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October 27, 2014

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Are Ecoships the latest maritime bubble?

As more than one industry commentator has observed in recent weeks, we live not just in interesting times but distinctly strange ones. Shipping seemingly exists half in crisis and half in clover, with huge amounts of hot money taking the place of bank finance and owners seemingly unable to stop themselves from ordering more and more tonnage at what are still historically low prices.

This is despite distinctly tepid demand, uncertainty on the macro level economic outlook and newbuilding oversupply so rampant that scrapping seems the only solution. Yet somehow owners continue to believe that if they sit tight, things will come good.

But everyone is keeping their game face on. At the recent Shipping and Law conference in Naples, we made the faux pas of asking a Greek shipping grandee if blaming shipyard overcapacity for the earnings slump wasn’t akin to blaming a sweetshop for poor dental hygiene. He was unamused by the comparison.

Shipping has structural problems that are preventing a sustainable recovery, not all of which are entirely of its own creation. But there is one big one: a private equity-fuelled stampede to order Ecoship tonnage that promises better fuel consumption and other operational efficiencies.

This is a step change for an industry that previously held maximising cargo carrying capacity as its holy grail, but the result has been to create a two-tier market in which even young tonnage is considered uncompetitive against the very latest which can slow steam without damaging the engine and consume notably less fuel.

The unintended consequence of this is that owners have flooded into a space that makes sense only as long as the downturn holds. Once the good times return, there is some doubt as to who will charter ships that could have cost 10-20% more to build, when older tonnage is able to compete and all will be sailing at full speed.

Conference organiser Francesco Lauro of Studio Legale Lauro pondered whether there is a ‘new narrative’ in which Ecoships become obsolete in three to five years and many of his fellow panellists expressed concerns about whether or not to invest.

As Michele Francioni, CEO of RINA Services pointed out, it is the market that drives the direction of new technology: shipyards were able to build Ecoships 10 years ago but didn’t because nobody was asking for them. “Owners were asking for cargo capacity not fuel consumption so this is an evolution. We can expect the technology to improve further in future if the high fuel/low rates trend continues.”

But Valeria Novella of tanker management company Ottavio Novella admitted she was still trying to decide whether ‘Eco’ stood for economy or ecology. Both terms delivered the wrong understanding but sadly she had more questions than answers.

“How long will low consumption ships fulfil commercial needs once a better market emerges and higher speeds are needed – will these ships be able to maintain their advantage? Are we sure we need these vessels and can the system absorb new tonnage?” she asked. This might matter less if for each Ecoship launched, one traditional vessel was scrapped but until that happened she would not invest.

Med Offshore Managing Director Andrea Garolla di Bard suggested that an owner with money to spare might get a better return investing in a specialist fund than the ships themselves because the high purchase price meant the rate premium was ‘burned’ in delivering return on investment.

“Who is going to buy these ships in five years time? I really fear an Ecoship bubble because we do not have the capacity to absorb them. Making a big investment has pros and cons and there are scale economies to gain, but I doubt the fleet can grow so fast in a small time,” he added.

Head of Maritime Investments for boutique bank Jefferies, Jeff Pribor said that US investors were learning to differentiate between the two and are interested in good owners whether their tonnage is Eco or not. “They want to know if you have a sensible idea. If you have a bulk carrier and don’t fit energy saving devices that’s irresponsible but investors are willing to believe that a retrofitted vessel can be viable.”

“Like any asset-based business, price is adjusted over time to reflect the business model so it could be perfectly possible to survive with older ships,” he said, but added “we are still finding this stuff out.”

Francesco Lauro in his presentation suggested a much more robust answer to whether Ecoships delivered the promised performance. Building a vessel that fails to live up to promises on fuel consumption or emissions standards is a breach of contract, he said, something that should allow the buyer to seek compensation.

Given that potential fuel consumption savings could be 15%-20% compared to a standard ship, this would be a substantial amount over a vessel’s 20-25 year lifespan.

Under English law, liquidated damages are limited to a genuine pre-estimate of losses arising from breach of contract, effectively capping the yard’s liability, an arrangement that was inadequate from the owner’s point of view.

In the end then, it is about economics, not the environment. As President of the ItalianAssociation of Marine Engineering Alberto Moroso observed, solutions will continue to be found that keep vessels in the market. Human ingenuity would see to that.

“There are no problems that cannot be solved but the human variable is really important,” he said, adding with a typically Neapolitan flourish a quote attributed to the legendary inventor Nikolai Tesla. “Sir, nothing is impossible, what you are asking for is merely expensive.”

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