Ships are large expensive assets that are financed over long periods of time. Therefore, in the case of warships, they are physical expressions of a state’s fiscal power. Meanwhile, cargo ships, including tanker ships, require private financing which has been leveraged to greater degree just in the past sixty years or so. However, shipping is a volatile business. The vessels take years to build and it’s difficult to predict what market conditions will be like once an ordered ship is delivered. Freight rates are also very sensitive to economic conditions. Financing these assets amidst such volatility is not straightforward.

Cash

            Ship finance arguably became of wide interest with the creation of the big European trading monopolies of the 16th century. These firms raised money from shareholders to build large fleets to engage in East-West trade with little competition. By the mid-19th century, with their monopolies abolished, these companies were as good as gone. Shipping capacity became more widely distributed. In the 19th century, ships in the United Kingdom were occasionally divided into sixty-four shares allowing funds to be raised from more investors. Still, ships were typically wholly-owned by individuals and it was also uncommon for them to be mortgaged. Where there was a mortgage, money was usually borrowed against the security of the ship to fund repairs rather than the acquisition of the ship itself.

            Among the 554 ships registered in the City of London in 1848, only 18% were mortgaged. The early 20th century saw a more turbulent market for freight shipping companies and shipowners; more heavily indebted firms failed, encouraging shipowners to stick to conservative practices. Indeed, up until the late-1950s, shipping companies generally avoided borrowing to expand or replace their fleet. Instead, they used retained earnings to deploy the cash gained in business into new ships.

            Conservatism would not serve the needs of industry for long though. The financing approach allowed for only slow growth as earnings were too low to fund much expansion. Returns to shareholders were also too low to entice more investment by issuance of more shares. To fill the gap, Greek and Norwegian shipowners began to borrow money to finance ship purchases but this was done under the unique conditions afforded by the liquidation of U.S. ‘Liberty ships’ after the Second World War. The Merchant Ship Sales Act of 1946 led to the disposition of these ships, their numbers far beyond the needs of the United States itself, at favorable prices with included financing built into the sale.

SS Hellas Liberty (ex-SS Arthur M. Huddell), a Liberty ship turned private transport ship turned museum ship in Piraeus, Greece (Source: K. Krallis)

Credit and Expansion

            The demand for oceanic shipping led to rising tanker and bulk carrier shipping rates in the late 1950s and 1960s. Starting from the late 1950s, trade was growing at a pace that exceeded the ability of shipowners to grow their fleets with retained earnings alone. Shipping companies, as well as oil companies and steel mills that needed to ship raw materials or finished product, demanded more ships. These companies were interested in chartering new vessels from independent shipowners.

            Likewise, shipowners were inclined to charter their ships on a long-term basis, often for between seven and fifteen years. They got banks to lend them money against these charters together with the security of the ship itself. The chartering of a ship to a creditworthy company was crucial; a mortgage on the ship itself was not sufficient security. Under this lending arrangement, ships were usually owned by special purpose vehicles that owned just a single ship, separating the risk of a single investment from a larger corporate group. This financing model was known as “charter-back”. By the late 1960s, about 80% of the independently owned tanker fleet in the world was financed in this way.

            Charter-back was used by Norwegian shipowners in the 1950s; during the decade, the Norwegian shipping fleet tripled in size and was particularly oriented towards tankers. Greek shipowners also used the system; like the Norwegians, they sourced debt capital from the United States.

           The shipping magnate Aristotle Onassis acquired 140 vessels between 1946 and 1975, half of them tankers, using American bank capital. These tankers would be chartered to oil companies like the American company, Texaco. He frequently obtained loans that paid for 95% of the purchase price of a ship allowing his group of offshore shipping companies to grow very quickly. Hong Kong shipping entrepreneurs also grew their fleets by chartering ships, in their case largely to Japanese charterers. In any case, an industry that had been conservatively financed for decades became more highly leveraged, and much larger.

Overproduction

            During the thirty years after the Second World War, the typical size of an individual ship by itself was getting larger. The tanker space was particularly transformed by the boom. Aristotle Onassis’s first tanker ship, Ariston, built in Sweden in 1938, had a capacity of 15,360 deadweight tons (dwt). In 1949, his second tanker, the U.S.-built Olympic Flame, was a ship of 28,385 dwt. Then there was his Tina Onassis, 46,080 dwt, built in Germany four years later. With purchase after purchase, his new tankers in the 1960s kept getting bigger; in 1969, Japanese-built Olympic Armour came in at 216,508 dwt and in 1973, Olympic Brilliance was built in Britain and Ireland, with capacity of 269,069 dwt.

Onassis Group’s Olympic Brilliance (Source: Shipspotting.com)

            In the 1970s, growth in freight rates became more erratic. Occasionally, short-term freight rates got so high that chartering a ship on a long-term basis looked far less appealing for owners. They could make more money on the spot market. This was more speculative since a longer-term charter meant steady revenues and a matching of charter income to debt service expense. Leasing a ship short-term would sacrifice this predictability. Also encouraging a more speculative management of ships was the fact that the old long-term charter contracts looked less appealing amidst higher inflation. With the growth in the world shipping fleet, shipping companies also found it less critical to commit to longer-term charters to secure the ships they needed.

            At the same time, credit was becoming easier to come by; banks were willing to lend against the value of the ship itself rather than also relying on a charter. Bankers had some basis for this reasoning; charter contracts could be bad if inflation increased and ships tended to hold their value or even appreciate, making a vessel good collateral by itself, at least on the basis of recent history up to then. However, with this financing in hand, shipowners could grow their fleets faster than the rate of growth in demand over the long-run. The oil boom led to huge surpluses that were invested in shipping fleets. In a single year, new orders for tankers amounted to 55% of the size of the global fleet. However, the danger of oversupply had never been higher.

            Overall, oil demand in the ten years preceding 1974 had been increasing 17% per year. More production was also happening far from consumer countries. So, tankers were the focus of speculative demand because of the booming business of shipping oil across sea for larger distances. Predictions of mammoth need for tankers were common. The Norwegian Research Council predicted in a 1970 report that tanker demand would call for a fleet of 450 million dwt by 1985 in a base scenario, with a low projection of 395 million dwt and a high projection of 505 million dwt also provided. In the end, these would all prove to be orders of magnitude too high. Hardly anyone could predict that demand for tankers could go down, but it did.

Trouble and Slow Recovery

            By 1980, the size of the world’s shipping fleet had outpaced growth in world trade which had been sputtering in the 1970s with oil crises disrupting trade. Besides a weaker economy overall, stagnating oil demand was behind much of the rut; in OECD countries, oil consumption fell by almost 15% between 1973 and 1982. Back in 1973, the U.S. Department of the Treasury predicted that American oil consumption would reach twenty-five million barrels a day in 1980; the actual number came in at 16.5 million barrels. Even the most conservative global tanker demand forecast of the Norwegian Research Council in 1970 would prove to be three times higher than what was actually needed.

            While the overcapacity trouble appeared starting from the mid-1970s, the consequences would not be most severely felt by the industry until the 1980s. In the late 1970s and early 1980s, shipping rates fell and the proportion of ships ‘laid-up’, or not in use due to lack of cargo, increased. Nevertheless, new orders for ships were still being made since credit remained available and shipowners believed it was smart to place orders while the market was soft; it takes a while to build a ship anyway.

            Unfortunately, the market did not turn, at least not quickly. Indeed, for the world freight market, the recovery from the downturn of the mid-1970s to the mid-1980s was far slower than in other periods of slack, notably that of the early 1920s and that coinciding with the Great Depression. In 1984, the proportion of the world’s tanker fleet laid-up reached a peak of 25%. Obviously, an unchartered ship laid-up cannot service its debts.

            Also, the old charter-back model itself was challenged by the failure of some companies to honor their charters, perhaps most notably Sanko which failed in the mid-1980s. Cumulatively, defaults on shipping loans in the mid-1980s reached $10 billion. Outright losses on bank loans and leases amounted to $3-4 billion. These write-offs could amount to as much as 10% of the loan book each year for a few years for some of the riskiest portfolios.

            Eventually, the market did recover. After some hesitation, capital flowed back into the market. The early investors made a lot of money buying ships at low prices during the years of distress. Later in the 1980s and in the 1990s, world trade recovered. Freight rates rose and the proportion of ships laid-up fell. Shipbuilding recovered but it was this crisis that killed off much of the shipbuilding industry in Western Europe.

Lesson

             During the last quarter of the 20th century, the world became far more globalized as trade volumes grew quickly. This caused more ships to be built and ships to grow larger. Buying a ship would seem to be a worthy investment opportunity. However, it was not smooth sailing. As lenders came to lend against the value of a ship rather than against a charter, bankers and shipowners could invest in fleets without being as constrained by future demand. On the one hand, this allowed fleets to grow at a time when the industry needed it. However, these financing practices also allowed massive oversupply to develop. Even a conservative shipowner could be ruined by the excesses of the rest of the industry. Over and over again, investments in booming industries are not sure-things as they create large chances for bubbles and busts.

More from the Tontine Coffee-House

           Read how sailors in the English East India Company conducted private trade for themselves while underway and the cost of marine insurance during the ‘quasi-war’ between the United States and France in the late 1790s. Consider subscribing to this blog’s newsletter or checking out book recommendations, which include many of the sources often referenced in my posts. 

Further Reading

1.      Harlaftis, Gelina. Creating Global Shipping Aristotle Onassis, the Vagliano Brothers, and the Business of Shipping, c.1820-1970. Cambridge University Press, 2019.

2.      Stopford, Martin. “Setting the Scene, Identifying the Objectives: Fifty Years of Ship Finance.” Marine Investments Financing Forum. 31 Oct. 2002, Grand Hotel, Amsterdam.

3.      Stopford, Martin. Maritime Economics: Martin Stopford. 3rd ed., Routledge, 2009.

4.      Tenold, Stig. Norwegian Shipping in the 20th Century: Norway’s Successful Navigation of the World’s Most Global Industry. Palgrave Studie, 2019.

External links to recommended reading are affiliate links. When you click on links to various merchants posted here and make a purchase, this will result in The Tontine Coffee-House earning a commission.

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