-
(such as fuel
oil) any projected change in these costs will affect the cost
of the charterer.
premium.
This
A.
This will be true as long as the interest rate is lower than the average
return realized on the total assets invested.
-^^All other variable costs and projected changes are considered in the calculation of the normal spot rate.
-20-
rate for the chartered vessel, and also for the marginal vessels at
both the point of transaction and the point of termination of the
contract.
2.
The total cost of the risk of unemployment is that extra amount which
must be recovered over the time
that the owner will be willing to yield to the charterer close to the
l/2"6
-21-
exponential and combines both the size of the vessel and the
time-charter duration.
4.
25j
years.
vides for a down payment of only 10% and a twelve-year loan for the
rest (90%) at 5% per year for twelve years.
oil consumption the greater the premium it will merit in the market.
If it is assumed that costs are expected to remain the same this vari-
B.
-22-
stress that the operating data, especially for the largest tankers, were pro-
Operating
portant part of such efforts lies in the theoretical development of the model.
If better data are available or if a person wishes to test different plans on
the basis of hypothetical data, the model is flexible enough to derive the con-
years
at a time
tlie
It is assumed
when the marginal vessel is 15,000 DWT for the Persian Gulf-
At
vessels for the three runs are assumed to be 100,000, 100,000 and 150,000 DWT
respectively.
The model develops the average normal spot rate during the charter period
and proceeds to adjust it for the impact of variables
X,
through X^.
For reasons
-23-
employment is greater than zero, then the owner will be more accommodating.
In the latter case the normal spot rate over the life of the contract will
be higher,
X_
and X
Always the
The differentials
Xj.)
J
to this
base.
tlie
This is as compared to average normal spot rates of $6,017 for absolute cer-
All rates as
shown in the last column of Tables 9, 10 and 11 yield at least 8% return to the
owners.
It
is
).
overtakes X
in significance.
For
For Run
(Persian Gulf -Japan) because we assumed that the marginal vessels are
larger, both at
significant as in Puns
and
X^
are not as
.24-
).
The greatest
III.
Conclusions
December 1966 shows that the conclusions reached in 1959 are still valid
today.
In most cases we can even make stronger statements now than we made
rates.
V/e
rates.
The spot rate exerts some influence on time-charter rates hut such in-
Under
extremely high or depressed market conditions, the spot rate will undoubtedly
-25-
converge asjmptotically from both above and below to the relevant break-even
time-charter rate.
Size and charter duration were found to be positively correlated, with
the correlation becoming stronger as the level of marginal spot rates rises.
Spot rates and charter duration were also found upon analysis to be positively
correlated.
and during the period under study all vessels over 55,000 DWT earned on the
presently inhibit the most efficient utilization of these mammoths will be removed.
-2G-
Now we
This im-
plies that not only are the larger vessels more efficient than the smaller ones
given a particular run, but what is more they may be relatively more efficient
if scheduled for the shorter runs.
larger vessels is greater, but to the extent that the probabilities of delays
and idleness (by size of such) apply uniformly and independently to all vessels
then the relevant criterion for minimization is the cost of delay per unit of
potential capacity.
tankers appear to be less intensive in terms of both capital and operating costs
per unit of capacity than the smaller tankers.
choice can be exercised, it may be better if the largest tankers are scheduled
for the shortest runs where port idleness occupies a greater part of the potential
capacity of a vessel.
DVJT
and 10 by
in
bility between the Persian Gulf-Japan run and the other two.
Table 1
Selective List
Table
'"1
X,
^2
1.0000
(size)
X^ (marginal spot
rate +100)
Xt
(duration)
X^ (lead time)
X5 (spot rate eq.
of time charter)
Xg (differential)
"
-.0076
1.0000
1.0000
.IllU"
.1269
.U032"-''
.0254
.6719'"'
-.71U3'''
.0985
-.2749"
-.2174"
.5223"
-.0014
.2744"
.2545'"'
1.0000
1.0000
-.1733'
1.0000
Variable
Table
Non-Log Formulation
Regression of
Xj-
on;
I
I
o
X
a
en
<
o
u
o
X!
c
o
I
01
(J
S-i
.a
Table
Logarithmic Formulation
Regression of X
on:
Table
1.0000
X2
-.3881
1.0000
Xo
.1387
.0488
1.0000
.01+60
.3357
.5402
1.0000
-.6570
.1050
(no)
.0876
(no)
1.0000
(yes)
.2508
(yes)
.7074
(yes)
-.UU73
(yes)
.lf)U7
.0196
(no)
.1446
II
1.0000
(no)
(no)
1.0000
Table
1.0000
-.1378
1.0000
.2323
-.1951
1.0000
.2007
-.1804
.4643
1.0000
-.4373
(yes)
.3365
(yes)
-.0094
.0326
(no)
1.0000
(no)
.4127
(yes)
.2381
(yes)
.1016
(no)
.1154
(no)
.4916
(yes)
II
1.0000
(^ 40,000 DWT)
1.0000
-.0900
1.0000
.1140
-.0898
1.0000
.0659
-.1115
.5769
1.0000
-.5896
(yes)
-.1058
.1252
(no)
.1057
(no)
1.0000
(no)
.4938
(yes)
-.1159
-.0834
-.1567
+.0768
(no)
(no)
(no)
(no)
1.0000
Table
<
43 (i.e. Below
Variable
43 to 68
54,355
X^
36.30
Mean
Mean
X
68 and Over
21,506
45.210
18,314
46.94
24,015
4.26
55.75
5.74
87.23
10.47
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