Ocean Carriers Case Study Discussion

Case Report
Ocean Carriers

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28th September, 2017

Abstract

In this case, Ocean Carriers faces the dilemma that they must decide whether to build a new ship or not for prospective lease. After searching the case, simulating and calculating the cash flow, we find that it is okay to make the deal in Hong Kong where there is no tax. However, New York office is not a good place to do this business. In addition, we also study the policy of not operating vessels over 15 years and find that it is better for them to abandon the policy.

Introduction

Ocean Carriers is an international shipping company with two offices in New York and Hong Kong. Its major business is to build and operate capesize dry bulk carriers. Customers lease those ships and pay them daily hire rate according to the length of the contract. The company has a special policy: when a vessel has been used more than 15 years, it will be sold in the secondhand market for the concern that there will be larger operation and maintenance expenses in the future. Company will receive a scrap value of the ship.

In Jan 2001, Ocean Carriers received an order. The customer wanted to lease a ship for three years since the early 2003. The company would lend their vessels as usual, however, this time the situation was a little bit difficult. The main problem is that the remaining ships in the company were either too old or too small to meet the customer’s needs. Worse still, there are also lack of that large size ship in the second market. As a result, the Ocean Carriers had to build a new ship if they want to cooperate with this customer.

However, we all know that constructing a new ship is quite costly, especially a large-size one. According to their estimation, this ship would cost 39 million. So it is very essential to decide how can this project can benefit the company in the long run. The later part of this case report include solutions of the five questions. In question 1 to 3 we will discuss the outer situation of the market. In the question 4, we will introduce the way to calculate the cash flow in detail. And in question 5, the policy of vessel lifetime will be reviewed and discussed based on the financial statement.

Discussion

Question 1

The daily spot hire rates were expected to decrease next year due to vessels’ oversupply. Fewer ships were needed to carry the same amount of cargo since they got bigger, faster and more fuel efficient. In addition to less demand, 3/4 of the capacity of the worldwide fleet of capsizes was less than 15 years old based on the Exhibit 2 of Case, which means there would be very few scrapings. Also, 63 new vessels were schedule for delivery in 2001. Moreover, Australian and Indian ore exports wouldn’t begin until 2003. Therefore, the daily spot hire rates would decrease next year.

Question 2

Daily hire rates were determined by supply and demand. As stated in Question 1, there were three ways to change the number of ships available, including the number of vessels in service the previous year, new ships delivered and scrapping and sinkings. If supply of capesizes is less the demand, the daily hire rate would definitely rise up. Basically, there are two factors influencing demand of capesizes. One is the development of basic industries will drive the daily hire rates a lot. Over 85% of the cargo carried by capesizes was iron ore and coal., whose production and demand increase greatly in a strong economy. Another driven factors are changes in trade patterns such as longer trade distance than before. If the distance increases, the demand of capesizes will increase, resulting in higher daily hire rate.

In short, the daily hire rates depend on supply and demand. If the market is in short supply, the daily hire rates will increase.

Question 3

In terms of the long-term prospects of the capesize dry bulk industry, there are several factors we should take into consideration. With the development of the technology, the size and efficiency of the ships would increase, which would decrease the need of dry bulk capesizes at the same amount of cargo. From 2001 to 2004, the number of current order vessels for dry bulk capesizes dropped from 63 to 9.

However, some positive factors would bring promoting effects. First of all, world economy played an important role in the demand of capesizes. Strong economy would stimulate imports and exports of cargo, such as iron ore and coal, which would lead to a high demand of capesizes and vice versa. Iron ore was the main cargo carried by capesizes. Based on the market trend, Australian production in iron ore would be strong and Indian iron ore exports expected to take off in the next few years, which means more capesizes would be required in order to meet the business needs. Second, changes in trade patterns will bring good effects to the demand of dry bulk capesizes. If a Western European country change the supplier of iron ore from the United States to Australia, the transportation route would be affected. Greater distance between Western Europe and Australia definitely boosted the demand of capesizes. Thus, the positive influences are greater than the negative. We took an optimistic view of the long-term prospects of the dry bulk capesizes.

Question 4

We used the method of calculating total future Free Cash Flow (FCF) and Net Present Value (NPV) for the capesize vessel project from 2000 to 2017 to seek out if it is profitable for the Ocean Carriers company.